Chicago Fed Blogs

Did you know that the Federal Reserve Bank of Chicago has blogs? I didn't. Who would have imagined such a thing?

The Chicago Fed's homepage features links to three blogs, which deal with the Midwest economy, economic education, and pensions.

The pension blog features highlights from the Fed's State and Local Government Pension Forum. It has links to some interesting articles, including one about GASB 45, which we have written about previously on this site.

The pension blog is written by Rick Mattoon, Senior Economist and Economic Advisor of the Federal Reserve Bank of Chicago. He calls GASB 45 "The 800 Pound Gorilla in the Room." He says the new accounting standard, which requires public pension funds to estimate the future cost of benefits to their members, presents many challenges:

Estimating the total OPEB liability is an accounting nightmare. Unlike pensions where actuarial estimates can be at least somewhat understood, OPEB requires making guesses about things like health care and prescription drug inflation and utilization. One estimate suggests the unfunded liability is around $700 billion, but this is a back of the envelope guess. Other estimates suggest that OPEB exposure could range from five to ten times current outlays for retiree health care.

Managing OPEB costs is tricky. In most cases, retiree health care is not a contractual responsibility like pensions. It is a voluntary benefit offered by the employer. However where it is a contractual responsibility, the ability to require retiree contributions, increase co-pays or cut benefit coverage is limited. Where retiree health insurance can be modified, a concern is that when these liabilities are reported, some governments may choose to abandon or significantly reduce coverage, forcing the federal government to serve as the health care insurer of last resort.

There are strategies for managing OPEB costs. Efforts to contain health care costs and slow increases in health insurance premium costs can help. Shifting more costs to retirees can be an option, along with trying to limit future OPEB obligations by changing benefit packages for new employees. One strategy that is popular (and essentially required) for addressing OPEB costs is to set up a trust fund. A trust fund meets the new accounting standard requirement that an irrevocable source is identified for meeting OPEB obligations. It also has the advantage of allowing governments more flexibility in the use of investment options. Like pension funds, OPEB trust funds would permit investments in equities and other potentially higher yielding investment vehicles. A potentially attractive option that a trust fund may allow is the ability to issue OPEB bonds to cover part or even all of a government’s OPEB liability. Like pension bonds, these are essentially an arbitrage strategy, where the bond issuer anticipates that the investment yield they will receive from the bond assets will exceed the interest that will be paid to bond holders. Also like pension bonds, the OPEB bonds are not free from federal taxes so they must carry slightly higher interest rates than tax-free investments.

The impact on credit ratings for governments is another real concern. Once this liability is recognized, some governments’ finances might appear more fragile. To date, several of the major rating agencies have indicated that they will judge the creditworthiness of these governments based on whether their plan for meeting OPEB liabilities appears prudent rather than on the size of the liability on the balance sheet when it is first recognized. Credit agencies do expect OPEB liabilities to be largest in the Northeast and Midwest, where government entities have large unionized work forces and slightly older workers on average than in other areas.

Finally, OPEB is still a major concern for the private sector. It is estimated that for the 337 companies in the S&P 500 that have OPEB obligations, the funding ratio is around 27% (versus 88% for pensions). For the 282 companies with the most complete financial records, the unfunded liability in 2005 was estimated at $292 billion versus an unfunded pension liability of $149 billion. OPEB liability is concentrated in Ford and GM. Their unfunded liability alone is $94 billion, representing 32% of the S&P 500’s total. (These two companies also have 13% of the total pension underfunding.) Telecom is the other industry where OPEB is a significant issue.

The Chicago Fed's pension blog has a lot of good stuff, but it is not updated frequently. Of course, if that were a crime, I'd be doin' time. ;-)