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The Silent City Killer

Michigan cities owe a staggering $7 billion in unfunded OPEB liabilities. 

I recently published a study which examines liabilities (debt) for cities in Michigan, particularly OPEB liabilities. OPEB stands for Other Post Employment Benefits, i.e. healthcare plans/benefits for retired workers. A large amount of city operating costs are city employees, so in some ways, it makes sense that cities would owe large amounts of money to retired employees. However, the current numbers are unsustainable, and cities are already scrambling to cover these high costs.  Furthering these issues, cities in the State of Michigan owe around $2.5 billion more in unfunded pension liabilities.  If you’re keeping track, these numbers amount to around $10 billion dollars in unfunded liabilities for legacy costs.

In Michigan, OPEBs have been funded on a pay-as-you go status, meaning that cities have a required contribution to the OPEB fund per year, referred to as an ARC (annually required contribution). Essentially, a city puts money into an account to fund current and future projected healthcare benefits. A city can contribute less than the required contribution amount, but will have to catch up for these payments in the future.  Further, the more money a city contributes to the fund, the more it will grow, making them even better off in the future.

Cities have had a hard decade in the State of Michigan. Michigan cities are particularly dependent upon property tax revenues, which took a major hit in 2008 as a result of the Financial Crisis. Due to the particular mix of policies and institutions in the State of Michigan (which I wrote about for the blog), cities were hit hard in 2008, and have struggled to catch up in terms of revenue. As a result, cities have struggled to provide core services, much less provide for future financial security by making the required annual contributions to their OPEB funds. This has all led to a massive debt, which many Michigan cities are struggling to deal with.

We can see from the figure 1 that these unfunded OPEB liabilities dwarf other more recognizable government debt, i.e. pensions, infrastructure, etc.  However, the annual required contributions for cities currently is around 20% of total government wide revenue, meaning that at current, cities have to spend around 20% of the money available to them on an annual basis on funding their OPEB liabilities. This is not insignificant percentage, and as we know, failure to pay the ARC hurts a city more in the future, furthering this death spiral.

So what can be done? In the State of Michigan, as I’ve documented in other research works, cities have a hard time. There are four main ways that cities can deal with their unfunded liabilities: (1) increase taxes, (2) decrease spending, (3) borrow to address unfunded liabilities, or (4) reduce liabilities. While reducing benefits is politically unpopular, many municipalities cannot continue to increase taxes because these locations will risk further population decline and foreclosure; nor, can municipalities cut spending any further without substantially impairing or completely eliminating vital public services. As a result, municipalities have been making changes to public contracts to reduce health benefits and thus their overall liabilities. Municipalities are generally making changes to benefits to three areas: (1) the type of health benefit plan available, (2) the level of government contribution and (3) eligibility requirements.

While cities are struggling with this issue, county governments are also in trouble, with around $3 billion dollars in unfunded OPEB liabilities. County governments in Michigan also have a higher unfunded pension rate than city governments, as we can see in Figure 2. As a result, county governments will be even more handicapped moving forward.

In 2013 I conducted the first major study looking at the OPEB liabilities for the State of Michigan, as cities and counties were not even required to estimate these liabilities until recently. At that time, I found that cities had around $13 billion dollars in unfunded liabilities. Since that time, almost three years later (2014 data), the conditions have not changed dramatically. Two cities, Detroit and Flint, have dramatically reduced their retiree health care unfunded liabilities due to extraordinary fiscal emergencies and state intervention. Some other jurisdictions have reduced their overall unfunded liabilities, and others have actually seen an increase since the original report. The net effect is that Michigan local governments still owe nearly $10 billion in unfunded liabilities due to pension and retiree health commitments. These are the issues that are silently choking city governments in the State of Michigan, and until addressed, will continue to contribute to the financial and human crises that have occurred over the past several years.