UNM recently appointed a task force to propose a solution to the problem of a $162million unfunded liability associated with healthcare benefits promised to retirees. Changes to accounting rules require UNM to include the annual actuarial accrued liability (AAL) in their accounts, which can negatively impact the institutions ability to borrow money.

I was a member of the task force, and have done research into the issue of unfunded liabilities. I am not an expert on this topic, but I am an economist, and I am interested in sharing what I have learned and understand about the issue. Below is a list of Frequently Asked Questions (FAQ) offering general information about using a Voluntary Employee Beneficiary Association (VEBA) trust to partially fund retiree health benefits, and specific information relating to UNM retiree benefits and the UNM VEBA.

Retiree Benefits and Unfunded Liability – Frequently Asked Questions

What are retiree benefits? Most employees receive a pension or other kind of income benefit from their employer when they retire. The also receive Other Post-Employment Benefits (OPEBs) which are most commonly healthcare benefits. UNM employees who retire can expect a pension and continuation of their healthcare benefits, although what they contribute to premiums, the deductibles and copays, and the covered services may differ.

What is an unfunded liability? UNM makes promises to employees to provide benefits after retirement including pensions and OPEBs. Like the US Social Security system, UNM expects to fund these promises on a “pay as you go” basis. Promises made today to retirees in the future will be funded by future employees, just as current employees are funding benefits to current retirees. If UNM promises more benefits than it can expect to fund each year into the future, it generates an unfunded liability. Although actual benefits paid out each year can be less than the funds contributed and accumulated, each year, a liability emerges because healthcare costs are expected to rise in the future. Actuaries make assumptions about the current employees and retirees and about healthcare costs in the future and calculate the unfunded liability. The present value of this future liability (calculated over 30 years) is called the Actuarial Accumulated Liability (AAL). The most recent estimate of UNM’s AAL associated with retiree OPEBs is $162 million.

Why is an unfunded liability a problem? If an employer accrues an AAL, new accounting rules require the employer to post the annual share of that liability on to their balance sheet. Even though UNM does not pay out that amount each year as a direct cost, an AAL entry on the balance sheet means that UNM must set aside an equivalent amount of revenue to balance the accounts. This ties up money that could otherwise be spent. In addition, an unfunded liability affects the ability of UNM to borrow money by issuing bonds as it directly affects UNM’s capacity to pay off the loans.

What is the best way to eliminate an unfunded liability?  Don’t create one in the first place! It exists because the value of promised benefits exceeds the ability–or willingness–of the employer and employee to pay for them. The only solution is some reduction in benefits, or an increase in contributions, or both.

Seriously, how do we reduce the unfunded liability? The math is relatively simple: the liability can be reduced by raising contributions (revenues to the system,) or by lowering benefits (expenditures out of the system.) At recent (April 2013) meetings, the UNM Board of Regents talked about increasing deductibles. Although this does not change what is covered by the health insurance policy, it increases the out-of-pocket expenses paid by the retiree, and therefore lowers the benefits paid by the system. This point requires a digression.

Digression: Whose interests are being “protected” here? The unfunded liability appears on the books of the employer. Lowering the AAL helps the employer, not the employee or retiree. Yet, the argument will always be made that the welfare of retirees is dependent upon the financial health of the employer. Not that UNM will ever face bankruptcy, but it could certainly be in a financial position where it must lower expenditures on health benefits to employees and retirees. Health insurance is an employee benefit and forms part of total compensation. One could argue retiree health benefits are also part of total compensation, but deferred until after retirement. UNM can only continue to offer benefits to employees and retirees if it deals with the total compensation promises it has made to employees.

Can we get back to reducing the unfunded liability? On the expenses side, reducing coverage, lowering the share of premiums paid by the employer, and increasing the out-of-pocket costs to retirees are all ways to reduce the future costs to the employer/system. All these “solutions” mean that retirees pay more themselves for healthcare. This is difficult on a fixed income, and often leads to retirees using less healthcare. One Regent talked about “gap insurance” to reduce some of these burdens, and that’s addresses at the bottom of this page.

On the revenue side, the unfunded liability can be reduced by increasing contributions, which could mean the employer contributes more to fund the system, but usually means the employees and retirees contribute more to the system. The employer generally doesn’t want to increase contributions because it means lower profits (not a problem for UNM) or less discretionary spending as the money is tied up in funding benefits. Employees and retirees can contribute more by trading compensation today (lower wages and salaries) for security of benefits tomorrow (maintaining the health of the system by pre-funding the liability.) This is where a VEBA comes in.

What is a VEBA? VEBA stands for Voluntary Employee Beneficiary Association. Set up under federal law (IRS codes,) a VEBA is a trust fund established to pay employee and – and dependent – benefits, in this case healthcare benefits. VEBAs have existed for decades and can be used to fund many types of employee benefits. There are many details to distract an interested reader, (such as this paper from the Harvard Law School by Aaron Bernstein,) but the single most important aspect of a VEBA trust for UNM is its capacity to pre-fund part of the unfunded liability.

How does setting up a VEBA reduce the unfunded liability? As mentioned above, the employer could set aside an amount of current earnings each year, and invest it, to cover the unfunded liability. However this is unlikely. By creating a VEBA trust, part, or all, the funding of future benefits is shifted to the VEBA, (a completely separate financial and legal entity,) and part, or all, the AAL is moved off UNM’s books. The VEBA also enjoys favorable tax treatment, increasing the potential for the fund to cover more of the future benefits for a given initial investment and periodic contributions.

Who benefits from creating a VEBA? Below is a list of benefits to both employers (UNM) and employees/retirees of establishing a VEBA.

Advantages to Employers:
+Moves some, or all, liability under applicable accounting rules to the VEBA
+Improves financials of employer, such as AAL, and bond rating.
+Lowers exposure of employer to future health care cost risk

Advantages to Employees:
+Directly pre-funds future benefits (promises made today, benefits paid in the future)
+Protects future benefit promises against employer failure to honor them (to varying extent)
+Places funds in a “lockbox” specifically set aside to pay future benefits.

This emphasizes the distinction between the employer and the employee/retiree. The VEBA establishes a separate “lockbox” account that can be used to fund future health benefits. There may not be sufficient funds in it to cover all future costs, but it is protected from the employer going bankrupt, or failing to uphold promises made. However it does so by shifting the risk of future healthcare costs from the employer to the retirees. As economists are fond of saying, there’s no such thing as a free lunch!

Digression: How have VEBAs been used by other organizations? The largest VEBA in the world, and perhaps the most famous, was formed to pre-fund the liabilities associated with union retirees of GM, Ford and Chrysler. In fact, the recent resurgence in VEBAs was largely fueled by unions. In a comprehensive 2009 paper Phyllis Borzi, covers both the origins and descriptions of VEBAs, but also covers the United Auto Workers union VEBA. The UAW VEBA has about $60 billion in assets, and was setup with initial contributions of about $46 billion from the three car companies. Not all these initial contributions were in cash, and the VEBA does not receive on-going contributions indefinitely. Essentially the UAW VEBA replaced the employer retiree benefits system, and has full responsibility for paying all future promised benefits to retirees with a fixed pot of money. Only by investing the assets successfully will the UAW VEBA be able to pay the promised benefits in full.

What role will the UNM VEBA play in retiree health benefits? Although the UNM VEBA has not been created yet, the information made available so far (April, 2013) suggests it will be used to partially pre-fund the liability. The task force was able to reduce UNM’s AAL about 50% by creating a VEBA and lowering the share of retiree premiums paid by UNM. That means there is still an $80+ million unfunded liability.

UNM is not planning on making any initial contribution to the VEBA like the car companies did with the Auto Workers. UNM’s VEBA will be set up with a $0 balance and start building with contributions from UNM and employees. It should have about $6 million in it after the first year, and it should build quite quickly, but the current UNM HR director estimates it will not contribute to funding retiree benefits for at least 10 years. In other words, UNM will still be “in charge” of all benefits for quite some time. And since the VEBA is intended to only partially fund the benefits, it may remain a relatively minor actor in this play.

Digression: Is a VEBA a magic bullet? No. Creating a VEBA does not reduce the present value of future promises. Only changes in plan specifics can reduce the value of future promised benefits. Lower health care costs and/or reduced incidence of illness will reduce plan outlays, but these are generally considered outside the control of the system. The unfunded liability can only be reduced by lowering expenses, or raising contributions. The VEBA essentially increases contributions going into the system–in a specific and beneficial way.

How is the VEBA going to work at UNM? At the moment, the only answer we have for this question is what has been published on the HR website. Current employees are offered this information and information sessions throughout May. There are some important elements of change here! In particular “Premiums (for retiree benefits) will NOT be calculated according to years worked” (Emphasis in the original.) Benefit premiums will be calculated on VEBA points, which are based on how many years you’ve been contributing to the VEBA.

What does it mean to OPT IN? This means doing nothing, as the default is IN. Initially, all current employees hired before July 1, 2013 will be given 25 years of VEBA credit (regardless of how many years you’ve actually worked at UNM!) With 25 years of VEBA credit you will receive the highest level of UNM subsidy of the insurance premiums (40% currently.) So long as you remain IN you can retire and expect to receive the best “deal” on benefit premiums offered by UNM.

What does it mean to OPT OUT?  This means you actually check the box, and sign the form, stating you know what you’re doing. You will not receive post-retirement benefits from UNM. You won’t contribute 1% of your earnings to the VEBA, and neither will UNM contribute on your behalf. The VEBA trust account will have less money in it, and the fund balance won’t grow as much, thanks to not having your $40 per month. When you retire, you’ll have to buy health insurance on the open market. (See the digression below.) You can opt out at any time (once a year, actually) but there is a second chance offer.

Is there a second chance to OPT IN? Yes. After five years outside the system, each person who opted out gets a chance to opt back in. But you lose your 25 VEBA credits! You start in the system with zero credits and earn one for each year you are contributing to the VEBA until you retire. People with fewer VEBA credits pay a larger share of the premiums for their health insurance (for example, according to information provided by HR, if you have 0 to 5 years of VEBA credits, you must pay 100% of the premium. If you do not opt in at this time, you can never opt in again.

Should you OPT-IN, or OPT-OUT? Well, this is the 64 dollar question. While the obvious answer is “it’s up to you,” there are some things to think about when making the decision that go beyond simply your personal situation or preferences. You can assume UNM will continue to fully fund its retiree benefit promises into the future. If so, why should you forego any current income to contribute to a system that is intended to “let UNM off the hook?” But let’s get real here…the UNM Regents want to reduce the institutional cost of providing benefits to retirees, so there’s a relatively big chance that they will NOT fund benefits promises in the future to the extent they have in the past. The VEBA is at least a partial guarantee of some funding for benefits.

If UNM contributes to the VEBA as intended by matching the dollars from employees, then the VEBA is being subsidized by the employer. That’s not as good as the employer funding it totally, but it’s better than the employer not contributing anything! Remember, the VEBA is providing a financial benefit to UNM–it’s taking part of the unfunded liability off the books–so it’s reasonable to think UNM should pay something for this benefit, in terms of its contribution to the VEBA.

Opting OUT is quite punitive, as either all retiree health benefits are lost, or are substantially reduced from full (25 credits) to partial (resetting to zero credits.) By opting out you lose all post-retirement health benefits, and you may have to pay a lot more for them on the open market. Also, as more people opt out of the VEBA, UNM’s unfunded liability fall. (In fact, as more people out of the VEBA the balance in the account doesn’t grow as much, which is a negative consequence, but the unfunded liability shrinks by a far greater amount, which is a positive consequence for those responsible for UNM’s finances.)

Opting IN maintains the option of receiving the employer subsidy, ensures receipt of the full benefit, and contributes to the solvency of the entire retiree health benefit system.

June 1, 2013 further thoughts: When is OPTING OUT a good idea? Predicting the future is difficult, just ask any economist, or fortune teller! But based on current data, there is an argument for opting OUT of the VEBA if certain conditions apply. IF your income is relatively high, and if you plan to retire after the age of 65, then above a certain salary ($82,800 at current rates) what you pay into the VEBA each year is greater than what you can expect to receive from UNM in reduced premium costs.

For example, with an annual salary of $100,000 the employee VEBA contribution is $1000. If that employee retires (using current rates) at 66, he/she can purchase Presbyterian Premium coverage for two persons (retiree and spouse) at an annual premium of $1932. If that same person had opted out of the VEBA, the premium would be $2760. UNM picks up the difference of $828. So by paying UNM $1000, the employee will get $828 “back” from UNM in the form of lower premiums. The negative return increases at higher salaries.

But the future is very uncertain, and it’s quite likely health insurance will cost more then, and it’s also possible UNM will subsidize retiree premiums at a lower share. Higher future premiums will make the VEBA contribution more attractive, but a lower UNM share will make it less attractive. As is often the case it depends: if you’re a low paid optimist, the VEBA is a great idea, but if you’re a high paid pessimist, opt out of the VEBA, but be sure to save the money to buy your health insurance in retirement.

Isn’t it likely UNM will alter the contributions to the VEBA in the future? As a stand-alone independent entity, the VEBA is not directly under the control of UNM. It can either be controlled by a third party trustee, or a board of trustees from UNM employees. Some of these employees could be administrators, but they will not be Regents. UNM has no special rights in the VEBA just because it partially funds it. The Trustees will have responsibility for managing the funds. UNM could decide to stop contributing to the VEBA, and UNM can always alter the health benefits plan (for example it can increase deductibles, or co-pays, or restrict coverage.) The VEBA only partially funds the health benefits of retirees, so retirees will always be subject to whatever decisions UNM makes regarding its health benefits plans.

Digression: Are UNM post-retirement benefits a good deal? According to information provided at UNM HR’s presentations on the VEBA in April and May, buying equivalent health insurance on the open market currently costs about twice as much as UNM retirees pay in premiums. By paying in to the VEBA, you ensure the receipt of UNM benefit rates and the share of the premiums UNM pays. But this may not be true in the future. UNM Regents may approve changes to the benefits plan, for retirees, or for everyone. There may be other options to buy private insurance as a consequence of the Affordable Care Act. Once you turn 65 health insurance coverage is based on Medicare, and UNM pays a lower share of the premium for supplemental insurance.

What about changes to the benefits plan such as high deductibles? In recent (April 2013) meetings the UNM Regents have discussed changing to a high deductible health insurance plan. No details are yet available. It would seem highly unlikely that UNM would create two distinct plans–one for employees and one for retirees–so if it were to raise deductibles for retirees, it would have to raise them for all those covered by its health insurance plan. This would mean a substantive and substantial change in the fundamental nature of healthcare benefits UNM offers its employees and former employees. I believe it premature to undertake too much analysis of this, as yet, undefined option.