State and Local Government Retiree Benefits: Current Status of	 
Benefit Structures, Protections, and Fiscal Outlook for Funding  
Future Costs (24-SEP-07, GAO-07-1156).				 
                                                                 
State and local retiree benefits are not subject, for the most	 
part, to federal laws governing private sector retiree benefits. 
Nevertheless, there is a federal interest in ensuring that all	 
Americans have a secure retirement, as reflected in the special  
tax treatment provided for both private and public pension funds.
In 2004, new government accounting standards were issued, calling
for the reporting of liabilities for future retiree health costs.
As these standards are implemented and the extent of the related 
liabilities become known, questions have been raised about	 
whether the public sector can continue to provide the current	 
level of benefits to its retirees. GAO was asked to provide an	 
overview of state and local government retiree benefits,	 
including the following: (1) the types of benefits provided and  
how they are structured, (2) how retiree benefits are protected  
and managed, and (3) the fiscal outlook for retiree benefits and 
what governments are doing to ensure they can meet their future  
commitments. For this overview, GAO obtained data from various	 
organizations, used our model that simulates the fiscal outlook  
for the state and local sector, and conducted site visits to	 
three states that illustrate a range of benefit structures,	 
protections, and fiscal outlooks. Cognizant agency officials	 
provided technical comments which were incorporated as		 
appropriate.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-1156					        
    ACCNO:   A76607						        
  TITLE:     State and Local Government Retiree Benefits: Current     
Status of Benefit Structures, Protections, and Fiscal Outlook for
Funding Future Costs						 
     DATE:   09/24/2007 
  SUBJECT:   Accountability					 
	     Cost analysis					 
	     Employee medical benefits				 
	     Employee retirement plans				 
	     Federal employee retirement programs		 
	     Federal/state relations				 
	     Health care costs					 
	     Local governments					 
	     Pensions						 
	     Program management 				 
	     Retirees						 
	     Retirement 					 
	     Retirement benefits				 
	     Retirement income					 
	     State employees					 
	     Statistical data					 
	     Strategic planning 				 

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GAO-07-1156

   

     * [1]Results in Brief
     * [2]Background
     * [3]State and Local Retiree Benefits Typically Include a Defined

          * [4]Defined Benefit Plans Still Provide the Core Benefits for Mo
          * [5]Supplementary Savings Plans Are Largely Voluntary, with No E
          * [6]Group Health Coverage Is Widely Available with Varying Level
          * [7]The Cost of Other Benefits, when Provided, Is Primarily Paid

     * [8]State and Local Law Generally Provides Legal Protections for

          * [9]Laws Protecting Pensions Are Often Anchored in State Constit

               * [10]Pension Benefits, Once Accrued, Are Generally Protected
               * [11]Pensions Are Typically Managed as Trust Funds with Board
                 Ove

          * [12]Laws Provide Less Protection for Retiree Health Benefits

               * [13]Retiree Health Benefits Are Subject to Change
               * [14]Retiree Health Benefits Are Treated as an Operating
                 Expense

     * [15]Strategies Exist to Manage Future Pension Costs, but Not to

          * [16]Current Contribution Rates Are Generally on Track, but Could
          * [17]Retiree Health Care Costs Could More than Double as a Percen
          * [18]State and Local Governments Generally Have Strategies to Man

               * [19]Governments Use Various Strategies to Keep Their Funding
                 Sta
               * [20]Failure to Maintain Acceptable Funding Levels May Place
                 Futu

          * [21]Most State and Local Governments Have Yet to Develop Long-Te

     * [22]Concluding Observations
     * [23]Agency Comments

          * [24]National Level
          * [25]State and Local Level

               * [26]California State
               * [27]California Local
               * [28]Michigan State
               * [29]Michigan Local
               * [30]Oregon State

     * [31]Development of Factors for Employment, Retirement, Wages, an
     * [32]Projections of Necessary Contributions to Pension Funds for

          * [33]Basic Formulation of Necessary Steady Level of Employer Cont
          * [34]Sensitivity Analyses of Necessary Steady Level of Employer C

     * [35]Projections of Retiree Health Benefit Costs for State and Lo
     * [36]GAO Contacts
     * [37]Staff Acknowledgments

          * [38]Articles and Books
          * [39]Surveys and Studies

     * [40]GAO's Mission
     * [41]Obtaining Copies of GAO Reports and Testimony

          * [42]Order by Mail or Phone

     * [43]To Report Fraud, Waste, and Abuse in Federal Programs
     * [44]Congressional Relations
     * [45]Public Affairs
     * [46]PDF6-Ordering Information.pdf

          * [47]GAO's Mission
          * [48]Obtaining Copies of GAO Reports and Testimony

               * [49]Order by Mail or Phone

          * [50]To Report Fraud, Waste, and Abuse in Federal Programs
          * [51]Congressional Relations
          * [52]Public Affairs

GAO

September 2007

United States Government Accountability Office

Report to the Committee on Finance, U.S. Senate

STATE AND LOCAL GOVERNMENT RETIREE BENEFITS

Current Status of Benefit Structures, Protections, and Fiscal Outlook for
Funding Future Costs

GAO-07-1156

Revised on November 15, 2007, to reflect a correction to a reference to
the New York comptroller, who is an elected official (not appointed by the
governor as originally reported). Changes were made on page 24, third
paragraph, and on page 25, footnote 28..

Contents

Letter 1

Results in Brief 3
Background 5
State and Local Retiree Benefits Typically Include a Defined Benefit Plan,
a Voluntary Savings Plan, and Partially Paid Health Coverage 9
State and Local Law Generally Provides Legal Protections for Pensions, but
Less So for Other Retiree Benefits of Public Employees 18
Strategies Exist to Manage Future Pension Costs, but Not to Meet
Escalating Costs for Retiree Health Care 27
Concluding Observations 39
Agency Comments 40
Appendix I Organizations, Associations, and State and Local Agencies GAO
Contacted 42
Appendix II Technical Background on Pension and Retiree Health Care
Simulations 44
Development of Factors for Employment, Retirement, Wages, and Benefits 44
Projections of Necessary Contributions to Pension Funds for State and
Local Government Sector 51
Projections of Retiree Health Benefit Costs for State and Local Retirees
53
Appendix III State and Local Government Retiree Benefit Plans in
California, Michigan, and Oregon 56
Appendix IV GASB Statements for Pensions and OPEB 62
Appendix V GAO Contacts and Staff Acknowledgments 63
Bibliography 64
Related GAO Products 70

Tables

Table 1: Different Types of Defined Contribution Plans for Voluntary
Tax-Deferred Savings for State and Local Government Employees 12
Table 2: Constitutional Protections for Pension Benefits 19
Table 3: Composition and Responsibilities of Boards of Primary Public
Employee Pension Plans in California, Michigan, and Oregon 23
Table 4: GAO Simulation of the Projected Government Contribution Level
Needed to Fully Fund the Liability for Pension Benefits for the State and
Local Government Sector, in Aggregate 28
Table 5: GAO Simulation of the Projected Government Cost for Retiree
Health Benefits for the State and Local Government Sector, in Aggregate 30
Table 6: Different Vehicles for Prefunding Retiree Health Costs 37
Table 7: GASB Statements for Pensions and OPEB 62

Figures

Figure 1: Projected Health and Non-Health Expenditures of State and Local
Governments through 2050 6
Figure 2: Types of Pension Plans in Place for Newly Hired General State
Employees, as of 2007 10
Figure 3: Percentage of Premium Paid by Employer for Health Insurance
Coverage for Retirees under Age 65 (Pre-Medicare-Eligible), by State in
2006 15
Figure 4: Various Interests Represented on Boards of Each State's Pension
Plan for General State Employees 22
Figure 5: Distribution of the Funded Ratios of 126 of the Nation's Largest
State and Local Defined Benefit Pension Plans 31
Figure 6: Cumulative Percentage Distribution of Public Pension Fund
Revenue Sources Nationwide, 1982 to 2005 32

Abbreviations

CalPERS California Public Employees' Retirement System
CBO Congressional Budget Office
COLA cost-of-living adjustment
CPIU consumer price index for all urban consumers
DROP deferred retirement option plan
ECI employment cost index
ERISA Employee Retirement Income Security Act
FASB Financial Accounting Standards Board
GAAP generally accepted accounting principles
GASB Governmental Accounting Standards Board
GDP gross domestic product
HRET Health Research and Educational Trust
MEPS Medical Expenditure Panel Survey
MSERS Michigan State Employees' Retirement System
NASRA National Association of State Retirement Administrators
NIPA National Income and Product Accounts
OASDI Old-Age and Survivors Insurance and Disability Insurance
OPEB other postemployment benefits
OPERS Oregon Public Employees' Retirement System
VEBA Voluntary Employees' Beneficiary Association

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United States Government Accountability Office
Washington, DC 20548

September 24, 2007

The Honorable Max Baucus
Chairman
The Honorable Charles E. Grassley
Ranking Member
Committee on Finance
United States Senate

Over the past half-century, the number of state and local government
workers has grown significantly. In 2006, this sector accounted for about
12 percent of the nation's workforce. Since 1996, accounting standards
calling for state and local governments to report their liabilities for
future pension costs have been in place, but standards calling for similar
treatment of the future costs of retiree health benefits have only
recently been issued. It is unclear, as yet, what actions state and local
governments may take once the future costs of these benefits are known.
However, future decisions about the appropriate levels of benefits for
retirees will likely occur in a broader context of persistent fiscal
challenges that state and local governments will face in the next decade.
Hence, concerns have been raised about the public sector's capacity to
meet the rising cost of providing its retirees with promised pension and
other postemployment benefits, such as retiree health care.

State and local retiree benefits are not subject, for the most part, to
federal laws governing private sector retiree benefits. Nevertheless,
there is a federal interest in ensuring that all Americans have a secure
retirement, an interest that is reflected in preferential tax treatment
for contributions and investment earnings associated with qualified
pension plans in both the public and the private sectors. To better
understand these benefits and the future challenge state and local
governments may face, you requested that we provide an overview of state
and local government pension plans and retiree health benefit programs.^1
Specifically, we examined

^1 This report reflects the findings of one of two GAO studies that were
conducted in response to this request. The other study is focused on
providing a more detailed look at the funding status of state and local
retiree benefit plans, with a report estimated to be published in late
2007. Other ongoing GAO work is focused on examining pension fund
investment choices in the public and private sector.

           (1) the types of state and local retiree benefits provided and how
           they are structured,
           (2) how state and local retiree benefits are protected and
           managed, and
           (3) the fiscal outlook for state and local retiree benefits and
           what governments are doing to ensure they can meet their future
           commitments.

For nationwide information about state and local retiree benefits, we
spoke with experts, advocacy groups, and union officials from various
national organizations and associations (see app. I). To profile the types
of governance and benefits provided, we obtained data from these
organizations, from various federal agencies, and from various
nongovernmental entities that analyze government data and conduct surveys
on these topics. (See the selected bibliography at the end of this report
for brief descriptions of each of these studies.) Much of the available
data are self-reported, but we conducted data reliability assessments and
determined that the data are sufficiently reliable for our purposes. We
also used our model that simulates the fiscal outlook for the state and
local government sector to develop projections for funding state and local
government retiree benefits in aggregate nationwide (see app. II). In
addition, we conducted site visits and gathered detailed information about
the benefits provided and the future fiscal implications in three states
(California, Michigan, and Oregon) and two local governments (San
Francisco and Detroit). We selected these sites to illustrate various
types of plan structures, legal protections, and levels of employer
funding commitments. For example, in California, the primary pension plan
for most state and local government employees is a defined benefit plan,
with protections in the state constitution,^2 and with a funded ratio of
87.3 percent in 2005. In Michigan, the primary pension plan for general
state employees hired on or after March 31, 1997, is a defined
contribution plan, which is covered by the same state constitutional
provision applicable to the previous defined benefit plan; the previous
plan, now closed to new members, had a funded ratio of 79.8 percent in
2005. In Oregon, the primary pension plan for most state and local
government employees includes both a defined benefit and a defined
contribution component, with no explicit protections in the state
constitution; the defined benefit component's funded ratio was 104.2
percent in 2005. (See app. III for an overview of retiree benefit plans in
our site visit locations.) Finally, to illustrate a wider range of retiree
benefit system characteristics, in some instances, we complemented
information from our site visit locations with information gathered about
retiree benefits provided in other state and local jurisdictions. We
conducted our work from November 2006 to August 2007 in accordance with
generally accepted government auditing standards.

^2 Throughout this report, our discussion of constitutional protections
refers only to provisions specifically applicable to the funding,
protection, management, or governance of employee benefit plans.

Results in Brief

State and local entities typically provide a pension plan with defined
benefits, a supplemental defined contribution plan for voluntary savings,
and partially paid health coverage. As of 2007, most states still have
traditional defined benefit plans as the primary retirement plans for
their workers. Only two states (Alaska and Michigan) and the District of
Columbia had adopted defined contribution plans as their primary plans for
general public employees; two states (Indiana and Oregon) had adopted
primary plans with both defined benefit and defined contribution
components; and one state (Nebraska) had adopted a cash balance defined
benefit plan as its primary plan. State and local entities also typically
offer tax-deferred supplemental voluntary plans to encourage workers to
save toward retirement. In terms of health benefits, for virtually all
state and local retirees age 65 or older, Medicare provides the primary
coverage. Survey data gathered by Workplace Economics, Inc., indicate that
most state and local government employers provide supplemental health
coverage for Medicare-eligible retirees. For state and local retirees who
are under age 65 (that is, not yet Medicare-eligible), state and local
employers generally provide access to group health coverage with varying
levels of support. As of 2006, 14 states provided no employer contribution
for retirees' coverage, while 14 other states picked up the entire cost,
and the remainder fell somewhere in between. States also typically provide
access to group rates for other postemployment benefits such as dental and
vision coverage, long-term care, and life insurance, but the cost of these
other benefits is often paid primarily, if not entirely, by retirees.

How both pension plans and retiree health benefits are protected and
managed is typically spelled out in state statutes or in local ordinances,
but these laws generally provide greater protection for pensions than for
retiree health benefits. State or local statutes, and state constitutions
or local charters, often include explicit protections for pension
benefits, such as provisions stating that pensions promised to public
employees cannot be eliminated or diminished. In addition, state
constitutions and/or statutes often require pension plans to be managed as
trust funds and overseen by boards of trustees. Our analysis of national
organization data on pension boards indicates that the size, composition,
and responsibilities of these boards vary. For example, we found that the
size of these boards ranged from 5 to 19 members, with various
combinations of those representing active members, retirees, union
members, state or local governments, or others having technical knowledge
such as investment specialists. Moreover, boards of trustees typically
establish overall policies for the operation and management of the pension
plans, which can include adopting actuarial assumptions for calculating
liabilities, establishing procedures for financial control and reporting,
and setting investment strategy. In contrast to pensions, state and local
law provides less legal protection for other state and local government
retiree benefits, such as retiree health care, and any such protections
more frequently stem from negotiated agreements between unions and
government employers. In addition, state and local governments have
generally treated their costs for retiree health benefits as an operating
expense on a pay-as-you-go basis, and managed these benefits together with
active employee benefits.

In general, we found that state and local governments have set aside funds
to meet most of their future pension costs, but have not yet developed
long-term strategies to finance future escalating health care costs for
retirees. We analyzed the expected future costs of pensions and retiree
health benefits for the state and local government sector as a whole and
found that, assuming that certain historical trends continue, state and
local governments would need to raise their contribution rates only
slightly to meet future pension costs. However, this estimate is
particularly sensitive to changes in rates of return, and if rates were to
fall below historical averages, the funding requirements to meet future
costs could become much more significant. Moreover, according to our
sector analysis, we found that future retiree health care costs would
likely more than double as a percentage of salaries between 2006 and 2050,
if the costs continued to be funded on a pay-as-you-go basis. As with
pensions, this estimate is particularly sensitive to assumptions about the
growth in health care costs, and costs could rise more rapidly than
projected. In addition, the actual forecasts and outcomes for individual
state and local governments will, of course, vary from our analysis. For
example, although nationwide data gathered by the National Association of
State Retirement Administrators (NASRA) indicates that most state and
local governments are on track toward full funding of their pension plans,
a few plans have failed to maintain what is generally viewed as an
acceptable funding level. If efforts are not made to improve the funding
status of those plans, tough choices lie ahead about whether and how to
maintain the current level of pension benefits for future retirees. State
and local governments may be faced with the need to raise taxes, cut
spending, or reduce benefits in order to meet their obligations. Across
our site visit locations, we found that state and local governments employ
a variety of strategies to keep the funding status of their pension plans
on track, but that long-term strategies to address escalating health care
costs for retirees are generally lacking. Officials told us that they are
just beginning to estimate the amount of their unfunded liability for
retiree health care costs in response to the newly issued accounting
standards and that they had not yet developed strategies to manage these
future costs.

The Internal Revenue Service, state and local officials, and experts in
the field provided technical comments which we incorporated as
appropriate.

Background

The state and local government sector is likely to face persistent fiscal
challenges within the next decade. In July 2007, we issued a report based
on simulations for the state and local government sector that indicated
that in the absence of policy changes, large and growing fiscal challenges
will likely emerge within a decade.^3 Our report found that, as is true
for the federal sector, the growth in health-related costs is a primary
driver of these fiscal challenges (see fig. 1). Two types of
health-related costs are of particular concern at the state and local
level: (1) Medicaid expenditures, and (2) the cost of health insurance for
state and local government employees, retirees, and their beneficiaries.

^3 GAO, State and Local Governments: Persistent Fiscal Challenges Will
Likely Emerge within the Next Decade, [53]GAO-07-1080SP (Washington, D.C.:
July 18, 2007).

Figure 1: Projected Health and Non-Health Expenditures of State and Local
Governments through 2050

Note: Historical data through 2006, projections from 2007 through 2050.
The primary data source is the National Income and Product Accounts
(NIPA). Interest expense is not included in this analysis. (GDP = gross
domestic product.)

Retirement benefits consist primarily of two components: pensions and
retiree health benefits. According to Census data, in fiscal year
2004-2005, state and local governments provided retirement benefits to
nearly 7 million retirees and their families. In addition to supporting a
secure retirement for state and local government employees and their
families, such benefits constitute an important component of the total
compensation package state and local governments offer to attract and
retain the skilled workers needed to protect lives and health, and to
promote the general welfare. These workers include highway patrol
officers, local police, firefighters, school teachers, and judges, as well
as general state and local government employees who staff the broad array
of state and local agencies.

Pension plans can generally be characterized as either defined benefit or
defined contribution plans. In a defined benefit plan, the amount of the
benefit payment is determined by a formula typically based on the
retiree's years of service and final average salary, and is most often
provided as a lifetime annuity. In defined benefit plans for state and
local government retirees, postretirement cost-of-living adjustments
(COLA) are frequently provided. But benefit payments are generally reduced
for early retirement, and in some cases, payments may be offset for
receipt of Social Security.^4 State and local government employees are
generally required to contribute a percentage of their salaries to their
defined benefit plans, unlike private sector employees, who generally make
no contribution when they participate in defined benefit plans. According
to a 50-state survey conducted by Workplace Economics, Inc., 43 of 48
states with defined benefit plans reported that general state employees
were required to make contributions ranging from 1.25 to 10.5 percent of
their salaries. Nevertheless, these contributions have no influence on the
amount of benefits paid because benefits are based solely on the formula.

In a defined contribution plan, the key determinants of the benefit amount
are the employee's and employer's contribution rates, and the rate of
return achieved on the amounts contributed to an individual's account over
time. The employee assumes the investment risk: The account balance at the
time of retirement is the total amount of funds available, and unlike with
defined benefit plans, there are generally no COLAs. Until depleted,
however, a defined contribution account balance may continue to earn
investment returns after retirement, and a retiree could use the balance
to purchase an inflation-protected annuity. Also, defined contribution
plans are more portable than defined benefit plans, as employees own their
accounts individually and can generally take their balances with them when
they leave government employment. There are no reductions based on early
retirement or for participation in Social Security.^5

Accounting standards governing public sector pensions were established by
the Governmental Accounting Standards Board (GASB) in 1994. Comprehensive
accounting and financial reporting standards governing other
postemployment benefits (OPEB) in the public sector, such as health care,
were issued in 2004 (superseding the interim standards issued previously).
Implementation of the new OPEB standards is currently being phased in (see
app. IV). The purpose of these standards is to prescribe accounting and
financial reporting requirements that apply broadly to state and local
government employers' benefit plans. Reporting by employers and plan
administrators helps keep the municipal bond market, taxpayers, elected
public officials, plan members, and other interested parties informed
about employers' OPEB costs and obligations, and the operation and funded
status of the plans. As with the Financial Accounting Standards Board
(FASB) in the private sector, it is not the GASB's function to enforce
compliance with the standards it promulgates. Rather, the GASB functions
as an independent standard setter, and its statements and interpretations
constitute the highest source of generally accepted accounting principles
(GAAP) for state and local governments, as specified in the Code of
Professional Conduct of the American Institute of Certified Public
Accountants. State and local governmental entities issue annual financial
reports prepared in conformity with GAAP for a variety of reasons--such as
to comply with general or specific state laws requiring GAAP financial
reporting, or to protect the highest possible credit rating on the
government's bonds in order to reduce the government's cost of borrowing.
Compliance with GASB standards is necessary in order to obtain an
independent auditor's report that the financial statements are fairly
presented in conformity with GAAP, and a failure to do so would result in
a modification of the auditor's report if the effects were material.

^4 Unlike in the private sector, there are large groups of state and local
government workers who are not covered by Social Security. According to
data from the Social Security Administration, about 30 percent of all
state and local government workers nationwide are not covered, although
the extent of coverage varies widely by state and by occupation.

^5 There could, however, be federal tax penalties if funds are withdrawn
before the employee reaches a certain age. 26 U.S.C. S 72(t).

Although the Employee Retirement Income Security Act of 1974 (ERISA)
imposes participation, vesting, and other requirements directly upon
employee pension plans, governmental plans such as those provided by state
and local governments to their employees are excepted from these
requirements. In addition, ERISA established an insurance program for
defined benefit plans under which promised benefits are paid (up to a
statutorily set amount), if an employer cannot pay them--but this too does
not apply to governmental plans. However, for participants in governmental
pension plans to receive preferential tax treatment (that is, for plan
contributions and investment earnings to be tax-deferred), plans must be
deemed qualified by the Internal Revenue Service.^6

^6 Contributions to qualified pension plans that meet certain
requirements--whether defined benefit or defined contribution--are not
counted as taxable income to employees when the contributions are made.
However, when pension benefits are paid, amounts not previously taxed are
subject to federal and perhaps state tax. This also applies to the
interest income such contributions generate.

State and Local Retiree Benefits Typically Include a Defined Benefit Plan, a
Voluntary Savings Plan, and Partially Paid Health Coverage

State and local governments typically provide their employees with
retirement benefits that include a defined benefit plan, a supplemental
defined contribution plan for voluntary savings, and group health
coverage. However, the way each of these components is structured and the
level of benefits provided varies widely--both across states, and within
states based on such things as date of hire, employee occupation, and
local jurisdiction.

Defined Benefit Plans Still Provide the Core Benefits for Most Retirees

Most state and local government workers still are provided traditional
pension plans with defined benefits. In 1998, all states had defined
benefit plans as their primary pension plans for their general state
workers except for Michigan and Nebraska (and the District of Columbia),
which had defined contribution plans as their primary plans, and Indiana,
which had a combined plan with both defined benefit and defined
contribution components as its primary plan.^7 Almost a decade later, we
found that as of 2007, only one additional state (Alaska) had adopted a
defined contribution plan as its primary plan; one additional state
(Oregon) had adopted a combined plan, and Nebraska had replaced its
defined contribution plan with a cash balance defined benefit plan. (See
fig. 2.) Although still providing defined benefit plans as their primary
plans for general state employees, some states also offer defined
contribution plans (or combined plans) as optional alternatives to their
primary plans. These states include Colorado, Florida, Montana, Ohio,
South Carolina, and Washington.

^7 See GAO, State Pension Plans: Similarities and Differences Between
Federal and State Designs, [54]GAO/GGD-99-45 (Washington, D.C.: Mar. 19,
1999). Also, as of 1998, across all state and local employees nationwide,
Bureau of Labor Statistics survey data indicate that 90 percent were
covered by defined benefit plans. (For further details on this survey, see
the selected bibliography at the end of this report. The survey is to be
updated again in 2008.)

Figure 2: Types of Pension Plans in Place for Newly Hired General State
Employees, as of 2007

Note: Plans depicted are those in which newly hired general state
employees in each state are required to participate as their primary
pension plan. In some states, employees may opt to participate in
alternative or supplementary defined contribution plans, but participation
in these plans is not mandatory.

In the states that have adopted defined contribution plans as their
primary plans, most employees continue to participate in defined benefit
plans because employees are allowed to continue their participation in
their previous plans (which is rare in the private sector).^8 Thus, in
contrast to the private sector, which has moved increasingly away from
defined benefit plans over the past several decades, the overwhelming
majority of states continue to provide defined benefit plans for their
general state employees.

Most states have multiple pension plans providing benefits to different
groups of state and local government workers based on occupation (such as
police officer or teacher) and/or local jurisdiction. According to the
most recent Census data available, in fiscal year 2004-2005, there were a
total of 2,656 state and local government pension plans. We found that
defined benefit plans were still prevalent for most of these other state
and local employees as well. For example, a nationwide study conducted by
the National Education Association in 2006 found that of 99 large pension
plans serving teachers and other school employees,^9 79 were defined
benefit plans, 3 were defined contribution plans, and the remainder
offered a range of alternative, optional, or combined plan designs with
both defined benefit and defined contribution features.

Supplementary Savings Plans Are Largely Voluntary, with No Employer Match

In addition to primary pension plans (whether defined benefit or defined
contribution), data we gathered from various national organizations show
that each of the 50 states has also established a defined contribution
plan as a supplementary, voluntary option for tax-deferred retirement
savings for their general state employees, and such plans appear to be
common among other employee groups as well.^10 These supplementary defined
contribution plans are typically voluntary deferred compensation plans
under section 457(b) of the federal tax code.^11 (See table 1.)

^8 In the private sector, when a new plan is adopted, the previous plan is
often frozen. Existing employees keep the benefits they have accrued to
date, but cannot continue to participate in the previous plan from that
point forward. In the public sector, when a new plan is adopted, existing
employees generally are allowed to continue to participate in the previous
plan. Generally only new employees, hired after adoption of the new plan,
are required to participate in the new plan from that point forward.

^9 For further details on the National Education Association study, see
the selected bibliography at the end of this report.

^10 In addition, over the past 10 years, many public sector employers have
established deferred retirement option plans (DROP). DROPs were created to
retain experienced employees by permitting those eligible to retire to
stay on the job and earn a lump-sum payment at retirement in addition to
their defined benefit annuity.

Table 1: Different Types of Defined Contribution Plans for Voluntary
Tax-Deferred Savings for State and Local Government Employees

Plan name (based on                                                        
section of the                                                             
Internal Revenue                                                           
Code)               Description of plan                                    
401(k) plans        Cash or deferred arrangements that permit employees to 
                       defer a portion of their pay to a qualified            
                       tax-deferred plan. Employee deferrals are held in      
                       trust for the sole benefit of the participants and     
                       their beneficiaries. The employee typically directs    
                       the investments. Employers may also make               
                       contributions. These plans are intended primarily for  
                       private sector employees; the Tax Reform Act of 1986   
                       prohibited state and local governments from            
                       establishing any new 401(k) plans after May 6, 1986,   
                       but existing plans were allowed to continue. (Pub. L.  
                       No. 99-514, S 1116(b)(3), 100 Stat. 2085, 2455.)       
403(b) plans        Tax-sheltered annuity plans that permit public         
                       education employees to defer a portion of their pay to 
                       a qualified tax-deferred plan. Employee deferrals are  
                       invested in annuity contracts provided through         
                       insurance companies or custodial accounts invested in  
                       mutual funds. Employers may also make contributions,   
                       and employee rights under such plans generally are not 
                       forfeitable.                                           
457(b) plans        Deferred compensation plans that permit employees to   
                       defer a portion of their pay, which is immediately     
                       vested and set aside for their exclusive benefit.      
                       Since taxation of the amounts in 457(b) accounts is    
                       deferred, this portion of the employee's pay is not    
                       taxed until the funds are paid from the plan. Most     
                       state and local government employees today have such   
                       plans available to them as supplementary retirement    
                       plans.                                                 

Source: Internal Revenue Code.

Note: This table describes the various types of defined contribution plans
that may be used for supplemental retirement saving plans for state and
local government workers. When the defined contribution plan is the
primary retirement plan, it is generally a 401(a) plan.

While these defined contribution plans are fairly universally available,
state and local worker participation in the plans has been modest. In a
2006 nationwide survey conducted by the National Association of Government
Defined Contribution Administrators,^12 the average participation rate for
all defined contribution plans was 21.6 percent.

One reason cited for low participation rates in these supplementary plans
is that, unlike in the private sector, it has been relatively rare for
employers to match workers' contributions to these plans, but the number
of states offering a match has been increasing. According to a state
employee benefit survey of all 50 states conducted by Workplace Economics,
Inc., in 2006, 12 states match the employee's contribution up to a
specified percent or dollar amount.^13 Among our site visit states, none
made contributions to the supplementary savings plans for their general
state employees, and employee participation rates generally ranged between
20 to 50 percent. In San Francisco, however, despite the lack of an
employer match, 75 percent of employees had established 457(b) accounts.
The executive director of the city's retirement system attributed this
success to several factors, including (1) that the plan had been in place
for over 25 years, (2) that the plan offers good investment options for
employees to choose from, and (3) that plan administrators have a strong
outreach program. In the private sector, a growing number of employers are
attempting to increase participation rates and retirement savings in
defined contribution plans by automatically enrolling workers and offering
new types of investment funds.^14

^11 26 U.S.C. S 457(b).

^12 For further details on the National Association of Government Defined
Contribution Administrators' 2006 survey, see the selected bibliography at
the end of this report.

Group Health Coverage Is Widely Available with Varying Levels of Employer
Support

State and local governments typically provide their active employees with
health coverage,^15 and they often pay the bulk of their premiums.
According to the Workplace Economics, Inc., 2006 survey, on average, state
employers paid over 90 percent of the cost for single employee coverage,
and over 80 percent of the cost of family coverage, for active workers.
Once workers retire, access to group coverage generally continues, but the
extent of the employer contribution often declines, and different benefits
are often provided depending on whether or not the retiree is eligible for
Medicare.^16

^13 The Workplace Economics, Inc., 2006 survey instructed states to provide
information on benefits that cover the largest number of employees, or
that were otherwise deemed representative. For further details on this
survey, see the selected bibliography at the end of this report.

^14 GAO, Employer-Sponsored Health and Retirement Benefits: Efforts to
Control Employer Costs and the Implications for Workers, GAO-07-355
(Washington, D.C.: March 30, 2007).

^15 About 82 percent of state and local governments with 200 or more
employees offer health benefits to active workers, according to a 2006
survey conducted by the Kaiser Family Foundation and the Health Research
and Educational Trust (HRET). (For further details on the Kaiser/HRET 2006
survey, see the selected bibliography at the end of this report.)

For virtually all state and local retirees age 65 or older, Medicare
provides the primary coverage. Most state and large local government
employers offer supplemental group health coverage, but do not always
contribute to the cost of the premiums. According to the Workforce
Economics, Inc., 2006 survey, all states but one provide access to such
supplemental coverage. Only Nebraska provides no access to group coverage
for retirees age 65 and over.^17 In 12 states, retirees are provided
access to coverage through a state health care program, but the state
provides no support for the coverage.^18 At the other end of the spectrum,
in 16 states, employers pay the entire cost for at least one coverage plan
under some circumstances. Of those states contributing to the premium
costs, the maximum employer payments for employee-only coverage ranged
from $40 per month (in Tennessee) to $850 per month (in Alaska).

For state and local retirees who are under age 65 (that is, not yet
Medicare-eligible), most state and large local employers provide the
primary health care coverage. According to the Workplace Economics, Inc.,
2006 survey, all states provide access to group health coverage for
pre-Medicare retirees,^19 but in 14 states, the plan participants pay the
entire cost of the coverage (see fig. 3). In 14 other states, employers
pay the entire cost for at least one coverage plan in some circumstances.
Of those states providing an employer contribution, the maximum payments
for retiree-only coverage ranged from $105 per month (in Oklahoma) to $850
per month (in Alaska).

^16 According to a more comprehensive study of state retiree health
benefits in 2004, some states offered a single health care plan statewide,
but typically retirees had about three or four plans available. The plans
offered to pre-Medicare retirees were generally similar to those for
active employees, while Medicare-eligible retirees had somewhat different
plans available. For further details, see Stan Wisniewski and Lorel
Wisniewski, State Government Retiree Health Benefits: Current Status and
Potential Impact of New Accounting Standards, Workplace Economics, Inc.,
#2004-08, AARP, Washington, D.C.: July 2004. (For further details on this
survey, see the selected bibliography at the end of this report.)

^17 Indiana also provides no coverage under a state plan, but provides
access to a Medicare complementary plan that retirees can purchase on
their own. In addition, Oregon provides no coverage under a state plan for
retirees eligible for Medicare if they were hired on or after August 29,
2003.

^18 In four additional states, no employer funding is provided unless the
retiree meets certain years of service or other requirements. Similar
requirements generally exist for both pre-Medicare and Medicare-eligible
retirees. For example, in Arizona, a retiree must have 10 years of service
to receive any employer contribution in either case.

^19 Often state and local employees are eligible to retire before age 65.
According the Workplace Economics, Inc., 2006 survey, several states allow
government employees to retire at age 50 or 55, or at any age with a
specific number of years of service.

Figure 3: Percentage of Premium Paid by Employer for Health Insurance
Coverage for Retirees under Age 65 (Pre-Medicare-Eligible), by State in
2006

Note: When employer contributions to the cost of premiums vary for those
hired or retired before a certain date, percentages depicted are for
payments provided to the latest group of workers who retire. When
contributions vary based on a retiree's years of service, plan selected,
or other criteria, the maximum amount of payment is depicted. For states
with no set maximum, the percentage shown is for retirees with 30 years of
service. The Workplace Economics, Inc., 2006 survey instructed states to
provide information on benefits that cover the largest number of
employees, or that were otherwise deemed representative. For further
details on this survey, see the selected bibliography at the end of this
report.

In most cases, states are continuing to provide retirees with prescription
drug coverage following the rollout of the Medicare prescription drug
program beginning in January 2006.^20 In May 2006, the Segal Company, in
cooperation with the Public Sector HealthCare Roundtable, conducted a
survey of 109 state and local entities concerning retiree health care, and
found that most of the public entities surveyed continued to provide
prescription drug coverage to their retirees, and that only one entity
planned to eliminate drug coverage entirely.^21

Nationwide survey data indicate that while the vast majority of state and
local government active workers participate in employer-sponsored health
benefit plans,^22 participation rates among retirees in these
employer-sponsored health benefit programs are relatively low. According
to data from the Department of Health and Human Services, in 2004, about
42 percent of state and local retirees participated in employer-sponsored
health insurance programs.^23 Among our site visit locations, we found
that participation rates varied widely based on level of employer cost
sharing. For example, in California, where the state may pay up to the
full premium in some cases (depending on the retiree's date of hire, years
of service, and choice of coverage plans);^24 and in Michigan, where the
state pays as much as 95 percent of the retirees' premium for those under
the defined benefit plan, we estimated participation rates to be
approximately 70 percent and 90 percent of all state retirees,
respectively. In contrast, in Oregon, where the state pays nothing toward
retirees' premiums for coverage under the pre-Medicare-eligible health
care program administered by the Public Employees Benefit Board, it has
been estimated that the participation rate among eligible retirees is
about 30 percent.

^20 The Medicare Prescription Drug, Improvement, and Modernization Act of
2003 created a prescription drug benefit for beneficiaries called Medicare
Part D. Pub. L. No. 108-173, tit. I, 117 Stat. 2066, 2066. Under Part D,
sponsors of employment-based prescription drug benefit plans (including
state and local governments) qualify for a federal subsidy payment if they
provide benefits meeting certain requirements. For further information,
see GAO, Retiree Health Benefits: Majority of Sponsors Continued to Offer
Prescription Drug Coverage and Chose the Retiree Drug Subsidy,
[55]GAO-07-572 (Washington, D.C.: May 31, 2007).

^21 Although not changing the benefits they offer, almost half of the
entities indicated that they now terminate prescription drug coverage for
those retirees enrolled in a Medicare plan on their own, and a growing
number of entities were considering contracting with a prescription drug
plan or Medicare-Advantage prescription drug plan to provide prescription
drug coverage for their retirees in the future. (For further details on
Segal's 2006 survey, see the selected bibliography at the end of this
report.)

^22 About 92 percent of eligible state and local workers participate in
employer-sponsored health plans, according to the Kaiser/HRET 2006 survey.
(For further details on this survey, see the selected bibliography at the
end of this report.)

^23 This estimate is based on participation data from the Department of
Health and Human Services, Agency for Healthcare Research and Quality,
Medical Expenditure Panel Survey (MEPS); and data on the number of retired
employees from the Census Bureau's annual survey, State and Local
Governments Employee-Retirement Systems. (For further details on these
surveys, see the selected bibliography at the end of this report.)

The Cost of Other Benefits, when Provided, Is Primarily Paid by Retirees

Beyond basic health care, other postemployment benefits (OPEB) that are
sometimes offered to state and local government retirees include
stand-alone supplemental dental or vision benefits, long-term care, or
life insurance. When such benefits are made available, state and local
government entities typically provide access to group rates, but the cost
of the benefits is often paid primarily, if not entirely, by retirees.

For example, among our site visit locations, postemployment benefits
provided to retirees in addition to health care include the following:

           o State employees in California generally have access to group
           term life insurance with a lump-sum benefit of $5,000, paid by the
           state. Retirees also are provided access to group dental benefits,
           which may be partially funded by the state in some cases, and a
           retiree vision program with premiums fully paid by retirees.
           Long-term care insurance is also available to all public employees
           in the state (active or retired), as well as their family members,
           generally as a fully member-paid program with no state
           contribution.
           o In Michigan, dental and vision (as well as health) coverage is
           provided to general state employees at retirement. For those under
           the defined contribution plan (that is, hired on or after March
           31, 1997), payments range from none for those with less than 10
           years of service, to 30 percent of the premium cost for those with
           10 years of service, plus 3 percent per year additional up to a
           maximum of 90 percent of the premium cost for those who have 30 or
           more years of service. The state also negotiated a group plan for
           long-term care insurance for active and retired workers, and their
           family members, but it is administered completely through a third
           party with no state support.
           o Oregon's other postemployment benefits for state retirees
           include group coverage for dental and vision benefits, but not
           life insurance. Long-term care insurance is also available, but
           only for some retirees. No employer contribution is provided for
           any of these benefits.

^24 In California, the state's contributions to retirees' health benefits
are equal to 100 percent of a weighted average of retiree health premiums
for single enrollees in the four basic health plans with the largest state
employee enrollment during the prior year. Employees hired before January
1, 1985, vest for the full weighted average premium contribution at
retirement after 5 years of service. Employees hired between January 1,
1985, and December 31, 1988, vest for the full weighted average premium
contribution at retirement if they have at least 10 years of service.
Employees hired after January 1, 1989, if represented (or January 1, 1990,
if unrepresented) vest for the full weighted average premium contribution
at retirement only after 20 years of service.

State and Local Law Generally Provides Legal Protections for Pensions, but Less
So for Other Retiree Benefits of Public Employees

How both pension plans and retiree health benefits are protected and
managed is typically spelled out in statutes or in local ordinances, but
these laws generally provide greater protections for pensions than for
retiree health benefits. Laws protecting pensions are often anchored by
provisions in state constitutions and local charters. Across the multiple
plans providing benefits, state and local law typically requires that
pensions be managed as trust funds and overseen by boards. In contrast,
state and local law provides much less protection for retiree health
benefits. Retiree health benefits are generally treated as an operating
expense for that year's costs on a pay-as-you-go basis and managed
together with active employee benefits.

Laws Protecting Pensions Are Often Anchored in State Constitutions and Local
Charters

State and local laws generally provide the most direct source of any
specific legal protections for the pensions of state and local workers.
Provisions in state constitutions often protect pensions from being
eliminated or diminished. In addition, constitutional provisions often
specify how pension funds are to be managed, such as by mandating certain
funding requirements and/or requiring that the funds be overseen by boards
of trustees.^25 Moreover, we found that at the sites we visited, locally
administered plans were generally governed by local laws. However, state
employees, as well as the vast majority of local employees, are covered by
state-administered plans.

Protections for pensions in state constitutions are the strongest form of
legal protection states can provide because constitutions--which set out
the system of fundamental laws for the governance of each state--preempt
state statutes and are difficult to change. Furthermore, changing a state
constitution usually requires broad public support. For example, often a
supermajority (such as three-fifths) of a state's legislature may need to
first approve changes to its constitution. If a change passes the
legislature, voters typically must approve it before it becomes part of
the state's constitution.

^25 Given the ways in which defined contribution plans differ from defined
benefit plans, these types of provisions may be less readily applicable or
relevant to them.

The majority of states have some form of constitutional protection for
their pensions. According to AARP data compiled in 2000, 31 states have a
total of 93 constitutional provisions explicitly protecting pensions.^26
(The other 19 states all have pension protections in their statutes or
recognize legal protections under common law.) These constitutional
pension provisions prescribe some combination of how pension trusts are to
be funded, protected, managed, or governed. (See table 2.)

Table 2: Constitutional Protections for Pension Benefits

Constitutional provisions                                         Numberof 
requiring                      States                               states 
Certain standards are to be in Arizona, Florida, Georgia,                  
place for how the retirement   Louisiana, Maine, Michigan,                 
system should be funded.       Mississippi, Montana, New                   
                                  Hampshire, New Mexico, North                
                                  Dakota, South Carolina, Texas, and          
                                  Virginia.                                14 
Assets in a trust fund are to  Alabama, Arizona, California,               
be for the exclusive purpose   Louisiana, Maine, Mississippi,              
of the retirement system.      Montana, New Hampshire, New                 
                                  Mexico, North Carolina, Oklahoma,           
                                  Texas, Virginia, and Wyoming.            14 
Trust fund assets are not to   Alabama, Louisiana, Maine,                  
be diverted for nonretirement  Mississippi, Montana, Nevada, New           
uses.                          Hampshire, New Mexico, North                
                                  Carolina, Oklahoma, South                   
                                  Carolina, Texas, and Virginia.           13 
Retirement system boards of    California, Montana, Nevada, New            
trustees are to be off limits  Mexico, and Texas.                          
to the legislature.                                                      5 
Participants in a retirement   Alaska, Arizona, Hawaii, Illinois,          
system have a guaranteed right Louisiana, Michigan, Missouri, New          
to a benefit, and that accrued Mexico, and New York.                       
financial benefits cannot be                                               
eliminated or diminished.                                                9 
States have investment         Indiana, Michigan, Montana,                 
authority for their retirement Nebraska, South Carolina,                   
systems.                       Washington, and West Virginia.            7 
Retirement system money is to  Arizona, California, Nevada, New            
be held in a separate trust    Mexico, and Virginia.                       
fund.                                                                    5 
Retirement benefits may be     Georgia, Nebraska, Pennsylvania,            
increased.                     Washington, and Wisconsin.                5 
A retirement system is         Louisiana, Texas, and Virginia.             
required.                                                                3 
The payment of retirement      Georgia and Oklahoma.                       
benefits is authorized.                                                  2 
Other protections are in       Mississippi, Missouri, Nebraska,            
place, such as prohibiting     and Nevada.                                 
constitutional changes to the                                              
retirement system through the                                              
initiative process.                                                      4 

^26Although the AARP study focused on pension plans for a particular group
of public employees (retired educators), our analysis revealed that the
provisions identified in all but two states were applicable to pension
plans for all state employees. (For further details about the AARP study,
see the selected bibliography at the end of this report.) In addition, we
learned that subsequent to this study, Oregon adopted a constitutional
provision in 2003 to authorize the issuance of pension obligation bonds.

Source: AARP, 2000.

  Pension Benefits, Once Accrued, Are Generally Protected

In nine states, constitutional provisions take the form of a specific
guarantee of the right to a benefit. In two of the states we visited, the
state constitution provided protection for pension benefits. In
California, for example, the state constitution provides that public plan
assets are trust funds to be used only for providing pension benefits to
plan participants.^27 In Michigan, the state constitution provides that
public pension benefits are contractual obligations that cannot be
diminished or impaired and must be funded annually.^28

The basic features of pension plans--such as eligibility, contributions,
and types of benefits--are often spelled out in state or local statute.
State-administered plans are generally governed by state laws. For
example, in California, the formulas used to calculate pension benefit
levels for employees participating in the California Public Employees'
Retirement System (CalPERS) are provided in state law.^29 Similarly, in
Oregon, pension benefit formulas for state and local employees
participating in the Oregon Public Employees Retirement System (OPERS)
plans are provided in state statute.^30 In addition, we found that at the
sites we visited locally administered plans were generally governed by
local laws. For example, in San Francisco, contribution rates for
employees participating in the San Francisco City and County Employees'
Retirement System are spelled out in the city charter.^31

27Cal. Const., art. XVI S 17.

^28Mich. Const., art. IX S 19 and 24.

^29For example, see Cal. Gov't. Code S 21353 (Deering 2007).

^30Or. Rev. Stat. S 238.300 (2005).

Legal protections usually apply to benefits for existing workers or
benefits that have already accrued; thus, state and local governments
generally can change the benefits for new hires by creating a series of
new tiers or plans that apply to employees hired only after the date of
the change. For example, the Oregon legislature changed the pension
benefit for employees hired on or after January 1, 1996, and again for
employees hired on or after August 29, 2003, each time increasing the
retirement age for the new group of employees.

For some state and local workers whose benefit provisions are not laid out
in detail in state or local statutes, specific provisions are left to be
negotiated between employers and unions. For example, in California,
according to state officials, various benefit formula options for local
employees are laid out in state statutes, but the specific provisions
adopted are generally determined through collective bargaining between the
more than 1,500 different local public employers and rank-and-file
bargaining units. In all three states we visited, unions also lobby the
state legislature on behalf of their members. For example, in Michigan,
according to officials from the Department of Management and Budget,
unions marshal support for or against a proposal by taking such actions as
initiating letter-writing campaigns to support or oppose legislative
measures.

  Pensions Are Typically Managed as Trust Funds with Board Oversight

In accordance with state constitution and/or statute, the assets of state
and local government pension plans are typically managed as trusts and
overseen by boards of trustees to ensure that the assets are used for the
sole purpose of meeting retirement system obligations and that the plans
are in compliance with the federal tax code.^32 Boards of trustees, of
varying size and composition, often serve the purpose of establishing the
overall policies for the operation and management of the pension plans,
which can include adopting actuarial assumptions, establishing procedures
for financial control and reporting, and setting investment strategy. On
the basis of our analysis of data from the National Education Association,
the National Association of State Retirement Administrators (NASRA), and
reports and publications from selected states, we found that 46 states had
boards overseeing the administration of their pension plans for general
state employees.^33 These boards ranged in size from 5 to 19 members, with
various combinations of those elected by plan members, those appointed by
a state official, and those who serve automatically based on their office
in state government (known as ex officio members). (See fig. 4.)

^31San Francisco City Charter A8.525.

^32A trust established by an employer for the exclusive benefit of its
employees, and any income it generates, is exempt from federal income tax.
26 U.S.C. S 501(a).

Figure 4: Various Interests Represented on Boards of Each State's Pension
Plan for General State Employees

Note: Percentages do not total 100 because of rounding.

Different types of members bring different perspectives to bear, and can
help to balance competing demands on retirement system resources. For
example, board members who are elected by active and retired members of
the retirement system, or who are union members, generally help to ensure
that members' benefits are protected. Board members who are appointed
sometimes are required to have some type of technical knowledge, such as
investment expertise. Finally, ex officio board members generally
represent the financial concerns of the state government.

^33The four states that do not have boards overseeing the operation and
management of their pension plans for general state employees are Florida,
Iowa, New York, and Washington. (In addition, the District of Columbia
does not have a board overseeing its pension plan for its general
employees.)

Some pension boards do not have each of these perspectives represented.
For example, boards governing the primary public employee pension plans in
all three states we visited had various compositions and responsibilities.
(See table 3.) At the local level, in Detroit, Michigan, a majority of the
board of Detroit's General Retirement System is composed of members of the
system. According to officials from the General Retirement System, this is
thought to protect pension plan assets from being used for purposes other
than providing benefits to members of the retirement system. Regarding
responsibilities, the board administers the General Retirement System and,
as specified in local city ordinances, is responsible for the system's
proper operation and investment strategy.

Table 3: Composition and Responsibilities of Boards of Primary Public
Employee Pension Plans in California, Michigan, and Oregon

                             Number of  Composition                           
                                 board  of board                              
State      Pension plan     members  members       Board responsible for   
California California            13  3 appointed   Management and control  
              Public                                  of CalPERS, including   
              Employees'                6 elected     the exclusive control   
              Retirement                              of the administration   
              System                    4 ex          and investment of the   
              (CalPERS)                 officio^a     retirement fund.^b      
Michigan   Michigan State         9  4 appointed   Administering and       
              Employees'                              managing the defined    
              Retirement                5 ex          benefit plan by making  
              System (MSERS)            officio^c     investment decisions    
                                                      and arranging for an    
                                                      actuarial valuation.^d  
Oregon     Oregon Public          5  5 appointed^e Managing the retirement 
              Employees'                              system, including       
              Retirement                              responsibilities such   
              System (OPERS)                          as arranging for        
                                                      actuarial services and  
                                                      publishing an annual    
                                                      report on the           
                                                      retirement system.      

Source: Statutes, as cited below.

aCal. Govt. Code S 20090 (Deering, 2007).

bCal. Gov't. Code S 20120 (Deering, 2007).

cMich. Comp. Laws S 38.3 (2007).

dMich. Comp. Laws S 38.2 (2007). The defined contribution plan is
administered and its assets invested by the state treasurer. Mich. Comp.
Laws S 38.9 (2007).

eOr. Rev. Stat. S 238.660 (2005).

Pension boards of trustees typically serve as pension plan fiduciaries,
and as fiduciaries, they usually have significant independence in terms of
how they manage the funds. Boards make policy decisions within the
framework of the plan's enabling statutes, which may include adopting
actuarial assumptions,^34 establishing procedures for financial control
and reporting, and setting investment policy. In the course of managing
pension trusts, boards generally obtain the services of independent
advisors, actuaries, or investment professionals.

Also, some states' pension plans have investment boards in addition to, or
instead of, general oversight boards. For example, three of the four
states without general oversight boards have investment boards responsible
for setting investment policy. While public employees may have a broad
mandate to serve all citizens, board members generally have a fiduciary
duty to act solely in the interests of plan participants and
beneficiaries. Likely at least partially because of this specific duty,
one study of approximately 250 pension plans at the state and local level
found that plans with boards overseeing them were associated with greater
funding than those without boards.^35

When state pension plans do not have a general oversight board, these
responsibilities tend to be handled directly by legislators and/or senior
executive officials. For example, in the state of Washington, the pension
plan for general state employees is overseen by the Pension Funding
Council--a six-member body whose membership, by statute, includes four
state legislators.^36 The council adopts changes to economic assumptions
and contribution rates for state retirement systems by majority vote. In
Florida, the Florida Retirement System is not overseen by a separate
independent board; instead, the pension plan is the responsibility of the
State Board of Administration, composed of the governor, the chief
financial officer of the state, and the state attorney general.^37 In New
York, the state comptroller, an elected official, serves as the sole
trustee and administrative head of the New York State and Local Employees
Retirement System..^38

^34Actuarial assumptions are assumptions as to the occurrence of future
events affecting pension costs, such as mortality, retirement, and rates
of investment earnings.

^35 Marguerite Schneider and Fariborz Damanpour, "Public Choice Economics
and Public Pension Plan Funding: An Empirical Test," Administration &
Society, vol. 34, no. 1 (2002). (For further details on this study, see
the selected bibliography at the end of this report.)

^36 Wash. Rev. Code S 41.45.100 (2007).

^37 Fla. Stat. S 215.44 (2007).

Laws Provide Less Protection for Retiree Health Benefits

In contrast with pensions, there are less likely to be statutory
protections applicable to retiree health benefits. To the extent that any
such legal protections exist, they more frequently stem from the
negotiated agreements between unions and government employers. In
addition, the cost of annual retiree health benefits typically have been
treated as an operating expense and managed together with active employee
benefits, although the benefits offered retirees may differ from those
offered active employees. Despite the general absence of a fund to manage,
retiree health programs frequently still have boards that help to
determine the terms of the health plans to be offered.

  Retiree Health Benefits Are Subject to Change

Unlike the law governing pensions, the law governing retiree health
benefits for state and local government workers generally does not include
the same type of explicit protections. To the extent retiree health
benefits are legally protected, it is generally because they have been
collectively bargained and are subject to current labor contracts.

In cases where reductions to retiree health benefits are challenged in
court, the ultimate outcome depends on the specific facts and
circumstances and the applicable state and/or local law in each
jurisdiction. In Segal's 2006 survey of over 100 state and local plans, 62
percent of respondents said that statutory or regulatory obligations
affected their ability to change retiree health coverage; 25 percent said
that retiree health coverage was subject to collective bargaining; and 17
percent said that other factors affected their ability to change retiree
health coverage.^39 In two recent cases, however, the courts have upheld
the state's right to modify retiree health benefits (see sidebar).

^38 N.Y. Const. Art. V, S 1 and N.Y. Retire. & Soc. Sec. Law SS 11 and 13
(Consol. 2007).

^39 Segal, Results of the Segal Medicare Part D Survey of Public Sector
Plans. The Segal Group, Inc., New York, N.Y.: Summer 2006. (For further
details on this survey, see the selected bibliography at the end of this
report.)

  Retiree Health Benefits Are Treated as an Operating Expense

Retiree health benefits generally have been treated by state and local
governments as an operating expense for that year's costs on a
pay-as-you-go basis. State and local governments typically do not set
aside funds while employees are working to pay their future retiree health
benefits. Moreover, retiree health benefits are mostly managed together
with active employee benefits, although the actual benefits offered to
retirees and to active employees may be different. In most cases, retiree
health benefits are administered under the state or local employee benefit
system.

Despite the general absence of a fund to manage, the administrators of
retiree health benefits may still look to boards to help determine the
health coverage to be offered. For example, in California, the same
CalPERS board that oversees the pension fund also oversees a health care
program. With respect to this health care program, the CalPERS board is
responsible for selecting insurers through which participants can receive
coverage.^40 The CalPERS board negotiates, for example, the specific
services covered, premiums, and participant co-payments. Although many
local governments participate in the CalPERS program, the City and County
of San Francisco has chosen to administer its own separate program. The
Health Service System (a city department) is responsible for administering
the benefits for both active and retired employees, with oversight from
the Health Service Board (a city board). The Health Service Board is
charged with establishing rules and regulations for the Health Service
System and for conducting an annual review of the costs for medical and
hospital care. In Oregon, the Public Employees Benefit Board, a separate
entity from OPERS, is responsible for managing the health benefits of both
active and pre-Medicare-eligible retired employees, with authority to
negotiate the terms of their coverage.^41

^40 Cal. Govt Code S 22850 (Deering 2007).

^41 Or. Rev. Stat. S 238.410 (2005).

Strategies Exist to Manage Future Pension Costs, but Not to Meet Escalating
Costs for Retiree Health Care

While state and local governments generally have strategies to manage
future pension costs, they have not yet developed strategies to fund
future health care costs for public sector retirees. We analyzed the state
and local sector's fiscal outlook with respect to the sector's ability to
maintain current retiree benefits--that is, the sector's ability to fund
its future liabilities--from two perspectives and came to similar
conclusions. First, in our simulation of the fiscal outlook for the state
and local sector, we developed projections of the likely cost of pensions
and retiree health benefits that already have been and will continue to be
earned by employees. Our simulation shows that the additional pension
contributions that state and local governments will need to make in future
years to fully fund their pensions on an ongoing basis are only slightly
higher than the current contribution rate. Our simulation also shows that
health care costs for retirees will likely rise considerably as a
component of state and local budgets, if these costs continue to be funded
on a pay-as-you-go basis. Second, we analyzed data on the funded status of
126 of the nation's largest public sector retirement systems and found
that with some notable exceptions, most are relatively well funded, but
that long-term strategies to fund future health care costs for retirees
are generally lacking.

Current Contribution Rates Are Generally on Track, but Could Still Fall Short of
Future Pension Needs

Our simulation indicates that state and local governments, in aggregate,
will need to make contributions to pension systems at a somewhat higher
rate than in recent years in order to fully fund their pension obligations
on an ongoing basis.^42 Assuming certain historical trends continue and
that there is a steady level of pension contributions in the future,
contribution rates would need to rise to 9.3 percent of salaries--less
than a half percent more than the 9.0 percent contribution rate in 2006.

Our model is based on a variety of assumptions regarding employee
contributions, future employment, retirement, wages, rates of return,
pension characteristics, and other factors. For example, our analyses
relate to defined benefit plans only. (For details on our assumptions and
our model, see app. II.) We assume that employee contribution rates to
these pension funds will remain the same, relative to wages, as in the
past. We also assume that in the future, the real rate of return on
pension assets will be about 5 percent, which is based on the real returns
on various investment instruments over the last 40 years.

^42 By "ongoing basis" we mean that pension promises continue to be made
to current and new employees, and that state and local hiring remains at a
level such that the state-local workforce, relative to the population,
remains constant. We estimated the steady level of employer contributions,
relative to wages, that would need to be made in every year between 2006
and 2050 to fully fund promised pension benefits. (For further details,
see app. II.)

Our findings regarding the required contribution to pension funds on an
ongoing basis were, however, extremely sensitive to assumptions about the
future rate of return on invested pension funds. Some economists and
financial analysts have expressed concern that returns in the future may
not be quite as high as those in the past. Future investment returns may
not match past returns because, for example, slower labor force growth may
lead to slower economic growth, which may, in turn, reduce investment
returns. Also, pension managers may choose to invest in less risky,
lower-return investments in the future. If future rates of return are more
or less in line with historic experience, then our simulation should
provide a reasonable estimate of the contribution rates that will be
needed in the future. But if future rates of return decline, then
contribution rates would need to be higher than 9.3 percent of salaries,
as indicated by our base case simulation results. (See table 4.) Moreover,
the results for individual state and local governments may vary
substantially.

Table 4: GAO Simulation of the Projected Government Contribution Level
Needed to Fully Fund the Liability for Pension Benefits for the State and
Local Government Sector, in Aggregate

                                                  Difference between the      
                         Projected government     projected ongoing           
                         contribution level       government contribution     
Simulation assumption needed to fully fund the level needed and the actual 
for the rate of       liability for pension    contribution level in 2006  
return on             benefits on an ongoing   (at 9.0 percent of          
investment^a          basis                    salaries)                   
Higher return         5.0 percent of salaries  - 4.0 percent of salaries   
scenario: 6 percent   per year                 per year                    
real rate of return                                                        
Base case: 5 percent  9.3 percent of salaries  + 0.3 percent of salaries   
real rate of return   per year                 per year                    
Lower-return          13.9 percent of salaries + 4.9 percent of salaries   
scenario: 4 percent   per year                 per year                    
real rate of return                                                        
Risk-free scenario: 3 18.6 percent of salaries + 9.6 percent of salaries   
percent real rate of  per year                                             
return                                                                     

Source: GAO simulation. For details, see appendix II.

Note: All scenarios assume prefunded pension funds across the sector.

^aAccording to NASRA's Public Fund Survey, the predominant rate of return
used by states in determining their unfunded liabilities is 8 percent.

Retiree Health Care Costs Could More than Double as a Percentage of Salaries
over the Next Several Decades

Our simulation indicates that projected costs for retiree health benefits,
while not as large a component of state and local government budgets as
pensions, will more than double as a percentage of salaries over the next
several decades, if these costs continue to be funded on a pay-as-you-go
basis. In 2006, these costs amounted to approximately 2.0 percent of
salaries, but according to our simulation, by 2050, they will grow to 5.0
percent of salaries--a 150 percent increase. The key reason for this
substantial increase is the more general rise in health care costs, which,
if left unconstrained, will continue to cause costs to rise as a
percentage of salaries.

As with the projections of necessary pension contributions, our estimates
of retiree health benefit costs are also dependent on certain assumptions,
and are particularly sensitive to assumptions about the growth in health
care costs. For example, on the basis of research and discussions with
experts, we assumed that health care costs would grow at a higher rate
than the growth in the nation's gross domestic product (GDP).^43 If health
care costs were to rise only at the same rate as GDP, then by 2050, our
projected costs would grow only from 2.0 percent to 2.9 percent of
salaries, instead of 5.0 percent. Also, because our model is based on data
that did not incorporate possible savings attributable to the Medicare
Part D drug subsidy that began in 2006, the estimates may slightly
overstate retiree health costs. However, if health care costs were to rise
more rapidly than they have over the past 35 years, then the cost of
retiree health benefits would exceed our projected costs of 5.0 percent of
salaries. (See table 5.)

^43 Through 2050, the excess cost factor we used averages 1.2 percent per
year above per capita GDP growth. By way of comparison, since the early
1970s, the excess cost factor for all medical expenditures in the economy
has averaged 1.4 percent per year above per capita GDP growth.

Table 5: GAO Simulation of the Projected Government Cost for Retiree
Health Benefits for the State and Local Government Sector, in Aggregate

                                                 Difference between the       
Simulation assumption for                     projected contribution level 
the rate of "excess cost  Projected           needed in 2050 and the       
growth" of health care    government cost for actual contribution level in 
above per capita GDP      retiree health      2006 (at 2.0 percent of      
growth                    benefits in 2050    salaries)                    
Lower health care cost    2.9 percent of      + 0.9 percent of salaries    
inflation: no excess cost salaries                                         
growth                                                                     
Base case: average of 1.4 5.0 percent of      + 3.0 percent of salaries    
percent excess cost       salaries                                         
growth through 2035,                                                       
declining to 0.6 percent                                                   
by 2050                                                                    
Higher health care cost   8.4 percent of      + 6.4 percent of salaries    
inflation: average of 2.8 salaries                                         
percent excess cost                                                        
growth through 2035,                                                       
declining to 1.2 percent                                                   
by 2050                                                                    

Source: GAO simulation. For details, see appendix II.

Note: All scenarios assume pay-as-you-go financing across the sector.

State and Local Governments Generally Have Strategies to Manage Costs for Their
Future Pension Commitments

State and local governments typically set aside funds to finance the cost
of future pension obligations and use a variety of strategies to keep the
funding status of their plans on track. Funding status is a measure that
captures a government's ongoing effort at one point in time to prefund its
future pension liability, generally expressed as the ratio of assets to
liabilities (also referred to as the funded ratio). Assessing the funding
status of public sector pension plans provides a second perspective on the
fiscal outlook of state and local government efforts to fund future
pension benefits. According NASRA's Public Fund Survey as of 2007, the
most recent reports from 126 of the largest state and local pension plans
in the country indicate that over three-fifths of the plans were at least
80 percent funded--a level generally viewed as being acceptable to support
future pension costs.^44 However, funding levels across the different
plans ranged from about 32 to 113 percent. (See fig. 5.) Those state and
local governments with plans that are funded below acceptable levels may
face tough choices in the future between the need to raise taxes, cut
spending, or reduce benefits in order to meet their obligations.

^44 A funded ratio of 80 percent or more is within the range that many
public sector experts, union officials, and advocates view as a healthy
pension system.

Figure 5: Distribution of the Funded Ratios of 126 of the Nation's Largest
State and Local Defined Benefit Pension Plans

Note: The Public Fund Survey updates its database continuously as new data
become available. Nevertheless, as of July 2007, when we accessed the
database, although most plans had reported actuarial valuations for 2005
or 2006, a small number of plans reflected earlier valuations. (For
further details, see the selected bibliography at the end of this report.)

^a Of nine plans reporting that they were 100 percent funded, eight used
the aggregate cost valuation method. Under this method, the actuarial
value of liabilities is equal to the actuarial value of assets and no
unfunded liability is identified.

  Governments Use Various Strategies to Keep Their Funding Status on Track

A primary way state and local governments keep the funding status of their
pension funds on track is to make their actuarially required
contributions. There are three sources of revenues for pension benefits:
investment earnings, employee contributions, and employer contributions.
Investment earnings provide the major source of funding (see fig. 6). The
amount that employees are required to contribute is generally fixed by
state statute as a percentage of salary, while state and local governments
determine the level of employer contributions based on their plans'
funding status--that is, the extent to which liabilities already accrued
are funded. Actuaries calculate the contribution amount needed to cover
the liability that accrues each year and to pay an installment on any
unfunded liability. If a plan sponsor (that is, a state or local
government employer) is making these actuarially required contributions,
the plan can have a funded ratio below 100 percent yet still be on track
toward full actuarial funding.

Figure 6: Cumulative Percentage Distribution of Public Pension Fund
Revenue Sources Nationwide, 1982 to 2005

Governments use various strategies to help them make their actuarially
required pension fund contributions. One strategy that governments use to
lessen the volatility of fluctuations in their actuarially required
contribution is to average the value of plan assets over a number of years
(referred to as "smoothing"). For example between 1999 and 2005,
California's contribution rate for one of CalPERS' pension plans ranged
from 1.5 percent of salaries to 17 percent of salaries. In 2005,
California began using smoothing techniques, and the contribution rate
over the last 2 years changed only slightly--from 15.9 percent of salaries
in 2006 to an estimated 15.7 percent in 2007.

Another strategy government sponsors use to control their pension fund
contribution rates is to implement new, less costly benefit levels for
newly hired employees. Plan sponsors create a new "tier," with different
benefits, for all employees hired after the date the new tier goes into
effect. For example, New York has four tiers in its State and Local
Retirement System, based on an employee's occupation and date of hire.
General employees in tier 1 (hired before July 1, 1973) can retire at age
55 after 20 years of service with no reduction for early retirement.
However, general employees in tier 3 (hired between July 26, 1973, and
September 1, 1983) must be age 62 with 5 years of service or age 55 with
30 years of service to retire with no reduction in benefit.

In addition to creating new tiers within the same pension plan, government
sponsors can also lower costs by adopting entirely new plans for future
hires. For example, Alaska recently switched from its previous defined
benefit plans to defined contribution plans for all general public
employees and teachers hired on or after July 1, 2006. According to the
state's 2006 comprehensive annual financial report, the new pension system
was adopted to help stabilize contribution rates for all public employers
within the state. Also, in 2003, Oregon adopted a new program with both a
defined benefit and a defined contribution component as its primary plan
for public employees. Under the new program, Oregon continues to provide a
defined benefit funded by employer contributions (with a lower benefit
formula for new employees), while the employees' contributions are now
placed in individual accounts with no state matching (the defined
contribution component). Oregon officials estimate that its pension
reforms save public employers over $400 million per year.

Yet another strategy plan sponsors use to manage their costs is to seek
higher contribution rates from its employees. For example, in 2005,
Louisiana enacted legislation to raise the employee contribution rate for
general state employees participating in the State Employees' Retirement
System hired on or after July 1, 2006, from 7.5 to 8.0 percent.^45

Finally, another strategy that some plan sponsors have used as part of an
overall strategy for managing pension costs is to issue bonds to reduce
their unfunded actuarial liabilities. If the interest rate on the bond is
less than the rate of return earned on pension assets, sponsors can
achieve some savings. For example, in 2005, Detroit issued $1.44 billion
in bonds to pay down the unfunded accrued actuarial liabilities of its two
retirement systems. Similarly, Oregon recently issued pension obligation
bonds to help reduce its employer contribution rate for the Public
Employees Retirement System. According to officials from Oregon's
Legislative Fiscal Office, by issuing the pension bonds, they were paying
a lower interest rate on the debt service for the bonds (about 5.75
percent) than they were currently earning on the bond proceeds. OPERS
officials said that earnings on the bond proceeds have averaged over 15
percent over the last 4 years. However, it should be noted that issuing
bonds to make the employer contribution increases the government's overall
exposure to financial risks to the extent that the bond proceeds are
invested in equities or highly leveraged portfolios for returns to exceed
the borrowing costs. Also, if rates of return were to move lower than the
bond rates, state and local governments would no longer realize an
advantage to having issued the bonds, because the rate they could earn on
the proceeds may no longer cover the debt service costs.

^45 La. Rev. Stat. Ann. 11:62 (2007).

  Failure to Maintain Acceptable Funding Levels May Place Future Taxpayers
  and/or Beneficiaries at Risk

Public pension plan funding levels are sensitive to a variety of external
influences, such as the rate of return on the funds' investments, the
annual stream of contributions to the fund, and changes to the levels of
benefits that ultimately affect future liabilities. Although strategies
are being used to keep the funding of most plans on track, we found some
notable exceptions where the failure to use such strategies caused the
funding status to drop significantly. Over time, state and local
governments could be faced with the need to raise taxes, cut spending, or
reduce benefits in order to meet their obligations.

As investment earnings are the major source of pension funding, timely
payment of contributions is key to maximizing the compound interest
earned. However, sometimes a combination of factors makes it difficult for
state and local governments to make their actuarially required
contribution, and funding levels can drop. For instance, the sharp and
prolonged decline in the stock market that occurred in the early 2000s
reduced the value of many plans' assets and increased the amount many
states and local governments needed to contribute to remain on track
toward full funding. Furthermore, to the extent state and local
governments experience slower economic growth, revenues might not keep up
with expenditures, making it difficult for the governments to meet their
funding commitments for pensions. For example, from 2001 to 2007,
Michigan's contribution rate for the State Employees' Retirement System
(MSERS) dramatically increased--from 4.7 percent to 18.1 percent of
payroll. During this period of slow revenue growth, Michigan used money
transferred from a pension fund subaccount to supplement the amount it
contributed to MSERS to make its full actuarially required contribution.
Even so, from 2002 through 2005, MSERS's funded ratio dropped steadily
from 98.7 percent to 79.8 percent.^46

In some cases, employers fell short of making their actuarially required
contributions at the same time that they adopted significant increases in
pension benefits for their employees, and did so for years. For example, a
New Jersey state treasury department official told us that in 1997, the
state viewed the status of its pension funds as "overfunded," and began
substituting "excess" pension assets for their actuarially required
contributions. The state skipped payments to the retirement plans over a
7-year period, totaling $8 billion. While in this "overfunded" position,
the state also approved costly benefit enhancements and early retirement
packages. According to the official, as a result of these enhancements and
less than prudent funding arrangements, compounded by the downturn in the
market conditions beginning in 2001, the funded ratios of several New
Jersey pension plans fell below acceptable levels. For instance, since
1999, the funded ratio of New Jersey's Public Employees' Retirement System
declined from 113.5 to 79.1 percent as of June 30, 2005. Overall, the
state now faces an $18.9 billion unfunded liability for all of its
retirement plans combined. Similarly, in San Diego, the city did not make
its actuarially required contribution to the San Diego City Retirement
System by about $80 million from 1999 through 2004. At the same time, the
city increased benefits to current employees, and in a litigation
settlement, increased benefits to current retirees. As of June 30, 2006,
the actuarial valuation report for the system stated that the funding
status had dropped from 97.3 percent in 2000 to a low of 65.8 percent in
2004, with an unfunded liability of $1.37 billion. However, as of 2006,
the system had regained ground up to 79.9 percent, with an unfunded
liability of about $1.0 billion.

Most State and Local Governments Have Yet to Develop Long-Term Strategies for
Financing Future Health Care Costs for Retirees

Most state and local governments generally lack long-term strategies to
address future health care costs. In addition, many of the governments are
still in the process of responding to the new GASB statement calling for
valuations of the liability for the future cost of other postemployment
benefits (OPEB), including health care benefits for retirees, as the
standard is being implemented in phases. Officials for the governments we
visited said that once the valuations were completed, they would consider
options for addressing these costs, if needed.

^46 When Michigan closed the defined benefit plan to new members in 1997,
new actuarial methods were adopted, such as reporting investments at their
fair market value rather than cost, and the funded ratio jumped from 91.5
to 109.0 percent. Since then, the funded ratio has been on a general
decline.

Several funding vehicles are available under the federal tax code to help
facilitate state and local government efforts to accumulate funds to meet
their future health care liabilities. (See table 6.) As noted earlier, of
the state and local governments that contribute to retiree health
benefits, most treat the cost of the benefits as an operating expense and
do not prefund the future obligation. Of the states that provide an
explicit contribution to the premiums for retiree health coverage,^47 it
has been reported that 13 partially prefund their future health care
costs.^48 But these prefunding efforts have been slow to get started. For
example, in 1989, the Connecticut Teacher's Retirement System created a
Health Insurance Premium Account, using a 1 percent of salary contribution
from active teachers to fund health benefits for retirees. The fund was
facing insolvency by 1999. To address the shortfall, in 2004, Connecticut
increased active teachers' contributions to the fund from 1 percent to
1.25 percent of salary. In Michigan, state budget officials said that they
would like to prefund retiree health care benefits for state employees,
but other state priorities have prevented them from doing so. However, a
fund was recently set up for local employees in Michigan. In 2004, the
Municipal Employees' Retirement System of Michigan created a Retiree
Health Funding Vehicle to allow municipalities to contribute to a trust
fund for retiree health benefits. As of September 2007, system officials
reported that 55 employers were participating in the program, and that the
fund had over $95 million available for retiree health care costs.^49 More
recently, in March 2007, CalPERS launched the California Employers'
Retiree Benefit Trust Fund, an investment vehicle that allows public
employers that contract with CalPERS for employee health benefits to
prefund their future OPEB costs.

^47 Employer-provided retiree health benefits include not only explicit
employer contributions (that is, those that a government previously has
identified and labeled as OPEB contributions), but also implicit employer
contributions resulting from arrangements in which the age-adjusted
premiums attributable to retirees exceed the contributions required from
the retirees, and the employer effectively pays the difference. Thus,
among those states not providing an explicit payment for a share of their
retirees' health insurance premiums, some may still incur implicit costs
that are to be included in their calculation of their annual costs and
long-term obligations for OPEB under GASB standard 45. According to GASB,
"In health insurance plans where a government's retirees and current
employees are insured together as a group, the premiums paid by the
retirees may be lower than they would have been if the retirees were
insured separately--this is called an implicit rate subsidy." GASB adds,
"Implicit rate subsidies should be included by governments . . . as OPEB."

^48 Survey conducted by Credit Suisse, Americas United States/Equity
Research, 2007. (For further details on this study, see the selected
bibliography at the end of this report.)

Table 6: Different Vehicles for Prefunding Retiree Health Costs

Section of the                                                             
Internal Revenue Code Vehicle description                                  
501(c)(9)             Voluntary Employees' Beneficiary Association (VEBA): 
                         A tax-advantaged exempt entity, usually a trust, for 
                         the benefit of a voluntary membership of active and  
                         retired employees, and from which tax-free           
                         distributions may be made for qualifying health care 
                         expenses of retirees.                                
401(h)                Health benefits subaccount: A separate subaccount of 
                         a defined benefit pension trust that allows up to 25 
                         percent of the total employer contribution to the    
                         pension fund to be allocated to retiree health       
                         benefits. Investment income on assets in the         
                         subaccount accumulates tax free, and retiree health  
                         benefit payments made from the subaccount are not    
                         taxable to retirees.                                 
115                   Governmental trust: A trust established by a         
                         governmental employer to fund an essential           
                         government function, which may include providing     
                         retiree health benefits. Contributions to the trust  
                         are not limited, unlike contributions to a VEBA or   
                         health benefits subaccount. The investment income on 
                         the trust is not taxed, and the benefits ought to be 
                         tax free to the retiree when received, with          
                         confirmation from the Internal Revenue Service.      

Source: Internal Revenue Code and Congressional Research Service, 2006.

At the sites we visited, state and local government officials we spoke
with said that the rising cost of health care was one of the biggest
fiscal challenges confronting them in the near term. They said the drivers
of their health care costs mirror those of the nation as a whole: rapidly
escalating costs for prescription drugs, medical care, and hospital care.
Further, they noted that the health care industry's practice of shifting
costs not paid by the Medicare and Medicaid programs to employers is
causing employers' costs for health insurance premiums to rise even
faster. In addition to the costs associated with providing health care
benefits for their active and retired workers, states also must contend
with rising costs for their uninsured residents and federal changes to
Medicaid. Officials who administer health benefits for California state
and local governments noted that much of the cost increase for the health
care market is due to health care inflation and demographic factors that
are outside of their control. At the same time, with respect to health
care, there are also factors that are within their control to help manage
these costs, such as their program's benefit design and eligibility
criteria.

^49Additionally, the Municipal Employees' Retirement System of Michigan
offers a health care savings program from the same trust fund. This
employer-sponsored program provides tax-favored individual medical savings
accounts for tax-free reimbursement of postemployment medical expenses,
including health insurance premiums. According to system officials, as of
September 2007, this program had over 75 enrolled employers (representing
over 2,000 employees) and about $10 million invested.

Aside from prefunding through establishment of a trust, several states
have taken steps to address escalating costs of retiree health benefits by
negotiating lower premium costs and/or reducing benefits. For example, as
in the private sector, some public employers have negotiated lower
premiums by increasing the deductibles, co-payments, and coinsurance that
employees must pay out of pocket. In addition, several states have
introduced requirements that employees must work a certain number of years
before becoming eligible for various levels of retiree health benefits.
California introduced such vesting requirements for partially paid retiree
health benefits for workers hired in 1985 and thereafter; and Michigan
introduced similar requirements in 1997. In 2006, North Carolina enacted
legislation requiring that employees hired after February 1, 2007, must
have 20 years of service to be eligible for retiree health benefits.^50
Other states have reduced the benefits provided and/or instituted health
savings accounts. Oregon has discontinued its retiree health care support
for those hired since 2003. Also, to reduce state costs, Utah recently
discontinued its policy of providing retirees a month of health insurance
for every day of unused sick leave (a policy initiated when health
insurance costs were substantially lower). Instead, Utah now deposits wage
amounts equal to unused sick leave into health savings accounts that
retirees can use to purchase their own health insurance.

State and local governments indicated that they may take a range of
actions in response to the new GASB standards. At the locations we
visited, all the officials we spoke with said that their governments were
planning to comply with the new standards and report their liability for
retiree health benefits. However, while various options were being
discussed, none of the officials we spoke with said that their governments
had developed plans to address their unfunded liabilities. In California,
for example, the governor had established a 12-member Public Employee
Post-Employment Benefits Commission to propose ways to address the state's
growing postemployment benefits and retiree health care obligations, with
a recommended plan due by January 1, 2008. According to Oregon retirement
system officials, their state had also formed a workgroup to study options
related to GASB 45. In Detroit, the city budget director said that city
officials would wait to find out if any practices emerge that gain wide
support before deciding their next steps. San Francisco is also taking a
wait-and-see approach with respect to devising a strategy for dealing with
the unfunded liability. A senior city official said that the city wants to
have several years' experience estimating the unfunded liability to feel
confident that the estimates are valid before negotiating any remedies
with the unions. Otherwise, he noted, if the costs end up being greater
than anticipated, it could be difficult to reopen negotiations with the
unions and the city would then have to deal with the greater costs on its
own.

^50 N.C. Gen. Stat. S 135-40.2(a)(2) (2007).

Concluding Observations

Across the state and local government sector, the ability to maintain
current levels of public sector retiree benefits will depend, in large
part, on the nature and extent of the fiscal challenges these governments
face in the years ahead. While public sector workers have thus far been
relatively shielded from many of the changes that have occurred in the
private sector, provisions that lend stability for public sector pensions
and retiree health benefits are subject to change. Pension benefits are
often protected by state constitutions and city charters, but these
protections can be amended if voters feel the need to rebalance priorities
as fiscal pressures increase. In fact, our recent work on state and local
government fiscal conditions indicated that persistent fiscal challenges
will likely emerge within the next decade. Retiree health benefits are
generally easier to change simply through the annual budget process.

As we heard from some state officials, the impetus for changing retiree
benefits often surfaces when the projected costs for these benefits starts
to grow faster than expected. When this occurs, governments may eventually
have little choice but to reduce future benefits or raise taxes. One way
state and local governments can address unexpected gaps in funding is to
prefund the promised benefits. Even though our simulation suggests that
the sector as a whole is generally on track with funding its pension
obligations, continued diligence will be necessary to ensure that funding
is adequate in the future. When state and local governments take breaks
from their regular contribution schedules, such as when investment returns
are high, they may be putting their ability to pay future retiree benefits
at risk. According to our simulation for state and local governments, to
ensure that they have the resources they need to meet future costs, they
will have to maintain (and as a sector, increase slightly) their
contributions to their pension funds. Moreover, our long-term projections
indicate that if future returns turn out lower than expected, governments
may need to ratchet up their contributions substantially.

The provision of retiree health benefits presents an entirely different
scenario. Given that our simulations show that over the next several
decades, the cost of providing health care benefits for public sector
retirees will more than double as a share of salaries, state and local
governments may find it difficult to maintain current benefits levels. It
is clear from our model and from discussions with budget officials that
health care inflation is driving these future costs. Budget officials with
whom we spoke said that they will face challenges financing future health
care benefits in general--including Medicaid benefits and health benefits
for active government employees, not just for their retirees. As state and
local governments begin to comply with GASB reporting standards,
information about the future costs of the retiree health benefits will
become more transparent. Policy makers, voters, and beneficiaries can use
this new information to begin a debate on ways to control escalating
health care costs, the appropriate level of future benefits to be provided
to public sector retirees, and who should pay for them.

Agency Comments

We provided officials from the Internal Revenue Service with a draft of
this report. These officials provided us with informal technical comments
that we have incorporated in the report, where appropriate. In addition,
we provided GASB officials and officials from the states and cities we
visited with portions of the draft report that addressed aspects of the
pension funds and retiree health benefit programs in their jurisdictions.
They, too, provided us with comments that we incorporated in this report,
where appropriate. Finally, we also benefited from comments provided by
two external reviewers knowledgeable about the subject area.

As agreed with your office, unless you publicly announce the contents of
this report earlier, we plan no further distribution until 30 days from
the report date. At that time, we will send copies of this report to
relevant congressional committees, the Acting Commissioner of Internal
Revenue, and other interested parties. We will also make copies available
to others

upon request. In addition, the report will be available at no charge on
the GAO web site at [56]http://www.gao.gov . If you or your staff have any
questions concerning this report, please call me at (202) 512-7215. Key
contributors are listed in appendix V.

Barbara D. Bovbjerg
Director, Education, Workforce, and Income Security Issues

Appendix I: Organizations, Associations, and State and Local Agencies
GAO Contacted

National Level

AARP (formerly, American Association of Retired Persons)
American Federation of Labor and Congress of Industrial Organizations (AFL-CIO)
American Federation of State, County and Municipal Employees
American Federation of Teachers
Employee Benefit Research Institute
Fitch Ratings, credit rating firm
Governmental Accounting Standards Board
Gabriel, Roeder, Smith & Company, consulting firm
International Association of Fire Fighters
International Brotherhood of Teamsters
Lussier, Gregor, Vienna, & Associates, Inc., consulting firm
Moody's Investors Service, financial research firm
National Association of State Auditors, Comptrollers and Treasurers
National Association of State Budget Officers
National Association of State Retirement Administrators
National Conference of State Legislatures
National Conference on Public Employee Retirement Systems
National Coordinating Committee for Multiemployer Plans
National Education Association
Pew Center on the States
The Segal Company, consulting firm
Service Employees International Union
Standard & Poor's, credit rating firm

State and Local Level

  California State

California Legislative Analyst's Office
California Public Employees' Retirement System
California State Controller's Office
California State Association of County Retirement Systems

  California Local

Alameda County Employees' Retirement Association
Los Angeles County Employees Retirement Association
Orange County Retirement System
Sacramento County Employees' Retirement System
San Francisco Office of the Controller
San Francisco Employees' Retirement System
San Francisco Health Service System
San Joaquin County Employees' Retirement System

  Michigan State

Michigan Department of Civil Service
Michigan Office of the Auditor
General Michigan Office of Retirement Services
Michigan Office of the State Budget
Michigan Senate Fiscal Agency
Municipal Employees' Retirement System of Michigan

  Michigan Local

Detroit Budget Department
Detroit Finance Department, General Retirement System
Detroit Finance Department, Policemen and Firemen Retirement System
Detroit Human Resources Department
Detroit City Council, Fiscal Analysis Division
Detroit Office, American Federation of State, County and Municipal
  Employees (Council 25)
Detroit Office of the Auditor General

  Oregon State

Oregon, American Federation of State, County and Municipal Employees
  (Retirees Local 155)
Oregon Department of Administrative Services, Budget and Management
  Division
Oregon Department of Administrative Services, State Controller's Division
Oregon Education Association Oregon
Legislative Fiscal Office
Oregon Office of the Secretary of State, Audits Division
Oregon Public Employees' Benefit Board
Oregon Public Employees Retirement System
Oregon State Legislature, Office of the Legislative Counsel

Appendix II: Technical Background on Pension and Retiree Health
Care Simulations

One of the primary costs of state and local governments is the salaries
and benefits of employees, and part of those costs are the pensions and
other postemployment benefits of retirees of state and local governments.
This appendix provides information on the development of simulations of
future pension and health care costs for retirees of state and local
governments. These analyses are part of a larger GAO effort that examines
the potential fiscal condition of the state and local sector for many
years into the future,^1 and are an aggregate analysis of the entire state
and local sector--no individual governments are examined. This appendix
provides information on (1) the development of several key demographic and
economic factors such as future employment, retirement, and wages for the
state and local workforce that are necessary for the simulations of future
pension and retiree health care costs; (2) how we project the necessary
contribution rate to pension funds of state and local governments; and (3)
how we project the future yearly pay-as-you-go costs of retiree health
benefits.

Development of Factors for Employment, Retirement, Wages, and Benefits

Key underlying information for the pension and health care cost
simulations relates to future levels of employment, retirees, and wages.
In particular, to understand the postretirement promises that the sector
has and will continue to make, we need to project the number of employees
and retirees in each future year, as well as the dollar value of pension
benefits that will be earned and the extent to which those benefits will
be funded through employee contributions to pension funds.^2 These
analyses relate to defined benefit plans only. We project the following
key factors for each year during the simulation time frame: (1) the number
of state and local government employees, (2) the state and local
government real wages, (3) the number of pension beneficiaries, (4)
average real benefits per beneficiary, and (5) yearly employee
contributions to state and local government pension plans.

1. Steps to Project Future Employment Levels

Future growth in the number of state and local government retirees--many
of whom will be entitled to pension and health care benefits--is largely
driven by the size of the workforce in earlier years. To project the level
of employment in each future year, we assume that state and local
employment grows at the same rate as total population under the
intermediate assumptions of the Old-Age and Survivors Insurance and
Disability Insurance (OASDI) Trustees.^3 The implication of these
assumptions is that the ratio of state and local employment to the total
population remains constant.^4 The Trustees assume that population growth
gradually declines from 0.8 percent during the next decade to a steady
rate of 0.3 percent per year beginning in 2044. Accordingly, state and
local government employment displays the same pattern in our projections.
The relationship used to project total state and local government
employment (egslall) is shown in equation 1:

^1 GAO, State and Local Governments: Persistent Fiscal Challenges Will
Likely Emerge within the Next Decade,  [57]GAO-07-1080SP (Washington,
D.C.: July 18, 2007).

^2 The estimated cost of health care expenditures is described later in
this appendix.

                         np
1) egslall  = egslall    __t    
          t          t-1 np
			                  t-1

where: np is population in the indicated year

egslall is the number of state and local employees in the indicated year

2. Steps to Project Future State and Local Government Real Wage

The pension benefits that employees become entitled to are a function of
the wages they earned during their working years. As described below, we
developed a rolling average real wage index for different cohorts of
workers to estimate the average real pension benefit of the recipient pool
in each future year.

^3 See The 2007 Annual Report of the Board of Trustees of the Federal
Old-Age and Survivors Insurance and Disability Insurance Trust Funds.
Washington, D.C.: May 1, 2007, Table A2.

^4 This assumption implies that if there were no growth in the
productivity of state and local workers, the output of services per person
served would remain the same. As such, any increased growth in services
provided per citizen hinges on the degree to which productivity in public
sector services advances.

First, we assume that the real employment cost index for the state and
local sector (jecistlcr) will grow at a rate equal to the difference
between the Congressional Budget Office (CBO) assumptions for the growth
in the employment cost index (ECI) for private sector wages and salaries
and inflation as measured by the consumer price index for all urban
consumers (CPIU), as published in the January 2007 CBO Budget and Economic
Outlook. These data are available through 2017. For later years, we hold
the growth rate constant at the rate that CBO assumes between 2016 and
2017.

CBO's assumptions for growth in the ECI and the CPIU are 3.3 percent and
2.2 percent per year respectively, implying a real wage growth of 1.1
percent per year during the simulation time frame. Since the analysis is
scaled to the real wage bill over the simulation time frame, we calculate
that aggregate amount for each future year. As shown in equation 2,
aggregate real wages are assumed to grow at the combined rate of growth in
the real employment cost index (jecistlcr) and employment (egslall).

                                   jecistler - egslall
                                            t         t
2) gsclwageallr  = gsclwageallr    ____________________
               t			       t-1
                                   jecistler    - egslall
                                            t-1          t-1		

where: jecistler is the real employment cost index in a given year

       gsclwageallr is the real wage bill of the state and local sector

As noted previously, population growth slows from 0.8 percent in the
upcoming decade to a steady rate of 0.3 percent after 2044. Because
population growth drives employment in our projections, this slowdown
implies that aggregate real wage growth slows from 1.9 percent per year to
a steady long-run rate of 1.4 percent.

3. Steps to Project Growth in the Number of Pension Beneficiaries

While actuaries use detailed information and assumptions regarding the
age, earnings, service records, and mortality rates applicable to the
entities they evaluate, information in such detail is not available for
the state and local government sector as a whole. This lack of detailed
data necessitated the development of a method of projecting aggregate
state and local beneficiary growth that is much simpler than the methods
that actuaries employ.

The method we developed reflects the logic that each year's growth in the
number of beneficiaries is linked to past growth in the number of
employees. Total state and local government employment from 1929 through
2005 was obtained from the National Income and Product Accounts (NIPA)
tables 6.4a, b, c, and d. The Census Bureau provided a continuous series
of data on the number of state and local pension beneficiaries from 1992
through 2005 during which continuous observations were available.

Cyclical swings in the employment series were removed using a
Hodrick-Prescott filter. Then, both the employment and beneficiary series
were logged and first-differenced, transforming the data from levels to
proportionate changes. We developed a routine that searched across 45
years of lagged employment growth to select a set of weights for the years
in which past employment growth best explained a given year's growth in
beneficiaries.^5 The routine included the restrictions that the weights
must be non-negative and sum to 1. The method produced the relationship
shown in equation 3, where beneficiaries is equal to the state and local
pension benefit recipients, eglsall is state and local employees, and the
coefficients are weights, derived from the estimation, that reflect the
contribution of a particular past year's employment change in explaining a
given year's change in retirees. In particular, the estimated relationship
suggests that beneficiary growth in a given year is largely determined by
employment growth 34, 21, 22, and 23 years prior to the given period. This
pattern appears consistent with the categories of workers that the sector
employs. Many fire and police positions, for example, offer faster pension
accrual or early retirement due to the physical demands and risks of the
work, while many other state and local workers have longer careers.

3)(egslalld.)(egslalld.)ries(beneficiadt-t-t-t-t21222334log230log190log020log560log )3++

d log(beneficiaries ) = 0.56 d log (egslall    ) + 0.02 d log (egslall    )
                   t                       t-34                       t-23   


+ 0.19 d log (egslall    ) + 0.23 d log (egslall   )
                     t-22                       t-21

where: beneficiaries is the number of retirees receiving pensions in the
indicated year.

^5 The Excel Solver function was used to find the weights that minimized
the sum of the squared residuals between actual and fitted beneficiaries.

4. Steps to Project Real Benefits per Beneficiary

While, in the long run, the average real benefit level should grow at the
same rate as real wages--that is, at 1.1 percent per year--in the first
decades of the projection the average real benefit will be affected by
real wage changes that occurred before the projection period. Accordingly,
we developed a relationship that reflects how the average real benefit
level will change over time according to changes in the number and average
real benefit level of three subsets of the retiree population: (1) new
retirees entering the beneficiary pool, (2) new decedents leaving the
pool, and (3) the majority of the previous year's retirees who continue to
receive benefits during the given period. Each group's real benefit is
linked to the real wage level in the average year of retirement for that
group. Thus, to determine the average real benefit overall in any future
year, we need weights and real wage indexes for the three groups that can
be used to develop a rolling average real wage of the recipient pool in
each future year.

Equation 3 above projects the percentage change in the total number of
beneficiaries between two successive years, but this difference is
actually composed of two elements: the percentage change in new retirees
minus the percentage change in decedents. Therefore, to determine the
weight for new retirees, we also need an estimate of the number of new
decedents in each year. In order to estimate a "death rate," we utilize
Social Security Administration data on terminated benefits^6 and total
OASDI recipients, which excludes disability recipients.^7 Our estimate of
the "death rate" for the forecast period is assumed to be equal to the
number of terminated Social Security recipients divided by the total
number of OASDI recipients in 2003 (3.67 percent). This analysis then
enables a derivation of weights for each of the three groups as follows:

           o weight for new retirees: the number of beneficiaries this year,
           less the number of beneficiaries last year who are still alive,
           divided by the number of beneficiaries this year (W   )
                                                              N,t

           o weight for continuing recipients is equal to last year's
           beneficiaries divided by this year's beneficiaries (W[C,t])

           o weight for the deceased is the death rate (3.67 percent)
           multiplied by last year's beneficiaries divided by this year's
           beneficiaries (W[D,t])

^6See Annual Statistical Supplement to the Social Security Bulletin, 2005
(Washington, D.C.: February, 2006), T [58]able 6.F1: Number of benefits
terminated, by type, 1940-2004 .

^7 See Annual Statistical Supplement to the Social Security Bulletin, 2005
(Washington, D.C.: February, 2006) Table 5.A4 Number and total monthly
benefits, by trust fund and type of benefit, December 1940-2004, selected
years .

Mathematically the weights are calculated as follows:

4a) Wn,t equals (beneficiaries[t] minus (1 minus .0367)beneficiaries[t-
1]) divided by beneficiaries[t]; 
Wc,t equals beneficiaries[t-1] divided by beneficiaries[t]; 
Wd,t equals .0367 times beneficiaries[t-1] divided by beneficiaries[t]. 

Next, we need to identify the real employment cost index that determines
the real benefit level for each of these three groups. We do so by
estimating the average retirement year applicable to each of the three
groups. First, we assume the average retirement age is 60. We developed
this estimate based on an analysis of the March Supplement to the Current
Population Survey (CPS) for 2005-2006, which indicated that the average
state and local government retiree had retired at 60 years of age. We also
analyzed detailed data on the age distribution of OASDI recipients
provided by the Office of the Actuary of the Social Security
Administration. These data showed that the average age for new decedents
is about 81 during the initial years of OASDI's simulations, and we thus
used a 21-year lag--81 minus 60--to estimate the real wage applicable to
this group. For the newly retired group, we use the current year's
employment cost index. For the remaining retirees--those already retired
and remaining in the group--we use information from CPS for 2005 that
indicated that the average age of a retired state or local retiree was 68.
Therefore, we apply an 8-year lag to the real employment cost index to
determine real benefits of this group.

Using the weights shown in equation 4a and the appropriate periods' values
for the real employment cost index (jecistlcr), the rolling average
jecistlcr is constructed as follows:

[See PDF for equation] 

4aa) (Wn,t jecistlcr[t] plus Wc,t jecistlcr[t-8] minus Wd,t jecistlcr[t-
2] equals wjecistlcrt:

where: wjecistlcr is the rolling average employment cost index for 
retirees in year t. 

This equation approximates the average employment cost index at retirement
of the retiree pool in a given year. To do this we take the employment
cost index 8 years prior to the given year and weight this by the portion
of the total retirees in the given year who were already retired last
year. We add to this a factor to account for new retirees who have a
higher employment cost index because they just retired. Finally, because
some of the retirees from last year have deceased, the first factor
overstates the number of retirees, and therefore we subtract a factor for
those who have died, weighted by the cost index 21 years ago, when, on
average, this group entered retirement.

The ratio of the given year's weighted average real wage index to the
previous year's weighted average real wage index should equal the ratio of
the current to the previous year's average real benefit levels. Thus, as
shown in equation 4b, a given year's average real benefit level grows at
the same rate as the rolling index of real wages. The relationship has the
desired property of capturing the effect of historical real wage growth in
the initial decades of the projection before converging to a long-run
average annual growth rate of 1.1 percent, which is consistent with our
assumption for real wage growth. To calculate aggregate real pension
benefit payments penbenr, the average real benefit derived using equation
4b is multiplied by the number of beneficiaries projected using equation
3.

[See PDF for equation] 

4b) penbenr[t] divided by beneficiaries[t] equals penbenr[t-1] divided 
by beneficiaries[t-1]times [(Wn,t jecistlcr[t] plus Wc,t jecistlcr[t-8] 
minus Wd,t jecistlcr[t-21]) divided by (Wn,t jecistlcr[t-1] plus Wc,t 
jecistlcr[t-9] minus Wd,t jecistlcr[t-22])].

5. Steps to Project Employee Contributions to Pension

Employee contributions represent an important funding source for state and
local government pension plans. In 2006, for example, NIPA data indicate
that employees contributed 4.7 percent of their wages and salaries to
their retirement funds. To estimate future employee contributions, we
simply assume that the 2006 contribution level is held constant as a share
of aggregate wages (see equation 5).

[See PDF for equation] 

5) eeconpenr[t] divided by glscwageallr[t] equals eeconpenr[t-1] 
divided by glscwageallr[t-1]. 

where: eeconpenr is the real aggregate employee contribution to pension
funds

Projections of Necessary Contributions to Pension Funds for State and Local
Government Sector

The purpose of the pension simulations is to estimate the level of
contribution that state and local governments would need to make each year
going forward to ensure that their pension systems are fully funded on an
ongoing basis. In the previous section we calculated a variety of critical
demographic and economic factors that are necessary for this analysis. In
the following section, we describe our basic formulation and sensitivity
analysis for employer contributions to pension funds.

Basic Formulation of Necessary Steady Level of Employer Contributions

The necessary contribution rate can now be derived according to a simple
concept: the present value of future pension benefits minus the sum of
2006 pension fund financial assets and the present value of employee
contributions, all divided by the present value of future wages. The
starting value of pension assets for state and local government pension
plans--approximately $2.979 trillion in 2006--is obtained from the Federal
Reserve Flow of Funds Accounts. Future wages are simulated within our
model. The logic of this estimation is that the benefits that are promised
to employees (including liabilities already made and promises that will be
made in the future) must be paid from three sources: existing pension
funds in 2006, contributions that employees will continue to make to those
funds in the future, and contributions that employers will make to those
funds in the future.

Our analysis estimates the steady level of employer contribution, relative
to wages, that would need to be made in every year between 2006 and 2050
to fully fund promised pension benefits. Although we are only interested
in developing necessary contribution rates over the simulation time
frame--that is, until 2050--we actually have to derive the contribution
rate for a longer time frame in order to find the steady state level of
necessary contributions. This longer time frame is required because the
estimated contribution rate increases as the projection horizon increases
and eventually converges in a steady state. If the projection period is of
insufficient length, the steady level of contribution is not attained and
the contribution rate necessary is understated.^8 As such, all of the
flows in the calculation extend 400 years into the future. We use a real
rate of return on pension assets of 5.0 percent (rpenreal) to discount
future flows when deriving present values.^9 Equation 6 shows
mathematically the estimate of the employer contribution rate.

[See PDF for equation]

where: rpenreal is the real rate of return on pension assets

^8 Pension funds hold substantial assets, amounting to $3.0 trillion at
year-end 2006. Because the calculation we make implies that all assets are
used to pay benefits, the estimated contribution rate would be negative
over short intervals. But, in fact, some of the assets already in the
pension funds are related to liabilities that will not be paid for many
years into the future. As the time horizon increases, the present value of
liabilities grows relative to assets, resulting in an increase in the
estimated contribution rate. When the projection horizon lengthens
sufficiently, however, the contribution rate stabilizes. That is, at some
point there is virtually no difference in contribution rates estimated
over successively longer projection periods. A 400-year projection horizon
is long enough to provide an estimated contribution rate invariant to
further increases in the projection period. The result is an estimate of
the contribution rate necessary to fund pension payments on a sustainable
basis.

^9 When evaluating state and local government pensions, standard practice
is to use a discount rate based on the expected rate of return on pension
fund investments. To develop a measure of the expected pension return, we
analyzed data from Flow of Funds Accounts table L.119 (State and Local
Employee Government Retirement Funds.) We calculated each asset category's
annual share of total fund assets and assigned a rate of return to each
category. The asset groups included money-like assets (sum of checkable
deposits and currency, time and savings deposits, money market mutual
funds, and repurchase agreement securities), open market paper, Treasury
securities, agency- and government-sponsored enterprise-backed securities,
municipal securities, corporate and foreign bonds, mortgages, corporate
equities, mutual fund shares, and other miscellaneous assets. Although
data are available beginning in 1952 for pension fund assets, yields for
all of the asset categories are only available starting in 1965.
Accordingly, for each year from 1965 through 2005 we calculated the
weighted average nominal return by summing the product of each asset's
share and its return. Factoring out each year's CPIU increase provides an
estimate of the real pension fund return. Because there has been a
long-term shift in pension fund portfolios away from fixed assets toward
equities, the average real return over this period is not representative
of likely future returns. To find an estimated real pension yield more
representative of the recent composition of retirement fund investments,
we used the average asset shares during the most recent 10-year period as
portfolio weights. Multiplying these 10-year weights by each asset
category's average real return over the entire period from 1965 through
2005 and summing the products results in an estimated real pension return
of 5.0 percent. In our base case, therefore, we use a real discount rate
(rpenreal) of 5.0 percent to find the present value of future cash flows.

Applying this analysis, we found that in aggregate, state and local
government contributions to pension funds would need to increase by less
than half a percent to fund, on an ongoing basis, the pension liabilities
they have and will continue to accrue. In particular, the 2006 pension
contributions for the sector amounted to 9 percent of wages, and our base
case estimate is that the level would need to be 9.3 percent each year to
fully fund pensions.

Sensitivity Analyses of Necessary Steady Level of Employer Contributions

We altered certain of our assumptions to examine the sensitivity of our
model results. We found that the model results are highly sensitive to our
assumptions regarding the expected real yield. For our primary
simulations, we based the expected real yield on actual returns on various
investment instruments over the last 40 years as well as the disposition
of the portfolio of assets held by the sector over the last 10 years. This
generated a real yield of 5 percent. But some pension experts have
expressed concern that returns on equities in the future may not be quite
as high as those in the past. In fact, some analysts believe that an
analysis of this type should consider only "riskless returns." Under such
an approach we would assume that all pension funds are invested in very
safe financial instruments such as government bonds. We estimated the
necessary steady level of employer contributions holding all elements in
the model stable except the real expected yield. In particular, we
analyzed a 4 percent real yield and a 3 percent real yield--that latter of
which is a reasonable proxy for a riskless rate of return. We found that
if returns were only 4 percent, the necessary contribution rate would rise
to 13.9 percent, and if we used a risk-free return of roughly 3 percent,
the necessary contribution rates would need to be much higher--nearly 18.6
percent of wages. On the other hand, if real returns were higher than our
base case level--perhaps 6 percent--the necessary contribution rate would
only be only 5.0 percent, much lower than their current contribution rate.

Projections of Retiree Health Benefit Costs for State and Local Retirees

Most state and local government pay for retiree health benefits on a
pay-as-you-go basis--that is, these benefits are generally not prefunded.
We made projections of the pay-as-you-go cost of retiree health benefits
for the sector, as a percentage of wages, in each year until 2050. To
estimate the costs of retiree health benefits in future years, we made
many of the same assumptions as for the pension analysis. In particular,
we use the same method to develop projections of employment in the sector,
the number of retirees, and the level of wages. An additional assumption
for the health care analysis is that in future years, the same percentage
of retirees of state and local governments will be enrolled in health
insurance through their previous employer as we observe were enrolled in
2004--the most recent year for which data were available. To develop this
measure, we use data from two sources. The Census Bureau's State and Local
Government Employee-Retirement System survey provided data on the total
number of state and local retirees, and the Health and Human Services
Department's Medical Expenditure Panel Survey provided data on state and
local government retirees who are covered by prior employer-provided
health insurance. On the basis of these data sources, we found that the
share of retirees with health insurance is 42 percent, and we hold this
constant through the simulations. From the latter data source we also
obtain the most recent year state and local government spending on health
care for retirees.

One of the most central assumptions we must make to estimate the
pay-as-you-go health care costs for retirees in future years is the cost
growth of health insurance. The cost of health care has been growing
faster than gross domestic product (GDP) for many years. As such, we
developed assumptions about how much faster health care costs would grow,
relative to the economy, in future years. The extent to which the per
person cost of health care is expected to grow beyond GDP per capita is
called the "excess cost factor." We developed these estimates based on our
own research and discussions with experts. In particular, we assume that
the excess cost factor averages 1.4 percentage points per year through
2035, and then begins to decline, reaching 0.6 percentage points by 2050.

Using these assumptions, we develop a growth projection for the per capita
costs of health care for retirees each year through 2050. The following
equation shows that health care costs are assumed to grow with GDP per
capita plus this excess cost factor.

7) (retgslchlth / rethlth ) = (retgslchlth (-1) / rethlth (-1)) *

(hlthnheexcgr) * ((gdp / np) / (gdp (-1) / np (-1)))

where: retgslchlth is the aggregate health care cost for the sector

rethlth is the number of retirees with health insurance

hlthnheexcgr is the excess cost factor for health insurance

We found that the projected costs for retiree health benefits, while not a
large component of state budgets, will more than double as a percentage of
wages over the next several decades. In 2006, these costs amounted to
approximately 2.0 percent of wages, and we project that by 2050, they will
grow to nearly 5.0 percent of wages--a 150 percent increase. As with the
projections of necessary pension contributions, our estimates of retiree
health benefit costs are highly sensitive to certain of our assumptions.
In particular, the assumptions regarding health care cost growth are
critical. For example, if health costs were to only rise at the rate of
GDP per capita, these costs would only grow, as a percentage of wages,
from 2 percent today to 2.9 percent by 2050. Conversely, if health costs
were to grow by twice the rate we assume in the base case, these costs, as
a percentage of wages, would constitute 8.4 percent by 2050.^10

10Because our state and local government retiree health care cost
estimates are based on data that did not incorporate possible savings
attributable to the Medicare Part D drug subsidy that began in 2006, the
estimates may overstate retiree health slightly.

Appendix III: State and Local Government Retiree Benefit Plans in
California, Michigan, and Oregon

CALIFORNIA                                                                                                    
State and local government workers
Total number (2006)^a                                      2,199,700                                          
o State workers                                           473,500                                          
o Local workers                                         1,726,200                                          
Percentage covered by unions (2005)^b                          57.5%                                          
Percentage participating Social Security (2004)^c              42.0%                                          
State-administered      Approximately 81% of all state and                                                    
plans (6 total)^d       local workers statewide^e                                                             
(1) CalPERS Public         o Safety (law enforcement,      1,490,172     1,545 CalPERS                        
Employees' Retirement      correctional officers, and                          health care                    
Fund                       firefighters)                                       program                        
                           o Schools (nonteaching                              provides                       
                           employees)                                          coverage to                    
                           o State industrial (non-sworn                       state                          
                           correctional employees)                             employees,                     
                           o Miscellaneous (all others)                        retirees,                      
                                                                               and their                      
                                                                               families, by                   
                                                                               law. In                        
                                                                               addition,                      
                                                                               most local                     
                                                                               public                         
                                                                               agencies and                   
                                                                               school                         
                                                                               employers                      
                                                                               can contract                   
                                                                               to have                        
                                                                               CalPERS                        
                                                                               provide                        
                                                                               these                          
                                                                               benefits to                    
                                                                               their                          
                                                                               employees                      
                                                                               (whether or                    
                                                                               not they                       
                                                                               contract for                   
                                                                               CalPERS                        
                                                                               retirement                     
                                                                               program). As                   
                                                                               of 2006,                       
                                                                               1,137                          
                                                                               entities                       
                                                                               participated                   
                                                                               in the                         
                                                                               program.                       
                                                                               Health plans                   
                                                                               offered,                       
                                                                               covered                        
                                                                               benefits,                      
                                                                               monthly                        
                                                                               rates, and                     
                                                                               co-payments                    
                                                                               are                            
                                                                               determined                     
                                                                               by the                         
                                                                               CalPERS                        
                                                                               Board, which                   
                                                                               reviews                        
                                                                               health plan                    
                                                                               contracts                      
                                                                               annually.                      
                                                                               Employers                      
                                                                               make a                         
                                                                               contribution                   
                                                                               toward the                     
                                                                               member's                       
                                                                               monthly                        
                                                                               premiums,                      
                                                                               with members                   
                                                                               covering the                   
                                                                               difference                     
                                                                               between the                    
                                                                               employer's                     
                                                                               contribution                   
                                                                               and the                        
                                                                               actual                         
                                                                               premium                        
                                                                               amount. The                    
                                                                               employer                       
                                                                               contribution                   
                                                                               rate is                        
                                                                               normally                       
                                                                               established                    
                                                                               through                        
                                                                               collective                     
                                                                               bargaining                     
                                                                               agreements.                    
(2) CalPERS Judges'        o Supreme court judges              3,329        59 (CalPERS                       
Retirement Fund            o Courts of appeal judges                           health care                    
                           o Superior courts judges                            program--see                   
o Tier I:                                                                   above)                         
Appointed/elected                                                                                          
before 11/9/94                                                                                             
o Tier II:                                                                                                 
Appointed/elected on                                                                                       
or after 11/9/94                                                                                           
Pension plans, by level                                    Number of Number of              Retiree health    
of administration       Occupations covered                members   employers              benefits          
(3) CalPERS                o State legislators (closed to        309         1              (CalPERS health   
Legislators' Retirement    legislators elected on or after                                  care program--see 
Fund                       11/7/90)                                                         above)            
                           o Constitutional officers                                                          
                           o Legislative statutory                                                            
                           officers                                                                           
(4) CalPERS Volunteer   Volunteer firefighters                 4,301        54              (Not eligible for 
Firefighters' Award                                                                         CalPERS health    
Fund                                                                                        care program)     
(5) California State    Teachers/educators employed by       794,812     About              According to a    
Teachers' Retirement                                                     1,400              report from the   
System (CalSTRS)           o School districts                                               Legislative       
                           o Community college districts                                    Analyst's Office, 
                           o County offices of education                                    schools and       
                           o Regional occupational                                          community college 
                           programs                                                         districts vary    
                                                                                            widely in the     
                                                                                            health benefits   
                                                                                            they provide      
                                                                                            their retirees.   
                                                                                            For example, in   
                                                                                            2004              
                                                                                                              
                                                                                               o 114          
                                                                                               contracted     
                                                                                               with CalPERS   
                                                                                               for employee   
                                                                                               and retiree    
                                                                                               health         
                                                                                               coverage;      
                                                                                               o about 265    
                                                                                               purchased      
                                                                                               coverage       
                                                                                               through 11     
                                                                                               benefit        
                                                                                               trusts, which  
                                                                                               allow multiple 
                                                                                               districts to   
                                                                                               join together  
                                                                                               to achieve     
                                                                                               economies of   
                                                                                               scale;         
                                                                                               o 250          
                                                                                               participate in 
                                                                                               the            
                                                                                               Self-Insured   
                                                                                               Schools of     
                                                                                               California     
                                                                                               joint powers   
                                                                                               agency,        
                                                                                               administered   
                                                                                               by Kern        
                                                                                               County; and    
                                                                                               o the          
                                                                                               remaining      
                                                                                               districts      
                                                                                               either secure  
                                                                                               health         
                                                                                               benefits on    
                                                                                               their own or   
                                                                                               do not provide 
                                                                                               these          
                                                                                               benefits.      
(6) University of          o Senate faculty and              212,154                      1 The University of 
California Retirement      non-faculty academics                                            California offers 
Plan (UCRP)                o Management/senior                                              continuation of   
                           professional                                                     medical, dental,  
                           o Professional/support staff                                     and legal         
                                                                                            insurance to      
                                                                                            eligible members  
                                                                                            who elect monthly 
                                                                                            retirement        
                                                                                            income. Health    
                                                                                            and welfare       
                                                                                            benefits are not  
                                                                                            accrued or vested 
                                                                                            benefit           
                                                                                            entitlements. The 
                                                                                            University of     
                                                                                            California's      
                                                                                            contribution      
                                                                                            toward the cost   
                                                                                            of medical and    
                                                                                            dental coverage   
                                                                                            is determined by  
                                                                                            the University of 
                                                                                            California and    
                                                                                            may change or     
                                                                                            stop altogether.  
                                                                                            (If a retiree     
                                                                                            elects a lump-sum 
                                                                                            cashout, all      
                                                                                            rights to         
                                                                                            continue retiree  
                                                                                            medical, dental,  
                                                                                            and legal         
                                                                                            benefits are      
                                                                                            waived.)          
Locally administered    Approximately 19% of all state and                                  A September 2005  
plans (55 total)^d      local workers statewide.^e                                          survey by the     
                                                                                            California State  
o 21 county                                                                              Association of    
o 24 city                                                                                Counties found    
o 10 special                                                                             that of the 49    
district                                                                                 counties          
                                                                                            responding (of 58 
                                                                                            total), including 
                                                                                            8 of the 10       
                                                                                            largest counties, 
                                                                                            48 reported that  
                                                                                            retired employees 
                                                                                            are eligible for  
                                                                                            some type of      
                                                                                            health benefits.  
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                members   Number of employers    benefits          
Locally administered       o Firefighters                     53,246                      1 Retirees are      
example:                   o Police                                                         entitled to       
                           o General (all others)                                           continue          
o City and County of                                                                     membership in the 
San Francisco                                                                            city's Health     
                                                                                            Services System.  
                                                                                            Any premiums      
                                                                                            payable for       
                                                                                            coverage may be   
                                                                                            deducted from the 
                                                                                            retirement        
                                                                                            payment.          
MICHIGAN                
State and local government workers
Total number (2006)^a                                        615,700                                          
o State workers                                           170,700                                          
o Local workers                                           445,000                                          
Percentage covered by unions (2005)^b                          59.9%                                          
Percentage participating Social Security (2004)^c              88.0%                                          
State-administered      Approximately 87% of all state and                                                    
plans (6 total)^d       local workers statewide.^e                                                            
(1) Michigan State         o State civil service employees    85,772                      1 Michigan's        
Employees Retirement       o Executive appointed officials                                  Department of     
System (MSERS)             o Employees of the legislature                                   Civil Service,    
                           and judiciary                                                    Employee Benefits 
o Defined benefit                                                                        Division,         
plan: Hired before                                                                       administers       
3/31/97                                                                                  health insurance  
o Defined                                                                                contracts for     
contribution plan:                                                                       both active and   
Hired on or after                                                                        retired state     
3/31/97                                                                                  employees. For    
                                                                                            those in the      
                                                                                            defined benefit   
                                                                                            retirement plan   
                                                                                            (i.e., those      
                                                                                            hired before      
                                                                                            3/31/97), current 
                                                                                            health plan       
                                                                                            premiums are 95%  
                                                                                            state-paid for    
                                                                                            retirees under    
                                                                                            age 65, and 100%  
                                                                                            state-paid for    
                                                                                            Medicare-eligible 
                                                                                            retirees. Dental  
                                                                                            and vision        
                                                                                            premiums are 90%  
                                                                                            state-paid. For   
                                                                                            those in the      
                                                                                            defined           
                                                                                            contribution      
                                                                                            retirement plan,  
                                                                                            there is a        
                                                                                            10-year vesting   
                                                                                            requirement with  
                                                                                            an employer       
                                                                                            contribution of   
                                                                                            3% for each year  
                                                                                            of service,       
                                                                                            capped at 90%.    
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                  members    Number of employers benefits          
(2) Michigan Public     Employees of                         478,347                    716 Retirees have the 
School Employees'                                                                           option of health  
Retirement System          o                                                                coverage, which   
                           Kindergarten-through-12th-grade                                  is funded on a    
                           public school districts                                          cash disbursement 
                           o Public school academies                                        basis by the      
                           o District libraries                                             employers. The    
                           o Tax-supported community                                        system has        
                           colleges                                                         contracted to     
                           o Certain universities (7                                        provide the       
                           total)                                                           comprehensive     
                                                                                            group medical,    
                                                                                            hearing, dental,  
                                                                                            and vision        
                                                                                            coverage for      
                                                                                            retirees and      
                                                                                            beneficiaries. A  
                                                                                            significant       
                                                                                            portion of the    
                                                                                            premium is paid   
                                                                                            by the system,    
                                                                                            with the balance  
                                                                                            deducted from the 
                                                                                            monthly pension.  
                                                                                            (Pension          
                                                                                            recipients        
                                                                                            generally are     
                                                                                            eligible for      
                                                                                            fully paid master 
                                                                                            health plan       
                                                                                            coverage and 90%  
                                                                                            paid dental,      
                                                                                            vision, and       
                                                                                            hearing plan      
                                                                                            coverage.)        
(3) Michigan State      State police officers                  4,530                      1 Under the         
Police Retirement                                                                           Michigan State    
System                                                                                      Police Retirement 
                                                                                            Act, all retirees 
                                                                                            have the option   
                                                                                            of continuing     
                                                                                            health, dental,   
                                                                                            and vision        
                                                                                            coverage.         
                                                                                            Retirees with     
                                                                                            this coverage     
                                                                                            contribute 5%,    
                                                                                            10%, and 10% of   
                                                                                            the monthly       
                                                                                            premium amount    
                                                                                            for the health,   
                                                                                            dental, and       
                                                                                            vision coverage,  
                                                                                            respectively. The 
                                                                                            state funds 95%   
                                                                                            of the health and 
                                                                                            90% of the dental 
                                                                                            and vision        
                                                                                                              
                                                                                            insurance.        
(4) Michigan         State legislators                        351                      1 Under state law,  
Legislative                                                                              all retirees and  
Retirement System                                                                        their dependents  
                                                                                            and survivors     
           o Defined                                                                        receive health,   
           benefit                                                                          dental, and       
           plan:                                                                            vision insurance  
           Elected                                                                          coverage.         
           before                                                                                             
           3/31/97                                                                                            
                                                                                                              
           o Defined                                                                                          
           contribution                                                                                       
           plan:                                                                                              
           Elected on                                                                                         
           or after                                                                                           
           3/31/97                                                                                            
(5) Michigan Judges        o State judges                        840                    159 The Supreme Court 
Retirement System          o Governor                                                       Justice, Court of 
                           o Lieutenant governor                                            Appeals, or       
o Defined benefit       o Secretary of state                                             elected officials 
plan: Hired before      o Attorney general                                               may enroll in the 
3/31/97                 o Legislative auditor general                                    state health plan 
o Defined               o Constitutional court                                           when they retire  
contribution plan:      administrator                                                    and their premium 
Elected or appointed                                                                     rate is           
on or after 3/31/97                                                                      subsidized. All   
                                                                                            other judges may  
                                                                                            enroll in the     
                                                                                            state health plan 
                                                                                            if they wish to,  
                                                                                            but they must pay 
                                                                                            the entire        
                                                                                            premium cost.     
(6) Municipal Employees Local government employees            65,100                    685 MERS Premier      
Retirement System                                                                           Health provides   
(MERS)                                                                                      group health      
                                                                                            coverage for      
                                                                                            public employers  
                                                                                            including         
                                                                                            employee and      
                                                                                            retiree medical,  
                                                                                            prescription      
                                                                                            drug, dental and  
                                                                                            vision benefits.  
                                                                                            (MERS also offers 
                                                                                            a Group Life and  
                                                                                            Disability        
                                                                                            Insurance         
                                                                                            Program.)         
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                  members    Number of employers benefits          
Locally administered    Approximately 13% of all state and                                                    
plans (134 total)^d     local workers statewide^e                                                             
                                                                                                              
o 24 county                                                                                                
o 101 city                                                                                                 
o 9 municipality                                                                                           
Locally administered    General city employees and those      21,216                      1 The city will     
example:                employed by                                                         continue to pay   
                                                                                            the cost of       
o City of Detroit^f     o Department of Transportation                                   hospitalization   
                           o Water                                                          insurance, in     
                           o Sewage                                                         accordance with   
                           o Housing                                                        collective        
                           o Library                                                        bargaining        
                                                                                            agreements and    
                                                                                            city council      
                                                                                            resolutions in    
                                                                                            effect at the     
                                                                                            time of           
                                                                                            retirement. After 
                                                                                            age 65, if you    
                                                                                            are eligible for  
                                                                                            Medicare, the     
                                                                                            city will provide 
                                                                                            a supplement to   
                                                                                            your Medicare     
                                                                                            benefits.         
                                                                                            According to city 
                                                                                            officials, in the 
                                                                                            early 1980s, the  
                                                                                            city instituted a 
                                                                                            cost-sharing      
                                                                                            formula with      
                                                                                            general city      
                                                                                            employees and     
                                                                                            retirees for the  
                                                                                            cost of           
                                                                                            hospitalization   
                                                                                            insurance. The    
                                                                                            formula included  
                                                                                            multiple tiers    
                                                                                            reflecting        
                                                                                            various           
                                                                                            collective        
                                                                                            bargaining        
                                                                                            agreements and    
                                                                                            city council      
                                                                                            resolutions. In   
                                                                                            the last round of 
                                                                                            contract          
                                                                                            negotiations,     
                                                                                            however, the      
                                                                                            cost-sharing      
                                                                                            formula for       
                                                                                            general city      
                                                                                            employees was     
                                                                                            modified to an    
                                                                                            80% city, 20%     
                                                                                            employee/retiree  
                                                                                            split.            
State-administered      Approximately 99% of all state and                                                    
plans (1 total)^d       local workers statewide.^e                                                            
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                  members    Number of employers benefits          
Oregon Public              o State government employees      289,223                    881 Under state law,  
Employees' Retirement      o School district and community                                  the board         
System (OPERS)             college employees                                                contracts for     
                           o Employees of local political                                   medical and       
o Tier I: Hired         subdivisions (optional, but                                      hospital          
before 1/1/96           irrevocable once elected)                                        insurance on      
o Tier II: Hired on                                                                      behalf of retired 
or after 1/1/96 and                                                                      members. Members  
before 8/29/03                                                                           and their         
o Oregon Public                                                                          dependents are    
Service Retirement                                                                       eligible for      
Plan: Hired on or                                                                        OPERS health care 
after 8/29/03                                                                            coverage if the   
o Judges                                                                                 member is         
                                                                                            receiving a       
                                                                                            retirement        
                                                                                            allowance or      
                                                                                            benefit under the 
                                                                                            system.           
Locally administered    Approximately 1% of all state and                                                     
plans (3 total)^d       local workers statewide.^e                                                            
                                                                                                              
o 2 county                                                                                                 
o 1 city                                                                                                   
State and local government pension plans
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                members   Number of employers    benefits          
State and local government pension plans
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                  members    Number of employers benefits          
OREGON                  
State and local government workers
Total number (2006)^a                                        257,500                                          
o State workers                                            75,000                                          
o Local workers                                           182,500                                          
Percentage covered by unions (2005)^b                          52.4%                                          
Percentage participating Social Security (2004)^c              91.0%                                          
State and local government pension plans
Pension plans, by level                                    Number of                        Retiree health    
of administration       Occupations covered                members   Number of employers    benefits          

Sources: U.S. Bureau of Labor Statistics, U.S., Census Bureau, Bureau of
National Affairs, Social Security Administration, and various state and
local government 2006 comprehensive annual financial reports and other
publications.

^aU.S. Bureau of Labor Statistics Data. State and Area Employment, Hours,
and Earnings. Not seasonally adjusted. State and Local Governments, 2006.

^bBarry T. Hirsch and David A. Macpherson. Union Membership and Earnings
Data Book. The Bureau of National Affairs, Inc., Washington, D.C.: 2006,
Table 5a.

^cOffice of Research, Evaluation and Statistics, U.S. Social Security
Administration. Table 1-8: Estimated Social Security Coverage of Workers
with State and Local Government Employment..

^dU.S. Census Bureau Data. State and Local Governments Employee-Retirement
Systems. 2005 data file.

^eU.S. Census Bureau. Employee-Retirement Systems of State and Local
Governments: 2002 (2002 Census of Governments, Volume 4, Number 6,
GC02(4)-6) U.S. Government Printing Office, Washington, D.C.: December
2004, Table 10.

fAs we went to press, the most recent annual report available online for
the Detroit General Retirement System was for 2005.

Appendix IV: GASB Statements for Pensions and OPEB

The Governmental Accounting Standards Board (GASB) is an independent,
private sector, not-for-profit organization that establishes standards of
financial accounting and reporting for U.S. state and local governments.
Governments and the accounting industry recognize the GASB as the official
source of generally accepted accounting principles (GAAP) for state and
local governments. GASB standards are intended to result in useful
information for users of financial reports, and to guide and educate the
public--including issuers, auditors, and users--about the implications of
those financial reports. Standards relevant to state and local government
retiree benefits are listed below.

Table 7: GASB Statements for Pensions and OPEB

Year issued Statement number Title and summary of statement
Statements for pensions
1994        No. 25           Financial Reporting for Defined Benefit
                                Pension Plans  and Note Disclosures for
                                Defined Contribution Plans:
                                                        
                                Establishes financial reporting standards for
                                defined benefit pension plans and for the
                                notes to the financial statements of defined
                                contribution plans of state and local
                                governmental entities. (Effective for periods
                                beginning after June 15, 1996.)
               No. 27           Accounting for Pensions  by State and Local
                                Governmental Employers: 
                                                        
                                Establishes standards for the measurement,
                                recognition, and display of pension
                                expenditures/expense and related liabilities,
                                assets, note disclosures, and, if applicable,
                                required supplementary information in the
                                financial reports of state and local
                                governmental employers. (Effective for
                                periods beginning after June 15, 1997.)
2007        No. 50           Pension Disclosures--an amendment of GASB
                                Statements No. 25 and No. 27:
                                                        
                                This statement more closely aligns the
                                financial reporting requirements for pensions
                                with those for OPEB and, in doing so,
                                enhances information disclosed in notes to
                                financial statements or presented as required
                                supplementary information by pension plans
                                and by employers that provide pension
                                benefits. (Effective for periods beginning
                                after June 15, 2007.)   
Statements for other postemployment benefits (OPEB)
2004        No. 43^a         Financial Reporting for Postemployment
                                Benefit Plans Other Than Pension Plans:
                                                        
                                Establishes uniform financial reporting
                                standards for OPEB plans and supersedes the
                                interim guidance included in Statement No.
                                26. (Effective dates were phased in between
                                2005 and 2007 based on the government's total
                                annual revenues.)       
               No. 45           Accounting and Financial Reporting by
                                Employers for Postemployment Benefits Other
                                Than Pensions:          
                                                        
                                Establishes standards for the measurement,
                                recognition, and display of OPEB
                                expense/expenditures and related liabilities
                                (assets), note disclosures, and, if
                                applicable, required supplementary
                                information in the financial reports of state
                                and local governmental employers. (Effective
                                dates are being phased in between 2006 and
                                2008 based on the government's total annual
                                revenues.)              

Source: GASB, 2007.

aStatement No. 43 superseded previous statement No. 26, issued in 1994,
entitled "Financial Reporting for Postemployment Healthcare Plans
Administered by Defined Benefit Pension Plans."

Appendix V: GAO Contacts and Staff Acknowledgments

GAO Contacts

Barbara D. Bovbjerg (202) 512-7215 or [email protected]

Staff Acknowledgments

In addition to the contact named above, Bill J. Keller, Assistant
Director; Amy D. Abramowitz; Joseph A. Applebaum; Susan C. Bernstein;
Gregory J. Giusto; Richard S. Krashevski; Bryan G. Rogowski; Jeremy S.
Schwartz; Margie K. Shields; Jacquelyn D. Stewart; Craig H. Winslow; and
Walter K. Vance made important contributions to this report.

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Legislative Analyst's Office. Retiree Health Care: A Growing Cost for
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Mattoon, Richard H. "Issues Facing State and Local Government Pensions."
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Moore, Cynthia L., Nancy H. Aronson, and Annette S. Norsman. Is Your
Pension Protected? A Compilation of Constitutional Pension Protections for
Public Educators. AARP, Washington, D.C.: 2000. This publication provides
a compilation of constitutional pension protections in 50 states,
specifically concentrating on retirement systems that serve retired
educators. The descriptions were reviewed by AARP and National Retired
Teachers Association staffs, including the AARP Office of General Counsel.
The constitutional context is current as of July 1998. According to one of
the authors, however, although the report was done several years ago,
there have been few changes in constitutional pension protections in
recent years.

National Association of Government Defined Contribution Administrators,
Inc. 2006 Biennial State and Local Government Defined Contribution Plan
Survey. NAGDCA, Lexington, Kentucky: 2006. This survey is conducted every
2 years, to obtain specific information on state and local governments'
457 and 401(k) plans, and beginning with the 2006 survey, on their public
401(a) and 403(b) plans as well. The survey includes defined contribution
plans that are the governments' primary pensions plans, as well as those
that are supplemental voluntary plans. In 2006, responses were received
with information on a total of 105 state and local defined contribution
plans, including 40 state 457 plans, 33 local government 457 plans, 10
state 401(k) plans, 3 local 401(k) plans, 11 state 401(a) plans, 4 local
government 401(a) plans, 2 higher education 401(a) plans, 1 state 403(b)
plan, and 1 higher education 403(b) plan. According to respondents, these
plans held $87.9 billion in assets, received $6.2 billion in annual
deferrals, and had approximately 1.6 million active participants in 2005.

National Education Association. Characteristics of Large Public Education
Pension Plans. NEA, Washington, D.C.; December 2006. Information for this
publication was gathered between July and September 2006, and was based on
consolidated annual financial reports, state treasurers' reports,
actuarial valuations, system audits, legislative or plan-related review
commissions, plan handbooks and newsletters, departments of human
resources' guidelines for electing trustees, state legislators' and
governors' Web sites containing information on legislative changes, state
or local statutes, and publicly available communications between
government officials and plan participants.

Ranade, Neela K. Employer-Sponsored Retiree Health Insurance: An
Endangered Benefit? Congressional Research Service, Domestic Social Policy
Division, Washington, D.C.: April 13, 2006. This report summarizes the
current coverage levels for retiree health insurance for public and
private sector retirees. It outlines the provisions that govern employer
accounting for postretirement health insurance plans in both the public
and private sectors, and describes the public policy options that may be
considered by Congress to address the problems created by the erosion of
employer-sponsored retiree health insurance plans.

Segal. Results of the Segal Medicare Part D Survey of Public Sector Plans.
The Segal Group, Inc., New York, New York: Summer 2006. In May 2006, the
Segal Company, in cooperation with the Public Sector HealthCare
Roundtable, asked public entities about the actions they were considering
for their retiree health care programs as the Medicare Part D program was
being implemented. Responses were received from 109 state and local plans.

U.S. Bureau of Labor Statistics. Employee Benefits in State and Local
Governments, 1998. (Bulletin 2531) U.S. Department of Labor, Bureau of
Labor Statistics, Washington, D.C.: December 2000. This bulletin presents
the results of the 1998 Bureau of Labor Statistics Employee Benefits
Survey, conducted jointly with the bureau's Employment Cost Index. It is a
survey of the incidence and detailed provisions of selected employee
benefit plans in state and local governments. In 1998, the survey provides
representative data for 16.5 million employees, and estimates cover all
state and local government establishments in the United States. Data were
collected from June 1998 to November 1998, from a sample of 1,011
government establishments chosen from unemployment insurance reports. The
survey is to be updated again in 2008.

U.S. Census Bureau. Census of Governments. A census of governments is
taken at 5-year intervals as required by law under title 13, United States
Code, Section 161. The 2002 census, similar to those taken since 1957,
covers three major subject fields: government organization, public
employment, and government finances. The unique and important nature of
public employee retirement system data in the world of government finance
requires the Census Bureau to conduct a universe survey each year (see
next listing below). Thus, the starting point for this census of
governments was the 2001 survey listing, which generated a final universe
mail file of approximately 2,670 retirement systems. Results of the 2002
census are summarized in Employee-Retirement Systems of State and Local
Governments: 2002 (2002 Census of Governments, Volume 4, Number 6,
GC02(4)-6) U.S. Government Printing Office, Washington, D.C.: December
2004.

U.S. Census Bureau. State and Local Governments Employee-Retirement
Systems. An annual survey of public employee retirement systems
administered by state and local governments throughout the nation. The
2005 State and Local Government Public Employee-Retirement Systems survey
covered 2,656 public employee retirement systems for the fiscal years that
ended between July 1, 2004, and June 30, 2005.

U.S. Department of Health and Human Services, Agency for Healthcare
Research and Quality, Medical Expenditure Panel Survey (MEPS).The Medical
Expenditure Panel Survey, which began in 1996, is a set of large-scale
surveys of families and individuals, their medical providers (doctors,
hospitals, pharmacies, etc.), and employers across the United States. MEPS
collects data on the specific health services that Americans use, how
frequently they use them, the cost of these services, and how they are
paid for, as well as data on the cost, scope, and breadth of health
insurance held by and available to U.S. workers. The insurance component
of the survey is conducted annually. A nationwide sample of employers,
including state and local governments, is specifically designed so that
national and state estimates of health insurance offerings can be made
each year.

Wisniewski, Stan, and Lorel Wisniewski. State Government Retiree Health
Benefits: Current Status and Potential Impact of New Accounting Standards.
(Workplace Economics, Inc., #2004-08) AARP, Washington, D.C.: July 2004.
This publication is based on information from the Workplace Economics,
Inc., proprietary database, developed over 15 years, on benefits provided
to state government employees in all 50 states. The database is the
product of an annual survey of state governments on their employee
benefits as well as an analysis of state employee health insurance plan
documents. In addition, data were gathered and analyzed from state
governments' annual financial reports.

Workplace Economics, Inc. 2006 State Employee Benefits Survey. Workplace
Economics, Inc., Washington, D.C.: 2006. The information in this report
was collected by means of a written survey sent to all 50 states, followed
by telephone and e-mail contacts to clarify information, and in some cases
by confirmation with official documents or contacts with employee
organizations. Because most states offer multiple sets of benefits to
different groups or categories of employees, survey respondents were
instructed to provide information on benefits that cover the largest
number of employees or that were otherwise deemed representative. The
information reported reflects benefits in effect January 1, 2006.

Zion, David, and Amit Varshney. "You Dropped a Bomb on Me, GASB."
(Americas/United States Equity Research, Accounting & Tax) Credit Suisse,
New York: March 22, 2007. This report focuses on the OPEB obligations for
each of the 50 states, along with the 25 largest cities in the United
States, based on a review of each state's comprehensive annual financial
report, as well as other documents such as actuarial studies, bond
offering documents, and U.S. Census data, and phone calls with state
officials. Information was obtained on unfunded OPEB liabilities for 31
states. Among the other 19 states, it was determined that 3
states--Mississippi, Nebraska, and Wisconsin--had no OPEB plans. For the
remaining 16 states, estimates were made by multiplying the number of
full-time equivalent employees for each state (based on 2004 Census data)
by $100,000, a rough estimate based on the data gathered on the 31 states.

Related GAO Products

State and Local Governments: Persistent Fiscal Challenges Will Likely
Emerge within the Next Decade. [59]GAO-07-1080SP . Washington, D.C.: July
18, 2007.

Retiree Health Benefits: Majority of Sponsors Continued to Offer
Prescription Drug Coverage and Chose the Retiree Drug Subsidy.
[60]GAO-07-572 . Washington, D.C.: May 31, 2007.

Employer-Sponsored Health and Retirement Benefits: Efforts to Control
Employer Costs and the Implications for Workers. [61]GAO-07-355 .
Washington, D.C.: March 30, 2007.

Private Pensions: Information on Cash Balance Pension Plans. [62]GAO-06-42
. Washington, D.C.: November 3, 2005.

State Pension Plans: Similarities and Differences Between Federal and
State Designs. [63]GAO/GGD-99-45 . Washington, D.C.: March 19, 1999.

Public Pensions: Section 457 Plans Pose Greater Risk than Other
Supplemental Plans. [64]GAO/HEHS-96-38 . Washington, D.C.: April 30, 1996.

Public Pensions: State and Local Government Contributions to Underfunded
Plans. [65]GAO/HEHS-96-56 . Washington, D.C.: March 14, 1996.

An Actuarial and Economic Analysis of State and Local Government Pension
Plans. PAD-80-1. Washington, D.C.: February 26, 1980.

Funding of State and Local Government Pension Plans: A National Problem.
HRD-79-66. Washington, D.C.: August 30, 1979.

(130618)

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References

Visible links
  53. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1080SP
  54. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD-99-45
  55. http://www.gao.gov/cgi-bin/getrpt?GAO-07-572
  56. http://www.gao.gov/
  57. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1080SP
  58. http://www.ssa.gov/policy/docs/statcomps/supplement/2005/6a.html
  59. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1080SP
  60. http://www.gao.gov/cgi-bin/getrpt?GAO-07-572
  61. http://www.gao.gov/cgi-bin/getrpt?GAO-07-355
  62. http://www.gao.gov/cgi-bin/getrpt?GAO-06-42
  63. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD-99-45
  64. http://www.gao.gov/cgi-bin/getrpt?GAO/HEHS-96-38
  65. http://www.gao.gov/cgi-bin/getrpt?GAO/HEHS-96-56
  66. http://www.gao.gov/
  67. http://www.gao.gov/
  68. http://www.gao.gov/fraudnet/fraudnet.htm
  69. mailto:[email protected]
  70. mailto:[email protected]
  71. mailto:[email protected]
*** End of document. ***