New York City Budget Director Mark Page testified this week that additional cuts to services may be necessary.  The current financial plan, released on February 17^th, showed the City in a relatively good financial position, but still relies on State action worth $600 million to close the budget gap for fiscal year 2012.   In the event the State does not restore some of the lost aid, the City has asked most agencies to make cuts of an additional 4 percent, and the police and education departments for an additional 2 percent.

Some have suggested that these cuts can be avoided by making additional withdrawals from the retiree health insurance trust fund, which was established by the Mayor and City Council in 2007 to fund the large unfunded liability created by retiree health benefits. This approach is imprudent and short-sighted. The City is already planning to withdraw $1.2 billion from this trust for general budget relief; rather than depleting these resources, the City can generate greater savings by eliminating the reimbursement for Medicare Part B and requiring retirees to share the cost of their premiums.

Contending with the True Cost of Retiree Health Benefits

New York City pays the full premium for comprehensive health insurance for its retirees.  When they reach 65, Medicare becomes their primary form of insurance, and the City fully reimburses the cost of Medicare Part B premiums. The cost of these benefits is increasingly expensive. In 2005, retiree health insurance cost $883 million; in the current year, it is $1.5 billion and projected to grow to $2.2 billion by 2015 – a ten-year growth of 150 percent.

Because the benefits are promised in the future, they create an unfunded liability for the City.  Unlike pension contributions, whose costs are actuarially determined, retiree health insurance benefits are paid for on a pay-as-you-go basis.  As a result, the unfunded accrued liability for retiree health benefits is about $70 billion.

New York City was a leader in recognizing the true costs of retiree health benefits and, more importantly, in doing something about it. In 2007, the Mayor and City Council established a trust fund to accumulate resources for paying down this liability.  Using surplus revenues when the City was prospering, they deposited $2.5 billion into the trust over two years, and the interest generated total resources of $3.2 billion by fiscal year 2009.

Since the economic downturn, however, temptation to tap the fund has been high.  Last year, elected officials agreed to make a total of $1.2 billion in withdrawals to help close budget deficits.  The size of the drawdowns initially was linked to pension contribution increases necessitated by the market downturn.  In fiscal year 2010, $82 million was withdrawn; a drawdown of $394 million is planned for the current fiscal year and $695 million is scheduled for next year.  Further withdrawals are being discussed as the Executive Budget is being prepared for release next month.

Protecting the Trust Fund

The trust fund should be protected from any further drawdowns, including the ones already scheduled for the current and subsequent fiscal years.  The unfunded liability is large and onerous; New York City was right to establish the trust and the funds should be allowed to grow, with additional deposits made when the City returns to prosperity. Depleting the fund for short-term budget relief is short-sighted and neglects the City’s long-term fiscal vitality.

Protecting the trust fund will open a budget gap for fiscal years 2012 and 2013, but the City has other options for generating savings on a recurring basis.  First, the City should eliminate reimbursement of Medicare Part B premiums.  Only four other states reimburse most or all of the cost of these premiums and bringing the City in line with other public employers would generate savings of $240 million in the current year, growing to over $300 million in fiscal year 2014.

Second, the City should pursue more general reform of retiree health insurance by increasing vesting requirements and instituting premium sharing.  Vesting for retiree health insurance benefits was increased from 10 to 15 years for teachers in 2009, and similar changes should be made for the rest of the public workforce.  Retiree health insurance is a benefit rarely offered in the private sector and one to which public employees in most states must contribute. New York State has required premium-sharing since the 1980s, and the City should, too.  If retirees paid for half the cost of their premiums, the City would save $620 million in the current year, growing to over $870 million by 2014.  While the full value of savings would not be realized in the current fiscal year, the combined value of the savings in fiscal year 2012 – $975 million – would enough to preserve the trust fund and reduce the need for additional service cuts if State aid is not restored when the State adopts its budget.