Posted by Nolan Miller on May 2, 2012
Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy)
Ever since Governor Quinn proposed his plan to reform government employee pensions in Illinois, I’ve been thinking about how to blog about it. The problem is, my primary opinion is a legal one – that the proposal clearly violates the non-impairment clause of the Illinois state constitution because it threatens current employees with excluding future pay raises from pensionable earnings in contradiction of the “contractual relationship” laid out in the Illinois Pension Code – and I’m not a lawyer. Better to stick with what I am supposed to know.
So, let’s turn to economics. While the non-impairment clause prevents the state from reducing pensions, it does not affect other benefits. In particular, the state would seem free to reduce or remove subsidies for retirement health benefits without running afoul of the non-impairment clause. New research from by Steven Nyce, Sylvester Schieber, John B. Shoven, Sita Slavov, and David A. Wise suggests that doing so might be a way to lower pension costs. In short, they show that removing the employer subsidy for health benefits for early retirees would cause people to work longer. And, when people work longer they contribute more toward the pension fund and draw pensions for less time, improving the overall finances of the pension system.
In the new article, entitled “Does Retiree Health Insurance Encourage Early Retirement,” the authors investigate the relationship between employer subsidies for health insurance to retirees. The paper begins by noting that many Americans delay retirement until they reach age 65 because employment gives them access to health insurance at far better prices than they could receive in the private market (if such insurance is even available). When an employer offers subsidized health insurance to those who retire before age 65, it makes it possible for people to retire earlier than they otherwise would. Using newly-available data, the paper finds that retiree health coverage significantly increases retirements among people in their early 60s. In fact, when employers subsidize 50 percent or more of the cost of retiree health insurance (as the state of Illinois does), retirements increase by “1-3 percentage points at ages 56-61, by 5.9 percentage points (33.7 percent) at age 62, and by 6.9 percentage points (43.7 percent) at age 63. Overall, an employer contribution of 50 percent or more reduces the total number of person-years worked between ages 56 and 64 by 9.6 percent relative to no coverage.”
What does this mean for the state of Illinois? Take, for example, SURS, the State Universities Retirement System. In this system, a worker’s total retirement benefit is limited to 80% of final salary. This means that, after about 36 years of working for the state, the worker’s pension no longer increases with additional years of service. Further, state law provides that the state will pay 5% of retiree health premiums for each year of service. (Importantly, the applicable law is not the Pension Code!) So, a person who started working for the state at age 25 would, by age 62, be eligible for the maximum pension and free health benefits.
Given this deal, it is no wonder that people choose to retire before age 65. This costs the pension system, since early retirees do not contribute and they draw their pension for longer. Removing retiree health benefits would have a significant financial impact on early retirees. Back in 2006, the most recent data I could find in a quick search, the average health insurance premium for an adult age 60 – 64 on the non-group health insurance market was around $360/month. A family policy would cost about twice that. Such policies are usually less generous than employer-provided insurance and feature higher deductibles and coinsurance rates. So, a near-elderly state employee contemplating retirement might face expected monthly costs of $500 – $700 or more if they had to pick up their own health insurance, and even more if they had a dependent spouse or children.
So, suppose the state were to eliminate retiree health benefits. Faced with such costs, many people would choose to work until age 65 (or at least until age 63.5 when the COBRA law would allow them to continue to purchase health insurance under the state plan until they become eligible for Medicare at age 65). And, when people retire later, they draw pensions for less time.
Now, I am not necessarily advocating this, and certainly not across the board. There are strong arguments why for some government employees – in particular police and firefighters –the physical demands of the job make early retirement reasonable. For other government employees, such as professors, there is no strong reason why the state should be subsidizing early retirement through providing free health benefits after I stop working.
My broader point is that whatever the state does, and it must do something, it must be done in a way that does not violate the constitution. While the state cannot touch pension benefits, it is free to reduce health insurance. And, since retiree health insurance makes retirement more attractive, reducing or removing retiree health benefits would seem to be a constitutional and, based on recent research, effective way to delay retirement, which would improve the ailing pension systems’ finances.
ADDENDUM (5/30/12): Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A. In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65. Obviously, removing employer-sponsored health benefits is much more complicated and controversial in this case.