Retiree Health Insurance, Early Retirement and the Illinois Pension Mess
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.
The Governor needs to start checking out all of his departments that waste more money on golf outings, car rentals, purchasing cars for director, and deputy directors, why can’t they drive their own car like everybody else. dinners and trips for the departments for board meetings, and meetings that do not require half of the department to be there. It is very obvious where money falls between the cracks in all the departments at the state. Governor needs to have someone available to check out what is going on in these state departments without the department heads knowing they are around. Maybe then he would have enough money to pay the retiree’s insurance and save the state some additional monies. Most of the department’s monies is hidden because they sure would not want to get less money to run their department than they got the year before. Oh my, what would they do if they couldn’t go golfing with all of their staff for 2 or 3 days.
40 years ago I chose to work for IL instead of the private sector , the pension benefit with health care was the deciding factor. The private sector paid more back then. To cheat me and other retired state workers out of the health care benefit is pathetic, even for a historically consistent corrupt state government. When IL legislators give up their pensions from 4-8 years of part time work, I will agree to pay a third of my health care cost after 29 years of service. Cut government waste, don’t lie and cheat retirees.
Thanks for your comment, Steve. For the most part, I agree with you. Much of this could have been avoided if the state had been more responsible in planning for its pension liabilities. I wouldn’t go so far as to say corrupt, but much of this crisis could have been avoided through better planning.
The part where I disagree is with the part about cutting government waste. Although there is certainly plenty of money to be saved, I can’t think of a single example of a situation where the government successfully solved a major financial crisis by cutting “waste, fraud and abuse.”
While the non-impairment clause clearly elevates pension promises to a higher level of guarantee — and we see what even that amounts to — it does so by specifying that membership in a pension system is a contracual relationship between the state and the member. It is possible that the state explicitly promised future health benefits to you when you went to work for them, and such a promise might form a contract. But, I suspect that, as is the case with many state workers, the promise of free health benefits was implicit rather than explicit. Even to the extent it is spelled out in state law, there do not seem to be any guarantees that the benefits will continue to be offered in the future.
So, it stinks. It is especially terrible for the state to do this for people who are already retired or are nearing retirement and might have planned their finances expecting the health insurance benefit. (Note: it is entirely possible that CMS will do the right thing in setting rates, we’ll have to wait and see.)
But, it is also clear that the state has to do something and is going to do something. The point of my post was to point out that the non-impairment clause makes it impossible to reduce pensions, so they’re going to have to go after whatever else is not tied down by the constitution. That leaves retiree health benefits.