A Michigan Supreme Court ruling will give local governments and municipalities in the state more flexibility in dealing with retiree healthcare costs.
On May 30, the state's high court ruled that Macomb County is not contractually bound to provide lifetime healthcare benefits to its retirees. The case stems from plan changes the county made in 2009 and 2010 that, among other things, produced higher co-payments and deductibles for retirees.
Eric Scorsone, an associate professor at Michigan State University, where he directs the Extension Center for Local Government Finance and Policy, said that the argument in the Macomb County case was that the county had essentially made statements in the past that was not explicitly in contract per se but could be read into the contract that benefit was a lifetime benefit.
Retirees sued the county, arguing that the unilateral nature of the changes was illegal and that OPEB benefits were a lifetime vested right.
The decision overturns two lower court decisions that the retirees' benefits were vested for life.
“In my mind the ruling was a building-up process,” Scorsone said. “We already knew that OPEB was not the same as pensions in Michigan and wasn’t constitutionally guaranteed. Now we have more affirmation that unless a contract explicitly says it’s a lifetime benefit, then it isn’t and you can’t read into the contract somehow that it is.”
For the metropolitan Detroit county of 840,000, the decision is credit positive because it gives it clear legal flexibility to lower unfunded OPEB liabilities via benefit reductions, said Moody’s Investors Service. Moody’s rates the county Aa1.
“It removes uncertainty surrounding the government's legal ability to alter retiree healthcare benefits,” Moody’s said. “The state Supreme Court's ruling will potentially benefit other Michigan local governments, some of which have very large unfunded OPEB liabilities.”
County officials said that, if the decision had gone against them, it would have burdened local governments across Michigan with huge unfunded liabilities, as they’d be forced to maintain costly benefit levels and be precluded from negotiating changes in insurance carriers.
Scorsone said that there were a number of cases pending similar to the Macomb case. The immediate impact, Scorsone said, will be that those cases get dismissed and those local governments are able to unilaterally change benefits to retirees, if they choose.
“It’s going to have an impact on governments that are thinking about it, which are probably quite a few in Michigan,” Scorsone said. “It will probably have an impact on contractual relationships where unions are probably going to want to put more explicit language, going forward, if they are able to. It could have an impact on arbitration — we have binding arbitration for public safety employees — so those arbitrators may have to rethink their decisions going forward. It’s a pretty big impact.”
Michigan’s total unfunded pension liability is estimated to be around $7.46 billion. The total unfunded liability for retiree healthcare is estimated at $10.13 billion. Moody's estimates that 19 entities in Michigan have adjusted net OPEB liabilities amounting to more than 150% of their revenues. It shows how pensions will continue to be a source of negative drag on creditworthiness.
Scorsone said that the state has more than 100 local governments with severe underfunding of OPEB liabilities.
"A lot of governments in Michigan have 0% funding on OPEB, but it’s just not a big part of their budget so they are being ignored,” he said.
James Hohman, the director of fiscal policy at the Mackinac Center for Public Policy, said in an email that Michigan’s recent experience has been an attempt to prefund the benefits instead of finding ways to lower costs. “Local governments have already saved around a third of what the benefits cost,” he said.
“This ruling gives local officials the ability to unilaterally cut costs on an expensive and underfunded benefit,” Hohman said. “I expect local governments that are approaching insolvency to try to reduce benefit expenses and this ruling will help them.”
Eric Lupher, president of the Citizens Research Council, a not-for-profit public affairs research organization, said that although Macomb officials have said they do not intend to reduce retiree healthcare coverage, the ruling means they aren’t “hamstrung on OPEB the way they are on pensions.” The county has publicly signaled that it has no plans to lower its unfunded OPEB liabilities via benefit reductions.
“The leaders are saying that they intend to continue, but if the recession starts tomorrow and money is tight they could change their minds and do something different,” Lupher said.
Most of Macomb County's balance sheet leverage is attributable to employee retirement benefits, according to Moody’s. The rating agency calculated that the county’s unfunded pension and OPEB liabilities at just over $1 billion combined, roughly 326% of the county's operating revenue. The county issued $263 million in OPEB bonds in 2015 to pay off the unfunded retiree healthcare liability and provide financial stability to the county budget.
“The specific cost to the county if it had been forced to retroactively compensate retirees for foregone healthcare benefits is unknown,” Moody’s said. “Nonetheless, the county will avoid having to use OPEB trust assets or current budget resources to effectively unwind benefit changes from roughly a decade ago,” the rating agency wrote.
“There was a lot of concern that the case could go against the county and be a setback for local governments that want to address these issues,” Scorsone said. “It’s a case, more than any other that has been pending, that if it had gone the other way, would have said that there are some obligations here that go beyond the life of the contract. That changes the landscape.”
OPEB relief could allow local governments to put more money toward infrastructure spending. “The simple facts are there is only so much money to go around," Scorsone said. “Infrastructure is suffering because of the increasing costs of pension and OPEB liabilities and it's part of why our infrastructure spending is down.”
Gov. Gretchen Whitmer has proposed a 45-cent-per-gallon hike in the fuel tax to raise the extra $2.5 billion the Michigan Department of Transportation said is needed annually for roads. Republicans who control the legislature rejected the first-year Democrat's proposal.
The West Michigan Policy Forum, a conservative business group, has proposed that the state bond to fund its teacher pension obligations, saying it would free up to $1 billion a year that could be used to fix the roads.
Jase Bolger, a former Republican speaker of the state House who now works with the West Michigan Policy Forum, said the state would issue a 30-year pension obligation bond to borrow $10 billion that would be used to pay down unfunded liabilities in the pension system.
The Republican-controlled House last month proposed an alternative plan that would shift revenue from the 6% sales tax on fuel purchases to roads, instead of schools and local governments, over two years. The plan would raise roughly $540 million annually.
Scorsone said it remains unclear what policy changes are coming but said that at the end of the day the state will have to put in more money to offset the costs of OPEB and pensions and infrastructure spending.
