State faces hefty up-front costs to fix its retiree benefits system

State officials recently got their first glimpse of the cost of escaping a pay-as-you-go health insurance program for retired workers, and it wasn’t pretty.

But on a long-term basis, the state’s health care consultants said, it’s far less expensive the the current practice of paying the bills out-of-pocket.

A preliminary analysis issued last week to the Post Employment Benefits Commission projected that annual spending, which currently approaches $500 million, will rise on the pay-as-you-go plan so that the average cost over the next 28 years will be $1.9 billion–a total outlay in excess of $53 billion.

If the state adopts a longer-term plan for funding the costs, the annual outlay would jump immediately to $1.2 billion, according to Milliman Inc. of Windsor, which provides health care consulting and actuarial services for the state comptroller’s office–but then stay relatively stable over 28 years, for a total outlay of roughly $34 billion.

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Members of the State Post Employment Benefits Commission review a new analysis of state retiree health care costs. From left: AFSCME Council 4 Executive Director Salvatore Luciano, Thomas Woodruff, director of health care policy for the state comptroller, and health care actuary William Thompson with Milliman Inc. (Keith M. Phaneuf)

Both scenarios could be dramatically affected if health care costs grow in excess of projections, Milliman warned.

“We all knew we were going to be looking at big numbers here,” state Office of Policy and Management Deputy Secretary Michael Cicchetti, the commission’s chairman, said afterward, adding there are no easy options for reversing a system state government has followed for decades. “There are no quick fixes here. … We’re looking to find ways to make the system more manageable.”

Gov. M. Jodi Rell created the panel, which includes representatives from her administration, state employee unions, and the treasurer and comptroller’s offices, to analyze longstanding under-funding problems tied to both the health insurance and pension benefits state government provides its workers.

State government is slated to spend $490.6 million in the fiscal year that begins July 1 on health insurance for about 42,000 retired workers. That’s about 2.5 percent of a $19.01 billion total budget.

That $490.6 million only covers the cost of health care for 2010-11.

But with people continuing to live longer and medical inflation stretching some years into double-digits, the potential for that bill to escalate is huge, analysts said. The state’s “accrued liability” – meaning the cost of covering eventual retirement health benefits for all current employees and retirees – now is projected to top $26 billion.

An alternative to the pay-as-you go scenario involves covering annual health care costs and depositing additional dollars into a trust fund so that investment earnings can pick up a share of the future expenses.

William Thompson, a health care actuary with Milliman, estimated based on 2008 numbers that Connecticut would have to budget $1.2 billion per year to convert into a trust fund system. That additional $700 million available after current costs are met would allow the state to amass enough extra through savings and interest to cover all future liabilities over the next three decades.

Without major investment income to offset costs, state government would need to reserve more than $1.9 billion per year, on average, to cover retiree health care over the next three decades, according to the Milliman analysis. If medical costs rose 2 percent beyond current inflationary trends, that cost tops $3.1 billion.

“That’s really the peril of the pay-as-you-go approach,” commission member Christine Shaw, state Treasurer Denise L. Nappier’s director of government relations, said of the lack of investment income available under the current system.

Thomas Woodruff, director of Comptroller Nancy Wyman’s health care policy and benefit services division, said health care costs have grown about 7 percent per year since 2008. Based on that estimate, the $1.2 billion projection could rise another $150 million or more.

But Cicchetti noted that the report did not analyze the cumulative effects of several health care cost-saving measures the Rell administration negotiated with the State Employee Bargaining Agent Coalition in 2009. These include higher co-payments for prescription drug purchases and a new requirement that workers with less than 10 years of experience contribute 3 percent of their annual pay toward retirement health insurance costs.

Commission members asked Milliman officials to prepare revised estimates for later this month.

The commission was given a July 1 deadline to submit cost-saving recommendations to the governor’s office, but Cicchetti said the panel still is awaiting further analysis of both health insurance and pension costs, and may need to seek a short extension into the summer.