Changed assumptions knock $25.1 billion off Illinois’ unfunded healthcare liability – Wirepoints

By: Mark Glennon*

Poof. Over $25 billion of debt that was earlier reported just disappeared.

Actuarial reports released last week say the unfunded liability of Illinois’ three big healthcare trust funds for government workers is about $25.1 billion less than last reported — a 43% reduction. That’s serious money — almost half of the State of Illinois’ annual budget. The $25.1 billion reduction knocks the unfunded unfunded liability down from $58.9 billion to $24.5 billion

How is that possible? The new reports are based on changed assumptions that underpin the actuarial calculations, which obviously make a huge difference.

You can expect state politicians to begin boasting about their success in debt reduction. The new actuarial reports are as of June 30, 2022 and report the changes for the year prior. Most of the improvement will flow through to the state’s audited financial reports for that year that should be published very soon.

Here are the details:

Retired state employees get healthcare benefits, aside from pensions. Generally speaking, the state covers healthcare between the date of retirement and the date of Medicare eligibility, as well as supplemental benefits after Medicare kicks in. Those benefits are provided through three trust funds known as SEGIP, TRIP and CIP. The State of Illinois is obligated to cover most but not all of the funding those trusts need.

The three trust funds are entirely unfunded. The healthcare obligation is “pay-go,” meaning claims are simply paid as they are incurred. Unlike pensions, nothing is set aside or invested to cover future claims. But paying those healthcare obligations is constitutionally guarantied thanks to an Illinois Supreme Court ruling that stretched the state’s constitutional pension protection clause to cover retiree healthcare.

The actuaries estimate the total for those future healthcare claims, which is complicated and based on many assumptions. They then reduce the total by a discount rate to recognize that a debt owed in the future is less costly than a debt owed today. The resulting discounted total shows up as debt in the state’s financial statements (aside from a fairly small part that which is not the state’s liability).

But how can it be, you should be asking, that those assumptions could change so drastically that the reported total liability drops by 43% in just a year? Skepticism is always appropriate for government financial reporting, especially on a topic this obscure.

The actuarial reports all show three assumption changes that account for most of the reduced liability: 1) improved claims and premium experience; 2) updated rates and assumptions for Medicare Advantage Prescription Drugs, or “MAPD”; and 3) a much higher discount rate, which reduces total estimated future cost, based on the surge in interest rates that began in 2022.

We can’t assess whether most of those assumption changes are sound because the accounting and actuarial work for this topic — Other Post Employment Benefits, or OPEBs — is so complex. It’s by far the most opaque area of financial reporting we have dealt with – even worse than pensions.

We therefore hope that independent OPEB experts or qualified financial reporters take a hard look at the Illinois changes.

We can, however, make the following observations and pose a few questions.

First, the State of Illinois will soon be publishing its Annual Comprehensive Financial Report, or ACFR, which will contain audited financial statements. Most of the debt reduction shown in the new actuarial reports will flow straight through to those statements, making the state’s position look much better.

Comptroller Susanna Mendoza already released, concurrently with the new actuarial reports, a revised “interim” ACFR. It shows an improvement in the state’s position of $17.7 billion, thanks in large part to reduction in the healthcare liability.

Celebration will ensue, but it will be based on what, for the public, is black box accounting. Almost nobody understands OPEB accounting and actuarial work. The general public will be asked to assume that the numbers are sound. In our view, the entire process of estimating healthcare costs decades out is utterly speculative.

Second, the big increase in the discount rate is understandable but produces odd results. The actuaries raised the discount rate from 1.92% on June 30, 2021 to 3.69% on June 30, 2022. That change had the third biggest impact of all the assumption changes in the actuarial reports.

The discount rate was increased because interest rates soared during that period, sparked by the Federal Reserve Bank’s aggressive changes starting at the beginning of 2022. That’s standard accounting logic that’s also used for pensions, where money is set aside to grow and cover future costs. But does it really make sense that those changes have the result of reducing reported healthcare liabilities in a pay-go system where nothing is set aside?

Third, the actuarial reports say the state negotiated to pay no premiums on the MAPD liability for five years. The MAPD assumption changes were the most impactful in the actuarial conclusions. Why the can was kicked out that way is unknown. The result, however, is to increase cost later on and subject more of the MAPD liability to the new, higher discount rate, thereby reducing the reported liability. Hmm.

We do not mean to direct any suspicion at the actuaries themselves, who we assume followed the rules. Instead, this is a matter of whether the accounting and actuarial work really tell us anything economically meaningful for taxpayers and voters. As with pensions, financial reporting for OPEBs is easily subject to manipulation and far too obscure for genuine public oversight.

Our central question is this: Did the universe of factors that go into measuring future healthcare liability change so much in one year that a 43% reduction is real?

*Mark Glennon is founder of Wirepoints.