Boomer health care costs and rising interests rates: A recipe for disasterArticle added by Dan McGrath on February 19, 2014
Joined: April 03, 2013
Ranked: #54 (1,004 pts)
Interest rates have been at historic lows since the start of the recession and now there are rumblings from those on Wall Street and other financial gurus that they will start to creep up. But has anyone thought about the ramifications of an increase in rates on governments at the state and local levels?
As investors know, interest rates and prices work inversely; if one goes up, the other goes down. Because of this relationship, when interest rates increase, home prices have historically gone down. This creates a significant problem for state and local governments because, according to the Census Bureau, the largest source of revenue for states and local governments is property taxes.
If home values decrease due to rates increasing, the unfortunate consequence is less tax revenue for state and local governments. These government entities have few options. They could increase the tax rates, property taxes and sales taxes, and even income taxes (depending on state). But what will be the ramification on their local economies?
It really comes down to a roll of the dice. Right now, most state and local governments cannot afford to hit snake eyes since they know there is an even bigger problem on the horizon: their employees heading to retirement.
State and local governments have obligations to their employees when they retire, in the form of pensions and health care benefits, and those obligations are getting bigger by the day.
According to the Pew Research Center, in its June 2012 “Widening the Gap Update”, the reported underfunding of obligations in public sector retirement plans was close to $1.38 trillion and growing. Although this problem is reaching a crisis point, it seldom receives any attention, even though everyone understands that it exists. It has truly morphed into being the “elephant in the room” which everyone — regardless of political leanings — is trying to ignore.
The most frustrating part of this problem isn’t really about providing retirement income for employees, as most state and local governments have done a somewhat decent job of funding those obligations. In fact, the Pew Research Center is reporting that at
least 16 states are at 80 percent or higher when it comes to funding their employee pension plans. Only two states, Illinois and Rhode Island, are under 50 percent funded. Each of the remaining 32 states is somewhere between these two numbers and they still have a little bit of time.
The primary reason why the problem is so frustrating is the true cause of the situation: the amount required to fund future retiree health care costs. In the same report, the Pew Research Center stated that in 2010 alone, “states should have set aside nearly $51 billion to pay for these promises in the 2010 fiscal year, but they contributed just over $17 billion, or about 34 percent of what was annually required”.
The Pew Center went on to conclude that instead of a double-digit amount of states properly funding health care obligations, not one was even close! In fact, of all 50 states, not one was even close to being 80 percent funded, and only two were above 50 percent. Fifteen states were in the single digits, 19 of them were at 0 percent and one, Nebraska, was listed as N/A.
The only “highlight” in 2010 was Arizona, which made a 100 percent contribution into its fund for that year, yet still remains at only 69 percent of its fully funded obligation. The only other state to be over 50 percent is Alaska, and it’s exactly at the 50 percent level.
With respect to health care obligations for future retirees, the argument being made by the states is that “most pay health care costs or premiums as retirees incur those expenses,” thus begging the question as to whether this is a recipe for disaster or reasonable justification? Especially if we factor in increasing in interest rates. Most experts would probably agree it’s a recipe for disaster, even if rates stay the same. The reason, very simply, is demographics.
Currently, there are about 76 million baby boomers approaching retirement, doing so at a rate of approximately 10,000 per day. Unfortunately, the generation expected to pick up the slack, Generation X, most likely won’t be able to handle the burden due to simple demographics. It’s important to understand that Gen Xers are a much smaller demographic group than the Boomers. Estimates peg the total at about 60 to 62 million, or 14 to 16 million fewer members than the boomers.
So, with a smaller population of Gen Xers to buy homes and simply spend money, what will provide the required state and local government revenue to keep up, especially if/when interest rates tick up? No one can answer this question, likely leaving state and local governments dependent on a handout from the federal government. If this occurs, will the dollars come in the form of a loan with or without strings attached?
As stated previously, the financial gurus and those in the media are all predicting an increase in rates in the near future. However, few of them have really considered the ramifications of this rate increase at the state and local level. As 76 million boomers head towards retirement, all of them will incur some level of expenses for their health care. Thus, the greatest threat to boomers in retirement will be health care cost. And only a handful of financial firms are even discussing this planning topic with them.
What chance do we really have if an industry makes its living on helping people plan for life’s uncertainties, but will not help those same people plan for life’s certainties?
The views expressed here are those of the author and not necessarily those of ProducersWEB.
Reprinting or reposting this article without prior consent of Producersweb.com is strictly prohibited.
If you have questions, please visit our terms and conditions