Buried in the report released yesterday by the State Budget Crisis Task Force is a terrific chart prepared by the Center for Retirement Research at Boston College. The chart neatly explains why governments should pre-fund retiree health care benefits and also why they don't.
So as of right now, it's about $1B cheaper for Texas to fund retiree health care on a pay-as-you-go-basis than to pre-fund. And it will remain cheaper (although less and less so), for about ten more years. Note also how much less aggressively the red, prefunding line ascends than the blue, pay-as-you-go line. In public finance, gradually-ascending lines are nearly always preferable to aggressive ascents, especially when we're talking about health care.
In a footnote, the report's authors note that the chart is based on figures calculated using a low-risk discount rate. Were Texas actually to begin to pre-fund, it would then almost certainly recalculate its liabilities using a higher rate based on the assumed rate of return on its investments. This would of course lower its annually-required contributions (the red line's figures). Looked at in this (admittedly inside-baseball) way, systems have an incentive to pre-fund, because it would allow them to reduce their reported liabilities. But of course this does not happen, since, as the report's authors note, in a philosophic turn, "[i]t is human nature to prefer the present to the future."
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