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* Fewer local governments offer retiree health coverage
* Average employee health care cost to hit $11,188 in 2013
By Jilian Mincer
Oct 15 (Reuters) - As cash-strapped U.S. cities and states struggle to address gaping budget holes, a long-honored benefit for public-sector workers has come into the cross-hairs of budget cutters: retiree health insurance.
A growing number of states and cities are eliminating or reducing health coverage for retirees, a benefit that has long fallen by the wayside for most private-sector workers.
But the coverage, which has meant that most retired public workers have all their medical bills fully paid, is expensive and hugely underfunded. And because health coverage does not typically have the strong legal protections that hamstring changes to public pension benefits, it is easier for governments to scale back.
The trend could leave millions of public workers with thousands of dollars in unanticipated healthcare costs.
"In 20 years, very few people will have this benefit," said Dennis M. Daley, a public management professor at North Carolina State University in Raleigh, North Carolina.
Illinois, which has some of the nation's largest pension liabilities, approved legislation in June that would for the first time require retirees to pay an increasing amount for previously free retiree health insurance. The state expects to save $800 million annually.
More than 77 percent of the roughly 19 million employees of large U.S. state and local governments were eligible in 2012 for retiree health insurance. That is in sharp contrast with the private sector where employers pay for retirement healthcare costs of only about a quarter of workers, according to the most recent Kaiser Family Foundation survey.
But rising healthcare costs, plummeting tax revenues and unfunded pension liabilities - which have forced some towns into bankruptcy - have forced states and cities into a rethink.
Many have increased eligibility ages, hiked out-of-pocket expenses and dropped coverage for family members. In some cases, they have eliminated insurance altogether. Others are planning similar scalebacks.
Almost a quarter - 23 percent - of local governments with at least 250 workers did not offer retiree coverage in 2012, compared with 17 percent in 2011, according to an October report by Cobalt Community Research, a nonprofit research coalition in Lansing, Michigan. Smaller governments provide even less help. Only 39 percent of governments with 51 to 100 employees offered retiree health insurance in 2012 versus 55 percent a year ago.
"I don't think any local government wants to hurt employees or retirees and reduce coverage, but they are balancing that with the challenge of lower revenues," said William SaintAmour, executive director of Cobalt, noting the stark choice between providing core services for citizens and benefits for employees. "It's been very much a pills or potholes discussion."
Consulting firm Aon Hewitt estimates that the average U.S. health-care cost per employee will climb in 2013 to $11,188, up from $7,874 in 2007. Providing retiree coverage could be a significant savings for employees.
Fidelity Investments estimates that a healthy couple retiring in 2012 with only insurance coverage from Medicare, the government program for the elderly, would spend about $240,000 on out-of-pocket healthcare costs before they die on average 17 years later for men and 20 years later for women. The savings for state and local governments could be much higher because many public employees retire in their 50s, long before they're eligible at age 65 for Medicare.
In addition, retiree health insurance is relatively low-hanging fruit for government budget cutters because there is no legal obligation for coverage, sparing governments from the type of lawsuits filed by labor unions over cuts to pension benefits for workers such as teachers, police officers and janitors.
"There is no guarantee for retiree health, there never has been," said Paul Fronstin, senior research associate at the Employee Benefit Research Institute in Washington, D.C. "It is not as simple to cut as it is in the private sector, but it's a target and it's unfunded."
Accounting rules only require governments to report but not set aside funds in advance for future healthcare obligations. As a result, most states typically use a pay-as-you-go method.
On average, states have set aside only about 5 percent of what is estimated to be their retiree health care and other non-pension benefits such as life insurance. At the end of 2010 that left a $627 billion gap, not far from the $757 billion hole seen for public pensions, according to a report by the Pew Center on the States.
Seventeen states had saved nothing and only seven states - Alaska, Arizona, North Dakota, Ohio, Oregon, Virginia and Wisconsin - had funded 25 percent or more of these obligations.
The report said states should have set aside almost $51 billion for these obligations during 2010, but they contributed only $17 billion.
Most states have cut back on their commitments. Almost 60 percent of state and local governments have changed the health insurance they provide to current and retired workers, according to a survey released in April by the Center for State and Local Government Excellence. Almost 11 percent had shifted more costs to retirees.
"It's the smaller changes where you're shifting a lot of the costs," says Daley of North Carolina State University. "It's the nickel and diming - your co-payment goes up from $20 to $25."
For example, beginning in 2014, the Ohio Public Employees Retirement System will change eligibility requirements for retiree health care coverage, restricting coverage to those at least 60 years old with at least 20 years of service, up from 10 years of service. Retirees will also face higher premiums and out-of-pocket expenses and will lose spousal coverage.
Ohio, with 986,000 members and about 184,900 retirees and beneficiaries, spends about $1.5 billion a year on retiree healthcare.
Without the changes, the retiree healthcare fund would be zero by 2020, said Julie Graham-Price, the system's spokeswoman. "People are living longer, which is great for the retirees, but a little tougher on the pension," she said.