On this Web site, we refer to OPEBs as retiree health benefits. Retiree health benefits are the most expensive OPEBs.

In California and across the country—in both the public and private sectors--employers' costs for these retiree health benefits have been rising rapidly. There are two main reasons for these cost increases. First, health care premiums have been rising faster than inflation for many years. Second, the aging of the "baby boom" generation, as well as lengthening life expectancy, have increased the number of retirees receiving these benefits. In California, recent changes in public pension systems also have increased incentives for public employees to retire earlier, and this has contributed to an increase in the number of retirees receiving health benefits.

For governments, when retiree health costs rise faster than the rate of growth of tax revenues, a larger and larger percentage of governmental revenues must be devoted to providing retiree health benefits. This means that a smaller percentage of revenues is available to provide services to the general public and to pay current governmental employees.

Beginning in 2007, the provisions of GASB Statement 45 (GASB 45) began to take effect for state and local governments. Under GASB 45, over the next several years, state and local governments will—for the first time—compile data about their retiree health and similar benefits and have an actuary calculate the unfunded liabilities that have been accrued to provide those benefits to retirees in future years. Governments already collect such information for their pension systems.

The GASB 45 is an accounting standard—not a legal requirement for governments to change anything about current public retiree health benefits or their funding. Nevertheless, under state and local laws, as well as bond agreements, most governments must release financial statements that comply with GASB rules, such as GASB 45, each year. Therefore, most governmental entities will release financial statements that include a valuation of unfunded retiree health liabilities at some point during the next few years.

Unfunded liabilities for retirement systems are estimated by actuaries. Actuaries make assumptions about a pension system's investment returns, the life expectancy of public employees, and future public employee salary increases to estimate the future costs of benefits that have been earned by current and past public employees. In very simplified terms, the unfunded liability is the amount of extra money that would need to be set aside today and invested by the pension system to cover the future costs of all promised benefits earned to date by members of that pension system.

Under Governmental Accounting Standards Board Statement 45 (GASB 45), governments will calculate unfunded retiree health liabilities for the first time. Because most governments have never had to set aside any funds to address future retiree health obligations, unfunded retiree health liabilities generally will be massive—often much larger than governments' unfunded pension liabilities.

There are two basic ways for governments to address unfunded retiree health liabilities. Governments can either (1) set aside money and invest it in order to address part or all of the future costs of retiree health benefits (sometimes called "prefunding") or (2) change retiree health benefits in some way so as to reduce future costs. Because unfunded retiree health liabilities often will be very large, neither of these options represents an easy choice for many public entities. Eliminating retiree health liabilities, for example, may require setting aside large amounts of money or implementing large cuts in benefits for some or all retirees.