February 4, 2015
Liabilities could be Fully Funded with Realistic Changes in Assumptions
Postal Service management has been warning frequently that it is in a large financial hole and needs substantial legislative reform to get out. As its cash position has gone from dire to healthy, management has relied more on unfunded liabilities to make its case. It is important to understand that these liabilities are estimates of future expenses that depend on many assumptions that change over time. They are not the types of liabilities that we incur when we take out a mortgage or auto loan in which all the terms, conditions and amounts due on specific dates are written in black and white. USPS liabilities, with the exception of its borrowing, make assumptions about future health care inflation, the number of postal retirees, and interest earnings on cash set aside.
Recognizing the variability of postal liabilities, the Office of the Inspector General (OIG) did an analysis that focused on how liabilities are estimated and pre-funded. The report is called “Considerations in Structuring Estimated Liabilities” and the introduction lays out the issue as follows:
“This report evaluates assumptions for Postal Service future liabilities, which have a significant impact on Postal Service finances and tabulation of its losses. It provides information that shows that the Postal Service is closer to being fully funded, or potentially overfunded, for estimated liabilities when certain assumptions are reasonably adjusted or considered. It also shows the challenges of mandating 100 percent prefunding of liabilities.
The Postal Service’s retiree healthcare and pension liabilities are estimated at $403.8 billion. Cash set aside for these estimated liabilities, totaling $335.6 billion, exceeds 83 percent of the estimated future payouts for health care and pensions for retirees. In addition, the Postal Service’s workers’ compensation liability is estimated at $18.4 billion. Based on these assumptions, retiree health care, pensions, and workers’ compensation were unfunded by about $86.6 billion at September 30, 2014.”
The report says that if the $86.6 billion is a good estimate of future liabilities, there should be a good estimate of assets that could be used to satisfy them. That’s why the estimate of the market value of our home is very important when we get a mortgage loan. USPS accounting uses net book value for its largest asset, real estate, totaling $13.2 billion. The OIG estimated the realistic market value of postal real estate as high as $85 billion, which is very close to the $86.6 billion in estimated liabilities. As far as offsetting liabilities with assets, the financial hole is not as large as it has been portrayed.
In addition to offsetting liabilities with assets, the OIG examined three important elements underlying the assumptions used in estimating the liabilities: recent historically low interest rates, the proposal (made by USPS and supported by the Senate Oversight Committee) to require postal retirees to participate in Medicare, and the idea of using postal-specific demographic assumptions. Reasonable adjustments to each of these independent assumptions have the effect of greatly reducing the estimated liabilities, according to the OIG white paper.
The 10-year Treasury note has averaged 5.34% over the last 75 years, yet on January 1, 2015 it was at 1.98%. The OIG stated: “These recent, low interest rates may significantly skew long-term assumptions. If assumptions are skewed, the results would be an inflated liability estimate.” The OIG then determined that “even a modest 1.25 percent increase in the current interest rate assumptions would reduce unfunded liabilities by $72.3 billion, significantly reducing the estimated unfunded balances.” This result is in line with what the Alliance Report has been saying for some time. And in fact, the expectation that U.S interest rates will soon start rising toward historical averages is widely accepted in the global financial markets. The expectation is one reason for the very strong dollar.
The Medicare participation proposal that was in the Carper-Coburn bill last year would cut the retiree health care liability by $42.9 billion, from $97.7 billion to an estimated $54.8 billion, according to the OIG. This would put the liability very close to the $48.9 billion in cash already set aside to fund it. In other words, the unfunded part of the retiree health care liability would go away. Essentially this proposal would require postal retirees to opt for Medicare as their primary health insurance when they become eligible, rather than the Federal Employee Health Benefits (FEHB) program that many use as their primary insurance.
Using postal-specific demographics in estimating retiree and health care liabilities, instead of government-wide demographics as is currently done by the Office of Personnel Management (OPM), would reduce the associated liabilities by $8.5 billion.
To summarize, four different factors independently reduce the impact of the estimated $86.6 billion in unfunded liabilities:
All four of these make complete sense.
Policy-makers should be very careful about “fixing” long-term “problems” with solutions such as price hikes and service reductions that would send the business in the wrong direction in the short run. Perhaps the “financial hole” that some claim due to estimated long term liabilities is not the best basis for policy prescriptions for our postal system. As John Maynard Keynes said in 1923: “But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.”
© Alliance of Nonprofit Mailers