Reforming the Postal Service’s Pension and Retiree Health Care Benefit Systems

Earlier this month I had the opportunity to participate in an R Street Institute panel discussion on the current fiscal health of U.S. Postal Service (USPS) pensions and retiree health care system, and how USPS compares with similar state and local systems.

The panel gave special attention to two bills currently pending in Congress—the USPS Fairness Act (H.R. 2382) and Postal Service Financial Improvement Act of 2019 (H.R. 2553)—that could affect the future solvency of postal worker benefit programs. Given the challenges that state and local governments are having with unfunded pensions, it’s important that Congress look at similar, even if less severe, issues at the federal level.

Currently, USPS workers are enrolled in one of the two pensions plans— the CSRS (Civil Service Retirement System) plan for workers hired before January 1, 1987, and the FERS (Federal Employees Retirement System) plan for workers hired thereafter. Whereas CSRS is a traditional defined-benefit plan, FERS is a side-by-side hybrid plan which combines a defined-benefit pension plan with a lower multiplier and a defined-contribution retirement plan known as the Thrift Savings Plan (TSP). Employees who are enrolled in FERS are auto-enrolled in the TSP, which provides contribution matching by their employer. When it comes to retiree health care, the Postal Service Retiree Health Benefits Fund (PSRHBF) is dedicated to paying retired workers their share of health insurance premiums.

As of 2019, USPS has funded 87.2 percent of CSRS and 86.9 percent of FERS liabilities. In comparison to the national public pension plan funded ratio average of 73 percent,  USPS’ roughly 87 percent funding level for both systems might look good. But the systems were fully funded just a few years back (2013 for FERS and 2011 for CSRS).

The 13 percentage-point drop for these systems in such a short time, and during a historic bull market, is an indicator of growing systematic issues. In absolute numbers, the total amount of unfunded pension liabilities for USPS is now almost $50 billion, which inevitably creates difficult budgetary decisions and pressures for USPS going forward.

Post-employment benefit plans in the public sector have suffered from low investment returns since the beginning of the century. USPS was no exception. It is worth noting that all USPS funds are invested solely in fixed-rate U.S. Treasury securities, in stark comparison to the average public pension plan asset allocation that includes equities and other alternative investment categories with a generally higher risk profile.

According to NASRA (National Association of State Retirement Administrators), the average public pension fund keeps about half of its assets in public equities, a little less than a quarter in fixed income, and the rest in “riskier” assets such as real estate, cash, and alternatives. Although Treasury securities are considered a safe asset, they also yield relatively low returns. Because of this unique investment philosophy, both of the USPS pension funds have an assumed rate of return (ARR) of 4.25 percent, whereas the average U.S. state and municipal public pension plan has an ARR of 7.3 percent. 

While USPS pension systems are about 87 percent funded, the health care portion of its retirement benefit system is only 44 percent funded, with $70 billion in unfunded liabilities. It is no surprise, therefore, that the legislation discussed during the panel was focused primarily on reforming the PSRHBF.

The USPS Fairness Act (H.R. 2382), the first of two USPS health plan bills under consideration in Congress, would reverse a reform made in 2006 by removing the requirement to pre-fund health care benefits. Before 2006, health benefit premiums were simply paid when they were due. However, after discovering that health benefits are deeply in the red, Congress decided to use pension savings for health benefit funding and created PSRHBF with the intention to pre-fund all future health benefits and avoid fluctuations in the cost of health care funding.  

Unfortunately, the USPS retiree health reform coincided with the decline in the agency’s revenue. Since 2007, USPS has lost over $69 billion. As a result, the USPS hasn’t contributed to its health fund since 2012, according to its latest financial statement. Together with amortization payments (debt service payments that accrue when liabilities are left underfunded), the total missed payments amounted to $47 billion as of 2019.

The critics of the 2006 law pointed out that pre-funding of health benefits is uncommon and that it disadvantages USUPS in the face of private competitors who don’t necessarily have to abide by the same requirement. While it is true that there is no requirement to pre-fund health benefits in the private sector, that fact alone does not invalidate the significant benefits of pre-funding the USPS retiree health plan.

While running a system on a pay-as-you-go (PAYGO) basis may temporarily result in lower expenses in the short term, pre-funding long-term retiree benefits can result in significant future savings because this method takes advantage of returns generated by investments, thereby minimizing the number of taxpayer contributions needed to fulfill benefit promises. Accordingly, using PAYGO can actually be an extremely costly way to run any sort of retirement benefits in comparison, since it eschews market returns on invested assets for maximum taxpayer contributions. For example, 63 percent of public pensions revenue from 1989-2018 came from investment earnings, according to NASRA.

The second piece of federal health plan legislation on the table, the Postal Service Financial Improvement Act of 2019 (H.R. 2553), would allow a portion of PSRHBF assets to be invested in index funds, which have been gaining popularity in the public pension world due to their lower expenses and fees when compared to actively managed funds. In addition, it has been found that passive management can outperform active management.

Whatever the direction of future policy action on USPS worker benefits, it is clear that running any sort of benefits system on a PAYGO scheme is the most expensive way. When it comes to adopting new investment practices, index funding could be a viable option for PSRHBF, because of the low cost of managing such funds and their high efficiency.

In choosing a reform strategy for the pension and retiree health care benefit systems for the U.S. Postal Service, Congress should follow best practices for pension solvency, such as prioritizing paying off debt, setting realistic assumed rates of return,  and requiring USPS to fully make its required contributions.