How prefunding retiree health benefits impacts the Postal Service’s bottom line — and how Brookings got it wrong

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A couple of weeks ago, the Washington Post ran a column by Lisa Rein entitled “Should the Postal Service be sold to save it?”

The article was about a recent paper by Elaine Kamarck published on the Brookings Institute’s website.  Kamarck is the Founding Director of the Center for Effective Public Management at Brookings, as well as being a Senior Fellow in Brooking's Governance Studies.  Her paper is entitled “Delaying the inevitable: Political stalemate and the U.S. Postal Service.” 

Kamarck’s thesis is that the Postal Service is going through a “crisis of obsolescence,” its financial losses are unsustainable, and “the political system is stuck and unable to do anything about it.”  The thing to do now, concludes Kamarck, is split the Postal Service in two.  One organization would fulfill the universal service obligation by delivering market-dominant mail.  The other part would be privatized and take over competitive products (Priority Mail and package shipping); it would also be given the freedom to expand into new areas of business now prohibited for the Postal Service.

The article prompted several critical responses, including pieces by Dave Johnson in Crooks & Liars and Zaid Jilani in AlterNet.  Rein also did a follow-up article in the WaPo — "Why sell off the Postal Service if it's making money?" — in which she goes more deeply into the conflicting explanations for the Postal Service’s financial problems.

One of the main issues in the debate has been the Retiree Health Benefit Fund (RHBF).  The critics of Kamarck’s paper (and Rein’s column about it) argue that were it not for the RHBF prefunding established in 2006 by the Postal Accountability and Enhancement Act (PAEA), the Postal Service would not have been posting huge losses.  The core of the financial problem facing the Postal Service is that it is required to fully fund decades of future retiree health costs with ten annual payments of about $5.6 billion, an obligation imposed on no other business or government agency.  

Kamarck anticipates this claim about the RHBF, and her paper tries to set it aside.  In so doing, however, she makes an error that’s worth looking at in some detail.

 

The fly in the ointment

Kamarck’s paper addresses the argument about the prefunding as follows:

Many believe that the prefunding requirement for retiree health benefits accounts for all of the Postal Service’s financial problems.  Although the prefunding requirement does account for a large share of net losses, retiree health benefits caused $22,417 million in expenses out of a total net loss of $5.5 billion in fiscal year 2014.

Kamarck is trying to make the case that prefunding the RHBF does not explain the Postal Service’s huge losses, which she thinks can only be explained by the declining mail volumes caused by the Internet.  To make this point, she says that prefunding accounted for $22,417 million (or $22.4 billion) of the $5.5 billion loss in FY 2014. 

This doesn’t make sense. She’s trying to show that the RHBF expense doesn’t account for such a large portion of the net loss, but according to her numbers, the expense was four times greater than the loss

That's not just illogical, it's wrong.  The RHBF expense in FY 2014 was not $22.4 billion.  It was $5.7 billion, as stated in the USPS 10-K report.  And the expense did not account for just a portion of the $5.5 billion net loss.  It accounted for all of it.  If it weren’t for prefunding, the Postal Service would have posted a profit in 2014.

I notified the Brookings Institute about the error in Kamarck’s paper on September 22, the day after the paper was posted on the Brookings website, but so far I’ve received no response, and the error still appears in the paper on their website.

Anyway, it seems like a pretty minor mistake, hardly worth noting, but it goes to the heart of Kamarck's argument.  She’s trying to refute the claim that prefunding explains the Postal Service’s financial problems, but the number she presents is wrong, and that’s all she has to say about the claim.  If prefunding really is the cause for the Postal Service's financial problems, the solution is obviously to fix the prefunding — not sell off and privatize the competitive products business, the one area that's actually growing. 

 

The source of the error

The error in Kamarck paper is derived from a misreading of a table in a financial analysis by the Postal Regulatory Commission, which is cited in footnote #8.  On page 21 of the PRC report, there’s a table showing “Structure of Assets and Liabilities” for the Postal Service. (You can see the table here.)  

The table shows that as of September 30, 2014, there was a liability of “$22,417 million” for “retiree health benefits.”  But this figure is not the expense for the retiree health benefit expense in FY 2014, as Kamarck says in her paper.  Rather, as the PRC explains in the text following the table, "The Postal Service has not yet paid RHBF statutory prefunding obligations for FY 2011 through FY 2014, which total $22.4 billion and comprise 52.7 percent of current liabilities.”

In other words, the Postal Service did not pay $22.4 billion into the RHBF as required for 2011-2014 (it defaulted on these payments), so the total for these unpaid obligations appears as a liability for retiree health benefits in the table.  The $22,417 million cited by Kamarck is the cumulative expense for four years, as of the end of FY 2014, not the expense for FY 2014 itself.

Kamarck is wrong on the larger point as well.  Prefunding is clearly the primary cause of the Postal Service’s net losses, and to a significant extent.

 

The impact of prefunding

Kamarck acknowledges that the “prefunding requirement does account for a large share of net losses,” but she doesn't say how large that share is.  

The following table shows what's happened since prefunding began.  It shows each year’s net loss, as reported in the PRC financial analysis (p. 26), along with the prefunding payment for the year and what the profit or loss would have been without the prefunding. 

The prefunding for 2007 includes $5.4 billion for the first annual RHBF payment and another $3 billion transferred into the fund from an escrow account,  (An earlier version of this article neglected to include the escrow transfer, but it is included in the $5.1 billion net loss, as explained in the 10-K report for 2007.)  The unusually large net loss in 2012 was due to the fact that the Postal Service was permitted by Congress to skip the RHBF payment in 2011, but then owed a double payment in 2012.  The figures for FY 2015 are estimates based on the first eleven months of the year, as reported in the USPS financial report for August.  

Impact of Prefunding on USPS losses
($ in billions)
Year Net loss Prefunding Profit/loss without prefunding
2007 $5.142 $8.358 $3.216
2008 $2.806 $5.600 $2.794
2009 $3.794 $1.400 -$2.394
2010 $8.505 $5.500 -$3.005
2011 $5.067 $0.000 -$5.067
2012 $15.906 $11.100 -$4.806
2013 $4.977 $5.600 $0.623
2014 $5.508 $5.600 $0.920
2015 $4.600 $5.700 $1.100
Total $56.305 $48.858 -$6.619

As the table shows, over the past nine years, the Postal Service has posted losses totaling about $56 billion.  Almost $49 billion of it — 87 percent — was due to prefunding.  

Over the past nine years, there were four years when the Postal Service would have posted a loss if it weren't for prefunding — the years of the Great Recession and its aftermath.  In the two years before the economy tanked, the Postal Service would have shown a profit if it weren’t for prefunding.  In 2013 and 2014, with the economy improving and postal revenues stabilizing, the Postal Service would again have shown profits if it weren’t for prefunding. 

The same will be true for FY 2015.  As of September 1, 2015, eleven months into the fiscal year, the Postal Service had a net loss of $4.1 billion, including a RHBF expense of $5.2 billion.  Depending on the size of the workers comp adjustment for September, the Postal Service will end the year with a net loss of something like $4.6 billion.  But without the RHBF expense, it would show a profit of about $1 billion, about the same as last year.

Kamarck writes that “many believe that the prefunding requirement for retiree health benefits accounts for all of the Postal Service’s financial problems.”  No one believes that prefunding accounts for all of the financial problems, but clearly it accounts for a huge part.  This is not a matter of belief.  It’s a fact.

 

The origins of prefunding

Congress should have fixed the prefunding problem back in 2009 or 2010, as soon as it became clear that the size of the payments was unmanageable in a recession.  Unfortunately, privatization advocates in Congress (like Darrel Issa) wanted to use the crisis as justification for legislation designed to dismantle the Postal Service.  Fortunately, there were others in Congress, Democrats and Republicans, who saw the value of having a vital public postal system.  That’s why there’s been a political stalemate.

But Congress should never have imposed the prefunding payments to begin with.  It’s worth recalling how that happened.

In 2002 the Office of Personnel Management (OPM) determined that the Postal Service was overpaying billions of dollars into one of its pension plans, but reducing the pension payments to the Treasury would have had a negative impact on the unified budget of the federal government — something that the Bush administration would not permit.

So when PAEA was winding its way through Congress, a deal was hatched between the bill’s crafters and the Bush administration, specifically the Office of Management and Budget (OMB).  Rather than paying for retiree health costs on a pay-as-you-go basis, as it had always done and probably could have continued to do, the Postal Service would begin setting aside funds for future retirees, decades in advance.  

The idea for the fund may have come from Postmaster General John Potter, who in 2003 recommended to Congress that a different pension overpayment (involving postal workers who were vets) might be transferred to a new Retiree Health Benefit Fund.  It was the next best thing to getting a refund on the overpayment, which Potter knew Congress would never approve.  The Postal Service's proposal to create such a fund is analyzed in more detail in this 2003 GAO report, which explains how the plan would be "scored," i.e., how it would impact the federal budget.

Three years later, Congress created the RHBF to address a different pension overpayment problem.  The overpayments were essentially shifted to the new fund, and they had to be as large as they were in order to offset the reduction in pension payments.  

A 2009 committee report in the House of Representatives about PAEA explained it this way:

The payment schedule for the first 10 years was established primarily to make the PAEA budget neutral, responding to the concerns of the Office of Management and Budget at the time the PAEA was passed, rather than corresponding to actuarial requirements or financial conditions at the Postal Service.

There was no urgent need requiring ten years of huge RHBF payments.  If Congress thought that it was a good idea to prefund retiree health costs, it could have spread out the liabilities on a 40-year amortization schedule, as Dan Blair, then the Acting Director of the OPM, had recommended in testimony to Congress in 2005.  But Congress was using the new fund to solve the pension overpayment problem, and small RHBF payments wouldn't have solved the problem.

USPS Inspector General David Williams tells the same story about the origin of the RHBF in a letter he wrote to the GAO about one of its reports expressing concern about postal liabilities.

“The Postal Service started prefunding its retiree health benefits as a result of the discovery that, due to external fund management misjudgments, it was on track to seriously overfund its pension obligations by $78 billion,” wrote Williams.  “The aggressive payment schedule appears to have been set based on byzantine ‘budget scoring’ considerations rather than actuarial assumptions or an evaluation of the Postal service’s ability to make the payments.”

So that's how the whole mess got started.  Congress was trying to fix the pension problem, and it created a new problem in the process. but it was the Bush administration’s OMB that was ultimately responsible for the payment schedule.  The Postal Service — and its workers and ratepayers — ended up with a huge burden, all so that PAEA would be "budget neutral."

(There’s more about the origins of prefunding in this previous post.)

 

Fixing the problem

Congress and the Bush administration created the prefunding problem, and one day Congress will have to fix it.  The latest bill proposed by Senator Tom Carper, one of those who helped craft PAEA, tries to do exactly that.  It would eliminate the existing payment schedule, cancel any outstanding payments, reduce the prefunding goal to 80 percent of projected obligations, and amortize payments over 40 years.  

Congress should have passed a bill five years ago saying just that and only that.  Perhaps then we would not have had to endure the endless stream of news articles about billion dollar losses, bleeding red ink, defaults on payments, and the obsolescence of the postal system. 

Perhaps then the Postal Service might not have found it necessary to increase rates, lower delivery standards, close post offices and plants, sell historic buildings, and make draconian cuts to its workforce.  And perhaps we would not be hearing from the Brookings Institute about why it’s a good idea to privatize the Postal Service.

(Photo credit: Brookings' panel on "The Future of the United States Postal Service")

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