A proposal to bifurcate Connecticut's main public pension fund has triggered extensive debate in a state where an unfunded liability mess contrasts with enviable per-capita income statistics.
The plan would divide the State Employees Retirement System, one of the state's two largest funds, into essentially a pay-as-you-go system for employees hired before 1984 and a separate fund for those hired after that year.
It's the lynchpin recommendation of a
"I think it's an interesting proposal," said James Spiotto, a managing director at Chapman Strategic Advisors LLC in Chicago.
Gov. Dannel Malloy commissioned the report.
"I'm very much committed to seeing Connecticut address this situation in the short run, that is get this thing done and it get off our backs," Malloy told reporters at the state capitol in Hartford on Nov. 10, after his administration released the study.
Malloy said the move could eliminate spikes and smooth out increases in amortization payments necessary to erase Connecticut's unfunded liability by 2032, as its current plan requires.
The overhaul, however, is easier said than done.
Connecticut faces several hurdles. State policymakers, the legislature, unions and pension boards all must sign off and an overhaul could be too volatile for 2016, an election year for lawmakers.
Right away, state Treasurer Denise Nappier, whose office oversees the investment of pension funds, waved caution flags.
"There are a myriad of investment, legal, actuarial and tax issues with which the state must contend," she said shortly after state officials released the BC report. "Policy leaders should examine less radical departures from Connecticut's current funding method that could still alleviate the general fund impact of a spike in pension payments while preserving the core principles of an actuarially sound plan."
State budget Director Benjamin Barnes acknowledged
The older tier has less than 2,000 pensioners, so the move at first glance seems less risky, politically and costwise. Still, prospects for sticky litigation hover.
"I always worry about how they justify the generational split," said Spiotto. "When you split up assets between older and younger, you get into generational issues. You want buy-in so you don't have to deal with litigation."
Connecticut administers six retirement systems overall. After SERS, the Teachers' Retirement System is second-largest. According to the BC report, the funded status for the top two systems has declined by roughly 20 percentage points over about a decade.
The report pegged the funding level of SERS and TRS at 42% and 59%, respectively, and the total unfunded actuarial accrued liability for the two systems combined at $25.7 billion – $14.9 billion for SERS and $10.8 billion for TRS.
Pew Charitable Trusts considers 80% an acceptable threshold.
In 2014, said the BC report, Connecticut paid $1.8 billion to amortize the unfunded liability in both plans compared with about $400 million for benefits earned by current employees. It said the state faces scheduled increases in amortization payments to fully erase the unfunded liability by 2032, as the current plan requires.
"The problem is not the level of benefits," BC researcher Alicia Munnell told reporters. "It's just a question of money has not been put aside."
The researchers did praise Connecticut for having paid, on average, 90% of the actuarially required contribution, or ARC, for SERS since 2001 after a rash of inconsistent funding. For TRS, the state issued $2 billion of pension obligation bonds since 2008 and has paid its entire ARC since.
"Connecticut has scoped out the problem and has committed to fully paying the arc," said Douglas Offerman, a senior director at Fitch Ratings. "They have a hard date [2032] and Connecticut has mostly stuck to that payoff plan for nearly a decade."
TRS funding was inconsistent before 2008. Connecticut paid more than 80% of the ARC from 2001 to 2003, nearly 70% in 2004 and 2005, and essentially 100% in 2006 and 2007, according to researchers.
"It's basically no surprise that we've been fairly poor in funding all our pension funds, particularly the SERS account, and we've not been getting good enough returns," said state Sen. Scott Frantz, R-Greenwich, deputy minority leader of the Senate Republican caucus and ranking member of the General Assembly's finance and commerce committees.
The Teachers' Retirement System earlier this month dropped its expected rate of return from 8.5% to 8%, parallel with SERS. Moody's Investors Service called the move a credit positive. The average assumption for similar plans nationally is 7.7%, according to Barnes.
Nappier, who said setting return assumptions at more attainable levels will strengthen the funds long-term, expects the teachers board to further examine the assumptions at its next meeting in February.
Spiotto urged Connecticut to review its pension practices, annually or biannually, for possible realignment.
"You have to throw in the imponderables," he said. "There are things you can't control, such as demographics – retirements and deaths."
Frantz cited headwinds, largely union driven, at previous attempts to lower the assumption rate.
"I tried about five years ago to singlehandedly reform the system and drop the assumptions to 5.5% or 6%," he said. "I went to a meeting of the investment advisory board and about 250 yellow shirts yelled at me and the whole thing came to a standstill."
Alan Schankel, a managing director at Janney Capital Markets in Philadelphia, called the split concept no panacea.
"It doesn't really change anything on the ground. It's not going to magically erase liabilities or reduce liabilities," he said. "It will, perhaps, make it easier to track and it could in certain years create more urgency for higher contributions.
"Basically, the legacy plan would end up being a pay-as-you-go -- in other words, each year they'd have to pay what the actual pension costs total up to, and then [under] the second plan, they would make contributions so that when those folks started retiring they would have enough money to pay their retirement."
The Indiana State Teachers' Retirement
"These features are designed to protect against disruptions in payments and to counter the escalating costs states face as workers live longer in retirement," said Nappier, who suggested Connecticut study the Indiana plan.
Indiana initially funded the stabilization account from $425 million of employer reserves. Additional contributions come from the state lottery among other resources, and a provision calls for steering half of any state reserve balances above 10% of appropriations into the fund.
Its balance as of June 30, 2014, was $2.9 billion.
Nappier also suggested the state reconsider its full-funding goal by soundly adjusting the amortization period when the plan is funded at 80%.
"This would need to be accompanied by an iron-clad commitment to pay the ARC annually; otherwise our undisciplined behavior in the past might return in the future," she said.
Pension debate in Connecticut intersects with discussions about the state's debt level and budget. The state's deficit may reach $400 billion by the end of the fiscal year.
"Even with the governor's $103 million of rescissions [in late September], we have about a $360 million deficit," said Frantz. "How are we going to keep our promises to our pensioners if we cannot balance a budget to save our lives?"
Fitch's Offerman pointed out that Connecticut tends to pick up certain services that local governments in other states deliver.
"They pay for teacher pensions even though teachers get their paychecks from local governments. They pay for a large percentage of school capital, so that affects their debt numbers," he said. "But their net tax-supported debt is still high, certainly high relative to other states."
Connecticut on Tuesday sold $650 million of general obligation bonds, with Barclays Capital the senior manager. Fitch Ratings and Kroll Bond Rating Agency assigned AA ratings with stable outlooks, while Standard & Poor's rated them AA with a negative outlook. Moody's Investors Service rates Connecticut Aa3 with a stable outlook.
"They have fooled me from day one up there," Frantz said of the rating agencies. "I thought they were going to downgrade us by two or three notches in 2009, when our portfolio took a hit. But they keep hanging their hats, all of them, on the state's unlimited ability to tax."
Connecticut is the nation's wealthiest state by per-capita personal income, though skeptics say the affluent Fairfield County stockbroker belt near New York City skewers the metrics and effectively masks debt, pension underfunding and poverty levels in other parts of the state.
"Connecticut's like every other state. There are very well-off areas and others that aren't," said Spiotto.
"In the Midwest, everyone assumes that it's Greenwich and Fairfield County, because they know of them. But it's also Hartford. States function best when they work for everyone."
