Pension fund puts new hole in the next governor’s budget

The first state budget that Connecticut’s next governor and legislature must craft has sprung another leak, according to a new consultant’s report analyzing the state’s pension fund.

The analysis submitted to the Post Employment Benefits Commission says the state’s original budgeted contribution to the state employee pension savings fund was $86 million short for the fiscal year that begins July 1, largely because of the 2009 retirement incentive program.

That incentive program, or RIP, will add $117 million more to the pension liability for 2011-12, the first budget that Connecticut’s next governor and legislature will write. That’s on top of $100 million that the state should pay the fund in the coming fiscal year but hopes to defer to balance the budget, for a total shortfall of $217 million.

“It certainly shows the necessity of questioning our defined benefit plan,” Office of Policy and Management Deputy Secretary Michael J. Cicchetti, who chairs the commission, said Wednesday of the analysis prepared by Cavanaugh Macdonald Consulting, a Kennesaw, Ga.-based actuary and health care consultant for statewide and municipal retirement systems.

Gov. M. Jodi Rell, a Republican who is not seeking re-election, and the Democrat-controlled General Assembly, originally budgeted $944 million for pension costs in 2010-11–about $86 million less than the amount needed to compensate for losses to the fund caused by the 2009 retirement incentive program, according to the new report.

But state officials then reduced that allocation to $844 million in the revised, $19.01 billion budget adopted in early May for 2010-11, citing a 2009 concession deal with the state labor unions that permits a reduction in the event of declining revenues.

The next leadership team at the Capitol already faces a significant challenge. According to the legislature’s nonpartisan Office of Fiscal Analysis, the 2011-12 budget faces a built-in deficit of $3.37 billion, an amount equal to nearly 20 percent of current spending. That shortfall projection does not include revised pension contribution requirements.

The Post Employment Benefits Commission, which was created in February by Rell and is expected to finish its work later this summer, only is empowered to make recommendations. It will be up to the next governor and legislature, who take office in January, to decide whether to follow them.

“It shows that unless you have the fiscal responsibility not to do these RIPs – and Connecticut has a history of doing them – they are going to set you back,” said Cicchetti, who has asked the commission to investigate several possible changes to the state’s retirement benefit system. These include shifting from a “defined benefit” plan, in which employers put aside money to guarantee retirees a certain pension payment, to a “defined contribution” system, such as 401(k) plans, that help workers save for their own retirements.

But Salvatore Luciano, a veteran state labor union leader and a commission member, said there is no evidence state government’s pension system needs further reform. The state created two new tiers of retirement benefits for workers hired after 1984. It is the cost of providing the highest level of benefits, to employees hired before then, coupled with the fact that state government has under-funded its pension program for decades, that is creating challenges now. “For 40 years it was pay-as-you-go,” he said.

Luciano added that if the administration is concerned about the stability of the pension fund, Rell shouldn’t have proposed another retirement incentive program – one that would have been open to workers as young as age 52 – back in April. The State Employees Bargaining Agent Coalition rejected the governor’s call for a 2010 retirement program, arguing it would place too great of a strain on the fund.

State officials relied on a 2009 retirement incentive program – believed to have saved $110 million that year – and $314.5 million in union-approved reductions to pension fund contributions to squeeze through tight fiscal straits over the past two years and in fiscal year that starts July 1.

The theory behind these retirement incentives is simple: Senior workers retire sooner than they planned – relieving the state of their higher salaries – and some are replaced with lower-paid hires.

But critics have argued that the savings from these programs are an illusion, and that any short-term reduction in salary costs is eventually offset by the long-term losses suffered by a pension savings account robbed of investment earnings.

According to the new report, state government needs to spend $1.03 billion next fiscal year both to cover the normal cost of its pension program, such as cash benefits to retired workers, and to gradually reduce what is commonly called the “unfunded liability.” According to its last, full actuarial valuation, the pension fund had $19.2 billion worth of obligations, or liabilities, and held just under $10 billion, or an amount equal to 52 percent of its liability.

Annual contributions to the fund are supposed to cover current costs for a system that includes about 53,000 workers and just under 40,000 retirees and to gradually erase the unfunded liability over a 30-year period.

University of Connecticut economist Fred V. Carstensen, who heads the Connecticut Center for Economic Analysis and is a vocal critic of retirement incentive programs, said they dangle a short-term saving that doesn’t last.

“It is a myth that they actually save anything,” he said. “You use them to balance the current services budget but you don’t have to balance your retirement budget, so no one thinks about it.”

While the senior worker is retiring and taking a higher salary off the books, Carstensen said, several other things are happening at the same time.

Each new retiree has stopped – earlier than planned – paying into the pension system. Workers are required to contribute, but retirees are not. That same person also has begun drawing benefits sooner.

And not only is the pension fund receiving less and paying out more, but each year it loses the interest earnings on that difference.

“You’re getting hit pretty hard, but you don’t realize it,” Carstensen said.