Wall Street agency poses tougher test for state pensions’ health

Just as Gov. Dannel P. Malloy’s plan to bolster the state’s cash-starved employee pension fund kicks in, a leading Wall Street credit-rating agency is posing a new way to test the pension system’s fiscal health.

Moody’s Investors Service has proposed a new methodology that would offer a much grimmer assessment of public employee pension plans in Connecticut, many other states, and most municipalities.

But officials here, who have until Sept. 30 to comment on Moody’s proposal, expressed confidence in the direction state pensions are heading.

And the head of Connecticut’s chief municipal lobby said cities and towns long have been aware of the challenges they face to maintain their pension programs, adding their fate will hinge on how well state officials preserve municipal aid and help control property taxes.

Moody’s revised approach hinges on how much long-term return government entities can assume to make as they invest pension funds.

Most states, including Connecticut, assume they will earn, on average, 8 percent or more over the next 25 to 30 years. The state employees pension fund assumes an 8.25 percent average return while the teachers’ fund assumes 8.5 percent.

But critics nationwide have argued since the last recession began in 2008 that, even though average returns over the past few decades have hit or topped the 8 percent mark, the same shouldn’t be expected in the future. Some have suggested a target closer to 3 or 4 percent, pointing to the yield on long-term U.S. Treasury bonds.

Moody’s proposal specifically uses the return of high-quality corporate bonds as its new guideline, noting that their average yield was 5.5 percent in 2010 and 2011.

The Pew Center on the States reported earlier this year a $757 billion cumulative gap between the pension obligations of all states and municipalities nationwide and their resources to cover them. According to some projections, Moody’s proposed method of assessing pensions would nearly triple that problem.

University of Connecticut economist Fred V. Carstensen, head of the Connecticut Center for Economic Analysis and one of the biggest critics of past raids on the state’s pension funds, said that while no methodology is perfect, the Moody’s approach could offer important perspective.

Fred Carstensen

Fred Carstensen. He doubts a long-term 8 percent return on investment is likely for state pension funds.

“Looking forward, there’s no reason to think we’re going to have anything like that” 8 percent, Carstensen said. “I think it’s healthy to look at a smaller number. I think you can have a much more constructive discussion. It might help policy-makers focus on these core issues of economic importance.”

The Pew Center wrote that after losing an average of 25 percent of their pension funds’ values during the stock market plunge of 2008, and then regaining just 21.6 percent through 2011, many states were debating whether to pull their assumptions below 8 percent.

Rhode Island lowered its pension assumptions to 7.5 percent last year, and an actuary for New York City recommended dropping assumptions for the city’s pension funds to 7 percent.

Connecticut’s state treasurer, Denise L. Nappier, reported that the state’s collective retirement plans also enjoyed strong growth in the first two fiscal years coming out of the recessional low. But in 2011-12, investment returns came in at negative 0.9 percent.

In the three fiscal years from 2009-10 through 2011-12, the combined investment return was 10.5 percent.

“It comes as no surprise that the 2012 fiscal year end performance results are not as we had hoped, but more along the lines of what we expected,” Nappier said when she reported those results on Aug. 9. “The Great Recession clearly was not a hit-and-run event. It has been an unprecedented financial crisis. And as investors in a global economy, we must be mindful that events in Europe and beyond have had and will continue to have far-reaching consequences.”

The treasurer, who declined to comment on Moody’s proposed rule change, said earlier this month that while pension investment strategy is designed for the long-term, “we have a ways to go before the state pension plan can, once again, enjoy longer term performance that meets or exceeds the actuarial return assumptions of 8.25 percent and 8.50 percent.”

Gian-Carl Casa, spokesman for the Connecticut Office of Policy and Management — Malloy’s chief budget and policy planning agency — noted Friday that Moody’s proposed change isn’t expected to lower bond ratings in the short-term.

“Moody’s revised calculation will indicate a larger amount of unfunded liability than the state’s current actuarial determined unfunded liability, but that will be the case for virtually all states,” he said.

But Malloy, who inherited a state employee pension fund at its lowest value in more than two decades when he took office in 2011, already has taken huge steps to reverse that, Casa said.

According to the latest valuation, the fund was worth $10.1 billion on June 30, 2011, with $21.1 billion in obligations, for a funded ratio of 47.9 percent.

First Malloy reached a concessions deal with unions in August 2011 that raised regular retirement ages for several employee classes, increased penalties for early retirement, modified cost-of-living adjustments to pensions and offered a new hybrid retirement program.

And earlier this year, Malloy secured both legislative and union approval to make an extra $3 billion in pension payments in total between this fiscal year and 2023. After 2024, the contribution would drop annually. Over the course of the next three decades, Connecticut would save an estimated $5.8 billion.

A veteran state employee union leader, Salvatore Luciano, said Friday that regardless of how Moody’s chooses to assess states’ and municipalities’ pensions, the basic principle remains unchanged: the system remains healthy when contributions are made on time, and then left untouched to earn investment income.

“The problems have come when states have raided their pensions or have under-funded,” said Luciano, executive director of Council 4 of the American Federation of State, County and Municipal Employees. He added that Malloy “has gone a lot way” to reverse decades of poor pension handling by state government here.

The Connecticut teachers’ pension fund is in slightly better shape, with $14.4 billion in assets and $23.5 billion in obligations, as of its last valuation in June 2010. That’s a funded ratio of 61 percent. It’s next valuation is due this fall.