Pension fund hits 24-year low as repair plan begins

The state employee pension system fell to a 24-year-low this fiscal year as investment losses and more conservative projections for future earnings left the fund with enough assets to cover just 42 percent of its obligations, according to a new report.

According to the latest actuarial valuation, prepared by Cavanaugh Macdonald Consulting of Kennesaw, Ga., the fund had $9.74 billion in assets and $23 billion in obligations for a funded ratio of 42.3 percent.

Analysts typically cite a ratio between 70 and 80 percent as fiscally healthy.

The cash-starved fund likely will begin to improve now that it has entered a new restoration program launched by Gov. Dannel P. Malloy, the governor’s budget chief said Tuesday. The system is expected to receive a dramatic infusion of cash — almost $210 million in additional funding — under the next state budget the governor will propose on Feb. 6.

Malloy, who took office in 2011, has been struggling to reform a pension system that has been plagued for decades by the state’s failure to save to meet the worker retirement benefits it guarantees.

For nearly four decades state government saved nothing, and therefore gained no investment earnings to help meet pension costs. That didn’t change until the early 1980s, yet a majority of today’s pension costs still go to cover the benefits of workers from many decades ago.

The funded ratio stood at 45 percent in 1988 when the comptroller’s office began listing it in its Comprehensive Annual Financial Report. It peaked in 2001 at 63 percent.

Legislatures and governors have routinely raided the pension account — with the permission of state employee unions — to avoid politically painful budget cuts or tax increases during tough fiscal times. The last raids occurred in 2009 and 2010.

The funded ratio declined gradually after 2001, though the slippage accelerated greatly during the last recession.

It fell to a then-record low 44 percent in 2010, then climbed to 48 percent in 2011 due to a combination of investment gains from a modest economic recovery, and pension concessions negotiated by Malloy and granted by state employee unions.

As the economy remained sluggish over the past year, the fund sustained modest investment losses totaling $93.5 million. That’s far less than the huge, $1.7 billion loss the fund sustained in 2008-09 in the midst of the last recession.

This time the pension fund’s fiscal health deteriorated — at least on paper — largely because state government began to recognize a weakness that was already present, but previously ignored. The Malloy administration decided in September to lower the fund’s discount rate from 8.25 to 8 percent. The discount rate is the average rate of return on fund investments assumed over the next 30 years.

Critics in the financial services and academic circles have argued since the last recession began in 2008 that most states have unrealistic discount rates. And 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 percent or 4 percent, pointing to the yield on long-term U.S. Treasury bonds.

Malloy’s budget chief, Office of Policy and Management Secretary Benjamin Barnes, said Tuesday that the Connecticut fund’s funded ratio, though low, is a more realistic assessment of the pension system.

And if the state assumes lower investment earnings, it must be prepared to make up the difference with larger contributions.

Connecticut already was heading for a higher pension contribution based on the plan Malloy unveiled one year ago. It reversed an agreement reached in two stages — in 1995 and 1997 — by then-Gov. John G. Rowland and the unions that reduced contributions and put the pension program on what amounts to a balloon mortgage schedule. That change alone means an extra $133 million will go in the fund this fiscal year. That contribution isn’t reflected in the latest report.

Put the investment losses, the more conservative earning assumptions and the governor’s plan all together and Connecticut’s required contribution jumps even further next fiscal year from $1.06 billion to $1.27 billion.

Technically, Malloy had pledged to pay even more into the pension fund starting in the 2013-14 fiscal year, but that payment now is in doubt.

Based repeal of the balloon mortgage provisions, Malloy’s plan also called for — but did not obligate — the state to make extra payments each year to bring the fund’s assets up to 80 percent of its funded obligations by the year 2025.

“That would be an enormous challenge in the immediate term,” Barnes said Tuesday, referring to a projected shortfall of nearly $1.2 billion built into the next, overall state budget.

Still, Barnes added, the rest of the governor’s pension fix, coupled with the extra contributions required by the latest pesnion report, put the state on a pace to reach the 80 percent mark by about 2027 — two years later than originally planned.

“We’re moving in the right direction, clearly,” said Salvatore Luciano, a veteran state employee union leader.

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Salvatore Luciano, executive director of Council 4 of the American Federation of State, County and Municipal Employees.

Luciano, executive director of Council 4 of the American Federation of State, County and Municipal Employees, said he believes most unions understand, given the deficit, if Malloy must scale back his pension repair plan in the short-term. “We understand in tough times if the governor has to make some tough decisions.”

Rep. Vincent J. Candelora, R-North Branford, a longtime member of the Finance, Revenue and Bonding Committee, said the exploding pension costs underscore the need to drive down spending across the entire state budget.

Malloy, a Democrat, has said he hopes to avoid raising taxes in the next state budget, though he hasn’t ruled that possibility out. The governor and Democrats did agree to raise $1.5 billion in new taxes in 2011 to close a deficit approaching $3.7 billion.

Candelora noted that Democrats, who hold a majority in both the House and Senate, worked with Republicans to help close a much smaller $365 million fiscal hole in the current budget in special session last month.

And it’s going to take a larger, collaborative effort, to cut spending enough to ensure the pension fund stops being a target for raids in the future, he said.

“There has to be an open and transparent dialogue between both parties,” Candelora said. “I don’t think we have an option except to work together. All of the caucuses have a lot of talent and I think it behooves all of us to bring all of that talent into the room.”