S&P warns Malloy’s pension plan could cause bond rating cut

A major Wall Street rating agency warned it might lower Connecticut’s bond rating – pushing up interest costs on capital projects – if the state adopts Gov. Dannel P. Malloy’s plan to restructure contributions to the employee pension fund.

Standard & Poor’s also wrote in its recent bond outlook pension system is a key “indicator of budget stress” that — along with a largely unfunded retiree health care system — raises the prospect of more state tax hikes in years to come.

“In our opinion, the pension proposal would represent a significant deferral of unfunded pension liabilities after fiscal 2018,” the S&P report states. “And if implemented in a way that led us to conclude that actuarial unfunded pension liabilities were likely to grow substantially over time, could prompt us to lower the state (general obligation bond) rating one notch.”

The Malloy administration stood by its proposal Tuesday.

“We believe our proposal holds the promise of considerable improvement in the state’s long-term fiscal stability, and the nationally renowned experts advising us agree,” Gian-Carl Casa, spokesman for the governor’s budget office, said.

Casa was referring to a pension system analysis the administration commissioned from the Center for Retirement Research at Boston College. According to the administration, that analysis shows this fiscal year’s $1.5 billion pension contribution could more than quadruple by 2032, hitting $6.65 billion.

But after 2032, they would drop dramatically, falling below $400 million per year.

To avoid that fiscal iceberg 17 years from now, the governor announced in late October that he wants to keep annual pension costs fixed at about $2 billion starting around the 2018-19 fiscal year.

That means Connecticut would save billions of dollars less for pensions between 2019 and 2032 — and would make up those contributions afterward.

Though some details of the governor’s proposal still are being developed, S&P estimates that somewhere between $8 billion and $20 billion in pension contributions would be deferred under the administration proposal.

But S&P and other critics of the plan, including state Treasurer Denise L. Nappier and the Connecticut Society of Certified Professional Accountants, note this deferral would come with a cost.

By making billions of dollars less in contributions between 2019 and 2032, Connecticut also would miss an opportunity to invest those funds and achieve additional earnings.

The Connecticut Society of CPA’s wrote in a recent statement that it “remains skeptical of the governor’s proposals with respect to the public employee pensions.  Connecticut’s unfunded liabilities represent a complex problem that can only be resolved through full and honest exploration of the mathematical, actuarial, legal, and economic realities that exist … and will most certainly not go away.”

These changes would need to be negotiated with state employee unions before they could be made.

“We recognize that there’s an unfunded liability and we recognize that there are different ideas to tackle that,” said Larry Dorman, spokesman for one of the largest state employee unions, Council 4 of the American Federation of State, County and Municipal Employees. “As this process unfolds, we’ve got to remember that defined benefit plans, real pension plans, are good for workers and good for the economy. They help to generate economic activity.”

Malloy’s original plan to fix a pension system plagued by decades of underfunding was to increase contributions into the program.

That began in 2012 and continues through the current fiscal year, and trend that S&P called “a credit bright spot” for Connecticut.

But while contributions have increased, a sluggish recovery and state budget deficits have prevented Malloy and the legislature from boosting contributions as much as the governor originally hoped.

Further complicating matters, Nappier says the pension forecast, though grim is not close to the nightmare scenario Malloy outlined last fall for two reasons

The administration assumes pension investment returns over the next 15 years will mirror the 5.5 percent average earnings of the previous 15 years.

But according to the treasurer, the administration’s forecast is skewed by poor timing. The 15-year period it analyzed began right as Connecticut headed into one recession, and ended just after a second major economic dip.

The second problem with the administration’s pension-spike scenario, according to Nappier’s staff, is that it is technically flawed.

The state must adjust its contribution every two years to compensate for several factors — including investment returns potentially falling short of targets.

In other words, if future investment earnings average 5.5 percent over any two-year period, Connecticut would have to immediately self-correct and contribute more. Malloy’s projections don’t reflect the full value of this required self-correction, according to Nappier.

This still would drive up pension contributions, but in a much less steep fashion than the administration projected.

So while the Malloy administration warned the $1.5 billion pension contribution could hit $6.65 billion by 2032 or 2033, Nappier’s office places it closer to $4.7 billion at that point, and peaking around $5 billion in 2034, assuming 5.5 percent returns.

More importantly, the treasurer says, if a 7 percent average return is assumed, the state’s contribution peaks around $3.8 billion in 2032.

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