Lembo offers a detailed plan to cope with pension costs

State Comptroller Kevin Lembo puts forward a plan for restructuring state pension funding.

Keith M. Phaneuf / CTMirror.org

State Comptroller Kevin Lembo puts forward a plan for restructuring state pension funding.

State Comptroller Kevin P. Lembo unveiled a detailed plan Thursday to help Connecticut dodge a fiscal iceberg nearly two decades from now by capping its annual pension costs below $2.3 billion through 2033.

The comptroller’s plan, which helps Connecticut avoid a nearly $4 billion pension payment in 2033, comes with a cost.

According to a series of actuarial runs included in the report, the state would have to maintain annual pension payments in excess of $1 billion for eight years after 2033 — a time when Connecticut was supposed to face costs well below that mark.

Lembo is now the third constitutional officer to unveil a strategy to counter the spiking pension costs Connecticut faces because of inadequate savings policies that date all the way back to 1939.

The comptroller also joined Treasurer Denise L. Nappier in differing with fellow Democrat Gov. Dannel P. Malloy over just how bad this pension nightmare might be.

Malloy reported back in October that the contribution to the state employees’ pension fund, which stands at $1.5 billion now, could quadruple to $6.65 billion by the early 2030s.

Lembo and Nappier both say the worst-case scenario, while still daunting, is closer to $3.8 billion.

Connecticut’s rocky pension history

“Pension reform, like any important public policy change, demands that we build a solution on data, research and actuarial best practices,” the comptroller said.

From 1939 until 1971, Connecticut operated a pay-as-you go pension system, meaning it saved nothing to cover promised retiree benefits while workers were employed. All funds to cover that benefit were drawn from the state budget after retirement.

By the mid-1980s Connecticut had begun both saving for workers’ pensions and had reduced pension benefits somewhat.

Still, since then the state frequently has saved less than actuaries have recommended, and also has weakened its pension programs by often paying incentives to encourage large numbers of senior workers to retire.

All of that means pension contributions, which already represent one of the fastest-growing segments of the state budget, will increase at an even faster rate over the next decade or two as those workers hired before the 1984 reforms still enjoy lucrative benefits.

Differing strategies to fix the system

The governor and treasurer are recommending largely opposite approaches to the problem, but Lembo’s approach has some parallels with each side.

Like the governor, he essentially is trying to find a way for Connecticut to pay less — in total — between now and 2033. But that approach means the state might forfeit some pension fund investment earnings for a period of time.

Malloy wants to effectively cap pension expenditures around $2 billion per year starting in 2019 — a move that would save Connecticut from having to budget billions of dollars more for pension contributions between 2019 and 2032.

But the state also would have to make up those deferred contributions, plus the investment earnings they would have achieved, after 2032 — a process expected to take at least a decade or two.

Standard & Poor’s, a major Wall Street credit rating agency, threatened late last year to lower Connecticut’s bond rating — a move that could push up interest costs on capital projects — if the state employs the governor’s approach.

The last slide in Comptroller Kevin Lembo's presentation on state pensions.

CTMirror.org

The last slide in Comptroller Kevin Lembo\’s presentation on state pensions.

The administration still has neither disclosed any actuarial runs nor said whether it has commissioned any.

Though the comptroller never referenced this issue regarding he governor’s plan, Lembo included several actuarial runs with his plan, showing precisely how pension costs were projected to shift year-by-year. And the comptroller concluded the Powerpoint presentation outlining his plan with a quote from famous statistician W. Edwards Deming that read: “Without data, you’re just another person with an opinion.”

Lembo also was cautiously optimistic he would face little or no backlash from Wall Street.

How Lembo’s plan works

His plan would allow Connecticut to reduce its pension payments by about $8 billion in total between 2021 and 2032. But it doesn’t make all of that up afterward.

The comptroller’s plan would force Connecticut first to ramp up pension payments very soon – getting ahead of itself by more than $550 million in preparation for the reduced payments to come.

And even during the period of discounted payments, Connecticut would spend close to $2.3 billion annually on pension contributions, about $200 million to $300 million more per year than under the governor’s proposal.

Between 2033 and 2041 under the comptroller’s proposal, the state would have to pay about $8 billion extra.

According to actuarial runs, the Lembo plan would increase Connecticut’s overall pension costs by just over $650 million over the next 25 years.

But after those dollars are adjusted for inflation, the comptroller added, Connecticut actually saves about $1 billion.

“Cost stability and predictability, in particular, must be the focus of any conversation about Connecticut’s budget, tax policy and – in this case – pension funding,” Lembo said. “… We must tame volatility and introduce much-needed predictability.”

Pension crisis is severe – but how severe?

The comptroller also agreed with Nappier’s assertion that the Malloy administration miscalculated the pension cost trajectory for the next decade-and-a-half and exaggerated the peak cost by almost $2 billion.

According to an analysis prepared for Malloy by the Center for Retirement Research at Boston College, this fiscal year’s $1.5 billion pension contribution could more than quadruple by 2032, hitting $6.65 billion.

That warning hinges, in part, on the assumption that future pension investment earnings will average 5.5 percent — as they did between 2000 and 2014.

But according to Nappier’s office, the administration’s pension-spike scenario doesn’t apply correctly one basic mechanism of the pension system. The state must adjust its contribution every two years to compensate for several factors — including investment returns if they fall 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. 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.

The treasurer also believes Connecticut could achieve closer to a 7 percent average return over the next 15 years. If that holds up, the state’s pension contribution peaks around $3.8 billion in 2032.

Lembo’s plan accepts Nappier’s assumptions both about the worst-case pension scenario, and the potential for Connecticut to earn a 7 percent investment return.

“The governor, to his credit, has raised the issue” of spiking pension costs, the comptroller said, adding that he agrees this is an “impending crisis.”

Even a peak contribution of $3.8 billion “is not sustainable, and we simply would not be able to afford it,” Lembo added.

The governor’s response to the comptroller’s plan on Thursday was brief.

“We appreciate that the Comptroller agrees with so many of our proposals,” wrote Malloy spokesman Chris McClure.

Unlike Lembo and Malloy, Nappier wants Connecticut to accelerate payments into the pension system now and thereby lessen the potential cost spike looming in the early 2030s. And while this would place more pressure on the overall state budget in the short term, it also would probably increase investment earnings in the pension fund.

The treasurer has warned repeatedly over the past few months that Connecticut developed its pension crisis in the first place by taking too many opportunities to contribute less than was required into its pension fund.

Nappier did not immediately respond to the comptroller’s proposal.

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