Teacher pension costs to surge, widen hole in next state budget

State spending on retired teachers’ pensions is set to surge $282.7 million next fiscal year – a 28 percent increase the state is obligated to fund and is likely to push the next state budget further into deficit.

The new pension contribution levels, if accepted by the Teachers’ Retirement Board Wednesday, are larger than those anticipated in next fiscal year’s nonpartisan deficit forecast by $47 million and in the 2018-19 projection by $42 million.

Independent financial experts informed the state this week that its required contribution to the teachers’ pension fund will increase from $1.01 billion this fiscal year to $1.29 billion in the fiscal year that begins July 1.

Connecticut is on the hook to contribute what the independent fund analysts report is necessary. That’s because in 2008 the legislature and then-Gov. M. Jodi Rell approved about $2 billion in borrowing to bolster the teachers’ pension fund that suffered from decades of inadequate contributions. In the bond covenant — the contract between the state and its investors — Connecticut pledged to contribute the full amount recommended annually by fund analysts.

The state’s Teachers’ Retirement Board is scheduled to meet tomorrow to approve the actuaries’ findings, which will cement how much the state will have to contribute over the next two years.

Officials at the Teachers’ Retirement Board and the Office of the State Treasurer declined The Connecticut Mirror’s request for a copy of the financial report, prepared by actuaries at Cavanaugh MacDonald Consulting, LLC.

“The document’s in draft form,” Chantelle Varrs, the fiscal manager of the retirement board, said Tuesday afternoon. “We need to review it to make sure that there is not going to be any changes or anything. So we are not releasing it at the moment.”

State Treasurer Denise Nappier’s office said the document had not been presented to the retirement board yet, and therefore was a “draft.” It also refused to say whether it was in possession of the document.

The Connecticut Mirror received a copy of the report from the Office of Policy and Management, Gov. Dannel P. Malloy’s chief budget agency.

The state Supreme Court ruled in 1998 that public reports are not necessarily “drafts” that are exempt from disclosure simply because the contents might be revised at some later time. If the drafts or notes “reflect that aspect of the agency’s function that precede formal and informed decision-making,” the agency must demonstrate that “the public interest in withholding such documents clearly outweighs the public interest in disclosure,” the high court ruled.

The surging pension contribution costs probably will worsen a significant deficit in the two-year budget Malloy and the legislature must craft starting in February.

State finances, unless adjusted, already are on pace to run $1.25 billion in deficit in 2017-18 and $1.4 billion in the red in 2018-19, reports the legislature’s nonpartisan Office of Fiscal Analysis, operating shortfalls of about 7 and 8 percent, respectively.

OFA projected last May that the roughly $1 billion contribution the state must make this fiscal year to the teachers’ pension would rise by about $236 million. Similarly, the governor’s budget office anticipated $259 million in growth.

But Cavanaugh Macdonald says the contribution must grow by $283 million next fiscal year. Cavanaugh sets its contribution requirement so that the teachers’  pension system will be fully funded by 2032.

“It’s disappointing and frustrating to see yet another hole appear in the state budget, while the majority party continues to sit by and wait,” Senate Minority Leader Len Fasano, R-North Haven, said Tuesday. “Those shortfalls represent real funding for programs and services. While tens of millions of dollars in the grand scheme of the budget may be a small percentage, it hurts our state all the same. If we don’t start addressing these problems now, they will only continue to grow. It’s exactly what we’ve seen happen before.”

State lawmakers in recent years have been forced to make large contributions after years of the legislature’s promising future benefits to retired teachers while not setting aside funding to pay for them.

The fiscal hit the fund took during the recession also drove up required contributions. Between fiscal 2008 and this year, the required state contribution has nearly doubled from $518.6 million to $1.01 billion.

The fund losses mirrored problems experienced by nearly all states in the last recession. The fund uses contributions from government and from teachers, as well as investment earnings, to pay an average annual pension of $56,700 to about 51,000 retirees who do not qualify for social security for their time as a teacher.

When earnings fall, contributions typically rise.

The return on investments announced this week over the last two fiscal years was 1.5 percent. Because the teachers’ pension system has large unfunded liabilities, it can experience cash-flow challenges. Because of that, some of the investments must be short-term and easily converted to cash, and such investments often yield a low return.

The fund still has a lot of work to do to completely rebound from the recession. Before the recession, the fund had enough assets to cover 70 percent of its obligations. That fell to 59 percent by June 30, 2014.  Analysts reported this week that fell to 56 percent as of June 30. Actuaries typically cite 80 percent as a fiscally healthy level, which the analysts projected the state should reach by 2027.

This means the state’s unfunded teachers pension liabilities increased from a cumulative $10.8 billion in 2014 to $13.2 billion going into the current fiscal year.

But there’s another factor driving up the state’s contribution besides making up for inadequate savings habits of the past and the recession.

In a move first proposed by the Malloy administration, The Teachers’ Retirement Board last year voted to lower the assumed rate of return on pension fund investments from 8.5 to 8 percent.

Because Connecticut now assumes a lower rate of return, the state’s contribution must rise to compensate for those investment earnings it no longer anticipates.

Many states assume their pension investments will earn, on average, 8 percent annually or more across a 25- or 30-year period. But critics in financial services and academic circles have argued that since the last recession began in 2008 that 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.

Moody’s Investors Service proposed a new methodology in July 2012 that used the return of high-quality corporate bonds as its new guideline, noting that their average yield was 5.5 percent in 2010 and 2011.

Both Malloy and state Comptroller Kevin P. Lembo have proposed restructuring payments into the state employees pension system to spread its debt further into the future. State contributions, currently projected to spike between now and the mid-2030s, still would grow, though not as severely. They would, however, remain at high levels into the mid-2040s.

With the teachers’ pension fund, however, the state’s bond counsel has said that is not an option because it would violate restrictions the state accepted when it borrowed $2 billion to bolster the fund eight years ago.

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