Updated at 3:50 p.m. with comments from the governor.
Gov. Dannel P. Malloy announced a deal Friday with state employee unions that would allow Connecticut to dodge a fiscal iceberg by holding down annual pension costs otherwise set to spike over the next 16 years.
But to get that relief, Connecticut would shift at least $13.8 billion in estimated pension expenses owed before 2032 onto a future generation.
Under the deal, the state still would pay hefty pension bills for the next 16 years, with annual costs rising from $1.6 billion to $2.2 billion over that period. But pension expenses that were supposed to drop as low as $300 million per year after 2032 would hover close to $1.7 billion in the 2030s and 2040s.
The plan does not affect benefit levels for current or future retirees, nor does it change workers’ pension contributions.
The plan allows the state to spread pension fund investment losses or gains deeper into the future. This would make pension costs less volatile. But if Connecticut consistently struggles to make its investment targets, annual costs could rise beyond targeted levels.
The agreement, which echoes some aspects of a plan Comptroller Kevin P. Lembo unveiled in January, also calls for the State Employees Retirement Commission to adopt a more conservative, 6.9 percent return on state investments to better reflect current financial markets.
The State Employees Bargaining Agent Coalition’s governing board ratified the deal on Thursday. The matter still must be considered by the General Assembly.
Could CT survive a $6 billion pension bill?
“I am very grateful to SEBAC leadership that we were able to reach this much-needed and forward-looking agreement,” Malloy said Friday. “It was incumbent upon us to reform this system before facing the fiscal crisis that could have resulted from a $4 billion to $6 billion” annual pension bill.
“Glad to see that an agreement has been reached after all proposals were put on the table,” Lembo said. “I am reviewing the details of this final agreement now, but this appears to be an important step.”
Union leaders praised the deal.
“The agreement is a responsible way to move the state employee retirement system toward stability – protecting members’ retirement security,” said AFT Connecticut President Jan Hochadel. “It’s also a traditional approach that creates a clear path to paying off past obligations – making it good for the public too.”
“Real pensions play an important role in Connecticut’s economy by supporting jobs and generating purchasing power in our communities,” said Salvatore Luciano, executive director of Council 4 of the American Federation of State, County and Municipal Employees. “This agreement is part of a larger policy imperative by our unions to create retirement security for all.”
Though the deal doesn’t affect pension benefits for current and future retirees, the administration and unions are continuing to negotiate. Malloy approached the unions earlier this year asking for more traditional concessions, such as wage and benefits givebacks.
For now, though, the agreement shifts a heavy burden to a future generation on the argument that the present one simply cannot afford to pay the full burden it faces.
On paper, Connecticut’s annual contribution to the state employees’ pension – currently $1.6 billion – would rise to $3.3 billion over the next 16 years under the current system. But that hinges on pension investments achieving, on average an 8 percent return, which state officials, economists and others have said no longer is a realistic assumption.
A study the administration commissioned in 2014 from the Center for Retirement Research at Boston College showed that state contributions to the employees’ pension could skyrocket if the return, for example, is closer to 5.5 percent per year.
Under that scenario, the annual cost would hit $3 billion by 2025, $4 billion by 2029, $5 billion by 2030, and approach a whopping $6.6 billion by 2032.
If Connecticut could survive that, though, past mistakes would have been corrected and the annual contribution would plunge dramatically, down to $300 million or less.
But Malloy’s budget director, Office of Policy and Management Secretary Ben Barnes said this fall that an annual payment topping $6 billion would be “suicidal to state government,” forcing “unsustainable” tax hikes and unprecedented cuts to vital programs.
Under the new agreement, this year’s $1.6 billion annual cost essentially would remain flat next fiscal year. It originally was supposed to increase by about $84 million. But after that it would rise steadily until it reaches $2.2 billion in 2022.
It could remain there — depending on how pension investments fare — until 2032.
It would drop below $1.8 billion in 2033 and, from there, it would remain close to $1.7 billion through at least 2046.
The new arrangement would come at a cost to the state, an expense that accountants and other analysts typically refer to as a “lost investment opportunity.”
Because the deal would reduce overall state pension contributions between now and 2032, Connecticut would have less pension resources to invest over that period. The state not only must make up for those deferred contributions after 2032, but also attempt to replace the investment earnings those unmade contributions would have returned.
The Malloy administration did not release an estimate Thursday of that lost investment opportunity. But a spokesman said the cost could be calculated in the coming weeks after an actuarial analysis of the new pension funding plan is completed.
This plan could be approved, under current legislative rules, without a vote from lawmakers, provided neither the House nor Senate vote to reject it within 30 days after the 2017 session begins on Jan. 4.
Senate President Pro Tem Martin M. Looney, D-New Haven, said that, “On its face, it appears that this agreement takes a balanced approach to ensuring that Connecticut meets its long-term obligations while better adjusting to changes in the market. I look forward to fully studying the agreement before commenting further.”
Workers’ benefits, deductions don’t change
But top Republicans in the House and Senate, Rep. Themis Klarides of Derby and Sen. Len Fasano of North Haven, argued the deal is unbalanced.
Though negotiations reportedly are continuing between unions and the administration, this agreement does not affect benefits paid to retirees.
It also does not require existing employees to contribute more for their pensions, something the Senate and House Republican caucuses recommended last April.
About one-quarter of all state employees contribute nothing toward their pension benefit. Most others pay 2 percent, which is still well below the national average of 7 percent.
Republican legislators recommended that all state workers in non-hazardous duties contribute 4 percent of their pay toward pensions.
“We appreciate all the work that went into this proposal, but it does not include critical issues such as pension benefits and individual contributions that must be addressed if the state is serious about fixing the retirement system,’’ Klarides said. “These plans will grow increasingly unaffordable for future generations. Quite simply, our children and grandchildren will get stuck with the bills.’’
Fasano called the plan “an incomplete bailout of a pension system that’s completely out of control. Simply refinancing our debt is not the structural change we need to change the direction of our state. This package will add billions of dollars in new costs onto taxpayers beyond what is reflected in the governor’s summary. It’s not a solution, and taxpayers deserve better.”
“While the administration has been working towards a solution on this problem, Senator Fasano has done nothing,” Malloy spokeswoman Kelly Donnelly responded. “He has never offered a realistic plan for saving Connecticut from the $6.6 billion pension payment in 2032 that our plan will avoid. As usual, he’s more interested in getting his name in a news story than working together to improve our fiscal future.”
Barnes said Friday that administration officials “met for informal discussions with SEBAC on several occasions recently, and we have more meetings scheduled.”
“I urged (unions) to come to the table, in an effort to avoid layoffs” when the 2016 legislative session began in February, Malloy said. “We were not able to do that last year.”
Since mid-April, state government has laid off nearly 1,100 workers and announced plans for approximately 500 more layoffs in 2017.
“I will continue to urge people to allow us to make — with them — the kinds of changes that would eliminate or mitigate the numbers of layoffs and reductions that will have to take place in state government,” Malloy said.
State employee union leaders note that workers agreed to wage freezes, higher health insurance costs and new pension restrictions in concessions deals in 2009 and 2011.
State government should increase taxes, they say, on wealthy households and major corporations to mitigate its budget woes.
Malloy: Businesses will welcome budget stability
Malloy predicted Connecticut’s business community, and Wall Street, would welcome his plan for bringing greater stability and predictability to the state budget.
Businesses “could look at the same charts we could look at and understand that the state was not in a position and would not be in a position to meet its obligations,” the governor told Capitol reporters. “This is a momentous occasion.”
“Wall Street knows that the state would not be in a position to pay $6 billion” per year, he said. “…No one in the state believes that.”
The governor acknowledged that when he tried to convince General Electric officials to keep their headquarters in Connecticut, company leaders expressed concern over the rapidly escalating pension bill. GE announced in January 2015 that it would move its headquarters from Fairfield to Boston.
“This agreement will help avoid that fiscal cliff, will put the state on a more sustainable course that the taxpayers and, quite frankly (and) very largely, the business community demands,” Malloy added.
Will pension costs exceed target limits?
Though the deal tries to limit spiking pension costs, there are some factors that still could produce larger-than-anticipated increases in the state budget.
About half of the costs associated with making up for past underfunding would be passed on to Connecticut taxpayers after 2032 and paid off over the following 25 years.
But the deal also asks future taxpayers to help whenever pension fund investment fall short of the 6.9 percent assumed return.
Currently, such losses must be offset by higher contributions made before 2032. The new arrangement allows the state to spread this burden out for 25 years after any losses occur.
This could be a recurring problem given many economists’ and financial analysts’ expectations for states’ pension fund investment returns.
Further complicating matters, because the employees’ pension fund has large unfunded liabilities, it can experience cash-flow challenges. Given that, some of the investments must be short-term and easily converted to cash, and such investments often yield a low return.
CT saved little for decades
The governor, Lembo and state Treasurer Denise L. Nappier have been warning for more than a year that Connecticut’s poor history of saving for retirement benefits — a problem that goes back seven decades — would pose huge challenges over the next 15 years.
Connecticut saved nothing between 1939 and 1971 — and very little until the early 1980s — to cover pensions promised to state employees.
Even after it began saving in earnest, it frequently contributed less than the full amount recommended between the early 1980s and 2011.
The cost of these past actions can be seen in the current budget and in future projections.
For example, 82 percent of this year’s $1.57 billion payment into the state employees’ pension fund, almost $1.3 billion, is to cover contributions or investment earnings not made or achieved in the past.
Fix was expected in the ’80s and ’90s
The state was supposed to have solved most of its pension problems in the 1980s and 1990s, but failed to do so despite the huge revenue boost that came from enacting a state income tax in 1991.
In 1986, shortly after Connecticut had begun major contributions to the state employees pension fund and created a revised tier of reduced pension benefits for new workers, the system had enough assets to cover 40 percent of its long-term obligations. Analysts typically cite 80 percent as a fiscally healthy ratio.
But over the last three decades, Connecticut has made little lasting progress in shoring up the fund.
According to the last actuarial analysis, issued in November 2014, the state had enough assets in its workers’ pension fund to cover 42 percent of its long-term obligations.
Several developments ate away at Connecticut’s progress.
- Gov. John G. Rowland struck deals with unions in 1995 and 1997 that allowed Connecticut to defer significant contributions annually. (Malloy and the unions undid those deals and went back to full pension funding in 2012 and have made full payments every fiscal year since.)
- Five times between 1989 and 2009, the state paid senior workers incentives to retire early — which eased pressure on the budget but drained extra resources from the pension fund.
- The state traditionally has assumed returns of 8 percent or more on pension fund investments. But since the last recession ended, critics in financial services and academic circles have recommended much smaller targets, generally between 3 and 5.5 percent, pointing to the yield on long-term U.S. Treasury bonds.