Connecticut is one of seven states that will run out of money to pay state employee pensions over the next decade, coming up short in 2019 due to poor savings habits and generous guaranteed benefit levels, according to a recent study by Northwestern University.
And Connecticut’s pension fund could become insolvent sooner than that, according to Joshua D. Rauh, an associate professor of finance at the university’s Kellogg School of Management, if the 8 percent return on investments this state and most others typically count on are not realized in the near future.
The collapse also could be accelerated by retirement incentive programs and deferred annual contributions — two fiscal shortcuts Gov. M. Jodi Rell and the General Assembly have employed over the past two years to mitigate tax hikes and programmatic spending cuts.
“States face the risk that higher inflation and low asset returns could make their systems even more vulnerable,” Rauh wrote. “State governments face a choice between taking more risk today and funding the liabilities to a greater extent.”
Pension woes are nothing new for Connecticut. For more than two decades, governors and legislatures have routinely approved annual contributions to pension accounts far below the level recommended by fiscal analysts to cover current retiree expenses and begin saving to offset future costs.
Connecticut, like most states, provides a defined benefit pension plan, meaning it promises its workers a specific annual payment once they retire. By comparison, the most common plans in the private sector involve defined contributions. Under these, employees save for their own retirement, making investments often matched in part or full by their employer.
According to its last, full actuarial valuation, the pension fund had $19.2 billion worth of obligations and held just under $10 billion in assets, or about 52 percent of its liability.
In February Rell formed the Post-Employment Benefit Commission, a panel of state budget and pension experts from management and labor charged with charting a long-term strategy to improve the system’s fiscal health.
“This study just underscores the reason why the governor put together the commission,” Office of Policy and Management Deputy Secretary Michael J. Cicchetti, who chairs the commission, said this week. “It also underscores the fact that we cannot sit back and do nothing. We have to get our arms around this and make some real changes.”
Cicchetti has urged the panel to investigate a broad range of possible changes to a package of retirement benefits that critics of state government have called too generous. The changes include shifting to a defined contribution system, requiring pension recipients to pay more for health care, and restricting access to health care for workers who leave state service before they reach retirement age.
Under current law, workers with 10 years of state service remain eligible for both a pension and health care even if they leave for other jobs before reaching retirement age.
A new report submitted last week to the commission by a Kennesaw, Ga.-based actuary and health care consultant showed Connecticut’s problem has worsened due in part to a 2009 retirement incentive program that saved $110 million that year. Further complicating matters, the governor and legislature have ordered $314.5 million in union-approved reductions to pension fund contributions to squeeze through tight fiscal straits over the past two years and in fiscal year that starts July 1.
Connecticut, like most states, also is vulnerable because it assumes a healthy return on what money it does invest in its pension program. Most states rely on 8 percent or more — Connecticut assumed 8.25 percent in its 2008 actuarial analysis. This is based largely on the historical average growth of the stock market since 1927.
If Connecticut and other states assumed a more conservative, guaranteed rate, closer to the 3 percent a U.S. Treasury security would yield, Rauh wrote, their pension savings would be even more inadequate.
According to Rauh, under the current scenario Illinois would the first state to face pension-fund insolvency, going belly up in 2018. Connecticut, Indiana and New Jersey would follow one year later, followed by Hawaii, Louisiana and Oklahoma in 2020.
By 2025, 20 state funds will have run out of money, according to Rauh. By 2030, 31 state funds will be broke. And because the problem is so widespread, he added, taxpayers will find it increasingly challenging to avoid the burden simply by moving to other states.
“There seems to be a high likelihood that future generations will have to bear the substantial burden of making up pension benefits for previous generations of state employees,” Rauh wrote. “While citizens of states that are particularly hard-hit by the pension crisis may be able to escape to other states, an acceleration of this demographic phenomenon would leave a dwindling taxpayer base behind in the states facing the largest liabilities.”