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Malloy seeks modest change in expected pension fund earnings

  • by Keith M. Phaneuf
  • September 20, 2012
  • View as "Clean Read" "Exit Clean Read"

Gov. Dannel P. Malloy wants to inject more economic reality into the state employee pension fund, embracing slightly more conservative expectations for fund investment earnings.

But the change endorsed by the governor and adopted this morning by the State Retirement Committee falls shy of a tougher standard proposed by a Wall Street credit rating agency.

It also likely won’t mean any larger pension fund contribution than worker unions already were expecting next year.

That’s because the administration can cover the added costs of the change by using dollars Malloy already pledged to the pension fund when he unveiled a multi-year bailout in January.

According to an email obtained by The Mirror, Malloy endorsed reducing the discount rate — the assumed annual return on fund investments — from 8.25 to 8 percent.

“I think this is a reasonable step in the right direction,” Office of Policy and Management Secretary Benjamin Barnes, Malloy’s budget chief, said when asked about the email.

Most states assume their pension investments will earn, on average, 8 percent annually across a 25- or 30-year period.

But critics in the financial services and academic circles have argued since the last recession began in 2008 that, even though average returns over the past few decades have hit or topped the 8 percent mark, 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 that uses the return of high-quality corporate bonds as its new guideline, noting that their average yield was 5.5 percent in 2010 and 2011.

But if the states assume lower investment earnings, they must be prepared to make up the difference with larger contributions.

“The governor has long championed a disciplined, fiscally responsible approach to pension funding,” the email states. “… The reduction from 8.25 percent to 8 percent reflects a more conservative rate of return on interest and mirrors a broad consensus in the industry that long-term portfolio returns may be lower than they have been in the past.

Barnes said “affordability is an issue” in terms of how much the state can reduce its discount rate now, but he also said, “It’s prudent to be very deliberate in how we manage our pension fund.”

The state analyzes its investment returns every five years, and Barnes said Connecticut still could make further adjustments in 2017 when the impact of the past recession and the ongoing recovery becomes clearer. “It may turn out Moody’s is correct, but I don’t know that for sure,” he added. “I’m not sure they really know.”

Technically, the change would commit the state to contribute an extra $101 million to the pension fund next fiscal year. But in actuality, the fund was almost certain to receive those funds — and possibly more — anyway.

That’s because Malloy, who persuaded most state bargaining units to accept a major concessions package to stabilize the budget in 2011, came back in January with a catch-up plan to reverse decades of pension account underfunding.

It requires the state to make additional pension payments over the next three decades, and also featured a Malloy pledge — but not a contractual guarantee — to kick in even more.

Based on the last actuarial valuation, the state’s pension contribution under the governor’s January plan has to grow by about $100 million next fiscal year, up to $1.16 billion.

And the administration says that the new, lower discount rate will force the state to add another $101 million to that next year.

But Malloy’s January plan already included the governor’s pledge to put an extra $177 million on top of the contractually guaranteed $100 million increase.

The pension fund has suffered from an array of questionable fiscal policies since it began in the mid-1980s with a huge financial hole. For nearly four decades before that, Connecticut had put nothing away, and therefore gained no investment earnings to help cover pension costs.

Several early retirement programs and pension fund raids under previous governors and legislatures to help balance the state budget also have weakened the fund. It plunged to its lowest level in more than two decades by mid-2010, holding enough assets to cover just 44 percent of its obligations.

The funded ratio had climbed to nearly 48 percent due to healthy investment earnings and some new pension restrictions Malloy negotiated with employee unions. But fund analysts typically cite a funded ratio of 80 percent as a healthy level.

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