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State officials have lowered their expectations for investment earnings from the teachers’ pension fund.

And while this move was hailed as an important step toward more realistic fiscal planning, it also worsens a huge state budget deficit looming after the 2016 elections. Even so, state Treasurer Denise L. Nappier said income expectations should have been set even lower.

After receiving recommendations from pension fund analysts, the Connecticut Teachers’ Retirement Board agreed Wednesday to assume that future fund investment earnings would average 8 percent per year. The assumed return had been set at 8.5 percent.

The move was endorsed both by Gov. Dannel P. Malloy’s administration and by both of the state’s two major teachers’ unions, the Connecticut Education Association and AFT Connecticut.

“We’re pleased because it more accurately reflects the rate of return,” CEA Executive Director Mark Waxenberg said. “It is the proper move.”

“Maintaining the integrity of the fund is vital to state taxpayers as well as the thousands of educators who depend on it for a secure retirement,” said Jan Hochadel, president of AFT Connecticut. “When middle class families can support themselves in their golden years, it’s good for the whole economy.”

“They are reducing the risks to Connecticut taxpayers while ensuring the pensions of public school teachers,” Office of Policy and Management Secretary Benjamin Barnes, Malloy’s budget chief, said.

Barnes noted Connecticut has moved closer to the 7.7 percent average investment return assumed by teachers’ pension funds nationwide. “This is absolutely in line with the recommendations of pension experts,” he added.

Critics in financial services and academic circles nationwide have urged states since the last recession began in 2008 to scale back expectations for the returns they can get by investing public-sector pension funds.

Even though average returns over the three decades before the last recession generally hit or topped the 8 percent mark, the same shouldn’t be expected in the future, they said. Some have suggested a target of 4 percent or less, pointing to the yield on long-term U.S. Treasury bonds.

Moody’s Investors Service proposed a new investment return methodology in 2012 based largely on high-quality corporate bonds, 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.

According to Barnes, the new assumption for the Connecticut teachers’ pension fund — which will be applied when the next biennial valuation is issued in June 2016 — means state government must deposit an extra $180 million per year.

That extra charge arrives in the 2017-18 fiscal year.

Waxenberg said he would like to see the assumed rate of return dropped further, but understands that this type of change is expensive and often must occur gradually.

Treasurer Nappier said she agrees in principal with the administration about the need to lower the assumed rate of return.

“The extent of the change may be subject to debate,” Nappier wrote in a statement, “but from the Treasury’s perspective, we’ve seen a significant shift in the capital market assumptions going forward, and the prospects for returns don’t resemble the robust results of the recent past.”

The treasurer added that lowering the rate to 8 percent is “not enough in my view.  The Treasury’s analysis suggests that an investment return assumption of 7.5 percent or below would be more in line with what we can reasonably achieve.  Clearly, it stands to reason that setting return assumptions at levels more likely to be attained, will strengthen the financial health of the funds over the long term. “

State Treasurer Denise I. Nappier
State Treasurer Denise L. Nappier

According to fund analysts, a 7.5 percent rate would mean the state would have to contribute an extra $330 million to the pension fund in the 2017-18 fiscal year. As it already stands, paying an extra $180 million might be difficult.

That’s because state finances already are on pace for considerable red ink at that time.

The legislature’s nonpartisan Office of Fiscal Analysis issued a projection in late June that the first new budget after the November 2016 state elections has a built-in hole of $927 million.

The increased teachers’ pension contribution would push that shortfall to about $1.1 billion.

And the Malloy administration this fall downgraded income tax revenues for this fiscal year by about $200 million. At least a portion of that problem is expected to continue into 2017-18.

“Forecasts for future revenues based on a more realistic rate of return will naturally require better budget choices,” Hochadel added. “If decisions made today put the future of vital services like public safety, health, and education in jeopardy, then policymakers should look for more holistic, long-term solutions.

“A good start would be to ask corporations and CEOs to pay their fair share to support the services that make Connecticut a great place to raise our families. It would also go a long way to addressing the single biggest problem facing our economy — growing income inequality.”

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Keith M. PhaneufState Budget Reporter

Keith has spent most of his 31 years as a reporter specializing in state government finances, analyzing such topics as income tax equity, waste in government and the complex funding systems behind Connecticut’s transportation and social services networks. He has been the state finances reporter at CT Mirror since it launched in 2010. Prior to joining CT Mirror Keith was State Capitol bureau chief for The Journal Inquirer of Manchester, a reporter for the Day of New London, and a former contributing writer to The New York Times. Keith is a graduate of and a former journalism instructor at the University of Connecticut.

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