Pension debt stands between Lamont and fiscal stability for CT

In the context of the state budget, the pension fund for teachers is the proverbial 800-pound gorilla.

The annual contribution Connecticut now must make to the long-neglected fund grows regularly — often massively. And every other priority in the budget must accommodate it.

For Gov. Ned Lamont, who insists he will end Connecticut’s cycle of budget deficits — there is no route to long-term stability that doesn’t have to navigate its way through the teachers’ pension.

“Let’s fix this damn budget, once and for all!” Lamont said in his Jan. 9 opening address to legislators. “In six weeks, I will present to you a budget which is in balance not just for a year, but for the foreseeable future.”

But to avoid the frequent deficit forecasts that plagued his predecessor, Gov. Dannel P. Malloy, Lamont must tackle Connecticut’s debt costs. What consumed about 10 percent of the General Fund two decades ago now eats up nearly one-third — and is projected to gobble far more by the early 2030s.

The new governor tackled part of that problem earlier this week, proposing a “debt diet” to slow the growth in bonded debt.

But it’s in the so-called “soft debt,” unfunded liabilities in pension and other retirement benefit programs, that the biggest challenge remains.

A 70-year legacy of pension debt

Between 1939 and 2010, Connecticut massively under-funded its pensions for teachers and for state employees.

Connecticut’s punishment for these fiscal sins, according to a 2015 study by Center for Retirement Research at Boston College, is a harsh one: the state’s annual payments to each pension fund would grow from just over $1 billion to more than $6 billion by 2032,

And while some argued those forecasts were too gloomy, more optimistic projections — which rely on Connecticut achieving healthy returns on pension investments — still had the annual payments tripling in a decade-and-a-half.

But all projections agreed that after the early 2030s, the pain would be over and annual payments to each pension would be a relatively small $300 million per year.

The problem is fiscally surviving until that day arrives. 

Malloy, unions and the legislature adopted a plan in 2017 to smooth the spiking payments in the state employees’ pension. 

Annual contributions still would rise sharply until 2022 — hitting $2.2 billion (instead of $6 billion or more) and then remaining around that mark until 2033.

But that relief comes at a cost.

Between 2033 and 2046 Connecticut still would pay between $2.2 billion and $1.7 billion annually to the state employees’ pension.

In other words, to smooth out the spike, the state will pay an extra $17 billion in the aggregate — with a future generation of taxpayers footing the bill.

Some legislators called it regrettable but unavoidable given Connecticut’s legacy of debt, and then turned their attention to the similarly fated teachers’ pension.

But there’s a problem.

What will Wall Street think?

Connecticut issued bonds to borrow $2 billion in 2008 to shore up that fund. And pledged in the bond covenant — the contract with investors — to contribute the full amount recommended by fund analysts for the full 25-year-life of the loan.

Former state Treasurer Denise L. Nappier, who retired last month after five terms in office, warned frequently against altering contributions to this pension until the bonds were paid off [Some of the bonds cannot be recalled, or paid off early, until 2025.]

“It was and remains essential that the state reverse the trend of shorting its payments, and that the teachers’ fund make progress toward near or full funding within a fixed period of time,” Nappier told the CT Mirror in June 2016 when Malloy suggested trying to restructure payments into the teachers’ pension. 

“Bond counsel made clear that changing the amortization schedule would violate the bond covenant,” Nappier added, citing a 2016 opinion from the Hartford firm of Day Pitney.

But Malloy’s budget director, Ben Barnes, disagreed with that interpretation. Barnes argued Connecticut could make adjustments that not only would be legal, but would be applauded by Wall Street credit rating agencies for placing the state’s finances on a more stable path.

Lamont and new state Treasurer Shawn Wooden both appear to share Barnes’ view that Connecticut has legal flexibility.

Office of Policy and Management Secretary Melissa McCaw told The CT Mirror that staying on a schedule of rapidly escalating payments into the teachers’ pension “is simply too risky.” Contributions to this pension alone could eat up 20 percent of the entire General Fund a decade from now.

“Such large and rapid increases in the employer share would force draconian cuts to spending and tax increases that would significantly impact our state’s economy and budget,” McCaw said, adding that “there can be no illusion that inaction is inconsequential.”

These changes would both strengthen the state’s fiscal position “and fit squarely within our covenant to bond holders while creating a more sustainable and smooth payment schedule,” she said.

Wooden declined to be interviewed for this article, but wrote in a statement that “I am working with the Office of Policy and Management on finalizing the details of a road map that puts both the teachers’ pension fund and the state’s fiscal health on a path toward long-term stability.” 

Wooden, a former partner at Day Pitney, added the solution “minimizes the impact” on taxpayers and remains consistent with the bond covenant while addressing the concerns of bond rating agencies.

“I will always look (to) put our state on a stronger financial path, as well as improve Connecticut’s standing on Wall Street,” the treasurer added.

The state commissioned legal advice on this issue from Nixon Peabody LLP. Neither OPM nor Wooden’s office would release a May 2018 memo from the firm.

Lamont’s first budget proposal, which will include recommendations regarding the teachers’ pension, is due to legislators on Wednesday.

Lottery could come into play

Another option Lamont and Wooden might employ to stabilize the teachers’ pension fund involves the state lottery.

The state Commission on Fiscal Stability and Economic Growth first recommended last year that Connecticut dedicate an asset, such as the annual proceeds it receives from the quasi-public Connecticut Lottery Corporation, to the pension fund.

The lottery sent between $330 million and $338 million into the budget’s General Fund in each of the past two fiscal years. 

For example, if this revenue stream were pledged to the teachers’ pension for a decade — and if reasonable growth is assumed from the investment of those revenues — it could be worth $4.5 billion to $5.5 billion to the pension fund over this period.

The teachers’ pension has enough assets to cover just 58 percent of its long-term obligations. But if lottery revenues were dedicated to the pension, the funded ratio would top 70 percent.

Legislative leaders are cautious

The state’s largest teachers’ union, the Connecticut Education Association has not taken a position on the prospect of smoothing out payments into the pension fund.

But the other major teachers’ union said Lamont should  consider a smoothing process similar to what was done with the state employees’ pension in 2017.

“Our members have long urged a solution for decades of politicians failing to prioritize stability in public employees’ retirement security,” said Jan Hochadel, president of AFT-CT. “Connecticut’s state’s teacher retirement system is a public asset that benefits everyone and helps empower our state’s working families to thrive together.”

Legislative leaders from both parties predicted this week that lawmakers would approach any changes to the teachers’ pension system cautiously.

“The state of Connecticut has significant fiscal issues and decisions that prevent pain from being realized and (smoothing) only pushes some of that pain onto the next generation,” said Deputy House Minority Leader Vincent J. Candelora, R-North Branford. “That has been the way this state has operated for the last 40 years.”

“I think we have to be open to the possibility that we have to engage in smoothing again,” said Rep, Jason Rojas, D-East Hartford, co-chairman of the Finance, Revenue and Bonding Committee. But he quickly added that decision will depend on the numbers — how much in payments are shifted, and how much overall costs rise.

“We have to ensure the state is on a path to grow,” Rojas said.