Pension overhaul: No drama

Hartford - Although it lacked the dramatic late-night negotiations of the education bill and the novelty of Sunday liquor sales, Gov. Dannel P. Malloy's overhaul of how the state government sets aside money for its largest retiree pension fund was one of his more ambitious initiatives this spring.

Malloy's plan smoothed out a back-loaded schedule for state contributions to the State Employees Retirement System, which supports the retirement livelihood of about 45,000 former state workers and is considered one of the most underfunded state pension systems in the nation.

Without corrective action, the governor's budget office said, required payments to the pension fund eventually would have eaten up an alarming portion of Connecticut's budget, starting in the next decade.

His proposal, which was approved by union leaders and the legislature, involves larger state payments to the fund over the next decade to eliminate the need for the much bigger payments that were previously set to follow in the years through 2032. Long-term, the payments are projected to save the state $5.8 billion.

There was an element of self-sacrifice to the strategy: Politicians are often accused of putting off hard decisions whenever possible, but here was a governor exacerbating his own administration's fiscal challenges to avoid potential calamity in the future.

Under the plan, the state will make a $1 billion contribution to the pension fund in the new July 1 fiscal year, or $123 million more than the former requirement.

The other sources of pension fund growth are employee contributions and investments.

"I made it clear from the day I took office that I am committed to ending years of bad financial practices and getting the state's fiscal house in order," Malloy said at his plan's unveiling.

But market forces could throw a wrench into Malloy's pension fix.

The key to the strategy is long-term investment. By giving more money to the pension fund now and investing it, State Treasurer Denise Nappier and her money managers have a chance to increase the fund's balance. And they're expecting it to grow relatively fast.

The anticipated annual rate of return for the State Employees Retirement System is set at 8.25 percent. The rate is 8.5 percent for the Teachers' Retirement System, which supports nearly 30,000 former teachers and administrators.

Yet other public-sector pension funds in the country have recently lowered their return assumptions below 8 percent, which is still considered the most-used investment return assumption.

Last year Rhode Island lowered its assumed rate to 7.5 percent from 8.25 percent, and New York City's top actuary has proposed dropping the city's pension funds rate projections to 7 percent from 8 percent.

Other pension fund managers are taking or considering similar downgrades, according to news reports.

"We have noticed a shift toward lower investment return assumptions the last two or three years," said Keith Brainard, research director for the National Association of State Retirement Administrators. "I suspect that outlooks, forecasts for (lower) interest rates and overall returns have led these funds to reduce their expectations."

Even a modest decrease in the return rate can be a big deal, because the less money that's made through investment, the more a state is required to contribute to the pension system.

Long-term strategy

The rates for the two largest Connecticut pension funds are set by individual governing boards.

Larry Dorman, spokesman for Council 4 AFSCME, whose executive director, Sal Luciano, sits on the pension governing board, said the return rate assumption hasn't been a hot issue.

"The debate doesn't seem to be happening with the same fervor here, in part because the governor took the steps to stabilize the fund," Dorman said.

Darlene Perez, administrator of the Teachers Retirement Board, said board members are not scheduled to re-examine the return rate until 2015. "One of the things the actuaries get concerned about is knee-jerk reactions to current economics, rather than realizing these assumptions should be set for long-term and not short-term," she said.

Ben Barnes, secretary of the Office of Policy and Management, said in an interview that he is comfortable with the current rates, as the numbers are long-term estimates to cover good and bad years in the market.

The average annual rate of return for the state's largest pension fund was 6.86 percent from the 1993 through 2009 fiscal years, according to a report by the State Post-Employment Benefits Commission. That figure includes the fund's 18.5 percent loss in the recent recession, although not the blistering 21 percent positive return last year for all six of the state's pension plans.

Nappier appears more open to lowering the pension fund rates. In a written statement, the state treasurer said that persistently high unemployment coupled with sluggish growth suggests to her that "sustainable recovery may take several years."

"Until then, the performance of the pension fund, much like that for most of our public pension peers, will continue to pose challenges in meeting the assumed rates of return … over the long-term," Nappier said. "The simple truth is that the respective retirement systems and their fund actuaries may have to accept that long-term expectations for investment performance may need to be modified to reflect a new reality that full recovery will take time."

And at least one state lawmaker with a background in banking and finance, Sen. Len Suzio, R-Meriden, said he is growing concerned.

"I don't think 8.25 percent and 8.5 percent is prudent or conservative," Suzio said of the anticipated return rates. "I pray and hope it actually happens. But if it doesn't materialize, it will mean that we are seriously underfunding our pension liabilities, on top of the underfunding that already exists."

Aggressive funding schedule

Connecticut's former payment schedule had been similar in structure to an adjustable-rate mortgage: small early payments in exchange for bigger ones in the future.

This was the result of two pension agreements that former Gov. John G. Rowland struck with the state employees unions in the mid-1990s. The strategy freed up revenue that, along with union concessions, helped finance the former governor's first-term tax cuts.

But after those years of easy payments, the required contributions were on a schedule to spike around 2027 and then peak five years later with a $4.5 billion balloon payment. The balloon payment alone would equal nearly a quarter of the state's current budget.

"Too many people wait until they are older to start saving for their retirements, and as a result they have to make large payments at the end," Malloy said in his overhaul presentation. "What we're announcing today is basically like starting a 401(k) when you're young and getting some of the work done earlier."

Connecticut is on an aggressive funding schedule because until the 1970s the pension system operated on a pay-as-you-go arrangement. In later years state contributions were inconsistent.

The ratio of assets to total liabilities for the State Employees Retirement System is 47.9 percent. The common benchmark for a healthy pension fund is 80 percent. (The teachers' fund is at 61.4 percent)

Once the retirement system's $11 billion in unfunded liabilities is finally paid down by 2032, the state's annual payments would be a manageable $250 million, Barnes said.

j.reindl@theday.com

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