January 31, 2017

A False Solution to Connecticut's Pension Problems

Mark J. Warshawsky

Former Senior Research Fellow
Summary

Accurately measuring and responsibly addressing Connecticut’s pension problems is no easy task. It requires politically difficult choices, such as cutting other government spending, raising taxes (which risks chasing more businesses away), increasing employee contributions, or reducing pension and other employee benefits.

Last month, Connecticut Gov. Dannel Malloy and union representatives struck a deal — based on an academic study — they claim will fix the state’s urgent public pension problem. But the proposal doesn’t come close to delivering a sustainable, robust, prudent, and reasonable retirement system for past, present, and future state employees. Instead, the announced agreement would effectively push the burden of funding the pension plan onto future taxpayers without addressing the underlying problems. 

Connecticut has among the worst-funded state employee pension plans in the country. According to the most recent report (for 2016), the main state plan has assets covering only 32 percent of its liability; the unfunded liability is nearly $22 billion. But these official metrics actually understate the extent of the problem because they are based on optimistic assumptions. Moreover, conditions are continually worsening — funded status has declined, and required contributions from the state have increased rapidly. 

The governor’s deal will become law unless the legislature disapproves it by the end of January. The law would change various actuarial assumptions, such as lowering investment and inflation rates, and methods, especially by lengthening the amortization schedules for unfunded liabilities. The net effect of these changes doesn’t seem to make much difference in required state contributions to the pension plan compared to what would have been required under immediate past practices, given recent poor investment and actuarial experience for the next several years. The law would, however, reduce scheduled state contributions to pay down the unfunded liability a decade or so out, and it extends them for a couple more decades beyond that point.

The unstated premise of the governor’s arrangement is that all the questionable actuarial assumptions made by the state will be met in the future. However, an examination of the past actual financial performance of the pension plan compared to past assumptions — as well as a sober evaluation of the latest assumptions for the future — proves this premise to be highly dubious. 

In the last two actuarial reports of the state employee plan, alone, losses came to $2.5 billion. Since 2001, there have been losses to the plan in every year except two. Looking forward, if we compare the new assumed plan investment return of 6.9 percent to the current market yield on Treasury bonds of 2.4 percent, the actuarial calculations appear unrealistically optimistic. 

In this context, it is worth noting the relative generosity of the pension plan for state workers and retirees. Although the overall benefit level and ongoing cost of the Connecticut plan are broadly similar to other state employee pension plans, the level of fixed employee contributions is quite low. The state has also offered workers several generous early retirement windows. 

But the relevant comparison is not just with other state pension plans. We should also look at past and current retirement benefits given to workers in the private sector, given that private-sector workers and retirees pay most of the taxes to support these government worker benefits. Unsurprisingly, perhaps, private-sector retirement benefits are significantly less generous and less costly by comparison.

This gloomy outlook is not restricted to Connecticut’s main state plan for government employees and retirees. The state’s large teachers’ plan is afflicted by the same problems: substantial underfunding (by $13 billion); falling funded status; rising required contributions; and unrealistic assumptions (an 8 percent investment return) with underlying investments similar to the state employee plan. 

Accurately measuring and responsibly addressing Connecticut’s pension problems is no easy task. It requires politically difficult choices, such as cutting other government spending, raising taxes (which risks chasing more businesses away), increasing employee contributions, or reducing pension and other employee benefits. 

Regrettably, the governor’s deal does nothing to fix the underlying drivers of the pension problems, nor does it reduce the risks and costs to current taxpayers and plan beneficiaries. Instead, it employs actuarial techniques to cover up the true financial status of the state pensions, while unfairly pushing the burden of the shortfall onto future taxpayers. The state legislature should act quickly to disapprove the proposed law.