Unfunded pensions are a danger

In the wake of Detroit’s municipal bankruptcy filing, CNBC has released a report on the condition of state and municipal pension obligations. The report found that Connecticut’s level of unfunded pension liabilities is one of the highest in the country. This is a precarious situation for taxpayers, and not only for those who work in the private sector. It is also dangerous for public employees who are expecting to receive predictable levels of retirement income.

As of its last biennial actuarial evaluation in 2012, Connecticut had $9.7 billion in assets and $23 billion in liabilities in its State Employees’ Retirement System (SERS), meaning that only 42.3% of its obligations were funded, and $13.3 billion, or about 58%, were unfunded. While an 80% funded ratio (20% unfunded) is generally considered healthy, Connecticut is one of nine states, according to CNBC, that have a ratio of less than 60%, and among those nine, it is second from the bottom of the list, just behind Illinois.

When new rules imposed by the Government Accounting Standards Board are implemented next year, Connecticut’s funding ratio may deteriorate further. This is because, among other things, the rules require public pension fund managers to adopt more realistic assumptions when estimating future investment returns.

The effect of Connecticut’s unfunded pension liabilities on the state’s bond ratings is certainly cause for concern. In early 2012, Moody’s downgraded its rating for Connecticut from Aa2 to Aa3, citing “Connecticut’s high combined fixed costs for debt service and post employment benefits relative to the state’s budget” and “pension funded ratios that are among the lowest in the country and likely to remain well below average.” This summer, Fitch downgraded its outlook for Connecticut’s bonds from “stable” to “negative,” citing “significant pension obligations” as one of the reasons, and just a few days ago, it reaffirmed that negative outlook. Lower ratings make borrowing money more expensive for the state and, by extension, for its taxpayers.

It’s also worth noting that the $13.3 billion in unfunded SERS obligations represent only a portion of the state’s unfunded long-term liabilities. Unfunded obligations related to the Teachers’ Retirement Fund and post-employment health and life benefits for both teachers and other state employees total about $25 billion. The state also has outstanding long-term debt of about $19 billion. The total is about $65 billion.

Looking just at SERS, since 2007 Connecticut’s funded ratio has declined from 53.6% to 42.3%. As the unfunded obligations increase, the annual contributions necessary to cover them by the time they come due increase as well. Finding the money to make those contributions means either generating more revenue or cutting spending in other areas. Residents feel the effects either way. For the current year, the planned contribution to SERS is about $1.27 billion, around 6% of the total budget.

Given the state’s level of debt, its heavy borrowing to pay operating expenses, and sluggish economy, it will be difficult to sustain annual contributions at that level or to increase them. Other states that have faced this problem, like Rhode Island and California, have determined that keeping up with or even increasing the contributions isn’t enough and are attempting to slow the growth rate of the obligations themselves in order to reduce their unfunded pension liabilities. Examples of their proposals include raising the minimum retirement age for state employees, moving active employees to hybrid defined benefit/defined contribution systems, increasing active employees’ share of contributions to the pension fund, and changing the way base salaries are determined for pension payment calculations.

In Connecticut any changes like these must be negotiated between the governor and state employee union leadership. Although it has not done so in recent years, the legislature does have the right — and many of us believe, the obligation — to exercise oversight and to vote on any negotiated changes. It should do its part to ensure accountability and taxpayer representation. While it’s understandable that state employees may not at first think such changes are in their best interests, the alternative may well be loss of the income they’ve been promised when they retire.

Without a frank, open, and realistic dialogue between the administration and union leaders to explore and select options like these now, residents risk further steep tax increases and service cuts, state employees risk a disappointing retirement, and the state risks further debt rating downgrades and serious threats to its solvency and its economic survival.

Information on the CNBC report on pensions is available at: cnbc.com/id/100929269

Ms. Lavielle represents Wilton, Norwalk, and Westport. She is ranking member of the General Assembly’s Commerce Committee.