Connecticut’s other billion-dollar deficit

Gov. Dannel Malloy signed a new budget into law last week, putting in place a framework for solving Connecticut’s projected $3.5 billion deficit, but the state still has long-term financial challenges it needs to face.

Malloy’s budget hinges on the ability of his administration to get $1 billion in concessions from state workers in each of the next two years – or to find another way to fill that gap through layoffs and other cuts.

One possible area for savings is public employee pensions and retiree health care. These costs contribute to the short-term deficit faced by the state, but they drive Connecticut’s long-term fiscal challenges.

In 2010 the state contributed $1.8 billion to cover retiree health and pension costs, according to the 2010 Comprehensive Annual Financial Report.

Unfortunately, the $1.8 billion contribution in 2010 was $2.1 billion less than the cost of those benefits, according to the CAFR.

In other words, the state promised $3.9 billion in retirement benefits to its employees last year, but only set aside $1.8 billion to pay for them.

This deficit adds to the accumulated deficits of previous years, with the state’s three main pension funds now behind by $20.8 billion, up $5 billion since the last estimate in 2008.

In addition to providing retirement benefits to state employees, Connecticut also provides health insurance and pensions to public school teachers who don’t work for the state.

The unfunded liability for healthcare costs is even larger. The state is behind $3 billion for teacher healthcare costs and $26.6 billion for state employees.

To put the annual cost of retirement benefits into perspective, the $3.9 billion in promised benefits exceeds the $3.3 billion the state paid in salary last year.

That’s more than 97 times the cost of longevity payments each year or the rough equivalent of giving longevity payments four times a week instead of twice a year.

If each Connecticut resident had to pay an equal share of the benefits promised in 2010, the bill would come to $1,115. The contribution the state actually made amounted to $517 per person.

The state is responsible for the majority of pension costs. For every dollar state employees contributed to their pension fund last year, the state paid nearly 11 ($66 million vs. $721 million).

In 2010, Connecticut’s contributions for retirement expenses amounted to 8.7 percent of the budget. For the current year, the state’s contribution is estimated at 9.6 percent. For the next two years, the state will put 11.2 and 11.4 percent of its budget toward retirement costs.

And if the state wanted to fully fund its pensions, it would have had to contribute even more.

Most state employees hired between 1984 and 1997 contribute nothing toward their pension. Employees hired since 1997 pay 2 percent of their salary, while those on hazardous duty pay 4 or 5 percent.

According to the Commission on Enhancing Agency Outcomes, only seven states require employees to contribute 2 percent or less (Appendices, p. 122).

The commission estimated the average state employee retirement package to be worth $22,353 per year, nearly 10 times the value of average private sector retirement benefits ($2,990).

Connecticut is not alone in facing deteriorating pension systems, according to The Widening the Gap, a report by the Pew Center on the States. Across the country, states have $1.26 trillion in long-term unfunded liabilities for pensions and retiree healthcare.

The Pew report ranks Connecticut near the bottom on funding its retirement obligations. The state is responsible for 4 percent of the nationwide unfunded liability, while it accounts for 1.6 percent of the national economy.

Connecticut’s long-term unfunded retirement liabilities add up to $50.4 billion, the equivalent of one-fourth of the state’s annual economic output or 2.5 years of state spending.

“The Malloy administration is well-aware of the unfunded liabilities facing the State and the potential negative impacts on our ability to grow the economy,” said Gian-Carl Casa, a spokesman for the Office of Policy and Management.

“That is why we have made the fiscal health of the State a priority – so that we can, in a transparent and comprehensive fashion, live within our means and address those liabilities,” Casa said. “That is why business leaders endorsed the Governor’s budget.”

According to critics of the underfunding of public pensions, the large unfunded liabilities point to the need for change in the way Connecticut and other states pay for retirement benefits.

“Pew’s numbers show that Connecticut’s pension system is not on solid footing,” said Eileen Norcross, a senior research fellow at the Mercatus Center. “The pension system is not sustainable and will require some structural policy changes, namely increasing contributions, making the full annual payment, reducing benefit accrual rates, closing the defined benefit system and moving to a defined contribution system, and possibly freezing or reducing the [cost of living adjustments] in order to meet its obligations over the coming years.”

“The public sector is now belatedly confronting the economic realities which the private sector began confronting many years ago, i.e., the un-sustainability of pension and retiree medical programs fashioned for a different world,” said Edward Zelinsky, a New Haven resident and professor at Yeshiva University’s Cardoza School of Law. His book, The Origins of the Ownership Society, recounts how defined-contribution plans have come to replace traditional pensions.

Unfortunately, Connecticut’s liability is only growing because each year the state fails to put aside enough money to fully pay for its new promises.

“If governors and legislatures had truly balanced the state’s budget, no taxpayer’s financial burden would exist,” said Sheila Weinberg, founder and CEO of the Institute for Truth in Accounting, which just released a report on Connecticut’s finances. “A state budget is not balanced if past costs, including those for employees’ retirement benefits, are pushed into the future.”

In 2009, Connecticut paid 96 percent of its required pension contribution, or $1.3 billion, while in 2010 the state paid $1.4 billion, which was only 87 percent of its required contribution.

If Connecticut paid its required contribution every year, after two decades it will have no liability left. However, the state would still need to pay the annual cost of retirement benefits.

According to Pew, Connecticut has the lowest level of funding of the 16 states with 2010 pension data available. It set aside only enough to cover 53 percent of its $44.8 billion in pension liabilities.

The funding level fell 9 percent from the previous year when Connecticut had funded 62 percent of its pension obligations.

In 2009 only 19 states funded 80 percent or more of their pension obligations, the threshold Pew sets for a “well-funded” pension system. Ten states that were well-funded in fiscal year 2008 fell below that threshold in 2009. Illinois only funded 51 percent of its pension obligations, the worst in the country in 2009. Seven other states fell below Connecticut’s funding ratio that year: West Virginia (56 percent), Oklahoma (57), Kentucky (58), New Hampshire (58), Rhode Island (59), Louisiana (60) and Alaska (61).

The situation is even more troubling when the state’s three main pension funds are looked at separately.

The Judicial Retirement Fund is in the best position, with 65 percent of its obligations funded although that is down from 72 percent last year. The JRF is also the smallest of the three funds, with its obligations measured in millions instead of billions, but it still doesn’t meet the well-funded threshold of 80 percent.

The Teachers Retirement Fund has funded 61 percent of its obligations, although the state is paying interest on $2.2 billion in bonds that were used to shore up the fund.

The State Employee Retirement Fund only has money set aside for 44 percent of its obligations, down from 52 percent a year ago.

Connecticut’s liability for retiree health insurance, also known as other post-employment benefits or OPEB, is even larger than its pension liability. The state has set aside no money to cover these costs. Instead, it pays only the amount needed by current retirees each year.

The most recent actuarially-required contribution, according to Pew, was $1.8 billion. Connecticut paid 26 percent of that amount, enough to provide healthcare for current retirees.

However, the state paid nothing for the healthcare obligations it owes to current employees who will eventually retire. Those costs will fall on future taxpayers.

As of 2010, the state had unfunded healthcare promises to teachers totaling $3 billion. The most recent estimate for unfunded state employee healthcare promises, from 2008, is $26.6 billion.

“Health benefits don’t come with the same contractual guarantees as pensions do, but it is very worrying from a practical standpoint as employees are depending on these benefits,” said Norcross.

Massachusetts and Texas contributed the same percentage as Connecticut. Nine states contributed less: New Jersey (25), Arkansas (24), Illinois (24), Nevada (21), Vermont (19), Louisiana (18), Indiana (13), Montana (0) and Oklahoma (0).