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Fiscal danger lurks in state pension funds

In a Feb. 12 address to the Waterbury Regional Chamber, Connecticut Gov. Ned Lamont conceded the state’s huge pension and other, related debt is a larger problem than he anticipated. Really?

Countless people have used “unsustainable” and “unaffordable” to describe the state’s pension and health-care obligations under agreements with the State Employees Bargaining Agent Coalition (SEBAC). What did Lamont think those adjectives meant?

During the campaign last fall, Lamont told voters he would call Big Public Labor back to the bargaining table. If he now sees an even bigger problem than he saw last fall, why hasn’t he summoned the unions for discussions? Evidently, he hasn’t. Last week, Sal Luciano, head of the AFL-CIO in Connecticut, announced that the unions do not expect to be asked to make any concessions.

So, how bad is the situation? Let’s look at the State Employees Retirement System (SERS) and the state’s other big pension fund, the Teachers’ Retirement System (TRS).

Pension analysis is notoriously mind-numbing, involving myriad assumptions and a variety of arcane technical terms. Instead, let’s take another simpler yet equally revealing look at SERS and TRS. Let’s look at cash flow, i.e., what comes into a pension fund and what goes out.

In the fiscal year ended last June 30, SERS and TRS paid out almost $4 billion in retirement benefits – about double the benefit payments just eight years ago.

By far, the largest input to the funds was the state’s contribution of about $2.7 billion. Active employees and teachers contributed about $500 million, leaving the funds with a negative cash flow of about $800 million before investment income.

Cash investment income in the form of dividends and interest, net of fees and expenses, was roughly enough to cover the negative cash flow.

Pension funds may also achieve gains in market value. Such gains are important, since, without them, the funds can’t grow, and, in turn, dividends and interest can’t increase. In FY 2017-18, the market value of SERS and TRS increased about $1.3 billion, or about 4.5 percent, as the S&P 500 Index rose almost 11 percent from about 2450 to 2700.

What if there’s a stock-market decline? What if there’s a recession? The market value of the SERS and TRS funds will shrink, and future dividend and interest income will stagnate, if not decline, leaving the pension funds even more reliant upon state contributions.

This is not just a hypothetical risk.

Last fall, the stock market plummeted, taking the S&P 500 Index down to about 2500 on Dec. 31. The market value of SERS and TRS declined 4.4 percent from June 30. While the S&P has recovered the lost ground so far in 2019, it hasn’t gained ground. Similarly, it is unlikely SERS and TRS have achieved any gains since last June 30.

Unless the stock market advances unendingly, the state will have to bear even more of the burden of the pension funds’ ever-increasing benefit payments to its ever-growing population of retirees. The combined number of retired state workers and teachers has grown from 72,000 just eight years ago to 88,000 on June 30, 2018.

Moreover, former Gov. Dannel P. Malloy predicted in mid-2017 that 40 percent of the state-employee workforce, or about 20,000 workers, would retire before 2022. While this may moderate the cost of the state’s active workforce, retirement-benefit expenses will explode. Was Lamont not listening when Malloy issued this warning?

Last year, the state hired Pew Research to conduct stress tests of SERS and TRS. Pew concluded “TRS’ risk of insolvency is not insignificant if required contributions are not met.”

TRS must reach full funding by 2032 to comply with covenants on outstanding state bonds. With only about $17 billion in current assets, TRS has just 13 years to close a funding deficit of about $14 billion. The new state treasurer, Shawn Wooden, says he has a plan to refinance those bonds and stretch out the funding challenge. However, if that were easy to do, or could be done without incurring significant additional costs, wouldn’t Malloy and former Treasurer Denise L. Nappier have done so?

Without investment income, TRS would face insolvency unless the state’s contribution skyrocketed, which would crowd out a massive amount of other government spending. In its report, Pew observed “This (crowd-out) issue is driven primarily by the funding requirements of TRS and is widely understood by policymakers in the state.” Did Lamont understand – or read – the Pew report?

While we do not know what our likable new governor will propose in his budget this week, it is worrisome that he is admitting just beforehand that state pensions and related obligations are bigger problems than he anticipated and that, especially in light of that admission, he has given no sign that he intends to a follow through on his campaign promise to call Big Labor back to the bargaining table.

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