Hartford Business Journal

www.HartfordBusiness.com November 23, 2015 • Hartford Business Journal 3 Pension split aims to avoid major future tax hikes By Matt Pilon mpilon@HartfordBusiness.com G ov. Dannel P. Malloy's recent proposal to lengthen the payoff date of Connect- icut's $25.7 billion unfunded pension obligation comes with an unknown pricetag, but also acknowledges the increasing risk of annual retirement contributions swamping the state budget in the not-so-distant future. Malloy and his budget director, Office of Poli- cy and Management Secretary Benjamin Barnes, said in an interview this month with the Hartford Business Journal that pension-plan changes are needed, and the sooner they come, the lesser the overall impact will be on future state budgets. If no changes are made, Barnes warned businesses and other significant taxpayers will likely conclude that the state will need to raise taxes further to meet higher pension obli- gations in the years ahead, which he likened to heading for a fiscal cliff. "Who's going to want to be in that car?" Barnes asked. Thanks to a series of reforms negotiated in 2011 and 2012, Malloy was able to significantly reduce the state's unfunded liability for retir- ee health benefits. He has also made the full required annual contribution to the pension system over the past several years. But Connecticut's unfunded liability for retiree pension payments has shot up since 2000, thanks to early retirement incentives, overly optimistic assumptions about stock market returns, and lower-than-required con- tributions in several years. The employee and teacher retirement plans were 42 percent and 59 percent funded as of last year. Even if those funds average annual returns of 8 percent until 2032, and the state's actuaries make correct assumptions about retirement rates and other factors, annual costs will rise from around $1.8 billion today to $6 billion in 2032, adding a significant bur- den to the state budget. It's possible to hit or beat those investment assumptions. From 1983 to 2000, the teach- er's and employee's funds averaged returns of 13 percent and 11 percent, respectively. But what if the market underperforms like it has over the past 10 years, averaging just 5.5 percent returns? It will create a much worse reality for the state, according to a recent report by The Center for Retirement Research at Boston College, which was com- missioned by the administration. "If, instead of realizing the assumed returns, the systems' investment experience is similar to the past decade, total annual costs for the two systems could balloon to $13 billion in order to be fully funded by 2032," the report said. The current annual state budget is about $20 billion. Even if the result ends up somewhere in the middle of those two scenarios, Malloy said it will create a serious financial challenge. "There's no way we're ever going to make the size payments that would be required if we don't step up to the plate right now," Mal- loy said. "It's the 800-pound gorilla in the room. Always has been." Split lengthens pay-off horizon Malloy has proposed a structural change no other state has tried: Splitting off approximate- ly 30,000 of the most expensive retirement-sys- tem members, known as Tier I beneficiaries, and paying their annual benefits through an appropriation in each state budget. After splitting off the Tier I members, the state would continue to prefund its obliga- tions to the remaining less expensive plan beneficiaries on an actuarial basis. If the entire plan's assets are applied to those remaining members, the plan will immedi- ately be 95 percent funded, reducing required state contributions, Barnes said. The combination of payments to the split- off members and the remaining members would be about $2 billion per year, Barnes said. Under Malloy's proposal, the debt to the Tier 1 pension recipients, which the governor insisted remains "an absolute obligation," could be paid off over a longer period, though exactly how long is not clear. Malloy committed in 2012 to fully fund the pension system by 2032. But state gov- ernment and pension officials have known for some time that the deadline carried a risk of sharply increasing annual costs in the later years. In addition to investment risk, the Continued Vito's By e Park Vito's Pizzaria Vito's by the Water Book your holiday party or catered event for 25 people or more and we'll hook you up with a $100 gift card to start your new year right. use promo code: HBJ Order Online or Make a Reservation at VitosCT.com In a visit to the Hartford Business Journal this month, Gov. Dannel P. Malloy (right) and OPM Secretary Benjamin Barnes said the state will not likely be able to pay off its pension debt by 2032, as previously planned. H B J P H O T O | G R E G B O R D O N A R O

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