The Pension Bomb
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But solutions are not in the offing at present. With a state budget hundreds of millions in arrears and the prospect of the deficit growing into the billions, the focus in Hartford understandably is elsewhere. Unfunded future obligations are not something legislators and union bosses are inclined to worry about just now. As Scarlett O’Hara said, “I can’t think about that right now. If I do, I’ll go crazy. I’ll think about that tomorrow.”
The crux of the matter is that Connecticut taxpayers, already in a deep hole due to consistent neglect and investments turned sour during the stock market collapse, are on the hook for billions of dollars in pension payments. It is a contractual obligation which the state must address and which, unlike private pension funds, cannot be passed off on the federal Pension Benefit Guarantee Corp.
Most state employees are eligible to draw pensions at age 62 and after as little as five years on the job. About 7,000 employees remain under an older retirement plan that lets them start drawing pensions at 55. Workers are eligible for health-insurance retirement benefits after 10 years on the job. Most employee pensions are calculated as 2 percent of the average of the employee’s salary for the last three years on the job times the number of years in state employ. As workers approach retirement, they can increase their overtime and add accrued unpaid vacation time to increase their earnings up to 130 percent of salary for the purposes of calculating their pension payments.
So a worker who retires after 25 years and who made an average of $66,000 during the last three years on the job would get $33,000 a year in pension benefits. In addition, the state picks up the tab for health insurance for the retiree and his family. As of June 2008, according to the most recent actuarial assessment, the average pension was $27,500, totaling $1.04 billion annually for the state’s 38,100 retirees. The average figures to rise significantly in the future, reflecting steady increases in state-employee salaries.
A pension fund has three primary funding sources: employee contributions, employer contributions and investment gains. Connecticut at present takes in $330 million annually in employee contributions and is supposed to match that with taxpayer funding amounting to about $335 million in fiscal year 2009 and $340 million in fiscal year 2010. Further, to shore up the unfunded liability, the state, via tax revenue, is supposed to contribute an additional $562 million in 2009 and $603 million in 2010.
Investment gains, on the other hand, cost taxpayers nothing, but all too often they have been used to cover up deficiencies in contributions. In Connecticut, appreciating assets normally contribute from 60 to 80 percent of what the various pension funds take in each year. State Treasurer Denise Nappier, who has been widely praised for the job she is doing with investing pension monies, admits the last 18 months have been a challenge. “When the market hit its lowest point in the fall of 2008—the crash that was heard around the world—I knew we were in for trouble, she says. “In the fiscal year ending June 30, 2009, we were down 17.3 percent.”
The third quarter 2009 saw a 13 percent increase, “but it’s highly unlikely that the pension funds will generate positive enough returns so that the double-digit gains of this year will mitigate the double-digit losses of last year,” says Nappier. “But as painful as the market environment has been, we do measure our performance over the long haul. We’ve gone through cycles when the market was up and when it was down, but over the long haul we are getting 8.9 percent,” beating the actuarial assumption of 8.5 percent.
Even so, she says, the pension liability is growing faster than assets. With an ever-increasing retiree population, a larger percentage of the funds must be kept liquid to pay current obligations, which leads to smaller returns. “We need a disciplined approach to financing pension-benefit obligations,” she says. “We’ll always have market volatility. The outlook for the current fiscal year and the next five years is quite uncertain, so we need to be aware of what’s going to be a continuing storm.”
But politicians will often look for ways not to pay into the funds. When Gov. M. Jodi Rell and the state employee unions agreed last spring to forgo pay raises for a year in exchange for a promise of no layoffs, a little-noticed provision allowed the state to postpone $100 million of its required annual contribution to the State Employee Retirement Fund if the deficit exceeded $300 million. That provision became a key piece of the deficit-reduction plan House Democrats presented in December to counter Rell’s proposed budget cuts, but, if approved, it just digs the hole a little deeper—with interest. “Most people think that when the state doesn’t contribute fully, that’s it,” Nappier says. “But it’s not a waiver of the contribution, it’s a suspension. And it comes with an 8.5 percent interest charge that’s compounded year after year.”
“We have choices,” says Dan Livingston, a lawyer who represents state employee unions at the bargaining table. “We can increase taxes, we can cut spending, or we can in effect borrow money by slowing down the repayment to the pension fund.