Connecticut’s pension system may be in much worse shape than previously thought according to a new study from the Hoover Institution, a public policy think tank at Stanford University.
In 2015, Connecticut reported its pension liability as $30 billion but the Hoover Institute study says that figure was actually $68 billion.
In its second edition of Hidden Debt, Hidden Deficits, study author Joshua D. Rauh examined 649 state and municipal pension systems and found that even states like South Dakota, which are reportedly overfunded, are actually facing a large debt.
The most recent official estimate of Connecticut’s pension debt is $22 billion, but in actuality that figure may be much higher.
The difference lies in the way the state determines pension liability. Until 2016, Connecticut assumed an 8 percent rate of return on its pension investments and that assumption causes the pension system to appear more fully funded, even though those returns may never materialize.
The assumed rate of return is often called a “discount rate” because future payments are discounted at that rate. A higher discount rate allows the state to contribute less money toward the pension fund and still say the state is meeting its funding obligations.
Rauh says those assumptions are far too optimistic and result in states underestimating the true cost of their pension debt – a debt which he characterizes as the state borrowing money from its own employees.
“What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire, but the accounting standards allow the bulk of this debt to go unreported through the assumption of high rates of return,” he wrote.
By depending on a high discount rate, a state government hides the true debt that it owes to the pension fund and ultimately to state workers.
For instance, a government that assumes a 7.5 percent discount rate believes that $50,000 in the pension fund will become $100,000 in ten years. However, state governments are rarely able to reach these goals.
The actual ten year rate of return for Connecticut’s state employee pension system was only 5.14 percent. For the teachers’ retirement system the actual rate of return was 5.25 percent. But during that time the state was assuming an 8 percent return.
As part of the deal to refinance Connecticut’s pension liabilities, the State Retirement Commission lowered Connecticut’s assumed rate of return from 8 percent to 6.9 percent in 2016. The change came on the heels of a deal made between Gov. Dannel Malloy and union leaders to refinance the pension debt to avoid a massive increase in state payments in 2022.
The pension deal, approved by legislators in January of 2017, defers billions in state payments past 2032, meaning Connecticut will be paying off the pension debt into the 2040s.
Lowering the expected rate of return also means the state will have to contribute more to the pension system each year to meet its funding obligations.
But even with the changes to the pension payments and the discount rate, Rauh says the assumption is still too high and hides the reality of Connecticut’s pension burden.
Instead, he says the “appropriate” discount rate would be the same as a government bond because the discount rate essentially functions as a debt owed to employees. Based on those valuations, Connecticut’s 2015 pension debt grows from $30 billion to $68 billion.
This method of accounting for pension debt is not new but is not the method used by state governments. A 2014 study estimated Connecticut’s pension debt to be $76 billion.
Rauh writes in the Hoover Institute that the report “reveals the extent to which state and local governments are in fact not running balanced budgets.”
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