A June special report from the Center for Retirement Research at Boston College (CRR) suggests Connecticut should consider splitting its legacy pension debt – defined as pension debt acquired before 1971 – from its modern pension debt to reduce retirement costs associated with current state employees.

The authors suggest creating a separate government entity to manage Connecticut’s legacy debt, combined with dramatically lowering the assumed rate of return for Connecticut’s pension investments. The legacy debt would then be paid down more slowly over multiple generations.

The study argues the change would represent a “trade-off,” increasing the annual pension payments, but reducing the annual costs of Connecticut’s legacy debt and resulting in “a more rational allocation of costs that results in improved intergenerational fairness, better resource allocation by government, and – ultimately – greater public credibility.”

The suggestion is complicated to say the least; separating out $6 billion in state employee legacy pension costs from the debt acquired in the modern actuarial accounting age and smoothing out the payoff costs to ultimately save money in the long-term. It involves lowering Connecticut’s assumed rate of return to match municipal bond yields, which would increase Connecticut’s total debt on paper, but could also have the welcome effect of lowering the fringe benefit costs of state employees that has plagued state agencies and universities for years.

Connecticut’s State Employee Retirement System (SERS) has roughly $22 billion in unfunded liabilities, according to the latest report from the Connecticut Comptroller’s Office. The cost of unfunded pension liabilities are combined with the “normal cost” of state employee pension benefits, which increases the overall payroll cost of each employee. 

According to the Comptroller’s Office, the typical SERS retirement fringe benefit rate is 67.4 percent. For hazardous duty employees, that rate increases to 91.49 percent. The majority of that fringe benefit cost goes toward paying down Connecticut’s unfunded pension liabilities. 

CRR argues that splitting off legacy pension debt and lowering the assumed return will ultimately reduce the retirement costs associated with state employees will lower the “perceived cost” of each worker from 54.3 percent (using CRR’s calculations) to 12.1 percent, which could be a welcome change as the state is currently looking to fill thousands of open positions in the state workforce.

Lowering Connecticut’s assumed rate of return on its pension investments to match municipal bond yields, however, would ultimately increase the estimated unfunded liabilities and the state’s annual payments, but CRR argues it would change little for the reality of Connecticut’s pension debt.

“The use of bond yields to value liabilities would increase reported liabilities, which some may take as an indication of worsening plan finances,” the researchers wrote. “In reality, little about the retirement system’s finances will have changed – asset levels, the promised benefit payouts, and the contractual obligation to fulfill promised benefits are the same.”

CRR’s 2015 report that showed Connecticut’s pension payments would likely spike to unsupportable levels if nothing was done raised alarm bells in the state and led to lowering the return assumption and re-amortizing the debt. The change added billions to the long-term cost of paying down the debt, but also reduced future annual payments by stretching them out over a longer period of time.

For decades, Connecticut used an 8.5 percent assumed rate of return for its major pension systems before dropping down to 8 percent. Gov. Ned Lamont’s administration oversaw lowering that rate of return to 6.9 percent, but even with the lowered return, the state has often not met that benchmark.

According to CRR’s research, between 2001 and 2021, Connecticut’s annualized returns were 6.2 percent, and with the stock market having a rough year thus far. The Treasurer’s Office shows SERS investments coming in at negative 11.3 percent for the year.

Lamont’s administration has also re-amortized Connecticut’s pension debt for both state employees and teachers, stretching payments out until 2045. 

While the Center for Retirement Research’s plan is novel, Connecticut’s plan toward paying down its pension debt is much simpler: utilizing surpluses from volatile tax revenue tied to investment earnings to pay down the liabitlities – similar to a lump sum payment toward the principle on a mortgage.

Over the course of 2021 and 2022, the state has paid off nearly $6 billion in pension debt for its two largest plans — SERS and the Teachers Retirement System. The payments ultimately lower the annual contribution required to pay off the debt, saving the state hundreds of millions in the near term and giving lawmakers some wiggle room in future budget negotiations.

But utilizing those annual savings and toward new government programs and spending is basically the same as continuing to make the minimum payments on the mortgage, rather than funneling those savings toward paying down the debt more quickly. There’s little guarantee that Connecticut will continue to see surplus tax revenue from those investment earnings as stocks have plummeted on concerns of high inflation, rising interest rates and worries about a recession. 

The research center made the same suggestions for Connecticut’s unfunded teacher pension debt, which stands at $18 billion, according to the latest report issued in 2020. It does not appear the CRR has accounted for Connecticut’s debt payoff based on the timing of the report.

“Given the challenges that legacy debt poses to current funding policy, this Report presents a new approach that separates the funding of legacy liabilities from other pension liabilities, while valuing liabilities in a manner more consistent with modern accounting and finance,” the authors wrote.

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