Muniland: When Good Intentions Go Wrong

The best intentions can sometimes lead to bad outcomes. While the State of Connecticut has been relatively aggressive in funding its pension for the past 14 years, it still has a $27 billion unfunded pension liability. Its funding ratios are near the bottom of the state pension rankings. At 42% for its State Employee Retirement System (SERS) and 59% for its Teachers’ Retirement System (TRS), funding levels surpass only last place Illinois.

Connecticut is one of the wealthiest states in the Union, but its pension funding levels are so low that the Center for Retirement Research at Boston College (CRR) was asked to perform an analysis of the state’s retirement systems to determine the factors that contributed to the problem. The CRR identified four factors that have contributed to the state’s low funding levels:

  1. Legacy Costs – Prior to 1971, the state did not set aside assets to pay for future benefits. Those legacy costs now represent $9.3B of the unfunded liability.
  2. Inadequate Pension Contributions – The state’s average pension contribution since 2001 has only been 90% of its annual required pension contribution (ARC). While it did issue $2 billion of pension obligation bonds in 2008, the 10% deficit in the ARC has resulted in $4.7 billion of the unfunded liability.
  3. Assumed Rates of Return Too High – Connecticut pension plans returned about 5.6% annually between 2000 and 2008 versus an average 8.25% assumed rate of return. The incorrect return assumption resulted in $8.9 billion of the unfunded pension liability.
  4. Inaccurate Actuarial Experience – Finally, actuarial experience can be significantly different than reality. Early retirement incentive programs or incorrect assumptions about how long retirees live greatly impacts pension results and currently accounts for $4.1 billion of the unfunded liability. 

Our readers are well aware that pension liabilities are of major focus for us as we analyze the financial condition of municipalities. Some states, like Connecticut, we avoid entirely because of these issues. CT is selling $650mm of general obligation bonds this morning, but we’ll be on the sidelines as the yields on the bonds don’t adequately compensate investors for the long-term risks presented by these types of issues.   

Source: The Center for Retirement Research at Boston College, SNWAM Research