Riots by government employees in Greece are far away from us, but make no mistake: Connecticut, and many other states, face similar financial crises soon as we have to make good on all the pension and health benefits our elected officials promised to government employees.
For politicians the tactic was a slam dunk. They knew that government workers would turn out to vote, so by promising generous pension and retirement health benefits that didn’t have to be paid for years, they could get elected and get re-elected.
Some politicians, including Gov. M. Jodi Rell and state Treasurer Denise L. Nappier, have been warning us about the problem for years, with little success. But it’s time to wake up folks, because things may be even worse than what they have told us.
The reason is that the gloomy figures they are looking at are based on the BEST scenario of how well the investments that have been socked away will perform in the future to pay for these debts – where our total shortfall exceeds $30 billion.
In the last month some financial experts have been casting serious doubts about the projections Connecticut and other states have been making about the returns that can be expected on our assets invested in stocks, bonds and real estate. They are saying that states are starting to take riskier bets with their investments to try to get the higher returns. Of course, by its very nature, the more the risk the higher the probability of losing money.
And not meeting those projections would add billions to our debt, even double its size.
It is because of that problem, the experts say, that government officials don’t want to face the reality that market conditions have changed as the result of the Great Recession and the trillions of dollars in additional debt that the federal government has taken on to bail us out.
To simplify the issue we can look at a typical middle-class person planning for retirement. If she wanted her yearly retirement income to be $40,000, the amount of assets she would need to produce that amount of money would depend on how much she thought her nest egg would grow each year. That way she could plan on how much she needed to save each year to get to her magic number at retirement.
If she projected that in the next 20 years – with spikes up and down – she would average annual returns of five percent – a fairly reasonable assumption today considering certificates of deposits may get up to 3 percent – she would need to have $795,000 when she retired.
But, say she thought she was a brilliant investor and could goose her returns to average 8.25 percent. She would only need to have saved $475,000 to be able to spend the $40,000. That is quite a difference.
Well, the state of Connecticut, like most states, has used the much higher rate of return to calculate how much money will be needed to pay those debts – figures that John E. Peterson, professor of public policy and finance at the George Mason School of Public Policy, referred to as “Fairy Tale Pension Projections” in his March article for Governing magazine.
While those projections may have made sense in the last 25 years, Peterson and other financial experts doubt that today they are based in reality.
John Garrett, an actuary with Cavanough Macdonald Consulting of Kennesaw, Ga., is Connecticut’s new pension consultant and is working on developing a new analysis, including what should be the proper projected all-important rate of return.
In a telephone interview Thursday, Garrett said he didn’t know what his firm will come up with, but said Connecticut’s 8.25 percent projection was not unreasonable considering that in the past 25 years the average annual rate for state pension funds was higher. He also noted that Connecticut last year reduced its projection for state employee pensions from 8.5 to 8.25.
Both Gov. Rell and Michael J. Cicchetti, deputy commissioner of the state Office of Policy and Management, are less sanguine about the problem.
“This is a financial Sword of Damocles hanging over the stateâ€™s head that we literally can no longer afford to ignore. This mounting debt has been virtually ignored for decades. Ignorance may be bliss, but that bliss carries a price – too high a price,” outgoing Governor M. Jodi Rell said Wednesday in a response to questions I asked her staff about the projected rate of return and the growing pension and health debt.
“For that reason, I have established a working group, with representatives from the Treasurerâ€™s and Comptrollerâ€™s Offices, my budget office, the state employees union, accountants, actuaries and others to propose short and long term plans for addressing our unfunded liabilities. Their first report is due by July 1,” she said.
Cicchetti, the man who heads that working group, said Thursday he doesn’t feel comfortable with the present projections, especially after reading Professor Petersen’s article and a recent New York Times piece that predicted that states will have to make much riskier investments to try to meet their unreasonable projections. The New York Times article points out that experts are questioning projected rates of return even in the 7 percent range, much lower than Connecticut’s.
Cicchetti, who said he has provided members of the working group with copies of the article and the New York Times story, said it’s crucial “to know what we are dealing with â€¦ the magnitude of the problem. A one percentage point difference means a huge amount of money.”
“If we are using numbers that are unreasonable, we need to know that,” he said.
The biggest problem Cicchetti sees is health care for retired state workers, who receive full coverage, without any premium for themselves and their spouses, from age 55 to 65. That is an unfunded liability projected at more than $25 billion, higher than the state’s annual budget of $18 billion.
The New York Times March 8 article by reporter Mary Williams Walsh is an eye-opening account of how state pension funds are moving into riskier investments – unlike private pension managers who are doing just the opposite, moving into safer bond investments.
â€œIn effect, theyâ€™re going to Las Vegas,â€ Frederick E. Rowe, a Dallas investor and the former chairman of the Texas Pension Review Board, which oversees public plans in that state, told Walsh.
“Though they generally say that their strategies are aimed at diversification and are not riskier, public pension funds are trying a wide range of investments: commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. And some states that previously shunned hedge funds are trying them now,” she wrote. â€œNobody wants to adjust the rate, because liabilities would explode,â€ said Trent May, chief investment officer of Wyomingâ€™s state pension fund.”
Professor Petersen’s answer is to do what private firms have been doing over the last few years: Terminate fixed benefit programs.
“Freeze the promised benefits as of a certain date,” he recommends. “Though unpleasant for public workers, it’s preferable to the unsustainable arrangement in which governments default on pension payments. While drastic, it brings decision-making into the bright light of the tough choices in an aging, slow-growth, high-risk economy.”
Now let’s see if we the voters have the smarts to elect representatives and a governor who have the courage to meet this challenge, because I can assure you, most of the unions will fight this tooth and nail.
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- Politicians and Unions Hiding Real State Pension Liabilities
- Municipal, State Employee Benefits Not Assured In Bankruptcies
- Connecticut, Massachusetts Among Five State With Most Serious Pension Problems