How to fix teacher pension fund
When he left office in January, Gov. Dannel P. Malloy could honestly claim that he had reformed and improved virtually every area of Connecticut state government. Except one. He was prevented by obstructionist Republicans from reforming the teachers pension fund. As a result, annual payments to the fund, which now total $1.4 billion, or 7 percent of the budget, could exceed $3 billion by 2032. Gov. Ned Lamont has now taken up the challenge of reform, offering a comprehensive solution in his proposed biennial budget. Here’s how we got here, and how Gov. Lamont proposes to fix it.
First, far from being too expensive to afford, as Republicans claim, Connecticut’s public school teacher pension benefits are actually lousy. The Boston College Center for Retirement Studies’ 2015 report concluded that the “generosity” of Connecticut teacher pension benefits, as measured by the normal cost as a percentage of payroll, falls below that of teacher benefits elsewhere. The Urban Institute’s analysis of state teacher pension benefits awarded Connecticut an “F,” one of just five states receiving a failing grade.
Moreover, Connecticut is one of just 12 states whose teachers are ineligible to collect Social Security benefits. According to a recent report by Cavanaugh MacDonald Consulting that compared teacher pension benefits in those dozen states, Connecticut’s benefits were inferior to nine, and better than just one. With notable understatement, the report concluded that Connecticut teacher pension benefits are “modest.”
Yet Connecticut teachers are forced to pay significantly more for those meager pension benefits than are teachers in most other states. In 2017, General Assembly Republicans, aided by a handful of conservative Democrats, passed a budget unilaterally imposing a $60 million “teacher tax” that raised teachers’ required pension contributions, but not their benefits. Connecticut teachers now contribute twothirds of the normal cost of their pensions, compared with the national average of just 40 percent. By contrast, the state of Connecticut contributes less than half the national average to teachers pensions’ “normal cost.”
So, since the teachers aren’t to blame, why are the state’s annual required pension contributions rising so sharply? First, Connecticut failed to fully fund required pension contributions (“ADEC”) from 1983, when the fund was first created, through 2007. That failure was partly offset by 13.4 percent annual investment returns from strong capital markets through 2000, resulting in a relatively healthy level of 83 percent by that point. But the next decade proved disastrous.
Republican governors John Rowland and M. Jodi Rell underfunded the ADEC every year through 2007, while capital market performance dropped dramatically. In 2008, Gov. Rell decided to prop up the pension fund by issuing a $2.2 billion “Pension Obligation Bond.” But the bond was terribly timed, the proceeds being invested right as capital markets collapsed. Far from boosting the fund, the bond actually increased required contributions for years. Those factors combined to reduce funded liabilities from 83 percent in 2000 to 59 percent when Gov. Malloy took office.
A major impediment to reform comes from a little-noticed covenant in that 2008 pension bond, which forbade the state from making any changes to its funding formula. In 1992, the General Assembly passed a bill requiring that the teachers pension fund be fully funded by 2032. The bond covenant requires the state to adhere to full funding by 2032, even though it will require massive increases in annual contributions to get there. Gov. Malloy proposed a plan in 2017 to circumvent the bond covenant and eliminate the 2032 cliff, but the GOP refused to act. So while Gov. Malloy fully funded the ADEC each year in office, the menace of the 2032 cliff remains.
Gov. Lamont has now taken up the reform challenge. He proposes front-loading fund contributions by using the “even dollar” method in place of “percentage of payroll,” which “back-ends” payments, resulting in ballooning contributions over time. He also proposes reducing the expected rate of return from 8.0 percent to 6.9 percent. Key to the reform plan, Gov. Lamont proposes circumventing the bond covenant by creating a contra-account within the $2.6 billion “rainy day fund” equivalent to a year’s pension contribution that bondholders could access should the state fail to fully fund the ADEC. Creating that reserve would permit the state to eliminate the 2032 cliff, lengthen amortization and postpone full funding until 2049, sharply reducing annual payments in the process. Indeed, the plan projects that pension contributions would essentially flatline for years to come.
In addition, Gov. Lamont has proposed that municipalities begin paying some portion of the normal cost of teacher pensions. Why is that important? Because funding teacher pensions is a local school district responsibility in every state, except Connecticut and New Jersey. After all, school teachers are municipal, not state, employees, and sharing the responsibility will further strengthen teacher pensions. Given that most of the annual payments go to making up arrears, not the normal cost, the cost to municipalities would total just $75 million in 2022 out of the $1.4 billion total pension contribution.
Gov. Lamont’s plan will not only protect Connecticut teacher’s contracted pension benefits for years to come, but also control the state’s pension contributions, and eliminate the looming 2032 pension cliff. Unlike 2017 when obstructionist Republicans blocked structural reforms, and punished teachers with their “teacher tax,” this year General Assembly Democrats should be able to finally fix the teacher pension fund, and put the entire state budget on a strong and sustainable trajectory for years to come.