For Connecticut’s pensions, investment forecasting is the triumph of hope over experience.
The state’s $17 billion teachers pension returned an average of 3.2 percentage point less than its 8.5 percent assumed annual rate of return between fiscal 2001 and 2015, the sixth-widest gap among 112 state retirement funds over the period, according to data compiled by the Center for Retirement Research at Boston College. The difference between assumed and actual returns of Connecticut’s municipal employee and state workers pensions wasn’t much better, ranking eighth and 15th-widest, respectively.
The failure to meet such targets is significant because governments need to boost contributions to make up the difference. Doing so would worsen the financial squeeze on Connecticut, which was downgraded by all three major credit-rating companies this year because of its budget deficit.
“Plans are aiming to hit their assumed return and so when they fall short, there’s something wrong with the system,” said Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research. “Either someone is telling them to set it too high or the investment manager isn’t hitting his goals.”
Connecticut’s pensions had less than half the assets needed to pay its $63.7 billion of pension promises, according to the most recent audited figures. In 2015, its retirement system was the fourth-worst among U.S. states behind New Jersey, Kentucky and Illinois, according to data compiled by Bloomberg.
Public pensions from California to New York have been lowering their return goals, adopting a more modest outlook after being roiled by last decade’s booms and busts and a long period of historically low interest rates. Of almost 130 public retirement funds, about three-fourths have reduced their targets since fiscal 2010, resulting in a decline in the average return assumption to 7.5 percent from 7.9 percent, according to the National Association of State Retirement Administrators.
Connecticut’s teachers pension reduced its projected return to 8 percent from 8.5 percent in November 2015. The state employees fund cut its to 6.9 percent from 8 percent this year.
“Eight-point-five is delusional, 8 is still delusional, in the 6s is a bit more realistic,” said Richard Warr, a professor of finance at North Carolina State University’s Poole College of Management.
Connecticut’s teachers fund didn’t lower its assumption deeper because of conditions in a $2 billion pension bond issued in 2008 that require the state to pay 100 percent of its required contribution annually and eliminate the unfunded liability by 2032. Lowering the return below 8 percent would have caused those contributions to jump.
To ease the burden on the state, which is facing a $5 billion two-year budget deficit, Governor Dannel P. Malloy has proposed shifting some of the teachers pension costs to cities and towns, which don’t contribute to the fund. Local elected officials panned the proposal, saying it would force them to raise property taxes.
Denise Nappier, a Democrat who has served as Connecticut’s treasurer since 1999, says she’s not willing to take on extra risk to exceed the return target.
“I have never designed an asset allocation plan in the last eight or nine years to beat eight-and-half percent, because it’s unrealistic,” Nappier said.
In Connecticut, the pensions’ goal is set by board members appointed by the governor and public employees.
Between fiscal 2001 and fiscal 2015, Connecticut’s teachers fund returned an average of about 5.3 percent, while the state employees pension returned an average 5.2 percent. The much smaller municipal pension returned about 5 percent. The median state pension returned 5.6 percent, according to the retirement research center’s data.
Comparing Connecticut’s returns to other states is misleading because it doesn’t account for the state’s need to have more cash on hand to cover pension checks, given its “significant” liabilities, Nappier said.
The pensions also missed out on outsize returns generated by private equity and real estate investments because of a moratorium on those asset classes in the early 2000s, she said. She also pointed to data from the Wilshire Trust Universe Comparison Service showing that Connecticut’s pensions performed better than 58 percent of those with assets greater than $10 billion during her tenure.
Investment performance isn’t the only factor underlying Connecticut’s $35 billion pension funding gap.
Connecticut didn’t begin setting aside money to pay retirement benefits promised to state employees and teachers until 1971 and 1982, respectively. And elected officials from both parties later compounded the problem by failing to make the government’s full annually required contribution.
“The system would actually be relatively well-funded if you could remove the liability associated with benefits earned before they were pre-funded,” said Aubry.
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