Connecticut’s total and unfunded liabilities have significantly outpaced their asset growth over the last six years, according to the state’s Office of Fiscal Analysis.
Between the end of June 2010 and the end of June 2016, the state’s total liabilities surged 53% to $32.3 billion, from $21.1 billion, while its unfunded liabilities grew at an even faster pace, rising 73% to $20.4 billion from $11.8 billion. And during those six years, the funded ratio dropped to 37% from 44%. Meanwhile, the state’s assets increased only 28% to $11.9 billion in 2016 from $9.3 billion in 2010.
But as bad as those numbers seem to be, the reality may be worse, according to a report released in May by the Hoover Institution. According to “Hidden Debt, Hidden Deficits: 2017 Edition,” state treasuries are underestimating the true cost of their pension debt by billions of dollars.
By the calculations of report’s author, Joshua Rauh, a senior fellow at the Hoover Institution, and professor of finance at the Stanford Graduate School of Business, Connecticut’s unfunded liability in 2015 was more than twice what the state had reported: $68.4 billion, instead of $30 billion.
Governmental accounting standards for pensions were changed in 2014 and 2015 with the implementation of Governmental Accounting Standards Board (GASB) statements 67 and 68. Statements 67 and 68 require state and local governments to report on the assets and liabilities of their systems with a greater degree of harmonization.
“However, these standards still preserved the basic flaw in governmental pension accounting: the fallacy that liabilities can be measured by choosing an expected return on plan assets,” said the report. “This procedure uses as inputs the forecasts of investment returns on fundamentally risky assets and ignores the risk necessary to target hoped-for returns.”
For example, the report said that a liability-weighted expected return of 7.6%, which was the average expected return in 2015, implies that state and city governments are expecting the money they invest today to double approximately every 9.5 years.
“That means that a typical government would view a promise to make a worker a $100,000 payment in 2026 as ‘fully funded’ even if it had set aside less than $50,000 in assets in 2016,” said the report. A similar payment in 2036 would be viewed as “fully funded” with less than $25,000 in assets in 2016, it said.
“This practice obscures the true extent of public sector liabilities,” said the report. “In order to target high returns, systems have taken increased investment positions in the stock market and other risky asset classes such as private equity, hedge funds, and real estate.
“The targeted returns may or may not be achieved, but public-sector accounting and budgeting proceed under the assumption that they will be achieved with certainty,” added the report. “Furthermore, while systems face somewhat stricter disclosure requirements under the new GASB standards, these standards will not directly affect funding decisions.”