New SEBAC Agreement Inches Connecticut State Employees Pension Plan Towards Sustainability

Connecticut’s out-of-control spiral into a fiscal crisis has been well documented. And for too long the Nutmeg State has ignored proposed solutions while continuing to underfund its state and teacher pension funds. However, a new labor agreement just approved by the Connecticut Legislature will take a small step towards bringing Connecticut out of its spiral for the State Employees Retirement System (SERS).

The new labor agreement does not fully fix the plan. And even combined with a separate funding policy agreement made in February this year it is still likely the state will see unfunded liabilities continue growing over the next few decades. But for a state that has failed consistently for decades to live up to the funding commitmentsit has made to state workers, any small step should be welcome.

The most notable provisions in this new agreement are:

• For current workers:

o Increased employee contributions to healthcare premiums

o Increased employee contributions to the pension system by 1.5% in 2017, up to 2% in 2019

o A revised cost-of-living adjustment (COLA) formula that limits payments based on the consumer price index (CPI)

• For new hires:

o A “hybrid” pension system for that includes a modified version of the current defined benefit plans along with small contributions to a defined contribution plan

The first two provisions will guarantee more money is going to fund employee benefits, certainly an improvement to the 43%funded plan. The third listed provision will slow the growth of employee benefits by fixing any COLAs to the CPI when inflation is below 2%, and then providing only a partial increase in COLA payments for inflation above 2%. This is an improvement, as SERS’s previous COLA was not pegged to the CPI, making it more like a permanent benefit increase than something designed to preserve a benefit’s value.

The last part – affecting new state employees only – creates a so-called “hybrid” retirement plan on a similar model as Michigan teachers have had access to since 2010. But this new benefit system is not a hybrid retirement plan in the traditional sense.

Typically, a hybrid retirement plan would balance a defined benefit pension with a defined contribution plan. For example, the federal government’s hybrid plan for civilian workers offers a defined benefit pension with a 1% multiplier and up to 5% in matching employer contributions to a DC plan. Pennsylvania recently created two hybrid retirement plan options with 1% and 1.25% multipliers alongside DC plans that will have between 5% and 6% in total contributions.

By contrast, the new hybrid plan for Connecticut state workers includes a defined benefit pension with a 1.3% multiplier and a DC plan with just a 1% employer contribution match. The meager contributions to the DC portion of this retirement benefit will never be enough to accumulate much wealth. Retirement plans that are DC-only typically need 10% to 16% in contributions over the course of a lifetime to yield a meaningful retirement benefit. The total of 2% in contributions – 1% from each employee and employer – makes the DC portion of the new Connecticut SERS hybrid little more than a supplemental savings plan alongside a reduced pension benefit for new hires.

This is not to say the new retirement plan makes matters worse. To be sure there is some risk reduction in offering a slightly lower multiplier (the 1.3% multiplier is down from a 1.4% multiplier). And there is certainly some risk reduction in shrinking the COLA benefit to match CPI. Rather, it’s important to emphasize that the gains made under this reform are modest at best. And calling the new retirement plan a “hybrid” plan masks the reality of the underlying benefit structure.

Consider the reality that Connecticut SERS faces, as my colleague Anthony Randazzo and I discussed in a paper earlier this year:

“SERS is clearly a troubled pension plan, with $21.7 billion to $25 billion in unfunded liabilities (depending on how they are valued). Over the past few decades, investment returns have consistently underperformed expectations by a wide margin, while the asset allocation has been shifting toward riskier investments in an effort to compensate for these shortfalls and chase higher yields.

Given SERS’s current actuarial assumptions and funding policies, there is a high degree of volatility in prospective future employer contribution rates, creating budgeting challenges down the road. The amortization methods used for paying down unfunded liabilities over the past few decades have been focused just on keeping near-term payments low, rather than actually reducing or eliminating pension liabilities. And even when the state has paid 100% of the actuarially determined contributions – a practice that has been anything but consistent – they haven’t been enough to fund the plan properly because the discount rate used to value liabilities has been too high.”

Until these reforms are coupled with substantial changes to address these specific problems, SERS still has a ways to go before it’s out of the woods. To put it more bluntly, it’s going to take a lot more than 0.5% more in employee contributions and minor adjustments to future benefits to tackle that challenge.

What is unclear is to what degree members of Connecticut SERS are aware of this challenge. The labor agreement was put to a vote and approved by over 80% of union members. This is an important fact. At a minimum, it means there is some degree of engagement on the issue from labor by both leadership and membership. Public sector workers and their representatives are obviously stakeholders in these negotiations, and they should have a say in the process. It also helps to have unions involved from the start to avoid legal complications that other states have encountered when seeking to move unilaterally on pension reform (even with rational and reasonable changes).

Particularly when it comes to deals as complicated as this one, organizations with the ability to collectively bargain on behalf of members (i.e. public sector unions) are important not only to translate the preferences of members into coherent policy proposals, but also to sell members on a final compromise.

Still, the changes approved here are so small and weighted towards the unrepresented future membership of Connecticut SERS that it appears likely the full scope of danger for this pension plan has not been made apparent to those depending on it.