CT Treasurer Proposes Using Lottery to Fix Pension Fund

Denise Nappier eyes lottery-backed revenue bonds to support Teachers’ Retirement Fund.

Connecticut State Treasurer Denise Nappier has recommended tapping into the state’s lottery to help fund its Teachers’ Retirement Fund (TRF)

Nappier made her recommendation in a presentation to the Pension Sustainability Commission, which would involve transferring $3 billion in state assets and bonds to the teachers’ pension fund, including $1.5 billion in lottery-backed revenue bonds.

“Years of kicking the can down the road have deteriorated the health of the fund, and the state now finds itself in the midst of another fiscal storm,” Nappier said in a release, adding that the proposal “is designed to put the Teachers’ Retirement Fund back on firm fiscal footing, and represents a concrete, tangible plan that would strengthen the long-term sustainability of the TRF while providing relief to the State and avoiding a potential spike.”

Nappier said that from 1991 through 2005, a total of $979 million was not contributed to the TRF. Had this amount been contributed and invested, she said, taxpayers could have saved approximately $5 billion in contributions. As of June 30, the TRF had assets of $18.1 billion, with liabilities of $31.1 billion for a funded ratio of 57.7%.

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In her presentation, Nappier said that an infusion of cash and assets in fiscal 2020 would improve the funded status of the TRF, which would reduce the state’s annual actuarially determined employer contribution (ADEC), without hurting the fund’s cash flow.

She recommended that the state issue lottery-backed revenue bonds to generate cash proceeds of approximately $1.5 billion for deposit into the TRF, in addition to transferring an additional $1.5 billion of state assets. According to Nappier, this would lessen the impact of lowering the investment return assumption to “a more realistic” 7.5% from 8%, which she proposed for 2020.  This would comprise one part of the plan, which has three main components.

The second component is to pay off the state’s pension obligation bonds in fiscal year 2026, which is the first full fiscal year they can be redeemed. Nappier said this would allow for more options for responsible recalculation of future contributions. And the third component is to re-amortize the TRF’s remaining unfunded liability, as well as further reduce its investment return assumption to 7%, which she said is more consistent with capital market expectations.

“An essential element for ensuring the soundness and affordability of any actuarially designed plan is consistent funding in an amount determined by the State’s actuaries as necessary to reach full funding at the end of the amortization period,” Nappier said.

According to the Connecticut State Treasurer’s office, infusing $3 billion to the fund in fiscal year 2020, while reducing the return assumption to 7.5% from 8.0% will reduce the state’s ADEC contributions by approximately $941 million for the five years ending fiscal year 2025. The state is required to annually pay the full amount of the ADEC for as long as the bonds remain outstanding and prohibits certain changes to the calculation methods in order to reduce those annual payments. After deducting debt service, the savings to the general fund would be approximately $441 million.

According to Nappier’s plan, after fiscal year 2025, the state would be in a position to pay off the pension obligation bonds for roughly $1.9 billion, using the estimated state contribution, and the pension obligation bond debt service payment for that year. At that point, she said, the bond covenant would disappear and the state then could restructure the amortization of the remaining liability to “smooth out future annual ADEC payments, thereby avoiding the often-discussed potential spike in state contributions.”

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SFERS Board Cuts Rate of Return to 7.4%

The minuscule cut reduced the expected rate of return from 7.5%, the highest return projections of any pension plan in California.

The board of the $24.5 billion San Francisco Employees’ Retirement System (SFERS) has approved a small reduction to its expected rate of return to 7.4% from 7.5%, retaining the system’s status as having the most optimistic return projections of any public pension plan in California.

The return assumption comes as the pension system’s general investment consultant, NEPC, forecasts that the plan’s investment returns will see a lower 6.9% annualized investment return over the next five to seven years. On a 30-year basis, NEPC is more optimistic, predicting an annualized return of 8%.

A video stream of the board’s meeting on Nov. 14 and agenda material shows that the system’s actuary, Cheiron, recommended the system’s board take one of three options on the rate of return assumption: cutting it to 7%, 7.25%, or 7.4%.

A Cheiron analysis shows that the median return expectations of all California public pension plans over the next three decades was 7.2%, with four plans below 7%. The lowest plan had a 6.75% rate of return. Cheiron said while the San Francisco system has the highest projected rate of return in California, 7.5% was in line with the median national US average of 7.5%.

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The largest US pension plans, the $361.1 billion California Public Employees’ Retirement System (CalPERS) and the $320 billion California State Teachers’ Retirement System (CalSTRS), each have dropped their assumed rate of return to 7% from 7.5%.

Cheiron projects that the action taken by SFERS, cutting the rate of return by one-tenth of 1%, reduces the pension system funding level to 86% from 87% and increases the unfunded liability to $3.6 billion from $3.3 billion.

If the plan had cut its rate of return to 7.25%, the unfunded liability would have increased to $4.1 billion, an 85% funding level, and if it went down to 7%, the unfunded liability would have gone up to $4.9 billion, or an 82% funding level.

“Those are ugly numbers,” the system’s Executive Director Jay Huish told the board.

Huish said the mayor’s office had authorized him in meetings to tell the board that the city was comfortable with the reduction in the rate of return to 7.4%. Huish said he had briefed city officials on the rate of reduction cuts being considered. While the retirement system operates independently from the city, three of the seven members are appointed by the mayor, and a fourth member is appointed by the president of the board of supervisors.

Pension plan costs have a huge impact on the city of San Francisco.

Under the plan cutting the rate of return to 7.4%, the city’s cost per employee for pension benefits varies in different years over the next decade but is as much as 25% of salary per employee in 2021 to a low of 19.2% in 2024, shows a Cheiron analysis.

Each percentage point drop has an even greater impact. For example, if the rate of return had been cut to 7.25%, the city’s cost per employee over the next decade would have risen to a high of 26.1% in 2021 to a low of 21% in 2024, the Cheiron forecast shows.

If NEPC is right, and the pension system does not achieve its short-term return expectations, the system’s funding ratio would fall and SFERS might be forced to raise the contribution rate even higher. The Cheiron analysis does not examine the shortfall impacts on the pension plan’s unfunded liability if the annualized short-term rate of return falls below 7.4%

Cheiron data shows the pension plan has been unable to meet its return assumptions over the last 20 years. The actuarial firm said the annualized return for the pension system was 7.1% over that period compared to an expected assumed rate of return of 8.25%. Using a shorter five-year period, however, Cheiron noted that SFERS achieved on average a 9.4% return, higher than the expected rate of return. The pension plan has had a 7.5% expected rate of return since 2014, when it lowered the rate of return from 7.58%.

SFERS board member Joseph Driscoll, a fire captain, told the board that he favored the 7.4% rate of return before the unanimous vote approving it. He said public pension system critics, who have argued that a lower rate of return as practiced by corporate pension plans (often in the area of a 5% rate of return) were not realistic and that reduction would lead to a 40% to 45% contribution rate per employee for the city.

“We’re not going down that road,” Driscoll said, noting that “a realistic rate that is achievable is 7.4%.”

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