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July 20, 2015 SILVER TSUNAMI

CT urged to get fiscal house in order before health, social costs skyrocket

HBJ Illustration | C!
Peter Gioia, economist, Connecticut Business & Industry Association

Connecticut has a $47.2 billion unfunded obligation to its retiring state workers.

If those costs and more aren't reconciled over the next 20 years, state government — without significant economic growth — will have to raise more taxes or slash services to pay for all the expected and unexpected health and social costs that come with an aging and retiring population, particularly among the private workforce.

“It is safe to assume that we, the state government, need to get our financial house in order because there is going to be demand placed on our services, some anticipated and some unanticipated, that have the potential to be very big,” said State Comptroller Kevin Lembo.

As demonstrated this past legislative session, the state budget already is strained, as Gov. Dannel P. Malloy and the Connecticut General Assembly had to raise taxes by $1.3 billion — the second largest tax increase in the state's history — mostly just to maintain the status quo on spending, Lembo said.

The budget, however, is completely unprepared for significant increases in program demands — such as health care and food and housing assistance — that are likely to accompany significant workforce retirements and an aging population, Lembo said.

“We have to start living within our means, and we aren't there yet,” said Donald Klepper-Smith, a New Haven economist. “There is every indication that we are a state that doesn't have a revenue problem. We are a state with a spending problem.”

Shrinking workforce

In the next 10 years, 35 percent of Connecticut's population will be aged 55 years or older, according to the Connecticut Economic Resource Center.

At the same time, the size of Connecticut's workforce is shrinking. A report by New York City business researcher The Conference Board said the state's working population will shrink 3.3 percent in the next 15 years, factoring in retirements, births, emigration and immigration.

That's problematic because the workforce powers the economic engine that funds the state budget and pays for social services for those too young or too old to work, Klepper-Smith said.

In the next 15 years, the size of Connecticut's nonworking population (those aged under 18 and over 65) will be nearly equal to its working population, Klepper-Smith said.

“If we end up having an outmigration of young workers because they don't see Connecticut as a good place for them, then we have an even bigger problem,” said Peter Gioia, economist for the Connecticut Business & Industry Association.

A $47B repayment plan

One major expense directly related to the aging workforce that Connecticut must get under control before the mass retirements start is its obligations to state employees, particularly for pensions and other postemployment benefits (OPEB) like health care.

Connecticut is the third worst state in the nation for its unfunded pension liability, behind only Kentucky and Illinois, according to Standard & Poor's Rating Services. Connecticut has funded 49 percent of what it needs to fully pay the pensions of its current and retired employees, leaving a $25.2 billion liability on top of what it owes to stay current every year.

The large unfunded liability was the result of the state for years paying less than what it needed to stay current. Since becoming governor, Malloy has prioritized getting the pension system fully funded, developing a 20-year plan to drastically increase pension payments.

The state followed that plan for the last three fiscal years and will spend $1.5 billion in fiscal 2016 on its pension, 82 percent of which will help cover unfunded obligations.

If the state can stay the course over the next 17 years on Malloy's repayment plan, the annual pension payment will drop from roughly $1.5 billion today to $275 million.

That would give state government more than $1 billion extra each fiscal year to deal with the rising needs of an aging population.

“Paying off the pension will help with long-term issues. The alternative of not doing that is pretty damaging,” Gioia said.

State health benefits

Connecticut's other obligation to its state workers — OPEB, which is mostly healthcare costs — is underfunded by $22 billion, according to Standard & Poor's. That is nearly 10 times worse than the national median of $2.7 billion in unfunded OPEB liabilities.

OPEB costs can be harder to predict, Lembo said, and the state needs to be vigilant in keeping healthcare costs in check, including shaving $13 billion off that obligation by keeping people healthier and creating a trust that all employees pay into.

The unfunded OPEB liability could increase dramatically, though, Lembo said, if the state decides to offer early retirements again, as it did for about 4,700 workers in 2009 and again in 2011 for a much smaller number under Malloy.

Early retirements put workers into the OPEB system at a much younger age, meaning the state is paying for their medical benefits longer until they reach age 65, when Medicare takes over as the primary insurer.

“We need to stop doing early retirements. It doesn't save money,” Lembo said.

Unfunded costs

Having a $47.2 billion unfunded liability costs Connecticut in indirect ways too. The state, for example, has less money to invest and get a return on.

In fiscal 2014, State Treasurer Denise Nappier was able to grow the State Employees' Retirement Fund 15.6 percent through various investments. Combined with the teachers' retirement fund, that growth equated to an extra $3 billion. If the state pension system had been fully funded — instead of 49 percent funded — those investment gains would have been more than double.

Substantial unfunded pension and OPEB obligations also put downward pressure on the state's credit ratings. S&P in June gave Connecticut's “AA” rating a negative outlook based on its debt overhang.

Those credit ratings influence interest rates the state pays on borrowed money for major capital projects like road improvements.

“The good news is Connecticut has moved to fully fund its [pension system],” said David Hitchcock, Standard & Poor's primary analyst for the state of Connecticut. “If they continue to make their full [annual payments], then they will meet all their obligations at some point in time.”

Expected, unexpected expenses

The short- and long-term burdens placed on the state budget by Baby Boomer retirements are impossible to nail down exactly, said Gian-Carl Casa, spokesman for the Office of Policy & Management, because it's difficult to forecast how much of the general population will stay in the state once the mass retirements begin and how much state revenues will change as the Connecticut economy adjusts to a younger workforce.

Some expenses like health care and the cost to the Medicaid system are easier to nail down, although they can be somewhat fluid. The state is working to mitigate the expected rise of its $1.6 billion in annual payments for long-term, nursing home care — whose patient population is anticipated to grow 26 percent over 10 years — by advocating for more home care.

An aging workforce will also create increased demands on transportation, housing and food assistance, and technological infrastructure, further constraining the state budget.

Meanwhile, unlike state workers who receive a pension, the majority of the general population will rely on their 401(k) plans and other investments to fund their retirements, Lembo said.

In Connecticut, 41 percent of full-time employees don't have a retirement plan, so it is reasonable to assume a similar percentage of the retiring workforce won't be ready for retirement expenses, which could shift the burden onto government, Lembo said.

“If they are financially unprepared, that has the potential to whiplash back on government, both state and federal,” Lembo said.

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