State Employees Retirement System (SERS)

Connecticut's State Employees Retirement System (SERS), the State's largest retirement system, is a "defined benefit plan" administered by the State Employees Retirement Commission. A defined benefit plan means, upon retirement, an eligible member participating in SERS will receive a fixed pension benefit that is determined by — among other factors — the number of years the individual worked for the State of Connecticut and the individual's final average salary. SERS is funded with contributions from the State and employees, plus any investment returns (or minus any losses) generated by the system's assets.

Although SERS began providing retirement benefits to its members in 1939, the State adopted a "pay-as-you-go" approach to the system for much of SERS' history and inadequately saved for retirement benefits promised to state employees. Instead of "pre-funding," or contributing to an employee's pension benefits from the beginning and entirety of his/her employment, the State of Connecticut paid pension benefits to retired SERS members as they came due through annual appropriations.

As a result of this practice, and several other critical factors, SERS has accumulated more than $21.7 billion in unfunded liabilities and currently has the third-lowest funded ratio (35.5 percent) of any state pension system in the nation. A pension system's funded ratio refers to the percentage of total assets in a system to pay for future payments to retirees and current employees.

This unfunded liability exists despite the cost of benefits to SERS members being below the national average. In fact, in fiscal year 2016, benefits earned by current SERS members amounted to $449.3 million. In comparison, the State paid $1.3 billion in interest in fiscal year 2016 in order to be able to gradually pay off its unfunded liabilities over time.

Four factors have primarily driven SERS' unfunded liability problems:

1. Years of No State Contributions
Prior to 1971, future retirement benefits for SERS members were completely unfunded by the State of Connecticut with the State only paying for retirees' benefits as they came due. When the State did begin pre-funding SERS in 1971, it had an unfunded liability of $712 million (284 percent of the total payroll of SERS' members). That unfunded liability has grown substantially over the years (currently $21.7 billion or 583 percent of SERS' payroll) and is still being impacted by the State's years of no contributions to SERS. More than $5.2 billion (35 percent) of SERS' total unfunded liability in fiscal year 2014 was attributable to the State not contributing to the pension system for 30 years.

2. State Contributions Often Fell Short
Once the State did begin making contributions to SERS, it often did not make its full annually required contribution (ARC). Beginning in 1972 with a contribution of 30 percent of its ARC, the State was required to gradually increased the portion of its ARC that it would contribute to SERS until 1985 when the State was expected to make its full contribution. While the State paid the full ARC for the first few years, it repeatedly fell short of paying the full ARC throughout the 1990s, primarily as a result of agreements with the State Employees Bargaining Agent Coalition (SEBAC), which allowed for the lower than required payments. While the State has made its full ARC every year since fiscal year 2013, its underfunded contributions added $3.2 billion to SERS' total unfunded liabilities by fiscal year 2014, roughly $2 billion of which were "a direct result of SEBAC agreements and other negotiated reductions." 

3. Assumed Returns Have Been Overly Optimistic in Recent Years
SERS' unfunded liability has also increased over the years as a result of investments made with SERS pension funds have not met their assumed rates of return. Prior to fiscal year 2001, investments made with SERS pension funds regularly produced return rates higher than the system's assumed rate of 8.5 percent. During this time, SERS' averaged an annual actual rate of return of 11.3 percent — 2.8 percentage points higher than its assumed rate. These higher than assumed rates of return lowered SERS' unfunded liabilities. However, since that time, SERS' annual actual rate of return has fallen short of its assumed rate five times, and its average actual rate of return has been 5.4 percent. As a result of these return shortfalls, SERS' unfunded liabilities have increased by billions of dollars. Although SERS' assumed rate of return has been lowered three times in the past 10 years (8.25 percent in 2008; 8.0 percent in 2012; and 6.9 percent in 2016) the current assumed rate of 6.9 percent is still significantly higher than the three or four percent assumed rate that many in academia and the financial sector argue is more realistic since the Great Recession.

4. Poor Actuarial Experience and Deviations in Retirement Patterns
When projecting how much money will be going in and out of a pension system such as SERS, certain assumptions (such as retirement rates, retirement ages, life expectancies, etc.) are taken into consideration in order to estimate a pension system's ARC and unfunded liabilities. Although these assumptions are not precise, they are expected to be "generally accurate over the long term." However, this has not been the case with SERS. Poor actuarial experience (the difference between the assumptions used to estimate SERS' ARC and unfunded liabilities and what actually happened) has accounted for more than $4 billion in unfunded SERS liabilities since 1985. A primary reason for this difference is the early retirement incentive programs (ERIPs) that the State used to help address budget crises in 1989, 1992, 1997, 2003, and 2009. Although the ERIPs helped improve the immediate budget picture in those years by reducing payroll costs, they added to SERS’ unfunded liabilities by "allowing retiring employees to collect benefits sooner, and for a longer duration, than had been anticipated while simultaneously reducing the number of years over which the employees and the State pre-funded their benefits."

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