State Employee Pension Oversight and Reform: What’s Next?
State Treasurer Erick Russell and political commentator and former Senate Minority Leader John McKinney discussed the impact the state employee retirement system has on taxpayers and Connecticut’s economy and the opportunities for reform with Chris Davis, CBIA’s head of public policy, at the Jan. 18 Economic Summit + Outlook.
The following is an abridged transcript of that discussion, edited for length and clarity.
Chris Davis: Treasurer Russell, this month marks your first year in office—it’s certainly been a busy one.
Erick Russell: There’s a lot that we’ve gotten done in a year, I can’t believe that the year’s flown by as quickly as it has. One of the top highlights is our overall commitment to fiscal health as a state.
We heard the governor talk about this, but the real bipartisan commitment and culture that’s been developed around addressing some of the long standing issues that we’ve had—that we’ve kind of kicked down the road for many years—we are finally in a spot where we are fully funding our pensions, we’re making these additional contributions, we have a full rainy day fund, we’re set up to withstand volatility or a downturn in the market.
And we’ve seen the impact of this. My office manages all of our credit rating relationships with rating agencies, we’ve seen several upgrades there, which are allowing us to continue to invest in our communities in the state, at the lowest cost to taxpayers.
And so I’m proud of that commitment for us as a state, to what I would say our investment performance, but really the strides that we’re making for long-term performance.
Davis: During your first year, a Yale research report documented a series of issues with the management of Connecticut’s state employee pension investments, issues the authors say cost the pension fund as much as $27 billion over a decade.
Those issues predate you and you’ve acknowledged they needed attention. The Yale report noted that many previous decisions—and I quote—“are now smartly being unwound by current leadership.”
How are you addressing those issues and how does pension performance impact the lives of Connecticut residents and businesses?
Russell: I appreciate you bringing it up. What is really important about the study, not only in showing opportunity for us to improve performance, but also bringing attention to this work and the importance of investment returns and the impact it has for pensioners and for taxpayers across the state.
We came in fully aware of some of these challenges, not necessarily looking at it from a historical perspective, but looking at opportunity moving forward. And so we hit the ground running with a strategic asset allocation study. We have a five-year pacing plan that we are working at hitting targets to align with that new asset allocation.
The second would be legislation. So one of our first pieces of legislation was to strengthen the Investment Advisory Council—essentially our oversight board. They are responsible for setting our asset allocation and high-level investment strategy. This new legislation was really aimed at making sure we can attract, and have appointed the best investment talent that we can get.
We obviously have a host of talent here in Connecticut. But the way the statutes were set up historically essentially prevented anyone who’s in the investment or financial industry from actually serving on the IAC, because of concerns around conflicts. We were able to change that legislation with the goal of really strengthening the IAC.
The second piece of that legislation was around recruitment and retention, to make sure we can attract and retain top tier investment talent, that we could be competitive in the market from a compensation standpoint, and that we could also build out ladders within the organization so people could work their way up.
Lastly, I would say it’s just being more efficient. We are again streamlining in areas that we’ve been able to eliminate managers or have more passive investments, which is lowering costs and fees. And so you know, we’re doing a lot of work in this first year, there’s obviously still plenty of work to do. But I think what’s great is that we’re starting to see many of these changes that we’re putting in place actually have a positive benefit on returns already.
Davis: To your point, just in this first year, your benchmark is a 6.9% return, and you hit 8.5% after some of the changes that you’ve made.
Russell: To put that in perspective, we performed in the top 25% of public pension funds across the country. I think that’s a good indicator, right?
At times, we could be the top performing pension fund, and we could be at a 3% return. And so our 6.9% target is not on an annual cycle, it’s over a market cycle. And as long-term investors, that’s really what our focus is.
Davis: Senator McKinney, you spent a lot of time when you were in the Senate working on the Connecticut’s unfunded pension liability issue. The comptroller just came out with a report that we’re about 51% funded now, which is a great change from when your time in the Senate when underfunding was in the high 70s. But we still face a big challenge, with unfunded liabilities at more than $60 billion.
John McKinney: I was first elected in 1998 and to be honest, I was less than successful on trying to get people to focus on our pension debt. And it really wasn’t until the fiscal guardrails in the bipartisan budget were implemented in 2017 that Connecticut said, “we are going to take money and we’re going to pay down our debt.”
We have a good budget, it’s balanced. A lot of other states are seeing deficits now. We’re not in large part because of those guardrails. The guardrails have taken away the annual urge of politicians to spend.
We were at 36% of our pension funding around 2016-2017. We’re now over 50%. We’re still 48th in the country, and the average is 78% nationally. We cannot change those guardrails until we get much closer to that average of 78%.
“My message is not a sexy one for people running for election, but ‘it’s what we’ve been doing is working and we need to continue doing it.'”
Former state senator John McKinney
And we are contractually obligated to make these pension payments to our retirees. There isn’t any getting out of it in the future. And I think people think, well, you know, maybe we just don’t have the money. We don’t have to pay it. No, that’s not the case. That’s not the State Employees Bargaining Agent Coalition agreement. That’s not what the contract is. So a lot more of what we’ve been doing over the last three, four years we need to continue to do.
There’s always going to be an urge to spend more money, there’s always going to be a need that is not fully met in the state of Connecticut. And even if we were to see the legislature raise taxes, increase spending, go to the spending cap, there’s still going to be people saying we haven’t raised enough revenue because we still need to spend more money.
So my message is not a sexy one for people running for election, but “it’s what we’ve been doing is working and we need to continue doing it.”
Davis: The SEBAC agreement expires in just a few short years, in 2027. And so people are already starting to think about, what does the future look like of that agreement?
McKinney: Guess what’s happening before the SEBAC deal expires? There’s an election in 2026. Will Gov. Lamont try to sit down with state employees to maybe renegotiate that before the election? I don’t know I would advise him to take a look at it. I’m not sure the state employees are going to want to do that.
But my message to all of you as that comes, is don’t blame the unions. Don’t blame the negotiators for whatever they ask for.
We just learned that the 2017 deal saved $5.4 billion roughly and the comptroller’s report said that was $500 million less than promised. No surprise, we never thought it was going to get everything that they said. You need to talk to your legislators about it.
It wasn’t until the bipartisan budget reforms that we actually voted on union contracts. Many people don’t know that we never voted on them in the legislature. If you didn’t vote, they were deemed approved. So we never voted. Now there’s a commitment to vote on everything and legislators need to be held accountable for that vote.
Davis: The CREATES Report that the Lamont administration commissioned three years ago to improve services and reduce costs identified between $70 million and $100 million in taxpayer savings through a series of overtime and workplace reforms. What kind of impact would those recommendations have?
McKinney: There’s a lot of good stuff in there. And Connecticut for a long time has been far too slow to to advance technology within our government.
The other thing—and this has been an issue for me going back since when I first ran—and it’s a politically difficult issue, but we have tremendous nonprofit, private providers in the state of Connecticut. We as a state also provide a lot of services to people in need.
Our private nonprofit providers provide those services—I would argue every bit as well, if not better than the state for almost half the cost. And we just can’t get over that political battle, to release more of that work with the state helping the private nonprofits rather than the state doing it.
It always frustrated me when the state would compete with private industry, because we never leveled the playing field. We never lived by your hiring employment and other rules. And yet, we said we’re going to compete with you. I don’t think it works financially.
And I think that’s probably the area where we can make the biggest savings. It’s also the hardest one to achieve in a political environment.
Davis: Treasurer Russell, the Yale report identified recruitment and turnover in the treasurer’s office as a significant challenge. What’s your approach to identifying, recruiting, and retaining top-level talent?
Russell: The reality is that with a strong investment team, you’re going to perform well. The legislation has been really important to make sure that that we can be competitive from a salary perspective.
Again, we’re in a very competitive market. And what we found is that we were kind of below the median for compensation for investment professionals.
“We don’t want to be in a spot where we’re losing the investment talent that we want to other public pension funds.”
State Treasurer Erick Russell
And when you’re in as competitive of a market, as Connecticut is with New York and Boston, we’re not looking to set the market.
But we don’t want to be in a spot where we’re losing the investment talent that we want to other public pension funds. We obviously know that we can’t compete with the private sector.
We have a great team in place, we want to make sure that we continue to provide the support for the team that they need—understanding that keeping the right people in place over an extended period of time is really going to benefit pensioners and taxpayers in the state.
McKinney: This is one area that actually would, would give the treasurer more latitude. You know, we’re investing billions of dollars.
There’s tremendous talent in Connecticut. A CIO investing billions of dollars successfully is going to make a heck of a lot more money working for Goldman than they are for the state of Connecticut, we should actually be competing with them for that talent.
We make those exceptions. You know, we’re not paying Geno Auriemma $200,000 to be a state employee—we wouldn’t have a women’s basketball program. And that’s just the reality.
Davis: And to that point, you said you had some different thoughts on how the IAC could be structured. And I know in your time in the state legislature, you attempted numerous bills to try to make that happen.
McKinney: I came in [to the state Senate] in 1999 and one of the first bills we put in was to change the treasurer’s office from a sole fiduciary, to a co-fiduciary with a board of directors. I just didn’t think—with all due respect to Erick, it’s not about Erick—that any one person should be responsible for all of this money.
The bill didn’t go anywhere. And if you’re not going to get buy-in from the treasurer’s office, and from the majority party and legislature, bills aren’t going to go anywhere.
“I think that’s a structural problem. When we have a good treasurer, it isn’t a problem, but that’s not always the case.”
McKinney
When I became the Republican Leader, I had an appointment to the IAC. I had to find a retired investment professional, which wasn’t difficult. I represented towns in Fairfield County and I found a gentleman who was very eager to do it. And after about a year and a half, he sent me a 12-page letter of resignation explaining why he resigned.
And his examples all included that when the council unanimously made recommendations to the treasurer’s office, the treasurer did not accept that. That’s not how Erick is operating. I want to be clear that this is long before Erick. And that that became a frustration.
I think that’s a structural problem. When we have a good treasurer, it isn’t a problem, but that’s not always the case. So again, the reforms have been good. I personally think we could go a little bit farther, but I think we’re headed in a better direction now for sure.
Davis: Treasurer Russell, the Yale report caught a lot of people’s attention. And it was before your time and before these changes that you’ve made, but it has gotten people thinking about the structure of decisions being made in the treasurer’s office.
There will be a number of bills introduced by lawmakers from both parties this legislative session seeking to strengthen oversight of pension management. What’s your reaction to those proposals?
Russell: I don’t know the specifics of many of the things that have been proposed. I haven’t seen details yet. So I don’t know exactly what that looks like.
I would say first, there’s some misconceptions about the role of the IAC. And I’m curious to know, the topics or specifics around what recommendations are being made.
“The Investment Advisory Council has more teeth than people think.”
Russell
It’s important to note that this report now dates back several years, and it doesn’t account for many of the changes that have been made up to this point. I think the IAC has more teeth than people think.
If I felt that that was kind of the fix, I would be the first one to recommend it. We are making incredible strides, we’re performing well, a lot of the reforms that we were able to make in this short period of time would have taken us years if we actually had a board structure.
Davis: Let’s talk about what those changes mean for the state. When pension investments are up, that means essentially less money has to be allocated from the General Fund to meet those actuarial requirements. And what that does is opens up some ability to make investments in housing, education, childcare.
McKinney: We’ve freed up $600 million in the budget because we’re not having to make additional debt payments because we’re paying off our pension obligations.
There was a year—in 2007 or 2008—we had a huge budget deficit and the legislature actually borrowed money to pay the interest cost on the money we borrowed.
This is why I only voted for two budgets in 16 years. I see people laughing. It’s true. You don’t even have to make up stories in politics, the truth is actually pretty funny sometimes.
“In 2007 or 2008 we had a huge budget deficit and the legislature actually borrowed money to pay the interest cost on the money we borrowed.”
McKinney
The more we’re going to pay down our debt, the more freedom we’re going to have within our budget.
Everybody knows dealing with businesses, small or large, is you want stability and predictability. And even if it’s bad news, tell me what that bad news is going to be, how long it’s gonna last, and stick to it.
Most of you out there aren’t planning three months, the next election, you’re planning for a lot longer horizon, and the fiscal guardrails provide that long-term planning—that is not natural to politicians running for election every two years.
Russell: This is an important point. We talk about our pension debt. And we talk about performance. The reality is that we didn’t get here because of pension fund performance.
We’re in this spot because we went 70 years without properly funding our pensions. And we’re not going to dig ourselves out of this hole through pension fund performance, either.
This commitment—and again, which has happened on a bipartisan basis—as a state there’s been this culture now of doing what we’re supposed to do and not kicking the can down the road or passing obligations down on to future generations as has been done in the past.
“As a state there’s been this culture now of doing what we’re supposed to do and not kicking the can down the road.”
Russell
It’s going to take some time, but there is this steady commitment to making sure that we are righting the wrongs of the past.
And we talked about the billions that could have been saved from pension fund performance, looking in the rearview mirror, where there could have been a lot more money saved as if we actually paid our obligations along the way, rather than passing them off.
I commend the legislature for the unanimous votes to continue these fiscal guardrails, to continue to pass sound budgets, and make sure that we’re moving in the right direction long term.
Davis: Could you touch upon the importance of keeping those fiscal guardrails where they are? It’s a very big priority for our business community to make sure we have sustainability and predictability going into the future.
And as one of the authors of those fiscal guardrails, I take it very personally. We’re seeing and hearing conversations about perhaps changing how things are formulated, or maybe trying to go around them as much as possible.
McKinney: It’s absolutely on the table. I talked to some of my former colleagues who are still in the legislature, they clearly are having discussions about the numbers related to the volatility cap and other ways where they can free up to spend more money.
And I would just urge all of you to continue to support the guardrails and to continue to stay the course. The governor’s right, they passed a very good budget, they understood. And unlike so many other states, when the COVID money ran out, we still have a budget surplus, our budget is balanced, and a lot of other states aren’t.
If that’s not a success story, I don’t know what it is, and why would you want to mess with success?
Russell: I agree. The reforms that have been put in place have obviously been very successful. There is always going to be this need to balance our overall fiscal health and long-term future and addressing a lot of the wrongs of the past with making investments in people and addressing needs now.
One of the things that’s positive is we are now in the position as a state where we are operating from a position of strength, rather than jumping from crisis to crisis.
A lot of these reforms and things that we’ve done to make long-term changes have freed us up to be in a much better position as a state.
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