STATE OF CONNECTICUT OFFICE OF THE STATE COMPTROLLER
Kevin Lembo State Comptroller	55 ELM STREET HARTFORD, CONNECTICUT 06106-1775	Martha Carlson Deputy Comptroller

February 28, 2013

To the Citizens, Constitutional Executive Officers, and Members of the Legislative General Assembly of the State of Connecticut:

It is a privilege to present the State of Connecticut Comprehensive Annual Financial Report (CAFR) for the fiscal year ended June 30, 2012. This report was prepared in accordance with Generally Accepted Accounting Principles (GAAP) as prescribed by the Governmental Accounting Standards Board.

Even though much of this report must be written in a rather formal and technical manner, my office has endeavored to present the information in a way that will help readers without a financial background to understand the State's overall fiscal position.

The State's largest governmental fund is the General Fund. This is the fund most often referred to in media reports about Connecticut's finances. Over three-quarters of all governmental financial transactions relating to the cost of providing State services and the collection of revenues to pay for those services occur within the General Fund.

A national recession that officially commenced in December 2007 produced a pattern of job losses in Connecticut that began in the first half of 2008. These job losses persisted until the start of 2010 and claimed 117,500 payroll positions. By the close of Fiscal Year 2012, Connecticut had regained 33,400 jobs or just over 28 percent of recessionary loss. This is a slower pace of recovery than the State had experienced in past post-recession periods. Compared to similar points in recovery cycles, the State had added 10,000 fewer jobs by the end of Fiscal Year 2012 than it had during the past two recoveries. Since the 1980s, the pace of post-recession job additions has been slowing. The State budget for Fiscal Year 2012 anticipated a recovery closer to historical trends.

The budget for Fiscal Year 2012 was formulated and controlled using a modified cash method of accounting. This accounting method records spending at the time of payment, but certain types of revenue are recorded prior to cash receipt. On this accounting basis, the State ended Fiscal Year 2012 with a General Fund deficit of $143.5 million. It should be noted that commencing with Fiscal Year 2014, the Governor's budget is formulated on a GAAP or modified accrual basis of accounting. This is consistent with the accounting method used to prepare fund statements in this report. In accordance with GAAP standards, most revenues and expenditures are accrued for forty-five days after the close of the fiscal year. For Fiscal Year 2012, the General Fund posted an operating surplus of $212.1 million on a GAAP basis.

Both the modified cash based deficit and the GAAP based surplus represent around one percent of the total General Fund budget. The difference between the two numbers results from differences in when revenues and expenditures are recorded as explained above.

As the budget for Fiscal Year 2012 was being developed, it was projected that maintaining the existing level of state services and the existing revenue structure would produce a budget deficit in excess of $3 billion. In order to bring the budget back into balance, as required by law, savings initiatives and revenue enhancements were implemented. These efforts greatly improved the State's budget outlook.

One of the most significant cost cutting initiatives implemented to close the budget gap was the renegotiation of salary, health, pension and other related compensation with State employees. The administration estimated that total saving in excess of $700 million would be achieved in Fiscal Year 2012 with savings growing and accumulating in the out years. The agreement imposed a wage freeze for two years, capped salary levels used to calculate pensions, increased the pension reduction for early retirement, imposed a 3 percent contribution rate on active employees to fund retiree health care, lowered the minimum cost of living pension adjustment and implemented a Health Enhancement Program (HEP) designed to reduce health care costs by promoting preventative care and by more appropriately directing points of service delivery. Many other changes were included in the agreement. In addition to lowering annual budget costs, this agreement was expected to reduce long-term liabilities.

On the receipt side of the budget, policy changes to General Fund revenue were expected to generate approximately $1.4 billion in net additional collections for Fiscal Year 2012. These changes included a restructuring of the personal income tax that expanded the number of tax brackets from three to six. The top income tax rate was increased from 6.5 percent to 6.7 percent. The sales tax rate was increased from 6 percent to 6.35 percent with 0.1 percent reserved for municipal revenue sharing. Many products and services previously exempt from the sales tax became taxable. A 20 percent corporate surcharge was imposed on businesses with annual gross income of $100 million or more and a tax liability in excess of $250. The inheritance and estate tax exemption was lowered from $3.5 million to $2 million with an expansion of the 7.2 percent rate. Many other adjustments were also passed into law. The changes were implemented with special attention to keeping Connecticut's tax structure competitive with the tax provisions found in other states in the region.

An essential component of growing Connecticut's economy is ensuring budget stability. Stabilizing the budget requires building adequate reserves to meet requirements during economic downturns. Since 1990, the State has accumulated revenue windfalls (revenue in excess of budgeted spending) of over $5 billion. However, budget reserves never exceeded $1.4 billion. My office has a long history of advocating for the set-aside of revenue windfalls into reserve funds that can only be accessed in the event of an economic slowdown. This strategy will ensure that taxpayers are not burdened with additional State payments in difficult economic times, as has repeatedly occurred during past recessions.

Major Policy Initiatives and Priorities

A focus of the 2012 legislative session was education reform. The Fiscal Year 2012 budget included a $50 million increase in the $1.9 billion Education Cost Sharing program, which provides education grants to towns. This was the first funding increase in the program since 2008. The overall package that totaled in excess of $100 million, was heavily directed to the lowest performing school districts. The initiatives include an expansion in preschool enrollment, expanded reading programs, additional state funding for charter schools, a new evaluation process for teachers and supervised school tum around plans.

In other areas, controlling rising health care costs has been a long-standing State priority. This has been a national issue as well with annual cost increases exceeding 8 percent. The Fiscal Year 2012 budget included several initiatives to control costs in the Medicaid program. Medicaid is the State's largest single program with outlays in excess of $4.7 billion in Fiscal Year 2012. The budget reductions included eliminating a scheduled rate increase for nursing homes, a reduction in the personal needs allowance for nursing home residents, reductions to spousal asset exemptions, a reduction in non-emergency dental coverage, reduced funding for emergency transportation services, creation of an alternative benefit package for low income adults, improved care utilization management and numerous other changes.

My office in partnership with labor and management has had success in controlling costs in the State employees' and retiree health plans. Health care premiums did not increase in medical, pharmacy and dental plans for Fiscal Year 2013. Several factors have contributed to this success: Increased utilization of primary care physicians following the implementation of the Patient­Centered Medical Home (PCMH) initiative and HEP, both designed to ensure that state employees and retirees receive better oversight by their primary care physicians and regular preventive care and screenings; Lower emergency room visits as a result of this better primary care coordination and through HEP's co-pay structure that seeks to stop unnecessary emergency room admissions; And, pharmacy initiatives that have reduced prescription drug costs and increased federal support.

Various environmental reforms were also passed into law. Following Tropical Storm Irene anti­flood programs and efforts to mitigate shoreline erosion were implemented. Grants were made available from the Clean Water Fund to promote phosphorus mitigation and bring the State into compliance with federal standards. Lastly, requirements were tightened to ensure that the State's goals for open space were measured and controlled.

Independent Auditor Opinions

As a Connecticut Constitutional Officer, the State Comptroller is responsible for setting state­wide accounting practices. Ultimate responsibility for the accuracy, completeness, and fairness of data presented in this CAFR, including all disclosures, rests with the State of Connecticut and my office. Connecticut statutes require an annual audit of the State's basic financial statements. These include statements prepared on the budgetary basis of accounting as well as statements prepared using GAAP. The State is also required to undergo an annual "single audit" for reporting to the Federal government. To meet all of these requirements, the State Auditors of Public Accounts have examined our financial statements and the appropriate supporting documentation.

The State auditors gave the CAFR for the State of Connecticut a "clean" opinion indicating they can state, without reservation, that the financial statements are fairly presented in all material respects in conformity with GAAP.

Profile of the Government and its Safeguards

The Nutmeg State

Connecticut became the fifth state of the United States on January 9, 1788. Its borders encompass 5,009 square miles. Within its compact borders, Connecticut has forested hills, urban sk:ylines, shoreline beaches, and historic village greens. Connecticut is a thriving center of business as well as a vacation location. It is both a New England State, and suburban to New York City. The population of Connecticut was 3,590,347 in 2012 according to U.S. Census estimates. Five large cities, Bridgeport, New Haven, Hartford (the State Capitol since 1875), Stamford and Waterbury, have populations in excess of 100,000 residents.

State Government

Separation-of-Powers provisions of the State Constitution established the three branches of State government: executive, legislative and judicial. The executive branch, which is responsible for enforcing state laws, consists of six state executive officers: Governor, Lieutenant Governor, Treasurer, Comptroller, Secretary of State and Attorney General. All are elected to four-year terms.

Connecticut's General Assembly or legislative branch is responsible for creating new laws and consists of a Senate and a House of Representatives. There are currently 36 State Senators and 151 State Representatives. Members of the General Assembly are elected to two-year terms. Connecticut also elects two U.S. Senators and five U.S. Representatives.

The Judicial Branch is responsible for interpreting and upholding our laws as consistent with the State Constitution and legal precedence. The Judicial Branch consists of three levels: The Supreme Court, the Appellate Court and, at the lowest level, the Superior Court which is further divided by state law into Civil, Criminal, Housing and Family Divisions. Judges of the Supreme Court, the Appellate Court and the Superior Court are nominated by the Governor from a list of candidates submitted by the Judicial Selection Commission and are confirmed by the General Assembly. They serve eight-year terms and are eligible for reappointment.

The Reporting Entity

The State of Connecticut financial reporting entity includes all of the funds of the primary government and of its component units. The primary government includes all funds, agencies, departments, bureaus, commissions, and component units that are considered an integral part of the State's legal entity. Component units are legally separate entities for which the primary government is financially accountable. Discretely presented component units are reported separately in the government-wide financial statements, to emphasize that they are legally separate from the primary government and to differentiate their financial position and results of operations from those of the primary government. Other component units, although legally separate entities have their financial position and operations blended with the primary government, essentially for technical reasons as explained more fully in the additional information on the reporting entity which is included in CAFR -Note 1, Summary of Significant Accounting Policies.

Internal Controls

Our State's internal control structure has been established to ensure that the assets of the government are protected from loss, theft, or misuse, and to ensure that adequate accounting data are compiled to allow for the preparation of financial statements in accordance with GAAP and State legal requirements. The internal control structure is designed to provide reasonable, but not absolute, assurance that these objectives are met. The concept of reasonable assurance recognizes that: (1) the cost of a control should not exceed the benefits likely to be derived, and (2) the valuation of costs and benefits requires estimates and judgments by management.

Budgetary Controls

The State Legislature prepares a bi-annual budget that contains estimates of revenues and expenditures for the ensuing two fiscal years. This budget is the result of negotiations between the Governor and the Legislature. Adjustments, in the form of budget revisions, executive orders, and financial legislation agreed to by the Governor and the Legislature, are made to the annual appropriations throughout the fiscal year. Budgetary controls are maintained at the individual appropriation account level by agency and fund as established in authorized appropriation bills. The objective of these controls is to ensure compliance with state laws embodied in the appropriations. The State Comptroller is statutorily responsible for control structures to safeguard revenues due the primary government, to determine the amount equitably due with respect to claims made and to ensure such expenditures are compliant with an appropriation contained in the budget for such purpose.

Budgeted appropriations are the expenditure authorizations that allow state agencies to purchase or create liabilities for goods and services. Before an agency can utilize funds appropriated for a particular purpose, such funds must be allotted for the specific purpose by the Governor and encumbered by the Comptroller upon request by the agency. Such funds can then be expended by the Treasurer only upon a warrant, draft or order of the Comptroller drawn at the request of the responsible agency. The allotment process, which includes limits on the power of the Governor to modify appropriations, preserves expenditure controls over special revenue, enterprise, and internal service funds and capital projects that are not budgeted as part of the annual appropriation act as revised.

The Spending Cap

In November 1992, electors approved an amendment to the State Constitution providing that the amount of budgeted expenditures authorized for any fiscal year shall not exceed the estimated amount of revenue for such fiscal year. This amendment thus provided a framework for placing a cap on budgeted appropriations.

Annual budgeted appropriations are capped at a percentage increase that is based on either the five-year average annual growth in the State's personal income or annual inflation, whichever is higher. Debt service payments, certain statutory grants to distressed municipalities, and appropriations required by federal mandate or court order are excluded from the limits of the cap.
The spending cap can be lifted if the Governor declares the existence of extraordinary circumstances and the General Assembly by three-fifths vote approves appropriations in excess of the cap. This has occurred in almost every year that the State has posted a budget surplus in the General Fund to enable the appropriation of surplus dollars that would have otherwise gone to reduce state debt and fill the rainy day fund.

Economic Condition and Outlook

The national economy as measured by real GDP grew at a moderate rate of just over 2 percent on an averaged quarterly basis during Fiscal Year 2012. Growth slowed during the first half of Fiscal Year 2013.

Connecticut added 7,300 payroll jobs in Fiscal Year 2012. This compares to 12,500 job additions in Fiscal Year 2011. The State's unemployment rate peaked at 9.4 percent in August of2010. The unemployment rate was 8.1 percent at the close of Fiscal Year 2012. During the fiscal year, the State's strongest employment sector was education and health services with the addition of 11,700 payroll jobs, followed by transportation and public utilities with 3,000 job additions. The most significant job losses were in the government and financial activities sectors down 3,000 jobs and 4,400 jobs respectively.

At the close of Fiscal Year 2012, Connecticut's personal income was growing at a rate of2 percent measured against the same period one year earlier. During that same time period wage and salary income grew at about the same rate.

Nationally, retail sales were expanding at a 3.5 percent rate at the close of Fiscal Year 2012. Connecticut's sales tax receipts were up 14.2 percent over the prior fiscal year due primarily to an expansion of taxable categories. Connecticut's strong export sector closed Fiscal Year 2012 up almost 17 percent from the close of the prior year.

The housing market in the Northeast continued a slow recovery with existing home sales at the close of Fiscal Year 2012 advancing 1.9 percent from a year ago with prices up 1.8 percent.

Acknowledgements

I want to thank my staff, the State Auditors, and all of the agency personnel and others who contributed to producing this report. I also want to thank its readers who bring meaning to the work that we do.

Sincerely,

Kevin Lembo
Connecticut State Comptroller

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