MANAGEMENT'S DISCUSSION AND ANALYSIS (MDA)

The following is a discussion and analysis of the State's financial performance and condition providing an overview of the State's activities for the fiscal year ended June 30, 2014. The information provided here should be read in conjunction with the letter of transmittal and in the basic financial statements.

FINANCIAL HIGHLIGHTS

Government-wide:
The primary government's liabilities and deferred inflows of resources exceeded assets and deferred outflows of resources by $12.6 billion (reported as net position deficit). Of this amount, $24.4 billion reported as unrestricted net position deficit while $11.8 billion is restricted for specific uses or invested in capital assets.

Net position deficit of governmental activities increased by $2.3 billion and net position of business-type activities increased by $462.0 million. Component units reported a decrease of $108.1 million from June 30, 2013.

Fund:
The governmental funds reported combined ending fund balance of $2.1 billion, an increase of $.1 million in comparison with the prior year. Of this total fund balance, $190.0 million represents nonspendable fund balance, $2.0 billion represents restricted fund balance, $635.6 million represents committed fund balance, and $28.6 million represents assigned fund balance. A negative $735.0 million unassigned fund balance offsets these amounts. This deficit, which belongs to the General Fund, decreased by $469.1 million during the fiscal year, due primarily to the issuance of GAAP conversion bonds in the amount of $598.5 million.

The State's stabilization account, the General Fund Budget Reserve Account (Rainy Day Fund) ended the fiscal year with a balance of $519.2 million.

The Enterprise funds reported net position of $4.8 billion at year-end, an increase of $462.0 million during the year, substantially all of which was invested in capital assets or restricted for specific purposes.

Long-Term Debt:
Total long-term debt was $32.4 billion for governmental activities at year-end, of which $20.8 billion was bonded debt.

Total long-term debt was $2.2 billion for business-type activities at year-end, of which $1.3 billion was bonded debt.

OVERVIEW OF THE FINANCIAL STATEMENTS

This discussion and analysis is an introduction to the State's basic financial statements. The State's basic financial statements comprise three components: 1) government-wide financial statements, 2) fund financial statements, and 3) notes to the financial statements. The report also contains other supplementary information to provide additional support to the basic financial statements.

Government-wide Financial Statements:
The government-wide financial statements are designed to provide readers with a broad overview of the State's finances, in a manner similar to a private-sector business. All revenues and expenses are recognized regardless of when cash is received or spent, and all assets, deferred outflows of resources, liabilities and deferred inflows of resources, including capital assets and long-term debt, are reported at the entity level. The government-wide statements report the State's net position and changes in net position. Over time, increases and decreases in net position measure whether the State's overall financial condition is getting better or worse. Non-financial factors such as the State's economic outlook, changes in its demographics, and the condition of capital assets and infrastructure should also be considered when evaluating the State's overall condition.

The statement of net position presents information on all of the State's assets and deferred outflows of resources, and liabilities and deferred inflows of resources with the difference between all reported as net position. Net position is displayed in three components - net investment in capital assets; restricted; and unrestricted.

The statement of activities presents information showing how the State's net position changed during fiscal year 2014. All changes in net position are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of the related cash flows. Thus, revenues and expenses are reported in this statement for some items that will result in cash flows in future fiscal periods (e.g., uncollected taxes and earned but unused vacation leave).

Both the Statement of Net Position and Statement of Activities report three separate activities. These activities are described as follows:

• Governmental Activities - The State's basic services fall under this activity including legislative, general government, regulation and protection, conservation and development, health and hospital, transportation, human services, education, corrections, and judicial. Taxes and intergovernmental revenues are major funding sources for these programs.
  
• Business-type Activities - The State operates certain activities much like private-sector companies by charging fees to cover all or most of the costs of providing goods and services. The major business-type activities of the State include the University of Connecticut and Health Center, State Universities, Connecticut Community Colleges, Employment Security Fund, and Clean Water Fund.
  
• Discretely Presented Component Units - A number of entities are legally separate from the State, yet the State remains financially accountable for them. The major component units of the State are Connecticut Housing Finance Authority, Connecticut Lottery Corporation, and Connecticut Airport Authority.

Fund Financial Statements:

A fund is a grouping of related accounts that is used to maintain control over resources that have been segregated for specific activities or objectives. The State uses fund accounting to ensure and demonstrate compliance with finance-related legal requirements. All of the funds of the State can be divided into three categories: governmental funds, proprietary funds, and fiduciary funds. Each of these categories uses different accounting approaches. Fund financial statements begin on page 36.

• Governmental Funds - Most of the State's basic services are accounted for in governmental funds and are essentially the same functions reported as governmental activities in the government-wide financial statements. Governmental funds use the modified accrual basis of accounting, which measures the flow of current financial resources that can be converted to cash and the balances left at year-end that are available for future spending. This short-term view of the State's financial position helps determine whether the State has sufficient resources to cover expenditures for its basic services in the near future.

Because the focus of governmental funds is narrower than that of the government-wide financial statements, it is useful to compare the information presented for governmental funds with similar information presented for governmental activities in the government-wide financial statements. By doing so, readers may better understand the long-term impact of the State's near-term financing decisions. Both the governmental fund balance sheet and the governmental fund statement of revenues, expenditures, and changes in fund balance provide a reconciliation to facilitate the comparison between governmental funds and governmental activities. These reconciliations are presented on the page immediately following each governmental fund financial statement.
 

The State reports five individual governmental funds. Information is presented separately in the governmental fund statements for the General Fund, Debt Service Fund, Transportation Fund, Restricted Grants and Accounts Fund, and Grants and Loan Programs Fund, all of which are considered major funds. Data from the other eighteen governmental funds is combined into a single, aggregated presentation. Individual fund data for each of these nonmajor governmental funds is provided in the combining statements immediately following the required supplementary information.

• Proprietary Funds - Proprietary funds include enterprise funds and internal service funds and account for activities that operate more like private-sector businesses and use the full accrual basis of accounting. Enterprise funds charge fees for services provided to outside customers. Enterprise funds are reported as business-type activities on the government-wide financial statements. Internal Service funds are an accounting device used to accumulate and allocate costs internally among the State's various functions. The State uses Internal Service funds to account for correction industries, information technology, and administrative services. Because these services predominately benefit governmental rather than business-type functions, they have been included within governmental activities in the government-wide financial statements.
  
  The State reports five individual proprietary funds. Information is presented separately in the proprietary fund statements for the University of Connecticut and Health Center, State Universities, Connecticut Community Colleges, Employment Security, and Clean Water all of which are considered major funds. Data from the other enterprise funds is combined into a single, aggregated presentation. Individual fund data for all nonmajor proprietary funds is provided in the combining statements immediately following the required supplementary information.
  
  
• Fiduciary Funds - Fiduciary funds account for resources held by the State in a trustee or agency capacity for others. Fiduciary funds are not included in the government-wide financial statements because the resources of those funds are not available to support the State's own programs. The accounting used for fiduciary funds is much like that used for proprietary funds. The State's fiduciary activities are reported in separate Statements of Fiduciary Net Position and Changes in Fiduciary Net Position.
  
  
• Component Units - The government-wide financial statements report information for all component units into a single, aggregated presentation. Information is provided separately in the component unit fund statements for the Connecticut Housing Finance Authority, Connecticut Lottery, and Connecticut Airport Authority. Data from the other component units is combined into a single, aggregated presentation. Individual fund data for all other nonmajor component units is provided in the combining statements immediately following the required supplementary information.

Notes to the Financial Statements

The notes to the financial statements provide additional information that is essential to a full understanding of the data provided in the government-wide and fund financial statements. The notes to the financial statements can be found immediately following the component unit fund financial statements.

Required Supplementary Information

The basic financial statements are followed by a section of required supplementary information. This section includes information regarding the State's funding progress and employer contributions for pension and other postemployment benefits, and change in employers' net pension liability.

Other Information

The combining financial statements for the State's nonmajor governmental, nonmajor enterprise, nonmajor fiduciary funds, and nonmajor discretely presented component units. This also includes the statistical section, which provides up to ten years of financial, economic, and demographic information.

FINANCIAL ANALYSIS OF THE GOVERNMENT AS A WHOLE

NET POSITION
The combined net position deficit of the State increased $1.8 billion or 16.9 percent. In comparison, last year the combined net position deficit decreased $10.5 billion or 1.0 percent.

State Of Connecticut's Net Position
(Expressed in Millions)

*Restated for comparative purposes

The net position deficit of the State's governmental activities increased $2.3 billion (15.1 percent) to $17.4 billion during the current fiscal year. Of this amount, $5.8 billion was invested in capital assets (buildings, roads, bridges, etc.) and $1.8 billion was restricted for specific purposes, resulting in an unrestricted net position deficit of $24.9 billion. This deficit is the result of having long-term obligations that are greater than currently available resources. The State has recorded the following outstanding long-term obligations which contributed to the deficit; a) general obligation bonds issued in the amount of $6.5 billion to finance various municipal grant programs (e.g., school construction) and $2.3 billion issued to finance a contribution to a pension trust fund, and b) other long-term obligations in the amount of $11.6 billion, which are partially funded or not funded by the State (e.g., net pension and OPEB obligations and compensated absences).

Net position of the State's business-type activities increased $462 million (10.7 percent) to $4.8 billion during the current fiscal year. Of this amount, $3.2 billion was invested in capital assets and $1.0 billion was restricted for specific purposes, resulting in unrestricted net positions of $0.5 billion. These resources cannot be used to make up for the net position deficit of the State's governmental activities. The State can only use these net positions to finance the ongoing operations of its Enterprise funds (such as the University of Connecticut and Health Center and others).

CHANGE IN NET POSITION

Changes in net position for the years ended June 30, 2014 and 2013 were as follows:

State of Connecticut's Changes in Net Position
(Expressed in Millions)

*Restated for comparative purposes

GOVERNMENTAL ACTIVITIES
The following graph is a representation of the Statement of Activities revenues for governmental activities. Governmental activities revenues increased by $485.6 million, or 2.0 percent. This increase is primarily due to an increase of $504.2 million from operating grants and contributions.

The following graph is a representation of the Statement of Activities expenses for governmental activities. Governmental activities expenses increased by $2.4 billion, or 10.2 percent. The increase is mainly attributable to increase spending in human services.

NET POSITION OF BUSINESS-TYPE ACTIVITIES
Net position of business-type activities increased by $462.0 million during the fiscal year. The following chart highlights the changes in net position for the major enterprise funds.

During the year, total revenues of business-type activities decreased 10.1 percent to $3.3 billion, while total expenses decreased 4.6 percent to $4.4 billion. In comparison, last year total revenues decreased 4.7 percent, while total expenses decreased 4.3 percent. The decrease in total expenses of $216 million was due mainly to a decrease in Employment Security expenses of $455.0 million or 30.0 percent. Although, total expenses exceeded total revenues by $1,086 million, this deficiency was reduced by transfers of $1,548 million, resulting in an increase in net position of $462.0 million.

FINANCIAL ANALYSIS OF THE STATE'S GOVERNMENTAL FUNDS

As of the end of the fiscal year, the State's governmental funds had fund balances of $2,097 million, an increase of $99 million over the prior year ending fund balances. Of the total governmental fund balances, $1,978 million represents fund balance that is considered restricted for specific purposes by external constrains or enabling legislation; $190 million represents fund balance that is non-spendable; $664 million represents fund balance that is committed or assigned for specific purposes. A negative $735 million unassigned fund balance offsets these amounts.

General Fund

The General Fund is the chief operating fund of the State. At the end of the fiscal year, the General Fund had a fund balance deficit of $41.2 million, a decrease of $547.4 million in comparison with the prior year. Of this total fund balance, $686 million represents non-spendable fund balance or committed for specific purposes, leaving a deficit of $727.2 million in unassigned fund balance.

At the end of fiscal year 2014, General Fund revenues were 13.6 percent, or $2,734.4 million, lower than fiscal year 2013 revenues. This change in revenue results from decreases of $2,873.5 million primarily attributable to taxes ($363.0 million), federal grants and aid ($2,493.9 million), and casino gaming payments ($16.6 million). These decreases were offset by increases of $139.1 million primarily attributable to licenses, permits, and fees ($65.0 million), lottery tickets ($7.4 million), charges for services ($4.2 million), fines, forfeits, and rents ($24.7 million), investment earnings ($2.9 million), and other revenue ($34.9 million).

At the end of fiscal year 2014, General Fund expenditures were 11.5 percent, or $2,147.1 million, lower than fiscal year 2013. This was primarily attributable to a decrease in human services of $2,610.2 million, offset by increases primarily in education, corrections, and judicial of $$238 million, $69.7 million, and $60.0 million, respectively. Net other financing sources and uses increased by $812.6 million, which is primarily due to the issuance bonds.

Debt Service Fund

At the end of fiscal year 2014, the Debt Service Fund had a fund balance of $659.5 million, all of which was restricted, a decrease of $.6 million in comparison with the prior year.

Transportation Fund

The State's Transportation Fund had a fund balance of $226.5 million at the end of fiscal 2014. Of this amount, $30.4 million was in nonspendable form and $196.1 million was restricted or committed for specific purposes. Fund balance increased by $1.8 million during the current fiscal year.

At the end of fiscal year 2014, Transportation Fund revenues and expenditures increased by $196.1, or 16.4 percent, and $30.4 million, or 3.7 percent respectively. The increased revenue is primarily due to an increase in taxes.

Restricted Grants and Accounts Fund

At the end of fiscal year 2014, the Restricted Grants and Accounts Fund had a fund balance of $45.7 million, all of which was restricted for specific purposes, a decrease of $313.4 million in comparison with the prior year.

Total revenues were 102.1 percent, or $2,832.3 million, higher than in fiscal year 2013. Overall, total expenditures were 104.4 percent, or $3,130.8 million, higher than fiscal year 2013. This is primarily attributable to the State transferring federal Medicaid spending from the General Fund to the Restricted Grants and Accounts fund.

Grant and Loan Programs

As of June 30, 2014, the Grant and Loan Programs Fund had a fund balance of $468.6 million, all of which was restricted for specific purposes, a decrease of $204.9 million in comparison with the prior year.

FINANCIAL ANALYSIS OF THE STATE'S PROPRIETARY FUNDS

Proprietary funds report activities of the State that are similar to for-profit business. Proprietary fund financial statements provide the same type of information as the government-wide financial statements, only in more detail. Accordingly, a discussion of the financial activities of the Proprietary funds is provided in that section.

FINANCIAL ANALYSIS OF THE STATE'S FIDUCIARY FUNDS

The State maintains Fiduciary funds for the assets of Pension and Other Employee Benefit Trust funds, an Investment Trust fund, and a Private-Purpose Trust fund. The net positions of the State's Fiduciary funds totaled $30.3 billion, an increase of $3.4 billion when compared to the prior year ending net position.

Budget Highlights-General Fund

The state budget as adopted for Fiscal Year 2014 was anticipating a small surplus of $4.4 million dollars on net General Fund appropriations of $17.2 billion. By the end of the fiscal year, a surplus of $248.5 million had emerged from operations. In accordance with state law, that surplus was deposited to the State's Budget Reserve Fund, which brought the total reserve balance in the fund to $519.2 million.

In Fiscal Year 2014, the federal portion of the State's Medicaid program transferred from the General Fund to the Restricted Grants Fund. This transfer reduced General Fund outlays for the fiscal year by approximately $2 billion. After adjusting for the impact of the elimination of federal Medicaid expenditures on trend analysis, General Fund spending increased at a rate of 2.4 percent over the prior fiscal year. In the four fiscal years leading up to the 2008 recession, General Fund spending had increased at an annual average rate of 7.3 percent. The recession resulted in the State simultaneously raising taxes and reducing growth in spending.

The General Fund payroll for State employees in Fiscal Year 2014 was $94.2 million below the actual dollar level reached in Fiscal Year 2009. Grant payments to other than towns experienced no spending growth in Fiscal Year 2014 over the prior fiscal year. This category includes most of the state's major human services programs. Grant payments going directly to towns increased by $128.3 million or 4.5 percent in Fiscal Year 2014. A majority of these dollars go to support education spending within the municipalities. The spending category referred to as non-functional (not directly assignable to state agency programs or functions of government) increased by $77.3 million in Fiscal Year 2014 or 2 percent from Fiscal Year 2013. Debt service, which is within the non-functional area, experienced a spending decline of $153.7 million or 8.5 percent. The decline results from favorable interest rates and the refinancing of 2009 Economic Recovery Notes. Other non-functional areas inclusive of fringe benefit programs posted spending growth of $231 million or 10.7 percent.

General Fund revenue in Fiscal Year 2014, again after adjusting for the Medicaid transfer, advanced by less than one percent over the prior fiscal year. The income tax, which is the General Fund's single largest source of revenue declined slightly in real dollar terms in Fiscal Year 2014 as compared to last fiscal year. A change in federal capital gains tax law contributed to the poor revenue generating performance of the income tax. The federal change shifted taxable gains from Fiscal Year 2014 into Fiscal Year 2013. The federal treatment of capital gains had a negative impact on receipts of both the income tax and estate and gift tax. Other revenue areas performed reasonably well and a tax amnesty program utilized to raise revenue in Fiscal Year 2014 was successful. The release of $190.8 million in dollars reserved from the prior fiscal year partially offset the weakness in revenue growth.

In Fiscal Year 2014, the adopted State budget contained appropriations for expenditure accruals. The lack of inclusion of these accruals within the budget is part of the reason that the unassigned fund balance within the General Fund had been growing overtime. In addition, in Fiscal Year 2014 the State Treasurer issued $598.5 million in GAAP deficit reduction bonds to reduce the General Fund's unassigned fund balance. Note 2 within this report provides a reconciliation of Fiscal Year 2014 General Fund operations for the statutory accounting basis and the accounting basis used within the fund financial statements in this report. Fiscal Year 2014 is the initial implementation year for the new budget approach to GAAP, as well as the year of the Medicaid transfer as discussed above. These factors result in some initial distortions in trend.

CAPITAL ASSETS AND DEBT ADMINISTRATION

Capital Assets

The State's investment in capital assets for its governmental and business-type activities as of June 30, 2014 totaled $16.3 billion (net of accumulated depreciation). This investment in capital assets includes land, buildings, improvements other than buildings, equipment, infrastructure, and construction in progress. The net increase in the State's investment in capital assets for the fiscal year was $815.8 million, due mainly to an increase in governmental activities' capital assets of $552.8 million or 4.6 percent.

Major capital asset events for governmental activities during the fiscal year include additions to buildings and equipment of $813.7 million and depreciation expense of $1,024.2 million.

The following table is a two-year comparison of the investment in capital assets presented for both governmental and business-type activities:

State of Connecticut's Capital Assets
(Net of Depreciation, in Millions)

*Restated for comparison purposes

Additional information on the State's capital assets can be found in Note 10 of this report.

Long-Term Debt - Bonded Debt

At the end of the current fiscal year, the State had total debt outstanding of $22.0 billion. Pursuant to various public and special acts, the State has authorized the issuance of the following types of debt: general obligation debt (payable from the General Fund), special tax obligation debt (payable from the Debt Service Fund), and revenue debt (payable from specific revenues of the Enterprise funds).

The following table is a two-year comparison of bonded debt presented for both governmental and business-type activities:

State of Connecticut's Bonded Debt (in millions)
General Obligation and Revenue Bonds

*Restated for comparative purposes

The State's total bonded debt increased by $1.6 million (7.4 percent) during the current fiscal year. This increase resulted mainly from an increase in general obligation bonds of $1.1 million.

Section 3-21 of the Connecticut General Statutes provides that the total amount of bonds, notes or other evidences of indebtedness payable from General Fund tax receipts authorized by the General Assembly but have not been issued and the total amount of such indebtedness which has been issued and remains outstanding shall not exceed 1.6 times the total estimated General Fund tax receipts of the State for the current fiscal year. In computing the indebtedness at any time, revenue anticipation notes, refunded indebtedness, bond anticipation notes, tax increment financing, budget deficit bonding, revenue bonding, balances in debt retirement funds and other indebtedness pursuant to certain provisions of the General Statutes shall be excluded from the calculation. As of December 2013, the State had a debt incurring margin of $4.5 billion.

Other Long-Term Debt
State of Connecticut Other Long - Term Debt (in Millions)

*Restated for comparative purposes

The State's other long-term obligations increased by $1.3 million (11.1 percent) during the fiscal year. This increase was due mainly to an increase in the net OPEB obligation (Governmental activities) of $1.1 million or 16.2 percent. Additional information on the State's long-term debt can be found in Notes 17 and 18 of this report.

Economic Outlook and Next Year's Budget

By the end of Fiscal Year 2014, the State had regained 60 percent of the 119,100 jobs that were lost during the 2008 recession. At the start of Fiscal Year 2014, the State was continuing to experience some employment losses; however, by the final quarter of the fiscal year Connecticut was posting consistent monthly job gains. As these gains continued, by December of 2014 the State had recovered over 80 percent of the recessionary employment loss. The state was adding jobs at a rate of 1,660 per month. Progress also continued in the State's unemployment rate. At the start of Fiscal Year 2014, Connecticut's unemployment rate was 7.9 percent. By December of 2014, the State's unemployment rate was 6.4 percent.

Fiscal Year 2014 began with Connecticut personal income growing at an annualized rate of just over 3 percent. By the third quarter of 2014, the annualized growth rate stood at 4 percent. This is still well below the average growth rate of 6.5 percent experienced during the pre-recession period. Wage and salary income in the State had been stagnant or declining throughout Fiscal Year 2014. By December 2014, there were some indications that wage and salary growth may be recovering.

Overall Connecticut like the national economy has been experiencing more modest periods of economic expansion then in past decades. From 1950 through the mid-1980s, there were numerous double-digit periods of volatile growth in U.S Gross Domestic Product (GDP). Since that time, there has been a gradual downward slope in the GDP rate of growth with lower variances between the highs and lows. Likewise, Connecticut's personal income and employment growth rates have been moderating over time. In Connecticut, as in many other states, these economic trends have resulted in higher tax rates and the imposition of tighter budget spending controls. Connecticut has kept its tax rates competitive with other states in the region.

Connecticut has continued to cope with these changing trends in its Fiscal Year 2015 budget. At present, the budget is undergoing appropriation reductions to ensure that it remains in balance.

CONTACTING THE STATE'S OFFICES OF FINANCIAL MANAGEMENT

This financial report is designed to provide our citizens, taxpayers, customers, investors, and creditors with a general overview of the State's finances and to demonstrate the State's accountability for the money it receives. If you have any questions about this report, please contact the State Comptroller's Office at 1-860-702-3350.

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