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, 2015

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, 2014. 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.

As discussed in the Management Discussion and Analysis (MDA) section of this report, a national recession 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 119,100 payroll positions, which is approximately 6 percent of Connecticut's labor force. Connecticut did not experience a consistent pattern of uninterrupted monthly growth in payroll employment until the final months of Fiscal Year 2014. The slow pace of economic growth experienced after the recession has held the average annual General Fund budget growth over the past five years to 2.5 percent. It also resulted in tax increases and other revenue enhancements.

A slower rate of economic expansion following recessions is becoming an established norm. Overall growth of the national economy has been moderating over the past several decades, and Connecticut's economy has been following that same slower growth trend. From 1950 through the mid-1980s, there were numerous double-digit periods of growth in U.S Gross Domestic Product (GDP). Since that time, there has been a gradual downward slope in the GDP rate of growth. Likewise, Connecticut's personal income and employment growth rates have been less robust over time.

This report devotes significant attention to the State's General Fund. The General Fund is the largest single governmental fund. This is the fund most often referred to in media reports about Connecticut's finances. About 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.

Fiscal Year 2014 ended with a General Fund surplus of $248.5 million on the budgetary accounting basis. The Fiscal Year 2014 budget contained appropriations for expenditure accruals to account for obligations of the fiscal year that were paid after the fiscal period had closed. Fiscal Year 2014 was the first year that appropriations had been made for accruals.

In accordance with State Law, the entire amount of the General Fund budget surplus was deposited to the State's Budget Reserve Fund. This brought the fund's reserve balance to $519.2 million, or about 3 percent of the General Fund budget. I have been a strong proponent of building these reserves. Current law allows up to ten percent of net General Fund appropriations to be deposited to the Budget Reserve Fund. I have advocated for a fifteen percent threshold. Proper reserve levels allow for budget stabilization during difficult fiscal times and avoid policy decisions that place additional downward pressures on a struggling economy.

Reaching the appropriate level of budget reserves is an attainable goal if fiscal discipline is exercised in surplus years. 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.

A complete discussion of Fiscal Year 2014 budget trends is contained in the MDA section of this report.

Major Policy Initiatives and Priorities

Transfer of Federal Portion of the Medicaid Program
In Fiscal Year 2014, the federal portion of the State administered Medicaid program moved from the General Fund to the Restricted Grants Fund. The Restricted Grants Fund accounts for the majority of federal dollars contributed to State programs. Connecticut's treatment of federal Medicaid dollars is now consistent with the practices followed in most other states. This change in accounting coincided with the Medicaid expansion under the Affordable Care Act (ACA) that was passed by Congress and signed into law by President Obama in March of 2010. The Connecticut ACA Medicaid expansion became effective in January of 2014. Through the expansion, additional adults without children qualified for Medicaid coverage. The income eligibility level for coverage in this population group increased from 56 percent to 138 percent of the federal poverty level.

The new accounting methodology transferred approximately $2 billion in expenditures and revenues related to the federal portion of the existing State Medicaid program from General Fund to the Restricted Grants Fund. Many of the numbers and trends presented in this report have been adjusted and footnoted within the presentation to reflect this transfer of funding. In addition to the movement of existing Medicaid dollars, the new ACA Medicaid eligible population is also accounted for within the Restricted Grants Fund.

Implementation of GAAP Budgeting
For the first time in Connecticut's budget history, the legal budget act for Fiscal Year 2014 contained line-item appropriations within budgeted funds for expenditure accruals. The accruals are payments made after the close of the fiscal year for obligations incurred during the fiscal year. The State payroll is one example. State employees work a number of days in June that are not paid until July. This has resulted in an extra bi-weekly payroll payment occurring once every ten fiscal years (27 payrolls rather than the normal 26). Funding the additional payroll in that tenth year has presented significant budget challenges. With this change, an accrual amount is now appropriated and reserved each fiscal year for that additional payment thus relieving the financial pressure in that tenth year when the extra payroll payment is distributed.

The negative unassigned fund balance in the General Fund, often referred to as the GAAP deficit, has been on an upward trend over time. The annual salary accruals and other expenditure accruals have been contributing to the growth in the GAAP deficit. This new budgetary approach is intended to mitigate the growth in the deficit.

In addition, in Fiscal Year 2014 the State Treasurer issued $598.5 million in GAAP deficit reduction bonds to lower the accumulated negative unassigned fund balance in the General Fund. The statements reflect this inflow of revenue to the General Fund in Fiscal Year 2014. There is also a current plan to begin annual amortization payments in Fiscal Year 2016 to address the remaining cumulative GAAP deficit.

It should be noted that there is no authoritative body that establishes GAAP budgeting standards. The GAAP standards applied to financial reporting are promulgated by the Governmental Accounting Standards Board (GASB). In their most recent statements on pension reporting, GASB noted that the methodology that they require for financial reporting of annual pension costs is likely to be too volatile to utilize for budget funding purposes. Accordingly, there will be occasions when budget amounts differ from GAAP financial reporting amounts contained in this report. The overriding policy objective of GAAP budgeting is to reduce and eventually eliminate the negative unassigned fund balance within the General Fund. It is left to the Governor and Legislature to formulate annual budgets that achieve that policy goal.

Open Connecticut
One of my primary objectives in my role as State Comptroller has been to open the State's financial records to the public. This has been an evolving effort that is now realized in an online financial data hub called Open Connecticut located at osc.ct.gov/openct. The site allows users to search real-time State spending by fiscal year, fund, function of government, agency, department, line-item and account. All State receipts can also be tracked by source.

The site features drop down filters, year-over-year trend analysis tabs, graphics that permit data drilldown and many other analytics. Data can be exported and users can share their analysis by creating a prompted link to e-mail or social media.

Creating this type of comprehensive access to the State's finances is not a static process. Continual upgrades and enhancement to data will be implemented overtime. This will provide academics, researchers, journalists, and the general public the information necessary to influence policy in Connecticut.

Independent Auditor Opinions

As a Connecticut Constitutional Officer, the State Comptroller is responsible for setting state-wide 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 skylines, 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 3,596,667 in 2014 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. Note 1 of this report contains detailed information on the reporting entity.

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 substantial 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

In December 2014, Connecticut entered the 58th month of recovery following the March 2008 thru February 2010 recession. With a recessionary job loss of 119,100 payroll positions, Connecticut's budget came under significant pressure as demand for support services grew and revenue fell. The State did not begin to experience a consistent pattern of job growth until February of 2014. This resulted in many challenging years of budget formulation under Connecticut's balanced budget requirements.

As the State began to emerge from the recession, job growth was extremely erratic with one month's gains quickly eroded by losses the next month. Initially the strongest job gains were experienced in the education and health services sector, which employees approximately 300,000 residents. The health care and social assistance components of the sector contributed the largest additions. The most significant percentage job losses were in the construction sector, which employs approximately 50,000 people in the state. As a consistent pattern of job growth gradually occurred, most employment sectors were experiencing growth. The only sector experiencing losses for the twelve month period ending in December of 2014 was financial services.

Paralleling the national economy, Connecticut has experienced stagnant wages and salaries throughout the recovery period. There are some very recent signals that growth in this area may be improving. Personal income in the State also appears to be rebounding. After declining 3.9 percent in 2009, annualized growth is now about 4 percent. This is still well off of the pre-recession growth rate, but positive growth rates have been posted in each of the past five years.

Connecticut's economy, along with the national economy, is steadily improving by most major indicators. When fully realized, the improving economic conditions will relieve some of the present pressures on the State budget.

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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