MANAGEMENT'S DISCUSSION AND ANALYSIS (MDA)

The following discussion and analysis is supplementary information required by the Governmental Accounting Standards Board (GASB), and is intended to provide an easily readable explanation of the information provided in the attached basic financial statements. It is by necessity highly summarized, and in order to gain a thorough understanding of the State's financial position, the financial statements and footnotes should be viewed in their entirety.

FINANCIAL HIGHLIGHTS

Government-wide:
As of June 30, 2006, the State had a total net asset deficit of $0.8 billion, an improvement in net assets of $588 million occurring this fiscal year. This improvement resulted from increases of $296 million and $292 million in the net assets of governmental activities and business-type activities, respectively.

During the year, revenues of governmental activities exceeded expenses by $1,008 million. However, this excess was reduced by transfers of $712 million, resulting in an increase of net asset of $296 million.

For business-type activities, expenses exceeded revenues by $420 million. However, this deficiency was offset by transfers of $712 million, resulting in an increase in net assets of $292 million.

Fund Level:
The governmental funds had a total fund balance of $3.1 billion at year end. Of this amount, $3.2 billion was reserved for various purposes, resulting in a total unreserved fund balance deficit of $0.1 billion. The portion of the total unreserved fund balance deficit that pertains to the General Fund was a $1.0 billion deficit. The General Fund had an actual budget surplus of $487 million this year.

The Enterprise Funds had total net assets of $4.3 billion, substantially all of which was invested in capital assets or restricted for various purposes.

Debt Issued and Outstanding:
Total long-term debt was $18.4 billion for governmental activities, of which $13.6 billion was bonded debt.

Total long-term debt was $2.2 billion for business-type activities, of which $1.6 billion was bonded debt.

OVERVIEW OF THE FINANCIAL STATEMENT PRESENTATION

There are three major parts to the basic financial statements: 1) government-wide financial statements, 2) fund financial statements, and 3) notes to the financial statements. This report also contains other supplementary information in addition to the basic financial statements.

GOVERNMENT-WIDE STATEMENTS (Reporting the State as a Whole)

Governments have traditionally focused their reporting on groupings of funds rather than on the government taken as a whole. The GASB 34 financial reporting model, upon which this report is based, retains this traditional focus on funds and adds an additional focus on the overall government's financial position and operations.

The Statement of Net Assets and the Statement of Activities are two financial statements that report information about the State as a whole and its activities. These statements help to demonstrate how the State's financial position as a whole changed due to the year's operating activities. These statements include all non-fiduciary assets and liabilities using the accrual basis of accounting.

The Statement of Net Assets presents all of the State's assets and liabilities, with the difference between the two reported as net assets. Over time, increases and decreases in net assets measure whether the State's financial position is improving or not.

The Statement of Activities presents information showing how the State's net assets changed during the most recent fiscal year. All changes in net assets are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of related cash flows. Therefore, revenues and expenses are reported in these statements for some items that will result in future fiscal year cash flows (e.g., earned but unused vacation time).

Both statements report three activities:

• Governmental Activities - Most of the State's basic services are reported under this category. Taxes and intergovernmental revenues generally fund these services. The legislature, the judiciary, and the general operations of the executive departments fall within the governmental activities.
  
• Business-type Activities - These activities are primarily funded by charges to external parties for the cost of goods and services provided. These activities are generally reported in Enterprise Funds in the fund level statements. The operations of Bradley International Airport, the Connecticut Lottery Corporation and Employment Security, are examples of business-type activities.
  
• Discretely Presented Component Units - Component units are legally separate organizations for which the State is financially accountable. More information on discretely presented component units can be found in Note 1 of the Notes to Financial Statement section.

Financial reporting for governmental activities traditionally has focused on changes in current spendable resources rather than on changes in total resources. This traditional focus has been retained for purposes of fund reporting. However, as governmental activities are included with other activities in the government-wide financial statement format, the focus for these activities shifts to changes in total resources. In other words, all activities reported in government-wide financial statements are reported in a manner similar to private-sector accounting. To increase the readers understanding, a summary reconciliation of the difference between the governmental fund financial statements and the government-wide financial statements is provided as part of the basic financial statements.

FUND LEVEL STATEMENTS

Fund financial statements focus on individual parts of the State's operations in more detail than the government-wide statements. Funds are accounting devices that governments use to keep track of specific sources of funding and spending for particular purposes. The State is required to report four categories of fund statements - governmental, proprietary, and fiduciary funds, to the extent that State's activities meet the criteria for using these funds, and �combining statements� for its component units. Under the GASB 34 financial reporting model, as presented here, governments focus on major individual funds rather than on fund types (with aggregated information presented for the total of all non-major funds).

Major Governmental Fund Financial Statements:

Governmental fund reporting focuses primarily on the sources, uses, and balances of current financial resources and often has a budgetary orientation. The State's major government funds include the General Fund, the Transportation Fund and the Debt Service Fund.

General Fund - The General Fund functions as the State's chief operating fund. All of the State's activities are reported in the General Fund unless there is a compelling reason to report them elsewhere.

Transportation Fund - The Transportation Fund is a special revenue fund that accounts for motor fuel taxes, vehicle registration and driver license fees, and other revenue collected for payment of debt service requirements and budgeted expenditures of the Department of Transportation and the Department of Motor Vehicles. The Department of Transportation is responsible for all aspects of the planning, development, maintenance and improvement of the State�s transportation system.

Debt Service Fund - The Debt Service Fund is a governmental fund, which accounts for the accumulation of resources for, and the payment of, Special Tax obligation principal and interest.

Budgetary Reporting - The State adopts a biannual budget for the General fund, the Transportation fund, and other Special Revenue funds. A budgetary comparison statement, using original and final budgets, is presented for the General and Transportation funds to demonstrate compliance with the current fiscal year budgets.

Major Proprietary Fund Financial Statements:

Proprietary funds (enterprise and internal service) are accounted for using the flow of economic resources measurement focus and the accrual basis of accounting where all assets and liabilities are reported on the balance sheet. Revenues are recorded when earned and expenses are recorded when incurred. In accordance with the requirements of the GASB 34 reporting model utilized in preparation of this report:

• Proprietary fund reporting distinguishes current assets and liabilities from non-current assets and liabilities.
  
• Three classifications are used to classify equity for proprietary funds. These three classifications are 1) invested in capital assets net of related debt, 2) restricted (distinguishing between major categories of restrictions) and 3) unrestricted.

Enterprise funds report activities that provide goods or services to the general public. An example is the Connecticut Lottery. Internal service funds report activities that provide supplies and services to the State's other programs and activities. An example is the State's motor fleet operations. Internal service funds are reported as governmental activities on the government-wide statements.

Fiduciary Fund Financial Statements:

The fiduciary fund category includes pension (and other employee benefit) trust funds, an investment trust fund, a private-purpose trust fund, and agency funds. These fund types are used to report resources held and administered by the State when it is acting in a fiduciary capacity for individuals, private organizations or other governments.

Fiduciary funds are not reflected in the government-wide financial statements because the resources of those funds are not available to support the State's operations and programs. The accounting used for fiduciary funds is much like that for proprietary funds.

Component Unit Combining Statements:

The same GASB 34 reporting rules regarding the determination of major funds are applied to the State's component units. The Component units of the State of Connecticut are:

Connecticut Housing Finance Authority - Classified as a major component unit, CHFA was created for the purpose of increasing the housing supply and encouraging and assisting in the purchase, development and construction of housing for low and moderate income families.

Connecticut Health and Educational Facilities Authority - Classified as a major component unit, CHEFA was created to provide resources for financing major projects for health and educational institutions.

Connecticut Development Authority - CDA was created to stimulate commercial development in the State.

Connecticut Resources Recovery Authority - CRRA was created to implement the State Solid Waste Management Plan.

Connecticut Higher Education Supplemental Loan Authority - CHESLA was created to provide resources for student loans.

Connecticut Innovations, Incorporated - CII was created to stimulate and promote technological innovation and application of new technology within the State.

Capital City Economic Development Authority - CCEDA was created to stimulate economic development in the city of Hartford.

University of Connecticut Foundation, Inc - The Foundation was created to solicit, receive, and administer gifts and financial resources from private sources for the benefit of the University of Connecticut.

FINANCIAL SECTION CONTENTS OTHER THAN FINANCIAL STATEMENTS

Notes to the Financial Statements - The notes provide additional information that is essential to a full understanding of the data provided in the government-wide and the fund financial statements.

Required Supplementary Information - The RSI provides additional information regarding the State's progress on funding its obligation to provide pension benefits to its employees.

Combining Financial Statements - Combining statements for non-major funds are not required to be presented or audited under generally accepted accounting principals. Nevertheless, these statements are presented as other supplementary information in this report.

FINANCIAL ANALYSIS OF THE GOVERNMENT AS A WHOLE

NET ASSETS

The following condensed financial information was derived from the government-wide Statement of Net Assets and reflects the financial position of the State at the end of the fiscal year 2006, compared to the prior year.

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

The State had a total net asset deficit of $0.8 billion at year end, an improvement in net assets of $588 million occurring in this fiscal year. This improvement resulted from increases of $296 million and $292 million in the net assets of governmental activities and business-type activities, respectively.

Governmental activities had a total net asset deficit of $5.1 billion at year end, an improvement in net assets of $0.3 billion occurring in this fiscal year. Of this amount, $4.9 billion was invested in capital assets (buildings, roads, bridges, etc.) or was restricted for various purposes, resulting in an unrestricted net asset deficit of $10.0 billion. This deficit does not mean that the State will not be able to pay its bills next year. Rather, it is the result of having long-term obligations that are greater than currently available resources. Specifically, the State had the following outstanding long-term obligations which contributed to the deficit: a) general obligation bonds in the amount of $3.8 billion which were issued to finance various grant programs of the State, such as school construction and other municipal aid programs; and b) other long-term obligations in the amount of $4.8 billion which the State has partially funded (net pension obligation) or not funded (compensated absences obligation).

Although the net assets of the business-type activities increased by $0.3 billion, these resources cannot be used to make up for the net asset deficit in governmental activities. The State can only use these net assets to finance the ongoing operations of its Enterprise funds, such as the University of Connecticut, Bradley International Airport, Employment Security, etc.

CHANGE IN NET ASSETS

The following condensed financial information was derived from the government-wide Statement of Activities and reflects the nature of the State's change in net assets during the fiscal year 2006, compared to the prior year,

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

* Restated for comparative purposes. See Note 21.

Special Items are significant transactions or other activity within management's control that are either unusual in nature or infrequent in occurrence.

Total revenues of the State increased by $1.6 billion to $21.9 billion. More than half of this increase was due to an increase in tax revenues. Total expenses increased by $1.3 billion to $21.2 billion. This increase can be attributed mainly to an increase of $1.1 billion in governmental activities' expenditures. Total net assets of the State increased by $588 million during the fiscal year.

GOVERNMENTAL ACTIVITIES

The following charts depict the distribution of revenues and expenses for Fiscal Year 2006.

Total revenues for the governmental activities increased by $1.5 billion to $18.4 billion. This increase was due mainly to an increase in tax revenue of $1.0 billion, reflecting a growing economy. Total expenses increased by $1.1 billion to $17.4 billion. This increase can be attributed mainly to increases in health and hospital, human services, and education expenses of $1.0 billion. Even though total revenues exceeded total expenses by $1,008 million, this excess was reduced by transfers of $712 million, resulting in an increase of net assets of $296 million.

As noted above, total revenues increased by 9 percent during the fiscal year because of a strong economy. Nationally, real Gross Domestic Product (GDP) grew a solid 5.6 percent in the third quarter of the fiscal year, after growing 1.7 percent during the second quarter of the fiscal year. However, the GDP showed growth slowing to 2.9 percent during the fourth quarter of the fiscal year. During the fiscal year, the State added 7,100 payroll jobs, which was about half of last year's job growth. The State's unemployment rate is 4.1 percent, compared to a national unemployment rate of 4.6 percent. Corporate profits grew at a rate of 14.4 percent and 11.9 percent during the second and third quarter of the fiscal year, respectively, after showing disappointing results during the first quarter of the year. During the last quarter of the fiscal year, advanced retail sales showed growth of 6.8 percent over the same quarter a year ago. Existing home sales in the State began to show signs of weakening, and permits to build have also been on a decline recently. The major stock indexes continue to show modest gains for the year.

Total revenues and expenses of business-type activities were virtually unchanged between fiscal years 2006 and 2005. Although, total expenses exceeded total revenues by $420 million, this deficiency was offset by transfers of $712 million, resulting in an increase in net assets of $292 million.

FINANCIAL ANALYSIS OF THE STATE'S FUNDS

The State completed fiscal year 2006 with a balance of $3.1 billion in its governmental funds. However, the General fund reported a deficit of $1.0 billion in unreserved fund balance. Although governmental fund expenditures exceeded fund revenues by $92 million, this deficiency was offset by other financing sources of $699 million, resulting in an increase in fund balance of $607 million in governmental funds in fiscal year 2006.

General Fund

The General fund is the chief operating fund of the State. At the end of fiscal year 2006, the General fund had a fund balance of $0.9 billion. Of this amount, $1.9 billion was reserved for various purposes, leaving a deficit of $1.0 billion in unreserved fund balance. Although, total fund revenues exceeded total fund expenditures by $1,017 million, this excess was reduced by other financing uses of $561 million, resulting in an increase in fund balance of $456 million for the fiscal year .

Budgetary Highlights-General Fund

Early in the fiscal year, the General fund surplus was estimated to be $18 million. By the end of the fiscal year, fund revenues had greatly increased because of a strong economy, causing the surplus estimate to grow to$940 million. However, most of the estimated surplus was eventually appropriated by the State legislature for various expenditure programs, resulting in a final estimated surplus of $455 million.

Although actual fund revenues exceeded expenditures by $499 million, this excess was reduced by other financing uses of $12 million, resulting in an actual surplus of $487 million. A portion of the 2005 surplus in the amount of $15 million was appropriated during the current fiscal year for various expenditure programs. This amount was reported in the budgetary statement as other financing source.

During the year, actual revenues exceeded original budget revenues by $865 million. A tax revenue variance of $760 million accounts for much of the total variance. Some of the tax revenues that exceeded original estimates were: personal income, $370 million; corporations, $141 million; and oil companies, $80 million.

During the year, final appropriations exceeded original appropriations by $450 million. Some of the major adjustments to initial appropriations that occurred during the year were: $86 million to pre-pay debt service on economic recovery notes; $246 million for deposit to the Teachers' Retirement Fund; and $33 million for property tax relief.

Other Funds

The Debt Service fund had a fund balance of $675 million at year end, all of which was reserved. Fund balance decreased by $3 million during the fiscal year.

The Transportation fund had a fund balance of $183 million at year end, of which $129 million was unreserved. Fund balance increased by $7 million during the fiscal year.

CAPITAL ASSETS AND DEBT ADMINISTRATION

Capital Assets.

As of June 30, 2006 the State had an investment in total capital assets (net of accumulated depreciation) of $13.0 billion. During the fiscal year, capital assets of governmental activities and business-type activities increased by $115 million and $150 million, respectively. Depreciation charges for the fiscal year totaled $0.9 billion.

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

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

Long-term Debt

Bonded Debt

The State, pursuant to various public and special acts, has authorized a variety of types of debt which fall into the following categories: direct general obligation debt, which is payable from the State's general fund; special tax obligation debt, which is payable from the debt service fund; and revenue debt, which is payable from specific revenues of enterprise funds.

State of Connecticut's Bonded Debt (in millions)

In fiscal year 2006 the State increased outstanding bonds by $232 million. Bonds of governmental activities increased by $324 million while bonds of business-type activities decreased by $92 million. The State's General Obligation bonds are rated Aa3, AA and AA by Moodys, Standard and Poors and Fitch respectively. Special Tax Obligation bonds are rated Aaa, AAA, AAA by Moodys, Standard and Poors and Fitch respectively.

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 October, 2006, the State had a debt incurring margin of $4.2 billion.

Other Long-Term Debt

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

* Includes Economic Recovery Notes of $146 million and $209 million in 2006 and 2005, respectively

The State's other long-term obligations increased by $136 million during the year. An increase of $101 million in the net pension obligation of governmental activities accounted for most of the change.

Additional information on the State's long-term debt can be found in Note 16 of this report.

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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