MANAGEMENT'S DISCUSSION AND ANALYSIS (MDA)

The following discussion and analysis is intended to provide readers of the State's financial statements with a narrative overview and analysis of the financial activities of the State for the fiscal year ended June 30, 2008. The information provided here should be read in conjunction with additional information provided in the letter of transmittal and in the basic financial statements.

FINANCIAL HIGHLIGHTS

Government-wide:
As of June 30, 2008, the State had a combined net asset deficit of $2.2 billion, an increase of $2.0 billion when compared to the prior year ending deficit balance. This increase resulted from a decrease of $2.0 billion in the net assets of governmental activities.

Fund Level:
The governmental funds had a total fund balance of $3.1 billion at year end. Of this amount, $3.7 billion was reserved for various purposes, resulting in a total unreserved fund balance deficit of $0.6 billion. The portion of the total unreserved fund balance deficit that pertains to the General Fund was a $1.1 billion deficit. The General Fund had an actual budget surplus of $0.1 billion this year.

The Enterprise funds had total net assets of $4.7 billion, substantially all of which was invested in capital assets or restricted for various purposes.

Long-Term Debt:
Total long-term debt was $20.3 billion for governmental activities, of which $16.2 billion was bonded debt.

Total long-term debt was $1.9 billion for business-type activities, of which $1.4 billion was bonded debt.

OVERVIEW OF THE FINANCIAL STATEMENTS

This discussion and analysis is intended to serve as 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. This report also contains other supplementary information in addition to the basic financial statements themselves.

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.

The statement of net assets presents information on all of the State's non-fiduciary assets and liabilities, with the difference between the two reported as net assets. Over time, increases or decreases in net assets may serve as a useful indicator of whether the financial position of the State is improving or deteriorating.

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 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).

The government-wide financial statements are intended to distinguish functions of the State that are principally supported by taxes and intergovernmental revenues (governmental activities) from other functions that are intended to recover all or a significant portion of their costs through user fees and charges (business-type activities). The governmental activities of the State include legislative, general government, regulation and protection, conservation and development, health and hospitals, transportation, human services, education, libraries, and museums, corrections, and judicial. The business-type activities of the State include the University of Connecticut and Health Center, State Universities, Bradley International Airport, Connecticut Lottery Corporation, Employment Security, and Clean Water, which are considered to be major funds, while the remaining business-type activities are combined into a single aggregate presentation.

The government-wide financial statements include not only the State itself (known as the primary government), but also the activities of eight legally separate Component Units for which the State is financially accountable: the Connecticut Housing Finance Authority, the Connecticut Health and Educational Facilities Authority, the Connecticut Development Authority, the Connecticut Higher Education Supplemental Loan Authority, the Connecticut Resources Recovery Authority, the Connecticut Innovations, Incorporated, the Capital City Economic Development Authority, and the University of Connecticut Foundation, Incorporated. Financial information for these Component Units is reported separately from the financial information presented for the primary government itself. Financial information of the individual component units can be found in the basic financial statements following the fund statements, and complete financial statements of the individual component units can be obtained from their respective administrative offices.

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.

Governmental Funds

Governmental funds are used to account for essentially the same functions reported as governmental activities in the government-wide financial statements. However, unlike the government-wide financial statements, governmental fund financial statements focus on near-term inflows and outflows of spendable resources, as well as on balances of spendable resources available at the end of the fiscal year. Such information may be useful in evaluating the State's near-term financing requirements.

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.

Information is presented separately in the governmental fund balance sheet and in the governmental fund statement of revenues, expenditures, and changes in fund balances for the General Fund, the Debt Service Fund, the Transportation Fund, and the Restricted Grants and Accounts Fund, all of which are considered to be major funds. Data from other governmental funds is combined into a single, aggregated presentation. Individual fund data for each of these nonmajor governmental funds is provided in the form of combining statements elsewhere in this report.

The State adopts a biennial budget for the General Fund, the Transportation Fund, and other Special Revenue funds. A budgetary comparison statement has been provided for the General Fund and the Transportation Fund to demonstrate compliance with the current fiscal year budgets.

Proprietary Funds

Proprietary funds (Enterprise funds and Internal Service funds) are used to show activities that operate more like those of commercial enterprises. Enterprise funds charge fees for services provided to outside customers. They are used to report the same functions presented as business-type activities in 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.

Fiduciary Funds

Fiduciary funds are used to 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.

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.

Required Supplementary Information

The basic financial statements are followed by a section of required supplementary information that further explains and supports the information in the financial statements. The required supplementary information includes information regarding the State's progress on funding its obligation to provide pension and other postemployment benefits to its employees.

Other Information

In addition to the basic financial statements and accompanying notes, this report also contains the following information.

• Combining Fund Statements and Schedules - Nonmajor funds
• Statistical Section

FINANCIAL ANALYSIS OF THE GOVERNMENT AS A WHOLE

NET ASSETS

As noted earlier, net assets may serve over time as a useful indicator of the State's financial position.
During the current fiscal year, the combined net asset deficit of the State increased 807 percent to $2.2 billion. In comparison, last year the combined net asset deficit decreased 69 percent.

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

The net asset deficit of the State's governmental activities increased $2.0 billion (42.2 percent) to $6.9 billion during the current fiscal year. Of this amount, $6.6 billion was invested in capital assets (buildings, roads, bridges, etc.) or was restricted for various purposes, resulting in an unrestricted net asset deficit of $13.5 billion. This deficit is the result of having long-term obligations that are greater than currently available resources. Specifically, the State has recorded the following outstanding long-term obligations which contributed to the deficit; a) general obligation bonds in the amount of $5.4 billion which were issued to finance various municipal grant programs (e.g., school construction) and construction projects at the University of Connecticut, and b) other long-term obligations in the amount of $4.1 billion (e.g., net pension obligation and compensated absences).

Net assets of the State's business-type activities increased $0.1 billion (1.8 percent) to $4.7 billion during the current fiscal year. Of this amount, $4.4 billion was invested in capital assets or was restricted for various purposes, resulting in unrestricted net assets of $0.3 billion. These resources cannot be used to make up for the net asset deficit of the State's 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 and Health Center, Bradley International Airport, and others).

CHANGE IN NET ASSETS

Changes in net assets for the years ended June 30, 2008 and 2007 were as follows:

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

GOVERNMENTAL ACTIVITIES
The following charts provide a two year comparison of governmental activities revenues and expenses.

During the year, total revenues of governmental activities increased 2.8 percent to $19.7 billion, while total expenses increased 16.0 percent to $21.0 billion. In comparison, last year total revenues and expenses increased 4.1 percent and 3.9 percent, respectively. The increase in total expenses was due mainly to an increase in transportation, human services and education expenses of $2.0 billion or 19.9 percent. Although, total expenses exceeded total revenues by $1.2 billion, this excess was increased by transfers of $0.8 billion, resulting in a decrease in net assets of $2.0 billion.

BUSINESS-TYPE ACTIVITIES
The following charts provide a two year comparison of business-type activities revenues and expenses.

During the year, total revenues of business-type activities increased 3.5 percent to $3.5 billion, while total expenses increased by 6.9 percent to $4.2 billion. In comparison, last year total revenues decreased 0.3 percent, while total expenses increased 3.1 percent. The increase in total expenses was due mainly to an increase in University of Connecticut and Health Center expenses of $0.1 billion or 7.0 percent. Although, total expenses exceeded total revenues by $0.7 billion, this excess was reduced by transfers of $0.8 billion, resulting in an increase in net assets of $0.1 billion.

FINANCIAL ANALYSIS OF THE STATE'S FUNDS

Governmental Funds

The focus of the State's governmental funds is to provide information on near-term inflows, outflows, and balances of spendable resources. Such information is useful in assessing the State's financing requirements. In particular, unreserved fund balance serves as a useful measure of the State's net resources available for spending at the end of the fiscal year.

As of June 30, 2008, the State's governmental funds had fund balances of $3.1 billion, a decrease of $0.2 billion when compared to the prior year ending fund balances. Of the total governmental fund balances, $3.7 billion represents reserved fund balance, meaning that this portion is not available for the new spending because it has already been committed for specific purposes. The remainder of fund balance is an unreserved deficit fund balance of $0.6 billion.

General Fund

The General Fund is the chief operating fund of the State. As of June 30, 2008, the General Fund had a fund balance of $0.9 billion. Of this amount, $2.0 billion was reserved for various purposes, leaving a deficit of $1.1 billion in unreserved fund balance. Fund balance decreased by $0.4 billion during the current fiscal year.

Debt Service Fund

As of June 30, 2008, the Debt Service Fund had a fund balance of $684 million, all of which was reserved. Fund balance increased by $7 million during the current fiscal year.

Transportation Fund

As of June 30, 2008, the Transportation Fund had a fund balance of $220 million. Of this amount, $60 million was reserved for various purposes, leaving $160 million in unreserved fund balance. Fund balance decreased by $28 million during the current fiscal year.

Restricted Grants and Accounts Fund

As of June 30, 2008, the Restricted Grants and Accounts Fund had a fund balance of $666 million, all of which was reserved. Fund balance increased by $312 million during the fiscal year.

Proprietary Funds

The State's Proprietary funds provide the same type of information found in the government-wide financial statements, but in more detail. Accordingly, a discussion of the financial activities of the Proprietary funds has been provided in that section.

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. As of June 30, 2008, the net assets of the State's Fiduciary funds totaled $27 billion, showing no change when compared to the prior year ending net asset balance.

Budgetary Highlights-General Fund

The General Fund surplus was originally estimated to be $0.7 million. Although the economy weakened during the year, the surplus estimate grew to $22 million by the end of the fiscal year.

Although actual fund expenditures exceeded revenues by $209 million, this excess was reduced by other financing sources of $308 million, resulting in an actual surplus of $99 million. This surplus was reserved by the State legislature to be spent in fiscal year 2009.

During the year, actual revenues exceeded original budget revenues by $103 million. A tax revenue variance of $71 million accounts for much of the total variance. Some of the tax revenues that were over or (under) the original budget were: personal income, $319 million; oil companies, $71 million; corporations, ($136) million; and real estate, ($41) million.

During the year, final appropriations exceeded original appropriations by $18 million or 0.1 percent.

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, 2008 totaled $13.4 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 current fiscal was $0.2 billion, a 1 percent increase for governmental activities and a 3 percent increase for business-type activities.
Major capital asset events during the current fiscal year included the following:

• Additions to infrastructure of $0.4 billion.
• Additions to equipment of $0.3 billion
• Depreciation expense of $1.0 billion.

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)

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 bonded debt of $17.6 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)

The State's total bonded debt increased by $2.4 billion during the current fiscal year. This increase resulted mainly from an increase in general obligation bonds of $2.5 billion that was offset by a decrease in revenue bonds of $0.2 billion.

The State's General Obligation Bonds are rated Aa3, AA and AA by Moody's Investor Service, Standard and Poor's Corporation, and Fitch Ratings, respectively. Special tax obligation Bonds are rated A1, AA, AA- by Moody's Investor Service, Standard and Poor's Corporation, and Fitch Ratings, 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 February 2008, the State had a debt incurring margin of $5.7 billion.

Other Long-Term Debt

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

The State's other long-term obligations decreased by $0.7 billion during the year. This decrease was due mainly to a decrease in the Net Pension Obligation of $1.9 billion that was offset by an increase in the Net OPEB Obligation of $1.2 billion.

Additional information on the State's long-term debt can be found in Notes 17 and 18 of this report.

Economic Factors and Next Year's Budget

During the fiscal year, the State added 6,000 payroll jobs. In the prior fiscal year, the State gained 20,800 jobs. The State's unemployment rate ended the fiscal year at 5.5 percent, its highest rate since fiscal year 2003. Existing home sales in the State hit a ten year low during the fiscal year, while new housing permits declined 25 percent. Taxable sales were weak expanding 2.5 percent. Personal income in the State grew by close to 4 percent throughout most of the fiscal year and ranked in the top quarter of all states for income growth. The State's export industries continue to show strength with exports continuing to expand at double-digit rates into the fiscal year.

For fiscal year 2009, the General Fund had a budget deficit initially estimated to be $10 million. Budgeted appropriations were expected to increase 4.7 percent to $17,083 million, while budgeted revenues were expected to increase 4.6 percent to $17,073 million. Some of the major increases in budgeted appropriations were $164 million for Medicaid assistance, $145 million for debt service, and $135 million for employee fringe benefit payments. However, because the economy went into a recession during the fiscal year, budgeted revenues are now expected to be $980 million lower than initially anticipated, resulting in a projected budget deficit of $922 million for fiscal year 2009. To help reduce the estimated budget deficit, the Governor has implemented certain measures, which include a ban on out-of-state travel, a hiring freeze, and a budget allotment rescission program.

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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