MANAGEMENT'S DISCUSSION AND ANALYSIS (MDA)

INTRODUCTION
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, 2016. The information provided here should be read in conjunction with the letter of transmittal in the front of this report and with the State's financial statements, which follow this section.

FINANCIAL HIGHLIGHTS
Government-wide Financial Statements
The State's total net position (deficit) increased $2.5 billion (or 7.0 percent) as a result of this year's operations. Net position (deficit) of governmental activities increased by $3.2 billion (or 7.9 percent) and business-type activities increased by $770 million (or 14.0 percent). At year-end, net position (deficit) of governmental activities and business-type activities totaled a negative $44.1 billion and $6.30 billion, respectively.

Component units reported net position of $2.35 billion, a decrease of $24.4 million or 1.0 percent from the previous year. The majority of the net position is attributable to the Connecticut Housing Finance Authority, a major component unit.

Fund Financial Statements
The governmental funds reported combined ending fund balance of $1.8 billion, a decrease of $0.3 million in comparison with the prior year. Of this total fund balance, $191.6 million represents nonspendable fund balance, $2.3 billion represents restricted fund balance, $354.8 million represents committed fund balance, and $24.9 million represents assigned fund balance. A negative $1.0 billion unassigned fund balance offsets these amounts. This deficit, which belongs primarily to the General Fund, increased by $265.7 million during the fiscal year.

The State's stabilization account, the General Fund Budget Reserve Account (Rainy Day Fund) ended the fiscal year with a balance of $235.6 million.

Personal income tax revenues in the governmental funds increased $904.2 million or 11.0 percent, compared to $434.4 million or 5.6 percent increase in the prior fiscal year. General fund tax revenues increased $433.6 million or 2.9 percent.

The Enterprise funds reported net position of $6.3 billion at year-end, an increase of $770.1 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 $62.7 billion for governmental activities at year-end, of which $23.9 billion was bonded debt.

Total long-term debt was $1.9 billion for business-type activities at year-end, of which $1.5 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 - Reporting the State as a Whole
The Statement of Net Position and the Statement of Activities beginning on page 35 together comprise the government-wide financial statements. These 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 2016. 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, Board of Regents (Connecticut State Universities & 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 - Report the State's Most Significant Funds
The fund financial statements beginning on page 36 provide detailed information about individual major funds, not the State as a whole. A fund is a group 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 � 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 four individual proprietary funds. Information is presented separately in the proprietary fund statements for the University of Connecticut and Health Center, Board of Regents (Connecticut 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.

Reconciliation between Government-wide and Fund Statements
The financial statements include schedules on pages 41 and 43 which reconcile and explain the differences between the amounts reported for governmental activities on the government-wide statements (full accrual basis of accounting, long-term focus) with amounts reported on the governmental fund statements (modified accrual basis of accounting, short-term focus). The following are some of the major differences between the two statements.

• Capital assets and long-term debt are included on the government-wide statements, but are not reported on the governmental fund statements.
   
• Capital outlay spending results in capital assets on the government-wide statements, but is expenditures on the governmental fund statements.
   
• Bond proceeds result in liabilities on the government-wide statements, but are other financing sources on the governmental fund statements.
   
• Net Pension Liability and Net OPEB Obligation are included on the government-wide statements, but are not reported on the governmental fund statements.
   
• Certain tax revenues that are earned but not yet available are reported as revenue on the government-wide statements, but are deferred inflows of resource on the governmental fund statements.

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 (RSI)
Following the basic financial statements are budgetary comparison schedules for major funds with legally adopted budgets. In addition, within the RSI there is a reconciliation schedule for budgetary vs. GAAP basis of accounting. The RSI also includes information regarding the State's funding progress and employer contributions for pension and other postemployment benefits, and change in employers' net pension liability.

Supplementary Information
The combining financial statements for the State's nonmajor governmental, nonmajor enterprise, nonmajor fiduciary funds, and nonmajor discretely presented component units.

Statistical Section
This section 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 $2.5 billion or 7.0 percent. In comparison, last year the combined net position deficit decreased $2.7 billion or 6.6 percent. The net position deficit of the State's governmental activities increased $3.2 billion (7.9 percent) to $44.1 billion during the current fiscal year.

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

*Restated for comparative purposes

Total invested in capital assets net of related debt was $4.5 billion (buildings, roads, bridges, etc.) and $2.0 billion was restricted for specific purposes, resulting in an unrestricted net position deficit of $50.6 billion for governmental activities. 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 $10.0 billion to finance various municipal grant programs (e.g., school construction) and $2.2 billion issued to finance a contribution to a pension trust fund, and b) other long-term obligations in the amount of $38.7 billion, which are partially funded or not funded by the State (e.g., net pension liability and OPEB obligations and compensated absences).

Net position of the State's business-type activities increased $770.1 million (14.0 percent) to $6.3 billion during the current fiscal year. Of this amount, $3.8 billion was invested in capital assets and $1.1 billion was restricted for specific purposes, resulting in unrestricted net positions of $1.4 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).

Changes in net position for the years ended June 30, 2016 and 2015 were as follows:

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

*Restated for comparative purposes

Changes in Net Position
This year the State received 60.1 percent of its revenue from taxes and 29.5 percent of its revenues from grants and contributions. In the prior year, taxes accounted for 60.1 percent and grants and contributions were 27.1 percent of total revenues. Charges for services such as licenses, permits and fees, rents and fines, and other miscellaneous collections comprised 7.4 percent of total revenue in fiscal year 2016, compared to 7.3 percent in fiscal year 2015.

Governmental Activities
The following graph is a representation of the Statement of Activities revenues for governmental activities. Governmental activities revenues increased by $817 million, or 3.1 percent. This increase is primarily due to an increase of $497 million from taxes.

The following graph is a representation of the Statement of Activities expenses for governmental activities. Governmental activities expenses increased by $6.1 million, or 27.2 percent. The increase is mainly attributable to increased spending in human services.

Business-Type Activities
Net position of business-type activities increased by $770.1 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 increased 3.0 percent to $3.4 billion, while total expenses increased 1.3 percent to $4.4 billion. In comparison, last year total revenues remained steady, while total expenses decreased 2.8 percent. The increase in total expenses of $80.0 million was due mainly to an increase in University of Connecticut and Health Center expenses of $100.0 million or 4.6 percent. Although, total expenses exceeded total revenues by $976.2 million, this deficiency was reduced by transfers of $1,746 million, resulting in an increase in net position of $770.1 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 $1.8 billion, a decrease of $265.4 million over the prior year ending fund balances. Of the total governmental fund balances, $2.3 billion represents fund balance that is considered restricted for specific purposes by external constrains or enabling legislation; $191.6 million represents fund balance that is non-spendable; $379.7 million represents fund balance that is committed or assigned for specific purposes. A negative $1.01 billion 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 $614.2 million, an increase of $424.3 million in comparison with the prior year. Of this total fund balance, $384.7 million represents non-spendable fund balance or committed for specific purposes, leaving a deficit of $998.9 million in unassigned fund balance.

Specific changes to the General Fund balance included the following:

• Nonspendable fund balance increased by $1.4 million or 2.8 percent.
   
• Committed fund balance decreased by $220.0 million or 39.8 percent. There also was a statutory transfer from the Budget Reserve Fund (Rainy Day Fund) for $170.4 million, after the transfer the fund ended the year with a balance of $235.6 million.
   
• Unassigned fund balance deficit increased by $205.7 million.

At the end of fiscal year 2016, General Fund revenues were 1.5 percent, or $260.9 million, higher than fiscal year 2015 revenues. This change in revenue results from increases of $538.3 million primarily attributable to taxes ($433.6 million), licenses, permits, and fees ($39.2 million), and other revenue ($65.5 million). These increases were offset by decreases of $277.4 million primarily attributable to federal grants and aid ($275.2 million), and other revenue ($2.2 million).

At the end of fiscal year 2016, General Fund expenditures were 3.0 percent, or $508.0 million, higher than fiscal year 2015. This was primarily attributable to increases in legislative, general government, regulations, conservation and development, human services, corrections, and judicial of $4.1 million, $337.5 million, $12.1 million, $81.2 million, $18.2 million, and $30.7 million respectively. Net other financing sources and uses increased by $29.6 million.

Debt Service Fund
At the end of fiscal year 2016, the Debt Service Fund had a fund balance of $738.2 million, all of which was restricted, an increase of $69.8 million in comparison with the prior year.

Transportation Fund
The State's Transportation Fund had a fund balance of $211.9 million at the end of fiscal 2016. Of this amount, $29.7 million was in nonspendable form and $182.2 million was restricted or committed for specific purposes. Fund balance decreased by $45.4 million during the current fiscal year.

At the end of fiscal year 2016, Transportation Fund revenues increased by $21.8 million, or 1.6 percent, and expenditures increased by $38.8 million, or 4.3 percent. The increased revenue is primarily due to an increase in taxes.

Restricted Grants and Accounts Fund
At the end of fiscal year 2016, the Restricted Grants and Accounts Fund had a fund balance of $197.9 million, all of which was restricted for specific purposes, an increase of $113.1 million in comparison with the prior year.

Total revenues were 5.5 percent, or $352.0 million, higher than in fiscal year 2015. Overall, total expenditures were 4.1 percent, or $267.9 million, higher than fiscal year 2015.

Grant and Loan Programs
As of June 30, 2016, the Grant and Loan Programs Fund had a fund balance of $689.4 million, all of which was restricted for specific purposes, a decrease of $63.6 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 $30.9 billion, a decrease of $234.2 million when compared to the prior year ending net position.

Budget Highlights-General Fund
The State budget is formulated during odd-numbered years; the General Assembly generates a two-year (biennial) budget. The process begins with the Executive Branch, when the governor asks the commissioner of each state agency to prepare draft budgets for the following biennium. Over several months the governor's budget office, the Office of Policy and Management (OPM), compiles this information, makes changes as it sees fit, and then works to match the agencies' spending projections with revenue estimates for the same period.

The result referred to as the 'governor's budget,' is delivered to the General Assembly in a formal address by the governor in early February. The annual budget address often includes policy, initiatives, spending proposals, and vehicles through which additional revenue may be generated. In the address, the governor identifies his priorities for the biennium.

Thereafter, the legislature goes through a similar process to determine spending priorities and corresponding revenue requirements. Later in the session, the Appropriations and Finance Committees approve a budget, which is often different from the governor's. Negotiations with the governor's office reconcile the two versions and determine the final budget language and the state's fiscal path for the following two years. Lastly, the budget must be voted on and passed by both the House and Senate and signed into law by the governor.

The General Fund ended Fiscal Year 2016 with a deficit of $170,418,432. A transfer from the Budget Reserve Fund eliminated the shortfall returning the unappropriated balance of the fund to zero on the budgetary accounting basis. After the transfer to the General Fund, the Budget Reserve Fund had a balance of $235,582,921. The reserves at the beginning of Fiscal Year 2016 were $406,001,353.

In evaluating the Fiscal Year 2016 General Fund deficit, it is instructive to recall that as the fiscal year budget formulation process began, projections indicated that maintaining existing levels of programs and services would produce a deficit of $1.1 billion.

In order to pass a balanced budget for Fiscal Year 2016, policy changes were implemented to reduce current service spending in the General Fund by $519 million. The actual changes in spending between Fiscal Years 2015 and 2016 are discussed below. In addition to the spending changes, adjustments were enacted to generate an anticipated $802.1 million more in gross General Fund revenue. The largest revenue changes were to the income tax ($169.3 million), the corporation tax ($258.1 million), and the health provider tax ($224.8 million). The gain in the health provider tax was to be partially offset by higher payments to hospitals. Since the hospital tax (Public Act 11-6) was implemented in Fiscal Year 2012 as a method of maximizing federal reimbursements, redistribution of the tax back to hospitals has steadily declined.

Within the first two months of Fiscal Year 2016, it became clear that General Fund revenue would fall short of budget targets. A significant stock market correction in August of 2015 dampened hopes of meeting income tax estimates, especially with respect to the capital gains portion of the tax. By the time of the November 10, 2015 consensus revenue forecast, General Fund revenues were projected to be $217.5 million short of budget expectations and a Fiscal Year 2016 General Fund deficit emerged. In December, a deficit mitigation target of $350 million was negotiated and Public Act 15-1 was passed to rebalance the budget. Public Act 15-1 made line-item reductions to agency budgets and delayed revenue transfers to the Transportation Fund and to the Municipal Revenue Sharing Account, among other changes.

Revenue estimates continued to deteriorate throughout the fiscal year and on March 16, 2016, the Governor issued budget rescissions totaling $78.7 million across all branches of government. At the end of Fiscal Year 2016, the General Fund deficit estimate was $279.4 million, which was prior to accrual activity. Positive accrual results have reduced the General Fund deficit number for Fiscal Year 2016 to $170.4 million as cited above.

General Fund spending of $17,921.3 million in Fiscal Year 2016 grew by $501.6 million or 2.9 percent over last fiscal year. Almost 80 percent of this spending increase was attributable to two appropriation line-items: Debt Service increased by $265.5 million or 18.7 percent and the State Employees' Retirement System Contribution grew by $125.9 million or 13 percent. The functional program areas with the largest dollar reductions in spending from last fiscal year were general government administration (down $34 million or 5.1 percent), health and hospitals (down $19.4 million or 1.1 percent) and conservation and development (down $11 million or 5.3 percent). The largest functional program area increase was to education, which grew by $96.6 million or 1.9 percent. Education is the largest single program area accounting for almost 30 percent of General Fund expenditures.

In Fiscal Year 2016, General Fund revenue expanded by $498.8 million or 2.9 percent from the prior fiscal year. This gain was primarily due to the revenue policy changes discussed above, and it was well below initial budget expectations. The largest variance from the original budget estimates was in the income tax, which fell $652.8 million short of the target. Compared with the previous fiscal year, the payroll driven withholding portion of the income tax grew by 3.4 percent in Fiscal Year 2016. However, the estimated and final payments portions of the income tax, which are related to capital gains and bonus payments, dropped by 4.4 percent despite an increase in the upper bracket tax rate.

The disappointing revenue results for Fiscal Year 2016 were largely produced by an economy that has yet to reach past recovery growth levels, as well as considerable stock market volatility.

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, 2016 totaled $18.2 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 $1.01 billion.

Major capital asset events for governmental activities during the fiscal year include additions to buildings and land of $523 million and depreciation expense of $988.0 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)

Additional information on the State's capital assets can be found in Note 9 of this report.

Long-Term Debt - Bonded Debt

At the end of the current fiscal year, the State had total debt outstanding of $25.3 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  

The State's total bonded debt increased by $1.4 billion (5.9 percent) during the current fiscal year. This increase resulted mainly from an increase in general obligation bonds of $992 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 July 2016, the State had a debt incurring margin of $2.9 billion.

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