STUMP » Articles » Pension Obligation Bonds: Oregon and Alaska -- DON'T DO IT

Pension Obligation Bonds: Oregon and Alaska -- DON'T DO IT

by meep

4 October 2016, 05:59

Before we get to the current groups considering putting on those Bad Idea Jeans, here are prior posts on pension obligation bonds:

Here is a third party source that has a more measured take on POBs: PENSION OBLIGATION BONDS: FINANCIAL CRISIS EXPOSES RISKS from the Center for Retirement Research at Boston College. That was published in 2010, when POBs looked really bad. Some look good now, after some years of up markets. Which can easily fall down again.

Reminder: POBs are when the pension sponsor issues bonds, the proceeds of which are put into the pension fund. The theory is that the pensions will earn 7% -8% over time (sure thing!) and that the bond yield was only 5% or some such. Arbitrage!

Here we go with our latest batch of suckers!

ALASKA

Public employee pension plan can proceed with blessing of lawmakers

A plan to reduce Alaska’s public employee pension obligation using borrowed money may proceed without legislative approval.

The Alaska Dispatch reports that Revenue Commissioner Randy Hoffeck notified lawmakers last week that the administration could raise up to 3-point-2 billion dollars through pension obligation bonds.

Governor Walker floated a similar idea late last year, asking the legislature to put the bonds on the ballot. The new approach could be done directly, with bonds issued by a state corporation.

The pension obligation bond corporation is scheduled to meet next week to consider whether to issue the bonds.

Walker administration resurrects plan to borrow for pension shortfall

Alaska Gov. Bill Walker’s administration is resurrecting a stalled plan under which it would use borrowed money to reduce the hundreds of millions of dollars that the state pays into its pension funds each year.

The plan calls for as much as $3.2 billion in borrowing through pension obligation bonds, according to a letter to state lawmakers sent by Revenue Commissioner Randy Hoffbeck last week.

[Read the letter]

Walker’s administration considered a similar plan earlier this year but ultimately dropped it after lawmakers gave the complicated plan a hostile reception, citing its potential risks.

At the time, Hoffbeck said the borrowing wouldn’t happen without legislative approval. But now, since lawmakers aren’t in session, Walker’s administration isn’t expecting to seek permission, said Jerry Burnett, deputy revenue commissioner.

The executive branch, through a state corporation led by top Walker administration officials, can unilaterally issue up to $5 billion in pension obligation bonds without legislative approval based on 2008 legislation sponsored by Rep. Mike Hawker, R-Anchorage.

For what it’s worth, they’ve been thinking of this since January. That was for $2.6 billion. (yes, with a B)

Alaska Governor Walker authorized up to $3.5 billion in POB issuance.

But we’re not too late — it’s just the authorization. The bonds aren’t issued yet.

Some Alaska legislators are pushing back, so maybe the bonds may not be issued after all:

Alaska lawmakers took a skeptical look Thursday at a plan by the administration of Gov. Bill Walker to nibble at Alaska’s pension debt.

One week ago, the three-member Pension Obligation Bond Corporation Board voted to borrow up to $3.5 billion from bond markets from Asia. Proceeds from that bond sale would be invested in global markets, and any difference between the interest earnings and the interest paid on the bonds would go toward the state’s unfunded pension debt.

The board is assuming 8 percent average earnings, deputy commissioner of revenue Jerry Burnett told the Senate Finance Committee on Thursday afternoon.

It expects to be able to borrow money from Asian pension funds at 4 percent interest.

Oh I expect all sorts of things.

I can see why they may expect to be able to get 4% from Asian investors, though — when their alternative is negative yields at issue, four percent yields are just peachy.

Back to the article:

“It’s a gamble,” Sen. Mike Dunleavy, R-Wasilla, declared.

“It’s a gamble to have an unfunded pension system and assume we’ll have enough” money when payments come due, Burnett responded.

And it’s still a gamble after the POBs are issued. Even more so: now you’re under obligation to more people.

I want to reach through the screen and slap Burnett.

And more:

Several analyses presented Thursday, including one by the independent reporting firm ProPublica, have found pension obligation bonds a risky option.

The nonpartisan Government Finance Officers Association also opposes pension obligation bonds, calling them “complex instruments that carry considerable risk.”

While lawmakers also appeared skeptical, their ability to stop the plan seems limited. The bond corporation board was empowered by a 2008 law and has the authority to issue up to $5 billion in bonds without approaching the Legislature again.

As planned, the bonds will be marketed through October and sold in the final week of the month, with deals closing on Halloween.

There’s still time! You don’t have to do it!

But wait! There’s more lining up!

OREGON

Bond idea floated to fund growing pension needs

Members of two state boards are floating the idea of a statewide bond issue to deal with the $22 billion in unfunded liabilities of Oregon’s public pension system over the next decades.

Members of the Public Employees Retirement System board and the Oregon Investment Council discussed the concept at a joint meeting Friday, Oct. 1, although only the Oregon Legislature can propose and Oregon voters approve such a measure.

“What is important is that we are dealing with the liability up front,” said Lawrence Furnstahl, a PERS board member and chief financial officer of Oregon Health & Science University, who advanced the idea.

He said relatively low interest rates and the state’s current bond ratings make the idea worth exploring.

“We are just throwing some ideas out,” said John Thomas, PERS board chairman. “Our two boards are not going to be able to address the problem.”

……
Back in 2003 — after lawmakers overhauled the public pension system to provide for less generous benefits for newly hired employees after August 2003 — they proposed and voters approved $2 billion in bonds to cover part of state government’s future pension obligations.

PERS spokesman David Crosley said the size, scope and purpose of any new bond issue would differ from the 2003 measure.

A legislative task force is considering further changes in the system.

But the Oregon Supreme Court has ruled that benefit changes cannot be made retroactive, so lawmakers cannot tinker with the more generous benefits for those hired before the 2003 overhaul.

The system has 130,000 retirees, who account for 64 percent of liabilities, and still-active public workers hired before August 2003 account for 25 percent. Just under half of Oregon’s 200,000 public workers, however, fall under the post-2003 system.

…..
So the system’s funded status dropped from 96 percent at the end of 2013 to 79 percent at the end of 2015 — and the numbers are even lower if the set-asides by state governments and others for future pension liabilities are subtracted.

Investment earnings, which account for seven of every $10 paid in pension benefits, have accumulated at a rate of 4.8 percent for the first eight months of 2016 — still short of the assumed rate of 7.5 percent.

“It is not possible to earn our way out of this problem,” said Katy Durant, Oregon Investment Council chairwoman, who will be leaving after 12 years on the board that oversees state investments.

Rex Kim, a new member of the council, said the problem of lagging investment earnings would remain even if lawmakers proposed and voters approved a massive bond issue to cover pension liabilities.

Thank goodness some people know it’s a bad idea.

FROM THE PAST: MENDOCINO COUNTY, CALIFORNIA

I will likely be returning to this letter from a Mendocino County pension board member for a separate post, but look at this:

2. Actuarial surprises that the taxpayers and users of services pay for is the legacy of the pension board. In 1996 we fully funded the plan with a county Pension Obligation Bond or POB to “fix” the problem(fool me once, shame on you), in 2002 we “fixed” the NEW underfunding with *another POB*(fool me twice, shame on me), today we have a larger unfunded liability than ever before and it is getting worse(fool me trice, shame on us!). I no longer give the actuaries very much credibility.

…..
9. Our Target Rate of return (7.25 percent) is 1 percent to 1.25 percent higher than we can justify by what our investment advisor tells us we can expect over the next ten years (6.2 percent) or we have experienced over the last 10 years (5.6 percent). This is the gross rate of return after subtracting the investment management and administration costs. IF we dropped our Target Rate 1 percent our plan funding would go from about 70 percent funded to about 57 percent(include the POBs and we are only about 46 percent funded). With the drop in the Target Rate of Return, employer and employee costs would go up. This is resisted by county and employees because of the “cost”, but there is no free lunch; the cost will be paid now or later. The expected rate of return is what it is. If we do not lower the Target Rate the entire shortfall will be paid via debt by the taxpayers and users of county services; the employees will pay nothing (until their benefits crash). The hesitation and delay is also what one expects to experience from a moral hazard.

…….
13. We have had a miraculous market recovery. When I came on the pension board I was told that the plan funding would return when the market recovered. In 2008 our funding was 94.5 percent, in 2010 it was 78,9 percent, last year it was 70.2 percent. This year it will be worse. Oh how I wish the market would recover; oh, my gosh, it did! Note if you adjust for the overstated Target Rate and the pension obligation bonds as in #9 above…funding is substantially lower.

Here, the board member is doing the proper thing: he is taking the outstanding value of the POBs and adding it to the pension liability. Too often, the bond issuer pretends that this “new” debt is totally separate of the pension system, when it obviously has a direct link.

WHY POBS ARE A BAD IDEA

I will never get tired explaining why POBs are of the devil.

From that post:

I elided over all the bad thinking — the sure debt of 5% in POBs for the supposed good-as-sure 8% returns the pension funds are supposed to yield.

Bullshit.

The point is that it’s a fake bolstering of the balance sheet — the debt is still there, but now it’s in the form of bonds, and the debtor is not the pension fund but the state (or other government employer) itself. But the pension fund debt was the state’s debt to begin with.

As I said in the last POB post, POBs are like a balance transfer.

Only accounting magic makes the debt look smaller than it actually is. And the debt to the pension fund is actually larger than originally stated. Now the state has two creditors: the holders of the POBs and the pension fund. That sounds more like the dollar auction now.

The POB debt is “sure” — the state is supposed to pay off the interest and the principal. The pension debt is less sure, but somehow it seems to grow even faster after this particular POB trick.

And the only states that feel the need to avail themselves of this particular trick tend to have gotten in their position by bad behavior, and they’re not about to change their behavior after the POB is issued.

This is why I say POBs are of the devil — whether or not you believe in a literal devil, the literary devil is the kind that helps you rationalize the bad behavior you already did and are determined on continuing.

Now, if they’re really going to amend their ways, then fine. POBs might not be a bad thing.

But if you plan on fully-funding, then why not do the right thing and pay the full ARC year-to-year, with the unfunded liability being amortzed for the fixed period you would have done a POB? Thing is, you’d really need discipline for the second, while the POB papers over the hole for now (because you put the POB hole elsewhere).

There really is little good reason to do a POB other than two things happening (and both must be happening):
- some entity other than the pension sponsor is bailing out the plan (an example would be a state bailing out a city pension — the state issues the POB to make it an official liability of the state)
- the pension sponsor really will be appropriately funding and managing the pensions in the future

Many times neither situation is holding. The pension sponsor itself issues the bonds, and the pension sponsor continues its bad underfunding ways.

In which case, the pension obligation bonds only made the situation worse, especially if the sponsors think they’re getting free money arbitrage out of the deal…. and the pension accounting encourages this sort of thinking, even still.

STUMP » Articles » Pension Obligation Bonds: Oregon and Alaska -- DON'T DO IT » 4 October 2016, 05:59

Pension Obligation Bonds: Oregon and Alaska -- DON'T DO IT