STUMP » Articles » Public Pension Quick Takes: California, Oregon POBs, and the Meaning of Liability Value » 10 October 2016, 12:40

Where Stu & MP spout off about everything.

Public Pension Quick Takes: California, Oregon POBs, and the Meaning of Liability Value  


10 October 2016, 12:40

Let’s get this out before the lunch hour is over!


In yesterday’s post, I talked about pensions getting cut in Loyalton, California.

Here’s a bit in the New York Times:

Public pensions are supposed to be bulletproof, because cities — unlike companies — seldom go bankrupt, and states never do. Of all the states, experts say, California has the most protective pension laws and legal precedents. Once public workers join Calpers, state courts have ruled, their employers must fund their pensions for the rest of their careers, even if the cost was severely underestimated at the outset — something that has happened in California and elsewhere.

There and elsewhere, local taxpayers are paying more and more, and some elected officials say they want to get off the escalator. But Calpers is strict, telling its 3,007 participating governments and agencies how much they must contribute each year and going after them if they fail to do so. Even municipal bankruptcy is not an excuse.

The showdown in Loyalton is raising the possibility that California’s pension promise is not absolute. There may be government backstops for bank failures, insurance collapses and pensions owed to workers by bankrupt airlines and steel mills — but not, apparently, for the retirees of a shrinking town.

“The State of California is not responsible for a public agency’s unfunded liabilities,” said Wayne Davis, Calpers’s chief of public affairs. Nor is Calpers willing to play Robin Hood, taking a little more from wealthy communities like Palo Alto or Malibu to help luckless Loyalton. And if it gave a break to one, other struggling communities would surely ask for the same thing, setting up a domino effect.

Yup, absolutely correct.

It also undermines the argument that pensions can’t be cut for any reason, even bankruptcy.

Remember when Calpers filed an amicus brief to that end for the Detroit bankruptcy? Seems like only yesterday, but it was two years ago.

Calpers does not like the Detroit pension plans being treated like unsecured creditors in a bankruptcy proceeding, and cites the constitutional (state constitutional, that is) protections for pensions. Thing is, there’s law, and there’s reality.

Oh, look! Reality!

Well, that was quick.


Thanks to Jack Dean of Pension Tsunami, who sent me this link in response to my post on Oregon contemplating issuing Pension Obligation Bonds.

Seems my concern for Oregon is a bit tardy, as Oregon loves them some POBs:

Relative to its size, no state can match Oregon’s enthusiasm for POBs. Laws passed in 2001 and 2002 allowed government agencies in Oregon to issue pension bonds and invest the proceeds in PERS-managed accounts. Since then, 97 school districts, 16 community colleges, the state of Oregon and numerous cities, counties, ports and fire districts have issued $5.9 billion worth.

Moreover, only a tiny fraction of the pension obligations bonds issued in Oregon included a call provision, meaning most can’t be refinanced to take advantage of lower rates.

Further clouding the POB picture: The transactions increase the volatility of employers’ PERS costs, and are built on assumptions about payroll growth that may not hold up.

A decade into Oregon’s pension bond binge, results are mixed. Public agencies who borrowed early saw their POB investments skyrocket. Resulting rate credits have slashed pension costs and projections show big savings to come.

“For us, it’s proven to be an enormously valuable strategy,” said David Wynde, deputy chief financial officer at Portland Public Schools. “If there’s an opportunity to do more, it behooves us to look at it. But we’d look very seriously at the risk reward equation.”

Agencies who borrowed in 2004 and 2005 are still living in the shadow of the 2008 market swoon. They realized upfront budget relief, sometimes substantial, and benefited from two years of double-digit returns on their bond proceeds. But the financial crisis struck back. Some still forecast a steady stream of savings. Others face a break even scenario or small losses for the next 15 years, even assuming annual investment returns of 8 percent.

Those who hesitated until 2007 have lost.

Even today, many employer business managers characterize their POB strategy as “refinancing” their pension liability, like a homeowner refinancing an overpriced mortgage. They describe borrowing at rates between 4.7 and 6 percent to “pay” unfunded liabilities on which PERS was “charging” them 8 percent.

But that’s not the way it works. The bond proceeds don’t pay off anything, per se. The better analogy is taking a second mortgage, sticking the proceeds in a mutual fund, and hoping stocks deliver.

Employers’ bond proceeds were deposited in “side accounts” at PERS, which invested the money alongside its pension assets. Employers effectively prepaid their pension contributions for years ahead, and put them at risk along with the historical contributions they’ve already made to the fund.

PERS gradually draws on the side accounts over 20 years to offset annual pension contributions. The account draws are called rate credits, and the system’s actuary recalculates them every two years in order to exhaust the side account by Dec. 31 2027, when the last debt payments on the pension bonds are scheduled to be made. If investment returns are good, side accounts grow, as do rate credits. If the market tanks, the account balance goes down, and rate credits shrink.

“Savings,” in POB parlance, are achieved when the rate credits exceed the debt service on the bonds. The transactions were structured assuming that investments would yield 8 percent returns every year and payroll would grow steadily at 3.75 percent a year. Under those conditions, projections showed steady savings until the bonds were repaid in 2027, even with escalating debt payments.

For employers who borrowed in 2002 and 2003, it worked even better. Side accounts ballooned with compounding double-digit investment returns until 2006, as did the resulting rate credits.

By 2011, POB rate credits generated by smaller school districts like Astoria, Lincoln County and Molalla River were sufficient to wipe out required contributions to PERS, then running at nearly 20 percent of payroll for school districts. That left POB debt payments as the districts’ only retirement expenses.

Portland Public Schools was one of the biggest winners. It borrowed $490 million in 2002 and 2003 and saw its side account fatten to $786 million by the end of 2007 –three times its payroll. Even after 2008, rate credits almost entirely offset PPS’s required pension contributions. So far, PPS figures it has “saved” more than $120 million from the bonding. If projections hold, and its account earns 8 percent annually between now and 2027, the district could save an additional $260 million.


The viability of Oregon’s POB arbitrage is dependent on another variable that’s tough to forecast: payroll growth.

The POB transactions were structured assuming that employers payroll will grow 3.75 percent each year. PERS’ actuary resets employers’ rate credits every two years to take account of what actually happened with payroll and investments returns, but its rates are locked in for two years.

If, in the period between rate resets, payroll grows more quickly, that fixed rate can draw down an employers’ side account more quickly than forecast, robbing future years of investment earnings potential. In an analysis prepared for employers this summer, Seattle Northwest called it “eating the seed corn.”

Sherwood School District, for example, issued two series of bonds, in 2002 and 2005, totaling $13.5 million. By 2011, it had realized $4.7 million in budget relief, as its side account generated rate credits averaging $1.3 million a year to offset PERS contributions. That was more than double its annual debt service on the bonds.

But what drove those rate credits, in part, was payroll growth averaging nearly 12 percent a year.

Sherwood still has 15 years left on its bond payments. But it’s side account is so depleted by aggressive crediting that future draws are unlikely to exceed debt payments — even if PERS returns average 8 percent annually.

This is why I look to the past (that bit was from December 2012, but it’s talking about even older POB issues). See what bad things happened and don’t do it again.

And “maybe we might get lucky!” after one round of Russian Roulette doesn’t mean you should try it again.

Anyway, the author of that piece, Ted Sickinger, has written the best explanation of POBs like so:

Even today, many employer business managers characterize their POB strategy as “refinancing” their pension liability, like a homeowner refinancing an overpriced mortgage. They describe borrowing at rates between 4.7 and 6 percent to “pay” unfunded liabilities on which PERS was “charging” them 8 percent.

But that’s not the way it works. The bond proceeds don’t pay off anything, per se. The better analogy is taking a second mortgage, sticking the proceeds in a mutual fund, and hoping stocks deliver.


He’s also written a recent piece on Oregon considering issuing even more POBs.

I don’t have much hope, but maybe this time it will work.


And part of the reason I know it won’t work is because nobody really listens to the actuaries. They barely listen when we tell them something they want to hear, so you’d better believe they’re not going to listen when it’s bad news.

To kick this off, a bit from John Bury reacting to an op-ed:

Thomas J. Healey, a senior fellow at Harvard’s Kennedy School of Government, coordinated the work of the New Jersey Pension and Health Benefit Study Commission which has been totally ignored leaving him little to do but vent in a Baron’s editorial* that concludes:

Elected officials have an obligation to look beyond short-term political expediency and undertake comprehensive reforms that do right by their employees, retirees, and taxpayers. Everyone must wake up to the fact that unfunded pension and health benefit liabilities are explosive. Expecting conditions to improve with an uptick in the stock market or the imposition of a new tax or two is irresponsible, if not delusional, governance.

Which will continue at least through 2017 and the next gubernatorial election but Mr. Healey may have unintentionally hit upon the reason for the stasis earlier in his piece:

Two decades of fiscal and political irresponsibility have led New Jersey to one of the worst pension funding ratios in the U.S., along with repeated downgrades of the state’s credit ratings. Elected officials of both parties made pension promises they refused to honor through appropriate funding. They spent money on things voters can see rather than stowing it away in funds only actuaries can appreciate.

A doctor diagnoses cancer and you go on chemotherapy the next day. An engineer uncovers a design defect and a bridge closes to traffic the next day. An actuary predicts pension bankruptcy (albeit in a footnote on page 83 of a 134 page actuarial report which includes 40 nonsensical histograms) and it is only the actuary who appreciates the seriousness of the situation!

Not all cancer patients die and not all bridges with defects collapse so why are those professionals taken so much more seriously? It’s something to ponder.


The op-ed from Thomas J. Healey, a senior fellow at Harvard’s Kennedy School of Government, is at Barron’s, and I want to emphasize a different part:

While pensions are about numbers, pension reform is about politics. Without a crisis staring them in the face, legislators are only too willing to punt. Even the most tottering plans may have 10 years, 20 years or more before the well actually runs dry, so neither lawmakers nor citizens perceive an imminent threat in need of immediate action.

In New Jersey, the general public has met dire warnings of fiscal chaos with resounding yawns, while public employees have sought to strangle reform by a constitutional amendment mandating that existing pension benefits be maintained and funded in full, regardless of cost. Although such constitutional guarantees have made reform more difficult in other troubled states, New Jersey taxpayers have been told that revenue growth will ensure the proposed amendment will not cost them a dime in new taxes or service cuts.

If a state chooses to sanctify its benefit payments, its officials should be forced to provide permanent funding for the promises they make to public employees.

People need to realize that the pensions/pensioners are being cheated well before the pension benefits get cut. When pensions are deliberately underfunded, that’s already telling you they don’t plan on paying the benefits.

Now, some politicians can go the ‘we’re just ignorant!’ route, backed up with crap like this:

Tim Dolehanty, the county’s controller-administrator, said MERS’ goal is to assure all of the money needed to pay pensions would be available if every county employee retired at the same time.

“It’s a ridiculous scenario,” Dolehanty said. “But, that’s what they’re trying to do.”

As I wrote at the Actuarial Outpost, it’s Dolehanty who is being ridiculous.

I highly doubt any actuary told this controller this. Looking at his background, I see he’s been controller in various places and got a Masters in Public Administration in the past decade. I’m going to guess they didn’t teach him what pension values on the balance sheet means.

It doesn’t mean everybody retires at the same time.

I’ve explained it before:

In no actuarial method that I know of do we assume that everybody is going to retire tomorrow in setting the value of that liability. There is a set of assumptions, one of which is the distribution of ages at which people will retire.

Now, those assumptions can be wrong, but nobody uses the “everybody retires tomorrow” assumption unless something really bizarre is happening.

It’s not quite the same, but it would be equivalent to “everybody dies tomorrow” assumption for an actuary valuing life insurance reserves or “everybody is in a car accident tomorrow” for an actuary setting personal auto reserves. It’s absurd… and would make the funded ratio look much, much worse.

There I was talking about the old funded ratio stuff, but here this is just about full funding.

So I checked out the Public Plans Database page on MERS, (ew, 70.6% funded) to get to their Dec 31, 2015 CAFR.

Here’s the retirement assumption: [numbered page 93, PDF page 103]

Retirement Rates

A schedule of retirement rates is used to measure
the probability of eligible members retiring during the
next year. The retirement rates for Normal Retirement
are determined by each member’s replacement index
at the time of retirement. The replacement index
is defined as the approximate percentage of the
member’s pay (after reducing member contributions)
that will be replaced by the member’s benefit at
retirement. The index is calculated as:

Replacement Index = 100 multiplied by Accrued
Benefit ÷ by [Pay – Member Contributions].

Retirement rates for early reduced retirement are
determined by the member’s age at early retirement.
The revised normal retirement rates below were first
used for the December 31, 2009, actuarial valuations.
The early retirement rates were first used for the
December 31, 2011, actuarial valuations.

And here’s the tables:

I don’t want to geek out about how to interpret these tables, or why they’re structured this way, but let’s just say: do you see 100% anywhere in those tables?

As in, everybody retires at the same time (for various definitions of “same time”)?


MERS does not use that assumption.

Please go ask the actuary as to the high-level meaning of the accrued pension liability. Please listen to the actuary.

You really need to learn what this stuff means if you’re in charge of making sure it’s fully funded.

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