STUMP » Articles » Two Awful Tastes That Go Great Together: Pension Obligation Bonds and 80% Funding Myth » 15 March 2018, 12:24

Where Stu & MP spout off about everything.

Two Awful Tastes That Go Great Together: Pension Obligation Bonds and 80% Funding Myth  


15 March 2018, 12:24

I thank my readers who emailed me these stories – (note: email me at – my normal news searches would have missed the crucial items.



Okay, maybe not, but there is some awfully suspicious behavior going on in these types of articles.



So here is the first one I came across.

New Haven will look to borrow $250 million to fund pension liability

NEW HAVEN — The city, to better situate one of its pensions, is proposing to borrow up to $250 million to bring it to a funding level recommended by actuaries.

It is a suggestion that at least one alder said he will need considerable assurance is the right move before he can vote for it.

The pension discussion came at the end of the first public hearing on the city’s fiscal 2019 $547 million budget proposal that represents a 1.52 percent increase over the current year and an 11 percent hike in the tax rate to 42.98 mills. The proposed capital fund is $79 million.

Acting Budget Director Michael Gormany and Controller Daryl Jones elaborated on the pension proposal before the Finance Committee of the board after a dozen residents had testified earlier in the evening that the tax hike was unaffordable.

The $250 million would shore up the City Employee Retirement Fund, or CERF. Both CERF and the separate Police & Fire Pension Fund are only funded at an estimated 40 percent.

The infusion of $250 million in pension obligation bonds into CERF would bring it to an 85 percent funding level. Actuaries want to see a pension funded at 75 percent or more.

As per my the comment I stuck on the story:

I am extremely suspicious about the unnamed actuaries who supposedly want to see the pension funded at 75 percent or more.

If an actuary mentioned 75% at all, they may have been referring to what the credit rating agencies are looking for, when considering municipal credit ratings. Whether they should be happy with only a 75% funded ratio after so many years of a rising stock market…. well, I’m not at a credit rating agency.

But there is nobody named — and for all I know, the non-actuaries running this meeting may have just made that 75% up.

Let’s get to the POB idea:

Jones said right now the 40 percent funding level negatively affects the city’s ability to borrow, but greatly increasing the funding level will help the city’s general financial standing.

The goal is to save money immediately on the annual required contributions to the pension fund, which is now $21 million, but could quickly drop to $18 million or $19 million and then lower, Gormany said.

The total pension liability is $746 million for both pension funds. Jones said every year the unfunded liability grows by 7.75 percent, making it hard to catch up unless more money is added to pay down the liability up front.

For the pension obligation bond to make sense, Gormany said the interest on this bond, plus the lower annual required contributions payment would have to be lower than the current annual required contributions.

“I won’t pull the trigger unless we’re below that amount,” Jones said.

So let’s think this through.


You have a big debt, and to meet your minimum payments means a large increase in what you’re needing to pay. This big debt has an interest rate of 7.75%.

You decide that what you need to do is refinance that debt at a lower interest rate. Let’s say you can get a rate of 5.5%. There is some upfront fee to do this refinance, but most of the time, if the interest rates are different enough, this is a clear winner. You’re going to pay much less in interest charges over life of your debt if you can reduce the interest paid.


That is the purported logic behind POBs.

Here is the reality.


You have a bunch of assets. Their value may have some uncertainty in them due to all sorts of reasons, but let us assume they have a market value. You could theoretically trade these assets and get cash right now. There is uncertainty in what these assets will be valued at in the future, and some uncertainty in the cash flows they throw off (such as bonds). Certain assets have more uncertainty in them than others.

You’ve made a bunch of pension promises, which have a lot of uncertainty in how much you’re going to be paying and when. Sometimes uncertainty is reduced (such as, when someone actually retires – you know what their initial benefit is, at least), but there is a range of outcomes.

You’re trying to match up the assets with these liabilities, so you make certain assumptions and estimations to see how well they match. Let us say, one of the assumptions is that the assets will have an effective investment return of 7.75% per year. But that’s only an assumption – you definitely don’t have a certainty.

Your current amount of assets, assuming they throw off 7.75% per year, do not match the promises already accrued. So you figure out what amount of additional assets – assets you do not currently have – also throwing off 7.75% per year would match your pension promises.

Let us suppose you issue a 30-year bond in the amount of this gap — and you get an interest rate of 5.5% on that bond.

This is what has happened: you have added a debt where you know how much you will be paying to pay that bond for the next 30 years.

The additional assets go into the big asset pile, with all its uncertainty. You definitely don’t have a guarantee that the assets will be throwing off 7.75% per year.

On top of that, the original pension promises still have all their embedded uncertainties.

From the point of view of the pension sponsor, you have made additional promises, in the form of this bond.

Theoretically, you could default on that bond in the future. Potential bondholders will require higher interest rates the more likely they think you’re going to default, especially since they know it’s well-nigh impossible to get money out of a pension fund for anything other than the pension once that money is in there.

So now, one has made additional promises to the tune of whatever they issued the POB for. One hopes one can do better with their big pile of assets than what they’re having to pay interest on — and remember, the bond debt is a sure thing, while the asset returns are not.

Check out my very complicated balance sheets:

The difference between the asset pile and the liability pile is unchanged. The total gap is the same, from the sponsor’s point of view. But that’s just at the moment of inception — once things start moving forward in time, the assets and pension liability will do whatever it does… and the bond liability G will have a deterministic trajectory.

To the extent that both the pension assets & pension liabilities behave as assumed, all will be well.

But it’s never going to behave as assumed – there is a huge range of possible outcomes. And a lot of them are bad.


I am put to mind of the people I knew in the 90s who were trading on margin.

Leverage in the financial world works similar to levers in the physical world: it amplifies things.

If you overshoot your target return, leverage amplifies it, and you make even more money! YAY!

But if you undershoot it, that undershooting is also amplified. You now have even more promises you have to fulfill.

I am not a market-timer, but it seems to me that timing is of the essence for these POBs.

I found this report on Connecticut municipal pensions, and POBs, from 2015.

Here’s a table:

Some of these sponsors issued bonds at very inopportune times, to say the least. August 2000? Yeesh.

But if you look at the Bridgeport Public Safety Plan A, which had the POB of $350 million issued in August 2000 (yeesh), and the funded ratio they have for the plan in July 2014 — only 44% — of the $337 million AAL they had to deal with at that point.

So let us understand this rightly — they currently have an AAL less than the POB issued (and I don’t know if it was structured as a sinking fund, for what term, etc… a lot of details are missing in this summary) — and they’re still only 44% funded. Oh dear god, they recently did another POB. JEEZ.

Anyway, POBs will not make unaffordable pensions magically affordable. Chances are, if you had a gawping hole in your pensions when you issue the POB, years later, you will still have a gaping hole and an additional debt obligation. Way to go.

Gary Doyens, a regular budget watchdog, said the document is “littered” with mistakes and bad projections to protect the status quo.

He was incredulous about the $250 million for the pension fund.

With the volatility in the stock market, “there is no assurance that whatever you can borrow at is going to do better in the market,” he said.

Thank you, Gary. New Haven would just adding to their indebtedness by borrowing.

In addition:

He said the idea that New Haven can weather the financial crisis at the state level is “foolishness.”

“It is time to get this budget in line with reality,” he told the Finance Committee. Half of New Haven’s property is non-taxable because of state laws.

“The state has no more money … it is not going to automatically fall from the sky,” Doyens said.

Yup, the state is not going to bail out New Haven. It can’t even bail out itself.


The next item in the article is this:

Wendy Hamilton, after approaching the alders asked: “Are you joking or are you on drugs?” referring to the tax increase. “I have two words for you: Tax Yale.”

Heh. Connecticut has tried doing this before.

April 2017: Let’s tax Yale — Here’s why and how

First, Yale (as a tax-exempt entity) did not have to pay corporate income taxes (as would other corporations) on the earnings from its $25 billion endowment — a savings of $2.1 billion. Second, it received $2.96 billion from a combination of federal contracts, grants and payments. Third, the state of Connecticut paid $31.8 million to Yale under various service contracts with state agencies (taxpayers are giving Yale a lot of business).

Finally, Yale saved $708 million in municipal property taxes (that other corporate entities would have paid over these years).

As a technical matter, it would be pretty easy to tax Yale, and I believe that Sen. Looney’s proposal to do something like this last year failed so miserably (and brought national ridicule to the state) because it was rolled out so badly. In fact, the proposal was based on some hard and competent tax thinking that has floated around Congress and Washington D.C. think tanks for years — and it would not “tax Yale” in the broad sense, but it would impose an excise tax only on the income and gains from Yale’s endowment (its “savings account”).

There is, in fact, a class of tax-exempt organizations (private foundations) that have been subject to a 2 percent tax of this type since 1969, and the Congressional proposal (which Connecticut could adopt) would piggy back on this same approach (at a tax rate to be determined).

Yale’s investment earnings in 2014 were $2.9 billion (as reported on line 10 of its publicly available tax return for that year), and I leave it to Mr. Pinkus to do the arithmetic necessary to figure out how much could be extracted to make a dent in the unfunded pension and healthcare obligations owed to his membership as a matter of human right or otherwise.

John M. Horak is the director of TANGO Nonprofit Education and Consulting.

Of course, Congress beat CT to the punch in taxing endowments. Heh.

The new endowment tax is for those with >$500K per student.

Checking out current rankings, that will hit Yale, definitely. They’ve got more than $1.8 million per student.

An earlier piece from 2016: Idea Of Yale Fleeing Taxes Makes CT Look Bad. And I could see Yale leaving — it’s not like NYU & Columbia’s link to NYC, or Harvard & Boston College’s link to Boston. Yale could be anywhere.


But wait, that was merely the first story on the New Have idea that I came across.

Here’s the second, and, if anything, it’s worse:

$250M In Borrowing Pitched For Pensions

They said that the new funding level would meet the definition of “fully funded,” which actuaries define as 75 percent or higher.



No, fully-funded is exactly what you think it is: 100% funded or better. Not 75%.


Jim Palermo is obviously talking about Illinois here:

But I want you to look at this graph from a January article:

And the text:

Created in 1958, New Haven’s pension for public safety employees is underfunded, both in the short and long terms, like many public pension funds.

Decades from now, the P&F fund won’t have enough money to pay out what employees are being promised, without more investment. According to a June 2016 valuation, the P&F fund meets only 43.2 percent of its liabilities — way down, just in the last decade, from covering 60.6 percent in mid-2008.

They weren’t in a good place in 2008, right before the market drop. In a decade, they have barely improved their position from post-drop.

The people making the decisions, with regards to the funding of the pension, are not the people who end up having to pay when it gets worse from year to year.

Issuing a pension obligation bond doesn’t fix the problem, but shoves a bigger problem onto the people who will have to pay for this later.

Please, do not do this. This is not a good idea.

Related Posts
The End of an Era: Where are the 80% funding myths of yesteryear?
At the Half: Updating the 80 Percent Funding Hall of Shame
80% Fundedness: An Excellent Example and The Usual Disappointments