City Adopts Innovative Funding Plan

SEPTEMBER 1998 - Worcester To Issue Pension Obligation Bonds - Ten
years ago, a new pension law, with far-reaching impact, took effect
that permitted local retirement systems to establish a 40-year funding
schedule in order to pay off their unfunded pension liabilities
(Section 22D of Chapter 32). Now 10 years later, another new law has
taken effect that could have as significant an impact on how local
systems pay off these liabilities.

Chapter
191, of the Acts of ‘98, permits the City of Worcester to immediately
implement an innovative plan towards paying off its unfunded pension
liabilities. It’s anticipated that other municipalities and their
retirement boards will be closely monitoring the Worcester plan and
considering similar legislation for themselves.

Section
22D requires a municipality, like Worcester, to make annual payments to
the retirement to satisfy its obligation toward the unfunded liability
under the funding schedule. Chapter 191 permits Worcester to issue
“special” municipal bonds, commonly referred to as pension obligation
bonds (POBs), and use the cash from the sale of the POBs exclusively to
pay in full, and not annually, its obligation.

Worcester
will be the first municipality in the Commonwealth to issue POBs. While
these bonds have been issued in other parts of the country, it has not
been universally adopted by the vast majority of pension funds
nationwide.

]POB Becomes Law At Session’s End

At
the same time that Worcester retirees began the big push for final
acceptance of the COLA law (see related article, p.17), city officials
sent a home-rule petition, authorizing the city to issue POBs, to the
State House (S-1220). Since it was filed so late in the legislative
session, S-1220’s prospects for enactment were uncertain at the outset.

But
the Public Service Committee acted promptly, reporting the bill out
favorably shortly after its filing. From there, the Worcester
legislative delegation successfully carried the bill through the
process to its final enactment by the Legislature.

While
the bill sat on the Governor’s desk for his signature, proponents were
concerned that since POBs had never been issued in the Commonwealth,
the bill could suffer a veto. Their concerns were not realized and on
the next to last day of the ‘98 legislative session, the Governor
signed Chapter 191 with an emergency order, allowing it to take effect
immediately.

Not Without Some Controversy

As
passed, Chapter 191 differs from the original home-rule petition in
that it requires state approval before Worcester can issue the POBs.
One major reason for this difference lies in the fact that the POB
concept is not without some controversy.

For
POB proponents, particularly those from Worcester, there’s no question
that the issuance of POBs can be beneficial to both the retirement
system and the municipality. “If issued when the proper economic
factors exist, then POBs can produce substantial savings for Worcester
while paying off its entire unfunded pension liability,” states City
Auditor Jim DelSignore who also sits on the retirement board. “But just
as importantly, the city’s retirees will have a retirement system that
will be fully funded in connection with their pensions and COLAs
(cost-living-living adjustments).”

Worcester’s
current unfunded liability, with cost-of-living adjustments being
included, is estimated at almost $215.8 million over the next 30 years.
If Worcester issued POBs to pay off this liability, rather than making
annual appropriations under the funding schedule, then it’s anticipated
the city will spend millions upon millions less over the next 30 years
- a substantial savings to say the least.

“To
understand POBs, one could think of the homeowner who is refinancing
his mortgage,” explains Terry Gerlich of Freedom Capital, which
currently manages pension funds for several retirement systems. “ Like
that homeowner who replaces his existing mortgage with a new one, at a
lower interest rate, in order to reduce monthly payments, the city will
use the cash from the sale of the POBs to pay off, in full, to the
retirement system its existing obligation toward unfunded liabilities.
Having paid that obligation in full, the city must then pay back the
purchasers of the POBs at a lower rate of interest.”

For
example. a city could be making payments under the pension funding
schedule, over the next 30 years, at what could amount to an interest
rate of 8 to 8.5%, but with the POBs it may be able to make its
payments on the bonds, during that same period of time, at a 6 to 7%
interest rate.

In other words, the
city saves the difference between what it would have been paying on the
pension funding schedule and what it will pay on the bonds. Assuming
that interest rates are low when the POBs are sold, then a municipality
could save substantial money over the next 30 years.

But
if bond rates go up, then the municipality could find itself paying
more for the POBs. Since there are risks unless economic factors are
right, the skeptics urge caution when it comes to the POB concept. And
that is where the controversy over the POBs arises.

“For
retirees, their benefits, including COLAs, are protected under the POB
concept, since, the risks, that concern the skeptics, fall on the
municipality, and not the retirement system,” says Legislative Chairman
Bill Hill. “Even so, if given the opportunity in the future, systems
will have to give the POB concept a long hard look to determine if it
is the proper fit for them”

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