Pension Obligation Bonds: Wave Of The Future?

MARCH 1999 - Battle Looms Over Who Benefits From A Pension Surplus - Ever
since the City of Worcester sold $220 million in pension obligation
bonds, POBs have become the hottest buzzwords in public retirement
circles. But even with all the fanfare, it remains to be seen if POBs
are the wave of the future.

There's
little doubt that Worcester's success has generated tremendous
interest. About a month ago, over 250 people attended a POB seminar in
that city, sponsored by the Mass Public Pension Forum.

While
Worcester may have been the first municipality to issue POBs, it
apparently won't be the last. At the close of the last legislative
session, both Everett and Holyoke succeeded in enacting laws that allow
each city to issue POBs (Chapter 455 for Everett and Chapter 454 for
Holyoke).

As anticipated, the push
for POB authorization at the State House does not stop with these 3
cities. "Our city (Brockton) has filed legislation for POBs," according
to that city's Retirement Board Chairman Bill Harris. "And I expect
we're not alone in doing that."

Several
municipalities, like Brockton, have introduced POB legislation. In
addition, a bill, allowing any city or town (including those belonging
to a county or regional retirement system) to issue POBs, has been
filed by the Mass. Municipal Association (H-1620).

Impending Battle With Full Funding

As
the legislature considers its next action, the debate on whether POBs
are the prudent strategy to achieve full funding continues among public
retirement officials. For retirees, POBs raise a fundamental issue that
must be addressed if the strategy is adopted, and that's the following:

What
happens once a retirement system becomes fully funded, as Worcester did
with the POB sale, and then continues to reap substantial earnings from
its investments? An impending battle looms over who will benefit when a
system, under this scenario, has investment earnings, exceeding the
rate of return it must achieve under the plan's assumptions, and has
what could be termed a surplus.

On
one side, municipal officials may argue that any surplus should be used
to reduce their annual appropriation to the pension system, possibly
down to zero. On the other side, retirees and employees will be
contending that such earnings should be used for benefit enhancements
(e.g. improved COLAs or increased minimum survivor benefits) or
reduction of employee contribution rates (e.g. new employees contribute
9% plus 2% over $30,000 in salary).

"Elected
officials should not lose sight of the fact that a pension fund's
excess earnings result from a retirement board's prudent investment of
retiree and employee monies in that fund," points out Association
President Ralph White. "We'll be working closely with the State House
and interested parties to ensure that retiree interests are upheld in
any comprehensive POB legislation."

Everett and Holyoke Develop Plans

While
interested cities and towns are anxiously awaiting legislative action,
Everett and Holyoke are developing their POB plans. According to
Everett's Auditor Don Andrew, who is also chairman of the city's
retirement board, "Our Board is working with the actuary to establish a
POB plan for local and state approval. We expect to be well along with
our plan by March."

Since timing is
all important in the POB sale, Holyoke is also moving fast to get
approval by the Office of Administration and Finance. "To its credit,
Worcester was able to take advantage of a favorable bond market," says
Holyoke Auditor Brian Smith. "Naturally, we want to seize that same
opportunity and, therefore, intend to proceed expeditiously with the
approval process."

As reported in
the January Voice, Worcester's retirement system received $217 million
with the POB sale. With that deposit, the system's assets total almost
$529 million, making Worcester the third largest in assets behind the
State/Teachers and Boston Retirement Systems. The city's Retirement
Board was able to put the new money to work right away. It has hired
new managers, including ones for a core real estate mandate, venture
capital, and timberland investments.

May Not Be Answer For All

As
we reported, POB interest is strong in the public retirement community.
But it may not be the answer for all retirement systems.

While
only a handful of systems, including Wellesley, Norwood and some state
authorities, are now considered fully funded, investment experience
over the past 10 years could mean that other retirement systems achieve
that status in the not-to-distant future. For those retirement systems,
it may not be prudent to extend out their debt (to pay off unfunded
liability) further with a POB sale.

Even
when a retirement board and local officials have done all their
homework, the actual POB sale depends upon a favorable bond market, as
existed for Worcester. If the market isn't there, a sale makes no
fiscal sense.

We've spoken with retirement and local officials about POBs. Here's a sample of what some of them had to say:

According
to Association Vice President Joe Graziani, who is on the Milton
Retirement Board, "We've taken preliminary steps with our financial
advisors in analyzing POBs for our town. Milton is a well-funded system
and also receives a state appropriation as a participant in the PRIT
Fund."

"It's questionable whether a
POB is the 'right fit' for Milton. But if it is, since the system's
value will be much greater, our PRIT appropriation should go up
appreciably."

For Milton and other
systems, there are a host of crucial questions, including the system's
ability to absorb new additional benefits after it's fully funded, or
what investment strategy will be adopted once the system is no longer
under-funded.

Because of these and
other complex issues, we found that most boards are proceeding in a
deliberate manner. For example, the Quincy City Council has passed a
resolution calling upon the retirement board to study POBs and report
its findings. "We will be closely examining the issue" says Board
member Fred McCray.

While some POB
proponents may contend that the time is now, it's apparent, from our
conversations, that, even assuming the legislative authority exists,
retirement boards have no intention to act hastily. According to
Braintree Retirement Director Phyllis DePalma, "Our board has directed
the actuary to make a preliminary analysis , and after reviewing these
initial findings as well as having discussed this with town officials,
it will then decide whether to proceed further."

We
have also seen from our sample that retirement systems may be
considering "modified" approaches to a POB sale. "Watertown is a
well-funded system; therefore, a POB sale to pay off the entire balance
of our liabilities may not be, in the final analysis, a prudent
decision," commented Town Treasurer Martin Walsh. "A partial POB sale
could make sense, but again we'll have to wait to see what the hard
numbers show and the legislation allows."

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