City Adopts Innovative Funding Plan

You are here: Home

Investments

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”

< Prev		Next >

Main Menu