City of New Haven Contemplating a POB

The City of New Haven, CT, is contemplating a pension obligation bond (POB) to sure up the City Employee Retirement Fund. The proposed ordinance allows the city to issue up to $250 million in pension obligation bonds next fiscal year to help pay down some of the unfunded liabilities.

CERF, along with the Police and Fire plan, is one of two defined pension plans that the city pays for each year to cover retirement benefits for city employees. The P&F covers pensions for public safety personnel like police and firefighters; CERF covers pensions for all other unionized city employees.

According to Acting Budget Director Michael Gormany and City Controller Daryl Jones, CERF and P&F are each currently funded at around 40 percent. But, we aren’t sure if this is based on GASB accounting or a true mark-to-market basis.  If the former, the funded status could be a lot uglier.

CERF and P&F were each funded at 60.6 percent in June 2008. That number has decreased precipitously over the past decade as the city has struggled to deposit, invest and earn enough money to keep up with the ever-increasing pool of retirees and beneficiaries.

The city is expected to contribute $21.9 million in CERF and $34.6 million in P&F, which are the same as last year, but since 2012 the combined contributions have grown by more than $16 million.

The proceeds from the potential POB would flow to CERF and not P&F.  It is anticipated that the funds would bring the funded status to 85%.  However, as we’ve witnessed on many occasions, the proceeds would be injected into the same asset allocation, and the goal would remain to achieve the return on asset assumption (ROA).

Given where equity valuations are, we believe that injecting this money into a traditional asset allocation is foolish. A better strategy for CERF would be to determine the amount of money necessary to retire all of the retired lives and to then immunize those lives. This strategy would improve the liquidity necessary to meet benefit payments and it would convert the fixed income exposure, with its interest rate sensitivity, to a cash matching strategy that eliminates this source of volatility.

Furthermore, by retiring all of the currently retired lives, the investing horizon is extended allowing for the liquidity premium to be captured from investments in equities, real estate, and other non-traditional investments (alternatives).

There are too many examples of public pension funds issuing POBs at the peak of the equity market in an attempt to capture the potential arbitrage between the ROA and the debt service. Unfortunately, most of those efforts have proved futile. Let’s stop managing pension plans against an ROA objective and start managing these assets to provide the promised benefit at the lowest cost.

The issuance of a POB is not the problem.  But, using the proceeds to fund a traditional asset allocation is! When will these plan sponsors and their consultants learn?



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