The Nebraska Legislature on Wednesday rejected authorizing the Omaha Public Schools (OPS) to issue $300 million in bonds to shore up its poorly funded pension fund. The pension obligation bonds (POBs) would have sought to take advantage of the margin between interest rates and the return on asset assumption (ROA).

According to Henry J. Cordes, writer, Omaha World-Herald, “proponents said the bonds could spare cuts in the classroom while also saving district taxpayers millions.” But they could not overcome concerns that the “bonds could prove a risky investment, would limit the district’s financial flexibility, and would not have required voter approval.” The legislation fell three votes short of the 25 needed to advance, failing 22-17.

Without assistance from the POB, OPS must cut its schools budget by $18 million — roughly 3% — and divert those dollars into the underfunded pension fund. That figure is projected to escalate annually, reaching $27 million by 2022.

Some in the Legislature questioned the wisdom of borrowing money with the hopes of making more on the margin between interest rates and investment returns. “I don’t think borrowing money to make money is ever a good idea,” said Sen. Lou Ann Linehan of Omaha.

According to the article, the vast majority of the shortfall “developed over the past decade due to a combination of poor investment decisions, poor economic conditions, benefits for retirees that were more generous than those for other school employees in the state, and the district’s failure to make extra payments into the fund.”

At KCS, we are favorably inclined to use POBs to close funding gaps in DB plans, provided that the proceeds from the bonds are used to defease the plan’s retired lives. We, too, believe that injecting these assets into a traditional asset allocation is risky. There are too many examples of POBs that are now underwater further damaging the funded status of those plans.

Utilizing a defeasement strategy is the foundation of the Butch Lewis legislation that is currently before Congress. Managing a pension plan should be about providing the promise (benefit) at the lowest cost and not the highest return.  Injecting more risk into the process guarantees volatility in returns, but not funding success.