I wasn’t always a fan of pension obligation bonds (POBs), as study after study revealed in most cases that pension plan sponsors that had issued a POB failed to improve the long-term financial viability of the program. The Center for Retirement Research at Boston College has produced a couple of studies related to the success(?) of POBs. Their last update was in July 2014. Their analysis makes some of Steven King’s most frightening plots seem like little more than a fairy tale.
It would be very appropriate to ask me why the change in opinion nearly 40 years into my career. Well, you can thank my involvement in the Butch Lewis Act (BLA) for adjusting my opinion. I’ve expressed my feelings about the BLA legislation many times during the last several years, and for the record, I still believe that this legislation would accomplish the goal of securing the promised benefits for participants in critical and declining multiemployer plans. It is truly sinful that the financial well being of 1.4 million Americans, who are in these struggling plans, hangs in the balance because the US Senate has failed to act.
That said, the BLA team put together a strategy to stabilize these trouble plans by departing from the status quo of trying to maximize returns and instead focused on securing the promised benefits by defeasing the Retired Lives Liability with the loan proceeds. Brilliant! This action enabled the plan sponsor to use the fund’s current assets and future contributions to meet future liabilities and the repayment of interest and principal on the loan, because the defeasing strategy bought essential time for the plan.
Unlike that which we’ve witnessed in many public pension systems throughout the country since the Great Financial Crisis (GFC), this proposed legislation did not achieve financial security on the backs of the participants. In fact, for multiemployer plans that had already gotten approval from the DOL to reduce promised benefits, the original benefits would have to be reinstated should they wish to take a loan out to further stabilize their system. Importantly, there was no calling for increased contributions from employees, longer careers until full benefits were achieved, increased retirement age, reduced benefits, etc.
The proposed legislation worked because the “reforms” were to be adopted by the sponsor and focused on how they managed the plan’s assets.
Taking the proceeds from the POB and injecting them into a traditional asset allocation subjects those new assets to all the risks of the markets with NO guarantee of achieving success. The arbitrage that they are seeking to capture between the target ROA and the interest on the bond comes with great risk. By defeasing the Retired Lives Liability the plan is no longer engaging in a game of chance, but is instead protecting all of the entities that ultimately fund that monthly benefit payment.
Given the current financial condition for many public pension systems, significant funding gaps are not going to be closed through annual budget contributions and market returns. These significantly negative cash flow funds must receive a financial lifeline to stop the bleeding before they are nothing more than pay-as-you-go entities. The POB, long distained by me, is the best option at this time. The fact that we are in an historically low interest rate environment only makes the use of these financial instruments more appropriate. But, time is wasting.