Question: What is the purpose of a Pension Obligation Bond?
- A POB is intended to take advantage of potential arbitrage opportunities by investing in higher return asset classes that should outperform the cost of the bond? or
- A POB is intended to secure the promised benefits and improve the plan’s funded status by investing the POB bonds proceeds in a cash flow matching strategy (bonds) that match and fund the pension plan’s liabilities from next month’s payment out as far as the POB proceeds permits?
For decades, most plans have said that 1 was the correct answer. It’s all about the arbitrage, especially with interest rates being at “historic lows”. But as multiple studies have shown, issuing a POB and hoping that the proceeds are invested in instruments that outperform the plan’s ROA over time is little better than screaming red when the roulette wheel spins. Given the low interest rates and stretched valuations for equities, is there a great probability that the plan will produce a total fund return that exceeds the cost of the POB during the next 10 years?
At Ryan ALM, we would unequivocally state that the true objective of a POB is to SECURE the promised benefits by cash flow matching the POB proceeds against the plan’s projected benefit payments and expenses. By doing so, the plan has bought time for the current alpha assets to grow unencumbered, improved liquidity, removed interest rate risk, and stabilized both the funded status and contribution expenses.
Remember, we have gone through several major corrections during the last two decades that would sabotage a POB strategy reliant on generating 6+% returns and capturing the arbitrage. Why take the risk? POBs are a great tool provided that they are implemented appropriately. Reach out to us at Ryan ALM to discuss our game changing strategy.