Another Arrow in Their Quiver

The Illinois State Assembly has passed HB0417, a piece of legislation designed to provide funding flexibility in support of the Chicago Park District pension fund. According to the brief explanation of the bill, the legislation “amends the Chicago Park District Act and authorizes the Chicago Park District to issue bonds in the principal amount of $250,000,000 for the purpose of making contributions to the Chicago Park District Pension Fund”. There are other provisions within this legislation, but the ability to raise funds through bonding is the critical element.

We continue to live in a nearly historically low-interest-rate environment. As we’ve discussed previously, it is quite prudent to take advantage of these low rates to stabilize defined benefit plans that will not achieve full funding through investment returns alone. An investment of $250 million through a pension obligation bond (POB) will dramatically improve the plan’s funded status and help stabilize annual contribution expenses.

Now that this legislation has passed, the fund and its advisors need to consider how the proceeds will be invested. Historically, POB proceeds have been injected into the plan’s existing asset allocation. This has proven to be a mistake in many cases and is very much dependent on the “timing” of the investments. POB proceeds should be invested in a way that ensures that the liabilities (promised benefits) are secured through a cash flow matching strategy (CDI) that will match and fund each monthly liability (and expense) chronologically until the POBs assets are exhausted. This strategy is NOT dependent on future market returns, as the assets and liabilities are matched no matter what happens with interest rates, as there is no interest rate sensitivity since we dealing with future values.

Furthermore, the current assets and future contributions can be managed more aggressively and unencumbered, as they are no longer a source of liquidity to fund benefits. Buying time for the alpha bucket improves the probability that the fund will achieve its return on asset (ROA) objective. The S&P 500 dividends alone account for over 50% of its growth in the last 40 years. This cash flow matching strategy is a return to pension basics. It is also how insurance companies and lotteries work, and quite successfully I might add. Why pension America ever departed from this approach escapes me. But let’s not focus on past mistakes. It is time to use all the tools in our toolbox or arrows in our quiver to help stabilize these critically important retirement vehicles. America’s workers are counting on pension systems to deliver on their promises.

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