We’ve been discussing pension obligation bonds (POBs) for the last couple of years and it seems as if folks are listening! According to a WSJ article that was published during the weekend, there have been 72 POBs issued in 2021 compared to the annual average of 25. In addition, more POB money has been raised this year than in any year during the last 15 years. We think that a POB can dramatically improve a plan’s economics provided that the proceeds are not used within the plan’s current asset allocation.
According to the WSJ article, the average interest rate for a municipal POB is 3%, while the average pension plan is striving for a 7% ROA. If the potential arbitrage is the driving factor in the decision to issue these bonds – good luck! Certainly, the historically low-interest rates help but remember that we are at historic levels for equities and the fundamental support is eroding. A dramatic decline in the equity markets would undercut the benefits of this issuance. We’ve seen this story unfold numerous times and it is what led the Center for Retirement Research at Boston College to issue their initial POB study in 2009. Their conclusions were not very supportive of using POBs to support DB plans.
There are potentially huge savings by issuing POBs in this environment, but plans need to be smart. Defease your pension liabilities chronologically as far out as possible using the POB proceeds. This allows your current assets and future contributions to be used for alpha-generating purposes, as they can now grow unencumbered as they are no longer a source of liquidity to meet benefits and expenses. Our work in this space has shown that plans can dramatically improve their plan’s funded status, stabilize contribution expenses, and in most cases reduce the target return on asset assumption (ROA). We’d be happy to produce a Custom Liability Index (CLI) highlighting the impact of your proposed POB on your plan’s future economics. Don’t hesitate to reach out for some help.