Norwich, CT residents (population 40,000) are going to the polls today to vote on a Pension Obligation Bond (POB) of $145 million. The pension system currently has a 59% funded ratio (under GASB accounting). The “need” to issue a POB is based on the fact that retirement costs have nearly tripled in the last decade. The city is proposing this issuance given the historically low interest-rate environment. City officials believe that they will be able to complete the sale of the bonds at a roughly 3% yield.
The issuance of POB debt in 2021 is near historic levels. In fact, 93 municipalities have issued debt year-to-date surpassing the total in every year since data was first kept in 1999. The $11.4 billion raised is eclipsed by only 2003’s total debt, which included Illinois’s $10 billion POB. We, at Ryan ALM, agree that the current rate environment makes POB issuance particularly attractive, but only if the proceeds are used to defease the Retired Lives liability. Historically, POB proceeds have been injected into the plan’s current asset allocation subjecting these new assets to the whims of the market. We have never liked this strategy and are particularly concerned at this point given US equity valuations, which are stretched no matter what metric is used.
The primary object of a defined benefit pension plan should be to secure the promised benefits at low cost and with prudent risk. It is not to take a flier on the markets HOPING to achieve an arbitrage between the bond’s cost and the targeted ROA, which in Norwich’s case is 7.25%. The drafters of the original Butch Lewis Act understood this concept that mandated that the loan provisions should be used solely to defease pension liabilities for as far out as the allocation would permit. We think that this is a prudent approach that minimizes the risk to the pension system, its participants, and the municipality’s taxpayers. We would be happy to provide interested readers with our turnkey system on how this is accomplished.