New Study of Pension Obligation Bonds in MA Warns Plan is a “Risky Quick Fix”

New Study of Pension Obligation Bonds in MA Warns Plan is a “Risky Quick Fix”

A new warning has been issued about the risk of issuing pension obligation bonds (POBs). Providence is poised to move forward with a plan to borrow $515 million to pay down the unfunded liability of Providence’s pension system.

The new study released in Massachusetts warns that the issuing of POBs to refinance $360 million of the MBTA Retirement Fund’s (MBTARF’s) $1.3 billion unfunded pension liability would only compound the T’s already serious financial risks.

Earlier this month the City of Springfield, MA, who was planning to borrow $755 million in POBs, but canceled the plan to the instability in the financial markets and rising interest rates.

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With POBs, government entities deposit revenues from bond sales into their pension funds and use the money to make investments they hope will deliver returns that outpace borrowing costs.

The new study was published by Pioneer Institute.

“Virtually every study of POBs finds that timing and duration of the bond issues are critical,” said E.J. McMahon, author of “Rolling the Retirement Dice.” “Bonds floated at the end of a bull market are the most likely to lose money, and that makes this idea a wrong turn at the worst possible time.”

If investments don’t meet a pension fund’s assumed rate of return, it could be left with debt service costs in addition to the pre-existing unfunded liability. In 2015, the Government Finance Officers Association bluntly warned that “State and local governments should not issue POBs.” It reaffirmed its guidance last year.

 

In Providence

Three weeks ago, 4% of registered voters Providence voters turned out and voted to approve the borrowing, and legislation to allow the borrowing is now working its way through the Rhode Island State House.

According to the state legislation that authorizes the city to move forward with the pension obligation bonds, the interest rate for the borrowing must be 4.9% or lower. The instability of the financial markets is threatening the borrowing rate.

Governor Dan McKee last week signed the state legislation enabling Providence to move forward with the scheme.

 

Warning for MBTA

If the MBTA were a private company, federal law would require it to base the expected rate of return on its pension investments on the current and historic yields for low-risk assets such as high-quality corporate bonds. These returns are currently around 4%.

But under more permissive government accounting standards, the MBTA has set its expected rate of return at 7.25% annually.

The MBTARF is currently projected to require $3.07 billion to cover pension expenses through the lifespans of its youngest vested employees, but its assets come up about $1.3 billion short. Assuming the more conservative 4 percent rate of return, total liability rises to over $4 billion.

As recently as 2007, the MBTARF had more than 90 percent of the assets needed to meet its obligations. Yet despite annual employer (MBTA) contributions that rose from $21 million in 2001 to $148 million last year, the retirement fund was only 53.55% funded by fiscal 2020. Among large U.S. transit agencies, only Chicago has a lower funding ratio and a larger unfunded liability, said the study.

The T contributes 26.7% of covered salaries to the MBTARF, while employees kick in 9.33% of pre-tax salaries. Two-thirds of the money goes toward the unfunded liability, not the “normal cost” of new pension liability that accrues each year.

McMahon identifies several issues behind these problems. The first is poor investment management. A 2016 Pioneer study found that the MBTARF would have earned an additional $900 million between 2001 and 2014 if it deposited its funds in the better performing Massachusetts State Employee Retirement System.

The second reason is that the T underfunded the MBTARF by $66 million from 2007 to 2014. If it had made its full contribution during those years, that $66 million would have grown to $183 million by the end of 2021.

Meanwhile, annual pension benefits continue to grow, from $96 million in 2001 to $220 million in 2020.

Finally, in large part, because the majority of T employees can retire in their 40s or 50s, the MBTARF has fewer active employees paying into the fund than retired transit workers drawing pensions. The MBTARF has 0.845 active employees for each person collecting pension benefits. Overall, the state average for active employees-to-beneficiaries is 1.358. The MBTARF is one of only four of 105 public pension funds in Massachusetts that has more beneficiaries than contributors.

Underlying all these issues are the MBTA’s fundamental budgetary challenges. Fare revenue is projected to remain 25 percent below pre-pandemic levels through fiscal 2023, and the Authority will have to draw down reserves to balance its $2.6 billion budget.

“The T’s financial condition requires fiscal prudence, not a risky quick fix like pension obligation bonds,” said Pioneer Executive Director Jim Stergios. “Such ploys rarely work – and a bit like a Hail Mary pass, it’s the wrong play to call especially right now.”

The concerns of this new study mirror the warnings issued by the Government Finance Officers Association -- that "Affirm Guidance That State and Local Governments Should Not Issue Pension Obligation Bonds."