Tuesday 28 June 2022
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The risk of issuing pension obligation bonds (POBs) was again warned. Providence is poised to advance a $515 million borrowing plan to pay off the unfunded liabilities of Providence’s pension system.
The new study, published in Massachusetts, warns that issuance of POBs to refinance the MBTA Retirement Fund’s (MBTARF) $1.3 billion of unfunded pension liabilities of $360 million would exceed the already existing one serious financial risks of the T would only increase.
Earlier this month, the city of Springfield, MA planned to borrow $755 million in POBs, but canceled the plan due to instability in financial markets and rising interest rates.
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In POBs, government agencies deposit proceeds from bond sales into their pension funds and use the money for investments that they hope will provide returns that exceed the cost of borrowing.
The new study was published by the Pioneer Institute.
“Virtually every study of POBs finds that the timing and duration of bond issuance is critical,” said EJ McMahon, author of Rolling the Retirement Dice. “Bonds issued 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 do not meet the assumed rate of return of a pension fund, there could be debt servicing costs on top of the pre-existing unfunded liability. In 2015, the Government Finance Officers Association bluntly warned that “state and local governments should not issue POBs.” Last year she confirmed her forecast.
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Three weeks ago, 4% of Providence’s registered voters voted to approve the borrowing, and the borrowing approval legislation is now working its way through the Rhode Island State House.
Under the state law authorizing the city to front the pension obligation bonds, the interest rate on the borrowing must be 4.9% or less. The instability of the financial markets threatens the borrowing rate.
Gov. Dan McKee last week signed state legislation allowing Providence to proceed with the program.
Warning for MBTA
If MBTA were a private company, federal law would require it to base the expected return on its retirement investments on current and historical returns on low-risk assets such as high-quality corporate bonds. Those yields are currently around 4%.
But under more permissive government accounting standards, the MBTA has set its expected rate of return at 7.25% annually.
MBTARF is currently projected to need $3.07 billion to cover retirement expenses over the lifetime of its most recent vested employees, but its assets are short by about $1.3 billion. Assuming the more conservative 4 percent yield, the total liability rises to over $4 billion.
As recently as 2007, MBTARF had more than 90 percent of the assets needed to meet its obligations. But despite annual employer contributions (MBTA) increasing from $21 million in 2001 to $148 million last year, the pension fund was only 53.55% funded through fiscal 2020, according to the study .
The T contributes 26.7% of covered salaries to the MBTARF, while workers contribute 9.33% of pre-tax salaries. Two-thirds of the money goes into the unfunded obligation, not the “normal cost” of a new pension obligation that accrues each year.
McMahon identifies several issues behind these problems. The first is poor investment management. A 2016 Pioneer study found that MBTARF would have made an additional $900 million between 2001 and 2014 if it had placed its funds into Massachusetts’ state’s better-performing employee pension 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, since the majority of T workers can retire at 40 or 50, MBTARF has fewer active workers contributing to the fund than retired transit workers drawing pensions. The MBTARF has 0.845 active employees for each annuitant. 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 of these questions are the fundamental budgetary challenges of MBTA. Fare revenues are expected to remain 25 percent below pre-pandemic levels through fiscal 2023, and the agency will need to reduce reserves to balance its $2.6 billion budget.
“T’s financial position calls for fiscal caution, not a risky quick fix like annuities,” said Jim Stergios, Pioneer’s executive director. “Tricks like that rarely work — and a bit like an Hail Mary pass, it’s the wrong play to call right now.”
The concerns of this new study echo warnings issued by the Government Finance Officers Association – that “the guidance reaffirms that state and local governments should not issue pension commitment bonds.”