STATE REPRESENTATIVE
PAUL C. CASEY

A View from the Hill

FOR IMMEDIATE RELEASE: August 2, 1999
CONTACT: Tom Nolan (617) 722-2240

BOND . . . . PENSION OBLIGATION BOND

When the governor was out in Hollywood a couple weeks ago, rumor has it that he got to visit the secret props laboratory on the set of a James Bond movie. Presumably talking about bringing the British super-spy to Boston for the filming of his next film, the Governor got to examine the secret cuff-link camera, the cane laser, and the exploding key ring that seem to inevitably bail "007" out of trouble.

While the Governor was working the Hollywood crowd, a special sub-committee was being formed at the State House to look into the latest bond drawing much attention -- the Pension Obligation Bond. Although Pension Obligation Bonds (POBs) are not as glamorous as 007, they can offer some of the same spine tingling risks and thrilling suspense for municipalities that the bronzed, daredevil heartthrob undertakes on the "big screen". Unfortunately, unlike a James Bond movie, we are unsure that the good guys are going to win in the end, making POB's a risky proposition for fulfilling the unfunded pension liabilities of our public retirement systems.

There are 106 public retirement systems in the Commonwealth covering state, county, authority and municipal employees. Although operating independently of each other, these systems are bound together by the provisions of one uniform retirement law found in Chapter 32 of the General Laws. Until the mid-1980's, these systems operated on a "pay as you go" basis, similar to the current federal Social Security system, at which point the participating systems were required to develop funding schedules for the purpose of depleting their unfunded pension liability.

While many municipalities are on schedule to be fully funded by the year 2018, or sooner (Wellesley having already achieved that status), there are some communities who continue to have rather large unfunded actuarial liabilities. Whether near fully funded, or lagging far behind, more and more municipalities are considering issuing POBs to immediately fully fund their respective systems. Last year, Worcester, Everett and Holyoke filed legislation and received the state's approval to issue POBs and several other towns have since filed bills to do the same. Before jumping on the proverbial bandwagon, we in the Public Service Committee thought it wise to play the part of Dr. No, at least until we thoroughly address whether and why POBs are worth the risk and for which type of communities.

Like James Bond in the movies, pension obligation bonds are depicted as the heroes of the day, and the downsides are either not mentioned, or summarily dismissed by proponents. The fact is, however desirable it may seem to municipalities to extinguish their outstanding pension liabilities, particularly during a time when the market is "right," reorganizing liability in this fashion is not without its risks and it may be unpropitious for some towns to replace the flexibility of their actuarial liability with the hard debt of bonds.

In the short term, issuance of POBs may very well seem beneficial to a system struggling to reduce its pension liability. Yet, since pension funding schedules can always be adjusted to reflect changes in the system or the economy, these obligations are flexible and allow municipalities sufficient budgetary leeway in periods of financial stress. Paying off the unfunded amount with borrowed funds by issuing POBs eviscerates that flexibility and creates hard debt which that community must satisfy when the bonds mature. This could have serious consequences for towns looking to adjust their budgets during times of economic downturn.

Such budgetary constraints are exacerbated by the fact that most of the "flavor of the month" POB bills exempt municipalities from the current laws that prescribe debt limits for local governments (21/2 the value for cities; 5% for towns). Therefore, towns that have maximized their bonding will be authorized to circumvent those limits and bind the city or town to millions of dollars in new debt. Any real advantage to these bonds depends largely upon the whims of the market. While we have been in a period of tremendous economic growth over the last few years, any investor worth his salt will be quick to explain that past performance is no indication of future gain. We need only look back to the period between 1966 to 1982 in which the S&P 500 grew at a marginal rate of 2.7% annually to realize the volatility of the market.

This is not to say the pension obligation bonds are always a bad idea and should not be investigated. Municipalities should, however, be cautious of the potential future risks. By way of example, the town of Chelsea recently filed legislation seeking state authorization to issue POBs. In its last valuation, Chelsea had the unenviable status of being the lowest funded system in the Commonwealth (at 47% funded). While this would seem to make the city a suitable candidate for authorization, other objective factors indicate that transforming this liability into hard debt obligations may ultimately work against Chelsea.

Historically, Chelsea has had its fiscal problems, and was recently forced into receivership in the early 1990's with the state coming to its rescue. Although no longer in dire financial straits, over half of the city's revenues (60.3%) still derive from state aid. Moreover, Chelsea had approximately $97 million in outstanding debt in FY'97, the 6th highest total in the state behind the much larger cities of Boston, Quincy, Worcester, Lowell and New Bedford. To satisfy its unfunded pension obligations, the city would have to issue approximately $40 million in new bonds. Moreover, because of its financial condition, the city's bond rating is equivalent to a junk bond status. The city would likely be required to purchase significant amounts of insurance in any bond issuance of this size.

Despite these figures which objectively indicate that Chelsea refrain from such a binding fiscal endeavor, the legislation passed through the House and will likely end up on the Governor's desk. The severity of this undertaking will likely not reveal itself for several years at which point the city may need someone like 007 to pull them from fiscal collapse.

Certain shortcomings may be seen much sooner, however. Worcester, for example, the first city to issue POBs in the state, has recently discovered that although believing it had satisfied its unfunded pension liability by issuing these bonds, it remains about $9 million underfunded. Furthermore, long term actuarial calculations fluctuate daily. The adoption of any changes to the pension benefit formulae in our laws, such as early retirement provisions for teachers and cost of living adjustments for our senior retirees, could change these numbers drastically, further complicating matters.

To be sure, if we could guarantee the continued growth of the market and burgeoning returns on town issued bonds, POBs would unquestionably be an endeavor even Inspector Gadget could undertake. Unfortunately, the future of the market is not as predictable as the outcome of a James Bond's encounters with the sinister villains he faces. With that in mind, we in the legislature have a duty to investigate "get rich quick" options and repel future Goldfingers at the gates of Fort Knox. To do otherwise could leave municipalities vulnerable to the Jaws-like strangle hold of a vicious economy causing them to spiral out of control like the ill-fated gondola in Moonraker.