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The University of California Retirement System Is Scrambling to Cover Funding Shortfalls

When a pension system gives employees and employers a 20-year contribution holiday, you can bet it’ll run into some funding troubles down the line. University of California’s retirement system has been knee-deep in that harsh reality for years now. That has led to the borrowing of billions of dollars to cover funding shortfalls. And the University system has now taken out another massive loan.

From Ed Mendel at CalPensions:

UC regents last week approved borrowing another $700 million internally to help close a pension funding gap, bringing the total borrowed to $2.7 billion in a pension bond-like strategy with risks or rewards, depending on investment earnings.

Five years ago University of California employers and employees were paying nothing into the pension system. In a remarkable contribution “holiday” that began in 1990, payments into the system dropped to zero and stayed there for two decades.

After restarting in 2010, the employer contribution to the UC Retirement Plan increased from 12 to 14 percent of pay this month and most employee contributions increased from 6.5 to 8 percent of pay, a total of nearly $2 billion a year.

But the steady increase of contributions that were once zero still falls short of closing the pension funding gap. Last year UC Retirement had only 76 percent of the actuarially projected assets needed to pay pension obligations over the next three decades.

To help close the funding gap, UC borrowed $1.1 billion from its own Short-Term Investment Pool in 2011 and $937 million from external sources. The $700 million loan approved last week is from the short-term pool.

The UC Retirement fund, with assets valued at about $50 billion, expects to earn an average of 7.5 percent a year, the same as the California Public Employees Retirement System. Critics say the earnings forecast is too optimistic and conceals massive debt.

In what some call arbitrage, money borrowed at a low interest rate from the UC short-term pool (which earned 1.7 percent last year) and invested in the pension fund earns a profit if the return is the expected 7.5 percent or even a little less.

“I do feel we are on a little bit of a slippery slope here,” said Regent Fred Ruiz. “I think we have to be very cautious … The market changes from year to year, and if we don’t get the returns we need to have, then we are in great trouble.”

This is the same concept, essentially, as Pension Obligation Bonds. And, just like POBs, the outcome of this borrowing can either be of great benefit or great harm to the U of C pension system. Whether this turns out good or bad depends on future investment returns.

STUMP blogger Mary Pat Campbell gives her take on the dangers of U of C’s decision:

One should always match one’s borrowing to one’s accrual of expenses. It’s okay to finance the acquisition of an asset (such as a car or a house) with a loan that amortizes over the life of the asset. It’s not okay to take out a 30-year-loan to pay for a trip to Disney. The first is based on good financial principles, the second indicates you are living way beyond your means.

Short-term financing for operational expenses is fine if one has “lumpy” cash flows (which the UC system may have, depending on how they pay their staff. I get paid for my adjunct teaching only during the semester.) But even though they’re calling it a short-term pool, it sounds to me like what they’re doing is borrowing under short-term limits, but keeping rolling over the debt, as if it were a longer-term loan.

I really don’t like the sound of that.

That is something that could escalate rapidly should interest rates start to rise.

Bottom-line: borrowing money for a fake arbitrage is bad finance. The 7.5% return is just an assumption, not a sure thing. Real life returns vary a lot the way they invest it — and the loan interest is a sure thing, just as the pension benefits are a (supposed) sure thing.

We won’t know for years how this decision ultimately plays out for the University of California system. But you can bet the Regents have their fingers crossed.

The Double DB Plan: An Experiment in Plan Design

Several retirement plan consultants have put their heads together and come up with an interesting new idea for designing defined benefit plans. Why is it interesting? Because it’s a defined benefit plan, but it is fixed-cost; on top of it, the creators claim that both employees and employers will benefit.

It’s called the “Double DB”. Will the plan work? We won’t know until its put into action. For now, it’s certainly serves as an interesting though experiment.

You can hear an in-depth conversation on the topic in the video above. Or, you can read an explanation below, from Kamp Consulting:

Here is an example for illustrative purposes only and does not imply any future results as outcomes are based on specific plan and market data.

Suppose that a plan sponsor of an existing traditional DB plan wants to soon transition their employees to a DC structure. Let’s also assume that the plan sponsor’s existing DB has current annual cost of 30% of salary, with 20% paid by the employer and 10% by the employees. Instead of shuttering the DB plan and adopting the DC plan, the plan sponsor can adopt Double DB, a hybrid DB structure whose assets can be commingled with the existing trust assets.

For accounting purposes, there are two component pieces in the Double DB design. Once the plan is established, each of the two DB components receives 15% of payroll in the initial year (or, half of the hypothetical current annual cost). The first component (DB one) is a regular DB plan with features similar to a traditional DB plan, but with more modest fixed benefits. The second DB component is referred to as a partner plan, and its benefits are not fixed.

Based on our selected funding method, actuarial assumptions and plan design, assume that the traditional DB plan is calculated to provide a multiplier of 1.5% of FAS (final average salary). However, if investment experience in the first year is poor and the first DB plan now requires 16% of the contribution instead of the 15% paid in year one to support the 1.5% multiplier, DB one (regular DB) gets 16% and DB two (partner DB) gets 14%.

If instead, the plan’s experience in year one was favorable and the regular DB plan requires only 13.5% of pay to support the 1.5% multiplier, regular DB gets 13.5% and the partner DB gets 16.5%.

This process continues year after year. The actuarially determined percentage of payroll cost of continuing the 1.5% multiplier in the regular DB is always provided and the partner DB always gets the residual amount. Annual benefits to the pensioner from the regular DB are always 1.5% of one’s FAS times the number of years of service. Partner DB assets contributed to one’s final benefit will be determined year-by-year and by experience.

Upon retirement, the beneficiary will receive one check with the benefit from the first DB component being added to the variable benefit from second DB accounting to provide a monthly payment. With this plan design, the assets of both the traditional DB and residual DB can be commingled, whereas a traditional DB and its new DC assets can’t be combined. The same investment management team can be used, as well as all service providers, granting the plan sponsors greater economies of scale, less complication, and potentially happier employees who don’t have to manage their retirement program.

Photo by American Advisors Group via Flickr CC License

Roadwork, Pensions and Congress’ Plan to Replenish the Highway Trust Fund

We could get a vote this week on the issue of replenishing the near-empty Highway Trust Fund, the federal fund used to finance transportation projects across the country. It’s funded by gas tax revenues, but due to run out of money within the month.

A solution has already been proposed and passed through the house, and now the Senate takes the reigns. If the fund runs out of money, many construction and infrastructure projects across the country would grind to a halt. But some critics say the the proposed solution could close the door on one problem and open the door for another.

What does any of this have to do with pensions? Josh Barro explains:

The Federal Highway Trust Fund is expected to run out of money in August. So, naturally, Congress is debating a temporary fix that involves letting corporations underfund their pension systems.

The latest proposal, which passed the Republican-controlled House Ways and Means Committee on Thursday, works like this: If you change corporate pension funding rules to let companies set aside less money today to pay for future benefits, they will report higher taxable profits. And if they have higher taxable profits, they will pay more in taxes over the 10-year budget window that Congress uses to write laws. Those added taxes can be diverted to the Federal Highway Trust Fund.

Unfortunately, this gimmick will also result in corporations paying less in taxes in later years, when they have to make up for the pension payments they’re missing now. But if it happens more than 10 years in the future, it doesn’t count in Congress’s method for calculating budget balance. “Fiscal responsibility,” as popularly defined in Washington, ignores anything that happens after 2024.

The official term for this method is called “smoothing.” Len Boselovic at the Pittsburg Post-Gazette gets into even more detail on the topic:

Smoothing affects the way pension funds value their liabilities, the benefits they are obligated to pay to retirees and their beneficiaries. The current value of those future obligations is based on a discount rate, which is determined by current interest rates. As Mr. Cole explains at www.taxfoundation.org/blog, if the future value of a pension benefit is $1, using a 4 percent discount rate puts the current value of the benefit at 96 cents. Using a 6 percent discount rate values it at 94 cents.

In other words, the higher the discount rate, the lower the current value of a pension fund’s obligations. The lower those obligations are, the less money a company has to contribute to its pension fund to comply with federal pension funding rules.

Interest rates have remained stubbornly low — forcing companies to contribute more to their pension funds. While that should make the funds better funded and put current and future retirees at ease, it crimps federal tax revenue. That’‍s because pension fund contributions are tax deductible. The more a company contributes to its pension fund, the less it contributes to the IRS.

Lawmakers who grasp that concept figure they can kill two birds with one stone: give pension funds relief from low interest rates and boost federal highway funding. They want to “smooth” the impact of lower interest rates by allowing companies to use a higher discount rate. That would lower companies’‍s pension funding requirements but raise their tax bills. The extra tax revenue would pay for transportation projects.

It’s an interesting way for Congress to approach this problem. But, as Pension360 has covered in the past, it’s a solution that causes its own problems, as Public Sector Inc. explains:

None of this is free, of course. Aside from the dangerous trend of allowing private firms to purposely underfund their pensions, the plan boosts federal revenues today at the cost of increasing the deficit over the long term.
Given this proposal, you would think that everything is just peachy with funding of private sector pensions in America. But The Pension Benefit Guaranty Corporation, which is responsible for insuring private pensions, just put out a report estimating it’s on an eight-year path to insolvency itself.
The nation’s laws dictating private sector pension standards were enacted to protect retirement plans. But Congress, in its endless quest for more revenues, can’t even live by the standards that it imposed on companies.

Pension360 will keep you updated on subsequent developments in this story.

Is S&P Downplaying the Instability of Local Governments Saddled With Pension Obligation?

Local governments around the country are increasingly saddled with mounting debts due to outstanding pension obligations. So why are many of them seeing boosts in their credit ratings?

At least one credit analyst is wondering aloud whether rating agencies –specifically, S&P– are purposely downplaying the risk of investing with local governments. From Governing:

Since last fall, when S&P released new scoring criteria, the agency has been reassessing ratings for thousands of local governments. Generally, and as predicted by S&P itself, the new criteria resulted in more upgrades of governments than downgrades. But a Janney Montgomery Scott analyst pointed out in his July note on the bond market that those changes have not put S&P’s ratings more in line with competitors Moody’s Investors Service and Fitch Ratings.

In some cases, rather, agencies’ ratings scores for the same local governments have diverged even more.

“I do not remember a time when I saw so many credits with not just a one-or-so-notch difference here and there, but multiple-notch differences in some cases,” said Tom Kozlik, the analyst who wrote the note. “This is not part of the typical ratings cycle (where sometimes one rating agency is a little higher and vice versa, I suspect). As a result, I expect that rating shopping could be on the rise if the current trend continues.”

In other words, the fear is that S&P is going easy on local governments in hopes that those governments will prioritize S&P’s rating services over those of its main competitors, Moody’s and Fitch. If a government published only its highest rating, it can mislead investors as to the risk of an investment. And, that appears to be exactly what is happening. From Governing:

There has been a pattern of governments only publishing an S&P rating. In June, for example, there were a little more than 200 local governments that sold debt competitively. Of those, one-quarter of them only published an S&P rating, according to Kozlik’s review. Another 11 governments only published an S&P rating but also had an outstanding Moody’s rating within the past three years (Kozlik dismisses 16 cases where the outstanding Moody’s rating is prior to 2011).

Like S&P, Moody’s has also revamped its ratings criteria in the wake of the financial crisis, however changes have mostly focused on giving pension and other long-term liabilities more weight in the final score. Most local government pension liabilities shot up during the financial crisis and many have still not gained back much – if any – ground. This change has contributed to Moody’s issuing more downgrades.

S&P has been quick to defend their ratings. The man behind the ratings change talked to Governing about the controversy:

Jeff Previdi, the S&P managing director for local governments who spearheaded the agency’s criteria change, defended the process. He said that the criteria had been heavily tested and had gone through a public comment period. The new criteria scores municipalities in seven categories: management, economy, budgetary flexibility, institutional framework (governance), budgetary performance, liquidity and debt/liabilities. The score for economy counts for 30 percent of the total score; all other categories are given a 10 percent weight.

The intent was to make the process and scoring as transparent as possible, Previdi said. Additionally, he added, the upgrades have tended to outpace downgrades for a very simple reason: Governments are doing better now than when they were last assessed.

“When we are reviewing under the new criteria, we’re not working with the same metrics of the old criteria,” he said. “It’s not done in a vacuum. Over this time we’ve been in a generally positive environment for local governments — that’s informing some of the results you see.”

While S&P is upgrading many local governments, Moody’s has been doing the opposite: the agency has issued twice as many downgrades as upgrades, according to Kozlik.

A Group of Lawmakers in Illinois Are Opting Out of Their Pensions

A group of legislators in Illinois are doing something a little strange and a lot unexpected: opting-out of their pensions.

It may only be for symbolic purposes, but it’s a rare, and interesting, occurrence nonetheless. From the Northwest Herald:

One of the first moves state Rep. David McSweeney made after assuming office in January 2013 was completing paperwork to opt out of the pension system, he said.

“I think this is a part-time job,” McSweeney said, “and with all the financial problems the state has, I don’t think legislators deserve pensions.”

As Illinois continues to grapple with pension reform in the midst of heavy financial woes, McSweeney, R-Barrington Hills, is joined in his decision by an increasing number of state legislators.

He is among a group of more than 20 known Illinois lawmakers forgoing pensions entitled to them through the General Assembly Retirement System, according to Reboot Illinois. McSweeney said he’s hoping to set an example.

“I would certainly encourage people to follow, and I think others are doing it,” he said.

Most of the participating lawmakers are relatively new to office. Coincidence? Actually, there’s a reason. From the Northwest Herald:

Upon entering into the legislature, members are “basically put into the plan automatically,” according to Tim Blair, executive secretary of the State Retirement System.

Those who have opted out had to do so within a 24-month period after becoming a member, Blair said, adding after two years, members no longer have the option to forgo the pension system.

Now, the absence of 20 pensions isn’t going to solve Illinois’ fiscal woes. But many groups have been calling for lawmakers to reduce or eliminate their pensions to help solve the ongoing fiscal crisis the state is facing. Here is a list of the participants, courtesy of Reboot Illinois:

Illinois-politicians-opt-out-pension-plans — Graphic courtesy of Reboot Illinois

New York City Funds Lag Behind on Private Equity Performance

The private equity analytics firm Bison just came out with a list ranking the private equity performance of 50 public pension funds. New York City’s pension funds have been particularly active in PE funds, and are looking to invest even more in the area in coming years. So, how did the city fare?

You have to pay to see the full rankings, but the New York Post kindly outlined the results. And the news wasn’t good for New York City’s four largest pension funds. From the NY Post:

The worst performers — the New York City Employees’ Retirement System and the New York City Teachers’ Retirement System — tied for 45th place. The police pension fund, in 42nd place, and the firefighters fund, 37th, didn’t fare much better when it came to picking private equity firms, according to the analysis by Bison, a Boston analytics firm focused on the private markets.

“They have scores that put them closer to the bottom of that list than to the top,” Bison research manager Michael Roth said. “Fund selection could be better.”

New York funds’ reliance on private equity is part of a broader strategy to produce big returns. Across the city’s five funds, about 11.5 percent of assets ($18 billion) were committed to private equity fund.

Still, the strategy isn’t working as well for New York as it is for others. From the New York Post:

New York City Comptroller Scott Stringer has tasked his new chief investment officer, Scott Evans, who started this week, with figuring out how to boost the pension funds’ private equity portfolio.

“While we are concerned about long-term return in private equity, we have reason to be encouraged by the relative returns of our private equity portfolio in recent years,” a spokesman for the comptroller’s office said.

For the Massachusetts state pension, which ranks 6th, every $100 invested in private equity 10 years ago generated a 17.7 percent annual return and is now worth $512. The same investment in the five NYC pensions, which combined generated a 12.4 percent return, is worth $322.

Industry sources blame the city’s byzantine system under former New York City Comptroller Bill Thompson, who oversaw many of the pensions’ private equity investments from 2002 to 2009.

“The city was a hard place for private equity firms to navigate,” a placement agent said, adding that firms with the best records didn’t bother dealing with the city.

As of 2012, NYCERS was only 66 percent funded. The teacher’s fund was only 58 percent funded, the police fund was 64 percent funded, and the firefighters fund was a mere 52 percent funded.

Photo by Chris Chan via Flickr CC

California Cities Are Lining Up To Divest From Fossil Fuels, but CalPERS Isn’t Following

A movement is taking hold in California that encourages state and local governments to divest in companies that hold the largest reserves of oil, natural gas and coal.

Over two-dozen California cities—Oakland, Richmond, Berkeley, San Francisco and Santa Monica among them—have already made plans to divest from such companies. Now, the mayors of Berkeley, Oakland and Richmond are publicly asking CalPERS to follow them. From an Op-Ed published by the mayors in the Sacramento Bee:

As elected officials, we believe our investments should instead support a future where residents can live healthy lives without the negative impacts of climate change and dirty air. It’s time for CalPERS to take our public pension dollars out of dirty fossil fuels and reinvest in building a clean energy future, for the sake of our health, our environment and our children.

In actuality, there are more than morals at play here. The value of fossil fuel investments, and by extension CalPERS’ portfolio, may be at risk as well. From the Sacramento Bee:

The International Energy Agency has concluded that “no more than one-third of proven reserves of fossil fuel can be consumed prior to 2050” if the world is to limit global warming to 2 degrees Celsius. That goal “offers the best chance of avoiding runaway climate disruption.”

That means if the world’s governments take responsible action to prevent climate catastrophe, fossil fuel companies will have to leave some 75 percent of their reserves in the ground. These companies are valued by Wall Street analysts on the basis of their reserves. Meanwhile, fossil fuel companies continue to spend hundreds of billions of dollars on exploration for new reserves. A growing “carbon bubble” – overvalued companies, wasted capital and stranded assets – poses a huge risk to investments in fossil fuels.

CalPERS holds almost $10 billion in major fossil fuel company stocks and recognizes this financial risk. It recently adopted “investment beliefs” that include consideration of “risk factors, for example climate change and natural resource availability, that emerge slowly over long time periods, but could have material impact on company or portfolio returns.”

There’s actually precedent for pension funds following social movements and divesting in certain companies. In the 1980’s many funds divesting from companies doing business in South Africa as a way of protesting Apartheid—in that instance, California funds pulled nearly $10 billion worth of investments.

And it happened again last year, when numerous funds (including CalSTRS) divested from gun manufacturers in the wake of several school shootings.

But this time, CalPERS doesn’t appear to be interested in divesting from fossil fuel companies. The fund’s senior portfolio manager Anne Simpson addressed the issue in an editorial in the Sacramento Bee:

We all have a shared concern with climate risk, but our view is that the solution lies in engaging energy companies in a process focused on finding solutions, rather than walking away.

We at CalPERS talk to more than 100 companies on an annual basis to ensure the high standards of corporate governance that underpin effective climate change risk management, and we invest in climate change solutions across our global equity, private equity and real estate portfolios.

CalPERS was a founding member of the Investor Network on Climate Risk, a leading group of 100 institutional investors representing more than $10 trillion in assets, addressing a policy agenda that calls on governments and regulators to introduce carbon pricing and disclosure, so that risks can be tackled effectively.

CalPERS is also actively collaborating in the Carbon Asset Risk Initiative, led by the nonprofit Ceres, which draws together 70 global investors managing more than $3 trillion in assets. The initiative asks 45 large oil and gas, coal and electric power companies – including ExxonMobil, Royal Dutch shell, BHP Billiton, Rio Tinto and Vale – to assess the financial risks climate change poses to corporate business plans.

Of course, there is some evidence that divesting doesn’t actually accomplish the social goals these funds have in mind when they pull their money from companies. Liz Farmer at Governing explains:

There’s no proof that divesting actually effects change. In fact, a 1999 study concluded that apartheid-related pension divestments had no significant financial impact on companies doing business in South Africa.

What’s worse, targeting investments based on social causes has proven to be dangerous for pension plans. In 1983, a study found that 10 states that had targeted investments in mortgage-backed securities as a way of encouraging homeownership either inadvertently or deliberately sacrificed returns. In some cases, they gave up as much as 2 percent in returns all for the goal of making homeownership more accessible. In 1990, Connecticut’s pension fund bought a 47 percent interest in Colt Industries in an attempt to protect Connecticut jobs. The firm went bankrupt two years later and the fund lost $25 million.

This will be an interesting story to watch play out. CalPERS will likely come under scrutiny no matter what they decide to do. In any case, any investment decision that results from this campaign should be transparent and financially sound. Pension360 will keep you updated on future developments.

Insiders Say Detroit’s Pension-Slashing Ballot Measure On Track To Pass

The ballots have been cast and the votes have been counted. And although Detroit officials are remaining silent on the results of the all-important pension-cutting ballot measure, a few leaks have made their way to media outlets. The consensus: the measure has enough “yes” votes to pass, according to the Detroit Free Press:

Detroit pensioners appear to have voted in favor of allowing the city to cut their monthly checks as part of the grand bargain to help resolve the city’s Chapter 9 bankruptcy, several sources familiar with the voting results told the Free Press.

Police and fire pensioners appeared to have accepted the deal by a wide margin, and while the vote was closer with civilian retirees, only an unexpected last-minute surge of “no” votes would derail the plan, according to people familiar with the voting results.

The city’s pensioners had until 5 PM last Friday to vote on the proposed measure to cut their pensions by 4.5 percent and eliminate future COLA increases. Those cuts are hard to stomach for some, but Detroit maintains that a “yes” vote would stave off even deeper cuts. The implications of a “yes” vote, according to the Detroit Free Press:

If the two separate classes of pensioners [public safety workers and civilian pensioners] vote yes, the City of Detroit would accept $195 million in upfront cash from the State of Michigan and $466 million in 20-year pledges from nonprofit foundations and the Detroit Institute of Arts to help reduce pension cuts and allow the museum to spin off. The deal for pensioners and the DIA has come to be known as the grand bargain.

If voters reject the measure, those cash infusions from the state and nonprofits fall through. That means that even deeper cuts in pension benefits will likely be necessary. Detroit Emergency Manager Kevyn Orr had originally proposed cutting pension benefits by up to 34 percent.

But it doesn’t look like that will be the case. From Freep:

Sources familiar with the vote said that although ballots mailed at the last minute have not yet been tabulated, a high percentage of public safety pensioners — classified under the Police and Fire Retirement System class — voted yes to accept a reduction in annual pension inflation adjustments from 2.25% to 1%.

It’s closer among civilian pensioners — classified under the General Retirement System class — the sources said.

Two people familiar with the situation said that with last-minute votes yet to be counted, more than 70% of GRS [General Retirement System] voters had voted yes.

The plot thickens just a bit here, because a simple majority isn’t enough to pass this measure. There are two classes of voters: public safety workers and civilian workers. Both classes must have a majority of “yes” votes. And the “yes” votes from each class must represent at least two-thirds of the dollar value of the debt owed to them.

The results of the vote don’t have to be publicly revealed until July 21. But even then, the measure can’t yet go into law. It needs to be first approved by a bankruptcy judge.

Is Amending the Constitution a Viable Option for Pension Reform in Illinois?

For a while, it looked like Illinois was set to ease some of the burden of the pension obligations that had been weighing it down like a boulder. The state’s reform law, though not perfect—various parties disagreed on the effectiveness and fairness of the measure—had at least ended years of inaction on the part of lawmakers.

But a state Supreme Court ruling earlier this month left the fate of the reform law up in the air and called its constitutionality into question. Now, Illinois’ government is weighing its options, deciding what steps should be taken if and when the reform law is struck down by the courts.

If the law is eventually found unconstitutional, the solution may be to simply amend the constitution to make it legal. Of course, that’s easier said than done. Crain’s explains:

Amending the constitution would not be easy, to say the least, given recent history and the state’s current political climate. It would need approval by a three-fifths vote in both the Illinois House and Senate. That’s just to put a proposed amendment on the ballot, where it would need 60 percent of those voting on the issue to be approved.

Chances for a constitutional amendment are “a lot better than it was last time,” says Mr. Sosnowski, after the Kanerva decision signaled how strictly the court viewed the pension protection clause. “A lot of people looked at that and said we’ve got possibilities.”

But it can’t be done quickly. The Illinois Constitution requires a six-month waiting period before a proposed amendment can be placed on the ballot, so November 2016 is the soonest it could be put up for a vote. Meanwhile, the statewide pension law changes have been stayed, keeping benefits and contributions and inflation adjustments all in place.

So the state needs two things to make this work: political compromise and time. Unfortunately, it doesn’t have a great deal of either.

History is not on Illinois’ side, either. Lawmakers actually attempted to pass a pension-related constitutional amendment two years ago. But as they learned, you can’t sneak these things past voters–especially ones who are willing to mobilize. From Crain’s:

Two years ago, a relatively innocuous constitutional amendment that would have required supermajority approval by the state Legislature and municipalities to increase pension benefits was pushed through the Legislature by House Speaker Michael Madigan.

Widely panned as a meaningless measure that would not reduce the state’s pension debt, it passed the House unanimously, with only two dissenting votes in the Senate. But only 56 percent of voters approved, falling short of the supermajority needed.

“It was more of a PR issue,” said Rep. Tom Morrison, R-Palatine, who co-sponsored Mr. Sosnowski’s bill to repeal the pension protection clause in the last session of the Legislature. “What elected board is going to increase pension benefits in this environment?”

But a union coalition quickly mobilized to defeat it at the ballot box.

“They’re going to be ready; this time it wouldn’t get a majority of votes,” said John Kindt, professor emeritus of business and legal policy at the University of Illinois in Urbana, who chairs the U of I’s faculty and staff benefits committee. “A constitutional amendment could get through the General Assembly, but voters have already rejected it and they will be well-organized if the Legislature does it again.”

Short of amending the constitution, some lawmakers want to start from scratch on reform and start writing a brand new bill. One such lawmakers is state Senator Mike Frerichs, who is also running for the state’s treasurer position. From the Chicago Tribune:

Mike Frerichs says he thinks lawmakers should “go back to the drawing board” and start over on changes to public employee pension benefits following a recent Illinois Supreme Court ruling.

“I think in their opinion on health care, they made it fairly clear what their opinion on the state constitution is and how they’re going to rule on it,” Frerichs said Sunday about the public employee pension law on the “Sunday Spin” radio program on WGN 720-AM.

“We’ll wait and see what the Supreme Court rules, but I think it’s good to have a backup in place and to start working (on a backup plan) because I think it’s pretty clear we’re going to have to do that,” Frerichs said. “I think it’s probably time to go back to the drawing board.”

Illinois Gov. Pat Quinn is among several high-level officials in the state who remain optimistic the law’s constitutionality will be upheld. Of course, no one will know the truth until the Supreme Court rules on the issue, even if many consider the court’s most recent ruling to be the writing on the wall.

Pension Obligation Bonds Help Some Governments But Hurt Many More, Says New Report

New Jersey, Illinois, and California.

Those are the states that, more than any others, have frequently scrambled to pay down their pension obligations by issuing a financial tool called Pension Obligation Bonds (POBs). Over the last three decades, those three states have issued a total of $25 billion worth of POBs in an attempt to ease the heavy burden of their pension systems’ on state finances.

But what are POBs, and do they work as advertised? A new report from the Center for Retirement Research sheds light on that question and suggests that POBs may not be beneficial, after all. But first, what exactly is a POB? From Governing:

The tool, called Pension Obligation Bonds (commonly referred to as POBs), allows governments to issue taxable bonds for the purposes of putting money toward or fully paying off the unfunded portion of a pension liability. The proceeds from the bond issue go in the pension fund. The theory is that the rate of return on the investment will be greater than the interest rate the government pays to bond investors so that the transaction is favorable to the government; it makes money off the deal.

The concept is simple enough. And, in theory, it’s pretty clever. But in practice? Well, let’s just say timing is key. And many state and local governments have failed to get the timing right. It has cost them dearly, as Liz Farmer summarizes:

The report noted that the governments more likely to issue POBs are ones that have pension plans that represent “substantial obligations.” The governments have large outstanding debt and are short of cash. However, rather than necessarily relieving such governments of financial pressures, the bonds actually create a more rigid financial environment. Issuing bond debt to pay off a long-term obligation like a pension liability turns a somewhat flexible pension obligation into a hard and fast annual debt payment. Thus, “governments that have issued a POB have reduced their financial flexibility,” the study says.

POBs’ net returns (what the investment has earns after making bond payments) has varied, depending on when the bonds were issued. According to the center’s research, the net rate of return has averaged in the low, single digits for most years (the 30-year average is 1.5 percent). Governments that issued Pension Obligation Bonds in 1998, 1999, 2000 and 2007 actually lost money on their investment. Detroit, for example, issued debt at the peak of the market in the mid-2000s to fund its pension plan and did so using a complicated interest rate swap deal. The result was that the deal went the wrong way for the city. Detroit was still on the hook to pay bondholders and though its pension was well funded, it had even less day-to-day cash to meet its financial obligations. That debt played a key role in Detroit’s decision to file for bankruptcy last July.

Illinois, New Jersey, Detroit—that’s not the kind of company you want to keep if you are a local government trying to curb the burden of pension obligations. Though, the reputation of POBs may not be completely deserved. After all, just because struggling governments use them unwisely doesn’t mean POBs aren’t an effective tool when used the right way.

Although examples are hard to come by, POBs can be used effectively. In 2002 and 2003, Winnebago County and Sheboygan County in Wisconsin issued POBs to the tune of $7 million. They paid a 3 percent interest on that debt, but earned 20 percent returns on investments made with the borrowed money. Unfortunately, it doesn’t always work that way.

You can read the CRR’s full report on POBs here.

Photo by Miran Rijavec Stan Dalone via Flickr CC License

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