Connecticut Officials Consider “Lockbox” Approach to Pension Funding

Connecticut officials are mulling ways to ensure the state’s lawmakers keep up with pension funding requirements: making full annual contributions, and delivering them on time.

A constitutional amendment is one way to do that. But State Comptroller Kevin Lembo is weighing a different idea: a pension obligation bond with a twist.

From the Hartford Business Journal:

In a recent interview, State Comptroller Kevin Lembo said he wouldn’t necessarily support a constitutional amendment, but he’s not opposed to other tactics that could force legislators to keep up with annual pension payments, including borrowing money in the form of a pension-obligation bond (POB) with restrictive bond covenants.

The state teachers’ pension system used a similar strategy in 2008, issuing a $2 billion POB with covenants that require the state to pay its full ARC each year, which it has done.

The strategy could be replicated for the state employee pension system, known as SERS, which is currently underfunded by $14.9 billion, Lembo said. Such a borrowing would likely be in the range of several hundred million dollars.

“So in the years when the legislature needs $100 million, they would realize pretty quickly” that they couldn’t forgo the pension payment to create budget savings, Lembo said. “We can lock them out of that. I’m open to talking about it because of the value it has in locking in good behavior.”

Asked for her opinion, State Treasurer Denise Nappier said she is in favor of at least discussing a POB, but that it would require an analysis of whether the returns on invested bond funds would meet or exceed the cost of debt.

“We also must consider the impacts of such a transaction on the state’s credit rating and debt levels,” Nappier said. “That said, a modestly sized and prudently structured transaction could be a powerful tool if it includes a bond covenant to improve fiscal discipline going forward — as was done with the POBs issued for the Teachers’ Retirement Fund in 2008.”

When issuing a POB, the state is making a bet that investment returns exceed the interest paid on the debt over the life of the bonds.

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