Pension Obligation Bonds: Financial Crisis Exposes Risks
by Alicia H. Munnell, Thad Calabrese, Ashby Monk, and Jean-Pierre Aubry
January 2010
SLP#9
Introduction
State and local government officials are facing a perfect storm of problems. On the one hand, the sharp decline in equity markets has resulted in a large increase in underfunded liabilities among state and local pensions. Research suggests that public pensions are now less than 80 percent funded and will require an additional $200 billion spread over the next five years to compensate for the increased shortfall. On the other hand, the recession has cut into state and local tax revenues, limiting the ability of governments to make up these shortfalls. The U.S. Census Bureau reports that second-quarter 2009 tax revenues dropped over 12 percent from the second quarter of 2008.
Historically, governments have turned to two "solutions" for managing their pension commitments in times of fiscal stress. Some governments choose to defer part of their annual contribution to the pension fund. However, some are obligated by statute to make the annual required contribution. In these cases, governments may choose to issue a pension obligation bond (POB) to fund their pension system. This instrument, which is a general obligation of the government, alleviates pressure on the government's cash position and may offer cost savings if the bond proceeds are invested in risky assets through the pension fund that realize a high return...
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Alicia H. Munnell is the Peter F. Drucker Professor of Management Sciences in Boston College's Carroll School of Management and Director of the Center for Retirement Research at Boston College (CRR). Thad Calabrese is an Assistant Professor at Baruch College-CUNY in the School of Public Affairs. Ashby Monk s a research fellow at the University of Oxford and a former research fellow at the CRR. Jean-Pierre Aubry is a research associate at the CRR. The authors would like to thank Beth Almeida, Keith Brainard, Jeff Esser, Ian Lanoff, Ed Macdonald, and Nathan Scovronick for helpful comments.