An Update on Pension Obligation Bonds

by Alicia Munnell, Jean-Pierre Aubry, Mark Cafarelli
Citation
Title:
An Update on Pension Obligation Bonds
Author:
Alicia Munnell, Jean-Pierre Aubry, Mark Cafarelli
Year: 
2014
Publication: 
State and Local Plans Issue in Brief
Volume: 
40
Issue: 
Start Page: 
End Page: 
Publisher: 
Center for Retirement Research at Boston College
Language: 
English
URL: 
http://crr.bc.edu/briefs/an-update-on-pension-obligation-bonds/
Select license: 
No License (All right reserved)
DOI: 
PMID: 
ISSN: 
Abstract:
This update shows how Pension Obligation Bonds (POBs) have fared since the financial crisis. This instrument, which is a general obligation of the government, alleviates pressure on the government’s cash position; and it may offer cost savings if the bond proceeds are invested, through the pension fund, in assets that realize a return higher than the cost of the bond. At the time of our last study, 2009 data showed that most issuers had lost money by issuing a POB. One question is the extent to which five additional years have changed that picture. The earlier study also looked at the factors leading a state or locality to issue a POB and concluded that those least able to absorb the risk were the most likely to do so. The second question is whether that continues to be the story.
 
The brief proceeds as follows. The first section presents a brief history of POBs from their introduction in 1985 to the present. The second section introduces the rationale for, and possible risks associated with, issuing a POB. The third section evaluates POBs at three points in time: 2007 (at the height of the stock market), 2009 (in the midst of the financial crisis), and 2014 (today). The fourth section summarizes the regression results – using an expanded sample that includes cities that do not administer their own pension plan – that relate the probability of issuing a POB to the financial pressures of the sponsor, the economic environment, and financial conditions such as the “expected spread” between interest rates and stock market returns. The fifth section presents a two-fold conclusion. On the one hand, five years of economic recovery have improved the performance of POBs; on average they have produced a real internal rate of return of 1.5 percent. On the other hand, while POBs could potentially be a useful tool under the right circumstances, evidence to date suggests that the jurisdictions that issue POBs tend to be the financially most vulnerable with little control over the timing.
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