Voters to decide on pension obligation bond proposal
- By Alexie Villegas Zotomayor - Reporter
Northern Marianas voters today decide on whether or not they will allow amending the constitution to authorize the floating of pension obligation bonds.
House Legislative Initiative 17-5 intends to add Section 10 to Article X of the CNMI Constitution to authorize the commonwealth to issue pension obligation bonds.
A previous attempt at amending the constitution for this purpose failed to gather the necessary two-thirds of the votes to pass the initiative.
Online sources state that issuing pension obligation bonds is a way for financially stressed municipalities to cover a shortfall in pension obligations.
According to the Center for Retirement Research, it is a general obligation of the government that alleviates pressure on its cash position that may offer cost savings if bond proceeds are invested in risky assets through the pension fund that realizes a high return.
The proposal to issue POBs has split the retired members of the community.
Commonwealth Retirement Association board directors see this as among the possible solutions to address the Retirement Fund’s underfunding crisis given that the plan sponsor — the CNMI government — is cash strapped.
During previous assemblies of retirees, Agnes McPhetres said the initiative would amend the Constitution to authorize it to incur a public debt for operations. “We’ll only float the bond when we need it.”
CRA chairman Lorenzo “Larry” Cabrera believes floating a bond will allow the government to pay the over the $300 million it owes the Fund.
Advantages of POBs
The cash-strapped CNMI government’s fiscal year 2013 budget of $114 million is not even a third of what it owes the Retirement Fund.
The approximately $70 million in pension payouts this year is three-fourths of the CNMI government’s total budget.
Those who favor the issuance of pension obligation bonds, including CRA, seeing that the government has no other alternative, believe that it is the most viable immediate solution to the Fund’s underfunding crisis.
The selling of Marianas House in Washington D.C., which according to the last appraisal was not worth more than $1 million, would not be enough.
Online sources show that fiscally stressed issuers resort to floating pension obligation bonds — taxable general obligation bonds — to finance shortfalls in pension obligations.
According to a presentation by the California Debt and Investment Advisory Commission, most POBs are issued by small, local governments.
POBs are used to pay a portion of the issuer’s unfunded accrued actuarial liability or pay its annual contributions or both.
As to the advantages of floating a pension obligation bonds, the presentation by the commission stated that among the reasons issuers consider POBs are it provides budget relief, enhances funded ratio and helps transition the system into a defined contribution plan.
The Center for Retirement Research at Boston College shares the same view that the POBs are sought for budget relief.
Officials consider POBs the least bad alternative, among a variety of tough fiscal choices, to address declining revenues.
The Center also sees cost savings in the effort. “POBs offer issuers an actuarial arbitrage opportunity, which, in theory, can reduce the cost of pension obligations through the investment of the bond proceeds in higher risk, higher return assets.
The report by the Center for Retirement Research also stated that by comingling POB proceeds with pension assets, it is assumed that bond proceeds will return whatever the pension returns.
It noted that the use of this instrument has the potential to be useful in the hands of the right government at the right time.
Although the POBs can offer immediate budget relief, several reports point to the manifold risks associated with using this debt instrument.
The potential risks include (1) interest costs can exceed asset returns; (2) POBs involve timing risks; (3) flexibility; (4) political risks; (5) overly risky.
The Center for Retirement Research explains that the success of the POB depends on the premise that pension returns on average exceed the cost of financing the debt.
The Pew Center on States, in its report, “The Trillion Dollar Gap,” stated that states need to muster convincing evidence that the timing is right.
The report cited an expert’s claim that POBs should only be issued during recessions or the early stages of economic recovery when stock prices are depressed.
The Boston College think-tank shares the same view with the Pew report: POBs involve considerable timing risk because proceeds are invested en masse into the pension plan.
It noted that requirements to amortize unfunded pension liabilities may be relatively flexible obligations that can be smoothed over time while POB is an inflexible debt with required annual payments.
It also pointed to the political risk.
If the pension system ends up with more assets than liabilities resulting from the government’s use of the POB to fully fund the pension, the Center for Retirement Research said this may lead to interest groups calling for benefit increases “despite the fact that the underfunding still exists.”
Meanwhile, the Government Finance Officers Association recommends that governments or issuers should use caution in floating POBs.
Some experts agree that the CNMI may end up incurring more debt and may pass on the debt to future generations of taxpayers.
Given the CNMI’s poor credit worthiness, it may end up with a high interest rate.
Fund investment consultant Maggie Ralbovsky, in an earlier interview, cautioned the CNMI on issuing POBs.
She said that if the CNMI were to float $300 million in POBs, it will cost the CNMI at least $30 million a year — in interest alone.
“There is no way the Fund can invest to get more than this return. Therefore, the CNMI government is creating a negative arbitrage in this event — meaning destroying value by doing so.”
According to Standard & Poor, a credit rating agency, if they do not make the investment returns, they’re going to have to pay not only debt service on the bonds but increased contributions for new unfunded liabilities.
For several retirees both on and off island, given the CNMI’s credit history, the government should err on the side of caution and refrain from considering floating POBs as it may saddle the government with even more debt.