The Government Finance Officers’ Association recently issued an advisory recommending that state and local governments not issue pension obligation bonds (POBs). POBs are taxable bonds that some state and local governments have issued as part of an overall strategy to fund the unfunded portion of their pension liabilities by creating debt. The use of pension obligation bonds rests on the assumption that, when invested with pension assets in higher-yielding asset classes, bond proceeds will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds.
GFOA noted the following concerns related to POB issuance:
- POBs are complex instruments that carry considerable risk.
- If the investment portfolio does not perform as anticipated, failure to achieve the targeted rate of return burdens the issue with both the debt service requirements of the taxable bonds and the unfunded pension liabilities that remain unmet.
- The invested POB proceeds may fail to earn more than the interest rate owed over the term of the bonds, leading to increased overall liabilities for the government.
- Issuing taxable debt to fund the pension liability increases a jurisdiction’s bonded debt burden and potentially uses up debt capacity that could be used for other purposes.
- POB’s are often structured in a manner that defers the principal payments or extends repayment over a period longer than the actual amortization period, thereby increasing the overall costs to the sponsor.