Pension Obligation Bonds

1
Pension Obligation Bonds
The Oregon Story
2
Overview

• Alaska vs. Oregon Pension System
• Origins of the Oregon PERS Crisis and Actions
  Taken
• Oregon Pension Bonds Our Experience

3
Oregon vs. Alaska Pension System

• As of December 31, 2003 for Oregon and June 30,
  2004 for Alaska.
• Actuarially computed at 18.89.
• Actuarially computed at 28.19 by Mercer and
  30.37 by Buck.
• Actuarially computed at 41.78 by Mercer.
• Prior to reforms rates were projected to hit
  30.
• Beginning in 2011. TRS projected to continue
  issuing to 56 by 2028.
• Projected at 4.4 billion and 2.5 billion by
  Buck. Rates projected at 32.43 and 42.14 for
  2005.

4
Oregon vs. Alaska Legal Issues

• Oregon
• Constitutional
• Amendment approved by voters in 2003 (by 55
  margin), authorizing State to use General
  Obligation Bonds for refinancing of pension
  obligations.
• Statutory
• Statutory authority granted to local governments
  and school districts (who have own issuance
  authority) to issue Full Faith and Credit
  Obligations. Voter approval not required.
• Jurisdictions also granted authority to enter
  into intercept agreements with the State, whereby
  operating funds were additionally pledged. This
  approach resulted in State credit rating.
• Statutes specifically crafted to protect lump sum
  deposits for benefit of employer making deposit.

5
Oregon vs. Alaska Legal Issues

• Alaska
• Under Constitution, debt must be for capital
  improvements and approved by voters.
• Restrictions do not apply to Certificates of
  Participation or other obligations subject to
  appropriation.
• Subject-to-appropriation debt is somewhat more
  expensive than full faith and credit debt.
• Although some home rule municipalities may be
  able to issue obligations under their own charter
  provisions, there is no general statutory
  authority for the issuance of pension obligation
  bonds.
• HB278 is pending in the Legislature and would
  provide authority for the issuance of obligations
  for this purpose.

6
Oregon vs. Alaska Potential Savings
(1) Issued between 2002 and 2005. (2) At assumed
rate of 8. (3) At assumed rate of 8.25.
7
Oregon PERS

• Retirement benefits for most public employees in
  Oregon are administered through the Oregon
  Public Employees Retirement System, or PERS.
• PERS is a state agency, with five board members
  appointed by the Governor effective with
  legislative changes made in 2003.
• PERS maintains three separate retirement
  programs
• Tier 1 all employees hired prior to 1996
• Tier 2 all employees hired between 1996 and
  August 29, 2003
• OPSRP all employees hired after August 29, 2003

8
How Did UAL Occur?
In 1999, UAL of Oregon system was calculated at
900 million. By 2002, UAL was projected to
exceed 17 billion.

• Taxability of pension benefits PERS benefits
  were raised to offset taxation of State pensions
  to equalize treatment with federal retirees.
• Money Match Hot stock market of late 1990s
  caused most Tier 1 employees highest benefit
  to shift to money match package. Actuary had
  inaccurately assumed full formula in payroll rate
  calculations at the same time employers thought
  rates would go down as a result of the higher
  market earnings.
• At this point (1999) 6 local employers initiated
  litigation against the PERS system for failure to
  follow the legislatively adopted pension system.
• Mortality tables used to calculate retirement
  annuities dated from 1970s, when life spans were
  four years shorter.
• Inadequate Funding of Reserves. Decisions to pay
  substantially more than 8 to Tier 1 Accounts
  throughout 1990s caused reserves to be
  under-funded.

9
How Did UAL Occur?

• Earnings for PERS funds
• 2000 0.54
• 2001 -6.96
• 2002 -8.93
• Tier 1 employees were guaranteed 8.

10
Handling the UAL

• Increased contribution rates 1999 - 10.74 2003
  15.30
• Legislative Reforms 2003
• Pension Obligation Bonds
• Litigation and more litigation

11
2003 Legislative Reforms

• 2003 Oregon Legislature approved various
  modifications to retirement package to reduce
  UAL
• Crediting rate for Tier 1 could not exceed
  guaranteed rate (8) unless reserve was fully
  funded for 3 years.
• Future employee contributions would be shifted to
  401(k)-style account which would not be subject
  to Money Match.
• Mortality tables modernized new tables must be
  adopted every two years.
• Shifted PERS board away from heavy union
  membership. Created new, 5-member board 1
  representing employees, 1 representing employers,
  and 3 non-affiliated members with expertise in
  business, investing or pension systems.
• New Successor Plan created for employees hired
  after 2003 with considerably reduced benefit
  package.

12
Oregon PERS Liabilities Current Status

• Shortfalls in PERS system were reduced by
  approximately 50 through legislation.
• Nevertheless, system continues to be
  significantly under-funded by approximately 6
  billion (not counting POB payments).
• Each Oregon city, county, special district,
  school district and the state itself has its own
  share of the total liability.
• Payroll rates have been steadily increasing over
  the past few years and are expected to be in the
  30 range for many jurisdictions as of 2007
  unless major actuarial methodology changes are
  adopted.
• Methodology changes are being considered, but
  have tradeoffs of keeping rates down at the
  potential exposure for additional unfunded
  liabilities.

13
Lessons Learned

• Legislative reforms were necessary!
• Litigation naturally flows from reforms to
  system.
• UAL was so large something else needed to be
  done.
• Pension Obligation Bonding worked and is working
  (fully disclose all risks).

14
What is a Pension Obligation Bond?

• A pension obligation bond is a financing used to
  defray unfunded pension costs.
• Pension systems measure assets on hand against
  the present value of projected liabilities over
  the long term.
• If liabilities exceed assets, the difference is
  known as the Unfunded Actuarial Liability or
  UAL.
• With lagging investment returns, increases in
  healthcare costs, and actuarial revaluations,
  many public and private pension systems have
  found themselves significantly under-funded.

15
What is a Pension Obligation Bond?

• Repayment of the UAL is amortized over a fixed
  period and built into payroll rates at a given
  interest rate, 8.0 in Oregon, 8.25 percent in
  Alaska.
• Retirement system thereby becomes the banker
  for the shortfall, as employers repay the loan
  over the amortization period.
• Many jurisdictions have used Pension Obligation
  Bonds to refinance these loans.

16
Bonding a Popular Tool
Many Oregon jurisdictions have chosen to finance
PERS liabilities with bonds.

• Original statutory authority provided to local
  governments and school districts in 2001 for
  issuance of full faith and credit obligations.
• Jurisdictions also granted authority to enter
  into intercept agreements with the State, whereby
  operating funds were additionally pledged. This
  approach resulted in State credit rating.
• State Constitutional amendment approved by voters
  in 2003 authorizing the State to issue GO bonds
  for its share of the liability. Voter approval
  margin was 55.25.
• Bond proceeds are placed in a lump sum account
  for benefit of employer. Earnings and losses
  directly accrue to that account.
• Lump sum account is used to provide prepayment
  credit on payroll rates charged to jurisdictions.
• Although bonds have to be sold on taxable basis,
  interest rates for most borrowings have been well
  under 6.

17
Oregon Bonding Examples
Miscellaneous other cities, counties and special
districts have sold bonds since 1999 at rates
ranging from 6.50 to 7.80, totaling in excess
of 1 billion dollars.
18
The Arbitrage Issue

• Issuing a pension bond is not like refinancing
  your mortgage

• Success from borrowing depends on the market
  returning more than the cost of the bond.
• For Oregon borrowers, if investment returns equal
  8 over 26 year period over the life of the
  bonds, costs will be reduced as estimated.
• If returns are greater than 8, cost reductions
  will be greater than projected.
• If returns are less than 8 cost reductions will
  be positive, but less than projected.
• If returns are less than the bond yield,
  borrowers will be worse off than those who do not
  borrow.
• This is where some jurisdictions walk away from
  the process.

19
Investment of Lump Sum Payments
Oregon Investment Council is responsible for PERS
investment

• Common stock acquisitions limited to 50.
• PERS has long history of strong investment
• performance.
• 10-year average 12.38
• 15-year average 12.69
• 56-year average 10.84
• July 2003 study by Russell Investment Group
• (Frank Russell Company) estimated expected
  annual
• total return on PERS would be 8.8 over 20
  years.
• State Treasury regression analysis conducted in
  July 2003 projected probability of positive
  arbitrage in PERS refinancing at nearly 90.

20
Recent Returns Lump Sum Accounts
Our school district (Roseburg Public Schools)
participated in both the Series 2002 and Series
2004 school district issues, with our portion
being approximately 38 million. If possible, I
strongly encourage pooling of issues for both
cost related issues as well as marketability.
21
The Roseburg Story

• Roseburg Public Schools participated in two
  separate bond issues as part of the OSBA Pension
  Bond Pools.
• In 2002 we issued 20.4 million at a TIC of
  approximately 5.6.
• In 2004 we issued 14.9 million at a TIC of
  approximately 5.5.
• The two issues totaled 35.3 million, which
  represented our total estimated UAL for the
  District.
• NPV savings were estimated at 9.235 million,
  which exceeded 25 as a percentage savings for
  refunding purposes, with total estimated savings
  of over 25 million over the 24-year period.
  Oregon requires 3 savings for refunding.
• Actual savings in each of the first 4 years have
  exceeded estimated savings, and are almost 4 of
  payroll, savings of about 1 million annually (15
  teachers).

22
City of Roseburg

• Evaluated bonding in 2005
• Current rates at 20.53 of payroll, with UAL of
  9.5 million
• Estimated total savings from bonding at 6, 3.5
  million
• Net present Value savings 2.0 million, or 18.3
  as a percentage savings for refunding purposes
• Estimated savings of almost 3 of payroll, about
  150,000 annually
• Determined not to issue due to uncertainty and no
  guarantee of savings
• Split vote by Council relating to a number of
  concerns

23
Other Considerations

• Payment to PERS does NOT guarantee UAL will be
  paid off in full.
• Changes in Calculation of UAL
• Judicial, legislative, regulatory or investment
  activities can cause future changes to UAL.
  Further increases would continue to be
  responsibility of jurisdiction.
• Reductions Lump sum payment would put
  jurisdiction in surplus. Funds will not be
  returned to jurisdiction, but surplus is used to
  reduce payroll rates further.
• Increases Lump sum payment would defray total
  deficit. UAL would not be as high as would
  otherwise be the case.
• In any case, arbitrage risks remain the same for
  existing lump sum payment.

24
Other Considerations

• Variations in crediting rate due to changes in
  payroll growth
• Rate adjustment will be different in each
  valuation based upon actual vs. projected growth
  in payroll.
• Timing of rate adjustment may cause short-term
  cash flow mismatch.
• Bond Related Considerations
• Bonds are not likely to be subject to early
  redemption.
• Rating agencies will scrutinize structure
  carefully to ensure payment of liability is not
  further deferred.
• Changes soft liability to hard liability,
  which may put some limitations on financial
  flexibility.
• PERS Regulatory and Accounting Issues
• Adequate protection and proper accounting of lump
  sum account are critical issues.
• Oregon statutes and regulations needed to be
  modified to ensure that the employers making the
  deposit were the ones getting the credit.

25
Final Thoughts

• A number of jurisdictions have evaluated
  participation in the pension obligation bonding
  process. Many have chosen to issue bonds, and to
  date have clearly saved money that can now be
  used to provide services.
• Those who have chosen not to issue debt have
  identified a number of issues to consider, most
  of which relate to uncertainty.
• Working cooperatively will provide you with the
  best chance for success not only in initial
  process changes and potential bond issuance, but
  also in ensuring that future pension changes will
  impact jurisdictions equally.

26
Questions?

• Carol Samuels, SNW
• [phone]
• csamuels_at_snwsc.com
• Jim Green, OSBA
• [phone]
• jgreen_at_osba.org
• Lance Colley, Roseburg Public Schools
• [phone]
• lcolley_at_roseburg.k12.or.us