Milliman on Pension Obligation Bonds

“It’s the dumbest idea I ever heard.  It’s speculating the way I would have speculated in my bond position at Goldman Sachs.”

Jon Corzine in 2008 on Pension Obligation Bonds

Pension Obligation Bonds generate a lot of fees and make the plans they are bought for appear better funded than they actually are which are two of the primary goals of the people who run many government plans.  In every other respect they are a disaster.  Milliman in their report criticizing Detroit’s official pension numbers under the heading “Impact on City of past Pension Obligation Certificates” took dead aim at this pernicious practice:

Both DGRS and PFRS received a significant influx of funds in 2005 from Pension Obligation Certificates (“POCs”) in the amounts of $740 million and $630 million, respectively.

While the POCs have increased the Systems funded statuses, in the big picture this is offset by the City’s liability to pay the debt service on the POCs.  In other words, the City is funding some of the pension liability by paying interest and principal to the bondholders.

In item E of the table above we have adjusted out the POC value to present the big picture view.

We do not have any details on the POCs such as the repayment period or coupon rate but we note that based on our general experience it is possible that the principal repayment is back loaded within the POC schedule, and it is further possible that initial interest payments may have been capitalized such that the POC payments are further back loaded.

We recommend that the POC repayment requirements be reviewed by the Board.

Milliman’s criticism was written on July 6, 2012, almost a year before another drawback was discovered: these bonds default and bondholders will be coming after available pension funds to get their money back.  Milliman only wanted to show the ‘big’ picture and as their final adjustment reduced assets by $1.3 billion to get their final FRIG conclusion on the status of the Detroit plans::

MILLIMAN NUMBERS @ 6/30/10 Assets at Market – POBs (in billions)
……………………………GENERAL…….PFRS……….TOTAL
Market Assets-POBs…..1.5……………2.4……….…..3.9
Mill Liabilities……………4.7……………4.8……………9.5
Deficit…………….………-3.2…………….-2.4……..….-5.6
Funded Ratio……………32%………..50%…….……41%

This concludes the detail on factors in Milliman’s secret report. Perhaps there is a later report but nowhere does a $3.5 billion liability amount appear in regard to unfunded pensions, as widely reported.  Even excluding the POB adjustment to assets the Milliman unfuded is worse at $4.3 billion.  Anyway, tomorrow you can look for yourself as I will link to the full July 6, 2012 Milliman report which includes warnings about the impact of the new GASB rules and another VRPG on Retiree Health Benefits – $5.6 billion liability there.

3 responses to this post.

  1. Posted by Tough Love on August 12, 2013 at 6:41 pm

    John, Quoting from above … “Milliman’s criticism was written on July 6, 2012, almost a year before another drawback was discovered: these bonds default and bondholders will be coming after available pension funds to get their money back. ”

    Re the words after the colon … do the bondholder have a genuine/legal security interest in Pension Trust asset revenue. It sounds like posturing by the bondholders (and their insurers) to me. Such an arrangement (a loan secured by Trust asset revenue) certainly would not be allowed in Private Sector Plans.

    Reply

    • I have no idea what happens in bankruptcy negotiations but if it’s like the pension arbitration hearings I’ve been involved in there’s probably a lot of room for negotiation. If I were a bondholder I would mention that this money still exists (inside the pension) and if Detroit expects to be in the market to sell bonds ever again they best keep their credit record clean. It’s just a guess but I see those POCs being paid back in full from pension money.

      Reply

      • Posted by Tough Love on August 12, 2013 at 10:57 pm

        If the Bondholders indeed had such a security interest, it would have to be spelled out in the Bond underwriting documents.

        While bankruptcy can change, modify, or end lot of obligations, truly “secured” creditors rarely* lose as they can fall back on their security interest (such as a mortgage on real estate).

        * I said “rarely” only because of how the GM Bankruptcy (with the help of the Obama administration) royally screwed the secured creditors to benefit the unsecured pensions of the UAW workers ….. and thereby turned 100+years of Bankruptcy law on it’s head.
        __________________

        Also, you said …” It’s just a guess but I see those POCs being paid back in full from pension money.”

        Since the POB proceeds are now “Trust assets”, in the absence of a security interest (as discussed above), I don’t see any legal mechanism to forceably remove that money from the Trust, and the Plan participants would be nuts to agree to it voluntarily.

        Reply

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