Pension obligation bonds

Pension obligation bonds are referred to as POB’s in the finance and investment industry. They are basically an instrument of debt which is issued by a government entity in order to finance a portion of or all of UAAL’s (Unfunded Actuarially Accrued Liabilities) for pension purposes and/or other PEB’s (Post Employment Benefits).

In so many words, and from an accounting standpoint, are capable of converting the liability of a short balance sheet to the liability of a hard balance sheet.

The benefits of investing in POB’S

There are three key advantages or benefits to investing in pension obligation bonds that you should be aware of if you are considering investing in these financial instruments:
• the disciplining of budgeting the annual payments of debt services in order to cover the newer obligations of the bonds
• the difference between the interest paid on these bonds and the actuarial assumed returns results in annual funding cost reductions of from 15% to as much as 30%
• cash is provided to the various retirement systems so that they can invest these in order to lower any unfunded liabilities as well as meet benefit payments in the future

The history of pension obligation bonds

In 1985, Orrick created financing for the City of Oakland by developing and issuing “pension bonds” as well as serving as the bond’s counsel. This resulted in a “snowballing” effect of financing and other copy-cats which rapidly followed and were tax-exempt financial instruments.

However, they were driven by the possibility of legal arbitrage occurring in the process. A number of these transactions were patterned after either annuity instalment sales or as lease financing.

Tax legislation relative to the Tax Reform Act that was passed in 1986 put an end to these tax-exempt bonds. Interestingly enough, financial institutions have continued to work on other tax-exempt pension obligation bonds due primarily to special non-arbitrary or rules of transition situations that may exist.

In 1994, a newer, taxable version of POB’s occurred in the state of California, the origination point being situated in Sonoma County.

These were driven by the rate of declining, taxable rates of interest compared to the actual rate of interest that was imputed by certain pension funds on the UAAL (see above). Additionally, needing budget relief and the legal arbitrage risk became opportunities in a much broader array of investments made by most pension funds compared to what the city or county governments had permission to make.