Herald-Leader Editorial

Borrowing to shore up state pension fund could bite Ky.

Some who tried it were burned; Ky. should exercise extreme caution

September 23, 2012 

With another task force looking for answers to the Kentucky Retirement Systems' unfunded liability, it was inevitable that "pension bonds" would become part of the conversation.

KRS accounts for about $19 billion of the more than $30 billion in unfunded liability for all state pension plans. Groups representing the public employees, both state and local, covered by KRS have urged the task force to consider making a bond issue part of the pension fix.

Even one of the experts advising the panel is on board — if the bond issue is part of a comprehensive reform. David Draine, a researcher for the Pew Center on the States, told the task force Tuesday a bond issue could reap savings and improve the retirement system's cash flow.

It all sounds so good. Borrow at a low interest rate, let the retirement system invest it at a higher rate of return and pocket the difference. Except it doesn't always work exactly as planned.

In recent years, Illinois has relied heavily on bond issues to fund its state pension programs. The Los Angeles Times reported in March that Illinois will spend 5 percent of its annual budget — $1.6 billion — paying interest on the bonds it issued during the last decade. And its pension fund is in worse shape than when the state started borrowing.

Oakland, Calif., went the bonding route in 1997. A 2010 city audit concluded Oakland would have been $250 million better off if it had simply made the recommended annual contribution to the pension plan instead of issuing the bonds. Pension bonds also were a factor in Stockton, Calif., filing for Chapter 9 bankruptcy.

Undeterred by experience, Illinois and Oakland have issued additional bonds after getting burned.

Other cities around the nation, including Lexington, continue to do so as well. (Since 2009, Lexington has issued bonds for more than $137 million and paid in $45 million in cash from the city's general fund to catch up on pension obligations.)

But cities are no longer resorting to pension bonds in the numbers they once did. According to an Aug. 24 report by Reuters, the amount of money borrowed through pension bonds this year could be the lowest since 2001.

There is good reason for backing off on pension bonds. A study led by Alicia H. Munnell, director of Boston College's Center for Retirement Research, looked at nearly 3,000 pension bonds issued from 1986 to 2009. A Sept. 3 story in The New York Times quoted the study thusly: "Only those bonds issued a very long time ago and those issued during dramatic stock downturns have produced a positive return. All others are in the red." The Times story did note, "Only one in five of the pension obligation bonds issued since 1992 has matured, so the results could change in the future."

Still, the Boston College study suggests that, while it might have been a winning strategy for Kentucky to jump into the pension bond market in the depths of the recent recession, it would be considerably riskier to make the leap now.

And even if KRS were lucky enough to play Wall Street just right, the profits alone would not fill the hole or put the system on sound footing going forward.

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