1. Bonding for Public Pensions
City Attorneys Association (ACAA) Summer Conference
Flagstaff, Arizona
Thursday, June 1st, 2017
Timothy A. Stratton

2. Public Pensions in Arizona
PSPRS (Public Safety)
ASRS
Correctional Officers Plan
Elected Officials Plan

3. A Problem of Sustainability
When we talk about the pension problem in AZ we are talking about PSPRS. It is the system with the largest degree of unfunded liability.
Benefits given are exceeding ability to keep the system funded.
A number of factors have influenced PSPRS's decline, the two biggest factors being: (1) the system’s current Permanent Benefit Increase (PBI) mechanism, and (2) underperforming investment returns.
$6.6 billion in unfunded liabilities over the past dozen years and stands at only 48% funded today.

5. The Arizona Situation Recent efforts at pension reform.
Prop 124 (approved by voters)
Creates multi-tier pension system; expected to help reduce the structural imbalance.

6. Prop 124
Cost of living increases (COLA) will be based on the consumer price index for Phoenix and capped at 2 percent and will be pre-funded (which is currently not happening).
New hires will be able to choose between defined contribution plan (like a 401(k)-style savings plan) or a hybrid defined benefit plan rather than the traditional pension system.
New hires will have the salary cap for pension calculations reduced from $265,000 to 110,000 per year, seriously limiting incentives for finding ways to "spike" pensions with bonuses or unused vacation time to jack up what retiring employees will be receiving.
The eligibility age for new hires will be increased from 52.5 to 55.
New employees will have to pay 50 percent of plan costs if the plan doesn't meet return assumptions.
Employers (that is to say, the government) will be forbidden from having "pension holidays," where they stop paying into pension funds when they are overperforming (which then turns into a crisis when pensions later underperform).

7. Where do we go from here? Do nothing.
Increase amount of cash contribution to the system each year.
Budget Law Considerations
Does statute allow for additional payments to system?
Can we borrow to make larger contribution?

8. A National Problem How are other states handing this?
Some states prohibit borrowing for pensions.
Some states specifically allow for pension obligations.
Some states are silent.
What is Arizona law on this?

9. A Massive Problem
Nationally, state public pension plans are now underfunded by nearly $5.6 trillion.
The nationwide funding level is a mere 35 percent
The price tag for unfunded pension liabilities is now $17,427 for every man, woman and child in the United States.

10. Arizona Authority on Pension Borrowing
Not specifically allowed under our statutes.
No such thing as a pension obligation bond in Arizona.
We lack specific or judicial authority for this type of bond.
Do we have any options to pay unfunded portion?

11. Yes! There are some possibilities
Asset Transfer Financing
Lease-Leaseback or Lease-Purchase
General Obligation Bonds

12. Asset Transfer Financing
Concept is straightforward.
Municipality “sells” or “leases” some city owned property to third party for collateral and third party lends money to city.
Municipality leases the asset back for term of financing.
Examples of this are State of Arizona leasing public buildings and Maricopa County leasing county owned property and using proceeds to pay for working capital costs.

13. Tax Considerations
Most municipal borrowing is done on a tax-exempt basis.
Payment of pension costs is an operating expense.
Operating expenses (working capital) must be financed on a taxable basis.
More expensive to issue these bonds.

14. Why would a City consider financing pension costs?
Allows municipality to “catch up” and reduce or eliminate the unfunded liability.
Goal is to take your bond proceeds and invest them at a rate higher than the rate of interest you are paying on the bond.
Can the plan earn that much return?

15. Comes down to the Math
If the system earns more on the investment than you are paying in interest you have succeeded.
If the return is less, you are stuck paying more for the bonds than you are earning.
May help your situation short term, but what is the long term diagnosis?

16. Pension Bonds…a Cure or Bandaid?
Once you are “fully funded” what then?
Have we solved the underlying structural deficit in the system?
Without solving the underlying deficit we are kicking the can down the road.
Will you need to issue more bonds once the system comes out of balance again?
Prop 124 seems to have stopped the bleeding but was it a permanent fix?

17. Other Considerations
If system is fixed then perhaps pension bonds make sense to fund the difference.
If system is not fixed then are municipalities throwing good money after bad?
Public perception and political issues.
Long term credit issues of borrowing to pay operating costs.

18. GFOA POLICY
The Government Finance Officers Association (GFOA) recommends that state and local governments do not issue POBs for the following reasons:
The invested POB proceeds might fail to earn more than the interest rate owed over the term of the bonds, leading to increased overall liabilities for the government.
POBs are complex instruments that carry considerable risk. POB structures may incorporate the use of guaranteed investment contracts, swaps, or derivatives, which must be intensively scrutinized as these embedded products can introduce counterparty risk, credit risk and interest rate risk.
Issuing taxable debt to fund the pension liability increases the jurisdiction’s bonded debt burden and potentially uses up debt capacity that could be used for other purposes.
POBs are frequently structured in a manner that defers the principal payments or extends repayment over a period longer than the actuarial amortization period, thereby increasing overall costs.
Rating agencies may not view the proposed issuance of POBs as credit positive, particularly if the issuance is not part of a more comprehensive plan to address pension funding shortfalls.

19. Questions?

20. Thank You!