Providence and Pension Obligation Bonds

Rhode Island State House; Photo by Mohan Nannapaneni on Pexels

The Trouble with a High Discount Rate, Low Assets Levels, and Cash Flow

According to the City’s promotional material, “Why we must act now to invest in Providence’s future” (April-May 2022), there were two main reasons for the bonds (aside from “bankruptcy is not an option”):

  • “Currently, the pension system is just 23.94% funded, even after making 100% of the City’s pension payments for ten years.”
  • “Currently pension costs consume 14.4% of the City’s General Fund revenues. By 2035, it will become 21.4%.”
Source: Providence July 1, 2020 Actuarial Valuation

POBs May Limit Future Debt Capacity

Under Rhode Island state law, a municipality cannot increase its aggregate indebtedness to an amount greater than 3% of taxable property. According to Providence’s 2021 financial statements, $42.2 million of current debt is subject to the limit, leaving about $407.5 million of additional debt capacity. If the POB debt is issued, it will place the city well above its debt limit. There are ways to exempt debt and the city already has $4.6 million of debt incurred outside this limit.

Studies Generally Show POBs are a Bad Idea and Depend on Timing

For States and Localities, Borrowing and Issuing Pension Obligation Bonds Increased as a Response to COVID-19,” Pew Charitable Trusts, May 2021

  • “Issuing debt to close budget gaps and pay down unfunded pension liabilities can alleviate short-term budget pressures but also presents long-term risks.”
  • “When POB proceeds are invested is particularly important. For example, the risk of incurring long-term losses is greatest when stock market valuations are near their peak.”
  • “Under current governance, POBs only resolve funding challenges over the short term.”
  • “Under our [the authors’] assumptions both taxpayer and beneficiary economic welfare is adversely affected by POBs. Hence, unless bond issuance is accompanied by structural changes in governance, they are a bad idea.”
  • “POBs had a negative average real return from 1992–2009, but show a small gain when the time period is extended to 2014.”
  • “POBs could be a useful tool for fiscally sound governments or as part of a broader pension reform package for fiscally stressed governments.”
  • “But results to date suggest that, instead, POBs tend to be issued by governments under financial pressure who have little control over the timing.”

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Timothy Little

Timothy Little

State and Local Government Finance | Cities, Transit, Infrastructure, Economics, Demographic Change | backofthebudget.com | Opinions are my own.