Supposed Benefits of Pension Obligation Bonds Sink With Market

Michigan legislators who might consider borrowing billions to prop up government employee pension and post-retirement health care benefits should first look at recent developments in California. That state's massive state pension system, CalPERS, may lower its expectations for investment returns. According to the Wall Street Journal, it is considering a drop in its return expectations from 7.75 percent to as low as 5 or 6 percent.

While such an adjustment may seem minor, it would drastically alter future projections for the financial needs of a pension plan. After 10 years, a million dollar investment that grows at 8 percent would be worth $368,000 more than one growing at 6 percent.

And more importantly for the idea of "pension obligation bonds," the lower return rates would halve the benefits such borrowing would supposedly generate. This is because the concept relies on large differences between hoped-for investment return rates versus the locked-in debt service costs of the bonds. The difference is used to cover retirement costs under such a scheme. To illustrate, if the state borrows at 4 percent and puts the money in investments that get 6 percent instead of 8 percent, only the 2 percent spread is available to pay for retirement benefits.

Borrowing billions to fund future pension benefits has always been a risky proposition.  Doing so to pay post-retirement government employee health care benefits for which there may in fact be no contractual obligation goes beyond risky. Lower investment returns makes it even more so.

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