3.3.2.2 Pension Obligation Bonds
While other public agencies can issue pension obligation bonds (POBs), most POBs are obligations issued by and payable from the general fund of a city or a county. Public agencies issue POBs to make a payment to the public agency’s retirement system (a self managed system, a group system, the California Public Employees’ Retirement System (CalPERS) or the California State Teachers’ Retirement System (CalSTRS) to satisfy an obligation to make payment to the system. The pension obligation funded can be the public agency’s required payments for the current fiscal year (its “normal annual contribution”), the public agency’s unfunded accrued actuarial liability (UAAL) or both. Financing the normal annual contribution in effect defers payment and provides the public agency cash flow relief in the current fiscal year. Financing the UAAL replaces a multi-year pension funding obligation with a multi year debt service payment obligation. Although a variety of policy considerations are involved, from a pure payment obligation standpoint, the public agency as a general matter will come out ahead if the retirement system invests the proceeds of the POB and earns more than the cost (debt service and issuance costs) of the POBs and will come out behind if it does not. The retirement system can invest in a broad range of investments, including equity securities.
Pension obligation financings are generally structured with an issuance by the public agency of a note payable to the retirement system. The note is then refunded with POBs issued under a refunding bond law statute. See Section 3.7.6, Refunding Bonds. Pension obligation bonds can qualify for the Obligations Imposed by Law Exception to the constitutional debt limit. However, a validation action under California Code of Civil Procedure Section 860 et seq. is generally required. See Section 1.2.4.6, Obligations Imposed by Law Exception.
POBs are generally payable from the same source as the financed pension obligations (e.g., the public agency’s general fund) and can be issued as either fixed rate or variable rate obligations. There is generally no debt service reserve fund. Because of limitations on the ability to fund working capital, POBs are generally issued as taxable debt for federal income tax purposes. See Section 4.5, Cash Flow Borrowings.
Public agencies have also explored ways of financing their other post-employment benefit (OPEB) obligations. Because of complexities in the calculation of these obligations and because public agency responsibilities with respect to OPEB obligations are less clearly defined than they are with respect to pension obligations, financing OPEB obligations is challenging.