Hank KimNCPERS

Jim LinkThe PFM Group

Girard MillerOCERS

PENSION OBLIGATION BONDS PANELGreg SmithCOPERA

• Issuers of Pension Obligation Bonds (“POBs”) issue debt in the taxable fixed rate markets and deposit the proceeds into their pension system.

• POBs are a risk-bearing arbitrage strategy between the cost of financing and the return on investment.

Pension Obligation Bond Mechanics

2© 2016  The PFM Group

– Investment rates that are greater than borrowing costs will achieve net savings to the pension obligation.

– POB proceeds should be invested in asset classes that provide the best risk/return trade-off (i.e. Equities).

• POBs replace a ‘soft liability’ with a ‘hard liability’.

Hypothetical Example

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What is the Benefit Bonds Window?

Benefits Bond Window

© 2016 The PFM Group

• The period of time an issuer of benefits bonds can invest bond proceeds in the stock market without witnessing lower stock prices in the subsequent economic recession

– Measured from the bottom of the stock market (which typically corresponds to the trough of an economic business cycle) until thestock market ‘breakeven’ level with the subsequent stock market bottom

– Theoretically, the period in which the risk of subsequent-cycle loss is < 50%– Quantifiable only in hindsight

Colorado POBs

» Risks• Market timing of proceeds

» Mitigated through multiple issuances» Long-term strategy (measurement of success not

until last bond paid off)• Structural issues causing problems

» Variable rate cost of capital» Underfunding future required contributions

» Solutions• Fixed rate debt instruments only• Bond covenants that mandate minimum future funding

» Not a payment default BUT:• Triggers an inherent reporting obligation• Impact on credit rating of the sponsor/issuer

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Long-Term Historical Public Market Returns30-Year Rolling Annualized of 75 Percent Equity and 25 Percent Fixed Income

The portfolio is constructed using quarterly returns ranging from December 1926 through March 2015 with a 75 percent allocation to Equities and a 25 percent allocation to Fixed Income – Data collected and calculated by Aon Hewitt Investment ConsultingThe Equity portion was constructed using the following indices: January 1936 through December 1969 Center for Research in Security Prices US Broad Equity Index, March 1970 through December 1987: MSCI World Index, March 1988 through December 2012: MSCI AC World Index, and January 2013 through March 2015: MSCI AC World IMI Index.The Fixed Income portion was constructed using the following indices: January 1926 through December 1975: Ibbotson Intermediate Term Government bonds, March 1976 through December 1989: Barclays Aggregate Bond Index, March 1990 through March 2015: Barclays Universal Bond Index. Headline CPI—seasonally adjusted— calculation method adjusted over time

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