CHICAGO -Illinois' pension funds failed during three of the 10 subsequent years to make the arbitrage play on interest rates work in the state's favor on its 2003 $10 billion pension bond issue, according to a new report.
Results from fiscal years 2004 through 2013 still favors the state in its decision to go forward with the borrowing but it underscores the risk associated with such financings, according to a Sept. 4 report from the Civic Federation of Chicago. The local government research group reviewed the information in the state's bond offering statements.
"This interplay between the interest owed on the POBs and the rate of return achieved by the retirement funds defines the risk inherent in borrowing to improve the state's pension funding," the report said. "Since Illinois has exceeded this amount in most years, issuing the 2003 pension obligation bonds at this moment appears have benefited the state financially. At other times the POBs might look less successful if investment returns suffer due to market fluctuations."
The state's data shows that in 2008, 2009 and 2012 the rate of return was lower than 5.05%. During some of the stronger years, the system saw double-digit returns. The state's retirement system is saddled with $100 billion of unfunded liabilities and is funded at just a 39% rate.
The federation, citing bond documents, reports that anytime annual investment returns exceed the 5.05% interest cost of the bonds the state's unfunded pension liabilities are lower than they would have been without the additional assets from the bond issue. But in any the annual investment returns fall lower than 5.05%, the unfunded liabilities of the systems are higher than they otherwise would have been.
Former Gov. Rod Blagojevich won General Assembly approval for the $10 billion sale that pumped $7.3 billion in the state's retirement system, trumpeting the improvement that resulted in the funded ratios. The state defended the play on arbitrage citing the low taxable rates offered on the bonds at the time. Through the transaction, the state brought its pension system up to a 63% level of funding from 54%.
The state used the remainder to cover part of the state's contributions in fiscal 2003 and all of its 2004 payments to ease a budget deficit, adding to its future structural budget woes.
The Civic Federation cited a July study by the Center on Retirement Research at Boston College that reviewed all 5,109 POBs issued across the country by 529 governments, totaling $98 billion in 2013 dollars. The researchers found that as of 2013 the POBs netted 1.5% in positive earnings, but that followed lost value in 2009. The study concluded that it's difficult to assess the overall success of such borrowing since most bonds have a 30 year life.
