Fewer than 4000 people just approved boosting Providence Rhode Island liabilities by $515 million
Pension obligation bonds: not even once
There was a special election on Tuesday, June 7, in which less than 4% of Providence, Rhode Island voters showed up.
Of that 4%, 70% agreed to the issuance of $515 million in pension obligation bonds. This would be a new liability, on top of the liabilities they already have. Sure, they’d get a $515 million cash infusion, which they’d give to the pension plan… but I will get to that in due time.
Providence voters OK $515 million pension bond
In a low-turnout special election, 70% of Providence voters approved the city’s massive bond proposal aimed at digging the capital city’s pension system out of “critical status.”
According to the unofficial results, 3,545 voters approved the $515 million bond, while 1,519 voters rejected it.
Only 4% of eligible voters participated.
As it stands, Providence has a $1.2 billion unfunded pension liability, a gaping hole between how much the city’s investments are projected to be worth and what it will owe its current and future retirees over time.
But opponents of the bond warned it was too risky to invest so much cash and count on a return higher than the interest due, especially in a volatile market.
The voters are not the final decision-makers in whether to borrow the money. State lawmakers must authorize the bond, because it goes above the city’s allowed borrowing capacity. According to the proposed legislation, city leaders will only be able to float the bond if they can get an interest rate below 4.9%.
Another piece, from Boston Globe: Providence voters back $515m pension bond in low-turnout election
Fewer than 3,600 city voters on Tuesday backed Mayor Jorge Elorza’s proposal to borrow $515 million to shore up Providence’s ailing pension fund, according to unofficial results from the Board of Canvassers.
But even fewer voted against the bond.
The bond was backed by Elorza, most of the Providence City Council, all three of the current candidates for mayor, and state Treasurer Seth Magaziner, but even supporters acknowledge that it comes with some risks.
City leaders argued that the bond is necessary because Providence has few options when it comes to addressing its troubled pension system, and its annual taxpayer-funded contribution to the system – $96 million in the current fiscal year – is growing at 3.5 percent each year.
A Rhode Island Supreme Court decision in 2020 limits the city’s ability to reduce benefits for employees and retirees who are part of any previous settlement with the city. That includes anyone who agreed to pension changes under former Mayor Angel Taveras a decade ago.
So let’s look at the Providence pension plan and let’s think about the timing.
Providence ERS Snapshot
First, here are the contributions they’ve been making for the pension plan:
Yes, for over five years now, they’ve been contribution more than 50% of payroll to the pension plan as the full contribution to the pensions.
In the past, they mostly contributed the full requirement, though in some years they didn’t. The requirement used to be less than 50%, but when you short the fund, and when you underperform on investments (which we will see in a bit), that’s expected, right?
So let’s see how the funded ratio has been doing — for all these full payments, the funded ratio must be healthy, correct? [if you didn’t read my excerpts above]
Funded ratio history for Providence ERS
The red line is what’s happening in the rest of the country, which isn’t great. It’s been stagnant at about 72% funded for about forever.
The blue bars is Providence ERS, which has had a declining funded ratio. So the contribution rate is sky-high and has been increasing. But the funded ratio has eroded.
This has been classic asset death spiral territory.
Don’t do it, Rhode Island legislators
As noted in the news pieces, the vote was more or less pro forma. The politicians wanting the pension obligation bonds didn’t have to ask the voters for approval, and the power lies with the Rhode Island legislature anyway. They’ve asked for this before, at the tune of $700 million in bonds, and it was denied before. Now they’ve reduced their request to a mere $515 million.
I don’t think this is a strong electoral result — sure 70% approved, but that was only a 4% turnout. Not exactly a mandate.
Using the numbers from the news accounts, there is a $1.2 billion unfunded pension liability (at last measurement… but I’ll get back to that in a moment) and the pension is 23% funded. That means the full pension liability must be about $1.6 billion. If $515 million in cash comes in, the unfunded liability would drop to about $0.7 billion, and the pension’s funded ratio would now be 56%.
I mean, doubling the funded ratio sounds good, doesn’t it?
However. I’m arguing the state legislators should throw out this request as well.
A high-level look at the assets and liabilities
What you’re doing by issuing pension obligation bonds is injecting more leverage into the system. It’s actually adding a liability to the system, so rather than doing the math the way I did it, in just looking at numbers like this:
Assets : $0.4 billion
Total Liab: $1.6 billion
Net Liab : $1.2 billion
Assets : $0.9 billion
Total Liab: $1.6 billion
Net Liab : $0.7 billion
You should look at the system like this:
Providence, Rhode Island:
Pension Assets : $0.4 billion
Pension Total Liab: $1.6 billion
Pension Net Liab : $1.2 billion
Providence Net Liab: $1.2 billion
Pension Assets : $0.9 billion
Pension Total Liab: $1.6 billion
Pension Net Liab : $0.7 billion
Pension Obligation Bond: $0.5 billion
Providence Net Liab: $1.2 billion
Basically, nothing has fundamentally changed, except, here is the biggest one: the valuation of those liabilities are not of the same nature.
The cash flows being promised for the pension obligation bond are sure. You’re sure of the timing and amount of the cash flows being promised in the POBs.
That is not true for the pension cash flows. That’s why actuaries get paid so much (theoretically).
From a legal standpoint, forget about the net liability — there is a total liability that Providence is responsible for. They have been told they’re legally responsible to pay for the Providence pension cash flows.
By adding on a POB, they have simply added to their total liability. Sure, they’ve added to their assets. This is called leverage. So why do this in the first place?
The big thing is that the interest paid on POBs are supposedly much lower than the rate of return on the assets they’re going to be investing for the pension.
Here is the relevant graph from the Public Plans Database:
The current assumed rate of return on assets for Providence ERS is 7%. This is higher than the 4.9% limit on the interest for the POBs (they won’t issue POBs higher than that under the proposal).
Before 2019, the rate had been 8%. You can see that the 10-year experience has been in line with this assumption, but the 5-year has not. This is not necessarily concerning, but from a valuation point of view, this is all beside the point.
Just look at the blue bars, which show the actual annual returns. The pensions are supposed to be supporting guaranteed cash flows to retirees, and they’re using a fairly volatile investment mix to do so.
If you look at their investment allocation, it looks pretty boring compared to most of the U.S. plans:
You may be thinking (as am I), “well, at least they don’t have much in alternative asset classes”, but they are very heavy on equities compared to fixed income for a pension fund.
They would be taking the POB proceeds and likely investing it in a similar allocation. Given the current state of the market, is that really wise?
They could be taking this cash, and then going from that theoretical 56% funded ratio down to a 40% ratio in no time at all… and then they’d still have the pension liability to pay, plus this new liability, the POB, on top of it. The situation has only been made worse.
Be aware of more shenanigans like this
I am not surprised that this sort of thing is coming from Rhode Island, and specifically Providence. They had some of the worst finances coming out of the Great Recession, and it took a lot of wrangling to try to get it in line, and it’s still not there.
With rising interest rates, many of the more desperate public finance players will be trying to get their ducks in a row. They had been sitting back in 2020 and 2021 as they got their federal funds bonanzas, and as money washed over individual taxpayers they got some of the largesse as well.
But now that money-pa-looza translated into inflation, which has led to the interest rate situation we see now. Maybe some of them remember the early 1980s:
So watch to see the usual suspects trotting out similar ploys.
Things in the market may move faster than the Rhode Island legislature can, and it can be that Illinois, Kentucky, Connecticut, California, and more and more will find they will not be able to execute on POBs. I hope not.
I understand the people who argue that these can be tools that help in public finance, which is a nice theory, but I’ve seen how these politicians actually behave.
I do not think this is a good time to add more debt to the system. You’ve got enough, thank you very much.
You can go to my Rhode Island post compilation to see some of the earlier posts reaching back to 2014, but most of the Rhode Island financial troubles had been worked through before I got STUMP set up.