State works to prop pensions with bonds

Unfunded liability for state employees set at $7.4 billion over 25 years

Posted: Friday, June 20, 2008

Alaska is moving ahead with selling billions of dollars in bonds to prop up the state's underfunded public pensions system, after approval of the plan recently by the Legislature and governor.

"It's definitely a win for the retirement system, and it may well be a win for the state," said Michael O'Leary, an investment adviser for the Alaska Retirement Management Board.

O'Leary was among investment professionals reporting the board at a meeting last week.

The bonds are known as pension obligation bonds and are issued at low costs backed by the state's strong credit rating. The proceeds are then invested in potentially higher yielding investments such as stocks.

The process is called arbitrage, and it is being increasingly used by public pension funds facing unexpectedly high estimates of future retirement payments.

In Alaska, the latest estimates show the unfunded liability for the public employee and teacher retirement systems at $7.4 billion over the next 25 years.

The Legislature this year authorized issuing up to $5 billion in pension obligation bonds in an effort to reduce that liability. Department of Revenue Deputy Commissioner Brian Andrews said he expects Alaska to issue only $2 billion of that amount, but that may change depending on what markets and interest rates do in the near future.

The success of the deal for the state hinges upon the state getting better returns on its investments than it has to pay out in interest on the bonds. Over the long term that's likely to happen, Andrews said, but so far this year the stock market is down about 10 percent.

That decline highlights the risks of pension obligation bond transactions, but ironically, increases the chances the deal will be good for the state.

"The market has moved down since last fall," Andrews said. "For this transaction, this is a good thing for us. We want the market to turn after the sale."

Andrews reported to the ARM board that progress was going well in setting up the sale. Some of the top names on Wall Street will be working for the state, including CitiBank, Merrill Lynch and Goldman Sachs, to sell the bonds, Andrews said.

The state also has been working with major bond rating agencies Standard & Poor's, Moody's and Fitch to improve the state's bond rating, Andrews said. That will reduce the state's interest rate cost on the pension obligation bonds and improve the chances of a profitable transaction.

The top rating is AAA, and Andrews is talking up the state's financial strength, and hence its ability to repay the bonds, to seek the best rating possible.

Standard & Poor's recently gave the state an AA+ rating. Andrews hopes Fitch will as well, and thinks the state will do even better with Moody's.

Alaska is "almost pretty much guaranteed a AAA rating from Moody's," he said.

Andrews called a low interest rate "one of two secret ingredients in the sauce to make this transaction a success."

If interest rates go up significantly before the bonds are issued, Andrews said they may delay the sale or reduce the size. More bonds may be issued later, if conditions improve.

The second key to success, Andrews said, is for Alaska to market the bonds well.

The most likely buyers are European banks, he said, and Alaska wants to make sure they know the bonds are available and that Alaska is financially strong.

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