In what is the product of the sustained low-rate environment, many municipalities are considering addressing their pension position through bonds. This should be encouraged by policymakers and explored by pension systems.
Bond markets are offering municipalities the opportunity to exchange discount rates of 6, 7 and sometimes even 8 percent for bonds with yields below 3 percent. The spread between the discount rate and the bond yield is the root of the appeal of pension obligation bonds.
A natural question is “How do pension systems become underfunded?” The answer is a combination of issues. The two largest are underperforming investments and insufficient employee contributions.
BY ERIC J. MASON