via Bloomberg:
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City bets investment profits from bonds will fund health care
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Tactic has been used widely for pensions, with mixed results
It’s a “considerable risk,” a “bad idea,” or, as one expert put it, “insanity.” And it may be the next big pitch Wall Street bond underwriters make to states and cities desperate to cover ballooning health-care costs.
Dearborn, Michigan, the 94,000-resident city that’s home to Ford Motor Co., tested the waters this week by selling $35 million of bonds to chip away at the $161 million it needs to cover the medical bills of workers who will retire in the years ahead. The city is betting that by investing the proceeds it will earn more than it will pay in interest, with the profits helping to cover health-care expenses.
Many states and cities have used the same strategy for their pensions, and Chicago Mayor Rahm Emanuel Wednesday proposed a $10 billion debt sale for the city’s ailing retirement system. Some have came out ahead. Others were burned by stock market losses or because the temporary boost allowed governments to cut their annual pension payments. Illinois, New Jersey and Puerto Rico borrowed billions only to see the large shortfalls reappear.
The tactic has been used far less for health-care costs, but it isn’t unprecedented. Over a decade ago, five Wisconsin school districts plowed borrowed funds into collateralized debt obligations, the toxic investments that blew up after the housing market crash, with the intent of spending the earnings on health care. They lost the money instead.
“These are expenses that should be paid for out of the budget — not bonded out,” said Thad Calabrese, an associate professor at New York University who studies public financial management and called such deals “insanity.” “It’s surprising it hasn’t been done more and I’m thankful it hasn’t.”
Market Timing is Key
Pension bonds have paid off, unless they were sold before stocks crashed
Source: Center for Retirement Research at Boston College
Governments are eager for ways to cover the health benefits that they’ve promised retirees, which, unlike pensions, are usually funded out of their annual budgets on a pay-as-you-go basis. S&P Global Ratings said the costs are a “growing” concern, with states alone facing $678 billion of unfunded liabilities. New York City’s $98 billion unfunded liability for retiree health care is bigger than its bond debt and its pension-fund shortfall.
The Government Finance Officers Association recommends against selling bonds to finance those medical costs, citing the “considerable risk.” That’s because there’s a chance they will earn less than it cost to borrow, leaving them deeper in the hole, which has been the case with governments that sold pension bonds just before stock market routs.