MSU Extension Center for Local Government Finance & Policy

Per Article IX § 24 of the Michigan Constitution, past accrued pension benefits are protected and the state and local governments are contractually obligated to provide these benefits. Once an employee becomes vested in her employer’s defined benefit pension plan (“DB”), the employer cannot take those benefits away. DB pension plans are funded by both employer and employee contributions that are then invested. Pension plan investment portfolios have traditionally tended to be heavily weighted in lower risk and lower return assets. Because traditional investments are not yielding desired returns, in recent years, pension portfolios have taken on more risk with investments that have greater potential returns. Pension fund managers, employers, and employees want to know there will be enough assets in the fund to cover accrued pension benefit payments. Michigan’s municipal governments (i.e. townships, cities, and villages) and counties have a limited number of revenue raising tools to use to meet their contribution obligations. One tool recently made available to Michigan local units is the ability to issue pension obligation bonds.

Pension obligation bonds (POBs) “may offer cost savings if the bond proceeds are invested, through the pension fund, in assets that realize a return higher than the cost of the bond.” However, if the return is not higher than the cost of the bond, the municipality or county will need to decide how to pay back bondholders in addition to pension payments. Additionally, POBs are issued to finance pension systems and financing is not the same as funding. The underlying issues leading to large unfunded pension liabilities still exist and the local governments will need to address them at some point. Pension obligation bonding impacts more than just public sector employees and employers. It also impacts taxpayers because bonding directly influences the rest of the local unit’s operating budget. Consequently, issuing POBs to finance unfunded pension liability can effect taxes as well as public services.

This policy brief will explore pension obligation bonding in the United States as well as in Michigan specifically and will discuss:

• Michigan law regulating local government pension obligation bonding, including Act 34 of 2001, the Revised Municipal Finance Act.
• The reasons Michigan local governments issue pension obligation bonds, including to save money, increase fiscal responsibility, and provide short-term budget relief.
• Various risks associated with pension obligation bonding, such as investment risk, political risk, and flexibility risk, and the way these risks manifest in Michigan.
• Policy considerations to make pension obligation bonding less risky and more likely to produce positive results for all parties involved.