Town of West Hartford Looking to Approach Unfunded Pension Liability with Pension Obligation Bonds, Reserve Fund

West Hartford Town Hall. Photo credit: Ronni Newton

The West Hartford Town Council will vote Tuesday night on an ordinance permitting the issuance of Pension Obligation Bonds and the establishment of a reserve fund to mitigate potential economic downturns.

By Ronni Newton

The West Hartford Town Council will hold a public hearing Tuesday night, and at the meeting that follows will vote on two ordinances – one which authorizes the sale of Pension Obligation Bonds, and the other which establishes a reserve fund intended to mitigate the risk of economic downturn – a combination of measures intended to virtually eliminate the town’s existing unfunded pension liability while also leveling annual payments for the next 30 years.

“This is the biggest transformational plan since I’ve been on the Town Council,” Mayor Shari Cantor said in an interview last week.

The town’s unfunded pension liability is not a new situation, but rather the result of traditional defined-benefit pension plans that for years were provided to town employees (non-public safety employees, and non-certified employees of West Hartford Public Schools) – and which due to a combination of economic factors and decisions by past councils were not adequately funded.

Pension debt has been one of the biggest drivers of the town’s budget.

Town employees hired more recently participate in a hybrid plan more closely resembling benefit plans found in the private sector. The hybrid plan reduces the town’s cost of future retirement benefits, but the town is contractually obligated to maintain pension benefits for legacy employees.

The unfunded liability today totals roughly $315 million assuming a discount rate of 6.99%, Town Manager Matt Hart said, and is funded at just under 41%. The town’s financial consultants have advised the use of a discount rate of 6.25%, which would make the unfunded liability closer to $365 million.

“Despite the good work by the Council,” the funded ratio has barely moved, Hart said. ADEC – the Actuarily Determined Employer Contribution – continues to increase at a rate that is higher than inflation.

“This isn’t a new liability for us, this is just a financial plan to minimize the impact to our taxpayers, to level out and decrease the amount of that liability,” Cantor said.

Council members will be asked to vote Tuesday on the sale of a $365 million, 25-year term Pension Obligation Bond sale. The current interest rates are at historically low levels, and conservative financial models are contemplating a rate of 3%, but the rate could even be lower.

The proceeds from the bond sale would be used to fully fund the pension plan, with an annual debt service cost estimated at just under $21 million.

The town would still have to pay the normal costs – the annual pension plan contribution – but would be caught up on the past obligations. Going forward, ADEC would include just the normal costs.

Bond repayment is made in arrears, but rather than skipping a payment in FY21, the town is also proposing using what would have been budgeted to establish a reserve fund, which will be invested and used to mitigate any economic downturns impacting the payment of the normal costs in the future.

While Pension Obligation Bonds are often a measure used by communities that are struggling, West Hartford is looking at this as a unique opportunity to take advantage of low borrowing rates – and with the reserve fund, which will be invested at the direction of the town’s Pension Board at an estimated long-term growth rate of 6.25% over the life of the investment, the town will have funds available for use to offset volatility in the annual payment of normal costs.

As part of the town’s consideration of the plan, the town’s consulting actuary, Becky Sielman of Milliman, has performed a stochastic analysis of 10,000 different scenarios. Sielman said last week during a virtual meeting of the Council’s Finance and Administration Committee that the reserve fund will be adequate to mitigate any potential significant increases in future pension contributions in at least 97% of possible cases.

Over the course of the next 30 years, the plan is projected to to save the town more than $140 million in net present value.

Cantor has been interested in the concept of Pension Obligation Bonds as a means of leveling out that liability for several years, and because of current low interest rates both she, Hart, and the town’s financial advisors believe it makes financial sense at this time and is a strategic opportunity that will benefit the community for decades.

“When a distressed community does this it’s because they haven’t been making their ADEC payments,” Cantor said. “We have, and we see how it’s eating up the budget. That’s the trajectory.”

“We didn’t do it in the past because interest rates weren’t there,” West Hartford’s Chief Financial Officer Peter Privitera said. In addition, the establishment of the reserve fund is a unique aspect of West Hartford’s strategy.

Other financially sound communities that have learned about West Hartford’s proposal have recently reached out to ask him about it and have also expressed interest in Pension Obligation Bonds as an option, Privitera said.

Deputy Mayor Leon Davidoff, who chairs the Finance and Administration Committee, also expressed support for the plan. “This is a thoughtful and innovative approach that will help keep West Hartford on solid financial footing,” he said.

One of the projected scenarios developed by Milliman can be seen in the PDF below as an example of how the Pension Obligation Bond would work. The financial benefits will gradually accumulate, and become more signifiant over the next decade, benefiting future councils and future taxpayers.

While the overall cost savings won’t necessarily accrue on her watch, “this is most responsible thing we can do right now,” Cantor said.

The FAQs provided as a PDF below were prepared by the Town of West Hartford and offer more details about the strategy, and how it affects the town’s overall risk. The proposed ordinance to authorize the sale of Pension Obligation Bonds can be found here, and the proposed ordinance to establish the reserve fund can be found here.

Tuesday’s public hearing will begin at 6:30 p.m. For details about the hearing and instructions on how to participate, click here.

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