A New Approach for Pension Funding

The Florida Department of Management Services tracks 245 defined pension plans across the state’s various municipalities. Of these plans, 104 have a funding ratio of 90% or better; the remaining 141 pensions collectively owe $11 billion with an average funded ratio of 72%.

The Legacy Obligation Trust (LOT) concept is an innovative strategy whereby a government makes an in-kind contribution of real assets—like land, buildings, infrastructure, enterprises—to a professionally and independently managed trust. This LOT exists for the benefit of one or more underfunded municipal pensions and other post-employment benefit (OPEB) liabilities. Much like shares of stock, the trust issues Certificates of Trust (COTs) and divides them among the various pension and OPEB funds the government unit sponsors.  The government unit’s benefits include:

• an immediate credit against its unfunded liability based on the fair market valuation of the assets contributed to the trust;
• an immediate, positive cash flow impact on the unit’s budget as “catch-up” payments for the underfunding to decrease;
• the independent, professional manager is incented to create additional value to further increase the pension’s funded ratio; and,
• provided the LOT is not considered a component unit of the sponsoring government, the pension and OPEB funded ratios go up, which may improve the government unit’s credit strength among relevant rating agencies, lowering its interest rates on borrowed fund.

Pensions could realize liquidity through three approaches: (i) the cash flows generated by the assets in the trust that are sent to the pension via dividends associated with the COTs; (ii) the sale of some or all of the COTs; or (iii) the outright sale of the asset(s) from the trust via distributions from the trust. In all cases, the pension (as holder of the COTs) is the beneficiary of these cash flows.

The key to realizing meaningful value from unused and underutilized assets is to maximize the economic—rather than political—utility and potential of the assets in the trust. By growing asset value over time, the rising value of the COTs further offsets the underfunding.

For example, imagine a municipality holds raw land with no envisioned municipal or public use.  The land sits dormant on the municipality’s balance sheet valued at the lower of cost or market.  But if the land was contributed to a LOT and developed into a solar farm, it could be leased to a utility company and could create cash flow that never previously existed. Jobs are created as the project is built and maintained over time. The pension benefits from the new dividend from funds generated by the solar farm and the fair market value of the land, now enhanced through development, increases the value of its COTs and further reduces the pension’s unfunded liability.

Cash-flowing assets, like municipal golf courses, stadiums, and other public enterprises, provide a viable pool of in-kind funding opportunities but, whether surplus cash flows are dedicated to a specific purpose or merely a revenue source for the general fund, moving cash generating assets can create political friction. Governments would be well advised to evaluate contributing such assets carefully, and to contribute assets only after thoroughly analyzing stakeholder and budgetary impacts.

This is an evolving strategy that has been successfully applied both domestically and abroad, and various examples include:

• Real assets became a recovery currency to settle Detroit’s bankruptcy in 2014. Several European banks that had financed a $1.4 billion contribution to Detroit’s underfunded pension plan, and their bond insurers, accepted valuable real estate, including the Joe Louis Arena and the Detroit Windsor Tunnel, as part of their final settlement. The creditors’ long-term recovery would depend on their willingness to invest new money to maximize the economic utility of the assets. Judge Steven Rhodes cited this creative alignment of the city’s redevelopment with creditor recovery as an important feature of Detroit’s bankruptcy exit.
• This in-kind asset contribution approach in the Detroit case served as the catalyst for the Connecticut General Assembly to create the 2017 Pension Sustainability Commission^[1]. The Commission’s final report concluded that transferring state assets to a trust to help fund the state’s $34 billion pension gap was feasible.
• New Jersey, with a $75 billion net pension liability, second only to Illinois, contributed its state-owned lottery to its pension plan in 2017 to create a dedicated revenue stream to cover pension funding. In 2019, New Jersey began a comprehensive evaluation of all its capital assets for potential contribution to further address its pension crisis. And in April 2021, New Jersey introduced legislation that would create a LOT-like structure that would enable multiple local municipalities—and the state—to contribute hard assets to a trust vehicle as a means of pension funding. While this legislation has not yet passed, it demonstrates the seriousness with which New Jersey is considering the approach.
• To date, the most powerful example of this strategy comes from Australia. The state of Queensland chose to contribute the Queensland Motorways, a 70-kilometer state-owned toll road, to its pension fund in 2009. Queensland received an AU$3 billion credit against its underfunded pension. Professional management improved operations and expanded the toll road. In 2014, the pension plan sold the toll road to the private sector for AU$7 billion. In short, Queensland unlocked AU$7 billion of value sitting on its balance sheet for the benefit of the pensioners.

Raising taxes, cutting services, and issuing debt are the traditional tools for tackling pension underfunding. These tools, however, are limited and are often politically unpopular. Unlocking the fair market value of unused and underutilized assets sitting on municipalities’ balance sheets could reduce their pension liability now and grow to further offset these crippling obligations. Independent professional economic development and better use of assets could drive value up for the benefit of pensioners, rather than handing assets over to the private sector in a sale.

The next logical step to consider is to organize a group to study and evaluate how a LOT could benefit the various Florida municipalities that may find this strategy appealing. Many communities across Florida average 72% pension funding, and a joint approach that creates an aligned interests could catalyze regional economic development initiatives. Such initiatives could unlock hidden asset value to benefit struggling retirement systems.

[1] Disclosure: Michael Imber was financial adviser to the European banks in the Detroit bankruptcy case and is a member of the Connecticut Pension Sustainability Commission.

A version of this article first appeared in Law360.