Header, the Administration of the Honorable Lincoln C. Almond
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July 11,2001


In accordance with the provisions of Rhode Island General Laws § 43-1-4, I am transmitting herewith, with my disapproval, 2001-S 0122, Substitute A, As Amended, "An Act Authorizing the City of Cranston to Finance the Unfunded Pension Liability of the City of Cranston, by the Issuance of no more than $10,000,000 Bonds therefor and Authorizing the City of Woonsocket to Finance the Unfunded Pension Liability of the City of Woonsocket, by the Issuance of no more than $580,000,000 Bonds therefor."

This bill would allow two municipalities to issue pension obligation bonds after a public vote, presumably this year. The bill contains no standard concerning investment of die proceeds.

Rhode Island has had no experience in executing a State or municipal pension obligation bond, and I believe that it is the State's responsibility to provide a process and structure which should be followed by all municipal issuers of pension obligation bonds. Without such statewide statutory guidance, I fear that the risks of these transactions would not fully be disclosed to die local governing body and the individual taxpayers. The success of this type of financing lies in both the execution of the debt transaction and continued diligence in the investment of the assets. Therefore, it is critical that any community act prudently in executing -such a long-term financing plan. Moreover, considering the potential risk to the communities involved in pension obligation bonding and the huge size of the bonding, this type of bond financing should be presented only at a general election (every even numbered year) in order co ensure full participation by local voters. This is consistent with the current general law (35-3-7.l(c)) requiring that state general obligation bonds be presented at general elections. The next general election, of course, occurs in 2002.

Pension obligation bonds are a means of replacing one liability with another. The estimated unfunded liability of the pension system at the time of issuance is replaced or reduced by the debt service payable on the bonds. This method of financing has been viewed as a way of reducing overall cost to the taxpayers by taking advantage of the difference between tile rates at which the issuer sells the taxable debt and die long term investment return on the proceeds received. The key factors, which should be reviewed to determine the likelihood that the issuer will be better off after such a financing, include: the effectiveness in the execution of debt issue, including the structure of the debt, and the rare at which the community would issue the debt; the ability of the issuer to meet or exceed the assumed investment returns over the long term; and the ability of the issuer co recognize and control growth in the unfunded liability of the pension system.

The legislation before me would authorize the issuance of pension obligation bonds by the cities of Woonsocket and Cranston without setting any statewide processes or standards co address the factors discussed above. I feel this is a premature piece of legislation, and should be considered by the General Assembly during the next legislative session, when a more comprehensive legislative package has been developed. My Administration is committed 10 working with the General Assembly 10 provide assistance in developing such omnibus legislation in time for 2002 general election. The legislation should include certain requirements toward prudent execution of this alternative financing, but only after approval by the local voters at a general election.

In developing Statewide legislation, there are many issues to be addressed, including whether the proceeds of the bonds should be managed in the same way the state and municipal employee pension funds are managed, with the resulting transactional cost savings passed on to the municipality. Other options should likewise be explored. Preliminarily, issues that would need 10 be addressed include:

1. Reporting provisions char require an actuarial valuation, audit, and compliance reports to be provided each year that the pension obligation bonds are outstanding.

2. Provisions co minimize the risk of underperformance of the investment: portfolio. Options include, bur are not limited to: a) a requirement chat all or a portion of the "excess" returns be deposited into a reserve fund; or b) a requirement that if the reinvestment of the pension obligation bonds is nor sufficient to fund the obligations (triggered when the assumed investment return is nor met based upon a multi-year rolling average), there will be an appropriation required by the municipality on an annual basis.

3. Provisions that reduce the risk that the unfunded liability is misstated. This might include provisions which define die actuarial method to be utilized 10 amortize the unfunded liability, the frequency of actuarial analysis, the adoption or new assumptions based upon experience studies, and the selection of "actuarial auditors" 10 review the municipality's actuarial valuations.

4. Provisions to limit the growth in the unfunded liability of the system by prohibiting benefit changes that would unduly increase the unfunded liability of the system, including limits for cost-of-living adjustments for retirees, and other benefits provisions, 10 those granted 10 retired members of the State Employees Retirement System.

5. Provisions 10 encourage oversight on the structuring and issuance of the pension obligation bond debt. This might include a requirement that each issuing municipality retain the services of a financial advisor, independent of the underwriters, 10 assist in the structuring and sale of the bonds.

6. Provisions for full disclosure of the financing plan at a public hearing. This might include a requirement that the issuer present 10 the governing body prior to the final passage of any order authorizing the issuance of bonds, a report that sets forth an actuarial valuation of the system, the present value savings to the city or town that are reasonably expected to be achieved as a result of the issuance of such bonds, and the projected surplus of the unfunded liability. The report might include a detailed investment strategy with respect to investment of the proceeds of the pension obligation bonds, which demonstrates that the municipality reasonably expects 10 derive sufficient net earnings on such investments 10 meet the annual rare of return assumption set forth in the actuarial valuation report. Fulfillment of this requirement might be a condition precedent 10 the sale of the pension obligation bonds.

7. Provisions to encourage development of sound investment decisions. This might include a requirement for an oversight body within each issuing municipality consisting of persons with expertise In the area of finance and investments that would be responsible for ensuring that the goals of the pension obligation bond financing authorized are met, or it might include some provisions that define die process for determining the asset allocation and investment of proceeds. It might also include review of the State Investment Commission structure and guidelines as they relate to the investment of state and municipal pension funds. It might require thai prior co the sale of the bonds, that the municipality retain the services of a nationally recognized pension investment: advisor co advise the body on the investment of the proceeds of the bonds. The municipality shall covenant that the advisor, or successor advisors, shall continue to serve in an advisory capacity until the pension obligation bonds are fully repaid. Fulfillment or this requirement might be a condition precedent to the sale of the bonds.

What the above discussion shows is that more work on the state level, in the form of comprehensive legislation, should be done before pension obligation bonds are issued for the first time by any Rhode Island municipality. In addition, any bond issuance of this magnitude should occur only at after a public vote at a general election, just like stare general obligation bond issuances.

As such, this veto should nor be construed as my disapproval of the issuance of pension obligation bonds by Woonsocket or Cranston. Rather, it should be considered a call for a more comprehensive review of the issue of pension obligation bonds and their future impact on all Rhode Island municipalities and the state.

For the foregoing reasons, I disapprove of this legislation and respectfully urge your support of this veto.


Lincoln Almond