Employees rely on pension funds to have sufficient money to pay benefits upon retirement. Sometimes, pensions must get creative in order to make that happen. Issuing pension bonds is one such way, and it is a form of debt that the employer, or pension plan sponsor, takes on in order to keep the value of the retirement plan stable. The money has to be repaid with interest, but raising money in a debt sale gives the pension immediate capital and more time to grow the value of the retirement plan in other ways.
A pension's funding status is a representation of assets in comparison with liabilities, and a properly funded plan is typically funded at least 80 percent. Anything below that level may be considered an underfunded plan, and the severity of being underfunded increases as the gap between assets and liabilities grows wider. One way to improve the funding status of a pension is to sell pension bonds, a form of debt that must be repaid to investors over time.
Pension bonds are typically issued by the plan sponsor. If a public state plan is run by a local governing body, such as a state treasury, that body will typically be the one to issue the pension debt. Legislation will be in place that dictates how much debt a pension plan is permitted to take on.
In the capital markets, pension bonds are similar to other debt securities. Investors buy the bonds, essentially extending a loan to the pension or plan sponsor. The pension must make ongoing interest payments to investors until the expiration of the bond, at which time the principal investment amount must be repaid.
Plan sponsors of public pensions must make yearly cash contributions to the plan as outlined by local governing bodies. This is an attempt to keep the pension at a healthy funding status. If the plan sponsor neglects to make a planned contribution, this could seriously impact a pension's funding status and could lead to a need to issue pension bonds.
On top of contributions, a pension's value is supposed to increase based on investments that the pension makes. In addition to maintaining the value of a fund, investments are supposed to increase the pension's size. Assets are distributed to various categories, including stocks, bonds, real estate, and more. When investment performance lags or just does not deliver the type of profits that are needed to keep a pension properly funded, a plan sponsor might respond by taking on debt and issuing pension bonds.