For decades, when cash was scarce, corporate pension-plan sponsors have made in-kind contributions -- non-cash assets such as securities and real estate -- to fund their retirement plans. US Steel, for example, contributed 170,000 acres of timberland to meet its pension liabilities. General Motors used securities from a subsidiary company. Facing bankruptcy, Pan American World Airways transferred the lease for its flagship terminal at New York's Kennedy Airport to its pension funds. These private-sector plan sponsors looked to their balance sheets for assets they could monetize by contributing them to their pension funds.
Given the fiscal struggles that so many state and local governments face, it might seem that the idea of funding public retirement systems with cash-generating public assets or dedicated funding streams from them would be one that would have caught on long ago. It's an idea that, done properly, is worth considering. Yet state and local policymakers have only recently begun to follow the lead of corporate America. Most recently, New Jersey Gov. Chris Christie cited the private sector's practice of transferring assets to pension funds when he proposed funding his state's beleaguered public pension plans with revenues from the state's lottery.
The governor maintained that the strategy would immediately reduce the pension system's current unfunded liability (which is based on the actuarial assumptions for the fund), increase its funded ratio (a measure of its assets' market value), and lower the amount the state would have to pay into the system in coming years. He reckoned this would please taxpayers, bond investors, credit-rating agencies and public employees alike.
How this might be done is still to be worked out, but the notion of a pension plan generating income from a lottery asset is not new. In Canada, the Ontario Teachers' Pension Plan owns the licenses to operate both the British and Irish national lotteries. These assets were not in-kind contributions but rather a direct investment aimed at boosting the pension fund's returns.
The difference between a pension fund buying an asset and receiving one in lieu of cash is important. The former is like a marriage for love, while the latter is more akin to an arranged marriage with a dowry of uncompensated risks. An asset such as a state lottery is also much harder to value than stocks or bonds, less readily sold and much more complex to manage. Pension trustees might rightly suggest that policymakers just sell the asset.
Another complicating factor is that many pension funds are not authorized to own assets directly or to operate businesses. They can, however, acquire businesses that operate commercial assets. The British and Irish lotteries, for example, are managed by the Camelot Group, an operating company owned by the Ontario teachers' pension.
Yet there is a case to be made for in-kind contributions when the risks and rewards can be structured fairly and understood clearly by all parties. For governments, an in-kind contribution can make use of a surplus asset in a way that preserves precious cash, improves balance-sheet resiliency and avoids service cuts or tax increases -- all the while keeping a civic asset in the public sector. For pension plans, an in-kind contribution presents an opportunity to obtain an asset without acquisition costs.
It can also be argued that pension funds are better suited to managing certain assets than government agencies are. Gov. Christie suggested this in his proposal by acknowledging that the state government does not have the ability to tap into the significant value of a special asset like the state lottery. Case in point: The UK National Lottery has made record profits under the Ontario pension's management.
The in-kind contribution being proposed in New Jersey may eventually end up resembling one executed by Pittsburgh in 2010, when the City Council irrevocably dedicated parking revenues to the city's three employee pension funds for 31 years. The city effectively transferred the value of asset ownership to the pension plan without requiring it to assume the risks of ownership or management responsibilities. This past February, Fitch Ratings rewarded the city by raising its credit rating, citing Pittsburgh's ongoing plan to improve pension funding.
Both Pittsburgh's in-kind contribution and the one being proposed for New Jersey involve income-producing assets. In contrast, Hartford, Conn.'s Municipal Employees Retirement Fund is being asked to accept a 600-acre public park -- which does not currently produce revenue for the city -- as partial payment of the city's annual required contribution. This potentially puts the fund in a difficult position. Its options include selling a local civic asset, commercializing the land or accepting a reduced annual contribution.
Clearly, in-kind contributions are not a silver bullet for state and local governments or for public pension funds. It is hard to identify assets suitable for this funding mechanism and even more difficult to price and structure them fairly. But they may be worth the trouble and serious consideration. One of the most profitable in-kind contributions made to a pension fund was the conveyance in 2011 of a toll-road network owned by Australia's Queensland state government to the state's pension fund. Queensland Investment Corporation, the fund's savvy manager, restructured the business, added two additional roads to the toll network and sold the asset three years later at a $3.8 billion profit for the pension fund. Bottom line: Pension fund wins are wins for taxpayers too.