Flush With Cash: How a US Town is Using Sewers to Shrink its Deficit

(May 21, 2013) — Using alternative income streams to fund your pension deficit is starting to take off: A town in Pennsylvania has announced it will lease its water and sewer systems to help fund pension payments.

Allentown’s pension payments are due to double by 2020, and currently has an unfunded pension liability of $170 million, according to a report on Bloomberg.

Rather than use pension bonds and saddle itself with more debt to fund the deficit, the town has decided to hand over its sewer and water systems to a regional agency for an upfront payment of $220 million in a 50-year lease that will finance pension costs.

Municipalities like Allentown had been in favor of issuing debt to fund their pension gaps over the last few years, but the deals have become less popular in 2013 as the localities struggle to get on top of their debt obligations in a recessionary environment.

Finding alternative income streams to help fund your pension deficit is old news in the UK: their final salary schemes have been doing it for years.

Contingent assets – where the scheme holds the right to sell off an asset to fund the scheme in the event of the employer falling into trouble – have become popular in the UK.

Cheese and milk producer Dairy Crest boosted its pension fund’s coffers with a one-off £40 million payment in April this year, alongside a floating charge — or contingent asset — over maturing cheese inventories, with a maximum realizable value of £60 million.

Other interesting contingent assets used by pension funds have included planes that were handed over by British Airways as security to its defined benefit fund, television company ITV offering intellectual property rights of its digital arm, and grocery giant Tesco employing its superstore properties as a deficit reduction tool.

The UK has also seen a wave of Pension Funding Partnerships (PFPs), which use a Scottish Limited Partnership vehicle to provide an income stream from an employer’s asset to a pension fund, which can then be “switched off” in the event the pension fund reaches a fully funded status.

For an employer, the main attractions are; the opportunity to use corporate assets, rather than scarce cash, to fund its defined benefit plan, having longer to pay than might be the case when funding using cash alone (typically a Scottish Limited Partnership structure lasts for 25 years), ultimately retaining control of the asset, and eliminating wholly or significantly the underfunding in their defined benefit plan.

For trustees of the fund, the partnerships offer additional security for income into the pension plan over and above reliance on a pure company promise to pay, although they will still have to be wary of the value and covenant associated with the income generating assets – particularly in the event that the sponsor goes bust.

Alcohol manufacturer Diageo transferred its 2011 whisky inventory into the partnership at a value of £565 million. The UK pension fund then acquired a stake in the partnership, which entitled it to a distribution from the profits each year from when the partnership was established in 2011 to 30 June 2024. In 2012, that profit share totalled £25 million, and it’s expected to be around the same figure every year thereafter.

Then in 2024, Diageo will be required, depending on the funding position of the UK pension fund, to pay an amount of no more than the remaining deficit at the time (up to a maximum of £430 million) to buy out the UK pension fund’s interest in the partnership.

In addition, house builders Taylor Wimpey recently introduced a similar proposal involving a £100 million PFP using its show homes as an asset in a sale and leaseback structure.

So far, the Pensions Regulator has allowed these innovative structures to continue, but it continues to believe that Scottish Limited Partnerships remain vulnerable to a judge getting out of bed on the wrong side and “ruling them a breach of the post-Maxwell employer related investment legislation”, according to Francois Barker, pensions partner at law firm Eversheds.

“As (they) become increasingly mainstream, this concern looks overdone. However, under the regulator’s guidance, trustees and sponsors need to make provision for an underpin arrangement — something which will take effect in the event that the SLP fails,” Barker explained.

“Normally, the underpin takes the form of a company commitment to continue to make direct the payments that would have come from the partnership, coupled with a commitment to undertake a fresh valuation as soon as practicable.”

Barker added that there was no reason why Scottish Limited Partnerships couldn’t be used by pension funds outside of the UK. He warned, however, that it would be subject to local law and regulation, and there could be tax and jurisdictional issues with a plan being in one location and becoming a partner in a legal structure set up in another.