Are in-Kind Contributions for Public Pensions an Overlooked Opportunity?

(July 21, 2011) — In-kind contributions — a contribution of an investment asset such as company stock and real estate in lieu of cash, paid directly by a plan sponsor to a pension fund — have been a staple of corporate pension funding for years. The same cannot be said for public pensions. Why?

One of the earliest examples of an in-kind contribution is from over 20 years ago, when financially-stressed Pan American World Airways contributed its leasehold on the John F Kennedy “Worldport” passenger facility to five of its defined benefit pension funds. The value of the asset was approximately $170 million, taken as a credit against the company’s funding obligation and recognized by the funds themselves as an investment asset of the same value. The funds then leased the facility back to Pan Am. The transaction was implemented only after extensive review by the U.S. Department of Labor and was subject to an independent Employee Retirement Income Security Act (ERISA) fiduciary acting on behalf of the funds. The contribution helped fund the pension plans when Pan Am — lacking cash — was unable to pay cash contributions. The pension funds thereafter received lease payments from Pan Am as tenant and when the company entered bankruptcy, the payments continued uninterrupted until Delta bought the entire remaining capital value of the lease from the funds. Since then, publicly-traded and private companies have paid contributions by way of comparable real estate sale-leaseback transactions, subject to an independent fiduciary determining on behalf of the plan whether and on what terms to proceed.

Industry observers say that among private pension funds, in-kind contributions have been a creative partial response for dealing with their severe funding pressures, and that their success with this approach may be an opportunity for public funds. The explanation to the resistance of in-kind contributions taking hold in the public world exists only as speculations, as public pensions have proven to be oftentimes slow to adapt. 

Yet, given current financial pressures on governments and the pension and retiree medical funds they sponsor, both the governmental sponsors and fund boards may find the idea attractive, as the seriousness of underfunding has become increasingly apparent. “The basic concept of in-kind contributions began in the private ERISA world, where there is a long history with recent examples of plansponsors making various types of in-kind contributions, such as real estate,” Samuel (Skip) Halpern from Independent Fiduciary Services, told aiCIO.

Given current budgetary, financial and actuarial stresses in the world of public pension and retiree medical funds, the same sort of in-kind contribution of real estate might be suitable for such funds as well. “Many basic investment fiduciary principles that govern in the ERISA world are transferable to the public sector,” Halpern noted, adding that the fiduciary principles of prudence and objectivity apply in both the public and private spheres. “They’re transferable from an investment standpoint because the role of real estate in a private fund investment portfolio is essentially the same as in a public fund. The operational nuts and bolts of transferring, owning, and leasing real estate are — in many respects — the same, whether private or public.”

Most recent examples of public and private companies making in-kind contributions to DB and retiree medical funds have been in the form of employer securities, but some have also been in the form of real estate properties. “From a company standpoint, if cash is scarce and they still want to or are obligated to pay a contribution, this can be an effective way of doing it to the benefit of the plan no less than for the plan sponsor,” according to Halpern.

Industry observers note that the last five years have triggered a rise of in-kind contributions, fueled by the financial crisis, as companies have grown increasingly concerned about their levels of cash to meet funding obligations.

But, why haven’t public pension plans embraced this innovative form of meeting funding obligations? “So far there hasn’t been much, if any action on this front with public pension plans. Governmental entities own real estate, power plants, toll roads, office buildings — and with governmental budgets so severely cash strapped, why not defray some funding obligations in the form of an in-kind contribution, provided that the transaction is priced at no more than fair market value and is an attractive investment asset for the fund?” Halpern questioned. This type of arrangement would meet at least part of the government’s obligation to fund the plan, and would provide the plan an income-producing asset at fair value, according to proponents of such a transaction. One other advantage of an in-kind contribution, industry sources note, is the ability to keep assets in the public sector as opposed to selling them to the private sector. With cash being scarce, many consider in-kind contributions as attractive to pension funds and other stakeholders, which would still be receiving contributions to improve their actuarial conditions.

An in-depth report last year by the Pew Center on the States provided evidence for the immense funding pressures facing public plans and drew attention to the need for creative approaches to reach more sustainable levels. The Pew report revealed that many states face a cumulative $1 trillion gap for public pension retiree health and non-pension retirement benefits, giving weight to the general consensus in the industry that additional ways to fund pension schemes is a necessary objective.

“While the economic crisis and drop in investments helped create it, the trillion dollar gap is primarily the result of states’ inability to save for the future and manage the costs of their public sector retirement benefits,” said Susan Urahn, managing director of the Washington-based policy research organization, in a news release following the release of the Pew report in February 2010. “The growing bill coming due to states could have significant consequences for taxpayers — higher taxes, less money for public services and lower state bond ratings. States need to start exploring reforms.”

In-kind contributions are no silver bullet, of course. No magic wand will solve the tremendous funding pressures facing public plans, according to Halpern. But the embrace of this approach may be one helpful step in dealing with their overall set of pressures.