Connecting state and local government leaders
Can two major funding headaches fix each other's problems?
The Great Recession exposed underfunded public pensions as a major liability for many U.S. state and local governments. Likewise, over the last decade concerns about a lack of infrastructure investment and maintenance spending in the U.S. has become a bipartisan issue of concern.
This apparently leaves many local governments with a difficult investment dilemma—do we fund our public pensions or invest in maintaining our critical infrastructure?
Or is there a way to do both?
Corporations in the U.S. have a long track record of contributing assets to fund their defined-benefit pensions (such as an office building) in lieu of cash contributions. These are in-kind contributions in industry parlance.
At the same time, public-private partnerships for infrastructure are now quite common for large, complex projects in industrialized western nations, though less common in the United States. Some of those projects are invested in by private infrastructure funds, and where do those funds get a lot of their capital? You guessed it—public pensions.
In 2011, the state government in Queensland, Australia was facing a shortfall in its public pension similar to those faced by many U.S. states, and my colleagues and I at the Stanford Global Projects Center recently published a study of the results.
In this case, the government proposed selling a concession to operate the Queensland Motorway, a state toll road, and use the proceeds to shore up the pension and fund some other state programs. This was met with political resistance from many constituents, naturally stemming from concerns around the system’s valuation.
High-level estimates ranged that the toll concession could be worth between 2 billion and 6 billion Australian dollars. In the end, the state government chose to transfer the concession directly to its public pension, which was managed by the Queensland Investment Corporation (QIC), and this largely mitigated political resistance to the transaction, since the system would stay under effective public control. The government and QIC completed the transaction at arm’s length, with independent valuations on both sides, to determine a system value of around 3.1 billion Australian dollars.
QIC then implemented many of the changes that any other long-term investor would in managing the system. They incorporated performance-based metrics for the system’s executives, upgraded the tolling technology, and even acquired other toll roads that connected to the motorway to make the system more of a “network” than a single road.
They also put in place a long-term asset management plan to ensure maintenance was no longer deferred. After four years under their management, QIC determined that the valuation of the motorway had increased to the extent that it was too large a component of the overall pension’s portfolio, and that they would need to sell the system to re-diversify. They managed a tender for the remaining concession, and eventually sold it to a private consortium for just over 7 billion Australian dollars. The gains all but erased the pension’s unfunded liabilities.
The Queensland Motorway example is a strong indicator that an in-kind contribution could help governments “capture” more of the added value created by concession tenders for infrastructure, by simply transitioning the governance of public assets to enable them to take a longer-term perspective. There are certainly barriers, though, to making the model work in the United States.
The biggest barrier that we identify is that QIC, in this case, had the in-house capability to evaluate and manage complex infrastructure systems. QIC has an internal investment team, and has invested in other projects in Australia, the United States, and in the U.K. That same in-house capability is virtually non-existent in U.S. public pensions, which have invested their infrastructure allocations primarily via third-party fund managers.
Governance is another issue. The public pension involved in a transaction has to be able to approach it at arm’s length and keep its fiduciary responsibility to its beneficiaries absolutely paramount. That will enable it to approach a transaction without any undue political influence.
Finally, the government must accrue value from the transaction outright through a transparent valuation. The only difference is that, with an in-kind contribution, any gains from under-valuation, ex-post, will be captured by their public pension.
These governance issues make the in-kind model difficult to implement in the United States, but the model could be tailored to ensure the pension in question has the governance—and the capability—to increase the value of the public assets under consideration. In the meantime, Queensland Motorways is an example of the potential benefits of improving the governance of public assets, while helping ensure that much of that increased value winds up as funding for taxpayers instead of profits for investors.
Michael Bennon is Managing Director at Stanford Global Projects Center and served as a Captain in the U.S. Army and U.S. Army Corps of Engineers.