Pretty much everything related to retirement savings—401(k)s included—has taken a big hit due to the coronavirus pandemic, but the punch looks like it may be a little more damaging to defined benefit pension plans.
Pension plans, both public and private, were not exactly in great positions before the crisis hit, with most falling well short of the funded status needed to pay their obligations to retirees. Events such as the current COVID-19-fueled economic crisis are the kind of things that will bring light to exactly how poorly some plans have been managed, even during the longest bull market in history.
The CARES Act provided a little relief at a time when entities are facing serious challenges with cash flow, as quarterly pension plan sponsor contributions (including those that would have been due April 15) have now been deferred to Jan. 1, 2021, with interest.
But many pension funds are exposed to areas of the capital markets that have been hit the hardest, including oil, hotels, restaurants and airlines. When those investments take a hit, pension plans have to somehow make up for those losses in years to come—and doing so can create lots of difficulties for companies, local governments and the people they employ.
Here’s a quick look at the challenges facing public and private pensions, along with an update on what a possible COVID-4 federal stimulus bill might do to help troubled union pension plans.
Public pensions a ticking time bomb
Public pensions have been called the “time bomb of government finance.”
And as The New York Times points out in a article, now the coronavirus pandemic has that time bomb ticking faster.
Chronically underfunded, government-sponsored pension programs were battered by huge losses in their investment portfolios during a dismal Q1 2020 for the stock market, not to mention widespread business closures and exploding unemployment decimating state and local tax revenues public pensions rely heavily upon.
Moody’s Investors Service estimates state and local pension funds had lost $1 trillion in the COVID-19 pandemic-fueled market sell-off that began in late February, and in its most recent report said this will “severely compound” the pension liability problems already facing public pension plans.
Moody’s said U.S. public pension systems are on pace to see investment losses of approximately 21% for the fiscal year ending June 30, and the recent volatility of the equity markets could lead to either a significant improvement of those returns in the coming months or a further decline.
“Without a dramatic bounceback of investment markets, 2020 pension investment losses will mark a significant turning point where the downside exposure of some state and local governments’ credit quality to pension risk comes to fruition because of already heightened liabilities and lower capacity to defer costs,” the report said.
Public pension funds that run out of money could end up tipping local governments into bankruptcy.
“States would be in uncharted waters because there is no bankruptcy mechanism for them; the nearest analogy is a one-off law passed by Congress for Puerto Rico, which has resulted in years of federal oversight, austerity measures and reduced debt payments to bondholders,” the Times article states.
State laws and constitutions make it incredibly hard to make changes to public pension plans to alleviate stress on local governments, and any attempts are met with fierce opposition from plan participants.
That leaves local governments with few options, and none of them are easy to swallow. They can try to require working participants to pay more into the plan (although many participants are already paying in significantly more than the Social Security payroll tax rate).
They can raise taxes—an approach that Illinois has taken to the extreme in an effort to stem the tide of its public pension crisis. Illinois, which trails only Kentucky and New Jersey in terms of having the worst-funded public pension program according to the Pew Charitable Trust, has gained a reputation for putting a tax on everything (and increasing those tax rates) to help pay retiree pension benefits.
States can try to close pension plans to new hires, and instead offer defined contribution plans. This is an option likely to gain momentum moving forward, particularly in light of the current economic crisis.
The only other option is to reduce benefits, which always meets resistance and, as mentioned earlier, sometimes requires the added hurdle of amending a state constitution. Still, reducing benefits might be a final option when a pension plan sponsor is faced with potential bankruptcy.
Corporate pensions take Q1 hit too
Things aren’t much better on the private side, where corporate pension managers are dealing with falling stock prices and falling interest rates that are ballooning pension obligations.
The funded status of the nation’s largest corporate pension plans fell by eight percentage points during the first quarter of 2020, driven primarily by declines in equity markets, according to an analysis released April 2 by Willis Towers Watson.
Willis Towers Watson examined pension plan data for 376 Fortune 1000 companies that sponsor U.S. defined benefit pension plans. Results indicate the aggregate pension funded status is estimated to be 79% as of March 31, 2020, compared with 87% at the end of 2019. That’s the lowest funded status plans have experienced since 2012, when the year-end funded status stood at 77%.
The analysis found the pension deficit is projected to be $365 billion as of March 31, 2020, higher than the $229 billion deficit at the end of 2019. Unlike pension assets, pension obligations increased minimally from $1.75 trillion at the end of 2019 to $1.76 trillion on March 31, 2020.
“Corporate pension plans took a hit in the first quarter,” said Royce Kosoff, managing director, Retirement, Willis Towers Watson. “As a result, aggregate funding levels declined to a level we haven’t seen since 2012. Sponsors recently gained some reprieve with funding requirements deferred for 2020 but will likely face significant cost increases in 2021 and beyond. This serves as a fresh reminder for plan sponsors to carefully review their funding policy, investment allocation, and overall risk management approach.”
Pension plan assets decreased during the quarter from $1.52 trillion at the end of 2019 to $1.40 trillion as of March 31, 2020. Overall investment returns are estimated to have fallen by 7% in the first quarter, although returns varied significantly by asset class.
“The fallout from a volatile first quarter was not uniform across plan sponsors,” said Richard McEvoy, U.S. lead, Delegated Integrated Solutions, Willis Towers Watson. “On the growth asset side, the composition of growth assets was the primary driver of results with diversified allocations mitigating drawdowns. Rates and credit spreads also had a wild ride, and liability-driven investment strategies limited the damage to funding levels in many cases. A key element was how plan sponsors allocated between Treasuries and credit. Overall, we saw significant variations of outcomes, reflecting the wider variation in pension strategies taken today than in years past.”
Union pensions could see aid in COVID-4
If or more likely when the federal government starts finalizing details of a “COVID-4” stimulus bill within the next couple of months, early indications are there’s a good chance it will include aid for troubled union pension plans.
While President Trump has expressed a desire to make infrastructure improvements a focus of any fourth federal stimulus package, he has also indicated support for aiding troubled union pension programs—something Democrats are keen to include.
Pensions were excluded from aid in the massive $2.2 trillion package signed into law recently, with reports indicating Senate Majority Leader Mitch McConnell (R-KY) did not want provisions from the House-passed Butch Lewis Act in the bill.
“President Trump was actually supportive, but Mitch McConnell was not,” House Speaker Nancy Pelosi (D-CA) said. “And so, he said we’ll save it for the next bill. Well, here’s the next bill.”
The Butch Lewis Act was also cut from the massive omnibus spending bill signed by the President just before Christmas which gave us the SECURE Act.
The Act, a multiemployer pension bailout measure with a nearly $100 billion price tag, was included in the House’s recent economic relief package proposal, which ended up being pre-empted by the Senate’s CARES Act.
If COVID-4 includes the Butch Lewis Act, it would provide low-interest loans to the nation’s most underfunded union pension plans to help them stave off looming insolvency, and would provide an additional $71 billion in direct cash assistance to those struggling pension plans. Backers say it would help ensure the continuity of pension benefits for 1.3 million U.S. workers.
The nonpartisan Congressional Budget Office has said about 125 multiemployer pension plans will become insolvent in the next two decades, and some will go broke in the next few years, without aid.
Most of the chatter out of Washington makes it sound like the Butch Lewis Act may end up being tweaked during COVID-4 negotiations to obtain a union pension solution with bipartisan support.
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
