Public Pension Fund Debt Expected to Reach ‘All-Time High’

US pension funds, burdened with precarious funding ratios before the COVID-19 outbreak and large drops in the public equity market value, are finding their debt loads climbing, according to a new report from Pew Charitable Trusts.

“Absent positive returns in the next three months, overall state pension debt, currently $1.2 trillion, could increase by $500 billion, reaching an all-time high,” the report said. “The pressure to meet pension funding targets will be most acute in jurisdictions that had severely underfunded pension systems before the pandemic took hold. In Illinois, for example, nearly one in five state tax dollars is already going to pay for pensions before factoring in any revenue declines.”

Public pension funds are generally expected to struggle with meeting the required contribution targets they’ve established to keep their portfolios solvent as a result of their declines in revenue, but there’s an underlying issue that could extend the time frame for recovery, the organization said.

The funds must adhere to their contribution targets that are usually set at least one year in advance, meaning an appropriate target commensurate with the current status of the pension fund will lag until the pension’s board approves it for the following period.

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“This means this effect will not be immediate,” Pew said.

A pattern of reduced assumed rates of return, a fundamental calculation that pension funds use to determine how to adjust their operations and targets to become or remain solvent, are expected in the near term as well.

“These reductions would continue the three-year trend [of reduced assumed rates of return], which already saw assumed annual return rates decline from 7.5% to 7.2%,” Pew said. The organization suggests that long-term returns would be closer to 6.5%, even before factoring in the pronounced effects of the coronavirus fallout.

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Tags: Contributions, Coronavirus, Funded Ratio, Pandemic, Pew Research, public pension funds, solvency

Canadian defined benefit pension plans saw their sharpest quarterly decline since 2008 due to the economic impact of the COVID-19 pandemic, as both the RBC Investor & Treasury Services All Plan Universe and the Northern Trust Canada Universe posted losses of 7.1% during the first quarter of the year.

Despite the steep drop, it was “a modest decline in light of the unprecedented conditions,” Katie Pries, CEO of Northern Trust Canada, said in a statement. “In a volatile market riddled with fear, uncertainty, and unpredictability, Canadian pension plan sponsors navigated through uncharted territory, seeking a path to safety.”

The MSCI World Index tumbled 13.3% during the quarter, with growth stocks considerably outperforming value stocks. All economic sectors saw negative returns, with the energy sector faring the worst, while information technology (IT) performed the best. Because the Canadian dollar weakened against the US dollar during the quarter, plans with unhedged exposure to non-Canadian equities were somewhat sheltered from local currency losses, according to RBC.

Canadian equities as represented by the S&P/TSX Composite Index plummeted 20.9% during the quarter, erasing the annual gains from all of last year and significantly underperforming the global market. While the effects of the pandemic were primarily to blame for this, the dispute over the natural gas pipeline and the Russia-Saudi Arabia oil price war were also contributing factors.

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US equities fell 11.7% in Canadian dollars, as international developed markets as tracked by the MSCI EAFE Index ended the quarter down 15.2%, while the MSCI Emerging Markets index, which was hurt by both the pandemic and a strong US dollar, lost 16.1% during the quarter.

The FTSE Canada Universe Bond Index returned 1.6% during the first quarter, which provided the plans some safety from losses in the equity markets. After the Bank of Canada cut interest rates, the yield curve steepened, and short-term bonds outperformed long-term bonds. Federal bonds outperformed provincial and corporate bonds, and mid-term bonds outpaced both short- and long-term bonds.

In search of a safe haven from the falling markets, investors sold off riskier investments and turned toward government bonds as the FTSE Canada High Yield Index lost 9.0%, and the FTSE Canada Federal Bond index returned 5.1% during the quarter.

“It has been an exceptionally difficult period for Canadian pension plans to navigate, as the markets have been experiencing an unprecedented amount of volatility across asset classes,” David Linds, RBC’s head of Canadian Asset Servicing, said in a statement.

“However, the substantial monetary and fiscal policy response from governments across the globe gives us room for optimism. While it’s difficult to speculate on what may happen over the short term, we hope these measures will lead to some reawakening of our economic growth in the near future.”