Pension Debt Expected to Surge Due to COVID-19 Volatility

Underfunded defined benefit (DB) pension plans can expect to see their liabilities surge over the next several months due to volatility from the COVID-19 pandemic. According to research from Moody’s Investors Service, companies are on pace to see a 6% increase in total adjusted debt in 2020 as modest asset returns fail to offset tumbling discount rates.

Moody’s said in a recent report that 2020 has so far “proved to be a roller coaster ride” for the two drivers of pension funding: the discount rate and the return on plan assets.

It noted that the discount rate has plunged 96 basis points (bps) to an all-time low of 2.26% as of the end of July, while asset returns have had monthly swings from being down 5% in March to a high of being up 2% in July relative to their fair market value at the end of 2019.

The report also said that the transportation and auto industries lead the list of companies with legacy pension exposure that have also been affected by the pandemic. The top four companies in these two industries are American Airlines, Delta Airlines, Ford Motor Company, and General Motors.

Moody’s noted that many of the larger corporate pension plans have calendar year-ends, and that pension disclosures are updated on an annual basis and included in a company’s year-end filing.

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“The world has vastly changed since Dec. 31, which means disclosed pension funding levels may not be recognizable when Dec. 31 Form 10-Ks are filed,” according to the report.

The report also said that the “playing field for corporate plan sponsors will change once again” due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a more than $2 trillion economic stimulus bill that was signed into law in March. It said it expects many companies will take advantage of a provision of the CARES Act that allows plan sponsors to delay contributions that would have been due during calendar year 2020 until January 2021.

“Though the delay of these contributions will provide near-term cash flow relief for plan sponsors,” said the report, “interest expense will be accrued at the plan’s effective interest rate on these delayed payments, beginning on their original due date.”

In the report, Moody’s also noted that multiemployer pension plans (MEPPs) “are dangerously underfunded” due to a lack of regulation and a sharp drop in the number of companies participating in the plans.

“Many plans are now past a point where companies that contribute to these funds can cure the overall underfunding,” said the report. “While MEPP reform has been proposed many times in the US Congress, there has been little headway within the House and Senate.”

In the meantime, it said, the top 50 companies by multiemployer pension plan contribution “are seeing year-over-year growth in contributions that continue to be a drain on operating cash flow.”

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Tags: airlines, automotive, CARES Act, Coronavirus, COVID-19, Defined benefit (db) pension plans, discount rates, Liabilities, Moody’s Investors Service, Pandemic, Pension

The investment portfolio of the Canada Pension Plan Investment Board (CPPIB), also known as CPP Investments, returned a robust 5.6% net of costs during its first quarter of fiscal 2021 ending June 30, raising the fund’s total asset value to C$434.4 billion ($327.93 billion) from C$409.6 billion at the end of March. The fund also reported earning five- and 10-year annualized net nominal returns of 8.9% and 10.7%, respectively.

The fund said its active management strategy and resulting diversified investment portfolios have shown “resiliency amid the unprecedented challenges raised by the global COVID-19 pandemic environment.”

The C$24.8 billion quarterly increase in net assets was comprised of C$22.9 billion in net income after all CPPIB costs and C$1.9 billion in net Canada Pension Plan (CPP) contributions.

“While global financial markets experienced a strong rebound from March, significant uncertainty in health, social, and economic conditions persists,” Mark Machin, president and CEO of CPPIB, said in a statement. “Amid this environment, CPP Investments delivered solid performance, while our investment teams were active in creating long-term value across our diversified programs.”

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The fund said the global public equity markets’ return to positive performance is reflected in its public holdings, but that the strengthening Canadian dollar against most major currencies offset some of those gains, and that inflows from CPP were lower than normal due to initial forecasts of the impact of the COVID-19 pandemic on employment.

As of the end of June, the portfolio’s three largest asset allocations were to public equities (31.2%), private equities (24.3%), and government bonds (22.6%).

Every three years, Canada’s Office of the Chief Actuary conducts an independent review of CPP’s sustainability over the next 75 years. In its most recent review, the chief actuary reaffirmed that, as of the end of 2018, the fund remains sustainable over the 75-year projection period at the current legislated contribution rates.

The chief actuary’s projections are based on the assumption that the fund’s investments will earn an average annual rate of return of 3.95% above the rate of Canadian consumer price inflation, after all costs over the 75 years following 2018.

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