Public Pensions Could Suffer for Years from Pandemic Losses

Employers will have to increase contributions unless markets rebound sharply, says S&P.

US public pension plan sponsors and administrators are likely entering a period of fiscal stress, and rising pension obligations caused by the sudden pandemic-induced recession are expected to be felt for years by US state and local governments, according to a report from S&P Global Ratings.

S&P said US public pension funds in aggregate lost approximately $850 billion during the first quarter of the year, and that they would need to rebound sharply during the second quarter to maintain the average funded ratio from a year ago.

“In the public sector, market returns are built into the funding model and thus make up a large part of pension plan inflows,” the report said. “Should market returns remain below past peaks, the effect of poor returns will result in an increase in employer contributions.”

The report looks at how the recession is likely to impact public pensions during three periods—immediately, over the near-to-mid-term, and over the long term.

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The immediate concern for US public pensions is their liquidity position, according to the report, as a pension plan’s liquidity position mitigates near-term shocks. Pension asset portfolios without enough cash to cover benefits could be forced to sell return-seeking assets at inopportune times.

A pension plan’s liquidity-to-assets ratio can help determine how much liquidity risk it is carrying. A plan with a negative liquidity-to-assets ratio needs additional money to maintain operations and make benefit payments. And the further below zero the ratio is, the more assets that may have to be converted to cash.

During the near-to-mid-term, a plan’s funded level indicates the range of impact the recession will have. “Many public sector pension plans measure their assets in June and are recognized on employer financial statements the following year,” the report said. “Though markets have seen some gains in April, funded ratios are likely to decline in the near future.”

According to estimates from the Federal Reserve, US public sector pension assets were $4.8 trillion as of the end of last year and were allocated between market risk-mitigating investments—such as cash, fixed costs, and hedge funds—and return-seeking investments, which includes all other investments.

During the fourth quarter of 2019, the approximate aggregate return for return-seeking investments was 9.9%; however, during the first quarter of this year, those investments lost 23.5%. Meanwhile risk-mitigating investments returned 0.6% during the fourth quarter of 2019 and lost only 4.6% during the first quarter of 2020. The average target allocation for risk-mitigating investments for US pensions is 31%, while their average target allocation for return-seeking investments is 69%.

In its most recent surveys of states and the 15 largest cities, S&P Global Ratings found the average funded ratio to be 73%. For the plans to maintain that funded ratio, they would have to return nearly 30%, the report said. This would bring the annual return back from its current -12% up to the average assumed rate of 7.25%.

However, “if returns stagnate, we estimate the funded ratio for the average state and local government pension plan could decrease to 60% from 73%,” S&P said.

Over the long term, plans will likely have to consider adjustments to reduce plan costs and contribution increases to alleviate budgetary pressures, the report said.

“Though employer audits may not show the impact of the sudden-stop recession for months,” S&P said, “experience from the Great Recession of 2008 gives a sense of what’s to come.”

This includes methods such as five-year asset smoothing or “collars” that limit rapid contribution increases. While this doesn’t reduce losses, S&P said, it delays contributions and budgetary adjustments to make up for market losses.

Additionally, benefit tiers, employee contribution increases, and cost of living reductions are all options that are likely to be used to reduce contributions. However, additional actions may be limited since many of these actions have already been used, said S&P, citing a report by the National Association of State Retirement Administrators. 

“Plans that have either taken actions in the past to reduce contributions or lacked action when actuarial recommendations increased are seeing increased stress now,” S&P said. “With tightening budgets and operating cost pressures, pension contributions may be an outlet for temporary budget relief at the risk of plan funding.”

The report warns that while deferring costs in the near term may provide budgetary flexibility and could be a liquidity management tool, it will increase long-term pension costs.

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Sam Zell: Nice Distressed Real Estate Bargains Are Ahead

The Grave Dancer says virus shock will scar Americans’ psyches, but should benefit bargain hunters like him.

Sam Zell, who made his fortune in distressed properties, believes that the pandemic will scar America’s psychebut good deals still will be available despite the gloom. In scarfing up battered real estate.

Known as the Grave Dancer, for his affinity to buy ailing assets, Zell compared the present coronavirus-burdened economy to that of the 1930s, contending that people now will come away with similar caution.

The Great Depression’s massive joblessness and depleted bank accounts imbued a reluctance to invest in the stock market and a fearful thriftiness, he said. By the same token, the “extraordinary shock” of the coronavirus pandemic will lead to a reluctance to shop in stores, travel in planes, or stay in hotels, he predicted. “The fact that these places may be open,” he added, “doesn’t necessarily mean that they’ll be doing business.”

At the moment, owners of commercial real estate, his hunting ground, want to sell anything, he told Bloomberg TV, but that will change in time.

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“Those sellers that wanted to sell still remember the prices that were available seven or eight weeks ago,” he said. “The buyers are looking at a very different world and expecting to see significant discounts. When you’ve got that big a spread, nothing happens.”

To Zell, that situation will improve for buyers. Plus, in his view,  properties that look bad now will turn around with the benefit of time. He added that he doubted big cities such as New York were finished, which could bring him ripe pickings eventually.

“Bankruptcies are what you need to clear markets and what you need to end recessions and dips,” Zell said. “The fact that there’s a lot more distressed players today will help clear the market, but it also means that there aren’t anywhere near as many opportunities as there were in the past.”

His own empire has had mixed results during the current downturn, he said. Zell owns everything from shopping malls to a hospital chain. One of his largest holdings, the publicly traded Equity Residential, is down 30% since the February market peak. This real estate investment trust specializes in apartment buildings. He said he hasn’t yet seen any falloff in rental income from tenants.

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