It’s a Terrible Time for Pensions to Have Weak Liquidity

A market downturn is a difficult time for any investor, but it’s particularly bad for public pensions with weak liquidity. Because pension funds have long-term investment horizons that span decades, they often claim to be undisturbed by market turmoil as they have time to ride it out. But public pensions with liquidity stress don’t have that luxury in the kind of market we have right now.

“Given the current market downturn, US public pension plans may experience liquidity stress to cover benefit payments,” S&P Global Ratings said in a research note. “Assets in plans with weak liquidity are likely to be sold at a loss and may contribute to decreasing funded ratios. In our opinion, poorly funded plans and high discount rates may be indicators of excessive liquidity risk.”

According to S&P, US public pension plans have an average of 1% of their target portfolios held in cash and short-term investments to pay ongoing expenses, such as benefit payments and administrative costs. The firm said a liquidity-to-assets ratio can help determine how much liquidity risk a pension plan is carrying. A pension 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.

In a typical year, weak liquidity isn’t a major problem because investment returns can supplement cash flow. However, this is not a typical year, and selling non-cash assets during the current market downturn could mean large losses for pension funds. Additionally, plans with weak funded ratios and high discount rates translate to increased liquidity risk. S&P said there is a direct correlation between the discount rate—which is usually the assumed rate of return in the public sector—and the underlying target portfolio.

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“A high assumed return indicates a high level of risk accepted in investments, which sometimes indicates a low percentage of cash,” S&P said. “Plans with already weak funded ratios and limited cash might need to liquidate longer-term investments to meet annual benefit payouts, thereby eroding earning power and sinking into even weaker funded status.”

S&P said some public plans could completely run out of money to fund pension benefits. To demonstrate what happens at asset depletion, it provided examples of severely underfunded US pension plans, which the firm defines as under 40% funded. Five of the plans have ratios below zero, which signals possible negative available cash that would require either additional financing or a drawdown of assets for short-term support. This “could expedite their path to insolvency,” S&P said. Meanwhile the other plans are likely to experience significant deterioration during a prolonged and severe market downturn.

Liquidity Risk Heightened For Large Plans Under 40% Funded
Pension plan	Liquidity-to-assets ratio (%)
New Jersey Teachers	(7.46)
Chicago Police	(2.77)
KERS Non-Hazardous	(2.77)
Chicago Municipal	(1.39)
Illinois SERS	(0.68)
Connecticut SERS	0.34
Providence ERS	3.19
Pittsburgh	5.51

Source: S&P

Additionally, other post-employment benefits (OPEB) costs, such as retiree medical costs, are expected to increase because of the COVID-19 pandemic and may hurt pension sponsor liquidity, according to S&P. Because these costs are pay-as-you-go, that means that there is no room to reduce or delay contributions unless benefits are reduced.

To make matters worse, further pension deterioration is likely even when the market eventually turns around.

“Employer and plan sponsor budgets are going through a concurrent period of stress, so as sponsor and pension plans adjust budgets, they may look to defer contributions for budgetary relief,” said S&P, which added that steps that might be taken at the expense of funding the pension plan could include extended amortization payments, temporary changes to asset smoothing, or other means of contribution deferral.

“State and local governments with limited fiscal flexibility and weak economic metrics are more likely to consider these options,” S&P said. “Similar to the years following the last recession, many US public finance entities are likely to emerge seeking plan design and benefit changes in an effort to gain budgetary relief.”

Coronavirus Crisis Is ‘Crushing’ Global GDP Growth

S&P Global Forecasts Global Recession Due to Coronavirusv

Tags: Coronavirus, COVID-19, Downturn, Liquidity, Public Pension, S&P Global Ratings

There will be “an unprecedented shock” among the Group of 20 (G20) economies in the first half of this year as a result of the COVID-19 pandemic, according to Moody’s Investors Service, which now expects real gross domestic product (GDP) for the countries to contract 0.5% this year. Prior to the outbreak, Moody’s economic outlook called for the global economy to grow 2.6% this year.

“We have revised our global growth forecasts downward for 2020 as the rising economic costs of the coronavirus shock, particularly in advanced economies, and the policy responses to combat the downturn are becoming clearer,” Moody’s said in its most recent outlook.

The firm forecasts that business activity will fall sharply across the world’s advanced economies and projects cumulative contraction of 4.3% in the US, 5.4% in Germany, 4.5% in Italy, 3.9% in the UK, and 3.5% in France for the first two quarters of the year. And while it expects fiscal and monetary policy measures will likely help the economies recover in the latter half of the year and in 2021, it said the output lost in the second quarter will likely never be recovered.

“Our forecasts reflect the severe curtailment of economic activity in recent days as the coronavirus has spread throughout the world,” Moody’s said. “Financial sector volatility has exploded to levels last seen during the 2008 global financial stress, despite the expectation of rapid policy response from major central banks and governments.”

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Moody’s said the financial market stress is a reflection of deep anxiety and uncertainty around the real economic costs that households and businesses around the world will face. It also said the severe compression in demand over the next two to four months will likely be unprecedented. It noted that purchasing managers’ index (PMI) indicators for the eurozone area confirm a sharp contraction is already underway.

According to data and information provider IHS Markit, the eurozone economy suffered “an unprecedented collapse” in business activity in March as the coronavirus outbreak intensified throughout the continent. The “flash” IHS Markit Eurozone Composite PMI plummeted to 31.4 in March from 51.6 in February, which was the largest monthly decline in business activity since comparable data were first collected in July 1998, falling well below the previous record low of 36.2 that was recorded in February 2009.

Moody’s now expects real GDP growth in China to be 3.3% in 2020, followed by 6% growth in 2021. However, it said, slow improvement in consumer demand will hinder the pace of its recovery. It also said the recovery in other emerging markets will likely be relatively more subdued than in advanced economies.

“A general lack of social safety nets, a weaker ability to provide adequate support to businesses and households, and inherent weaknesses in many of the major emerging market countries will amplify the impact of the shock,” Moody’s said.

Additionally, the loss of income for businesses and individuals across the world will have “a multiplier effect” throughout the global economy as job losses will likely rise globally over the next few months. It said the speed of the recovery will depend on to what extent job losses and loss of revenue to businesses are permanent or temporary. Moody’s said that even in countries where governments are in a position to provide support through large and targeted measures, some small businesses and vulnerable workers in less-stable jobs will likely experience severe financial distress.

“It is impossible to accurately estimate the economic toll of this crisis,” Moody’s said. “There are significant unknowns, such as how long the virus will take to be fully contained and, by extension, how long economic activity will remain disrupted.”

The firm also warned of the possibility of a resurgence in new COVID-19 cases in countries after they lift travel restrictions and social distancing measures, which would result in longer stretches of restrictive measures.

“The risks to our baseline forecasts remain firmly to the downside,” Moody’s said. “In particular, a sustained pullback in consumption and prolonged closures of businesses would hurt earnings, drive layoffs, and weigh on sentiment. The longer these conditions persist, the more they would potentially feed self-sustaining recessionary dynamics.”