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Coronavirus - COVID-19March 26, 2020

US Public Pensions Lose $1 Trillion from Market Crash

Moody’s says governments are in a worse position to smooth costs than during financial crises.

US public pension investment losses are approaching $1 trillion as a result of the stock market crash caused by the COVID-19 pandemic, which will “severely compound” the pension liability difficulties many governments are already dealing with, according to a report from Moody’s Investors Service.

Moody’s said US public pension systems are on pace to see investment losses of approximately 21% for the fiscal year ending June 30, adding that 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,” the report said, “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.”

Based on Moody’s estimates, the adjusted net pension liabilities (ANPLs) for public pensions are expected to surge by nearly 50% to a record high of $3.6 trillion for fiscal year 2020 from $2.4 trillion at the end of June. The firm derives its estimates from a representative sample of 56 large US public pension systems, which covers roughly half of all liabilities and assets.

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“If governments’ revenue performance also deteriorates,” the report said, “pension affordability ratios will worsen significantly for some because of the combination of cost hikes and revenue stagnation or decline.”

To make matters worse, Moody’s said many governments have less capacity to “smooth” or defer pension cost hikes without “severe pension funding repercussions” than they did in the years following the financial crisis of 2007-2009.

“Significantly deferring costs to make up for 2020 investment losses would carry potentially severe long-term pension funding consequences for some governments,” the report said. “Many systems today have significantly negative non-investment cash flow relative to assets, attributable to their underfunded positions and rising benefit outflows due to rising numbers of retirees.”

Moody’s said the asset/benefit coverage, which indicates the rising risk of pension asset depletion without contribution increases, is lower for many US public pension systems than it was before the financial crisis.

The report compares a large US public pension system before the last recession with one today. It said participating governments in the system are currently contributing around 17% of payroll, compared to 12% in 2008. Despite the higher contribution rate, the system had more negative non-investment cash flow relative to its assets before any 2020 investment losses, and only slightly higher asset/benefit coverage compared to the 2007-2009 recession.

“If 2020 investment losses are as substantial as current market conditions suggest, the system’s asset/benefit coverage will fall to 6.8 years and its non-investment cash flow will fall below -6% of assets, both historic lows,” the report said. “Without increases to government contribution rates, we project that the system’s asset base is now on a far worse trajectory, and will continue to fall closer to insolvency.”

Moody’s said the ability to reduce government contributions is more difficult today than during the financial crisis because of the negative repercussions to the resulting condition of the pension system.

“Other options for governments facing rising pension affordability challenges and limited ability to increase revenues could include reductions to service levels, pension benefit cuts, or in the most severe cases, restructuring of long-term balance sheet liabilities through bankruptcy,” according to the report.

AM Best Creates Pandemic-Related Stress Test for Insurance Firms

Pension risk transfer market likely to slow because of downturn.

By Michael Katz

Global credit rating agency AM Best is developing a COVID-19 pandemic-related stress test for insurance firms’ balance sheets to determine the impact that the economic fallout of the coronavirus will have on their risk-adjusted capital levels, investment portfolios, and reserve adequacy, among other aspects of the risks they carry.

“The COVID-19 virus is unique in its scope and complexity of potential losses, and the uncertainty regarding the near-term impacts further exacerbates the situation,” AM Best said in a statement. “Consequently, the direct and indirect effects of the outbreak may not be understood fully for some time.”

The firm said it will send a questionnaire to rated insurance companies to determine how their operations have been affected by the pandemic, which lines of business they expect to be negatively impacted most, or if they expect any overall assumptions or forecasts to change. AM Best said it will also seek results of each organization’s own stress tests, which are typically considered when assessing each rating unit’s enterprise risk management framework.

The stress test follows previous crisis-related stress tests AM Best has conducted after events such as the Sept. 11 terrorist attacks or the eurozone debt crisis. The firm said that the volatility and uncertainty in the financial markets created by the pandemic are more likely to hurt the balance sheets of life and annuity insurers than those of property, casualty, or health insurers. As a result, it recently downgraded its market segment outlook on the US life/annuity segment to negative from stable.

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AM Best said it expects the financial effects of the pandemic will significantly hurt the life/annuity industry’s ability to quickly progress with expensive innovation efforts. However, it said that some factors that should lessen these negatives include the industry’s strong capitalization and improved liquidity; stress testing that has better prepared the industry for downturns from economic and pandemic-type events; and credit spread widening to help offset some of the interest rate decline.

“Carriers with less capital, questionable liquidity access, and limited business profiles or outsized exposures to at-risk sectors such as energy, retail, and travel, will feel the negative economic impact faster and more deeply than most of the industry,” AM Best said.

Additionally, the recent financial turmoil is likely to put a damper on the pension risk transfer market, which set new records in 2019, as new deals will not be as economically feasible. This is a result of the combination of declining interest rates and pension funds’ deteriorating funded status that will be caused by the market downturn.

“The pension risk transfer market will also likely slow with the funding status of pensions facing pressure,” AM Best said. The firm pointed out that funding has seen two significant drops since 2000 from the dot-com bubble burst and the financial crisis and, it said, “the current pullback should put this business on pause as well.”

However, AM Best said the insurance industry should be more resilient to financial market downturns today than it was during the 2008-2009 financial crisis, which put heavy attention on liquidity risk.

“At this time, rated companies are expected to be able to meet their commitments, despite the rapidly evolving situation,” AM Best said. “With these coming stress tests, access to liquidity, as well as the laddering and maturing of debt securities within the capital structures of insurance companies, will be additional areas of focus.”