By Michelle Jones. Originally published at ValueWalk.
Feb. 28, 2020 Update: As the public pension crisis continues with few signs that the massive unfunded liabilities are being handled, there could be some major overhauls to corporate pensions. The Wall Street Journal reported this week that low interest rates could convince more chief financial officers to change their pension accounting styles.
Lower interest rates on high-quality corporate bonds has increased plan obligations, offsetting companies’ returns on plan assets. If pension expenses suddenly increased, CFOs might change accounting methods so that the loss is in the past instead of amortized over several years, according to CFRA analyst Dan Mahoney.
As discount rates fall, debt increases because the current value of upcoming payments increases. That pressures companies to increase their assets via investment in stocks and bonds. This enables them to offset their liabilities.
Currently, most companies with pensions amortize their gains and losses over multiple years, which results in older pension losses hanging around. However, many companies have already switched to the mark-to-market method of accounting, especially since the Federal Reserve cut interest rates essentially to zero. Mahoney expects more and more companies to make this change as interest rates remain low.
Call on Trump to battle underfunded public pensions
Feb. 24, 2020 Update: The public pension crisis is no secret by this point as many of the nation’s state and city pensions are deeply underwater. A solution to the crisis has been evasive, with many systems choosing to kick the can further down the road. Now one writer is calling on President Trump to tackle the issue with a bold call to cancel every single one in systems that are underwater.
In a post for The Hill, Douglas MacKinnon argues that one benefit of having a businessman in the White House should be managing the nation’s public pension crisis. The site fights back against the argument that pensions are needed for public jobs because they are underpaid. However, many public employees are compensated quite well.
For example, nearly 17,000 public employees in Massachusetts made at least $100,000 a year, according to state payroll records for 2019 (via the Boston Herald). Massachusetts’ public pension system is significantly underfunded, and MacKinnon argues that it and other states’ underwater pensions should be canceled.
The site notes that many counties and states must stop or significantly cut back programs to help the disadvantaged because they must pay their pension liabilities. MacKinnon describes the public pension crisis as “perhaps the most destructive financial crisis of our time.” He also answers the argument that public employees paid for their pensions by saying most of them paid “pennies on the dollar for these generous plans.” He suggests paying employees exactly the amount they paid into their pensions and no more.
Further, he points out that when states with unfunded systems go bankrupt because of their pension problems, the federal government and American taxpayers will have to bail them out.
“President Trump is aware of that socialist strategy,” he argues. “Let’s hope he slams on the brakes to protect the fiscal health of our nation.”
Pension assets on the rise with alternative asset allocations
Feb. 12, 2020 Update: Global pension assets bounced back last year with a 15% climb to US$46.7 trillion, according to a survey released this week by Willis Towers Watson’s Thinking Ahead Institute. The U.S. remains one of the fastest growing pension markets in the world, trailing only South Korea and Hong Kong.
Over the last two decades, allocations to private markets and other alternative investments have also been rising. Allocations climbed from 6% 20 years ago to 23%. Pension funds have been shifting allocations from stocks and bonds and toward alternative investments. Allocations to equities were down 16%, while allocations to bonds declined 1% last year. The average asset allocation for pensions in the seven biggest markets is 45% equities, 29% bonds, 12% alternatives, and 3% cash.
Despite the increase in allocations to other investment types, the Thinking Ahead Institute said the recovery in pension assets in 2019 was partially driven by strong equity market gains during the year. The gains in 2019 mark a strong rally from 2018 when global pension assets declined 3.3%.
Public pensions on track for a positive fiscal year
Feb. 6, 2020 Update: State and city pensions in the U.S. recorded a median return of 6.1% for the second half of 2019, according to data from the Wilshire Trust Universe Comparison Service. A spokesperson said in a press release that interest rate cuts by the world’s central banks, ongoing growth in the economy, and progress in the trade negotiations with China raised stock prices.
Most states start their new fiscal years in the middle of the year, which means the second half of 2019 was the first half of their current fiscal year. According to Bloomberg, public pension funds usually expect to see an annual return of approximately 7.25% so they can keep up with their required payments to retirees. A return of 6.1% for the first half of the year means most public pension funds are on track to meet their expected returns for the current fiscal year.
The public pension crisis continues, although adjusted net pension liabilities declined in fiscal 2018. Although 2019 brought more declines in adjusted net pension liabilities, 2020 is expected to bring about a significant shift, according to Moody’s Investors Service.
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Pension liabilities were down, but they will rise
In a recent report, the firm said that in fiscal 2018, adjusted net liabilities declined in 37 of the 50 biggest local governments ranked by amount of outstanding debt. Moody’s expects that this trend continued in fiscal 2019 but predicts that adjusted net pension liabilities will increase in fiscal 2020.
The firm adds that now 10 years into the current economic expansion, some of the biggest local governments have limited pension risks. However, weak funding for pension and retiree healthcare and other post-employment benefits results in credit quality that is more vulnerable to market volatility for some local governments.
For most of the biggest local governments, unfunded pensions remain the most significant long-term liability. The 50 biggest local governments have a total of $450 billion in adjusted net liabilities, compared to $238 billion in debt and $167 billion in other post-employment benefits.
On their own, pensions were the largest long-term liability for 29 of the 50 biggest governments in fiscal 2018. Debt led the way for 20 of them, while other post-employment benefits was the biggest liability for one government.
Unfunded pension crisis continues
Moody’s expects falling interest rates to drive increases in pension liabilities for many local governments this year after two years of declines. Many governments report their pensions with a lag of up to one year, which is why their liabilities are likely to decline in their fiscal 2019 results and then spoke in 2020.
For many of these governments, the increase could be quite significant, the firm warned. The firm’s analysts added that the FTSE Pension Liability Index declined steeply in 2019. Further, revenue growth has been strong recently, so affordability ratios won’t skyrocket.
Not even treading water
Local governments aren’t even doing enough to tread water, let alone take care of their unfunded liabilities.
According to Moody’s, contributions relative to revenues ranged from about 1% to 17% among the 50 biggest local governments. Even though most of them had discount rate assumptions at or higher than 7%, 34 of them had tread water gaps in fiscal 2018. The firm also said higher discount rates tend to reduce tread water thresholds.
One concern related specifically to underfunded teacher pensions is the ongoing shift in costs. State governments have been responsible for K-12 education, but K-12 school districts now face risks of these costs being shifted to them. Such a shift could help rebalance the state budget. Some states have considered but not acted on such legislation, while Illinois has taken the opposite approach. Some states have taken on even more responsibility in the underfunded teacher pensions.
A warning about volatility in investments
Moody’s also warned that volatility in pension investments is a credit risk. The governments that are at a higher risk of material new unfunded liabilities have pension assets that are large compared to their own budgets. They also have return targets requiring heavy allocations to volatile investment classes.
“The governments with very underfunded pension systems with weak non-investment cash flow (NCIF) have very little flexibility to reduce their annual contributions without risk of severe pension asset deterioration,” Moody’s warned.
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