Average funding ratios for public pension funds have declined to 60% and below, down from 74% before the crisis, according to Goldman Sachs Senior Pension Strategist Michael Moran.
In an interview with Yahoo Finance, Moran discussed the most prominent issue pension funds will face: hitting their return targets. Usually set at about 7%, today’s extremely low interest rates will make that all the more difficult to attain in the future.
“What potentially changes [with public pension funds] is how they think about asset allocation and liquidity going forward,” Moran said. “Many of these plans have a 6.5% to 7% nominal return target, and I think many of them are questioning, ‘How do I hit that target in an environment where 30-year Treasury bond yields are below 1.5%.’”
“It just becomes more challenging and I think they’ll have to become more nimble, more tactical, certainly many of them have moved to alternatives over the past number of years, and I think that just accelerates going forward,” he said.
Hitting their return targets becomes even more difficult to achieve as local governments restrict their spending as a result of constrained budgets, which mean less money being funneled into the pension plans they’re associated with.
“A big issue for the public sector is not just what’s going on with their asset portfolios … [but also] what’s going on with state and local finances,” Moran said. “Because, as we have a recession, as state revenues decline, their ability to fund their pensions becomes a lot more challenged.”
The fiscal distress facing these local governments will make it more difficult for pensions to stay solvent, as it had in the past, Moran explained.
“Our work would indicate that coming into the year, public pensions were in aggregate funded about 72-73%, that has now dropped to below 60%,” he said.
“When we look at previous recessions—the period after September 11, or the period after the global financial crisis, for several years, many state and local governments under-contributed to their plans because they had budgetary stress and I think that’s going to be a key concern going forward,” he explained. “Their ability to make contributions, not just in 2020, but really over the next couple of years.”