US pension funds, burdened with precarious funding ratios before the COVID-19 outbreak and large drops in the public equity market value, are finding their debt loads climbing, according to a new report from Pew Charitable Trusts.
“Absent positive returns in the next three months, overall state pension debt, currently $1.2 trillion, could increase by $500 billion, reaching an all-time high,” the report said. “The pressure to meet pension funding targets will be most acute in jurisdictions that had severely underfunded pension systems before the pandemic took hold. In Illinois, for example, nearly one in five state tax dollars is already going to pay for pensions before factoring in any revenue declines.”
Public pension funds are generally expected to struggle with meeting the required contribution targets they’ve established to keep their portfolios solvent as a result of their declines in revenue, but there’s an underlying issue that could extend the time frame for recovery, the organization said.
The funds must adhere to their contribution targets that are usually set at least one year in advance, meaning an appropriate target commensurate with the current status of the pension fund will lag until the pension’s board approves it for the following period.
“This means this effect will not be immediate,” Pew said.
A pattern of reduced assumed rates of return, a fundamental calculation that pension funds use to determine how to adjust their operations and targets to become or remain solvent, are expected in the near term as well.
“These reductions would continue the three-year trend [of reduced assumed rates of return], which already saw assumed annual return rates decline from 7.5% to 7.2%,” Pew said. The organization suggests that long-term returns would be closer to 6.5%, even before factoring in the pronounced effects of the coronavirus fallout.