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

Market downturn could force some public pensions to sell assets for a loss.

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.

“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


Chicago Police


KERS Non-Hazardous


Chicago Municipal


Illinois SERS


Connecticut SERS


Providence ERS




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.”

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