With so much uncertainty, the health and economic consequences of the COVID-19 crisis are difficult to predict. Acknowledging that uncertainty, it is hard to be optimistic about the fate of public pensions during this downturn. One area that Arnold Ventures has historically invested in is improving the sustainability of public pension systems.
After the Great Recession, many public pension programs reported large gaps between the payments they had committed to pay and the resources they were expected to have to meet those obligations. Since then, the response to addressing these unfunded liabilities has varied. Some public plans made changes to the level of contributions, their investment strategies, and even how they calculate their obligations. Some plans made few changes. Going into this recession, while all plans will feel some effect, we suspect that some plans are better positioned than others to weather the storm.
How much money a pension plan has available to meet its obligations is a function of how much it contributes (from both the employer and employee) and how well markets perform. Following the previous recession, plans that had made a commitment to fully or nearly fully fund their estimated required contributions and had policies to manage risk ahead of time were able to bounce back over the course of a few years. Those that hadn’t made their payments or made those plans took the hit of the recession and then continued to struggle to reach full funding, even after the longest economic recovery in U.S. history. This is why funding discipline is so important. Markets have upswings and downswings. Those swings are beyond the control of policymakers. But meeting funding obligations each year is something that they can control, and making the required contributions enables the fund to grow during the next period of recovery.
Market performance, of course, is another key variable in determining the liability pension plans face. March 2020 was the worst month for the stock market since 2008. Where the public pension situation was bad, it just got much worse. Most systems will feel some impact. We know from research done by the Center for Retirement Research that some plans have continued to reduce their assumed rate of return, making the plans more conservative in their assumptions. To accompany these changes, some funds required a larger share of their assets be invested conservatively, with fewer dollars exposed to the most dramatic swings of the stock market. Still, other funds have sought higher returns, which means shifting their portfolios and putting more money in volatile investments. Those plans are even more susceptible to market downturns like we’ve seen of late.
What can we expect to happen to public pension plans during this recession? Within all of the variations there are three things worth keeping an eye on going forward.
- First, that as more certainty emerges in the next few months, we should have some sense of how well or poorly different funds were prepared for this latest recession. That story might not be clear until the end of this year or possibly later depending on the fiscal year end, but it should reveal a lot about the effectiveness of decisions to build more sustainable pension funds.
- Second, we will learn a lot about policy makers’ commitment to continue to fully fund their pension obligations. One historic problem for public pensions during downturns is that they are an easy area to ignore – especially when revenues are falling and demands for resources for other programs grow. Officials will face a tough political test when they are asked to keep paying for pensions in the face of these competing demands. As tempting as it may be, reducing or skipping payments will put a plan on a path that is much harder to correct down the road.
- Finally, it will be very interesting to see what happens once we have a better sense of the damage that has been done. The Great Recession was followed by reforms in how some pension plans were structured and commitments to making payments at the required levels. Arnold Ventures supported many of those efforts. And, its grantees will be ready to help again when stakeholders want to have those discussions.