Public pensions have been underfunded for years, and the coronavirus has only made their funded status even worse. Goldman Sachs Senior Pension Strategist Michael Moran told Yahoo Finance that he believes the average funding ratio for public pension funds is now down to 60%. Public pensions were 74% funded on average before the COVID-19 crisis, he added.
Hitting return targets
Moran said the big issue facing public pension funds now is reaching their return targets. Most funds set their targets at around 7%, but now that interest rates have been cut to zero, it will become even more difficult for them to achieve that return target.
He explained that what could change with public pension funds is the way they think about asset allocation and liquidity. Moran said many plans have a nominal return target in the 6.5% to 7% range. Moran believes many of them are asking how they will be able to hit that return target during a time when 30-year Treasury bond yields are less than 1.5%.
He added that it becomes more challenging to hit those return targets in such a situation, and he believes they will have to "become more nimble" and "more tactical." Moran noted that many pension funds have shifted toward investing more in alternative investments over the last several years. He expects that trend to accelerate from now on.
Another challenge for hitting return targets is the fact that governments are restricting their spending because their budgets are constrained. It means less money is being poured into the pension plans the governments are associated with.
He warned that whenever there is a recession, state tax revenues decline. As a result, their ability to fund their pensions is much more challenged than it was before.
Public pensions' funded status to worsen
Moran believes it will become even more difficult for public pension funds to remain solvent due to the fiscal problems faced by state governments. He said his work suggests that going into the year, public pensions were 72% to 73% funded in aggregate, but they are now less than 60% funded.
Looking at previous recessions, like the years after Sept. 11, 2001 or the years after the global financial crisis, many state and local governments contributed less and less to their pension plans because they were facing budget stress. He warned that the same thing will probably happen due to the coronavirus pandemic, not just this year but for the next couple of years as well.