The Next Crisis? Pension Plans

By David Gross

Author’s note: This article focuses on defined benefit pension plans in the private sector. To learn more about the pension challenges facing municipalities and states, check out this article by Mary Williams Walsh at The New York Times and the Federal Reserve’s analysis from December 2019.

Stock markets plummet by 20 to 30 percent. Long-term interest rates drop. Future economic growth and asset returns are in doubt. Each of these scenarios can threaten the solvency of defined benefit pension plans and pose challenges for the employers sponsoring and managing these plans. Like the Great Recession of 2007 to 2009, COVID-19 has delivered all three scenarios overnight. For companies that elected not to de-risk their plans over the past decade, or lacked the financial means to do so, the next decade will bring higher contributions and less discretionary cash for reinvestment, mergers and acquisitions, dividends, and buybacks. For some companies, the next decade will also make them less attractive, or unattractive, to potential acquirers or bring a reorganization or liquidation.

To put the scope and magnitude of this developing crisis into context, let’s begin with the S&P 1500. This index represents a set of companies which cover about 90 percent of U.S. market capitalization. As of December 31, 2019, the pension plans sponsored by these companies had a collective deficit of $301 billion and were 88 percent funded. Fast-forward 90 days to March 31, 2020, and the deficit had swelled to $576 billion, and the plans were just 76 percent funded. That’s a 90 percent deficit increase in 90 days.

Now, let’s consider the federal response. The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act (Section 3608) provides two pillars of “relief” for companies with single-employer pension plans: First, these sponsors may postpone their required minimum contributions for calendar year 2020 until January 1, 2021. Consequently, sponsors who elect this relief will find themselves on the hook for 2020 and 2021 calendar year contributions in 2021—at precisely the time that 2021 contribution can reasonably be expected to skyrocket due to negative asset returns in 2020 and lower interest rates. Second, sponsors may utilize their December 31, 2019 funded status (otherwise known as last year’s, pre-COVID-19 funded status), instead of their December 31, 2020 funded status, to determine whether certain restrictions on benefits and payments apply. The result: pension deficits will increase.

Next, you might ask, “What about private union/multi-employer pension plans?” The CARES Act did not address these plans, which are a perennial Washington hot potato, but it’s possible that a subsequent COVID-19 relief package addresses this ticking time bomb.

Against this backdrop and the prediction by JPMorgan’s CEO of a “major” and “bad” recession, what steps must sponsors take today? The irresponsible sponsors will make aggressive changes to asset allocations and key assumptions in order to minimize their required cash contributions. However, most sponsors will tackle this challenge head on and fund pensions at required levels—with some even making discretionary contributions to de-risk their pensions more quickly. If you are a sponsor, now is the time to prepare for the coming tsunami of higher pension contributions and ensure cash forecasts and planned uses of cash are up to date.

David Gross is a Founder & Managing Director at Strategic Value Partners (SVP). SVP delivers tangible results through strategic planning, team building and development, and intensive change management. SVP serves aerospace and defense, automotive, healthcare, natural resource, retail, and TMT companies. SVP also collaborates with alternative investment managers. In every case, SVP's goal is to create exponential returns while proactively managing strategic, operating, and financial risks. For additional information, please visit www.consultsvp.com or email connectwithus@consultsvp.com.