Key Points

  • We need to look at additional metrics of pension well-being as pension funds struggle with the triple-whammy of rising liabilities, falling asset values, and diminished ability to close the underfunding gap with accelerated contributions.
  • In particular, fund administrators should look beyond the subjective actuarial return assumption to both the risk-free rate of return and the required rate of return. The former highlights the reliance on assumed investment gains to meet fund liabilities, and the latter, if an impossibly high return, is a wake-up call that tough decisions are needed now on how to fund future liabilities.
  • We should know all of these figures on a per capita or per employee basis. Taking the numbers to a human scale helps us to better understand the magnitude of the challenges we face.
  • The underfunding gap has been growing for a quarter-century, but has widened dramatically in the wake of the Covid-19 market crash. The economic reality is that unfunded liabilities have already soared, but pension funding reports have not yet caught up with that reality.

Between mid-February and late March 2020, we saw a “take no prisoners” market crash. Anything with a whiff of perceived risk crashed, in direct proportion to its perceived risk. The only assets that soared—because of tumbling interest rates—were long Treasury bonds, and with them, the net present value of pension obligations. The catalyst was, of course, the growing recognition that an economic lockdown, intended to mitigate the spread of the COVID-19 virus, was going to have an extreme and lasting impact on the global economy.

Today is still self-evidently early days in the economic rout created by the COVID lockdown, and perhaps middle days in the health consequences of the virus. This ordeal, the policy choices we have made, and the health and economic impacts of those choices, will likely be studied for generations to come. After all, in the history of our country, we have never deliberately imposed an economic lockdown, not because of a pandemic such as the AIDS epidemic (with 32 million deaths globally, and counting), the Spanish flu of 1918–19 (50 million or more deaths), the Asian flu and polio epidemics of the 1950s (well over 1 million deaths each), nor because of world wars. Many of our readers will know my view, that it was never a choice between saving lives and saving the economy. We could have chosen to do both, as the East Asian democracies have proven.1 But, that’s not the point of this short article.

This article will focus on the impact of the COVID crash and economic dislocations on pension funding and on the resources available to present and future retirees. At a time when the resources available for pension contributions (tax revenues for public funds and company profits for corporate pensions) are in free-fall, pension administrators are faced with a triple-whammy of rising liabilities, falling asset values, and diminished ability—likely for some years into the future—to close the gap with accelerated contributions.

In writing this article, I’m not seeking to annoy the many pension sponsors who we count among our clients and friends. I know pension funding ratios are a controversial topic, even a lightning rod. Rather, I’m asking our industry to study additional metrics of pension well-being that can give us a richer understanding of the pension problem, sharply exacerbated in a single quarter by a drop in asset values and a sharp rise in the net present value of future pension obligations.