The coronavirus pandemic was one of the biggest disruptive events that most people will witness in their entire lifetimes. The normal lives of people were completely disrupted by the pandemic. During that time, there was a lot of uncertainty and many people were doubtful whether life would return to normal for a long period of time. Hence, it should not come as a surprise that coronavirus had a massive financial impact on pension funds as well. In this article, we will have a closer look at how the retirement funds of people were impacted by increasing volatility in the financial markets.
- Decline in Portfolio Values: The immediate impact of the coronavirus pandemic was that the value of the assets being managed by pension funds saw a massive reduction. The pandemic started with a 50% reduction in the valuation of most asset classes. Hence, there was a great deal of fear amongst the retirees as they saw the value of their retirement portfolios plunge with very little recourse at hand.
However, since the problem was affecting the entire world, governments started reducing interest rates in order to prop up the financial markets. The end result was that the next couple of years saw a huge increase in the valuation of financial assets. Therefore, what started as a decline in portfolio values ended up being a record increase in the value of the portfolio assets. Only people who ended up withdrawing money at lower valuations suffered losses.
- Increased Liabilities: A significant percentage of the pension being paid out is related to defined benefit plans. This is because most of the pensioners today belong to the previous generation. Hence, a lot of pension companies have to pay fixed nominal amounts of pension. Also, even if the pensioner is holding a defined contribution plan, they still buy annuities at the end of the plan.
Annuities sellers offer to pay the pensioners a fixed sum of money at the end of every month. Now, since governments all over the world reduced interest rates, this had a direct impact on the pension funds. This is because pension funds had to pay a higher interest rate per month on their annuities based on their contracts. However, they were not able to generate sufficient income because of the falling yields.
- Lower Contributions: The coronavirus pandemic saw a rapid increase in the unemployment rate across the world. There were many industries where the day-to-day operations had almost come to a halt. Also, people who were employed saw a drastic decrease in their incomes.
Pay cuts were common in most parts of the world. Since people were afraid that they were likely to lose their jobs and their incomes were also following, they did not want to invest their money in any scheme where it would be locked up for a long period of time. The end result was that the contributions being made to pension schemes across the world became drastically lower than the previous years.
- Increased Early Withdrawals: In most parts of the world, pension funds are considered to be illiquid. This means that the money invested in pension funds cannot be withdrawn until retirement. This is the reason that assets that are managed by pension funds tend to have a predictable inflow and outflow pattern.
Pension funds can therefore invest them over the long term without having to worry about liquidity issues. However, during the pandemic, many people lost their jobs. Hence, they wanted to tap the savings present in their pension funds in order to survive. Governments in many parts of the world allowed early withdrawals of pensions. These early withdrawals lead to some temporary liquidity issues.
- Switch to Defensive Portfolios: Most of the pension funds held by young investors are defined contribution pension funds. This means that the investors have control over the asset class in which these funds are invested.
The period immediately preceding the coronavirus pandemic witnessed an economic boom. This is the reason that a lot of investors had aggressive open positions in the market. However, as the pandemic began, uncertainty rose through the roof. The result was that there was an immediate flight to safety.
Investors all over the world started changing their portfolio allocations. Money invested in debt instruments was drastically increased. However, this only ended up crystallizing the losses for investors. Investors who had opted out of equity got lower returns in long run due to the bull market which immediately followed the pandemic.
- Operational Disruptions: Last but not the least, the pension fund industry also faced severe operational disruptions because of the coronavirus pandemic. Just like other industries, the offices of pension fund companies across the world were shut. Hence, they too were facing difficulties in finding investment opportunities as well as conducting their middle and back-office operations. This ended up slowing the pace of investments being made by pension funds.
Hence, it can be said that the working of pension funds was deeply impacted by the coronavirus pandemic and the financial events which followed it. Even though there is no way of predicting a pandemic, the covid crisis has taught pension funds that they should have risk mitigation mechanisms in place.