Many plan sponsors were under the impression that 2014 was a very good year for DB pension funding because the asset growth either met or exceed their plan’s return on asset assumption (ROA). We refuted those claims in blog posts in both March and May highlighting the fact that liability growth should be the primary plan objective, and not the ROA, and that liability growth far exceeded asset growth in 2014.
Well, we still believe that, and we are today sharing with you that the first six months of 2015 have been quite good for DB pensions. Why? According to our strategic partner, Ron Ryan from Ryan ALM, liability growth has been negative in the US in 2015, as US interest rates have trended upward. In fact, using Treasury STRIPS as a proxy for the risk-free rate, liabilities have fallen by nearly 3.7% through June 30th. If one uses AA Corporates as the discount rate, liability growth has fallen by 1.6%.
On the other hand, a 60% / 40% asset mix of the Russell 3000 Index (1.94%) and Barclays Aggregate Index (-0.10%) has returned 1.12% through the first six months. This result certainly appears anemic relative to the average public fund ROA of roughly 7.5%, but it is outpacing liability growth by as much as 4.8%. Funded ratios should be improving as a result of liability growth being exceeded.
Again, managing a pension plan is an incredibly challenging endeavor, made especially difficult when focusing on the wrong objective. Asset allocation decisions made solely on the basis of performance versus the ROA can lead a plan down the wrong path. 2014 was a poor year, yet perceived to be quite good, while 2015 has been a hand-wringing year for many sponsors despite good outperformance for assets versus liabilities.
DB plan sponsors should be focused on their plan’s liabilities as the primary objective and not the ROA. Allow KCS and Ryan ALM to create a custom liability index for your plan. It will provide you with a much greater understanding of how the liabilities are reacting to changes in the interest rate environment. It will also help you realize that 2015 is looking a lot better than your 2014 relative results!