Liabilities Are Like Snowflakes

P&I recently published a chart using data from that National Association of State Retirement Administrators (NASRA), which highlighted the fact that the once the holy grail 8% return on asset (ROA) target had moved from that level in 2001 to somewhere between 7.25% and 7.5%.  Although a full 50% of those using 8% in 2001 were still anchored there today.

We believe the data, but continue to shake our head at the foolishness of the ROA objective.  How is it that all these state plans, with a few exceptions, have a return objective that falls within 50-75 basis points of one another, especially when one considers the differences in current funding, contribution policies, workforces, economic environments, benefit structures, COLAs, etc.

As we’ve mentioned, if two plans have the same 7.5% objective they are likely going to have an asset allocation that is similar. But, does that make sense if one plan is 90% funded and the other one is 50% funded? Hell no! Given this example, one of these plans has an asset allocation that is either way to conservative or aggressive. The funded status and contribution policies should dictate asset allocation and investment structure – NOT the ROA.

A DB Plan should use cash flow (contributions) to meet benefit payments, where possible.  Why subject this important asset to the whims of the market? DB plans should also de-risk where possible.  The liability is known (promise made).  What isn’t known is how the markets will behave.  There are no guarantees, even with the benefit of time.  I suspect that most plan sponsors and their consultants would have assumed that the 8% was achievable over a 20 year horizon, but even the S&P 500 (7.7%) and the Russell 2000 (7.9%) failed to meet that objective for the 20 years ending October 31, 2016, and DB asset allocations aren’t only in equities.

It may be too much to ask of plan sponsors to completely flip the ROA switch off, but a portion of the assets should be se-risked in order to meet near-term obligations should the markets fall significantly from these levels.  Call us, we can help guide you on how to become more liability aware.

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