How are your defined benefit plan’s liabilities performing? If you are a public fund plan sponsor this simple question might be very difficult to answer. Why? Well, for one reason, you are only receiving an update annually, perhaps 4- 6 months dated, when your actuary delivers their annual update. Second, the totally arbitrary discount rate being used under GASB is understating the plan’s true liability in this low-interest rate environment.
As a reminder, the DB plan only exists to fund a promise (liability) that has been made to the plan’s employees/participants. It is funding this promise at the lowest cost possible that should be the ultimate objective. Regrettably, that is not the case for most plans, as they’ve been inappropriately convinced (hoodwinked?) that achieving the return on asset (ROA) assumption is all the matters.
I suspect that you know the current market value of assets in your plan down to the penny. If not today’s valuation then you certainly know the value as of January 31, 2017. Why is it more important to know the asset side of the equation than the liability side? If I were running a pension plan, I’d certainly want to know the following:
- What is the current value of the promise (liability) that has been made?
- What are the current funded ratio and funded status of the plan?
- What do the benefit payments look like on a monthly basis?
- Do I have the liquidity to meet those payments?
- Will the plan run out of money prematurely? If so, when?
- Are the estimated contributions enough to narrow the funding gap?
- What happens to the plan’s long-term funding if only a fraction of the contribution is made?
- Can I “safely” award a COLA or benefit enhancement?
- How much alpha do I need relative to liability growth to begin to whittle away at my unfunded liability?
I would suggest that without greater knowledge of the plan’s liabilities, you will not be able to answer the questions above. In fact, without a custom liability index (CLI) being produced for your plan’s specific liabilities it would be impossible to answer those questions.
Investment structure and asset allocation should be driven by the liability side of the equation. It makes no sense that trying to achieve an arbitrary ROA would be the plan’s primary objective. As we reported earlier today, the average public DB plan has a 7.6% ROA target with only 7 of 132 large public funds having a ROA < 7%. How is it possible that all these plans have roughly the same ROA objective?
One would think that a plan that is 90% funded would have a much more conservative asset allocation than one that is 50% funded. But if both plans are striving for the same 7.6%, they are going to get a very similar asset allocation from their generalist asset consultant. DB plans should be removing risk from the process as funding improves. But, if you don’t know how the liabilities are performing, then you can’t possibly know when to take risk off the table.
If you’d like to be able to answer the questions posed above, please reach out to us to construct a CLI for your plan. It isn’t prudent to perform surgery without a set of X-rays. Why engage in the management of a DB plan without the appropriate x-rays being made available for your plan’s liabilities?