Now, before everyone gets upset, I am not referring to generic drugs. I am specifically speaking about generic indexes to replicate liability streams for pension benefits, which seem to be all the rage these days. Corporate America has been derisking their pension systems for years and many use generic indexes to approximate duration. Unfortunately, duration strategies are never going to be able to match precisely any liability stream, as durations change daily with changes in rates.
Furthermore, a generic index couldn’t possibly work for more than one company in matching needed benefit cash flows unless those two companies have the exact same labor force characteristics. They would have to have the same benefit formula for their plan, and the employees would have to be the same age, started in their jobs on the same day, made the same wages, etc. I think that you get the picture. But, unfortunately, plans are still engaging in their use despite the potential for a significant margin of error.
The only way to properly de-risk a pension system is through a cash flow matching approach in which net liabilities (after contributions) are matched precisely with cash flows from a bond portfolio. Future values don’t change daily, which allows for the precise matching of cash flows with net liability payments. We believe that Pension America should be engaged in the derisking of their portfolios in order to meet near-term Retired Lives benefit payments for a variety of reasons. In order to accomplish this objective, a Custom Liability Index, no generics please, must be created to model that plan’s specific net liability cash flows. We’d be happy to do that modeling for you.