No Fairy Tale

Once upon a time in a land not so far from here, defined benefit pension systems were over funded and cash flow positive. Yes, really! As recently as 1999, most DB pension plans were showing strong funded ratios and were at least cash flow neutral. Oh, how 20 years can dramatically alter the landscape. What happened?

Unfortunately, neither the US interest rate environment nor global equity markets cooperated. US interest rates collapsed until long Treasuries were sitting at historically low levels (US 30-year Treasury Bond is 1.34% today), while we tried to migrate through equity market gyrations (’01-’02, ’07-’09, Q4’18, and 1Q’20) that would have Elvis Presley’s hips jealous.

As a result, we have an environment that has corporate DB plans doing their best impression of a dinosaur, roughly 130 multiemployer plans that are on life support impacting the financial future of an estimated 1.4 million American workers, and a public pension system that still believes that their programs are perpetual despite several examples of plans with funded ratios below 20%. All we need is for Freddie Krueger to start showing up at industry events!

We don’t have a retirement system without DB plans. We can kid ourselves about DC plans being a viable alternative, but asking untrained individuals to fund, manage, and disburse this “benefit” is poor policy and nothing more than a pipe dream. As an industry we need to get back to basics. This means that we once again focus on why these plans exist in the first place, which is to pay the promise that was made to the employee when they were first hired. It means managing to this promise every day. It means securing the promised benefits for some extended time so that the plan doesn’t have to force liquidity in environments where it doesn’t exist.

What it doesn’t mean is that plan sponsors and their consultants have to redo their ROA target or asset allocation framework. We can get pension America back to the basics by just converting the plan’s current fixed income exposure into a cash flow driven investing (CDI) strategy. It is an implementation that provides the necessary cash flow for the next 10 years to pay the plan’s monthly benefits and expenses.

By utilizing a CDI approach, plans will see dramatically improved liquidity, the elimination of interest rate risk, the extension of the investing horizon for the balance of the plan’s assets, and an 10% to 20% savings relative to the current pay as you go approach to meeting monthly benefit payments. Furthermore, the savings is realized immediately, and those assets which are not needed to support the CDI portfolio can be used in the alpha portfolio to meet future liabilities.

Corporate America has done a much better job of managing the volatility of both the funded status and contribution expenses. Perhaps the reason is that they are forced to under more stringent accounting rules. But, given their relative success, why aren’t publics and multis embracing these tools? Again, we don’t have a true retirement system without DB plans, but we are just kidding ourselves if we think that these plans will survive without a change in course. Benefits need to be paid. A CDI approach is the only strategy that actually secures those promised benefits. Isn’t it time?

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