The Custom Liability Index (CLI) – A Necessary DB Pension tool

I stumbled onto an article from 2008 that spoke to Ron Ryan’s “genius” when it comes to indexing. As most of you know, Ron was the Director of Research at Lehman in the ’70s and he has been credited with creating many of the world’s leading fixed income indexes, most notably the Aggregate, now known at the Bloomberg Barclays US Aggregate Bond Index. This article mostly dealt with his (Ryan ALM’s) work with ETFs, but I think that his most notable contribution to indexation has been the creation of the Custom Liability Index (CLI). I believe that every DB pension plan should have a CLI produced for them as each pension liability stream is unique and NO generic bond index can adequately match.

I am still amazed, even after 40-years in this business, that a plan’s liabilities aren’t driving asset allocation and investment decisions. The lack of liability information is certainly one of the primary reasons why this continues to occur. With a CLI, plan sponsors have the necessary information at their fingertips when it is needed. In 1991, Ron Ryan and his team invented the first CLI as the best representation of the true client objective. Although funding liabilities is the true objective of any pension, liabilities tend to be missing in action in asset allocation, asset/liability management, and performance measurement. The reason for this disconnect is the absence of a Custom Liability Index (CLI) that best represents the future value, present value, term structure, and risk/reward behavior of liabilities. Once a CLI is installed as the proper benchmark, then and only then can the asset side function effectively on asset allocation, asset/liability management and performance measurement.

As mentioned, liabilities are like snowflakes… you will never find two alike. Pension liabilities are unique to each plan sponsor since they each have a different labor force with a different salary structure, mortality, and plan amendments than any other pension. As a result, only a Custom Liability Index could ever properly represent or measure the unique liabilities of any pension. A CLI should be calculated accurately and frequently so the plan sponsor and its pension consultant can be informed with timely data that can support the asset allocation decisions.

Assets need to know what they are funding. The economic truth is that assets fund the net liabilities after contributions. A CLI should provide a net liability valuation based on all discount rates that apply (ASC 715, ROA, ROA bifurcated with 20-year munis, Treasury STRIPS, PPA spot rates, PPA 3-segment, PBGC). Ryan ALM is one of few vendors supplying ASC 715 discount rates since 2008. Our discount rates are consistently higher than other vendors providing a lower present value on liabilities thereby enhancing funded ratios and balance sheets. It may be wise for the CLI to have the economic valuation (U.S. Treasury STRIPS) as one of the discount rates to compare actuarial and accounting valuation versus economic valuation. Moreover, the CLI will provide a monthly or quarterly calculation of the economic present value of liabilities so the funded ratio and funded status can be updated, as well as a quarterly calculation of the economic liability growth rate so performance measurement of total assets versus total liabilities can be assessed.

Since current assets fund net liabilities after contributions, current assets need to know the projected benefits and contributions for every year as far out as the actuary calculates benefits. Noticeably, contributions usually play no role in the asset allocation strategy of most pensions, yet they are a major future asset. Given the size of contributions today, it is critical that contributions are a major consideration in the asset allocation strategy. For many plan sponsors, the contribution cost has risen as much as 5x to 10x or more from the fiscal 1999 level.

Don’t hesitate to reach out to us if you are interested in learning more about the Ryan ALM CLI. Without this pension X-ray, it is difficult to truly know what is ailing your plan.

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