It is Not an Absolute Objective

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I recently returned from an industry event focused on public pension plans. There were many important topics covered by excellent presenters. That said, I have to push back on the idea that public pensions have an absolute objective in managing pension assets despite the fact that the accounting rules under GASB allow for pension liabilities to be discounted at the return on asset assumption. The primary (only) objective in managing a pension system should be to fund (secure) the promised benefits in a cost efficient manner and with prudent risk. This makes the objective relative (assets versus liabilities)!

Was 2022 a good or bad year for pensions? Well, unfortunately that answer depends on if you are talking about private plans using FASB accounting or public/multiemployer plans using the ROA to discount pension liabilities. For private plans that use a AA Corporate rate to discount liabilities… it was a wonderful year despite the travails in the equity and bond markets as liabilities had a large negative growth rate (-25.52% E). On the other hand, public pensions had a “horrible” year as plan assets dramatically underperformed the ROA. Why should the outcomes be so different for pension systems with similar asset allocations investing in the same markets? It makes little sense and may in fact create an environment in which benefit and contribution decisions are incorrectly applied.

Furthermore, if managing a pension plan had an absolute objective, why would those plans continue to invest in assets that don’t have an absolute objective, such as equities, bonds, real estate, etc.? Endowments, Foundations and individual investors have an absolute objective because they have annual spending needs/requirements. Pension plans have a relative objective because their liabilities are bond-like and the present value (PV) rises and falls with changes in interest rates, which we are witnessing currently. Why wouldn’t a pension system want to know the true value of their promises? How do you know if you are actually winning the pension game if you only get the market value of your plan’s assets on a regular basis?  If assets are always priced at market values, why shouldn’t liabilities be priced at market values? Then, and only then, can you compare and manage assets versus liabilities.

The nearly four decade decline in US interest rates hurt Pension America’s funding and it caused a spike in contribution expenses. It appears that we are finally in an environment of rising US rates. Wouldn’t it be a great time to value those pension promises using market rates? Given the much higher rates, with potential higher levels to come, it is a great time to explore taking risk of the table by defeasing the Retired Lives Liabilities, while allowing the remaining alpha assets to grow unencumbered to meet future liability growth. As an industry we failed to do this after 1999. We can’t afford to miss this opportunity to secure these incredibly important retirement programs. The American worker is counting on us.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s