By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Ryan ALM has just completed the production of a Custom Liability Index™ (CLI) for a pension system in which we mapped the plan’s net liabilities (benefits and expenses net of all contributions) using two discount rates (Tsy STRIPS and AA Corp). Once the CLI was completed, we were able to construct a Liability Beta Portfolio (cash flow matching (CFM) and cost optimization process). Using a conservative implementation in which we limited the investible universe to BBB+ or better, we were able to defease this plan’s entire liabilities, while producing a small surplus. In contrast, the plan’s actuary has the plan’s funded ratio at <50% in their last valuation.
The plan’s liabilities are roughly $11.034 billion going out to 2114. The net liabilities (after contributions) are $5.756 billion. Plan assets are only $2.4 billion as of 3/31/23, so how is it that a cash flow matching implementation can claim that this fund is fully invested? Simple. A present value (PV) calculation of the future value (FV) benefits and expenses reveals that we ONLY need $2.24 billion in assets to defease the $5.756 billion in liabilities. This reduction in the future cost to fund benefits amounts to a 61.1% cost savings versus a pay-as-you-go system, which is how many pension plans are managed.
Some will argue that all we are doing is highlighting the “time value of money” and that might be the case, but the day that our portfolio is constructed is the day that those “funding cost savings” are realized and booked! How much annual volatility is associated with a traditional pension asset allocation: 10%, 12%, or more? One could probably cobble together a collection of products and asset classes that might accomplish the same objective over time but that strategy comes without the cash flow certainty provided by CFM. Why subject the plan’s assets to market risk when a CFM implementation allows you and the participants to sleep well at night (SWAN strategy).
The US yield environment has changed dramatically in the last 13 months. Pension plans can now use the cash flows of principal and interest from bonds to engage in risk reduction strategies like CFM. Insurance companies and lottery systems don’t play games with the promises that they’ve made. They utilize CFM to SECURE those promises. Isn’t it about time that Pension America got off the asset allocation rollercoaster before it is too late?
Hello Russ: 5.73 billion in in assets sounds better inflation adjusted all the way to 2114. and don’t we need accrual rates of pensions as a factor to determine future plan liabilities. What will it take for pensions to use CFM? A presentation from an insurance company?
Good morning, Joe. This plan has 93% of the participants already receiving benefits with a big chunk of the remaining 7% not accruing additional benefits as they are terminated vested participants. The plan’s assets and liabilities fall rapidly 10 years out. With regard to getting folks focused on CFM, that is my job! I am trying to provide education in a number of ways – writing, speaking, and teaching. We need plan sponsors to be open to doing things differently. It is difficult to get people who have been told one thing for decades to adopt an alternative approach. I will keep doing my best to help secure these critically important retirement vehicles. DC plans are not the answer.