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

As I mentioned in a previous post, I spent the last three days attending and speaking at the latest Opal Public Fund Summit in Newport, RI. I always find these events to be incredibly helpful and often wonder why conferences such as this are not better attended. Trustee education is so critical to our collective ability to protect and preserve defined benefit plans.

Despite spending the last 41+ years in the pension/investment industry, I try to attend as many of the sessions on the agenda as possible. I like to learn from plan sponsor trustees, consultants, actuaries, and the investment management community what they are focused on and why. I benefit tremendously from their willingness to share. It doesn’t mean that I agree with everything, but that is incredibly useful, too.

In fact, I was very surprised to hear a senior consultant from a major US asset consulting firm say that the current US rate environment wouldn’t have them change the asset allocation because the rate increases might be fleeting, and you can’t lock up the current 5% to 5.5% rate. Really? Sorry, but you absolutely can lock in the current higher US interest rates. It is called defeasance, and the strategy of cash flow matching (CFM) has been in existence for many, many decades. Just look at insurance companies and lottery systems. When you implement a cash flow matching strategy you have secured a certain cash flow of semi-annual interest payments and principal payments at the yield you purchased. No matter where interest rates go in the future, you have secured the certainty of these cash flows.

Pension America should be looking to take risk out of their DB plans. They should be trying to lock in these higher rates for a least a portion of their assets (liquidity). As a pension community, we blew it in the early 1980s and again throughout the ’90s, when the average pension plan was either over-funded or had an interest rate environment that was presenting a “once-in-a lifetime” gift of double-digit rates. Opportunities to SECURE the promised benefits were forfeited then, and it would be a travesty to witness another opportunity blown.

As a reminder, when a plan sponsor hires a cash flow matching specialist, such as Ryan ALM, Inc., to build and manage a defeased bond portfolio the plan’s assets and liabilities are matched for that portion of the portfolio. Changes in the interest rate environment have no impact on that portion of the portfolio. The funding cost savings is secured and the impact of a changing rate environment is mitigated. So, YES, you can lock in these attractive US interest rates at this time!

We, at Ryan ALM, don’t forecast interest rates. We don’t want to be in that game and you shouldn’t want to risk your pension benefit payments on interest rate speculation either. By engaging a CFM manager, you build certainty into your portfolio where traditional asset allocation frameworks create great uncertainty. You have no idea where equity and bond markets will be in 12 months, let alone 5-10 years, but you will know through a cash flow matching strategy that your plan’s CFM assets will match the plan’s liability cash flows.

The primary objective in managing a pension plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. It isn’t about achieving the highest return, which only ensures greater volatility and not necessarily success. We’d welcome the opportunity to provide you and your board with greater knowledge of how risk can and should be reduced in this environment in a cost effective manner.