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

As I mentioned in my last post, I am currently at the TexPERS summer program at the Woodlands just outside of Houston, TX. It is a well attended conference despite the excessive heat of 100+ temps all day long. In addition to the conference being well-attended, they are using a terrific website that allows for great interaction among the attendees, including producing polls. In one case, I asked the question: What is the primary objective in managing a defined benefit plan? The possible answers were:

The outcome from this poll has so far been surprising, as every respondent identified the securing of benefits as the primary objective – yes, 100%. We at Ryan ALM, Inc. absolutely agree (thrilled) with this choice, but we don’t see how this is being implemented in the day-to-day management of the public pension systems represented at this conference. Asset allocation decisions are being based on achieving the ROA. All of the assets are focused on beating their respective benchmarks, not the true objective of securing the promises (the plan’s liabilities). Why the disconnect?

One primary reason for this apparent dichotomy is the fact that a plan’s liabilities aren’t known on a daily, weekly, monthly, or even quarterly basis. It is absolutely necessary to measure, monitor, and manage a plan’s liabilities, but getting a once per year update through an annual actuarial report just doesn’t cut it. Can you imagine playing a football game and only knowing how many points you’ve scored (assets), but having no knowledge of how many your opponent has scored (liabilities)? How would you adjust your strategy? Unfortunately, that is how a significant percentage of Pension America has been operating. The Ryan ALM solution is a Custom Liability Index (CLI) invented by Ron Ryan over 30 years ago.

So, if SECURING the promised benefits is the primary objective, plan sponsors need to have a Custom Liability Index (CLI) created so that the liabilities can be monitored on a much more regular basis. Having this knowledge is the only way that a plan can even begin to secure the promises. Once the liabilities have been analyzed they can begin to be managed through a Cash Flow Matching (CFM) strategy that can accurately match asset cash flows of interest and principal with the plan’s liability cash flows of benefit payments and expenses.

Using a portion of the plan’s assets (bonds) to secure the fund’s near-term liabilities chronologically creates numerous benefits, including enhanced liquidity, an extended investing horizon for the plan’s growth assets, and more stable contributions and funded status. It is time to get off the asset allocation rollercoaster that only serves to create uncertainty. It does absolutely nothing to secure those promises which the folks at the TexPERS conference believe is the primary objective.