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

Those in attendance at a recently concluded industry conference voted unanimously that securing the promised benefits was the “primary” objective in managing a DB pension plan. It was great to get such a response, but once again, how do they accomplish that objective when achieving the ROA seems to be the singular focus.

You can’t possibly secure the promised benefits without first knowing your plan’s liability cash flow schedule. For decades, Pension America has focused almost exclusively on cobbling together a portfolio designed to exceed the return on asset assumption (ROA), and for decades many plans have failed.  As a result, the average Public plan funded ratio is no higher today than it was in 1999. As we have monitored ever since, this lower funded ratio has led to a significant increase in contributions since 1999.

As stated above, the objective of a pension system is to SECURE the promised benefits in a cost-efficient manner. Unfortunately, there are only two ways to secure benefits: 1) Insurance annuity buyouts, and 2) Cash flow matching (CFM) liabilities through a bond portfolio. Many believe that duration matching strategies accomplish this objective, but they don’t as they don’t match the asset cash flows to the liability cash flows.

Importantly, getting one’s arms around the promised benefits (plan liabilities) is the only way that a DB plan can de-risk. Through becoming more liability aware a plan sponsor can acquire the following:

• Greater transparency of the plan’s unique liabilities in multiple dimensions – discount rates based on GASB (ROA), FASB and risk-free rates (STRIPS)
• Enhanced knowledge of both cash flow and liquidity requirements
• Greater accuracy in calculating the TRUE return on assets (ROA) that is required in a test of solvency
• The ability to establish a cash flow matching bond portfolio created to meet benefit payments
• Stabilization of both the funded status and contribution expense
• A much longer investing horizon for the portfolio’s growth assets in order to fund future liabilities
• Reduced costs
• Peace of mind that benefits are secure for the next 10 years or so (depends on funded status)
• Enhanced viability of the pension system

These benefits seem to be pretty significant, yet many plans fail to gain these advantages. Regrettably, most plans only get a once-per-year view of their specific liabilities, which is too infrequent to engage in these important activities. Can you imagine playing a football game and knowing only how many points that your team has scored? How could you possibly adjust either your offense or defense to reflect the current game situations? Well, Pension America has been playing the game without knowing their opponents score for quite some time. It is about time that every plan sponsor has at their fingertips a Custom Liability Index (CLI) to help bring the pension game back into focus.

There are many reasons why we’ve witnessed a dramatic reduction in the use of defined benefit plans during the last four decades. Becoming liability aware will help plan sponsors secure those that remain. Our plan participants are counting on our industry to take a different path to help them achieve a prosperous retirement. Don’t hesitate to call on us. We’ll explain how you can begin to SECURE those promises, which will allow everyone to sleep better at night!