By: Ronald J. Ryan, CFA, CEO, Ryan ALM, Inc.

Contrary to industry beliefs and practices, pension liabilities are NOT long duration. They are a term structure of monthly benefit payments. When priced under ASC 715 (AA corporate bonds) they are a yield curve with an average discount rate. To accurately fund and hedge this term structure (liability cash flows) you need to match and fully fund each and every monthly liability payment. This is best accomplished by cash flow matching (CFM). CFM is an old and well proven strategy that used to be called Dedication in the 1960s through the 1980s. CFM is the only way to accurately match liability cash flows. 

If the true pension objective is to secure benefits in a cost-efficient way with prudent risk then CFM is the proper strategy. Duration matching does NOT fund liabilities efficiently and may create serious cash flow mismatches and cost to fund current monthly benefit payments. Any strategy that does NOT match and fund liability cash flows of monthly payments will create costly mismatches. The Ryan ALM CFM model (Liability Beta Portfolio™ or LBP) will reduce funding costs by 2% per year (1-30 years = 60% cost savings) using investment grade bonds. At a fee of 15 bps, we believe that the Ryan ALM LBP model is a best fit for every DB pension.

Any pension plan sponsor considering a pension risk transfer (PRT) by buying an insurance company BuyOut annuity should consider CFM for its Retired Lives liability since PRT is usually focused on Retired Lives. These liability cash flows are certainly different and shorter than Active Lives. Moreover, most, if not all, insurance companies use CFM as their investment strategy when acquiring a PRT. By cash flow matching Retired Lives the plan is now ready for a PRT which may reduce the fee charged since the insurance company will take securities in kind if it fits their defeasance objective.