By: Russ Kamp, CEO, Ryan ALM, Inc.

Dan Hougard, FSA and Associate Director, Actuarial Services at Verus has recently published an excellent thought piece on LDI for public pension plans. In this case, the LDI refers to Cash Flow Matching (CFM). We at Ryan ALM, believe that LDI is the label in which sits both CFM and duration matching strategies. Furthermore, we absolutely agree with Dan’s assessment that public pension plans can benefit in this environment of higher yields despite the accounting differences that may not make the use of CFM obvious.

As most readers of this blog know, we often criticize public pension accounting (GASB) for pension liabilities that allow the use of the ROA assumption to “discount” liabilities, while corporate/private pension plans use a market-based interest rate (FASB). We applaud Dan for stating that “the purpose of a pension plan’s investment portfolio (assets) is to ensure that the promised benefits (liabilities) can be paid to beneficiaries as they come due”. We at Ryan ALM believe that the primary objective in managing a DB plan is to SECURE the benefits at a reasonable cost and with prudent risk.

Key highlights from Dan’s research:

Many plan sponsors approach their investment policy without explicitly focusing on the liabilities

Because public plans discount liabilities at the ROA the perceived benefit of LDI (CFM) is not as obvious

Public plans could match longer-duration cashflows combined with “market-based” reporting for a portion of the liabilities – such as all current retirees.

The lowest risk asset class for pension investors are fixed income securities, as income is used to pay benefits, and securities are held to maturity so there is no interest rate risk.

During periods of market stress, negative cash flow plans may be forced to sell assets at depressed prices.

CFM can overcome that challenge by providing the needed cash flow to cover obligations while the return-seeking portfolio grows unencumbered.

IG credit yields haven’t been this attractive since 2010.

Public pension portfolios tend to have very uncertain outcomes and carry “tremendous” asset-liability mismatch.

Finally, CFM “investing can offer considerable value for many pension plans”!

It is wonderful to see a thoughtful article on this subject. We, at Ryan ALM, often feel as if we are all alone in our quest to protect and preserve defined benefit plans for the masses through cash flow matching, which SECURES the promised benefits at a reasonable cost and with prudent risk. It also allows for a wonderful night’s sleep during periods of excessive uncertainty.