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

I’ve been concerned about the U.S. retirement industry for many years, with a particular focus on traditional pensions. The demise of DB pensions is a major social and economic issue for a significant majority of American workers, who fear that their golden years will be greatly tarnished without the support of a traditional DB pension plan coupled with their inability to fund a supplemental retirement vehicle, such as a defined contribution plan.

I recently had hope that the rising U.S. interest rate environment would bring about a sea change in the use of DB pensions, but I haven’t seen the tidal wave yet. That said, the higher rate environment did (could still) provide plan sponsors with the ability to take some risk off the table, but outside of private pensions, I’ve witnessed little movement away from a traditional asset allocation framework. You see, the higher rate environment reduces the present value cost of those future benefit payments improving both the funded ratio and funded status of DB pensions, while possibly reducing ongoing contributions. Securing those benefits, even for just 10-years dramatically reduces risk.

But, again, I’ve witnessed too few plans engaging in alternative asset allocation strategies. That’s not the same as engaging in alternative strategies, which unfortunately continues to be all the rage despite the significant flows into these products, which will likely diminish future returns, and the lack of distributions from them, too. An alternative asset allocation strategy that Ryan ALM supports and recommends is the bifurcation of assets into two buckets – liquidity and growth – as opposed to having all of the plan’s assets focused on the return on asset (ROA) assumption.

By dividing the assets into two buckets, one can achieve multiple goals simultaneously. The liquidity bucket, constituting investment grade bonds, will be used to defease the liability cash flows of benefits and expenses, while the growth or alpha assets can grow unencumbered with the goal of being used to defease future liabilities (current active lives). One of the most important investment tenets is time. As mentioned above, defeasing pension liabilities for even 10-years dramatically enhances the probability of the alpha assets achieving the desired outcome.

So why am I concerned? The lack of risk mitigation is of great concern. I’m tired of watching pensions ride the rollercoaster of returns up and down until something breaks, which usually means contributions go up and benefits go down! Given the great uncertainty related to both the economy and the labor force, why would anyone embrace the status quo resulting in many sleepless nights? Do something, and not just for the sake of doing something. Really do something! Embrace the asset allocation framework that we espouse. Migrate your current core bond allocation to a defeased bond allocation known as cash flow matching (CFM) to bring an element of certainty to the management of your plan.

Listen, if rates fall as a result of a deteriorating labor force and economy, the present value of pension liabilities will rise. Given that scenario, it is highly likely that asset prices will fall, too. That is a lethal combination, and not unique given how many times I’ve seen that play out during my 44-year career. Reach out to us if you aren’t sure how to start the process. We’d be pleased to take you through a series of scenarios so that you can determine what is possible. Perhaps you’ll sleep like a baby after we talk.