By: Russ Kamp, CEO, Ryan ALM, Inc.
Negative cash flow occurs when a defined benefit pension plan pays out more in benefits and expenses than it receives in contributions. Don’t panic if your DB plan is experiencing this phenomenon, as negative cash flow is often a perfectly natural consequence of pension-plan maturity. In fact, as a defined benefit plan ages, you would generally expect its cash-flow profile to move in that direction. The issue isn’t the fact that the pension plan is experiencing negative cash flow, the potential problem is how the negative cash flow (liquidity) is financed.
I’ll be addressing this topic at both the FPPTA (9/29 in Orlando) and the IFEBP (10/26 in New Orleans). According to the Public Plans Data (publicplansdata.org), which has robust information on roughly 250 public pension plans covering about 95% of the public assets, 87.2% of the plans are currently in negative cash flow. There are many ways that pension plans are funding monthly benefits and expenses, including:
| Liquidity strategy | How it works |
| 1. Cash / money-market reserve | Maintain cash, STIFs or money-market funds for near-term benefit payments |
| 2. Contributions + investment income | Employer/employee contributions, dividends, and bond coupons fund benefits |
| 3. Fixed-income liquidity sleeve | Bonds serve as both investment allocation and source of liquidity |
| 4. Rebalancing to fund benefits | Sell overweight asset classes and use proceeds for benefit payments |
| 5. Public-market liquidation | Sell stocks, bonds, ETFs, or other liquid assets as cash is needed |
| 6. Distribution harvesting | Use dividends, interest, real estate/private-market capital distributions |
| 7. Cash-flow matching / bond ladders | Bond coupons and maturities are deliberately aligned with projected benefits |
The strategies above highlight two fundamentally different philosophies. The first category are the Asset-driven liquidity group whose practitioners believe that when they need liquidity, they can get it. They are the “When we need cash, where can we get it?” crowd. The strategies that fall under that philosophy include items 1-6 in the above matrix.
The second category is the Liability-driven liquidity cohort, whose supporters claim that “they know when benefits must be paid, so why don’t we arrange the assets today to produce the cash when those payments occur?”. This category includes the Cash Flow Matching and Bond Ladder folks.
The latter strategy is what Ryan ALM espouses for plans with negative cash flow. If you’d like to learn why or to receive a copy of my presentation, don’t hesitate to either reply to this post or email me at rkamp@ryanalm.com, and I’ll be happy to share it with you.
