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

We hope that you enjoyed your President’s Day. I remember way back in my grammar school years getting both Lincoln’s (2/12/1809) and Washington’s (2/22/1732) birthdays off from school. However, that fun was squashed in 1971, when the Uniform Holiday Act was passed by Congress, which moved some federal holidays to specific Mondays. Thus “President’s Day” was created as the third Monday in February.

As for the ARPA legislation, the PBGC didn’t quite open the floodgates, but they did allow the application portal to open wide enough to allow four initial applications to be submitted. These plans included, the Carpenters Pension Trust Fund – Detroit & Vicinity, Pension Plan for the Arizona Bricklayers’ Pension Trust Fund, Pension Plan of Local 102, and Maryland Race Track Employees Pension Plan. These funds are all non-priority group members. There have now been 27 plans from the waiting list to see some action in the ARPA process. As a reminder, there are 111 pension funds that were non-priority members.

For those four applications, the plans are seeking a combined $642.7 million in Special Financial Assistance (SFA) for their more than 25k plan participants. In other ARPA happenings, there were no applications approved or denied, and only one plan withdrew its application. The America’s Family Benefit Retirement Plan, a Priority Group 1 member, withdrew the revised application on February 13th. They are seeking $188 million in SFA for 3,109 members. As a reminder, Priority Group 1 members began filing applications in July 2021. Twenty-four of the 30 expected Priority Group 1 members have received approval and SFA funding to date.

US Treasury yields have risen by more than 30+ bps across the yield curve since the beginning of 2024. These elevated yields help reduce the present value (PV) cost of those future benefit payments. Cash flow matching strategies will take advantage of these higher yields and lock-in the savings (cost reduction) as soon as the asset cash flows from bonds (principal and interest) and the liability cash flows (benefits and expenses) are matched. 

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

The WSJ recently produced an article that highlighted the US economic activity relative to the other leading developed nations of Europe and Asia, with a particular focus on both the UK and Japan. In the case of Japan, which suffered an economic contraction over the latter part of 2023, its economy saw GDP growth contract by -0.8% in Q3’23 and -0.1% in Q4’23. This economic weakness has resulted in Japan falling to fourth place behind Germany in a ranking of economic powerhouses with a GDP of roughly $3.9 trillion. At the same time that Japan was witnessing weakness, the UK’s “statistics agency Thursday said gross domestic product fell at an annualized rate of -1.4% in the final three months of 2023.”(WSJ)

At the same time that these “leading” economies were experiencing economic contraction, the US was defying expectations posting a 3.3% GDP annualized growth rate in the fourth quarter. Why? All three economies have tight labor markets which would normally lead to economic expansion and not contraction. In fact, US and UK wage growth is finally eclipsing inflation, while Japan’s wage growth still lags. So, why is the US outperforming these other economies to the extent that they are? I believe that it is the US government’s deficit spending that is providing the stimulus necessary to keep the consumer demanding goods and services at a far greater extent than in Japan and the UK. According to the WSJ, they agree, stating that “government spending in the U.S. has also remained at historically high levels for periods outside of recessions, giving the economy an added boost.” 

As I’ve mentioned before, the US deficit (currently at $34 trillion) is an asset of the private sector. The ability of the US to deficit spend is an economic driver. The debt is actually “income” which is providing stimulus on top of what is being created by the private sector. The US deficit in fiscal year 2023 was $2 trillion. That is tremendous stimulus. So, the US is NOT facing a “debt crisis”, but a potential issue of greater inflation if the US economy cannot match the enhanced demand for goods and services through production created by this government stimulus.

Those expecting US rates to fall because of a looming recession have not appropriately considered the significance of the government stimulus. Instead of this debt being a burden it is economic rocket fuel. Furthermore, US rates remain low relative to history. The 10-year Treasury yield averaged approximately 6.5% from 1971 to 2021. Today, the yield on that note is only 4.31%. Furthermore, Yardini Research, Inc. has produced a long-term chart that indicates that the “real return” on the 10-year Treasury has been just over 3%. Today, the “real yield” is about 1% based on the latest CPI reading of 3.3%. Prognostications of 6-7 rate cuts for 2024 are appearing silly at this time. Inflation targets haven’t been achieved, US interest rates are not stifling economic growth, and the US government debt is not a burden but a driver of economic activity.

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

In 1971, Alka-Seltzer launched an Ad campaign with the now famous slogan “Try It, You’ll Like It”. I can’t believe that it was nearly 53 years ago when that phrase first hit the airwaves, since I remember it so well. As you likely know, those 5 words subsequently took on a life of its own. Not surprisingly, it has been used by many of us over the years.

Well, it is time for Ryan ALM, Inc. to dust off that saying. I believe that sponsors of DB pension systems would benefit tremendously from a greater focus on their plan’s liabilities, since they are the only reason why a plan exists in the first place. We believe that with more attention to the promises that have been given, a pension plan can achieve greater stability in its funded status and contribution expenses. The greater certainty should be embraced since there is so little certainty in most aspects of pension management.

As an FYI, we were recently approached by a prospect to undertake an analysis on what a defeasement strategy might do for their fund. Given the current rate environment, one in which we believe that we can reduce costs by roughly 2%/year, it wasn’t shocking that our cost optimization model estimated >54% reduction in the cost to defease the future value benefits! Yes, >-54%. You’re probably skeptical of that last statement. So let us prove it to you.

We’d be willing to create, at NO COST, a Liability Beta Portfolio™ (LBP), which is what we call our cost optimization model. All we need from you to create the output are the projected liability cash flows (benefits, expenses, and contributions) as far into the future as possible. We are confident that you will be pleasantly surprised by the results. Importantly, you dictate the allocation to our CFM strategy from as little as 5 years of benefit coverage to defeasing all of the Retired Lives Liability. We normally recommend converting your current total return fixed income assets to a CFM strategy thus keeping intact the fund’s asset allocation.

How often are you given an opportunity in our industry to have a comprehensive analysis done at no cost? There really is nothing to lose. If I can be so bold as to amend Alka-Seltzer’s original wording, I encourage you to “try us, you’ll like us!”

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

In case you were entirely focused on the PBGC’s implementation of the ARPA legislation, the Kansas City Chiefs won Super Bowl 58 last night in a thrilling overtime win 25-22. What did you think of the new OT rules? Personally, I think that they are here to stay. Good job NFL.

In more series news, the PBGC is still implementing the ARPA legislation despite the application portal being temporarily closed. There is a bit of news to report. One application was submitted on February 8th. CWA/ITU Negotiated Pension Plan, Mount Laurel, NJ, a non-priority group member, submitted a revised application seeking $516 million in SFA for 24,288 plan participants. While that was occurring, two funds – United Food and Commercial Workers Unions and Employers Pension Plan and the Kansas Construction Trades Open End Pension Trust Fund – both non-priority group members withdrew their initial applications. In total, they were seeking $115.4 million for roughly 23,500 participants.

There is still much to be done to get through the roughly 200 plans that are seeking financial assistance under this legislation. US interest rates have continued to rise since the beginning of 2024 given Chairman Powell’s cautionary comments about expecting the Fed to move soon on potential rate cuts. However, there is good news to report as the rise in rates is providing plan sponsors with additional cost cutting opportunities for those that elect to SECURE the promised benefits through a cash flow matching strategy. As a reminder, the rise in US interest rates reduces the present value of those future promises given the higher discount rate.

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

I had the opportunity to listen in on a conference panel yesterday in which the individuals of several public pensions were asked if the asset allocation frameworks for their pension systems were based on the return on asset assumption (ROA) or the plan’s funded status. Somewhat surprisingly each of the participants responded that the plan’s funded status didn’t influence the asset allocation. Perhaps it is an appropriate answer if the horizon is a one-year timeframe in which funded status isn’t likely to vary too significantly unless, of course, we experience another GFC. But for longer measurement periods the funded status should absolutely drive asset allocation.

For instance, does it make sense for a pension plan that is 60% funded to have the same asset allocation (AA) as one that is 90% funded even if they are striving for the same ROA? No, it doesn’t! Yet, we see this quite often. Why would the plan that is 90% funded want to assume the same level of risk as one that is more poorly funded? The plan that is better funded should be striving to reduce risk in order to stabilize both the funded status and contribution expenses. Again, reducing risk doesn’t mean shuttering the plan or eliminating the possibility of providing benefit enhancements or COLAs. What it does mean is that a portion of your assets should be removed from the rollercoaster of returns bringing some stability to the funded status and contribution expenses.

Furthermore, we don’t believe that an asset allocation strategy should have all of the assets focused on the ROA. That AA strategy guarantees a lot of volatility, but no guarantee of success. We highly recommend bifurcating the assets into two buckets – liquidity and growth. The liquidity bucket should be a bond portfolio that matches asset cash flows of interest and principal with the liability cash flows of benefits and expenses. By adopting this framework the plan assures that appropriate liquidity is always available even during periods of great market stress. By building a liquidity bucket the plan sponsor is buying time for the growth assets to grow unencumbered. One of the most important investment tenets is time! Then longer the investing period the higher the probability of achieving the desired outcome.

Importantly, this cash flow matching strategy can fit within the existing asset allocation framework. Bond allocations still exist in a significant majority of plans. They may be smaller given the interest rate environment from which we’ve just come, but they will still provide ample assets to begin to de-risk. A 5-year cash flow matching (CFM) program is better than not having secured the benefits at all. Once adopted, the CFM can always be extended, especially if the funded status continues to improve.

The primary objective in managing a DB plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. I would posit that the current focus on the ROA doesn’t support that objective. Get off the rollercoaster of returns and begin to bring effective risk control into your asset allocation process.

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

Milliman has once again released the results of its latest Milliman 100 Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. Funding improved from December’s 102.1 to 103.1 by the end of January. The key to the improved funding was the rise in the discount rate as US rates rose after a significant decline to end 2023.

According to Zorast Wadia, the producer of the Milliman report, the discount rate improved by 14 bps to 5.14%, which drove total pension liabilities down to $1.316 trillion. The improvement in the discount rate (higher rates mean lower PV of liabilities) was more than enough to overcome a minor -0.3% loss on the asset side of the equation. Assets for the members of this index now total $1.356, as of the end of January 2024, which is down $10 billion from December 31st.

With the improved funding, plan sponsors should further de-risk the asset allocation. Again, this doesn’t mean closing and terminating the plan. It does mean that those who haven’t taken substantial risk out of their plan’s asset allocation subject those assets to unnecessary risk. As we’ve preached, use your fixed income allocation to match and defease pension liabilities through the bond cash flows of principal and interest. Cash flow matching not only provides the sponsor with the liquidity to meet ongoing benefit payments, but it also provides the most efficient duration match, as each month of the assignment is duration matched. Check out the research on this subject and other LDI subjects at ryanalm.com.

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

There are always competing views within the investment community. That’s what makes markets! However, there seems to be more unanimity these days surrounding the view that the Fed has accomplished its objective and rates, as a result, will have to fall. But is that really what is going to happen, at least in the near-term?

The economy: I can’t tell you how many times per day I read something that highlights the slowing economy. But is it slowing? GDP for 2023’s third (4.9%) and fourth (3.3%) quarters highlight strong growth. Furthermore, the Atlanta Fed’s GDPNow model is currently showing a 4.2% annual GDP growth for the first quarter of 2024. Again, are those numbers indicative of a weakening economy?

Labor Force: The US just enjoyed a blowout jobs number for January, while November and December payrolls were revised up by 133,000. Wage growth remains above 4%. Job openings, which had been declining, have risen to >900K. The labor participation rate had been climbing but fell by 0.3% to 62.5% in December and remained there for January. A smaller workforce may make it difficult for business to hire without increasing wages.

Inflation: What appeared to be a one-way path for inflation since peaking at roughly 9%, may have taken a turn in January. Only time will tell if this is a new path or just a wiggle on the road to 2%, but it is disconcerting none-the-less. I’m specifically speaking about the 7.3 jump in the ISM’s services sector price index for January. That increase was the greatest jump since August 2012. The service sector makes up about 80% of the US economy. Oh, no!

Other factors: The 3 inputs referenced above would be more than enough to have investors pause the celebrations that the Fed is finished. However, there are many other considerations that need to be factored into the equation, including 2 wars, pirates in the Red Sea disrupting commerce, de-globalization, which imports inflation back into the US, and the US Presidential election.

Taken in totality, where’s the case for US interest rates to fall? Ryan ALM, Inc. doesn’t have a crystal ball that is any clearer than anyone else’s. As a result, we don’t forecast the direction of rates. What we do is provide an investment strategy that brings certainty to the management of pensions that constantly live with great uncertainty. Given the elevated level of rates (not high, but average), plan sponsors should take the opportunity to match bond cash flows of principal and interest with the plan’s liability cash flows. You’ll SECURE the pension promises while mitigating the great unknown of interest risk. What a win, win!

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

We, at Ryan ALM, Inc., have been saying “higher for longer” as it pertains to US interest rates. We have been focusing on the strength in the US labor market as the primary reason that a recession wasn’t likely and as a result, the Fed would be cautious in reducing rates. That strength remains a key variable in the recession vs. soft-landing debate, but it isn’t the only signal.

In a surprise, perhaps shock, to market participants, the Institute for Supply Management’s (ISM) services-activity index rose to 53.4 in January from 50.5 in December. Economists had forecast a less robust climb to 52.0. A reading above 50 indicates expansion in the services sector. The recent strength in this index has perhaps caught some folks off guard, as it has recorded 13 consecutive months of growth, and according to the WSJ, 43 of the past 44 months. Wow!

In further support of the soft-landing believers, the ISM’s employment index jumped into expansionary territory coming in with a reading of 50.5 from 43.8 in December. The new orders index ticked up to 55.0 in January from 52.8, while the survey’s measure of business activity held on month at 55.8.

Perhaps the most concerning (for bond investors) reading in this latest report is the index of prices rose 7.3 points to 64.0! The 7.3 increase is the largest monthly increase since August 2012. It is this reading that will likely give pause to policymakers at the Federal Reserve as they contemplate the next move in the interest rate chess match.

With US interest rates likely remaining higher for longer, any investment in high quality bonds should be for their cash flows of principal and interest. Use those asset cash flow to match your pension plan’s liability cash flows of benefit payments and expenses. By matching or defeasing these obligations you are mitigating interest rate risk for those assets, as benefit payments are future values that are not interest rate sensitive. A $1,000 payment in March is $1,000 whether or not rates are at 2% or 10%. Hope of falling rates is not an investment strategy that I’d want to hang my hat on, but cash flow matching is, as it brings certainty to a very uncertain investing environment.

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

Happy Monday. Here is the latest from the PBGC as they implement the ARPA legislation designed to secure the promises mad by nearly 200 struggling multiemployer plans. The PBGC is still not cranking out the SFA, but we are at least seeing a bit of activity following a prolonged quiet period.

During the most recently completed week, we witnessed one new application submitted. UFCW Regional Pension Fund, a non-priority group member, filed a revised application seeking $51.7 million for its 4,605 plan participants. The PBGC will have 120 days (May 30, 2024) to complete the review. In other news, there were three plans that withdrew applications during the past week. These plans included the Bakery and Confectionery Union and Industry International Pension Fund, a Priority Group 6 member, that pulled its revised application, the CWA/ITU Negotiated Pension Plan, a non-priority group member that withdrew its already revised document, and the Radio, Television and Recording Arts Pension Plan, also a non-priority group member that took back its initial application.

In total, these funds were seeking $3.8 billion in SFA for the nearly 128K plan participants. The majority of these assets would be earmarked for the Bakery and Confectionery plan ($3.2B). Rounding out our weekly update, there were no applications approved or denied and there were no new plans added to the waitlist, which continues to have 111 members, of which 22 applications have gone through at least an initial screen.

There are still roughly 130 plans that will potentially receive SFA grants. Given the plethora of risks to our capital markets at this time, I hope that plans are looking to secure the grant money through cash flow matching, while assuming risk within the legacy portfolio. Again, the purpose of the grant is to secure benefits as far into the future as the allocation can go. It is NOT about taking risk. Use the legacy assets which benefit from an extended investing horizon since they are not a source of liquidity until the SFA has been fully depleted.

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.