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

Managing a pension plan is not an easy task, but it doesn’t have to be as challenging as it currently seems to be. Why? For one thing, pension plans need to understand that they only exist to fund a promise that has been made to the plan participants. That promise – future benefit payments – needs to be measured, monitored, managed to, and then SECURED. But, without a means to do that on a frequent basis (daily, weekly, monthly, and/or quarterly) how does one actually accomplish the objective?

Importantly, a fund’s asset allocation should reflect the current funded status of the plan and not be driven by some return on asset (ROA) objective, that in many cases is a feel good number driven by the ability to manage contributions. Does it really make sense that two plans with very different funded ratios – say 60% and 90% – should have the same ROA objective? Absolutely not! Yet, we see that all the time. Furthermore, benefit payments are future values (FV) and plan assets are in present value (PV) terms, since we don’t know what value those assets will have in the future, except for bonds.

In order to successfully measure, monitor, and manage liabilities, let alone secure them, a plan sponsor needs a Custom Liability Index (CLI) on a frequent basis since each plan’s liabilities are going to be unique to that sponsoring entity. No generic index can ever truly replicate a pension’s liabilities. Importantly, those FV liabilities will be converted into a PV figure monthly providing the plan sponsor with a more accurate and frequent interpretation of the plan’s funded status. In this higher rate environment, the PV of liabilities will be much smaller than previously thought allowing sponsors to take more risk out of the current asset allocation framework.

Ron Ryan, Ryan ALM’s CEO, created the first CLI back in the early 1990s. We believe that every plan should install a CLI in order to do a more effective job of managing a plan’s assets to their liabilities. The CLI is a big part of our turnkey Asset/Liability Management (ALM) capability. Don’t hesitate to reach out to us if you’d like to have a CLI built for you. The first one is on us. We’re confident that you’ll quickly see the benefit in having one produced regularly.

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

You may recall that on July 14, 2023, I penned the post “It Ain’t Over Until it is Over” in which I covered the subject of rising oil prices at that time stating, one of the key factors contributing to the Fed’s success in driving down the CPI has been the significant fall in the price of oil. As you may recall, the price of a barrel of WTI crude oil peaked on June 6, 2022 at $120.67. It currently resides (10:03 am EST) at $76.52 which is a fall of -36.6%. Since petrochemicals derived from oil and natural gas are used in the production of >6,000 everyday products, this significant decline in the price of oil obviously goes a long way to mitigating inflation. But, one must ask, has the price of oil peaked and will the slide in price continue or will OPEC and other factors potentially disrupt this favorable trend?

I went on to state, there recently has been an uptick in the price of WTI, which stood at $70.64 on June 30, 2023. At $76.52 today (as of July 14th), WTI is up 8.3% MTD. I mention this trend because bond investors seem to think that the Fed has accomplished everything that it set out to do when it first increased the Fed Funds Rate on March 17, 2022. The subsequent 10 rate increases have meaningfully addressed inflation, but as we witnessed in the 1970s, declaring victory prematurely can bring about a swift reversal of fortune.

Well, WTI currently sits at a price of $88.66, a 25.5% increase since June 30th, and 15.9% above the price on July 14, 2023 when I wrote of my concerns about the trend for oil. Since that post, both Russia and Saudi Arabia have stated that production cuts would be sustained until at least year-end. Ouch! There are three FOMC meetings remaining in 2023. It still amazes me that the collective investing community still believes that the Fed has accomplished its objective and that 2024 will be the year of Fed Fund Rate cuts. Given that GDP growth is currently forecast to be 5.6% for Q3’23 as calculated by the Atlanta Fed’s GDPNow model, unemployment remains historically low, and housing and rental costs remain stubbornly high, I just don’t see where there is room for a rate cut on the horizon.

As we’ve mentioned on many occasions, don’t play the game of predicting interest rates and markets, SECURE the promised pension benefits at very attractive rate levels today. You’ll realize the cost reduction of those future benefit payments with little to no variability relative to your plan’s liabilities. I know that your participants would appreciate hearing that their benefits are absolutely secure for some prescribed period no matter what transpires in the capital markets.

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

I’ve never been a boxer, but I can certainly appreciate the instructions to stay away from your opponent in the last or later rounds when you have the match won on points even though Jimmy Braddock didn’t adhere to that strategy in the movie classic, “Cinderella Man”.

Actuarial firm Milliman has released the results of its latest Milliman 100 Pension Funding Index (PFI) for August 2023, which analyzes the 100 largest U.S. corporate pension plans. According to its study, the funding ratio dropped from 103.6% at the end of July to 103.3% as of August 31, ending the month with a $43 billion surplus for these 100 plans. Unfortunately, asset losses for the month outweighed liability gains, which fell as a result of the 16 basis point increase (US interest rates were up!) in the monthly discount rate. According to Milliman, “the market value of PFI plan assets decreased by $27 billion because of August’s -1.55% investment return, while the monthly discount rate climbed from 5.25% in July to 5.41% for August.”

Given our expectation that the Fed hasn’t accomplished its primary goal of containing inflation, and we’ll get another update tomorrow, we expect US interest rates to keep rising. That possible increase will reduce the present value (PV) of those future liability promises (benefits), which will continue to improve funding without the need for further asset gains. Given the current level of funding (103.3%), why stick your chin out at this time when we all know that the markets can hit back with a fury! We’ve seen this movie unfold many times.

In the analysis provided by Milliman, they frame possible future scenarios for both interest rates and asset growth. “Under an optimistic forecast with rising interest rates (reaching 5.61% by the end of 2023 and 6.21% by the end of 2024) and asset gains (9.8% annual returns), the funded ratio would climb to 107% by the end of 2023 and 120% by the end of 2024. Under a pessimistic forecast (5.21% discount rate at the end of 2023 and 4.61% by the end of 2024 and 1.8% annual returns), the funded ratio would decline to 100% by the end of 2023 and 91% by the end of 2024.” Why take the risk?

Increases in US interest rates have certainly negatively impacted the performance for total return-seeking fixed-income managers, but they’ve also dramatically reduced the PV of pension liabilities. Take advantage of these higher rates to SECURE the promises that have been made to your plan participants through a Cash Flow Matching (CFM) implementation. Witnessing another market correction that reduces your plan’s funded ratio back to the low 90% range or worse, depending on the magnitude of the correction, would be criminal. As we stated above, you’ve won the match. It is time to stay at least arm’s length away from your opponent!

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

Football season has begun in earnest, so you can’t blame the PBGC if their activity level was not quite up to the pace that they’d been operating under. For the week ending September 8, the PBGC did not accept any new applications from the waiting list nor did they approve or deny any applications under review. In fact, there wasn’t any activity except that which took place behind the scenes, as there are currently 22 SFA applications in the review queue, as highlighted in the chart below.

There remain more than 100 applications that need to be reviewed and acted on by the PBGC, so their workload will keep them busy for some time to come. As reflected above, 63 funds have or will soon receive Special Financial Assistance. The total grant money received to date exceeds $53 billion. As a reminder, the proceeds from this legislation are to be used to secure benefits and expenses as far into the future as the grant will permit. With US interest rates continuing to rise, a cash flow matching strategy is able to secure more months. Pension plans should be focused on extending the coverage period as far as possible. Using a portion of the 33% of the SFA grant to attempt to increase the allocation is a risky strategy with very little upside potential.

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

I suspect that most of us have no idea that today, September 8, 2023, is National 401(k) Day. This day is recognized every year on the Friday following Labor Day. The day is supposed to be an opportunity for retirement saving education and for companies to inform their employees about their ability to invest in company sponsored 401(k)s. Did you get your update today?

401(k) plans are defined contribution plans (DC). This plan type was created in the late 1970s as a “supplemental” benefit. Corporate America liked the idea of a DC offering because it helped them recruit middle and senior management types who wouldn’t accrue enough time in the company’s traditional pension plan. Again, the benefit was supplemental to the traditional monthly pension payment and not in lieu of it!

I think that defined contribution plans are fine as long as they remain supplemental to a DB plan. Asking untrained individuals to fund, manage, and then disburse a retirement benefit is a ridiculous exercise. Why do we think that 99.9% of Americans have this ability? Unfortunately, we have a significant percentage of our population living within 200% of the poverty line. Do you think that they have any discretionary income that would permit them to fund a retirement benefit when housing, health insurance, food, education, childcare, and transportation costs eat up most of an individual’s take home pay? Remember, these plans are predicated on what is contributed. Sure, there may be a company match of some kind, but we witnessed what can happen during difficult economic times. That employer contribution suddenly vanishes.

Defined benefit plans are the gold standard of retirement vehicles. They once covered more than 40% of the private sector workforce, most union employees, and roughly 85% of public sector workers. What happened? Did we lose focus on the primary objective in managing a DB plan which is to SECURE the promised benefits in a cost effective manner with prudent risk? Did our industry’s focus on the return on asset assumption (ROA) create an untenable environment? Yes, we got more volatility! Did we did we get the commensurate return? Not consistently. It was this volatility that impacted the financial statements and led to the decision to freeze and terminate a significant percentage of private DB plans. It is a tragic outcome.

What we have today is a growing economic divide among the haves and haves-not. This schism continues to grow, and the lack of retirement security is only making matters worse. DB plans can be managed effectively where excess volatility is not tolerated, where the focus is on the promised benefit and not some made up ROA, and where decisions that are made relative to investment structure and asset allocation are predicated on the financial health of the plan and the funded status. We need DB plans more than ever and ONLY a return to pension basics will help us in this quest. Forget about all the newfangled investment products being sold. Replacing one strategy for another is no better than shifting deck chairs on the Titanic. We need improved governance and a renewed focus on why pensions were provided in the first place.

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

For us in the Northeast, the start of September marks the beginning of another school year for our K-12 students. We hope that your summer has been wonderful. For the PBGC, the beginning of September just marks another month of focus on ARPA and the approval and distribution of Special Financial Assistance (SFA) for eligible multiemployer plans. They have now been active with ARPA since July 2021. To date, 60 plans have received SFA, with some getting additional funding through supplemental organizations.

During the last week of August, the PBGC approved the SFA for one plan – Ironworkers Local Union No. 16 Pension Plan – which will receive $75.8 million, including interest. This Priority Group 2 plan needed to submit a revised application before getting approval. In other news from last week, Teamsters Local 11 Pension Plan, a plan without a priority designation, submitted its revised application. They are seeking $28.9 million in SFA for their 2,012 plan participants. The week witnessed no applications being either withdrawn or denied and no new plans were placed on the waiting list.

In a post from earlier today, I reminded folks about the need to protect and preserve the SFA, as required by the legislation, especially given the rising rate environment and the potential significant losses that rising rates will cause to a bond’s principal. Who knows whether or not the Fed is done with tightening? But, if they remain data dependent, the current environment suggests to us that they have NOT accomplished their objective (controlling inflation) at this time.

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

August 2023, proved to be another challenging month for return-seeking fixed income managers and their strategies when using the BB Aggregate index as the proxy, as the index declined -4% (-3.98% if you want exactness). This was the most challenging monthly result so far in 2023. For the year-to-date period, the index has posted a 1.4% return, as the higher yields buffered the loss of principal value as US interest rates continued their path upward.

How are things shaping up for the balance of the year? Well, we at Ryan ALM, Inc. are not in the business of predicting US interest rates, but we do look at the data like most everyone else. What we see is a nearly historic labor market, rising oil prices, with WTI now over $87/barrel, and a GDP for Q3’23 of 5.6% according to the Atlanta Fed’s GDPNow model (as of 9/1/23), which would certainly suggest that a recession is not in our immediate future. Given these metrics, is there really any wonder where US rates might be headed?

As you may recall, we railed against the use of return-seeking fixed income strategies as investment vehicles for the Special Financial Assistance (SFA) received by multiemployer plans under ARPA. We spoke and wrote frequently that rising US interest rates would negatively impact the total return for traditional fixed income strategies… and they have! As a reminder, 2022 was the worst year, by far, for the BB Aggregate index as it posted a -13% return. 2023 is not nearly as bad, but it certainly isn’t helping preserve the SFA which is supposed to be used to secure benefits and expenses far into the future.

We also discussed the importance of the sequencing of returns. Witness dramatic losses, such as those incurred last year, early in the life of the SFA and you create a situation where the benefit “coverage” period is shortened, and perhaps dramatically so. For those plans still waiting (hoping) to receive SFA support, don’t play games with the funds. Use those proceeds to SECURE as many benefits and expenses as far into the future as possible (as the ARPA legislation requires). Remember, when you defease pension liabilities through a Cash Flow Matching (CFM) strategy, you are matching future value liabilities that aren’t interest rate sensitive, which remains the biggest risk in the management of bonds.

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

Those in attendance at a recently concluded industry conference voted unanimously that securing the promised benefits was the “primary” objective in managing a DB pension plan. It was great to get such a response, but once again, how do they accomplish that objective when achieving the ROA seems to be the singular focus.

You can’t possibly secure the promised benefits without first knowing your plan’s liability cash flow schedule. For decades, Pension America has focused almost exclusively on cobbling together a portfolio designed to exceed the return on asset assumption (ROA), and for decades many plans have failed.  As a result, the average Public plan funded ratio is no higher today than it was in 1999. As we have monitored ever since, this lower funded ratio has led to a significant increase in contributions since 1999.

As stated above, the objective of a pension system is to SECURE the promised benefits in a cost-efficient manner. Unfortunately, there are only two ways to secure benefits: 1) Insurance annuity buyouts, and 2) Cash flow matching (CFM) liabilities through a bond portfolio. Many believe that duration matching strategies accomplish this objective, but they don’t as they don’t match the asset cash flows to the liability cash flows.

Importantly, getting one’s arms around the promised benefits (plan liabilities) is the only way that a DB plan can de-risk. Through becoming more liability aware a plan sponsor can acquire the following:

• Greater transparency of the plan’s unique liabilities in multiple dimensions – discount rates based on GASB (ROA), FASB and risk-free rates (STRIPS)
• Enhanced knowledge of both cash flow and liquidity requirements
• Greater accuracy in calculating the TRUE return on assets (ROA) that is required in a test of solvency
• The ability to establish a cash flow matching bond portfolio created to meet benefit payments
• Stabilization of both the funded status and contribution expense
• A much longer investing horizon for the portfolio’s growth assets in order to fund future liabilities
• Reduced costs
• Peace of mind that benefits are secure for the next 10 years or so (depends on funded status)
• Enhanced viability of the pension system

These benefits seem to be pretty significant, yet many plans fail to gain these advantages. Regrettably, most plans only get a once-per-year view of their specific liabilities, which is too infrequent to engage in these important activities. Can you imagine playing a football game and knowing only how many points that your team has scored? How could you possibly adjust either your offense or defense to reflect the current game situations? Well, Pension America has been playing the game without knowing their opponents score for quite some time. It is about time that every plan sponsor has at their fingertips a Custom Liability Index (CLI) to help bring the pension game back into focus.

There are many reasons why we’ve witnessed a dramatic reduction in the use of defined benefit plans during the last four decades. Becoming liability aware will help plan sponsors secure those that remain. Our plan participants are counting on our industry to take a different path to help them achieve a prosperous retirement. Don’t hesitate to call on us. We’ll explain how you can begin to SECURE those promises, which will allow everyone to sleep better at night!

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

We hope that your “last” week of summer is a good one. Can’t believe that Labor Day is almost upon us. The PBGC has been laboring, as they continue to work through a massive universe of potential SFA recipients. They approved four applications during the previous week, including the following funds: Pension Plan for Employees of United Furniture Workers of America and Related Organizations, the Southern California, Arizona, Colorado & Southern Nevada Glaziers, Architectural Metal & Glass Workers Pension Plan (this plan now holds the unofficial record for longest fund name), the New Bedford Fishermen’s Pension Fund, and the Local 917 Pension Plan.

The PBGC continues to work through the applications from the initial Priority Groups, as they approved the revised submissions for four plans with one each from Priority Groups 1 and 2, while also accepting two from Priority Group 5. These four plans will receive a total of $613 million, including interest, for their 5,799 plan participants. In total, 62 plans have been awarded Slightly more than $53 billion in SFA grants.

There were no applications denied or withdrawn during the prior week. There were also no new applications permitted to submit from the waiting list, which still has 92 funds waiting for activity to begin.

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

Regular readers of this blog know that we’ve been on record since the first Fed Funds Rate increase that we were likely in a higher for longer scenario. That the prior nearly 40-year bull market for bonds was about to be eradicated, and with that would come pain for most investors who hadn’t worked and, in many cases, lived through a period of sustained inflation and rising rates.

One year ago, I published a post titled, “Tough August For Bonds“, which wasn’t referring to Barry Bonds once again being rejected by MLB’s Hall of Fame, although he was. At this point last year, the FOMC had elevated the FFR 5 times (which is now 11 times), and many investors were sure that US interest rates were nearing a peak. We didn’t think so, and expressed that sentiment with the following:

“Based on the current strong employment picture with 315,000 jobs created, 5.2% annual wage growth, and a labor participation rate that grew 0.3% in August (62.4%), it is likely that the Federal Reserve needs to continue to aggressively elevate rates until it accomplishes its primary objective of reducing inflation. This action will continue to weigh on the performance of the US bond market. Fed Chairman Powell has admitted that the Fed’s policy will inflict pain on American families as the strong labor market needs to be tamed. In order to impact the labor market, US rates must rise substantially. Are fixed-income managers and their clients prepared?“

Based on the following graph, I guess that we were correct.

The Fed’s action has yet to inflict pain on the American family (fortunately) despite the aggressive increases in US rates, as the US labor market remains strong. These increases really haven’t inflicted much pain on the overall economy, as GDP growth has been well above consensus so far through two quarters and the third quarter is looking exceptional, if the Atlanta Fed’s GDPNow model is to be believed as they are forecasting a 5.8% annualized growth rate. Oh, my!

It isn’t hard to imagine that the Fed will once again say in September that inflation remains well-above the stated objective and that rates will be adjusted based on the data. For us, that means a scenario of higher for longer. If so, I must ask: Are fixed income managers and their clients prepared?