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

As I mentioned in my last post, I am currently at the TexPERS summer program at the Woodlands just outside of Houston, TX. It is a well attended conference despite the excessive heat of 100+ temps all day long. In addition to the conference being well-attended, they are using a terrific website that allows for great interaction among the attendees, including producing polls. In one case, I asked the question: What is the primary objective in managing a defined benefit plan? The possible answers were:

The outcome from this poll has so far been surprising, as every respondent identified the securing of benefits as the primary objective – yes, 100%. We at Ryan ALM, Inc. absolutely agree (thrilled) with this choice, but we don’t see how this is being implemented in the day-to-day management of the public pension systems represented at this conference. Asset allocation decisions are being based on achieving the ROA. All of the assets are focused on beating their respective benchmarks, not the true objective of securing the promises (the plan’s liabilities). Why the disconnect?

One primary reason for this apparent dichotomy is the fact that a plan’s liabilities aren’t known on a daily, weekly, monthly, or even quarterly basis. It is absolutely necessary to measure, monitor, and manage a plan’s liabilities, but getting a once per year update through an annual actuarial report just doesn’t cut it. Can you imagine playing a football game and only knowing how many points you’ve scored (assets), but having no knowledge of how many your opponent has scored (liabilities)? How would you adjust your strategy? Unfortunately, that is how a significant percentage of Pension America has been operating. The Ryan ALM solution is a Custom Liability Index (CLI) invented by Ron Ryan over 30 years ago.

So, if SECURING the promised benefits is the primary objective, plan sponsors need to have a Custom Liability Index (CLI) created so that the liabilities can be monitored on a much more regular basis. Having this knowledge is the only way that a plan can even begin to secure the promises. Once the liabilities have been analyzed they can begin to be managed through a Cash Flow Matching (CFM) strategy that can accurately match asset cash flows of interest and principal with the plan’s liability cash flows of benefit payments and expenses.

Using a portion of the plan’s assets (bonds) to secure the fund’s near-term liabilities chronologically creates numerous benefits, including enhanced liquidity, an extended investing horizon for the plan’s growth assets, and more stable contributions and funded status. It is time to get off the asset allocation rollercoaster that only serves to create uncertainty. It does absolutely nothing to secure those promises which the folks at the TexPERS conference believe is the primary objective.

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

Happy Saturday. I am penning this post from roughly 28,000 feet as I travel to Houston, TX for the upcoming TexPERS conference, where I have the privilege of teaching an investment class tomorrow and speaking at the conference on Tuesday. Like America’s pension industry, the plane’s altitude (funded status) was greater, but the skies (like our markets/economy) are quite unsettled, and the pilots have settled at a lower altitude to deal with the turbulence.

I’ve recently produced a couple of posts addressing the psychological impact of uncertainty on human beings, as each of us naturally strive to reduce uncertainty to the greatest extent possible. As I previously stated, we all want solutions — answers to our questions and problems. When the answers aren’t apparent, we find it difficult to stop ourselves from obsessing over the uncertainty. That may be true generally, but as a pension industry we seem to embrace uncertainty by investing huge sums into markets that are uncertain every day, week, month, and year.

This practice has definitely contributed to the private sector’s rapid abandonment of the defined benefit plan, as uncertain outcomes had the potential to impact a company’s income statements. Something no CFO/CEO wants to have to explain to the investing community, let alone the folks within the company that have day-to-day responsibility for the pension plan.

We at Ryan ALM, Inc. continue to work tirelessly on implementing strategies that will rid Pension America of as much of the uncertainty as possible. We try to accomplish this lofty goal through a focus on NOT LOSING! I’ve often used the rollercoaster to represent the investing environment for pension sponsors, as we have a tendency to ride markets up and then down as these natural market cycles take form. When are we going to get into the habit of de-risking when the rollercoaster car is nearing it’s peak?

As I’ve stated before, insurance companies and lottery systems can’t afford to build their businesses embracing great uncertainty, and pension funds shouldn’t either. Collectively, we should be focused on not losing. We believe that a pension funds primary objective should be to SECURE the promised benefits at a reasonable cost and with prudent risk. It is not a return objective. Living on the investment rollercoaster is no way to secure benefits and expenses.

If the securing of benefits is truly the primary goal, then the management of pension assets must been done relative to a pension’s liabilities. Those liabilities much be measured, monitored, managed, and secured. The only way to accomplish this objective is to use cash flow matching (CFM) with bonds, as bonds are the only asset class with known cash flows of principal and income to accomplish the objective. You can find chapter and verse on cash flow matching (CFM) at ryanam.com or on this blog, which is accessible through the company’s website.

By focusing on not losing, we believe that you dramatically enhance the probability of success! We can’t afford the one-step forward and 3/4s of a step back that our industry has endured for decades. The fact that the current economic environment, which has produced decades high interest rates, is quite favorable for CFM makes the opportunity to get off the rollercoaster that much easier.

We need to protect and preserve defined benefit plans for the masses. We at Ryan ALM, Inc. have as our mission to do whatever we can to protect and preserve DB plans. We honestly believe that CFM is the best way to SECURE the promises that have been made to the plan participants. This is how insurance companies and lottery systems manage their liabilities and it is how Pension America should mange theirs. Let us help you to secure your defined benefit plan so that your participants can enjoy their golden years.

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

With the demise of the defined benefit plan for many works in the US private sector, Social Security benefit payments become ever more important for a greater percentage of the American retirees and those with disabilities. There have been several stories recently about Social Security and what the “average” recipient might receive in 2024 and worse, what their benefit reduction might be should the forecast of a “lock-box” shortfall in 2033 come to pass. We’ll get the official word on the 2024 COLA sometime in October, but early estimates are forecasting a 3% increase during 2024. This is a far cry from the nearly 9% increase received in 2023 and at 3%, barely matches the headline CPI which came in at 3.2% today.

Social Security’s average monthly benefit among all retired workers is $1,789 in 2023, according to the Senior Citizens League. If the 3% increase turns out to be correct, checks will increase to about $1,843 per month. If my math is correct, that equates to an additional $54/month. Please don’t plan to spend all of it too soon.  The maximum Social Security benefit for a worker retiring at full retirement age is $3,627 in 2023. A 3% COLA will bring that figure to $3,736 in 2024. For those retiring at 62-years-old the maximum benefit in 2023 is $2,572, while the maximum benefit for a worker retiring at age 70 is $4,555 in 2023. Those numbers will be adjusted accordingly.

Despite the on-going rhetoric about SS running out of money, it is a fallacy to believe that there exists an “operational constraint on the government’s ability to meet all Social Security payments in a timely manner. It doesn’t matter what the numbers are in the Social Security Trust Fund account, because the trust fund is nothing more than record-keeping, as are all accounts at the Fed.” (Warren Mosler, “Seven Deadly Innocent Frauds of Economic Policy”) He continues, “When it comes time to make Social Security payments, all the government has to do is change numbers up in the beneficiary’s accounts, and then change numbers down in the trust fund accounts to keep track of what it did. If the trust fund number goes negative, so be it. That just reflects the numbers that are changed up as payments to beneficiaries are made.”

What we should fear is our august Congress not understanding this concept and acting rashly to address the impending “crisis”. A recent article in Bloomberg placed the possible reduction in “benefits” at 23% in 2033. Try telling the nearly 70 million Americans that they will see a dramatic reduction in a promised benefit that they themselves helped to fund. With 40% of retirees using SS for more than 50% of their retirement income and another 14% in which SS makes up 90% or more of their retirement income, the economic impact from these potential benefit cuts would be cruel.

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

Milliman released the results of its latest Milliman 100 Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. They reported that July was a very strong month for pension funding as the PV of liabilities fell as interest rates rose (discount rate) and assets appreciated by 0.84%. The combination of falling liabilities and rising asset levels improved pension funding for the third straight month, with the average funded ratio now at 102.5%.

In addition, they provided both optimistic and pessimistic forecasts for 2023’s conclusion and 2024. “Looking forward, under an optimistic forecast with rising interest rates (reaching 5.50% by the end of 2023 and 6.10% by the end of 2024) and asset gains (9.8% annual returns), the funded ratio would climb to 109% by the end of 2023 and 122% by the end of 2024. Under a pessimistic forecast (5.00% discount rate at the end of 2023 and 4.40% 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.”

The pessimistic forecast doesn’t seem to be that unrealistic. Given that possibility, why would corporate America risk the improved funding status? Secure the promised benefits at this time through a cash flow matching (CFM) strategy. You’ll be surprised by how little of the corpus would be needed to accomplish that objective. The balance of the assets can now be managed with the goal of maximizing the surplus. The pension industry has had a few opportunities during the years to de-risk en masse. Those opportunities were often not acted on. Let’s not allow that to happen again.
 

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

The management of a pension system should be done in similar fashion to how both insurance companies and lottery systems operate. They know what the future value of liabilities are that they are obligated to fund and they manage to that objective. They don’t try to build an investment structure that might achieve an expected/desired return (ROA) some 10-, 20-, or 30-years out.

That said, the significant decline in US rates from 1982 to March of 2022 made managing a pension system incredibly challenging, as income from fixed income (bonds) was historically low forcing plans to take on more risk to try and achieve the plan’s ROA objective through more volatile investments. Well, the Fed’s aggressive action to thwart inflation which began in March 2022 and has now led to 11 increases in the Fed Funds Rate may have impacted the capital markets from a return standpoint in 2022, but they are having an incredibly positive impact on the income produced from bonds. As the yield curve below highlights, we’ve seen a massive shift up in rates across the Treasury yield curve, especially in shorter maturities.

This dramatic shift upward in Treasury yields has also been witnessed in the yields of corporate bonds, both investment-grade (IG) and High Yield (HY), as the chart (thank you, RBC) below highlights. At Ryan ALM, Inc. we believe that the primary objective in managing a defined benefit plan (DB) is to SECURE the promised benefits at a reasonable cost and with prudent risk. Given the significantly higher yields on US bonds, this objective has become much easier. We believe that cash flow matching (CFM) a pension plan’s liabilities (benefits and expenses (B+E)) with asset cash flows (bond interest and principal) a plan can accomplish the objective cost effectively and with prudent risk.

We’ve recently been building defeased (CFM) bond portfolios with yields in the 5.5% to 6% range through our focus on A and BBB bonds (no BBB-). These yields are providing our clients with a significant reduction in the cost to defease future liabilities. Bond math is very straight-forward. The longer the maturity and the higher the yield the greater the funding cost savings. We’ve entered a very attractive time when plan sponsors can effectively secure the promises made to their participants without having to take on substantial risk.

While the defeased bond portfolio is providing the liquidity to meet benefits and expenses chronologically, the non-bond assets (growth/alpha) can grow unencumbered with the goal of paying future B&E. It has been a long time since the bond market has provided such a wonderful opportunity. Given the uncertainty surrounding inflation and the Fed’s reaction to it, bond yields may in fact rise even further as real rates have not been achieved for longer-term maturities versus “core” inflation, which continues to hover around 5%. Don’t hesitate to reach out to us. We’d be happy to model the potential cost reduction that your plan could experience through a cash flow matching implementation.

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

No Summer doldrums for the PBGC, as last week witnessed considerable activity for the ARPA program. There were three pension plans that received approval for the SFA. In addition, there were three applications received and one withdrawn. Happy to report that there were no applications denied. Finally, there were no additions to the waiting list.

The three successful applications were for IUE-CWA Pension Plan, The Newspaper Guild International Pension Plan, and the UFCW Local One Pension Plan. These entities will receive $1.12 billion for the 38,761 participants in the plans. The UFCW plan has a Priority Group 5 and it is by far the largest of the three as they will receive $788 million. The other two recipients are the first non-priority group members to have their applications approved. As we’ve mentioned, there were 110 plans sitting on the waiting list. The PBGC has been actively permitting pension systems to submit the SFA application. To date, 13 plans have submitted applications from the waiting list.

The one application that was withdrawn during this latest week was Priority Group 5 member Local 917 Pension Plan, Floral Park, NY which was seeking $22.5 million for the plan’s 1,653 members. This latest application was previously revised. Perhaps the third time will prove to be charmed.

US interest rates continued to rise last week, with both short-term and long-term maturities along the Treasury yield curve rising to near peak levels since the interest rate cycle reversed. This action is making cash flow matching of the SFA assets even more attractive which will help lower the present value cost of those future benefits and expenses.

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

I recently published some info from a Vanguard 401(k) survey that indicated that the “average” account balance for a near-retirement participant (decade or less) was an anemic $71,000. Yesterday, there was an article on 401KSpecialistmag.com that highlighted output from Empower’s recent survey. Importantly, they focused on the likely impact on 401(k) contributions once federal student loan debt repayment began again. It shouldn’t be surprising that >40% of those surveyed indicated that they would likely divert contributions into their retirement accounts to fund the student loan debt payments. With one in three households expecting to pay more than $1,000 per month toward the student loan debt.

The Empower survey highlighted a number of other very frightening stats including the fact that 32% of those with student loan debt would likely increase credit card debt to be able to manage this burden. A significant number of responders discussed selling their car, moving back home, finding a roommate, finding a side hustle, cutting back on non-discretionary spending, etc. The one that had me scratching my head had 52% of responders claiming that they would look for a higher paying job, as if those are readily available. If they are, why haven’t they taken advantage of those opportunities already?

Then there is the Bloomberg story that referenced a Schwab national survey released this past Wednesday that asked 1,000 401(k) participants what their target balance was for retirement. Believe it or not, the answer was $1.8 million, an increase of 6% from last year’s survey. So, I ask, who are these survey participants, and do they truly reflect the average American worker’s views? I don’t understand how the average near-term retiree can have only $71,000 and yet, the target for another population of retirement “savers” can honestly say that $1.8 million is their goal. Inflation is impacting most Americans in terms of housing, transportation, food, childcare, medical expenditures, education, etc. 

With student loan repayments about to begin, is anyone surprised that 401(k)s will be the first victim of a finite pool of financial resources? Again, do we honestly believe that asking non-finance pros (the average American worker) to fund, manage, and then disburse a “retirement” benefit with little disposable income, knowledge of the capital markets and investment products, and no crystal ball to help determine longevity, an appropriate policy?

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

We at Ryan ALM, Inc. have been preaching the benefits of Cash Flow Matching (CFM) for nearly two decades. So, when we see one of the big boys (large fixed income shop) writing about the benefits of CFM we get excited. However, just because they are big, doesn’t necessarily mean that their approach is correct, as all CFM strategies are not equal.

Specifically, CFM when done appropriately is NOT a laddered bond portfolio which is sub-optimal in any market environment. Bond math is very straightforward. The longer the maturity and higher the yield, the lower the cost, which is the ultimate goal. A positively shaped yield curve is wonderful for us because it reduces costs. Done correctly, funding costs can be reduced by 2% or more per year in this environment. Secure the pension promises for Retired Lives 1-30-years and the present value (PV) cost to fund those future value (FV) benefits and expenses can be reduced by 50% or more. Furthermore, the current environment of higher short-term rates (inverted yield curve) does not make the opportunity to use CFM a short-term phenomenon. That might be the case if one were to ladder bonds, but since Ryan ALM uses a cost optimization process that truly matches cash flows, we very much appreciate the benefits of a “normal” positively sloped yield curve.

Pension plans need liquidity on a constant basis. Creating a bifurcated approach to asset allocation in which two buckets are used – liquidity and growth – as opposed to having all of the pension assets focused on the ROA, provides the pension plan with enhanced liquidity and lower transaction costs associated with constantly rebalancing the assets. This will eliminate the common approach of a “Cash Sweep” which takes away income from growth assets. Studies prove that close to 50% of the S&P 500 total return on a rolling 10-year horizon since 1940 (Guinness Asset Management) comes from dividends reinvested. So why would you want to take away these dividends… let CFM fund liabilities chronologically. Pension systems do not need to be fully funded or close to fully funded to receive significant benefits from using CFM. Given the liquidity needs, every pension plan should use CFM to secure the promised benefits for some prescribed period of time. We normally suggest funding Retired Lives or 1 to 10-years of liabilities which creates a long investing horizon for the growth assets that can now grow unencumbered. 

We are so thankful to see others in our industry write about the benefits of CFM, but as I stated earlier, not all CFM is created equal. It requires a deeper understanding of the implementation which is measured by the efficiency of the model’s output. The more efficient, the lower the ultimate cost to SECURE those promises.

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

We are pleased to provide you with the weekly update on the PBGC’s progress implementing the ARPA legislation passed in March 2021. The program to distribute the Special Financial Assistance (SFA) has been under way since July 2021. To date, 53 funds have received SFA proceeds. There is still a lot more to do, but the PBGC continues to make good progress and this past week is no exception.

There were an additional four funds on the waiting list that had their window opened to submit applications. These funds are Local 360 Labor-Management Pension Plan, Twin Cities Bakery Drivers Pension Plan, United Association of Plumbers and Pipefitters Local 51 Pension Fund, and the United Food and Commercial Workers Union Local 152 Retail Meat Pension Plan. In addition, Priority Group 5 member, Pension Plan of the Moving Picture Machine Operators Union Local 306 submitted its revised application. In total, these plans are seeking $358.8 million for nearly 20,000 plan participants.

There were no applications approved last week and happily none denied. Furthermore, there were no additions to the waiting list, which continues to have 110 names listed, but there was one fund on the list, San Francisco Lithographers Pension Trust, that had its name crossed off, as it already received SFA back in 2021. Finally, there was one fund that secured its valuation date. Pension Plan of International Union of Bricklayers & Allied Craftworkers Local #15 PA has chosen April 30, 2023 for their SFA measurement date.

The current US interest rate environment is providing these plans and their advisors a wonderful opportunity to secure the promised benefits chronologically as the legislation intended. We produced a post last week that highlights the fact that most of a plans ROA could be covered by a defeased bond portfolio. The same is true for the SFA assets that can cover far more liabilities today than just 16 months ago prior to the Fed’s aggressive action to increase rates. There is no reason to take on equity risk within this segregated portfolio.

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

US interest Rate moves have certainly impacted the capital markets in the last 15 months. The impact during 2022 was mostly negative as both bonds and stocks saw major declines in valuations. However, the current US interest rate environment is providing plan sponsors and their advisors with the opportunity to take risk out of their plans without giving up significant return.

We, at Ryan ALM, have produced our latest Pension Alert, which highlights the fact that A and BBB rated bonds have yields that can provide most of the return needed to meet the ROA objective. In fact, A rated corporate bonds produce 78.6% of the return, while BBB bonds produce 85% of the ROA goal.

Given that the US Federal Reserve is likely to increase rates another 25 bps today, there is a good chance that US interest rates will continue to rise providing the plan sponsor with an opportunity not seen since the late ’90s. Don’t waste this opportunity by continuing an asset allocation framework that has too much uncertainty. Use bond cash flows of interest and principal to SECURE the promised benefits chronologically. This will help stabilize the plan’s funded status and contribution expenses.