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.

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

Kudos for the new format for some of the educational sessions at FPPTA, which just concluded on Wednesday. The new format, which consisted of four subject experts and 36 attendees in a large square, led to much more conversation with greater interaction from the mostly pension plan trustees. The 3 modules during this conference included conversations with asset consultants, actuaries, and one focused on pension funding. Each one was terrific, as the experts guided the conversation in response to many fantastic questions.

During the asset consulting conversation, a trustee brought up the subject of de-risking and wondered why he hadn’t been introduced to the subject by his consultant. He asked if it was the responsibility of the consultant to introduce the subject despite the current total return (ROA) focus of his plan. As you may recall, I had just returned from an IFEBP conference in Las Vegas in which I brought up the subject of de-risking DB plans in order to protect and preserve the funded status and reduce the volatility associated with contribution expenses. I mentioned that the audience during my session was quite eager to learn more about de-risking and the mechanics to accomplish the objective. I implored the asset consulting community to take the lead in providing education on the subject.

What I found most interesting about the subsequent discussion on de-risking was the focus on the part of consultants on the issue of closed versus open plans. As I recall, each consultant said that they would absolutely explore de-risking if their client’s plan was “closed”. But does that limitation make sense? Defined benefit pension plans have on-going benefit obligations that must be met on a month-to-month basis. Yes, the liabilities of a closed plan are more concrete, but they aren’t precise despite the actuary’s best efforts. Open plans have a Retired Lives Liability (RLL) that is more certain and less susceptible to actuarial noise. Why wouldn’t you want to secure that ongoing monthly obligation as opposed to a pay-as-you-go approach used today.

We, at Ryan ALM, Inc., often talk about a new approach to asset allocation that bifurcates the assets into two buckets – liquidity and growth – as opposed to having all of the plan’s assets focused on the ROA. In our approach, the liquidity bucket should be a defeased bond portfolio of high-quality investment grade corporate bonds in which the asset cash flows (principal and interest) are matched against the liability cash flows (benefits and expenses) to ensure that the necessary liquidity is available each and every month. Does that only work in a closed plan? Of course not!

Open plans have experienced great volatility in their funded status and annual contributions because they ride the asset allocation rollercoaster up and down while chasing the return target. In the process, contributions grow and grow in order to make up the shortfall. This is no way to operate a DB plan. Secure a portion of your promises. The allocation to the liquidity bucket should be determined by the current funded status. A plan with a 90% funded ratio should have a greater exposure to bonds (liquidity) than a 60% funded plan, but that is not what we’ve observed throughout the years. If a plan has a 7% ROA objective, they are going to have a similar asset allocation no matter what the funded status.

Lastly, public pension systems continue to kid themselves by claiming to be a perpetual entity. Yes, most cities and states are not going anywhere, but just because something in perpetual doesn’t mean that it is sustainable. Secure your promises so that the sponsors of these critically important plans don’t decide that they can no longer afford to provide the benefits.

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

Another week, another ARPA update with little to report. Again, the PBGC has done a wonderful job implementing ARPA’s pension legislation in awarding $53.6 billion in Special Financial Assistance (SFA) to 70 multiemployer plans. But as reported in previous ARPA updates, the activity level has come to a screeching halt and this past week proved to be no exception as there were no new applications submitted through the PBGC’s portal, no applications were approved or denied, and none withdrawn.

As reflected in the chart above, there remain 90 applications that have to yet be submitted and another 38 that are either under review or have been withdrawn with the expectation that they will once again be submitted for consideration. I’m sure that the plan participants in those remaining plans are anxious for a positive outcome in the quest for SFA. Fortunately, US interest rates remain elevated, despite the bond rally in the fourth quarter, providing SFA recipients to secure years of benefits (and expenses) at reasonable cost.

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

I sincerely appreciated the opportunity to speak at the IFEBP’s Construction Industry Benefits Conference in Las Vegas yesterday. My topic: Investing Benefit Plan Assets. I focused much of my attention on the current economic environment, capital market expectations, as well as asset allocation, both traditional views and an alternative approach focused on the plan’s liabilities to drive asset allocation decisions. I was very pleased with the response from the attendees, who were engaged throughout the 75 minutes that I got to spend with them, as they asked one good question after another.

What was particularly noteworthy to me was the considerable interest from the trustees related to “de-risking” their plans in this environment. They understood that funded status for many DB plans had improved, and that the US interest rate environment was providing opportunities not witnessed in decades, but they were frustrated because they didn’t know what to do. Some had heard about LDI, but that is like saying that they heard about equities, while others heard that de-risking was done using annuities. None of those in attendance had ever heard of Cash Flow Matching (CFM).

In one particular exchange, the trustee of this fairly large fund mentioned that their plan was 107.5% funded but they were concerned about de-risking because they wanted to be able to provide enhanced benefits at some point. The gentleman was incredibly excited to hear that de-risking a DB pension system isn’t an all or nothing proposition provided that you approach the issue appropriately. Corporate America has engaged in buyouts and buy-ins for quite some time now as they look to disengage from their DB plans through a pension risk transfer (PRT). Those initiatives can be related to a partial transfer of pension liabilities (Retired Lives) or they can be for the whole kit and kaboodle. But, once the contracts are signed, the plan sponsor often loses flexibility related to those liabilities and the assets that are matched against them.

Utilizing a CFM approach allows the plan sponsor to allocate whatever percentage of their assets to the program while maintaining complete control over the assets. That allocation decision should be predicated on the funded status of the plan. The flexibility of the implementation is one of the most attractive features related to CFM. Because the program uses the cash flows from investment grade bonds to match and fully fund the liability cash flows. These bonds can be sold and the program unwound without fear of penalty, which can occur with buyouts and buy-ins.

There is a great opportunity for the asset consulting industry to educate clients on the benefits of de-risking strategies. As a reminder, the primary objective in managing a DB plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. It is not riding the asset allocation rollercoaster through up and down markets. DB plans were once managed similarly to that of insurance companies and lottery systems that focused on the future value obligation and funded it appropriately. They knew that current asset allocation approaches didn’t guarantee funding success, but they did lead to greater volatility and uncertainty.

If a DB plan terminates, no one wins, except perhaps the insurance company that is in the business to make money. The plan sponsor loses their ability to manage a labor force from retention to retirement. The plan participant, especially those still in the workforce, lose the ability to accrue greater benefits, while asset consultants, actuaries, plan administrators, investment managers, custodians, and any other entity that touches a plan, lose a client. We’ve witnessed thousands upon thousands of plans freeze and terminate throughout the last four decades or so.

Taking some risk off the table doesn’t diminish anyone’s role. It likely keeps them in the pension game longer, while securing those promises that plan participants are banking on. Let’s commit to providing the pension community with all of the information from which they can make informed decisions. De-risking may not be for every plan, but it certainly makes sense for most. We can certainly provide you with a series of benefits that result from engaging in this activity starting with a funding cost savings (reduction) of around 50%. Don’t hesitate to reach out to us. We are happy to provide you with the research resources (RyanALM.com) necessary to inform your clients.

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

By now most everyone in the pension industry has read about the Illinois Supreme Court upholding a law signed by Gov. JB Pritzker in 2019 consolidating pensions for Illinois’s “down state” police and firefighter unions. The primary goal in signing the legislation was to give small police and fire pension systems the scale to participate in larger investment opportunities that just might provide for improved/enhanced returns on the plan’s assets. There were also expectations that some expenses might be mitigated/lessened given the new scale. Those goals may prove to be attainable, but they don’t help to address the liability side of managing a pension plan.

As I understand, most, if not all, of those down state funds have retained their own actuary and trustee boards. As a result, they continue to be responsible for the day-to-day operation of the fund. So, no economies of scale there. Yes, investment decisions have been removed from the individual boards and are now consolidated within the two combined entities. However, managing a pension plan is not just about investments. The true objective in managing a DB pension plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. It isn’t an arms race focused on generating the highest return.

We believe that a plan’s asset allocation should be dictated by the funded status of that plan. A plan with a 60% funded ratio should have a very different asset allocation than one sitting at 100% funded. Yet, each down state fund is forced to have the same asset allocation no matter what the funded status. Does that make sense? As a member of a fire department for a small town somewhere in Illinois, I would want the opportunity to take risk off the table as my plan got better funded. I wouldn’t want the taxpayers of my community or the employees of my fund to take on too much risk when the battle has already been won.

In addition, as a member of a police department with a poor funded status, I would want the opportunity to perhaps reduce the future tax burden on my citizens or employees who need to contribute a greater % of their compensation by being able to inject more risk into the asset allocation. Unfortunately, neither scenario is available at this time, as every $ goes into one pool.

Here’s a thought, create commingled asset class sleeves in which these small pension systems can buy exposure based on their unique needs. A better funded plan can overweight fixed income, while a poorer funded plan will perhaps choose to overweight higher octane strategies. Again, managing a DB plan is not just about return. The liability side of the pension equation needs to be in focus every step of the way. You can’t secure the pension promise if you can’t manage to pension liabilities. The riding of the asset allocation rollercoaster in pursuit of higher and higher returns has led to unstable funded status and escalating contribution expenses. Bring some stability to the process by using the funded status to drive the investment decisions. All of the down state funds will appreciate having that opportunity.

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

When I was managing the Invesco quantitative group (>$30 billion in AUM), we attempted to take advantage of human biases that keep us from being great investors. By capturing those biases in a systematic framework, we were able to consistently apply our insights. By doing so, we removed a lot of uncertainty from within our process. I mention my history only because it amazes me how much uncertainty is being embraced by the pension plan sponsor community and their advisors.

The following is from an article by Catherine A. Sanderson, Ph.D., from September 21, 2021, in Psychology Today. The key points from her article are the following:

• When facing ongoing uncertainty, our bodies stay at a high level of physiological arousal, exerting considerable wear and tear.
• Uncertainty exerts a strong pull on our thoughts and inhibits our ability to act, leaving us in a suspended waiting game.
• We can manage uncertainty by figuring out what we can control, distracting ourselves from negative thoughts, and reaching out to others.

By embracing an antiquated approach to asset allocation in which all of plan assets are focused on a return objective, plan sponsors live with great uncertainty, as markets are truly out of the control of the individual. By continuing to ride the asset allocation rollercoaster, plan sponsors are negatively impacted by their inability to act. As a result, we continuously ride markets up and down. The result of this behavior has led to significant volatility around contributions and funded status.

How can plan sponsors get off this rollercoaster and begin to take some control of their plan’s destiny? Stop aggregating all of the pension plan’s assets into one giant return bucket. The primary objective in managing a DB plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. By chasing a performance objective you are subjecting all of the assets to great uncertainty. The Ryan ALM solution is to bifurcate the plan assets into two buckets – liquidity and growth. The liquidity assets will be bonds (investment grade preferred) whose cash flows of interest and principal will be used to match the plan’s liability cash flows (benefits). Once this process is completed, the plan will have brought certainty to at least that segment of the portfolio, as the asset and liability cash flows will move in lockstep whether interest rates move up or down.

Furthermore, the growth assets have now been given the luxury of time! With an extended investing horizon, growth assets have a much greater probability of achieving the expected outcome, as the volatility associated with 10-year periods is far smaller than volatility on 1-2-year horizons. As your plan’s funded status improves, port excess growth assets into the liquidity bucket further reducing uncertainty.

No one wants the psychological wear and tear associated with uncertainty. Stop embracing it through a traditional asset allocation. Adopt the Ryan ALM approach to asset allocation and you’ll be embracing greater certainty. As Catherine suggested, we can “manage uncertainty by figuring out what we can control“. Securing the promised benefits for even a relatively short period of time (say 10 years) sets us on a path to greater control. How comforting!

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

January has lived up to its billing in Northern NJ this year with frigid temperatures and a little snow. However, there seems to be a bit of thawing as it relates to the PBGC’s implementation of the ARPA pension legislation. For the first time since November 22, 2023, a multiemployer plan has had its application for Special Financial Assistance (SFA) approved. Laborers’ International Union of North America Local Union No. 1822 Pension Fund, a non-priority plan, will receive nearly $16 million to cover the promised benefits for 525 plan participants.

In addition, two plans withdrew previously revised applications. Printing Local 72 Industry Pension Plan, a Priority Group 5 member seeking $38.1 million for its 787 members withdrew its application on January 15th, while Mount Laurel, NJ based UFCW Regional Pension Fund, looking for $52.4 million to help protect the pensions for their 4,605 participants withdrew its application on 1/18.

There were no additional applications submitted for review. Fortunately, there were no applications denied during the previous week. There is still a tremendous amount of work ahead for the PBGC. Hopefully whatever issue(s) there were that slowed down the process have been rectified and we’ll soon witness an accelerated pace once again.

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

We have stated unequivocally that recessions do not occur when labor markets are at full employment. The expectation that the US Federal Reserve was going to reduce rates 6-7 times in 2024 was a pipe dream. Currently, US initial jobless claims continue to come in at levels last achieved in 2022. In the most recent release (1/18/24) initial claims were at only 187K while expectations were at 208K. As the chart below reveals, initial claims have remained at very modest levels.

The increase in the FFR from 0% to 5.25%-5.50% has had little impact on the US labor market, which continues to show unemployment at only 3.7% and a Labor Participation Rate (LPR) of 62.5% up from the depths following the initial Covid-19 restrictions when the LPR touched 60.8%. When folks are working and earning money, they are spending, as we witnessed in 2023 when the consumer carried the economy forward. They also tend to feel better about the economy as a whole. Today’s University of Michigan Survey of Consumers – preliminary data came it a 78.8 when it was expected to register at 70.2 certainly supports those enhanced expectations.

According to the Atlanta Fed’s GDPNow model, GDP growth for Q4’23 is estimated at 2.4%. Again, what recession? Why would the Fed be compelled to reduce rates in an environment of full employment and economic growth? The expectation of a looming recession drove investors into bonds during the 2022’s fourth quarter. As a result, Treasury yields collapsed from levels at or above 5% to in many cases below 4%. The extraordinary move certainly eased financial restrictions and brought Treasury yields to a level that seemed to be overbought. We wrote several posts related to the investing community getting ahead of themselves in the process.

Since the end of 2022, Treasury yields have once again climbed and the expectations for aggressive Fed easing have waned. What was once considered a slam dunk that the Fed would cut the FFR by 25 bps in March now has only a slightly > 50% of that occurring, and I think that those odds should be much lower.

There is good news for pension plan sponsors in this data. Higher interest rates help in two meaningful ways. First, higher rates reduce the present value (PV) of those future benefit payments. As a result, the asset side of the equation doesn’t have to work as hard. What really killed pensions in the private sector was the significant decline in US rates from 1982 to 2022, as the cost of pension promises went through the roof. Second, higher rates mean that bond yields can get you close to your ROA with far greater certainty and less volatility than investing in equities and alternatives. In addition, those bond cash flows of interest and principal provide the plan with the necessary liquidity to meet the monthly payments at lower costs.

Lower US interest rates certainly propped up risk assets during the last 4 decades, but in the process they truly harmed pension America as more and more risk needed to be injected into the asset allocation process. The subsequent rollercoaster ride of markets up and then down negatively impacted pension plan contributions and funded status since 1999. As I’ve stated before, humans hate uncertainty, yet traditional asset allocation frameworks bring with them great uncertainty. It is time to increase your allocation to bonds. Capture the greater yield currently available. In fact, defease those pension promises by matching bond cash flows to liability cash flows. You’ll sleep so much better and so will your plan participants!