By: Russ Kamp, CEO, Ryan ALM, Inc.

Happy St. Paddy’s Day to my Irish friends (I’m 1/2 Irish) and those that would like to be. May the luck of the Irish embrace you today.

As many of you know, we are always willing to provide to the pension and E&F communities a free analysis to highlight how a Cash Flow Matching (CFM) mandate could secure the promised benefits/grants for your fund and importantly, provide the necessary liquidity to meet future promises. In many cases, we will produce multiple runs covering a variety of periods usually 5-years to 30-years. Often the sponsor of the fund is shocked by the potential cost reduction of those future obligations.

We recently provided a large pension plan with several potential implementations, as they try to improve the fund’s liquidity profile, while also desiring to secure those future promises. Here are three scenarios that we provided to them and I’d welcome your feedback on what you would do.

Scenario #1 – Provide a CFM portfolio using the core fixed income allocation ($3 billion/15% of total assets) to match and fund the NET (after contributions) liability cash flows of benefits and expenses (B&E). In this scenario, we can cover the next 6-years of B&E through 6/30/32, covering $3.44 billion in FV benefits and expenses for $3.0 billion (a cost reduction of $443.3k or 12.88%). The YTM on the portfolio is 4.09 and the duration 3.09 years, with the average quality being A-. The remaining assets can continue to be managed as they currently are, but they now benefit from a 6-year investing horizon in which they are no longer providing any liquidity to meet monthly obligations.

Scenario #2 – Provide a CFM portfolio using the same $3 billion (only needed $2.96 billion) or 15% of the fund’s total assets, but implement the strategy using a vertical slice of the liabilities going out 30-years. In this example, we can cover 22% of the liability cash flows for the next 30-years. The FV of those liabilities are $6.3 billion (as opposed to the $3.44 billion using 100% CFM for 6-years). We can reduce the FV cost by $3.33 billion or 53%. The remaining 85% of the fund’s assets can be managed as they presently are, but they don’t benefit from the longer investing horizon, as they will be called upon to provide liquidity to meet the residual B&E.

Scenario #3 – 100% CFM covering net liabilities through 6/30/59. In this case we showed that we can cover 100% of the NET B&E for $9.9 billion in assets, while providing the plan with a $4.4 billion surplus. The FV of those B&E through 2059 are reduced by about $13 billion or 56%! The surplus assets now have a 33-year investing horizon to just grow and grow! A modest 6.5% annualized return for that period produces a surplus of $34.2 billion that can be used to fund B&E after 2059, enhance benefits, and/or reduce future contributions. An 8% annualized return produces a surplus >$75 billion. Oh, my! Also, in this scenario, the organization ONLY needs an annual 2.56% return on the remaining assets to fully fund ALL projected B&E well beyond 2059, as determined by our Asset Exhaustion Test (AET).

Importantly, these scenarios only work if the sponsoring entity provides the forecasted contributions, which in this case they have consistently done for the past 10+ years.

So, I ask once again, what would you do? Scenario 1 ($3 billion/15% of total assets) provides a 100% coverage for 6-years while reducing cost by 13%. Scenario 2 reduces the cost of FV B&E by 53% or $3.4 billion, but covers only 22% of the liabilities, while Scenario 3 reduces the FV cost by 56%, while securing the net promises through 2059 for a cost of $9.9 billion resulting in a surplus of $4.4 billion.

I guess that there is a fourth scenario which is to do nothing, but why would you want to continue to ride the proverbial performance rollercoaster that only guarantees volatility and not success when you can secure a portion of the liabilities, significantly reduce the cost of those future promises, improve liquidity, and “buy time” for the residual assets to just grow unencumbered?

As the Irish say – “May the most you wish for be the least you get“.