Tag Archives: bond-math

12.15.25
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Bond Math and A Steepening Yield Curve – Perfect Together!

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

We are in the midst of a project for a DB pension plan in which we were asked to model a series of liability cash flows (benefits and expenses) using cash flow matching (CFM) to defease and secure those liabilities. The plan sponsor is looking to allocate 40% of the plan’s assets initially to begin to de-risk the fund.

We first approached the assignment by looking to defease 100% of the liabilities as far into the future as that 40% allocation would cover those benefits and expenses. As it turns out, we can defease the next 11-years of projected B&E beginning 1/1/26 and carrying through to 10/31/37. As we’ve written many times in this blog and in other Ryan ALM research (ryanalm.com), we expect to reduce the cost of future liabilities by about 2% per year in this interest rate environment. Well, as it turns out, we can reduce that future cost today by 23.96% today.

Importantly, not only is the liquidity enhanced through this process and the future expenses covered for the next 11-years, we’ve now extended the investing horizon for the remaining assets (alpha assets) that can now just grow unencumbered without needing to tap them for liquidity purposes – a wonderful win/win!

As impressive as that analysis proved to be, we know that bond math is very straightforward: the longer the maturity and the higher the yield, the greater the potential cost savings. Couple this reality with the fact that the U.S. Treasury yield curve has steepened during the last year, and you have the formula for far greater savings/cost reduction. In fact, the spread between 2-year Treasury notes and 30-year bonds has gone from 0.35% to 1.35% today. That extra yield is the gift that keeps on giving.

So, how does one use only 40% of the plan’s assets to take advantage of both bond math and the steepening yield curve when you’ve already told everyone that a full implementation CFM only covers the next 11-years? You do a vertical slice! A what? A vertical slice of the liabilities in which you use 40% of the assets to cover all of the future liabilities. No, you are not providing all of the liquidity necessary to meet monthly benefits and expenses, but you are providing good coverage while extending the defeasement out 30-years. Incredibly, by using this approach, we are able to reduce the future cost of those benefits not by an impressive 24%, but by an amazing 56.1%. In fact, we are reducing the future cost of those pension promises by a greater sum than the amount of assets used in the strategy.

Importantly, this savings or cost reduction is locked-in on day one. Yes, the day that the portfolio is built, that cost savings is created provided that we don’t experience a default. As an FYI, investment-grade corporate bonds have defaulted at a rate of 0.18% or about 2/1,000 bonds for the last 40-years according to S&P.

Can you imagine being able to reduce the cost of your future obligations by that magnitude and with more certainty than through any other strategy currently in your pension plan? What a great gift it is to yourself (sleep-well-at-night) and those plan participants for whom you are responsible. Want to see what a CFM strategy implemented by Ryan ALM can do for you? Just provide us with some basic info (call me at 201/675-8797 to find out what we need) and we’ll provide you with a free analysis. No gimmicks!

06.16.25
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The Power of Bond Math

By: Ronald J. Ryan, CFA, Chairman, Ryan ALM, Inc.

Bonds are the only asset class with the certainty of its cash flows. That is why bonds have always been used to cash flow match and defease liabilities. Given this certainty, bonds provide a secure way to reduce the cost to fund liabilities. This benefit is not as transparent or valued as one might think. If you could save 20% to 50% on almost anything, most people would jump at the opportunity? But when it comes to pre-funding pension liabilities there seems to be a hesitation to capture this prudent benefit.

Bond math tells us that the higher the yield and the longer the maturity… the lower the cost. Usually there is a positive sloping yield curve such that when you extend maturity you pick up yield. What may not be evident is the fact that extending maturity is the best way to reduce costs even if yields were not increased. Here are examples of what it would cost to fund a $100,000 liability payment with a bond(s) whose maturity matches the liability payment date:

Cost savings is measured as the difference between Cost and the liability payment of $100k. As you can see, extending maturity produces a much greater cost reduction than an increase in yield. More importantly, the cost reduction is significant no matter what maturity you invest at, even if yields are unchanged. The cost savings range from 21.9% (5-years) to 38.1% (10-years) and 62.8% (20-years) with rates unchanged. Why wouldn’t a pension want to reduce funding costs by 21.9% to 62.8% with certainty instead of using bonds for a volatile and uncertain total return objective? Given the large asset bases in many pensions, such a funding cost reduction should be a primary budget consideration.

Ryan ALM is a leader in Cash Flow Matching (CFM) through our proprietary Liability Beta Portfolio™ (LBP) model. We believe that the intrinsic value in bonds is the certainty of their cash flows. We urge pensions to transfer their fixed income allocation from a total return objective versus a generic market index (whose cash flows look nothing like the clients’ liability cash flows) to a CFM strategy. The benefits are numerous:

Secures benefits for time horizon LBP is funding (1-10 years)

Buys time for alpha assets to grow unencumbered 

Reduces Funding costs (roughly 2% per year)

Reduces Volatility of Funded Ratio/Status

Reduces Volatility of Contribution costs

Outyields active bond management

Mitigates Interest Rate Risk 

Low fee = 15 bps

For more info on our Cash Flow Matching model (LBP) or a free analysis to highlight what CFM can do for your plan, please contact Russ Kamp, CEO at rkamp@ryanalm.com