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

We challenge you to find Pension Liabilities in any Generic Bond Index. We’re confident that you won’t. As a result, we’ve developed an appropriate solution, which we call the Custom Liability Index (CLI).

Pension liabilities (benefits and expenses (B+E)) are unique to each plan sponsor… different workforces, different longevity characteristics, different salaries, benefits, expenses, contributions, inflation assumptions, plan amendments, etc. To capture and calculate the true liability objective, the Ryan team created the first CLI in 1991 as the proper pension benchmark for asset liability management (ALM). We take the actuarial projections of (B+E) for each client and then subtract forecasted Contributions since contributions are the initial source to fund B+E. This net total becomes the true liability cash flows that assets have to fund. We then calculate the monthly liability cash flows as (B+E) – C. The CLI is a monthly report that includes the calculations of:

• Net future values broken out by term structure
• Net present values broken out by term structure
• Total returns broken out by term structure
• Summary statistics (yield, duration, etc.)
• Interest rate sensitivity 

We recommend that the Ryan ALM CLI be installed as the index benchmark for total assets, as well as any bond program dedicated to matching assets and liabilities. This action should be the first step in asset allocation. The CLI can be broken out into any time segment that bond assets are directed to fund (i.e. 1-3 years, 1-10 years, etc.). Moreover, total assets should be compared versus total liabilities to know if the funded ratio and funded status have improved over time. If all asset managers outperform their generic index benchmarks but lose to liability growth rate the pension plan loses and must pay a higher contribution.   

Since the CLI is a monthly report, plan sponsors can compare assets versus liabilities monthly. Furthermore, we suggest that there should never be an investment update of just assets versus assets (generic index benchmarks), which unfortunately is common practice today. It is hard to understand in today’s sophisticated finance world why liabilities are missing as a pension index. It should be clear that no generic bond index could ever properly represent the liability cash flows that assets are required to fund. It is apples versus oranges, at a minimum. 

“Given the wrong index benchmark… you will get the wrong risk/reward”

For more info on the Ryan ALM CLI please contact Russ Kamp, CEO at  rkamp@ryanalm.com