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The Pension Crisis 12/31/10 Ryan ALM, Inc. - The Solutions Company 1-888-RyanALM www.ryanalm.com
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The Pension Crisis
12/31/10
Ryan ALM, Inc. - The Solutions Company
1-888-RyanALMwww.ryanalm.com
2Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Index Returns YTD 2010
Estimated Weights
Liabilities : Market (Tsy STRIPS) FAS 158 (AA Corporates) PPA (3 Segment) PPA (Spot Rates) GASB /ASOP (8% ROA)
10.13 % 20.53 15.94 11.00 8.16
100 %
Assets : Ryan Cash Lehman Aggregate S&P 500 MSCI EAFE Int’l
Asset Allocation Model
0.37 % 6.54 15.08 8.44
5 % 30 60 5
11.89 % 100 %
Assets – Liabilities Market FAS 158 PPA (3 Segment) PPA (Spot Rates) GGASB/ASOP (8% ROA)
1.76% -8.64 -4.05 0.89 3.83
The Ryan Letter
3Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
4Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
5Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
City $ Deficit
% of Budget State $ Deficit % of Budget
Detroit, MI $ 85 5.5% Illinois $15.0 b 46.2%
Newark, NJ $ 30 4.5% New Jersey $10.5 37.5%
Wash. DC $600 4.4% Nevada $ 1.3 36.7%
Los Angeles, CA $438 4.4% California $25.0 30.2%
San Francisco, CA $380 3.9% Mississippi $ 1.2 27.6%
Honolulu, HI $100 3.7% South Carolina $ 1.3 26.1%
Cincinnati, OH $ 60 2.4% Minnesota $ 3.8 25.0%
New York, NY $2.0 b 2.1% Texas $10.0 22.3%
San Diego, CA $ 73 1.7% Connecticut $ 3.8 26.6%
Worst Cities / States Budget Deficits as a % of Budget Source: www.BusinessInsider.com
6Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
7Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Pension Plan Objective____________________
8Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Bad Pension Rules________________
Rules : Do NOT Mark to MarketSMOOTH Assets over 5 years
High Yield, Single Discount Rate for Liabilities
Leads to : Wrong Funded Ratio CalculationBad Asset Allocation DecisionsBad Contribution DecisionsBad Benefit Decisions
9Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Problem : Liability Valuation_________________________
Single Discount Rate
Not market interest rates
(ASOP = ROA, PPA = 2 year weighted average)
Present Value calculated annually/triennially
(Months delinquent)
Liability Term Structure not transparent
(Short, Intermediate, Long, Very Long)
10Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
FAS 158_______
Effective December 15, 2006
Same as FAS 87 (Amended) and FAS 106 on Discount Rates:
“The objective of selecting assumed discount rates is to measure the single amount that would provide the necessary future cash flows to pay the pension benefits when due. Notionally, that singleamount, the projected benefit obligation would equal the currentmarket value of a portfolio of high-quality zero coupon bonds whose maturity dates and amounts would be the same as the timing and amount of the expected future benefit payments”.
11Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Pension Protection Act (PPA)_________________________
Effective Calendar Year 2008Extends Pension Funding Act of 2004 thru 2007
Discount Rate Methodology:
1.Modified Yield CurveHypothetical Corporate zero-coupon bondsThree interest rates (0-5, 5-20, 20+ years)Smoothed over 24 monthsCorridor of 90% to 110%
2. Actual Spot RatesReal issues
12Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
GASB / ASOP 27______________
Section 3.6 Selecting an Investment Return Assumption and a Discount Rate
“Generally, the appropriate discount rate is the same as the investment return assumption. But for some purposes, such as SFAS No. 87 or unfunded plan valuations, the discount rate maybe selected independently of the plan’s investment return assumption”.
13Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
14Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Discount Rates (Public)
15Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Problem : Generic Indexes_______________________
Represent the market not client liability schedule
Generic Indexes do NOT represent clients’ true objective
Client liability schedule is unique to each client (snowflakes)
Confucius : Given Wrong Index … Get Wrong Risk/Reward
16Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
17Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Society of Actuaries (SoA)
(Principles Underlying Asset/Liability Management) October 2004
Accounting measures distort economic reality
Consistent ALM can only be achieved for Financial Objectives
Entities that focus on economic value tend to achieve their financial objectives
Entities who manage their assets based on accounting treatment end up mismatching liabilities
Translation : ALM Requires Economic Books
18Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Custom Liability Index _________________________
Provide a Proper Benchmark for the Asset side to function efficiently
Asset Allocation
Asset Management Performance Measurement
Create a set of Economic Books in harmony with SoA directive
Based on Market Value
Built as a Liability Index series
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Asset Allocation
_____________
Should be based on Funded Ratio
(Market Value of Assets / MV of Liabilities)
Requires Custom Liability Index to Measure MV of Liabilities
Large Deficit = Different Asset Allocation than Small Deficit
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com
20Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Liability Beta Portfolio ___________________
Matches Return of Objective
Pension Objective = Liability Driven
Beta = Asset / Liability Matched Portfolio
Beta = Liability Index Fund
21Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Liability Alpha Portfolio(s) _______________________
Objective = Liability Index
Alpha = Excess Return above Objective
Requires Custom Liability Index to Measure Alpha
Beat a Market Index …but Lose to Liabilities = You Lose !
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Performance Measurement
_______________________
Objective = Liability Driven
Beta Portfolio = Liability Index Fund
Alpha Portfolios = Portfolios that Beat Liabilities
Requires CLI to Measure Alpha and Manage Beta Portfolio
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com
23Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
24Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
No Generic Index has same Cash Flow as Clients Liabilities
Lehman Aggregate(12/31/06)
1-3 years 24.58%3-5 years 30.465-7 years 27.097-10 years 08.9110+ years 08.96
Lehman Aggregate = 40% in Securitized instrumentsCash flow behavior tends to move in wrong direction
Rates go up = duration gets longerCash flow gets reduced
Cash Flow________
25Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
26Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
27Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
