The
Pension Crisis
12/31/10
Ryan ALM, Inc. - The Solutions Company
1-888-RyanALM
www.ryanalm.com
The Ryan Letter
Index
Liabilities :
Market (Tsy STRIPS)
FAS 158 (AA Corporates)
PPA
(3 Segment)
PPA
(Spot Rates)
GASB /ASOP (8% ROA)
Assets :
Ryan Cash
Lehman Aggregate
S&P 500
MSCI EAFE Int’l
Returns
YTD 2010
Estimated
Weights
10.13 %
20.53
15.94
11.00
8.16
100 %
0.37 %
6.54
15.08
8.44
Asset Allocation Model
5%
30
60
5
100 %
11.89 %
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
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
2
Total Returns
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Assets
-2.50
-5.40
-11.41
20.04
8.92
4.43
12.25
6.82
-24.47
19.43
11.89
Liabilities
25.96
3.08
19.47
1.96
9.35
8.87
0.81
11.76
33.93
-19.52
10.13
Difference:
Annual
-28.46
-8.48
-30.89
18.08
-0.43
-4.44
11.44
-4.94
-58.40
38.95
1.76
-37.60
-73.40
-60.08
-66.13
-76.75
-64.60
-78.38
-181.57
-106.94
-115.67
Cumulative
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
4
Worst Cities / States Budget Deficits as a % of Budget
Source: www.BusinessInsider.com
City
$
Deficit
Detroit, MI
$ 85
Newark, NJ
% of Budget
State
$ Deficit
5.5%
Illinois
$15.0 b
46.2%
$ 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%
Ryan ALM, Inc.
The Solutions Company
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% of Budget
5
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Pension Plan Objective
____________________
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
7
Bad Pension Rules
________________
Rules :
Do NOT Mark to Market
SMOOTH Assets over 5 years
High Yield, Single Discount Rate for Liabilities
Leads to :
Wrong Funded Ratio Calculation
Bad Asset Allocation Decisions
Bad Contribution Decisions
Bad Benefit Decisions
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
8
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)
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
9
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 single
amount, the projected benefit obligation would equal the current
market 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”.
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Pension Protection Act (PPA)
_________________________
Effective Calendar Year 2008
Extends Pension Funding Act of 2004 thru 2007
Discount Rate Methodology:
1. Modified Yield Curve
Hypothetical Corporate zero-coupon bonds
Three interest rates (0-5, 5-20, 20+ years)
Smoothed over 24 months
Corridor of 90% to 110%
2. Actual Spot Rates
Real issues
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
11
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 may
be selected independently of the plan’s investment return assumption”.
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
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Discount Rates (Public)
Ryan ALM, Inc.
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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
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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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
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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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
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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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-ALM
www.RyanALM.com
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Liability Beta Portfolio
___________________
Matches Return of Objective
Pension Objective = Liability Driven
Beta = Asset / Liability Matched Portfolio
Beta = Liability Index Fund
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
20
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 !
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
21
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-ALM
www.RyanALM.com
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Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
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23
Cash Flow
________
No Generic Index has same Cash Flow as Clients Liabilities
Lehman Aggregate
(12/31/06)
1-3 years
24.58%
3-5 years
30.46
5-7 years
27.09
7-10 years
08.91
10+ years
08.96
Lehman Aggregate = 40% in Securitized instruments
Cash flow behavior tends to move in wrong direction
Rates go up = duration gets longer
Cash flow gets reduced
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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No Alpha in Bonds
________________
Total Returns
(Periods Ending 12/31/08)
Lehman Aggregate
Ryan 5-year STRIPS
Difference
10 yrs.
5.63%
6.86%
- 1.23%
20 yrs.
7.43%
8.39%
- 0.96%
Ryan Liability Index
9.43%
11.17%
Lehman Agg Duration consistently @ 5 years
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
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Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
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27