The Pension Crisis 12/31/10 Ryan ALM, Inc. - The Solutions Company RyanALM
2 Ryan ALM, Inc. The Solutions Company Ryan-ALM Index Returns YTD 2010 Estimated Weights 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 Asset Allocation Model 0.37 % % % 100 % Assets – Liabilities Market FAS 158 PPA (3 Segment) PPA (Spot Rates) GGASB/ASOP (8% ROA) 1.76% The Ryan Letter
3 Ryan ALM, Inc. The Solutions Company Ryan-ALM Total Returns Assets Liabilities Difference: Annual Cumulative
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5 Ryan ALM, Inc. The Solutions Company Ryan-ALM City$ Deficit % of BudgetState$ Deficit% of Budget Detroit, MI$ %Illinois$15.0 b 46.2% Newark, NJ$ %New Jersey$ % Wash. DC$ %Nevada$ % Los Angeles, CA$ %California$ % San Francisco, CA$ %Mississippi$ % Honolulu, HI$ %South Carolina$ % Cincinnati, OH$ %Minnesota$ % New York, NY$2.0 b 2.1%Texas$ % San Diego, CA$ %Connecticut$ % Worst Cities / States Budget Deficits as a % of Budget Source:
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7 Ryan ALM, Inc. The Solutions Company Ryan-ALM Pension Plan Objective ____________________
8 Ryan ALM, Inc. The Solutions Company Ryan-ALM 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
9 Ryan ALM, Inc. The Solutions Company Ryan-ALM 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)
10 Ryan ALM, Inc. The Solutions Company Ryan-ALM 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”.
11 Ryan ALM, Inc. The Solutions Company Ryan-ALM 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
12 Ryan ALM, Inc. The Solutions Company Ryan-ALM 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”.
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14 Ryan ALM, Inc. The Solutions Company Ryan-ALM Discount Rates (Public)
15 Ryan ALM, Inc. The Solutions Company Ryan-ALM 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
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19 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 Ryan-ALM
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22 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 Ryan-ALM
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24 Ryan ALM, Inc. The Solutions Company Ryan-ALM No Generic Index has same Cash Flow as Clients Liabilities Lehman Aggregate (12/31/06) 1-3 years 24.58% 3-5 years years years years08.96 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 Cash Flow ________
25 Ryan ALM, Inc. The Solutions Company Ryan-ALM No Alpha in Bonds ________________ Total Returns (Periods Ending 12/31/08) 10 yrs. 20 yrs. Lehman Aggregate 5.63% 7.43% Ryan 5-year STRIPS 6.86% 8.39% Difference % % Ryan Liability Index 9.43% 11.17% Lehman Agg Duration 5 years
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