Why Cash Flow Matching Deserves a Fresh Look

Written by Chris Scibelli

With 30-year Treasury yields at their highest level in a quarter-century, the old-school pension objective of matching contractual asset cash flows to future pension obligations warrants a fresh look. What represents a growing burden for the U.S. Treasury may offer a renewed opportunity for those entrusted with pension plan stewardship.

Decades ago, defined benefit pension plans were the principal source of retirement security for much of the American workforce. Defined contribution plans were still in their infancy, and pension management remained grounded in a practical objective: accumulating sufficient assets to pay promised benefits.

By the late 1970s and early 1980s, after years of high inflation and disappointing equity returns, funding those obligations had become comparatively straightforward. In August 1981, even one-year Treasury bills yielded an eye-popping 14.54%, while longer-term U.S. government bonds and investment-grade corporate credits also offered double-digit yields. At those rates, pension plans could secure substantial portions – and, in many cases, all – of their future benefit payments with the contractual coupons and principal repayments generated by fixed income instruments.

Then interest rates began a four-decade decline. Soon, PIMCO would pioneer an active, total-return approach to core bond management, launching what would become its ubiquitous Total Return Fund in 1987 and helping transform fixed income from a means of funding liabilities into an asset class evaluated by benchmark-relative performance.

As bond yields fell, shrinking contractual cash flows could support less of the liability burden, and pension management progressively shifted toward generating higher returns from increasingly diverse portfolios of risk assets evaluated through an expanding variety of benchmarks and performance measures. The investment industry became organized around asset classes, benchmarks and manager track records – and increasingly detached from the liabilities those assets existed to fund. Meanwhile, the growth of 401(k) plans reinforced the broader shift from funding defined liabilities to accumulating investment assets.

Today, the relative absence of cash flow matching (CFM) reveals how deeply asset-centric the pension industry became over those decades – evolving, as interest rates declined, from a practical focus on funding liabilities to an emphasis on generating benchmark-relative asset returns, in pursuit of the pension plan’s assumed rate-of-return objective.

CFM is sometimes mistaken for little more than a laddered bond portfolio. But this is not your grandfather’s liability matching. In practice, modern CFM is an optimization process that constructs a diversified portfolio of fixed income securities whose contractual coupons and principal repayments match a pension plan’s unique schedule of net cash requirements as far into the future as the size of the CFM allocation permits.

The modern pension industry's fixation on manager track records, style boxes and peer rankings reveals its persistent focus on assets in isolation. A pension plan, however, does not exist to accumulate impressive performance histories relative to an index. Its assets exist to satisfy its liabilities. Securing the promised benefits is the one benchmark that ultimately matters.

With bonds now offering more generous yields, the relative attractiveness of CFM has returned. Pension plans can once again secure meaningful portions of their future benefit payments with contractual bond cash flows, at yields that allow the CFM portfolio to do substantially more of the work – and without sacrificing as much expected return as would have been required during the prolonged low-interest-rate environment.

This holds for well-funded plans, and arguably more so for underfunded ones, which have the most acute need for liquidity. CFM supplies that liquidity with greater certainty, without forcing a premature sale of long-term growth-seeking assets during a market downturn. With near-term liquidity supplied by CFM, the residual return-seeking assets can remain invested through full market cycles.

CFM produces three principal effects:

1. It improves plan liquidity – benefit payments are funded chronologically by contractual cash flows rather than asset sales.

2. It reduces the risk surrounding promised benefits – contractual cash flows are scheduled to coincide with payments as they come due.

3. It extends the investment horizon for return-seeking assets – freed from near-term liquidity demands, growth assets can be allowed to compound through full cycles rather than being sold at inopportune moments.

The capital for CFM need not come at the expense of return-seeking assets. Many plans – well-funded or underfunded – already carry a meaningful allocation to actively managed core or core-plus bond portfolios tasked with outperforming the Bloomberg U.S. Aggregate Bond Index. These portfolios are inherently exposed to interest rate risk, and that exposure has gone largely unrewarded since rates bottomed: the Aggregate Index returned only 0.08% annualized over the five years ended June 30, 2026. Core and core-plus mandates have produced little return for the uncertainty they carry. Redeploying this existing allocation – in whole or in part – from core bonds to CFM requires no new capital and no reduction in return-seeking assets. It simply redirects capital already committed to fixed income toward the same three objectives described above: greater certainty of liquidity, reduced risk surrounding the payment of promised benefits, and more time for return-seeking assets to grow through market cycles.

CFM does not require pension plans to abandon diversification, return-seeking assets or modern portfolio management. It simply restores a measure of balance between assets and liabilities – using a portion of the core bond allocation to fund foreseeable liabilities with a high degree of certainty, while allowing the remainder of the plan’s assets to pursue growth. In an inherently uncertain world, pension fiduciaries should reconsider the value of CFM in securing the promises made to plan participants.

What does AI say about Pensions?

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Ronald J. Ryan, CFA - Chairman

I recently wrote a white paper titled “What is the TRUE objective of a Pension?”. I gave my paper to Chat GPT and asked for its critique. Here is what I received (paraphrased):

Your argument for cash flow matching (CFM) as the best fit for the true pension objective is compelling! The ultimate pension obligation is to pay benefits. CFM can more directly accomplish this stated mission by ensuring the timely payment of promised benefits. Although most public pensions have a return target objective (ROA), these plan sponsors do not need to abandon their return-seeking portfolio to adopt a CFM strategy. The plan could create a CFM liability securement allocation within fixed income. The question should be asked: why should the fixed income portfolio be constructed primarily against a generic bond index (e.g. Bloomberg Aggregate) rather than the cash flows of the pension liabilities?

YES, this is what Ryan ALM has promoted for decades and Ron Ryan since the late 1970s. We recommend separating the asset allocation into liquidity assets (Beta) and growth assets (Alpha). Let the liquidity assets fully fund the liability cash flows chronologically for as far-out as possible. Ryan ALM has created a modified Asset Exhaustion Test (MAET) that calculates the ROA needed to fund the residual liabilities not funded by the CFM allocation. Once the calculated ROA is acceptable as an attainable target-return for the Alpha assets then the asset allocation becomes a proper fit between the Beta and Alpha assets. The benefits of our MAET model are significant:

MAET Model Benefits

1. Complies with GASB accounting requirements as a “test of solvency”
2. GASB requires net liabilities to be calculated as: Benefits + Expenses – Contributions

   (Note: NET liabilities after contributions are not provided by the actuary)

3. MAET calculates MONTHLY NET liability payments (actuarial projections are ANNUAL)
4. MAET calculates ROA rather than an asset allocation-based ROA that disregards liabilities.
5. MAET usually calculates a lower ROA than the asset allocation version suggesting a less risky and less costly Alpha allocation is needed

We seldom read that the mission or primary purpose of any pension is to earn a target return on assets (ROA) yet that is how most public pensions work when it comes to asset allocation. This misguided objective has created funding volatility and contribution spikes since 2000. At Ryan ALM, we believe that the primary objective in managing a pension fund is to SECURE the promised benefits in a cost-efficient manner and with prudent risk. We strongly recommend that the best strategy to achieve the true pension objective is through cash flow matching (CFM) with investment grade bonds. Only CFM provides the certainty of cash flows to match and fully fund the actuarial projection of the liability cash flows thereby securing the promises made to the plan’s beneficiaries.

As our name implies, Ryan ALM is an asset liability manager. We specialize in CFM… our only asset management product. We call our CFM model… Liability Beta Portfolio™ or LBP. Our expertise and experience with CFM began in the 1970s when Dedication was in vogue.

LBP Benefits:

1. Reduces Funding Cost by about 2% per year (e.g. 1-10 years = 20%)
2. Eliminates Liquidity Risk – LBP fully funds and matches monthly (B+E) - C
3. Eliminates Funding Risk - fully funds chronologically monthly B+E with certainty
4. Buys Time for growth assets to grow unencumbered thereby enhancing their ROA
5. Eliminates need for “Cash Sweep” which significantly erodes ROA of growth assets

For more info on the Ryan ALM CFM model (Liability Beta Portfolio™)

Contact Russ Kamp – CEO 201-675-8797 rkamp@ryanalm.com

“Given the wrong objective… you will get the wrong risk reward”

What is the TRUE Pension Objective?

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Ronald J. Ryan, CFA - Chairman

We at Ryan ALM believe that the true objective of any pension is to secure the promised benefits in a cost-efficient manner with prudent risk. But don’t take our word for it… let’s see what the top five public pensions say is their mission statement:

CalPERS = $563b

“Deliver retirement and health care benefits to members and their beneficiaries.”

CalSTRS = $370b

“Today, we are the largest educator-only pension fund in the world and continue to deliver on our mission – securing the financial future and sustaining the trust of California’s educators.”

NY State Common Retirement = $201b

“To put in place investment policies and practices designed to ensure that investments are made for the exclusive benefit of the participants and beneficiaries of the System, on whose behalf the assets of the fund are invested, and that Fund investments are made with care that a prudent person serving in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims – the “prudence” and “exclusive benefit” fiduciary standards of investment.”

NYC Retirement System, combined= $336b

“The prime function of the New York City Employees Retirement System is to administer the statutory pension benefits of its members, retirees and beneficiaries.”

FL Retirement System (FRS) = $168b

“To deliver a high quality, innovative and cost-effective retirement system.”

We seldom read that the mission or primary purpose of any pension is to earn a target return on assets (ROA) yet that is how most public pensions work when it comes to asset allocation. This misguided objective has created funding volatility and contribution spikes since 2000. At Ryan ALM, Inc., we believe that the primary objective in managing a pension fund is to SECURE the promised benefits at a reasonable cost and with prudent risk. Thus, the best strategy to achieve the true pension objective is through cash flow matching (CFM) with investment grade bonds. Only CFM provides the certainty of cash flows to match and fully fund the actuarial projection of the liability cash flows securing the promises made to the plan’s beneficiaries. As our name implies, Ryan ALM is an asset liability manager. We specialize in CFM… our only asset management product. Our expertise and experience began in the 1970s when Dedication was in vogue.

Ryan ALM has built and maintains a cost optimization CFM model that will fully fund net liabilities ((benefits + expenses) – contributions or (B+E) – C) at the lowest cost to the client using an investment grade bond portfolio. The Ryan ALM CFM model solves the common and erroneous problems with funding liabilities:

1. Ryan ALM calculates NET liabilities after contributions (not provided by actuary)
2. Ryan ALM calculates MONTHLY liability payments (actuarial projections are ANNUAL)
3. Ryan CFM model reduces funding cost by roughly 2% per year (1-10 years = 20%)
   Bond math proves that the longer the maturity and the higher the yield… the lower the cost
   Ryan ALM CFM model skews weights to the longest maturities in the area being funded
   Ryan ALM CFM model skews weights to A/BBB+ corporate bonds (higher yielding)

The benefits of the Ryan CFM model (called the Liability Beta Portfolio™ or LBP) are numerous:

1. Eliminates Funding Risk - fully funds chronologically monthly B+E with certainty
2. Reduces Funding Cost by about 2% per year (e.g. 1-10 years = 20%)
3. Eliminates Liquidity Risk – LBP fully funds and matches monthly (B+E) - C
4. Buys Time for growth assets to grow unencumbered thereby enhancing their ROA
5. Eliminates need for “Cash Sweep” which significantly erodes ROA of growth assets

For more info on the Ryan ALM CFM model (Liability Beta Portfolio™)

Call Russ Kamp – CEO 201-675-8797 rkamp@ryanalm.com

“Given the wrong objective… you will get the wrong risk reward”

Is your Asset Allocation Responsive to your Funded Status?

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Ronald J. Ryan, CFA - Chairman

According to the Milliman Public Fund Survey of 2025, funded ratios improved significantly from June 30, 2020, where the average funded ratio was 71.0% versus 88.7% as of June 30, 2026.

The prudent plan sponsor should want their asset allocation to be responsive to this marked improvement by shifting more assets to fixed income to de-risk the plan. This is best accomplished through cash flow matching (CFM) the pension plan’s liabilities. Yet according to the Milliman annual study, asset allocation has been static for the last 12 years, with little change in the fixed income allocation. In fact, instead of adding to fixed income, the exposure was slightly reduced over the years.

Asset allocation should be responsive to the funded status. This was the problem in 2000 – 2002 when pension plans had the highest funded ratios and asset allocation had the highest allocation to equities. Most public pensions did not respond and let the asset allocation ride. Las Vegas has built a most profitable empire based on the human behavior of letting winnings ride… which become big losses in time.

The solution is to reallocate your plan’s assets from equities to a fixed income strategy called “cash flow matching (CFM)”. CFM matches and fully funds liability cash flows (benefits and expenses) chronologically. This strategy secures benefits while buying time for the growth assets to perform. The higher the funded ratio the more you transition to CFM. This should be an annual asset allocation discipline or whenever there is a significant improvement in the funded status. Again, we believe that asset allocation should be Responsive to the funded status and not Strategic, which tends to be more static and ignores the funded status in pursuit of a ROA target return.

“Common sense is not common”

Pension Alert: Check your Glide Path

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Ronald J. Ryan, CFA - Chairman

A pension glide-path strategy and discipline is supposed to be responsive to the funded status. As the funded ratio / status improves over time, asset allocation should respond by de-risking from a high allocation to risky assets to a more conservative fixed income allocation (ideally cash flow matching to secure the improved funded status). According to the Ryan ALM 2Q Newsletter, pension assets (based on a 5% Cash, 30% Bonds, 60% Stocks, 5% Int’l allocation) outperformed liabilities (Ryan ALM Liability Index of an equal-weighted Treasury STRIPS yield curve) by 6.3% so far in 2026. We calculated that this asset allocation starting at 100% funded at the end of 1999 has risen significantly to 140% funded ratio as of 6/30/26. Our static asset allocation is quite conservative. Most, if not all, pensions moved into a more aggressive and risky asset allocation over the last 25 years. Since 1999 most bond allocations have been reduced with a growing allocation to hedge funds and alternative investments (mainly private equity).

Although the true objective of pensions is to fully fund benefits in a cost-efficient manner with prudent risk, most pensions are focused on earning a target rate of return (ROA hurdle rate) which ignores the funded status and securing benefits. Today’s growing surplus funded status position reminds me of what happened in the early 2000s when pensions had a growing surplus and let it ride instead of securing benefits through a cash flow matching strategy (i.e. Dedication). The S&P 500 correction of 2000 – 02 sent funded ratios to a quick and deep deficit with spiking contributions as a result. According to the Ryan ALM Newsletter our calculated funded ratio went from 100% in 1999 to 77.4% in 2000 then down to 59.2% by 2005 and 53.8% in 2010.

Many feel that the US stock market today is overvalued. Perhaps, the average P/E multiple is a sign of this overvaluation. The current P/E multiple = 32.45x while the average P/E multiple since 1990 is around 24.6x:

Another sign of this overvaluation of our equity market is the notion of “Reversion to the Mean” that suggests that the future valuation of the equity market should resemble or be valued at a long-term moving average. Based on a series of moving averages would suggest that the future average return of the S&P 500 would have to be lower than in recent years. The return for YTD 2026 through June is 10.2%. Annual + Average Returns of the S&P 500 as of June 30, 2026:

Years	Average
2022	-18.1%
2023	26.3%
2024	25.0%
2025	17.9%
2026 YTD	10.2%
5	13.4%
10	15.5%
20	11.4%

Ryan ALM urges plan sponsors to follow the true objective of their pension and be responsive to the greatly improved funded status of today. We strongly recommend a higher allocation to fixed income using a cash flow matching (CFM) strategy. Our CFM model (Liability Beta Portfolio™) is designed to secure benefits in a cost-efficient manner where cost savings of 2% per year (1-20 years = 40%) can be achieved. Our CFM model will buy time for the risky assets to grow unencumbered (no cash sweep). The high P/E valuations of today suggest an equity correction is due. Let’s not repeat the major funded status erosion of the early 2000s.

“Common sense is not common”

Ron Ryan

Ryan ALM Turnkey System

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Pension Problems: Volatility of Contributions and Funded Ratio

Pension Solution: Ryan ALM Turnkey System

Ronald J. Ryan, CFA - Chairman

Pension Objective

To secure and fund the projected benefit payments in a cost-efficient manner with prudent risk. Pensions are all about asset cash flows versus liability cash flows. In addition, corporate pensions want the annual dollar growth of pension assets to match or exceed the annual dollar growth of pension liabilities to reduce or eliminate pension expense and enhance corporate earnings.

Facts

Pension assets fund NET liabilities after contributions not gross. Contributions are the first source to fund benefits + expenses (B+E). Pension assets need to know what they are funding… net liabilities. Unfortunately, net liabilities are not calculated by the actuary.

Problems

1. Most bond assets are managed vs. generic market indexes and not plan liabilities
2. Liabilities priced at ROA discount rate (assets and liabilities = same growth rate)
3. Liquidity to fund B + E comes from a sweep of several asset classes liquidity
4. Funded Ratio / Status does not include contributions as an asset
5. ROA is based on asset allocation and not the funded status

Solutions… Ryan ALM Proprietary Turnkey System

1. Custom Liability Index (CLI)

   In 1991 the Ryan team invented the first CLI as a best fit for the true pension objective. No two pension liabilities are alike… different labor force, salaries, mortality, plan amendments, etc. As a result, no generic bond index could ever properly represent and measure the liability growth rate and interest rate sensitivity (IRS). The proper pension plan benchmark should be based on the actuarial projections of:

   benefits + expenses – contributions ((B+E) – C) = net liabilities.

   Net liabilities is what pension assets must fund (not the gross liabilities)!

   CLI provides calculations needed for assets to be managed versus net liabilities:

   monthly liability cash flows (term structure), duration, YTW, growth rate, and interest rate sensitivity (IRS).

   Case Study

   The difference between net and gross liabilities is generally 20% to 50%. This suggests that the true funded status is much higher than what is reported. This should lower the ROA needed to fully fund net liabilities allowing asset allocation to become less risky and more attainable.

2. ASC 715 Discount Rates

   To understand the true economic valuation and growth rate of a pension you need to compare the market value (MV) of assets to the MV of liabilities. ASC 715 discount rates provide market valuation of liabilities. Ryan ALM is one of few vendors providing ASC 715 discount rates based on a AA zero-coupon corporate bond yield curve in conformity to ASC 715 (GAAP) accounting since FAS 87 and 158 were effective. Moody’s has adopted ASC 715 discount rates to assess the credit rating of municipalities.

   Case Study

   The difference between discount rates based on the ASC 715 and the ROA is generally 150 to 200 basis points (5.00% versus 7.00%). This would increase the present value of liabilities around 15% to 30%.

3. Liability Beta Portfolio™ (LBP)

   This is the core asset management product of Ryan ALM. The intrinsic value of bonds is the certainty of their cash flows. As a result, bonds have always been chosen as the way to defease and immunize liabilities. Our LBP is a cost optimization model composed of investment grade bonds skewed to A/BBB+ issues which calculates the lowest cost portfolio to fully fund net liabilities. The LBP will cash flow match monthly liabilities chronologically based on the CLI data. We recommend funding 1-10 years as the target area to fund given the greater certainty of these liability cash flows and to buy time for the performance assets to grow unencumbered. The LBP will provide the liquidity needed to fully fund these net liabilities in a cost-efficient manner so a cash sweep of performance assets is not needed. The LBP should also outyield traditional bond management which will enhance the ROA. The LBP should reduce funding costs by 2% per year (1-10 years = 20% cost reduction), reduce the volatility of the funded ratio and contributions and reduce asset management costs (fee = 15 bps).

   Case Study

   It has been our experience for the last 20 years that our LBP reduces the funding cost of pension plans by about 2% per year (i.e. 20% for 1-10 year liabilities). Moreover, the LBP is fully funding the future value of net liabilities using a portfolio of A/BBB+ corporate bonds. As a result, there is no interest rate sensitivity with future values as well as we have defeased net liabilities with certainty. The yield difference of the LBP versus ASC 715 discount rates should be about 50 basis points. Depending on the average duration of the LBP (10 – 15 years) the LBP future value should be about 5% to 7.5% higher than the future value of net liabilities. This would improve the solvency of the pension plan.

4. Performance Attribution Report (PAR)

   PAR compares the growth rate (total return) of the LBP to the CLI as a monthly report. PAR calculates 8 risk measurements, 4 return measurements and 2 risk-adjusted measurements. Two historical graphs comparing these monthly returns is also provided.

   Case Study

   Our 1 page PAR statistical report followed by our 2 page graphical comparisons of asset growth versus liability growth is quite succinct and tends to explain quite clearly the value added (or lost) from the LBP. Usually the difference in yield is the return value added of the LBP with the same or similar risk behavior as the CLI.

   Bonus: Asset Exhaustion Test (AET)

   AET is required by GASB 67/68 as a test of solvency. Assets are grown at the ROA to see if they can fully fund projected benefits – projected contributions (net liabilities). Where they are exhausted, GASB requires a bifurcated discount rate using AA 20-year muni rates. Ryan ALM modifies the GASB AET to calculate the ROA needed to fully fund net liabilities rather than the current ROA used that is based on asset allocation ignoring the funded status. We highly recommend this test for all pensions to calculate the ROA needed to fully fund net liabilities.

   Case Study

   It has been our experience that our modified AET model using a calculated ROA (economic ROA) is much lower than the actuarial ROA suggesting asset

   allocation could reduce its allocation to risky assets thereby also reducing costs.

Benefits

The benefits of the Ryan ALM turnkey system are numerous:

• CLI benchmark provides all the data and calculations needed for efficient ALM
• LBP de-risks the plan by cash flow matching benefit payments with certainty
• LBP provides liquidity to fully fund liabilities so no need for cash sweep
• Eliminates interest rate risk since it is funding benefits (future values)
• AET calculates the economic ROA needed to fully fund net liabilities
• LBP reduces funding costs by 2% per year = 20% on 1-10 years
• LBP reduces asset management costs (Ryan ALM fee = 15 bps)
• Enhances ROA by out-yielding active bond management
• Reduces volatility of the funded ratio + contributions
• CLI + ASC 715 discount rates provided at no cost
• Buys time for Alpha assets to grow unencumbered

The value added of the LBP model is the cost savings and risk reductions while fully funding liabilities chronologically (i.e. 1-10 years). The LBP is not interest rate sensitive (IRS) since it is funding benefit payments (future values) which are not IRS. This eliminates interest rate sensitivity, which is the major risk factor for most performance based fixed income asset management. By cash flow matching we have fully funded a target area of liabilities thereby reducing the volatility of the total funded status and contribution costs. The LBP buys time for the growth or Alpha assets to perform without being unencumbered to pay benefits. According to S&P data, 48% of the S&P 500 growth rate comes from dividends and reinvestment based on rolling 10-year periods since 1940. Buying time should enhance the ROA and funded status.

Please note:

• That the LBP does not change any accounting or actuarial books.
• Ryan ALM may have the longest experience with cash flow matching dating back to the late 1970s when Ron Ryan was the head of fixed income research at Lehman Bros.

For more info on the Ryan ALM turnkey system please contact:

Russ Kamp – CEO at rkamp@ryanalm.com

and check out our research at www.ryanalm.com

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Pension Problem: Future Values

Printable Version: Pension Problem: Future Values

The true objective of a pension is to secure promised benefits in a cost-effective manner with  prudent risk. Pension benefit payments are future value numbers. We do not know the future value  of pension assets except for bonds who have the certainty of their cash flows (principal + interest  payments). The least risky way to secure benefits is to cash flow match (CFM) these future value  benefit payments with U.S. Treasury STRIPS  (zero-coupon bonds). However, STRIPS may be  too  costly since  they have lower yields. The least costly way  to secure benefits is  through CFM with  investment grade bonds because of the certainty of their cash flows. 

Funded Ratio / Status 

Actuarial practices use present values (PV) to calculate the  funded ratio and  funded status… but  benefit payments are future values (FV). This suggests that the future value of assets vs. the future  value of liabilities would be the more appropriate and critical evaluation. Most asset classes are  difficult, if not impossible, to ascertain their future value. Only bonds (and insurance annuities) have  a known future value and, accordingly, have historically been used to cash flow match liabilities (i.e.  defeasance,  dedication).  To  prove  my  point  as  to  the  potential  misinformation  with  using  a  PV  calculation, let’s use a simple example below. Two pensions both at $100 million market value with  a 15-year duration would have the same  funded ratio in PV$. But pension B is 100% invested in  corporate  bonds  that  outyield  pension  A  (100%  invested  in  Treasuries)  by  100  bps  per  year.  Certainly, plan B has a much greater future value (@ 15.6% higher) and funded status if we used  future values. This suggests that the funded ratio and funded status are not the best indicators of  the true economic solvency: 

Pension	Composition	YTM	PV	FV
A	100% Treasuries	4.00%	$100 million	$180 million
B	100% Corporates	5.00%	$100 million	$208 million

The point of all this is that we need to focus more on the FV of assets vs. liabilities or cash flows. The  AET is the appropriate methodology to compare assets versus liabilities cash flows (future values). 

Pensions are all about cash flows… asset cash flows to fully fund liability cash flows! For some  reason  the  funded  ratio  /  status ignores contributions  as  asset  cash  flows.  Actuaries  say  this is  because  contributions  are  in  the  future  and  could  be  altered. Well,  isn’t  this  true  about  benefit  payments? Such  projections  of  contributions  and  liabilities  are  recalculated  annually  by  the  actuaries so  the  AET  should  be  monitored  annually  after  the  new  actuarial  projections.  We  congratulate GASB 67/68 on requiring a test of solvency (AET) where projected asset cash flows  including  contributions  grow  based  on  the  ROA and are  compared  to  projected  net  liabilities  (benefits + expenses – projected contributions or ((B+E) – C). Ryan ALM modifies this AET approach  where we calculate the ROA needed to fully fund net liability cash flows. In almost all cases, we find  it would take a lower ROA to fully fund net liabilities. This calculated ROA should be the hurdle  rate for asset allocation. 

The AET is a critical and accurate gauge of the solvency of a pension plan since it focuses on  asset cash flows funding NET liability cash flows (future values). It is a valuable tool for all pensions  (Private, Public, and Multiemployer). Notice, it includes contributions as a pension asset where  the  funded  ratio  and  funded  status  do  not. The  AET  correctly  considers  contributions  as  future  assets. 

A  corporate  bond  portfolio  cash  flow  matched  to  net  liability  cash  flows would secure  pension benefits and reduce funding costs (FV of liabilities - PV of assets) with certainty. This is why  cash flow matching of net liability future values is the most prudent and lowest cost methodology  to de-risk a pension through asset liability management (ALM). 

SOLUTION:  Cash Flow Matching 

As stated earlier, funding the net liability benefit payment schedule (liability cash flows or FVs after  contributions) in a cost-effective manner should be the quest of a pension plan sponsor. Ryan ALM  has  built  a  liability  cash  flow  matching  product,  Liability  Beta  Portfolio™ (LBP),  as  a  cost  optimization model that matches and fully funds the net liability payment schedule or cash flows  ((B+E) - C) chronologically at the lowest cost given the investment policy restrictions of our clients.  By focusing on future values, we avoid the present value problems of duration matching (i.e. interest  rate sensitivity changes daily and is a forecast of rates). By matching future values chronologically, the LBP has mitigated interest rate risk which dominates the present value behavior of bonds.  (Note, FVs are not interest rate sensitive.) The LBP is a perfect complement to the AET by cash  flow  matching  each liability  cash  flow payment chronologically (FV  of  benefits +  expenses).  By  matching future values, the LBP enhances the SOLVENCY of any pension at a reduced funding  cost. 

The LBP currently provides a roughly 2% per year funding cost savings (i.e. 20% on a 1- 10-year net liability cash  flow  schedule). This is a  serious cost  reduction and  should be a major  consideration of any pension asset allocation strategy. Yes, the LBP model may have some credit risk, but it remains very small since we are using investment grade bonds (BBB+ or better) with  credit filters (no bonds on negative watch list, low Bloomberg default risk, etc.) plus the cost savings  provides a large risk cushion.  

The funded ratio/status should dictate the allocation to bonds. A surplus or high funded ratio  should have a high allocation  to bonds cash  flow matched  to liabilities and  vice  versa  for a high  deficit or low funded ratio plan. Unfortunately, current asset allocation practices do not respond to  the funded status. In the late 1990s with funded ratios at 120% to 150%, why didn’t all pensions  cash flow match liabilities (defease) and secure this victory? Amazingly, instead of increasing their  bond allocation in response to a growing funded ratio most pensions reduced their bond allocation to the lowest in modern history by 1999 to achieve a target ROA (@ 8.0%). Had pensions cash flow  matched liabilities  then  they would  have  secured  benefits at low  cost in  harmony with  the  true  pension objective and created a surplus portfolio that could have been maintained for decades and used for other purposes (pay OPEB liabilities). 

“Where is the knowledge we have lost in information” 

T.S. Eliot

Pension Game - Find the Liabilities

Source: Pension Game - Find the Liabilities

The true objective of a pension is to fund liabilities (benefits + expenses) in a cost-efficient manner with prudent risk. Although the management of pensions should have a liability driven objective, it is hard to find a focus on liabilities in any of the critical pension management functions. This has led to a singular focus on assets versus assets for several decades.

Asset Allocation

Most pension asset allocation (AA) models are designed to earn a return equal to the return on asset (ROA) assumption. Asset management is required to perform versus a generic market index for their asset class as their benchmark. Most AA models use the historical returns of these generic market indexes benchmarks to create an average or expected asset class return as their forecast of future returns. These market indexes average returns are then weighted for each asset class based on the target exposure in the fund to arrive at the ROA. This asset allocation process is usually the job of the pension consultant. The pension actuary will then use this ROA to calculate the annual contributions needed to attain full funding. This ritual is repeated at some frequency by both the pension consultant and actuary in conjunction with the pension Board. So, what’s missing… liabilities and the funded status.

If the true objective of a pension is to fund liabilities in a cost-effective manner with prudent risk, then the funded status is paramount. Obviously, the pension objective is a cost objective not a return objective! Logically a 60% funded plan would need a higher ROA to reach full funding than a 90% funded plan. But regrettably AA models ignore the funded status and work with an asset only focus.

To make matters worse, the funded ratio/status ignores future contributions as future assets. The truth is assets fund net liabilities after contributions (benefits + expenses - contributions) not gross liabilities. GASB requires a test of solvency whereby a plan sponsor must prove that they can fully fund total liabilities with contributions. We applaud GASB for this test and funding awareness. Ryan ALM modifies this solvency or asset exhaustion test (AET) to calculate the accurate ROA needed to fully fund net liabilities after contributions. It has been our experience that the actual ROA is always different and most often lower than the current ROA target (maybe significantly). We recommend the Ryan ALM calculated AET be employed as part of the asset allocation process to determine the accurate ROA needed to fully fund the pension plan’s net liabilities.

Asset allocation should be responsive to the funded status rather than strategic (long-term) or tactical (short-term) AA that ignore the ever-changing funded status. If the funded status is steadily improving, then AA should respond by shifting the allocation to more fixed income to cash flow match (defease) liabilities and thereby reduce risk while increasing the certainty of full funding which should lower contribution costs. Funded ratios have improved dramatically since 2020 but the allocation to fixed income has not.

Ryan ALM offers the following solutions to fix this asset only focus of pensions:

Solution: Asset Exhaustion Test (AET)

Based on each client’s actuarial projections of benefits, administrative expenses and contributions, the Ryan ALM modified AET will create a matrix of ROAs to calculate what ROA is a best fit to fully fund net liabilities (B+E) – C. The projected contributions can be adjusted as well if the calculated ROA is meaningfully different than the current target.

Solution: Custom Liability Index (CLI)

Most institutional objectives mandates are liability driven (Pensions, OPEB, SFA grants, Lotteries, etc.). Yet it is hard to find the liability objective in anything the asset side does (asset allocation, asset management (other than LDI), performance measurement, etc.). There seems to be a definite disconnect here. If all asset managers outperform their generic index benchmark but lose to liability growth… did the client win or lose? Clients lost and may have to pay a penalty (higher contribution costs). The true objective for liability driven clients is to fund their unique and proprietary liabilities in a cost-efficient manner with prudent risk. Similar to snowflakes… no two liability cash flow schedules are alike. As a result, it is impossible for any generic index to properly represent the client’s liability objective. Only a CLI could be the proper benchmark for a liability objective. Now pensions can compare asset growth versus liability growth as the proper performance measurement for a pension. Ron Ryan and his team developed the first CLI in 1991… it remains as one of the key products of Ryan ALM and an essential tool in our turnkey proprietary cash flow matching system.

Liabilities are the realm of actuaries. They are usually difficult and tedious calculations. As a result, actuarial projections are produced annually months after the end of the fiscal year. This is not in harmony with active asset management which needs to monitor their objective often in detail. The Ryan ALM CLI is a monthly report that provides all the calculations and data needed for successful asset liability management (ALM). Our CLI will take the annual actuarial projections and convert them to monthly NET liability cash flows. Assets need to know what they are funding. Usually it is monthly (benefits + expenses) – contributions = net liability cash flows.

Ryan ALM will then price the CLI using our proprietary ASC 715 discount rates. Ryan ALM is one of a few ASC 715 vendors providing such rates since the inception of FAS 158 in 2008. In addition to a monthly net liability cash flow schedule, our CLI will provide numerous statistics based on ASC 715 discount rates: average duration, YTM, growth rate, interest rate sensitivity, etc.

Solution: Cash Flow Matching (CFM)

The value in bonds is the certainty of their cash flows. Bonds may be the only asset class with such value. Ryan ALM has consistently recommended to use bonds for the certainty of their cash flows. We do not consider bonds as performance or Alpha assets. We view bonds as liquidity or Beta assets. Bonds have always been the chosen asset class for the cash flow matching of liabilities. In the 1970s it was called Dedication. CFM has a long successful record of being the core portfolio to defease and fully fund the liability objective. With interest rates much higher today than in the last 20-years, CFM should be in vogue. We urge clients and their consultants to use CFM as the bond allocation to fully fund the net liability cash flows chronologically and replace the allocation to highly interest rate-sensitive active core bond strategies managed to a generic market index.

We call the Ryan ALM CFM model… Liability Beta Portfolio™ (LBP). Our LBP is a cost optimization model composed of investment grade bonds skewed to A/BBB+ issues at low cost to fully fund net liabilities. The LBP will cash flow match monthly liabilities chronologically based on the CLI data. We recommend funding 1-10 years of Retired Lives as the minimum target area to fund given the certainty of the liability cash flows and to buy time for the performance assets (the fund’s residual alpha assets) to grow unencumbered. The LBP will provide the liquidity needed to fully fund these net liabilities in a cost-efficient manner thereby reducing or eliminating the need to do a cash sweep from the performance assets. S&P data shows that dividends reinvested account for over 50% of the S&P 500 total return over 20-year periods since 1940. Since our LBP is skewed to A/BBB+ corporate bonds it should outyield traditional bond management which will enhance the fund’s ability to achieve the ROA. More importantly, our LBP should reduce funding costs in this rate environment by about 2% per year (20% for 1-10 years), reduce the volatility of the funded ratio, contributions, and reduce asset management costs (our fee = 15 bps).

Benefits

The benefits of the Ryan ALM process are numerous:

• AET will calculate the ROA that accurately fully funds liabilities after contributions

• CLI benchmark provides all the data and calculations needed for efficient ALM

• LBP de-risks the plan by cash flow matching benefit payments with certainty

• LBP provides liquidity to fully fund net liabilities so no need for cash sweep

• Eliminates interest rate risk since it is funding benefits (future values)

• Reduces funding costs by about 2% per year = 20% on 1-10 years

• Reduces asset management costs (Ryan ALM fee = 15 bps)

• Enhances ROA by out-yielding active bond management

• Reduces volatility of the funded ratio + contributions

• CLI + ASC 715 discount rates provided at no cost

• Buys time so Alpha assets grow unencumbered

Negative Cash Flows… Good or Bad for Pensions

Source: Negative Cash Flows… Good or Bad for Pensions

It is traditionally considered that it is bad for a pension to be cash flow negative (CFN). But let’s take a closer look. CFN means that benefits exceed contributions (B > C). Contributions are an extra cost caused by a funding deficiency where the present value of assets < present value of benefits. If the true objective of a pension is to fully fund and secure benefits in a cost-efficient manner, then you would think that the pension objective is to reduce or at least stabilize contribution costs. This is exactly what cash flow matching (CFM) achieves. Let me explain…

Spiking contribution costs have been a most onerous burden for many pensions, especially public pensions, since 1999. As I wrote in my 2013 book “The US Pension Crisis” I deduced that the pension crisis was created through spiking contribution costs. I featured New York City Employees Retirement System (NYCERS) where contribution costs increased more than 43 times in 12 fiscal years from $68,619,745 in FY ending 6/30/00 to $3,017,004,318 in 6/30/12 equal to a 37.1% annual growth rate. I quoted the financial objective of NYCERS in my book as:

… to fund benefits and to establish employer normal contribution rates that would remain approximately level over the future…

This spiking contribution cost trend was evident throughout pension America and was created by a heavy allocation to equities. The critical period was 2000 to 2002 when the S&P 500 had three consecutive negative return years that resulted in a cumulative negative return of -37.6%. Compounding this issue was the fact that interest rates were in a secular decline. On a market value basis, using ASC 715 discount rates, we calculated that most pensions had a cumulative liability growth rate of about 55.1% for those three years (2000-2002). This would have reduced the funded ratio for the average DB pension plan by about 60% sending most pensions from a surplus funded ratio to a deep deficit. As a result, contribution costs spiked throughout pension America damaging budgets, income statements, balance sheets, and credit ratings. Notably, several large cities were forced to file bankruptcy (e.g. Detroit, Jefferson County, Stockton, etc.) and corporate pensions decided to exit pensions through a pension risk transfer (PRT) thereby selling their pension liabilities to insurance companies.

Solution: Cash Flow Matching (CFM) Pensions are better funded today than at any time since 1999. To avoid another repeat of the spiking contributions dilemma (this time it may come from a private equity or alternatives bubble and another secular decline in rates), pensions should install a CFM strategy as the core portfolio.

CFM was the dominant asset strategy in the 1970s and 1980s when pensions were fully funded and was called Dedication. CFM is a best fit for the true pension objective since it is designed to fully fund net liability cash flows in a cost-efficient manner. Bonds are the only asset class with certainty of its future cash flows (interest income and principal payments at maturity). When CFM is done correctly, it skews the assets to the longer maturities within the maturity range it is funding. The Ryan ALM model (we call the Liability Beta Portfolio™ or LBP) is an investment grade portfolio emphasizing A/BBB+ securities. Bond math tells us that the longer the maturity and the higher the yield… the lower the cost. For example, if CFM is funding liabilities out to 10-years, it will have overweighted exposure to the 5-10-year area. This means that the 0-5 years liabilities are being partially funded, if not fully funded, by the cash flows (and higher interest rates) of the longer maturities.

The benefits of CFM as the liquidity assets are numerous:

1.     Reduces contribution volatility

2.     Provides timely liquidity to fully fund monthly liabilities (B+E)

3.     Eliminates need for a cash sweep which erodes the ROA of growth assets

4.     Buys time for the growth assets to grow unencumbered (enhances their ROA)

5.     Reduces the cost of funding liabilities by about 2% per year (1-10 years = 20%)

6.     Neutralizes interest rate risk since it is funding liability cash flows (FV numbers)

Conclusion: 

If the true pension objective is to fully fund and secure benefits in a cost-efficient manner with prudent risk, then pensions want to allow negative cash flows by letting the asset cash flows fully fund liability cash flows rather than increase contribution costs. This is best accomplished through a CFM strategy as the pension fund’s core portfolio.

Bond Math… Let THE FORCE be with you!

Source: Bond Math… Let THE FORCE be with you!

Defined Benefit pension planseverywhereface serious risk factors:

Liquidity Risk

The true objective of a pension is to fund liabilities in a cost-efficient manner with prudent risk. Pension liabilities are a term structure of monthly payments of benefits + expenses (liability cash flows). Funding liabilities in a cost-efficient, risk-controlled manner is increasingly difficult in a volatile market.Most pension plans rely on assets with uncertain cash flows which do not match the pension benefit payments schedule (liability cash flows). This mismatch creates unnecessary risk, unnecessary costs, and unnecessary stress. For many plan sponsors, this feels like fighting a battle with no clear weapon… let bond math, aka “THE FORCE”, be with you by adopting a Cash Flow Matching (CFM) strategy.

Funding Risk

When a pension sponsor adopts a CFM strategy, there is a significant funding enhancement. Instead of anxiety about market outcomes, contribution spikes, or liquidity needs, a CFM strategy turns the pension plan into aprecision cash flow process that fully funds liability cash flows in a cost-efficient manner with prudent risk. With Ryan ALM’s CFM in place, here is what life looks like for the plan sponsor:

• Liquidity risk is eliminated, no more cash sweeps

• Funded ratio stabilized for the portion of the plan using CFM

• Non-CFM (performance) assets grow unencumbered, enhancing total return

• Benefits are fully funded with cash flow certainty for the portion using CFM

• Funding costs are significantly lower by 2% per year (20% over 10 years, 40% over 20 years)

Cash Flow Matching (CFM) Methodology

Cash flow matching (Ryan ALM model = Liability Beta Portfolio™ or LBP) will secure monthly benefits and significantly reduce funding costs. Our LBP is a cost optimization model that goes through several iterations to find the optimal cost savings that will fund monthly liability payments with certainty. Since liabilities are priced like bonds… they behave like bonds (FASB or GASB discount rates require pricing as if liability cash flows are a portfolio of zero-coupon bonds). As a result, bonds become the proper proxy and assets to match and fund liability cash flows. Bond math tells us that the longer the maturity the lower the cost and the higher the yield the lower the cost for the same par value. Our LBP is comprised of investment grade bonds skewed to longer maturities and A/BBB+ credits. Importantly, the LBP yield of A/BBB+ bonds creates an excess return (Alpha) over the ROA assigned to bonds (YTM), which further enhances the funded status and reduces contribution costs. It will also outyield liabilities priced as AA corporates (ASC 715 discount rates) by roughly 50 - 100 bps. Skewing the portfolio weights to longer maturities within the designated liability term structure we are funding. As an example, means thata 30-year coupon bond will partially fund 29 years of benefits through interest income. The same is true for a 10-year bond partially funding 1-9 years of liabilities through interest income. Adding principal payments cash flow at maturity adds even more cash flow. Our LBP model will calculate a portfolio of asset cash flows (interest income + principal payments) that will match and fully fund monthly liability cash flows at a significant cost savings.

This is NOT how duration matching (DM) works, which has definite liability cash flow mismatches and cost inefficiencies. Since the longest duration bonds are around 19-years today, duration matching is forced to use Treasury zero-coupon bonds (STRIPS) to fund any liability past 19-years. Since Treasuries are the lowest yielding bonds… they are the highest cost bonds to fund and match liabilities. Moreover, duration is a present value (PV) calculation that is very interest rate sensitive. Duration matching (DM) is focused on matching liability growth rates and not on matching and funding benefit payments (future values). DM usually tries to match an average duration of liabilities or a series of key rate durations. Since duration matching is a PV focus, it does not produce a CFM of liability cash flows (future values) and can be an extremely interest rate sensitive strategy. Cash flow matching fully funds monthly liability cash flows thereby providing a more accurate and tighter duration matching fit.

BOND MATH = “The FORCE”

Just like “The Force” in Star Wars, bond math provides great power and control over asset cash flows. Bond math tells us:

The longer the maturity → the lower the present value

The higher the yield → the lower the present value

Example (bond Future Value = needed to fund $100 million liability payment):

YTM	Maturity	Present Value	Cost Savings	Savings %
5%	5 years	$78,352,617	$21,647,383	21.65%
5%	10 years	$61,391,325	$38,608,675	38.61%
6%	5 years	$74,726,215	$25,273,785	25.27%
6%	10 years	$55,839,479	$44,160,521	44.16%

Note: A 10-year bond at 5% YTM saves 52.8% more than a 5-year bond at 6% YTM. Bonds are the only asset with certain future values (interest income + principal)

Only cash flow matching (defeasement) can secure benefits and reduce funding costs with certainty. By matching and fully funding liabilities (benefits + expenses) our LBP reduces risk accordingly. Our LBP has numerous benefits that best achieve the true pension objective:

Benefit: Eliminates Liquidity Risk

• LBP fully funds liability cash flows chronologically (no need for cash sweep)

Benefit: Enhances Funded Ratio /Status

• LBP outyields ROA for bonds (usually skewed to an index heavily weighted to Treasuries)

Benefit: Reduces Funding Risk

• LBP provides certainty of asset cash flows to fully fund liability cash flows

Benefit: Reduces Costs

• LBP reduces Contribution, Funding and Asset Management Costs

Benefit: Reduces Volatility

• LBP matches and funds liability cash flows reducing volatility of funded status

Benefit: Eliminates Interest Rate Risk

• LBP and liability cash flows are future values (FV) which are not Interest Rate Sensitive

Benefit: Reduce and Stabilize Contribution Costs

• LBP will fully fund liabilities thereby reducing the volatility of contribution costs

Benefit: Buys Time

• LBP fully funds liabilitiesbuying time for other assets (Alpha) to grow unencumbered

Benefit: Portable Alpha

• As Alpha assets grow unencumbered, transfer (port) Excess Returns to LBP

The LBP should be the core portfolio of asset allocation since it best represents and funds the true client objective (funding benefits in a cost-efficient manner with prudent risk). The greater the allocation to the LBP, the greater the cost savings and stabilization of the funded status. We strongly recommend replacing the current bond allocation to active bond management managed versus a generic bond index with our LBP cash flow matching portfolio that manages assets versus liabilities. Since Retired Lives are the most certain and most important (most tenured employees) liabilities, we recommend funding Retired Lives through our LBP as a high priority of the pension plan. Ryan ALM can cost-effectively fund the Retired Lives liability cash flow schedule with low risk. Our Liability Beta Portfolio complements the performance or risky assets by removing the cash sweep and buying time for them to grow unencumbered which should significantly help them achieve their target ROA.

Cash… A Risky and Costly Investment For Pensions

Source: Cash…A Risky and Costly Investment For Pensions

Pension funds tend to have a cash portfolio, which is usually held by the custodian bank and often has an average maturity/duration of about 3 months. That cash “bucket” is meant to fund monthly benefits (and expenses). Any deficiency in the cash account to fund monthly benefits creates a cash sweep of other assets, including dividends and interest. This practice causes cash to be a risky and costly investment decision for the following reasons:

1. Reinvestment Risk – Pension liabilities (benefits and expenses) are monthly payments. It is rare that the allocation to cash matches the characteristics of the liability cash flows for the next 3 months. There could be either excess cash or an inadequate cash allocation. Excess cash has some reinvestment risk. A cash shortage usually requires the plan sponsor to sweep liquid assets from growth assets, including dividends and interest income, thereby creating a reinvestment drag or risk on future returns (ROA) of growth assets.

2. Opportunity Cost – Cash is usually the lowest yielding asset since the portfolio has a Treasury bias and maturities are short. This creates an opportunity cost when compared to cash flow matching (CFM) given the longer maturities and much higher yields.

3. Funding Cost – Funding liabilities with cash creates a pay-as-you-go strategy, which tends to be the highest cost strategy to fund liabilities. This is in direct contrast to a defeasance strategy using CFM to fully fund liabilities.

Solution: Cash Flow Matching (CFM)

CFM is designed to fully fund net liability cash flows in a cost-efficient manner. CFM skews the assets to the longer maturities within the maturity range it is funding. The Ryan ALM model (we call the Liability Beta Portfolio™ or LBP) is an investment-grade portfolio skewed to A/BBB+ securities. Bond math tells us that the longer the maturity and the higher the yield, the lower the cost. For example, if CFM is funding liabilities out to 10 years, it will have skewed the weights to the 5-10-year area. This means that 0-1 year liabilities are being partially funded by the cash flows of the longer maturities. The benefits of CFM as the liquidity assets are numerous:

1. Higher yield than cash, enhancing the probability of achieving the ROA.

2. Buys time for the alpha assets to grow unencumbered.

3. Reduces the cost of funding liabilities by about 2% per year.

4. Eliminates a cash sweep that significantly diminishes the ROA of growth assets.

5. Neutralizes interest rate risk since it is funding liability cash flows (FV numbers).

6. Enhances funded ratio/status since it outyields cash and traditional bond portfolios.

CFM should be the core portfolio and liquidity assets of a pension since it best represents the true client objective: funding benefits in a cost-efficient manner with prudent risk.

What Do Pension Sponsors Want For Christmas?

Source: What Do Pension Sponsors Want For Christmas?

When asked this question, most pension sponsors would answer:

• Lower or stable pension cost

• Lower volatility on funded status

Yet the asset allocation of most pension plans is skewed to risky and volatile assets. This skewness has created a long history of volatile funded ratios and increasing contribution costs. Fortunately, there is a product that will provide the answers pensions have long sought: Cash Flow Matching!

Given that the true objective of a pension is to fully fund benefits and expenses (liabilities) in a cost-efficient manner with prudent risk, plan sponsors and their consultants should be installing a strategy that is the best fit to achieve this true pension objective. CFM is a portfolio of investment grade bonds that provide an accurate and timely match of monthly asset cash flows to fully fund monthly liability cash flows.

The intrinsic value in bonds is the certainty of their cash flows (only asset class with such certainty). Bond math teaches us that the longer the maturity and the higher the yield… the lower the cost. The Ryan ALM CFM portfolio is created through a cost optimization model that fully funds monthly liability cash flows at a cost savings of about 2% per year (20% to fund 1-10-year liabilities). We call our CFM mode the Liability Beta Portfolio (LBP). The LBP should be the core portfolio for any DB pension fund replacing active fixed income management, which is highly interest rate sensitive. Since pension liabilities are future value costs the monthly payments are not interest rate sensitive. As a result, by matching the FV of liabilities, CFM mitigates interest rate risk! By matching and funding liabilities chronologically, the LBP also buys time for the performance or Alpha assets to grow unencumbered. The pension plan can gradually enhance its funded status and stabilize contribution costs by having CFM work in harmony with the Alpha assets. There are numerous benefits to a CFM strategy:

• No need for cash sweep as LBP provides the liquidity to fully fund liabilities

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

• Buys time for performance assets to grow unencumbered

• Outyields active bond management enhancing ROA

• Reduces Volatility of Funded Ratio/Status

• Reduces Volatility of Contribution costs

• Low Investment Advisory Cost = 15 bps

• Reduces Funding costs (2% per year)

• Mitigates Interest Rate Risk