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”