FPPTA Trustees School Program Ryan ALM Inc The Solutions Company 5616562014 wwwRyanALMcom What is Risk ID: 1000527
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1. How to De-RiskAPension*FPPTATrustees School Program Ryan ALM, Inc. The Solutions Company 561-656-2014 www.RyanALM.com
2. What is Risk?Sharpe (1966) Volatility of Returns Risk-free asset = 3 month T-BillRyan (1994) Uncertainty of meeting Objective Risk-free asset = matches objective
3. Pension ObjectiveTo fund liabilities such that contribution costs are low and stable over the future of active lives.To reduce risk over time.
4. Problem Liabilities are MIA in: Asset Allocation Asset Management Performance Measurement
5. Why? Actuarial Reports:Annual6+ months delinquentNo benefit payment scheduleActuarial valuation not marketS&P 500?
6. Custom Liability IndexProper BenchmarkGiven projected benefit paymentsCLI calculates Monthly reports:PV (GASB 67 and AA Corporates)Interest Rate SensitivityGrowth Rate
7. Funded Ratio / StatusAcid Test:FR = Assets / LiabilitiesFS = Assets – LiabilitiesCritical: FR/FS have correct valuations FR/FS are updated frequently
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10. Problem: Accounting GASB 25 GASB 67Assets Smoothed Fair Value (5 years) (Market Value)Liabilities ROA ROA until assets exhausted (yield of 20-year muni)Error: 36% to 48%Moody’s: AA corporates as discount rate
11. ROADiscount Rate for LiabilitiesHurdle Rate for AssetsROA became Asset Allocation focusInstead of Funded Ratio/StatusPension Consultant
12. ROAActuaryCalculates Projected ContributionsActuary needs growth rate for A + L Assets + Liabilities = same growth rate Deficits erased only thru Contributions
13. Contributions Future Assets Predictable + Sizable Fund Liabilities InitiallyExcluded Funded Ratio / StatusIncluded Asset Exhaustion Test Fiduciary Net Position (Assets – Liabilities)
14. Problem : Asset AllocationAsset Allocation models used to validate ROA (Auditors) AA uses historical returns of asset classes (except Bonds = Yields)Lower rates trend reduced Bond allocation1990s = Lowest Bond Allocation in history!
15. Solution: Responsive AA AA Based on Funded RatioSurplus =/= DeficitSeparate Beta + Alpha assets130% = Beta 100%, Alpha 30%60% = Beta 20%, Alpha 80%
16. Beta / Alpha Beta = Portfolio that matches ObjectiveAlpha = Excess growth vs. Objective growthRequires CLI = to calculate Objective growth to create Beta Portfolio to measure Alpha
17. Objective: De-Risk Plan Liability Beta PortfolioInvestment grade bond portfolioCash flow matches benefit paymentsChronologically or % of totalAt Lowest Cost Reduces CostReduces Risk (FR volatility)Buys time for Alpha assets to perform
18. De-Risk Plan Liability Beta PortfolioCash Flow Matches Liabilities at Low Cost$1 million Liability Payment 5 year costs = $920,870 (YTM = 1.67%) 10 year “ = $787,690 (YTM = 2.41%) 20 year “ = $556,930 (YTM = 2.96%) 30 year “ = $398,090 (YTM = 3.13%)
19. Performance Measurement Total Asset vs. Total Liability GrowthMeasured frequently + accurately (quarterly + market values)Requires CLI to measure: Liability GrowthAlphaRisk
20. Rates Go Up (5 Years) Liabilities = 3.00% >> 6.00% Growth Rate = ( 2.56%) Annual Note: Liabilities duration = 12 yearsAssets 5.0% 6.0% 7.0% Liabilities - 2.6% - 2.6% - 2.6%Alpha (Annual) 7.6% 8.6% 9.6% FR = 60% … 88% 92% 97%
21. Recommended Guidelines1. Install Custom Liability Index (CLI)2. Install Liability Beta Portfolio (De-Risk)3. AA respond to Funded Ratio/Status4. Total Asset vs. Total Liability Growth