Problem: Pension Crisis Solution: Portable Alpha Ryan ALM, Inc. - The Solutions Company 1-888-RyanALM

Problem: Pension CrisisSolution: Portable Alpha

Ryan ALM, Inc. - The Solutions Company1-888-RyanALM

www.ryanalm.com

2Ryan ALM, Inc.

The Solutions Company1- 888-Ryan-ALM

www.RyanALM.com

Index Returns YTD 2009

Estimated Weights

Liabilities : Market (Tsy STRIPS) FAS 158 (AA Corporates) PPA (3 Segment) PPA (Spot Rates) GASB /ASOP (8% ROA)

-19.52 % 12.67 4.54 23.53 8.16

100 %

Assets : Ryan Cash Lehman Aggregate S&P 500 MSCI EAFE Int’lAsset Allocation Model

0.53 % 5.9326.4632.45

5 % 30 60 5

19.43 % 100 %Assets – Liabilities Market FAS 158 PPA (3 Segment) PPA (Spot Rates) GGASB/ASOP (8% ROA)

38.95% 6.76 14.89-4.1511.27

The Ryan Letter December 2009(Copyright Ryan ALM, Inc. 2009 …All Rights Reserved)

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Assets vs. Liabilities Funding Ratio(Asset Allocation (30% Bonds/60% Equity/5% Int'l/5% Cash)

12/31/1988 - 12/31/2008

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

156.5

55.8

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Funding Ratio____________

Ratio Market Value of Assets / MV of Liabilities

Requires Custom Liability Index

1990s Most Pensions had Surpluses

Didn’t change their Asset Allocation

2000s Funding Ratios eroded by 40% to 60%

Problem Focus on ROA instead of Funding Ratio

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Pension Plan Objective____________________

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Risk ____

Tradition Volatility of Total Returns

Ryan ALM NOT Meeting the Client Objective (Uncertainty)

Objective Liability Driven

Sharpe Ratio Based on 3 month T-BillNew Ratio Based on Objective

(Information Ratio)

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Risk Management

________________

Tradition Reduce Volatility of Total Returns

Ryan ALMIncrease Certainity of Meeting Objective

Objective = Liability DrivenRequires Objective Index

Objective Index Custom Liability Index

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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)

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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

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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

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Custom Liability Index (CLI) _______________________________

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

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Asset Allocation________________

Should be based on “Funding 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

Should be Dynamic (Tactical)

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Solution: Contributions____________________

Enhances Funding Ratio

Contributions are a Future Asset

Usually pay Liability Benefit Payments

CLI will be recalculated to reflect this (Net Liability)

Current Assets should fund Net Liabilities

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Portable Alpha ________________

Transfer (Porting) of Excess Returns above Objective Index

from Alpha Portfolio(s)

to Beta Portfolio

Requires Custom Liability Index = Liability Objective

Alpha Portfolio = non-bonds to outgrow Liabilities

Beta Portfolio = bonds to match Liabilities



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Liability Alpha Portfolio(s) __________________________

Alpha = Excess Return above Objective

Objective = Outgrow Liabilities (Liability Index)

Beat a Market Index …but Lose to Liabilities = You Lose !

Liability Alpha = Excess Growth above Liability Growth

Requires Custom Liability Index to Measure Alpha

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True Alpha __________

Requires CLI to Measure Liability Growth (Returns)

Actual Return of Alpha Portfolios 5.00% - Actual Return of Liabilities - 5.00%

------------------------------------------ -------- True Alpha 10.00%

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Liability Beta Portfolio ___________________

Matches Return of Objective

Pension Objective = Liability Driven

Beta = Asset / Liability Matched Portfolio

Liability Beta = Liability Index Fund

Requires Custom Liability Index

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Portable Alpha(Benefits)___________

As Portable Alpha Transfers Excess Returns above Liability Index

Beta Portfolio grows and grows… creating 4 Major Benefits :

1. Reduces Contribution Costs (Fully Funds Liabilities)

2. Reduces Interest Rate Risks (Hedges Liabilities)

3. Increases Funded Ratio (Client Objective)

4. Increases Certainty of Meeting Objective

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Asset Allocation

______________

Should be based on “Funding Ratio” and “Time”

Deficit / Time (Average Life of Liabilities) = Alpha Needed

30% Deficit / 15 years = 2% per year

Larger the Deficit > Requires More Alpha

Estimated Alpha = ROA – YTM of Liabilities

ROA = 8%

YTM = 5%

Alpha E = 3%

2% / 3% = 67% allocation to Alpha



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Ryan ALM 5-year Scenario _______________________________________

Liabilities: Interest Rates go up

30-yr U.S. Treasury = 4.50% >> 8.50%

Growth Rate = ( 5.00%) Annual

Note: Liabilities behave like long bonds

------- Annual Growth Rate -------

Assets 5% 6% 7% 8% 9%

Liabilities - 5% -5% - 5% - 5% - 5%

Alpha (Annual) 10% 11% 12% 13% 14%

Funding Ratio = 50% > 82% 89% 94% 98% 103%

= 60% > 99% 104% 109% 115% 120%



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Bond Management________________

Mission Best Value in Bonds = Defeasance

Match + Fund Liabilities Chronologically

Liability Index Fund (Requires CLI)

Benefits Reduces Cost (Contributions)

Reduces Risk (Interest Rate Risk)

Reduces Volatility of Funded Ratio

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PIPER Study of Bond Managers____________________________

Annual Total Returns(Periods Ending 12/31/08)

5 yrs. 10 yrs.1st Quartile 4.67% 5.75%

Median 3.84% 5.22% Lehman Aggregate 4.64% 5.63%

Median Manager loses to Lehman Aggregate 1st Quartile loses to Lehman Aggregate (after fees)

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Problem: No Alpha in Bonds________________________

Total Returns (Periods Ending 12/31/09)

Indexes 10 yrs. 20 yrs. Lehman Aggregate 6.33% 7.01% Ryan 5-year STRIPS 7.21% 7.57% Difference - 0.88% - 0.56%

Lehman Agg Duration consistently @ 5 year Intrinsic Value of any investment = vs. Risk-Free Treasury

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No Generic Index has same Cash Flow as Clients Liabilities

Lehman Aggregate(12/31/06)

1-3 years 24.58%3-5 years 30.465-7 years 27.097-10 years 08.9110+ years 08.96

Lehman Aggregate = 40% in Securitized instrumentsCash flow behavior tends to move in wrong direction

Rates go up = duration gets longerCash flow gets reduced

Cash Flow________

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Bond Index Weights _________________

Tradition Market Cap Weighted Problem Don’t Know Current Amount Outstanding Treasury + Agency = Stripped Corporates = Sunk, Put Mortgages = Prepayment Delay New Breed Equal Weights (No Skewness)

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Performance Measurement

_______________________

Compares Assets vs. Objective

Objective = Custom Liability Index

Beta Portfolio = Liability Index Fund

Alpha Portfolios = Portfolios that Beat Liabilities

Requires CLI to Measure Alpha and Manage Beta Portfolio



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Problem: Pension Crisis Solution: Portable Alpha Ryan ALM, Inc. - The Solutions Company 1-888-RyanALM