The Pension Crisis 12/31/10

The Pension Crisis 12/31/10 Ryan ALM, Inc. - The Solutions Company1-888-RyanALM www.ryanalm.com

The Ryan Letter Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

Worst Cities / States Budget Deficits as a % of Budget Source: www.BusinessInsider.com Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

Pension Plan Objective ____________________ Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

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 Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

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) Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

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”. Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

Pension Protection Act (PPA) _________________________ Effective Calendar Year 2008 Extends Pension Funding Act of 2004 thru 2007 Discount Rate Methodology: • 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 Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

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”. Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

Discount Rates (Public) Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

Problem : Generic Indexes _______________________ • Represent the marketnot 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 Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

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 1- 888-Ryan-ALM www.RyanALM.com

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 1- 888-Ryan-ALM www.RyanALM.com

Cash Flow ________ No Generic Index has same Cash Flow as Clients Liabilities Lehman Aggregate (12/31/06) 1-3 years 24.58% 3-5 years 30.46 5-7 years 27.09 7-10 years 08.91 10+ years 08.96 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 Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

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 - 1.23% - 0.96% Ryan Liability Index 9.43% 11.17% Lehman Agg Duration consistently @ 5 years Ryan ALM, Inc. The Solutions Company 1- 888-Ryan-ALM www.RyanALM.com

The Pension Crisis 12/31/10