The Problem with De-risking Hedges

Many plan sponsors are coming to realize that subjecting their pension system’s assets to the whims of the market may not be the most prudent action to be taken. As a result, they are actively searching for strategies that might aide them in taking risk off the table in an attempt to stabilize their plan’s funded status and contribution expense. Unfortunately, they have in many cases pursued duration-matching strategies (Immunization), Interest Rate Swaps, futures, derivatives, risk overlays, etc. which are all hedging tools to help assets match the liability growth rate. Regrettably, they are NOT de-risking strategies since they do not match the liability cash flows (benefit payments). Duration matching hedges have several difficult data gathering choices particularly with determining the average duration of a plan’s liabilities.

Importantly, where do you get the average duration of liabilities? Most, if not all, actuarial reports do not provide this calculation. Furthermore, they do not provide the projected liability benefit payment schedule, which you would need to calculate duration. In addition, the fact that actuarial reports are lagged (3-6 months) annual reports there would be seriously delayed information. In addition, the duration calculation coincides with a precise moment in time. As time and interest rates change, so will the duration calculation. Only A Custom Liability Index (CLI) based on each pension’s unique liability benefit payment schedule could provide an accurate and monthly duration profile from which to accurately de-risk a pension plan.

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