Pension risk management

I just had the opportunity to speak at the Opal/LATEC conference in New Orleans on the topic of pension risk management. For many plan sponsors and their consultants, “risk management” is focused on the asset side of the equation, but managing a DB pension plan is much more than just assessing the risks associated with plan assets. We, at Ryan ALM, espouse a risk management approach that focuses first and foremost on the plan’s liabilities.  Liability-driven investing (LDI) is a refocusing of the management of the plan’s pension assets away from an “asset only” approach to an approach that considers both the assets and the pension plan’s specific liabilities. The objectives are two fold: 1) secure the promised benefits, and 2) maximize the cost efficiency of the plan’s asset allocation.

There is more than one way to de-risk a plan within the broad Liability-driven investing category:  pension risk transfers, duration matching, and cash flow matching are three of the most common approaches. At Ryan ALM we utilize cash flow driven investing (CDI) as the preferred implementation for we believe that it is the most precise and least expensive de-risking strategy.  However, many corporate plans, and some public funds and multiemployer plans, have used duration matching strategies to accomplish their goal of neutralizing interest rate risks (not necessarily securing the benefits) with a combination of target duration LDI, Treasury STRIPS, long government/credit, and in some cases derivatives to construct a portfolio suited to meet an individual plan sponsor’s liability hedging goals.

Plan sponsors that have used long credit maturities and longer duration STRIPS to duration match their plan’s liabilities may want to reassess the composition of their fixed income program at this time.  U.S. interest-rates continue to plummet, as both the 10-year (1.33%) and 30-year U.S. Treasury (1.82%) rates are at historic lows. By selling the long-term credits/STRIPS, plan sponsors can lock in significant gains from these assets and then use the proceeds to cash flow match near-term Retired Lives liabilities (1-10-years) chronologically in order to finally secure those promised benefits, while significantly reducing the interest-rate sensitivity of their holdings since CDI matches and funds future values (benefit payments) which are not interest rate sensitive.

Obviously, no one knows where U.S. rates are headed, but at these incredibly low levels the probability of seeing interest rates remain flat to rising is greater than rates continuing to fall much further from here. We encourage you to use this unique opportunity to restructure your LDI program away from duration matching and refocus on cash flow matching 1-10 year Retired Lives using shorter maturity bonds to truly secure the benefits that have been promised to your plan participants. We’d be pleased to help guide you in this process.