Pension immunization strategy

Have you considered immunizing pension plan liabilities? If your pension plans are underfunded, is an immunization strategy an option? Many plan sponsors are looking for ways to immunize their pension liabilities and minimize volatility.

The benefit of fully immunizing a pension plan is that the funded status of the plan remains fairly stable and predictable given most economic conditions. Even for an underfunded plan, an immunization strategy is an option and can be implemented via a “glide path” investment approach. This approach moves assets into fixed income in favorable market conditions and as the plan becomes better funded. A glide path maintains a good balance of retaining equity investments and lowering volatility over time as the funded status improves.

In order to take advantage of an immunization strategy, it helps to know the funded status of pension plans on any given day. In order to do this, a daily discount rate must be developed. However, discount rate indicators are typically only available on a monthly basis. The most popular discount rate reference is the Citigroup Yield curve, but again, this is only available at the end of the each month. However, there are other tools available that can provide “live” market values of a pension plan, on a daily basis, by developing a daily discount rate. Whether the discount rate is developed with the Citigroup Yield curve or a custom bond model, this tool develops an accurate proxy of your plan’s discount rate.

Once a discount rate is developed, a dashboard or daily automatic tool that can measure the daily funded status of your plan is important with a glide path investment approach. To do this, the plan sponsor needs to define a market measure of liability (e.g., pension benefit obligation, or PBO), determine asset reallocation trigger points (based on a plan’s funded status), and have access to a tool that automatically determines the funded status of a pension plan on a daily basis.

During the summer of 2012, the interest rate environment continued to be volatile. Pension discount rates exhibited a downward trend and often jumped significantly from one week to the next. Plan sponsors who monitored the daily funded status of their pension plans were able to reallocate assets quickly during opportune investment windows and improve and/or maintain a favorable funded status.

Immunization of pension plans is not a new concept. This strategy is usually implemented when a plan becomes fully funded. The ability to implement an immunization strategy for underfunded plans, and to monitor daily market conditions and quickly make asset reallocations, is now available and even advantageous with recently available tools. In addition, the Milliman Managed Risk Strategy can be used during phased de-risking as a way to protect plan assets from the downside exposures of investing in equities. For additional information on this approach or tool, please talk to your Milliman consultant to learn more.

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