- Multi-Asset Strategist
Skip to main content
- Funds
- Insights
- Capabilities
- About Us
- My Account
The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Cash-balance plan liabilities have been growing as a percentage of overall defined benefit (DB) plan liabilities, yet relatively little attention has been paid to the unique characteristics of these liabilities and their investment implications. In this paper, we first offer an introduction to cash-balance plans and the various formulas used to calculate their benefits. We then consider how each of these formulas affects the choice of an appropriate liability measurement and investment strategy. In particular, we look at the challenges faced by plans using a variable interest credit formula and propose an investment framework focused on three pillars: capital preservation, consistent income, and liquidity. Our analysis concludes that a dynamically managed blend of Treasuries, agency mortgage-backed securities, and credit can seek to keep pace with a variable interest credit rate while maintaining low volatility. We also address the liability characteristics and investment needs of plans using fixed interest credit and minimum interest credit formulas.
A cash-balance plan is very different from a traditional pension plan. In fact, it behaves a bit like a bank deposit. As Figure 1 illustrates, each plan participant has an individual notional account with an established balance at the beginning of the year. The balance grows over the course of the year based on the plan’s promised interest crediting rate, and the plan may make an additional contribution — called a “pay credit” — to the account as well.
Figure 2 highlights several key differences between cash-balance and traditional DB plans. The biggest of these is that the benefit of a cash-balance plan is expressed as the current account balance, while the benefit of a traditional plan is expressed as the annual benefit the participant is entitled to upon meeting retirement eligibility. This difference in how the benefit is defined and measured has implications for the interest-rate sensitivity, or duration, of the plan’s liability and, by extension, for the selection of an appropriate investment strategy that seeks to hedge or track the liability.
Further, cash-balance plans come in different flavors, depending on the plan’s choice of interest credit formula:
Variable interest credit (VIC) — The interest credit is reset each year based on an external market rate, such as the yield on the 30-year US Treasury bond. (Some newer plans set the interest credit based on the rate of return on plan assets.)
Fixed interest credit — The interest credit is set at a fixed level, such as 5%.
Minimum interest credit — The interest credit floats based on an external rate, but is subject to a floor. For example, the credit might be the greater of the yield on the 30-year Treasury bond or 5%. This formula has both VIC and fixed interest credit characteristics, driven by the relationship between the external rate and the minimum credit…
To read more, please click the download link below.
Time to derisk? Funded status up, but potential volatility ahead
Continue readingSetting ROAs for 2024: A guide for US corporate and public plans
Continue readingLiability-hedging diversifiers: What’s on your pension’s playlist?
Continue readingURL References
Related Insights
Stay up to date with the latest market insights and our point of view.
Time to derisk? Funded status up, but potential volatility ahead
LDI Team Chair Amy Trainor explains why US corporate DB plans may have a rare and limited opportunity to derisk and offers suggested action steps.
Using defensive equities in a return-seeking portfolio: A factor framework for corporate plans
Members of our LDI and Fundamental Factor teams share their views on defensive equity investments, including their role in a plan's portfolio and the current environment for defensive factors.
Corporate pension trends and topics: What’s top of mind for 2024?
Members of our LDI Team address a range of topics that US corporate plans will be thinking about in the coming year, from pension funding and accounting issues to portfolio diversification opportunities.
Setting ROAs for 2024: A guide for US corporate and public plans
How are pension plans adjusting their ROA assumptions? And how do those assumptions line up with our long-term capital market assumptions? Find out in this annual update.
Bank downgrades: Should LDI investors be worried?
Members of our LDI team discuss the implications of recent US bank credit-rating downgrades and offer potential next steps for corporate plan sponsors.
Liability-hedging diversifiers: What’s on your pension’s playlist?
Corporate pensions moving closer to their end state may benefit from more diversified liability-hedging allocations. To help, LDI Team Chair Amy Trainor offers a liability-hedging diversifiers “playlist” — a set of asset classes and strategies that may harmonize well with a variety of objectives, from downside mitigation to long-term outperformance versus long corporate bonds.
Keep your spread and earn on it too? The case for intermediate credit
Amid heightened volatility and an uncertain macro environment, members of our LDI Team see opportunity for corporate plans in the intermediate credit market.
Mind the liquidity (and cost) gap: Revisiting a plan’s hedge-ratio approach
Members of our LDI Team take a fresh look at the process of setting and managing liability hedge ratio targets, including liquidity considerations that are top of mind today and the implementation toolkit.
LDI in 2023: Ten questions corporate plan sponsors are asking
Members of our LDI Team address a range of topics that US corporate plans will be thinking about in the coming year, from the investment implications of pension accounting changes to the role of alternatives in a return-seeking portfolio.
Setting ROAs for 2023: A guide for US corporate and public plans
How are pension plans adjusting their ROA assumptions? How do those assumptions line up with our long-term capital market assumptions? Find out in this annual update.
URL References
Related Insights