Cash-balance liabilities: A new investment framework

Amy Trainor, FSA, Multi-Asset Strategist
Louis Liu, CFA, ASA, MAAA, Fixed Income Quantitative Strategist
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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. Please refer to the important disclosures section in the PDF available below.

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.

Introduction to cash-balance plans

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 1

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Authored by
Amy Trainor
Amy Trainor, FSA
Multi-Asset Strategist
Louis Liu
Louis Liu, CFA, ASA, MAAA
Fixed Income Quantitative Strategist

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