A dedicated cash-balance strategy: Why now?

For corporate defined benefit (DB) plans with a cash-balance formula that uses a bond-based interest-crediting rate, this might be the time to consider adding a dedicated cash-balance approach to the liability-hedging allocation. Here we outline three drivers behind our call to action:

• A steeper yield curve
• A lower incidence of minimum interest-crediting rates applying amid higher rates (as well as some regulatory changes applicable to minimum rates)
• A higher proportion of the liability being attributable to cash-balance formulas for hybrid plans (plans using both cash-balance and traditional DB formulas)

A steeper yield curve

Many plan sponsors with hybrid plans calculate the liability’s interest-rate duration by assigning zero duration to the cash-balance liability and blending it with the duration for the traditional liability. This blended duration is the target for the liability-hedging portfolio. There are many ways to construct a portfolio to achieve the blended duration target, all of which are generally equivalent to using cash to hedge the cash-balance liability and a duration-matching strategy to hedge the traditional liability. While this approach is effective in matching the liability’s interest-rate exposure, it can come up short in its ability to keep pace with the cash-balance formula’s interest-crediting-rate accrual and ultimately lead to a drag on the plan’s funded ratio.

In the inverted yield curve environment of the last few years, the duration-blended approach worked out well for plans, as cash returns outpaced the longer-duration yield index common in many bond-based cash-balance designs. But with the yield curve having returned to its more normal steepened state, this risk is more acute: The current spread between the 30-year Treasury yield (a common interest-crediting rate) and cash is about 120 bps (Figure 1) and the longer-term median spread is 240 bps.¹

Figure 1

With this risk in mind, we think plans should consider a dedicated cash-balance strategy that aims to match the interest-crediting-rate accrual over a market cycle by investing in a diversified mix of high-quality income-producing assets. For example, this mix might include:

1. Core income-producing sectors, such as corporate credit; noncorporate government sectors and taxable municipal bonds; and securitized credit
2. Modest “plus” allocations to enhance return potential, such as select high-yield and emerging market debt
3. High-quality, liquid sectors that may help with preservation of capital and accommodate lump-sum distributions, such as Treasuries and agency mortgage-backed securities

This diversified mix would maintain a low-duration posture to pursue a better balance between credit and interest-rate risk and, therefore, more attractive risk-adjusted returns. Our historical simulations indicate this type of approach can be more effective in matching the interest-crediting-rate accrual and maintaining the funded ratio, while adding only modestly to funded-ratio volatility (read more on this research here).

A lower incidence of minimum interest-crediting rates applying

As noted, many bond-based cash-balance formulas index the interest-crediting rate based on a long-maturity Treasury yield — typically, the 30-year yield or the 10-year yield. Many plans have also implemented minimum interest-crediting rates — for example, the greater of the 30-year yield or 4% (and in the low-rate regime that followed the global financial crisis, the pre-set rate floor often applied).

When the minimum rate significantly exceeds the market index yield (i.e., it’s deep in-the-money, to use options parlance), the cash-balance liability takes on duration, typically to around 8 – 12 years based on our observations, although it depends on plan-specific characteristics. The duration reflects the fact that the minimum interest-crediting-rate accrual has a value, and the lower rates go, the more valuable that guarantee becomes — and vice versa as rates rise toward the minimum rate. Many plans have appropriately reflected this duration characteristic in their liability-hedging targets.

But now rates have risen — the 30-year yield has been above 3% since the second quarter of 2022 and above 4% since mid-2023, and it is currently approaching 5%. As a result, many plans find themselves in (or soon to be in) a position where the index yield is above the minimum and the cash-balance duration has dropped back to zero.¹ This may warrant a refresh of the hedging strategy and the introduction of a dedicated cash-balance approach that, as mentioned, focuses on income accrual with a low level of risk and duration.

As an aside, many plans subject to ERISA implemented a minimum interest-crediting rate to comply with anti-backloading rules. The SECURE 2.0 Act amended these rules for cash-balance plans and allows removal of the minimum rate if certain conditions are met. Plan sponsors may want to inquire with their actuary and legal counsel to learn more.

A higher — and growing — cash-balance liability share

Hybrid plans that froze a traditional DB formula and replaced it with a cash-balance formula initially could treat the cash-balance component as “noise,” as it often applied prospectively only (in some cases, only to new entrants) and may represent a nominal share of the liability in the years immediately after adoption. But when traditional benefits to a grandfathered population have been paid out and a growing share of the population has built up sizable cash-balance accounts, plans may find that cash balance represents a more meaningful share of the liability.

How much is meaningful? Our research suggests that once the cash-balance proportion reaches 20% – 30% of the liability, a dedicated cash-balance hedging strategy may be warranted to be better positioned to keep pace with the interest-crediting-rate accrual. For more on this topic, read our article, Cash-balance and traditional liabilities: An integrated investment approach.

¹Source: Bloomberg. Month-end observations from 28 February 2021 to 31 January 2026. Current yields as of 31 January 2026.