Hedging the interest rate exposure of cash balance plans
For plan sponsors that have introduced cash balance plans as an alternative to more traditional defined benefit plans, the challenges of hedging the interest rate sensitivities that these plans introduce are complex but solvable.
The most used market benchmarks employed by pension plans are almost wholly inappropriate for cash balance plans and can potentially increase risk rather than reduce it. On this basis, the hurdle for introducing a customized liability benchmarked strategy is substantially lower than for traditional defined benefit plans. It is recommended that plan sponsors have a strong understanding of the unique market risk exposures cash balance plans present.
We continue to believe that setting explicit interest rate and credit spread hedge ratios for cash balance plans is appropriate, and in line with our previously released research.
An optimal strategy will involve a combination of credit assets to achieve the appropriate credit spread hedge (determined within a total portfolio context), Treasury securities and both long and short interest rate derivatives to match the specific key rate duration sensitivities of the cash balance plan.
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Learn more about hedging the interest rate exposure of cash balance plans in this whitepaper.
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