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New risks to de-risking and legacy glidepaths

July 27, 2022
clock 2 MIN READ

The rise of interest rates is top of mind for most investors. How is this change affecting pension plans?

Good news for funded status

The current rate environment has improved funded status for many pensions in the face of a declining equity market. How each plan responds to this shift is a function of its allocation to fixed income and the resulting hedge ratio. While this may feel like a great opportunity to lock in funded status, there are other factors to consider.

Bad news for funded status

There is an unintended consequence to the higher rate environment: the annual interest cost (or ongoing carry cost) has also increased. For example, in a low interest rate environment the annual estimate of liability growth may have been as low as 3 to 4%. With this increase in interest cost, it could now be 4.5 to 6.5%. This means that the return necessary to keep pace with liability growth, benefit payments, and expenses may increase to the point of needing to re-risk rather than de-risk.

Check your metrics

While generally positive for pension funded status, plan sponsors question how rising interest rates impact glidepath decisions. Specifically, does further de-risking make sense? The current environment warrants a review of asset allocation, glidepath, and the amount of Liability-Driven Investing (LDI), including the construction of the LDI and its yield vs interest cost.

Understanding the impacts on funded status in this environment is a first step to improving strategy and eliminating inefficient glidepaths. It is critical to examine these metrics. While on the surface this appears to be an opportunity to lock in funded status, there is an unintended consequence to the increase in discount rates. Plan sponsors may be quite surprised by the impact of de-risking further in this environment.

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Randy Cusick

Managing Director, Client Portfolio Manager, Institutional Group

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Information provided by SEI Investments Management Corporation, a registered investment adviser and wholly owned subsidiary of SEI Investments Company (SEI). Neither SEI nor its subsidiaries is affiliated with any firms mentioned herein.

There are risks involved with investing including loss of principal. No investment strategy, including diversification, can protect against market risk or loss.

Content as of 7/30/2022.