The extent of the damage inflicted on pension plans by last year's stock market plunge suggests companies sponsoring defined-benefit (DB) plans will take defensive action. But one pension consulting firm warns that in the current environment, plan sponsors should be wary of implementing a popular approach to limiting a plan's interest-rate risk, called liability-driven investing (LDI).
LDI strategies aim to match a pension plan's assets more closely to its liabilities to avoid a mismatch that cuts into funding. One common way to do that is to put on an interest-rate swap that lengthens the duration of the plan's assets to bring it closer to the duration of the liabilities.
But Jon Waite, chief actuary at SEI Investments, a provider of asset management and investment operations solutions, says initiating an interest-rate swap right now might not work out that well because it's likely that as credit becomes more available, spreads will start to narrow. "It's possible that credit spreads could expand from the current levels, but we expect that interest rate spreads will decrease to be more in line with their long-term norms and as that happens, the value of your interest-rate swap is going to decrease," Waite says. "And that decrease is not in line with what's happening with your liabilities."
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