What is the rule about active vs retired lives and pension plan duration?

Question

AcadiFi · Accepted Answer

**Short answer:** duration is the weighted-average time until a liability cash flow. Active employees have their biggest cash flows DECADES in the future (when they retire). Retired employees are receiving cash flows NOW. So a plan dominated by retirees has cash flows happening soon = short duration; a plan dominated by active employees has cash flows happening far in the future = long duration.

### The mechanism

```mermaid
flowchart TD
    A[Plan participant] --> B{Active or retired?}
    B -->|Active| C[Cash flows: starts at retirement, e.g., 20-30 years from now]
    B -->|Retired| D[Cash flows: NOW and continuing through life expectancy]
    C --> E[Average wait: ~15-20 years from now]
    D --> F[Average wait: ~6-10 years from now]
    E --> G[Active duration ~ 15-20 years]
    F --> H[Retired duration ~ 6-10 years]
    style G fill:#c9a84c,color:#0a0a0f
    style H fill:#0d6e3a,color:#ffffff
```

### A worked example

Plan A — Young plan:
- 700 active employees, average age 38
- 300 retired participants, average age 70
- $D_{\text{active}} \approx 18$ years (peak benefits start in 27 years, paid through age 85)
- $D_{\text{retired}} \approx 7$ years (already in pay, average remaining life expectancy)

$$D_{\text{plan A}} = \frac{700 \times 18 + 300 \times 7}{1000} = \frac{12{,}600 + 2{,}100}{1000} = 14.7 \text{ years}$$

Plan B — Mature plan (same total size):
- 200 active, 800 retired
- Same per-group durations

$$D_{\text{plan B}} = \frac{200 \times 18 + 800 \times 7}{1000} = \frac{3{,}600 + 5{,}600}{1000} = 9.2 \text{ years}$$

Difference: 5.5 years. Plan B has dramatically shorter duration → lower risk tolerance → more conservative asset mix (more bonds, fewer equities) and shorter-duration bonds matched to the shorter liability stream.

### What this means for asset allocation

```mermaid
flowchart TD
    A[Plan duration] --> B{What asset mix matches?}
    B -->|Long duration ~15 years| C[Higher equity allocation OK]
    B -->|Long duration ~15 years| D[Long-duration bonds to match]
    B -->|Short duration ~9 years| E[Lower equity allocation]
    B -->|Short duration ~9 years| F[Intermediate-duration bonds]
    style C fill:#0d6e3a,color:#ffffff
    style E fill:#c9a84c,color:#0a0a0f
```

Beyond risk tolerance, the duration of plan liabilities directly drives:
1. **Equity vs bond mix** — longer duration allows more equity (longer to recover from drawdowns)
2. **Bond duration** — bonds should be duration-matched to liabilities (immunization)
3. **Cash buffer** — more cash for mature plans to meet near-term benefit payments

### Workforce trajectory

The same plan ages over time. A 1980-vintage plan that started young with 80\% active workers now has 70\% retirees — the plan duration has DROPPED OVER TIME from ~15 years to ~8 years, and the asset allocation should have rotated AWAY from equities to MATCH.

A plan that DID NOT adjust its asset allocation as the workforce aged ends up with a long-duration equity-heavy portfolio funding short-duration retiree payments — a liquidity and volatility mismatch that often triggers crises.

For the full risk-objective framework see our [DB pension risk article](/knowledge/db-pension-plan-risk-considerations-five-dimensions-cfa-level-3).

What is the rule about active vs retired lives and pension plan duration?

The mechanism

A worked example

What this means for asset allocation

Workforce trajectory

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