What is contingent immunization and how does the cushion spread work?

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AcadiFi · Accepted Answer

Contingent immunization is a hybrid strategy that combines active management with a safety net: the manager runs an active strategy as long as the portfolio remains above a floor, and switches to full immunization if the floor is breached. Mechanics: 1. DEFINE THE TARGET: A minimum acceptable return (e.g., 4.5% over 7 years). 2. COMPUTE THE SAFETY NET ASSET VALUE: PV of the target at current immunization rates. 3. COMPUTE THE CUSHION: Current portfolio value − safety net. Positive cushion means manager can take active risk. 4. RUN ACTIVE STRATEGY: As long as cushion > 0, manage actively (duration bets, sector rotation, credit selection). 5. TRIGGER: If cushion hits zero, IMMEDIATELY switch to immunization at the then-current rate — this locks in the target. Worked example: Meadowlark Endowment starts with $50M. Target: $64M in 7 years (4% per year). Current 7-year immunization rate: 5.2%. PV of $64M at 5.2% over 7 years = $44.95M. INITIAL CUSHION = $50 − $44.95 = $5.05M. Manager runs an active long-duration strategy. Suppose rates rise 80 bps; portfolio value drops to $46.5M. New immunization rate: 6.0%. Required safety net = $64M / 1.06⁷ = $42.57M. New cushion = $46.5 − $42.57 = $3.93M. Still positive — continue active. Alternative: rates rise 200 bps, portfolio drops to $42M. Required safety net at 7.2%: $64M / 1.072⁷ = $39.5M. Cushion = $2.5M. Still cushion. But if portfolio drops to $39.5M, cushion = zero — TRIGGER. Manager immunizes immediately, locking in the 4% target. ```mermaid flowchart TD A[Start] --> B[Cushion > 0?] B -->|Yes| C[Active mgmt] B -->|No| D[Immunize
at current rate] C --> B ``` Risk: in fast-moving markets, the trigger may fire late or the manager may hesitate, blowing the target. Discipline is critical.

What is contingent immunization and how does the cushion spread work?

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