What drives funded ratio volatility and how can sponsors manage it?

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AcadiFi · Accepted Answer

Funded ratio (FR = assets / liabilities) volatility comes from three main sources: asset return volatility, liability sensitivity to discount rate changes, and cross-correlation between asset and liability moves. Assets are typically shorter duration than liabilities, so when rates rise, liabilities fall more in dollar terms than bond assets, and FR improves mechanically even without equity help. Conversely, rates falling hurts FR. For Lindmere Everest Pension with 14-year liability duration and 6-year asset duration, a 100bp rate drop lowers assets by ~6% but lowers liabilities by ~14%, so FR drops significantly. Equity returns add another source: a 20% equity rally in a 50% equity allocation adds 10% to assets, boosting FR by ~10/90 = 11 percentage points. Cross-effects matter — equities and rates are negatively correlated in some regimes (flight-to-quality) and positively correlated in others. ```mermaid flowchart LR A[Funded Ratio
Volatility] --> B[Asset
Returns] A --> C[Rate
Changes] A --> D[Inflation
Moves] ``` Dampening strategies. Duration matching: extend asset duration toward liability duration using Treasury STRIPS, swaps, or bond overlay. Inflation hedging: use TIPS and inflation swaps for inflation-linked benefits. Reduce RS allocation as funded status improves via a glidepath. Tail hedging: buy equity puts to protect against rare but severe downturns. A well-hedged plan can have FR volatility of 2-4% annually vs 8-12% for a 60/40 unhedged plan — massive contribution stability benefit for sponsors.

What drives funded ratio volatility and how can sponsors manage it?

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