How should pension plans approach asset liability management?

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AcadiFi · Accepted Answer

Pension ALM frames the investment problem as matching or managing the gap between plan assets and plan liabilities (the present value of projected benefit obligations). Unlike endowments with perpetual horizons, DB pensions have defined cash outflows driven by retiree longevity, salary growth, and demographic shifts. The liability behaves like a long-duration inflation-linked bond with embedded longevity options. Two philosophies dominate. Liability-driven investing (LDI) prioritizes hedging liability sensitivities — duration, convexity, and inflation — using long bonds, swaps, and inflation derivatives. Return-seeking (RS) prioritizes earning returns above discount rate to close funding gaps. In practice, most plans split assets into a hedging portfolio (maybe 60% of assets) and return-seeking portfolio (40%). For Argent Pinehurst Pension, a $4.2B plan with 85% funded status and 14-year liability duration, ALM would hedge roughly 90% of interest-rate duration with long Treasury STRIPS and interest-rate swaps, while the 40% RS sleeve in equities, private credit, and real assets targets excess return to close the funding gap. Key metrics: surplus ($ assets minus $ liabilities), funded ratio (assets / liabilities), surplus at risk (VaR-style measure of surplus). Glidepath policies automatically de-risk — shift from RS to LDI — as funded status improves, locking in gains. Frozen plans with no new accruals increasingly focus on full hedging or pension risk transfer. Sponsor covenant strength and PBGC insurance also shape risk appetite.

How should pension plans approach asset liability management?

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