Many plan sponsors have responded to the increased risks and affordability challenges of traditional defined-benefit pension plans by transitioning to cash balance plans. However, because cash balance plans base future benefits on a predefined crediting rate—which is often tied to long-term interest rates, such as a 30-year par yield—both their benefit amounts and their liability discount rate are sensitive to changes in interest rates.

Hedging to mitigate a cash balance plan’s interest rate risk is complicated. For one thing, many cash balance plans include interest rate floors (e.g., 5%), so liabilities are fixed at low interest rates but variable as rates rise, resulting in shorter durations at higher yields. Second, cash balance plans tend to use long-term interest rates, rather than short-term (cash or T-bill) rates, for indexation.