Search
 

How to Hedge the Interest Rate Exposure in Cash Balance Plans

Many companies mitigate the interest rate risk of their cash balance plans with floors using a binary approach. Here’s a better option.

By John Southall and Andrew Carter and Sabrina Ren | November 21, 2024 at 12:39 AM

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.

Complete your profile to continue reading and get FREE access to Treasury & Risk, part of your ALM digital membership.

Your access to unlimited Treasury & Risk content isn’t changing.
Once you are an ALM digital member, you’ll receive:

  • Critical Treasury & Risk information including in-depth analysis of treasury and finance best practices, case studies with corporate innovators, informative newsletters, educational webcasts and videos, and resources from industry leaders.
  • Exclusive discounts on ALM and Treasury & Risk events.
  • Access to other award-winning ALM websites including PropertyCasualty360.com and Law.com.

Already have an account?

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.

Treasury & Risk

Join Treasury & Risk

Don’t miss crucial treasury and finance news along with in-depth analysis and insights you need to make informed treasury decisions. Join Treasury & Risk now!

  • Free unlimited access to Treasury & Risk including case studies with corporate innovators, informative newsletters, educational webcasts, and resources from industry leaders.
  • Exclusive discounts on ALM and Treasury & Risk events.
  • Access to other award-winning ALM publications including PropertyCasualty360.com and Law.com.

Already have an account? Sign In Now
Join Treasury & Risk

Copyright © 2024 ALM Global, LLC. All Rights Reserved.