How ALM and LDI benefit pension plans

Plan sponsors have plenty to worry about these days. Many pension plans are facing funding gaps and higher resulting contribution requirements. In the corporate sector, low interest rates and new pension funding requirements have made managing volatility more important than ever. ALM and LDI provide the tools to manage pension funding volatility.

Because pension obligations typically reach far into the future, their values are highly sensitive to changes in discount rates. Plan sponsors now understand that they need to adjust how they manage their pension investments, or else they risk pension volatility becoming a burden on their cash flow or financial statements.

An asset-liability study can benefit a pension plan in the following ways:

• By quantifying the level and sources of investment risk and return relative to the plans' liabilities and analyzing the financial efficiency (risk/return) of the current asset allocation, an effective strategy that recognizes that both assets and liabilities can be employed to reduce volatility in contributions or on financial statements.
• We can analyze the effect on key risk/return metrics of making changes to the current asset allocation. This provides a more comprehensive understanding of the potential impact to the plan of altering the plan's asset allocation.
• Selecting the optimal asset allocation policy will help to control financial risks (funding, balance sheet, and pension expense) and maximize surplus returns to reduce the long-term cost of the plan.

Through a comprehensive risk-budgeting analysis, we also can address asset allocation (beta) and portfolio structure (alpha) risk/return together to develop more financially efficient portfolios than might otherwise be attained if they were addressed separately.