Cash-balance plan liabilities have been growing as a percentage of overall defined benefit plan liabilities, yet relatively little attention has been paid to the unique characteristics of these liabilities and their investment implications.
While a high-quality long-duration bond portfolio would generally be considered a natural hedge for a traditional plan liability, there is no such natural liability-hedging asset for many cash-balance plans due to their interest credit formula. Consequently, any investment strategy that aims to keep pace with the formula will require some degree of risk-taking.
With this in mind, we sought to devise an investment framework that aims not to hedge but to track cash-balance plan liabilities. We began by distilling the cash-balance liability into what we view as its key risk characteristics and then identified three desired investment attributes: preservation of capital, consistent income, and liquidity.
In this paper, we offer an introduction to cash-balance plans and the formulas used to calculate their benefits. We then consider how these formulas affect the choice of an investment strategy. Finally, we outline our new investment framework.