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People are enjoying longer lives and retirements, and the Society of Actuaries recently finalized new mortality tables that reflect this trend. Formal adoption of the tables by the IRS probably won’t come until 2016, but auditors have already begun asking plan sponsors to use them. The new tables will increase the liabilities for a typical plan by 4% to 8%. This may initially seem like a daunting setback, but as plans review their goals and the tools available for achieving them, they are likely to find that staying on track won’t require a heroic effort.

Thanks to the cushions built into glide paths, most plans will be no further from their end-points after the changes have been implemented. The new tables bring US GAAP valuations of the liabilities, used by plan sponsors, closer to the valuations used by insurers, who price longevity risk as accurately as possible. But since plans were already setting their glide path destinations well above 100% to allow for uncaptured risk, glide paths will need to be recalibrated rather than overhauled.

While longer liabilities may lower hedge ratios, capital efficient hedging tools can help keep plans on track. Along with raising the value of a plan’s liability, the new mortality tables also force a recognition of the fact that payments to retirees will extend further into the future. In more technical terms, the duration of the liability has increased. Together with the higher valuation, this increase in duration magnifies the sensitivity of the liability to changes in interest rates—with negative consequences for hedge ratios. But capital-efficient hedging instruments such as STRIPS and derivatives can help a plan restore its hedge without reducing its growth allocation.

Longevity and Pension Risk

Using liability cash flows to benchmark performance can improve governance and risk management.
Most fundamentally, liability benchmarking is about steering a pension plan by focusing on the plan’s core mission of providing retirees the benefits they have earned. It calls for managing the portfolio against the plan’s unique future expected benefit payments. A liability benchmarking framework can help prevent a portfolio’s interest rate hedge ratio from dropping when time horizons are extended, because an investment manager can dynamically adjust the portfolio to maintain the targeted hedge.