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The net impact of changes to accounting and regulatory regimes has been a much stronger focus on pension fund investment risk by corporate sponsors. Risk is no longer defined by way of fluctuations in the market value of defined benefit assets - instead, risk now means performance of a fund relative to movements in long dated bonds.

Simulataneously, the range of risk management products available from investment banks and asset managers has expanded significantly in recent years. Investment policies need to recognise the changed nature of risk and need to (where appropriate) incorporate use of sophisticated risk management products.

Mercer's investment insights

Interest rate hedging for defined benefit pension plans – A primer

Defined benefit schemes typically have very significant levels of embedded interest rate risk. Volatile interest rates mechanically lead to volatile funding ratios, as evidenced by balance sheet metrics in accounting disclosures. This is a significant issue for a majority of our clients and one which impacts both corporate financials and member security.

Investment banks and other financial institutions have an increasing range of products available to facilitate the management of interest rate risk. These products include swap overlays, interest rate derivatives, and leveraged bond funds. Our experience to date in working through the issues with clients, and in identifying the solution that best meets particular circumstances, suggests to us that there is value in publishing this ‘primer’ on the topic of interest rate hedging. This primer is a downloadable PDF.

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