Russ Proctor; Marty MeninDefined benefit (DB) plans have endured much over the past
few years, from new regulations to volatile interest rates and equity markets,
all of which has led plan sponsors to find better ways to match their assets to
the liabilities of the plan. For retirement plan advisers, helping their
defined contribution (DC) plan clients find solutions for their closed or
frozen DB plans, can be a significant opportunity. PLANADVISER sat down with
Russ Proctor and Marty Menin, both directors of institutional sales at Pacific
Life, to talk about liability-driven investing (LDI) and a new strategy for
defined benefit plan sponsors that can be of interest to retirement plan
PS: What are some challenges for the traditional LDI
Proctor: Precise asset/liability matching is difficult for
pension liabilities, particularly for traditional LDI strategies. The
liabilities are paid monthly over a very long period of time, and the pension
liability is measured annually based on corporate bond rates. As those
corporate bond rates move, the liability moves as well. The asset not only has
to deliver the monthly cash flows, it also has to match the movement in the value
of the liability.
Traditional LDI strategies have had trouble with that
precise matching, which results in tracking error.
A lot of asset managers talk about the fact that you cannot
buy the curve, and they’re referring to the Citigroup Pension Discount Curve
(CPDC) that’s used by many actuaries and plan sponsors to measure the plan
liabilities. It would be a difficult task for an asset manager to try and buy
all the bonds used to develop the monthly CPDC.
Also, the bonds in the CPDC may not be a prudent investment
for a pension plan, due to the concentration by industry and issuer of the
bonds used in the curve. This concentration increases the downgrade and default
risk of the investments, and thus will not meet the diversification requirements
of the plan’s investment policy. If a bond is downgraded or defaults during a
month, it is simply removed from the CPDC in the following month. Thus, the
CPDC never suffers losses from downgrades or defaults. However, a traditional LDI
investment portfolio that actually purchased those bonds that were later downgraded
or defaulted will suffer a loss. With Pacific Insured LDI, because it follows
the curve precisely and uses the same benefit payment stream as the plan
actuary to measure the liabilities, relatively speaking, there is no credit
risk (no downgrades or defaults), no interest-rate risk and thus no tracking
PS: Can you tell me more about this Insured LDI product and
how the contract works?
Menin: Pacific Insured LDI was developed in response to plan
sponsors’ need of a better asset match for their pension liability. Insured LDI
provides a guaranteed contract value compared to the traditional LDI strategies
that use a “best efforts” approach. Insured LDI is the first solution to
precisely match that movement in the pension liability: No matter how the yield
curve changes from month to month, Insured LDI will match the plan’s projected
liabilities; and thus, the funded ratio will remain stable.
Advisers and pension plan sponsors can spend a significant
amount of time trying to understand complex traditional LDI strategies,
comparing actual results to expected results and reasons for the variances.
With Insured LDI, advisers can help executives focus their energy on running
their operations and not on worrying about the funded status volatility of the
Insured LDI is also flexible, so plan sponsors can modify
the product to meet their objectives. It does not need to be used for the
entire plan. For example, some plan sponsors are looking to start using Insured
LDI to just stabilize their retired liability, as illustrated in the pie chart
It also provides liquidity through the monthly benefit
payments made by Pacific Life to the pension trust. The plan sponsor can also
exit the contract completely with no penalties or surrender charges. Thus, they
are not locked into the contract.
PS: You have a client who’s been using this Insured LDI
group annuity contract for a couple of years now. Has that product delivered
what you—and your client—expected and promised?
Proctor: We’re very proud of the performance it’s had over
the last couple of years. The contract value moved exactly with their plan
liability based on the projected benefits that the plan sponsor provided. So,
as interest rates moved fairly violently over the last four years from month to
month, Insured LDI performed exactly as advertised: It stabilized the funded
ratio. Every month, no matter what happened to the yield curve or the equity
markets, their funded ratio stayed the same—while providing monthly payments
along the way to meet their cash-flow needs.
PS: How has the market changed and evolved in the last four
years since the product was introduced?
Menin: Interest rates were higher last year and they’ve
backed off about 50 to 60 basis points since the beginning of the year. For a
plan sponsor interested in stabilizing their funded status earlier this year,
our insured LDI product would have been a great solution for them. Could interest
rates continue down another 100 basis points? Perhaps, but with Insured LDI,
the plan sponsor does not have to worry if rates move up or down. The product
is meant to protect the asset portfolio from those volatile interest-rate changes
and to provide a superior asset/liability match.
As funded status improves, shifting into a risk-protected
asset like Insured LDI can help lock in the big gains some DB plans made last
year. Particularly as they get close to 100% funded, there’s not as much upside
for the plan. If equities run up another 30%, it doesn’t help much to be 30%
over-funded, but you certainly pay the penalty if there is a bad year and your
funded status decreases. Now is a perfect time to lock in that funded status. Insured
LDI can work for ongoing plans, but it is particularly helpful for those closed
and frozen plans that are approaching full funding, now is a great time to use
this type of a product.
The chart below shows a plan using a portion of its
fixed-income asset allocation for Insured LDI to obtain a precise asset/liability