Pension funds—public and corporate—are suffering from volatility, both in funded status and annual expense, much of which is driven by the volatility of the assets they hold. For the past 10 or 20 years, the concept of risk management for pension funds has been focused on diversification. But diversification doesn’t work when everything falls at the same time.
The variable annuity industry provides an alternative model. Starting in the early 2000s, life insurance companies began using sophisticated risk management techniques in order to offset the liability of the guarantees that they promised their policyholders. These hedging programs were 93% effective during the financial crisis, and saved the insurance industry $40 billion.
How do we translate what the variable-annuity writers are doing into the pension plan space? Doing so involves two sophisticated risk management techniques: volatility management and a capital protection strategy.
This article first appeared in a supplement published by The Bond Buyer.