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Setting the Interest Rate Hedge for Pensions

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In setting the investment strategy for a defined benefit (DB) pension plan, a decision regarding percent of liabilities to hedge must be made. There is no one right answer – different plans have different views dependent on varying circumstances. In this whitepaper, we present the strategic perspective of our philosophy when setting the hedge level of a DB pension plan.

LGIM America recommends that plans set a strategic hedge ratio equal to the plan’s funding ratio (i.e., 80% hedge for an 80% funded plan). This minimizes short-term risk, which is often uncompensated due to the uncertain future level of interest rates. Rather than focus on a plan’s historic hedge levels or current interest rate levels, we recommend that a plan primarily evaluate its investment strategy relative to this strategic hedge ratio target.

Plans may diverge from this strategic hedge ratio to reduce longer-term risks, as various trade-offs and cost considerations are plan specific. We will explain the rationale behind setting the strategic hedge ratio to minimize short-term risk, as well as discuss the longer-term risks many pension plans face.

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Learn more about the investment markets, timely topics and our firm capabilities in this whitepaper.

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Views and opinions expressed herein are as of the date published and may change based on market and other conditions. The material contained here is confidential and intended for the person to whom it has been delivered and may not be reproduced or distributed. The material is for informational purposes only and is not intended as a solicitation to buy or sell any securities or other financial instrument or to provide any investment advice or service. Legal & General Investment Management America, Inc. does not guarantee the timeliness, sequence, accuracy or completeness of information included. Past performance should not be taken as an indication or guarantee of future performance and no representation, express or implied, is made regarding future performance.

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