The paper highlights why mismatching pension liability duration is not a costless bet on rising interest rates. Most asset allocation approaches do not include an estimate of the term risk premium and, in not doing so, exclude the expected cost of unhedged interest rate risk. In this paper, they explore:
• What the term premium is and how to estimate it;
• Why they believe a duration mismatch is expected to cost the typical U.S. plan around 1% in funded status annually; and
• Strategic asset allocation considerations to reduce this ‘hidden’ cost.