Revisiting the Term Premium Cost on Funded Status
After detailing our findings about the persistently positive term-risk premium across developed market yield curves and how it can affect pension plans’ funded status several years ago, we're revisiting the topic amid the considerable improvement in plans’ funded status and the corresponding implications for their fixed income allocations. Despite these improvements, we find many plans are still not fully hedged to their liabilities’ interest-rate risk.
In this paper, we update our analysis of the term-risk premium, explore new ways to measure it, and expand upon our view that increasing interest-rate hedge ratios can lower funded status risk while increasing expected funded status return. There are not many investment decisions that can lower risk and raise return—when these opportunities present themselves, they warrant careful consideration.
