How does offering a lump sum form of payment option affect an LDI strategy?
A lump sum benefit payment option (not just a temporary window) can have a significant effect on the design of a DB plan’s LDI strategy. Expected cash flows are less certain and it may be difficult to determine the correct duration of the plan liabilities by use of the expected cash flow information provided by the plan actuary alone.
The LDI manager needs to understand what assumptions and methods the actuary used to calculate the projected cash flows. Becoming familiar with the form of payment, actuarial equivalence and mortality assumptions is particularly important, to ensure that the LDI strategy is aligned to the appropriate hedging target.
Given the interest rate risk most DB plans carry, LDI is still a great option, but plan sponsors should be aware of potential LDI strategy challenges and be prepared to make adjustments where necessary.Download research