Understanding liability-relative return needs
Understanding their plans’ liability-relative return requirements helps defined benefit (DB) plan sponsors choose the most appropriate asset allocation strategy. Through this exercise, sponsors come to understand possible “hurdle rates” that need to be achieved through investment return. Depending on objectives and circumstances, return needs for DB plans can vary significantly – from a fully funded, frozen DB plan needing returns as low as 4% to 5% per year, to an underfunded, open/ongoing plan with return needs in the double digits that are unlikely to be achieved by investment returns alone. That said, return needs should also be balanced with other plan sponsor considerations, such as contribution policies and surplus risk management objectives.
In this paper, we break down the liability-relative return components for DB plans and provide a few examples of how these translate into specific DB return needs.