Key Takeaways
- • NEPC argues that VEBAs, which have traditionally pursued total return strategies, can benefit from a liability-driven investing (LDI) framework, particularly plans with funded status above 80%.
- • A de-risking and re-risking glide path is proposed as a key differentiator from pension glide paths, which generally de-risk as funded status improves but do not re-risk when funded status declines.
- • Limited benefits of a material surplus exist for VEBAs because of possible unrelated business income tax (UBTI) and the 100% excise tax on asset reversion to the plan sponsor.
- • Hedging liabilities precisely is difficult because liability discount curves are not investable and some actuarial assumptions are un-hedgeable, particularly healthcare inflation for health and welfare plans.
- • In a NEPC case study, Plan B moved to a two-way dynamic glide path and its funded status rose from 75% to 105% over three years, while Plan A continued a total return approach.
Summary
This final installment of NEPC's three-part series on Voluntary Employees' Beneficiary Associations (VEBAs) makes the case for liability-driven investing (LDI). According to the article, most VEBAs have traditionally pursued a total return approach, but NEPC believes an LDI framework is appropriate in certain instances. Like pension plans, VEBAs face regulatory and record-keeping requirements that call for actuarial valuations and projected benefit cash flow streams. NEPC argues that VEBAs can adapt the LDI approach that pension sponsors have used to manage funded status and contribution volatility while preserving long-term upside.
NEPC suggests that an LDI strategy with a glide path may be appropriate for VEBAs with funded status above 80%. The firm cites several reasons. First, a material surplus offers limited benefit unless asset transfers are contemplated, since some plans may begin generating unrelated business income tax beyond a certain funded status, and asset reversion to the sponsor is costly given the 100% excise tax. Second, liability values can fluctuate year to year due to assumption changes, demographic experience and discount rate movements, so an LDI allocation can align assets with obligations. Third, although valuations are generally annual, tools exist to monitor funded status daily, which NEPC describes as an essential component of an LDI framework.
NEPC's central differentiator is a de-risking and re-risking glide path. Pension glide paths generally de-risk as funded status improves but do not automatically re-risk if it declines. For VEBAs, a two-way structure is intended to offset the impact of un-hedgeable actuarial factors. Written into the investment policy statement, it can reduce the need for committees to deliberate on each allocation change, which the article notes can be cumbersome and lead to missed opportunities during rapid market moves.
The article also acknowledges practical challenges. Precise liability hedging is difficult because liability discount curves are not investable and some assumption changes cannot be hedged, which may introduce noise. NEPC recommends periodic funded status attribution reviews. For health and welfare plans tied to healthcare inflation, inflation-sensitive proxies may serve as a practical alternative to precise hedges.
In a two-plan case study, NEPC worked with one governance committee overseeing Plan A and Plan B, which operate in different industries. Both began with a 70% equity and 30% fixed income total return strategy, with funded status of 30% for Plan A and 75% for Plan B. Plan A's funded status ranged between 25% and 30%, and NEPC recommended it continue a total return approach that prioritized liquidity, shifting to a more balanced equity and fixed income mix and ceasing new private credit commitments. Plan B's funded status rose to 105% from 75% over three years, with average annual changes exceeding 10%, partly due to actuarial liability adjustments. Plan B adopted a two-way dynamic glide path, which the article says improved governance by enabling timelier responses to funded status changes without committee approval for each shift. The article concludes that LDI can suit some plans, depending on funded status, liabilities, governance and risk tolerance.
NEPC suggests that an LDI strategy with a glide path may be appropriate for VEBAs with funded status above 80%. The firm cites several reasons. First, a material surplus offers limited benefit unless asset transfers are contemplated, since some plans may begin generating unrelated business income tax beyond a certain funded status, and asset reversion to the sponsor is costly given the 100% excise tax. Second, liability values can fluctuate year to year due to assumption changes, demographic experience and discount rate movements, so an LDI allocation can align assets with obligations. Third, although valuations are generally annual, tools exist to monitor funded status daily, which NEPC describes as an essential component of an LDI framework.
NEPC's central differentiator is a de-risking and re-risking glide path. Pension glide paths generally de-risk as funded status improves but do not automatically re-risk if it declines. For VEBAs, a two-way structure is intended to offset the impact of un-hedgeable actuarial factors. Written into the investment policy statement, it can reduce the need for committees to deliberate on each allocation change, which the article notes can be cumbersome and lead to missed opportunities during rapid market moves.
The article also acknowledges practical challenges. Precise liability hedging is difficult because liability discount curves are not investable and some assumption changes cannot be hedged, which may introduce noise. NEPC recommends periodic funded status attribution reviews. For health and welfare plans tied to healthcare inflation, inflation-sensitive proxies may serve as a practical alternative to precise hedges.
In a two-plan case study, NEPC worked with one governance committee overseeing Plan A and Plan B, which operate in different industries. Both began with a 70% equity and 30% fixed income total return strategy, with funded status of 30% for Plan A and 75% for Plan B. Plan A's funded status ranged between 25% and 30%, and NEPC recommended it continue a total return approach that prioritized liquidity, shifting to a more balanced equity and fixed income mix and ceasing new private credit commitments. Plan B's funded status rose to 105% from 75% over three years, with average annual changes exceeding 10%, partly due to actuarial liability adjustments. Plan B adopted a two-way dynamic glide path, which the article says improved governance by enabling timelier responses to funded status changes without committee approval for each shift. The article concludes that LDI can suit some plans, depending on funded status, liabilities, governance and risk tolerance.
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