Immunization of Pension Funds and Sensitivity to Actuarial Assumptions: Comment

A 1980 article by Keintz and Stickney outlined a bond duration method for immunizing pension plans from market rate risk. Unexpected alterations in market rates cause offsetting changes in pension assets and liabilities. They employed Macaulay's bond duration formula to demonstrate how these opposing balance-sheet changes may protect a plan from random market rate movements. Keintz and Stickney, however, failed to point out that some pension plans may desire to invest in corporate bonds where call features could alter maturity structure unexpectedly. In addition to original purchase at premium or discount, bond duration also varies with redemption value and with the time period before the call takes place. Callable issues can be purchased while retaining some of the benefits of duration. Bonds with call periods in the far future and substantially higher yields than non-callable issues give durations which approximate fixed maturity bonds. Purchase of such instruments should allow a fund to diversify into corporate bonds without creating undue uncertainty as to duration.