Advisory Opinion Offers LDI Clarity

October 16, 2006 ( - The Department of Labor (DOL) has issued an advisory opinion that supports taking pension plan liabilities into account when setting out an investment strategy - even if that results in an incidental benefit to the plan sponsor.

While some of the wording in the opinion was characteristically “obtuse,” in Advisory Opinion 2006-08A, the DoL said that plan fiduciaries would not violate their duties under the Employee Retirement Income Security Act (ERISA) “solely because the fiduciary implements an investment strategy for a plan that takes into account the liability obligations of the plan and the risks associated with such liabilities and results in reduced volatility in the plan’s funding requirements.”

With changes looming for pensions—both in terms of rising contribution thresholds for underfunded plans, and the Financial Accounting Standards Board’s (FASB) looming overhaul of financial statement accounting standards for pensions—investment managers and consultants are actively touting asset-liability matching (also known as liability-directed investing, or LDI) as a long-term solution for pension funding stability (see ” Fighting Fire with Fire “).

“Within the framework of ERISA’s prudence, exclusive purpose, and diversification requirements, the department believes that plan fiduciaries have broad discretion in defining investment strategies appropriate to their plans,” the opinion said, and “In this regard, the department does not believe that there is anything in the statute or the regulations that would limit a plan fiduciary’s ability to take into account the risks associated with benefit liabilities or how those risks relate to the portfolio management in designing an investment strategy.”  

However, “whether any particular investment strategy is prudent with respect to a particular plan will depend on all the facts and circumstances involved,” the opinion cautioned.   

Clarity Call

The opinion had been requested on behalf of JPMorgan Chase Bank, N.A., which on Thursday issued a press release that noted that the opinion “provides defined benefit pension plan fiduciaries with greater clarity on the consideration of liabilities and associated risks as part of prudent investment decision making.”  

“Many of our clients currently are re-evaluating their approach to managing their defined benefit pension plans as they adjust to the new funding legislation and pension accounting changes,” David Oaten, head of the North American Pension Advisory Group within the Investment Banking Division of JPMorgan, said in the press release.   “We have been assisting clients in addressing the many complexities and risks they face. This Advisory Opinion validates techniques which take liabilities into consideration for pension risk management.”

Fact “Patterns”

In explaining the rationale it relied on in issuing the advisory opinion (advisory opinions apply the law to a specific set of facts), the DoL restated that “fiduciaries of the plan must act prudently, solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits and defraying reasonable plan administrative costs when deciding whether to invest in a particular investment or use a particular investment strategy.”  

With regard to investing plan assets, the DoL cited 29 C.F.R. §2550.404a-1, interpreting the prudence requirements of ERISA as they apply to the investment duties of fiduciaries of employee benefit plans.   This regulation provides that the prudence requirements of Section 404(a)(1)(B) are satisfied if the fiduciary making an investment or engaging in an investment course of action has given appropriate consideration to those facts and circumstances that, given the scope of the fiduciary’s investment duties, the fiduciary knows or should know are relevant, and the fiduciary acts accordingly, according to the opinion.   This includes giving appropriate consideration to the role that the investment or investment strategy plays in respect to that portion of the plan’s investment portfolio that is within the scope of the fiduciary’s responsibility.

According to the opinion, the regulation further specifies the facts and circumstances that must be given appropriate consideration, including (but not limited to) a determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties) to further the purposes of the plan.  

This also includes consideration of the following factors:

  • the composition of the portfolio with regard to diversification,
  • the liquidity and current return of the portfolio relative to the anticipated cash flow requirement of the plan,
  • the projected return of the portfolio relative to the funding objectives of the plan.