New DOL Advisory Opinion about Pension Fund Investment Strategies Focused on Liability Management

The U.S. Department of Labor yesterday released Advisory Opinion 2006-08A, which concludes that a fiduciary of a plan may, consistent with the exclusive benefit and the prudent man rules under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), take into account the liabilities of the plan in determining the appropriate portfolio investment strategy for the plan. A copy of the Advisory Opinion is attached hereto.

Investment strategies designed around plan liabilities were widely used in the 1980’s when many plans created “dedicated bond portfolios,” under which a plan would invest in bonds that would generate proceeds that matched the plan’s expected need to make cash benefit payments. More recently, plan fiduciaries have considered other investment techniques to match the funding level of a plan with its liabilities - e.g., to “lock in” a surplus position or other favorable funding level through the use of derivatives. While some have argued that the funding level of a plan maintained by a solvent plan sponsor should not influence investment strategies by the plan’s fiduciary, it is noteworthy that some plan sponsors that were financially solid in the recent past are today financially troubled companies that maintain severely underfunded plans. For this and other reasons, a prudent fiduciary might reasonably conclude in appropriate circumstances that an investment strategy focused around a particular plan’s liabilities is in the interest of the plan and its participants.

At the same time, plan sponsors have concerns about the effect of pension funding levels on the sponsor’s financial statements in light of newly-issued Statement of Financial Accounting Standards (FAS) 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, and on the volatility of the plan sponsor’s funding obligations in light of the changes made by the Pension Protection Act enacted in August of this year. Put simply, plan investment decisions will typically have a more significant effect on plan sponsor financials than in the past.

The Advisory Opinion indicates that, while it is ultimately a facts and circumstances question, a fiduciary may appropriately take a plan’s liabilities into account in formulating an investment strategy in the best interests of the plan’s participants, even though that strategy may incidentally benefit the plan sponsor by affecting the plan sponsor’s financials or funding volatility.

Any plan fiduciary seeking to use liability hedging strategies should take care to ensure that the decision is made in accordance with ERISA’s exclusive benefit and prudent man rules, that its effect is primarily to benefit plan participants with only an incidental benefit (if any) to the plan sponsor, and that the appropriate processes are followed and records preserved to demonstrate those facts. Particular care should be taken if the fiduciary making the decision to employ the strategy has both financial responsibilities to the plan sponsor and fiduciary obligations to the plan.

Please call any of your regular contacts at the firm or any of our partners and counsel listed under Employee Benefits in the Our Practice section of our web site if you have any questions.