Employer-sponsored private-sector defined benefit (DB) plans have been on the decline for many years as U.S. employers have shifted to defined contribution (DC) retirement plans. Just 17% of private-sector employees had only a DB plan or both a DB and DC plan as of March 2018, according to the Bureau of Labor Statistics (BLS). Meanwhile, 51% are enrolled in a DC plan. (Thirty-two percent have neither.)
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Among the private-sector DB plans still in existence, different stages in their lifecycles can be identified. As of March 1, 2017, according to other BLS data:
- 63% of employees in pension plans were in active plans;
- 25% were in soft-freeze plans (closed to new hires); and
- 12% were in frozen plans.
DB plan sponsors that have resolved to terminate their plans typically turn their attention to two important factors: financial and operational readiness, global pension consultant Milliman said in a May 7 blog post. How can your company determine whether your DB plan is financially and operationally ready to terminate?
Best-Prepared Sponsors
When interest rates rise (typically leading to better funded status for DB plans), the best-prepared plan sponsors are those that are ready in both those ways, Milliman said. Here are some ways the consulting firm suggests for measuring both aspects:
Financial readiness: If your plan has a projected benefit obligation (PBO) calculated yearly and the assumptions are conservative and up to date, chances are that the plan is financially ready (or nearly ready) for termination when it is funded in a range of 105% to 120% of PBO.
Operational readiness: Operational readiness differs from plan to plan, but generally means your plan:
- Knows where to find participants (with high accuracy);
- Can demonstrate (on an individual level) how each participant’s benefit was calculated—for those not-in-pay status;
- Has complete beneficiary information; and
- Has identified all potential alternate payees under the plan.
Derisking Preparation
Typically, plan sponsors begin winding down their pension plans years before the plan termination date. Plan design changes, such as closing the plan to new hires or freezing benefit accruals, are one step in the path to termination, Milliman said.
Others are finding the right mix of contributions and investment risk to optimize volatility-adjusted returns in plans that are on the path to “derisking.” Derisking is the reduction of pension liabilities through transfer of pension obligations to an insurer, annuity sales, lump-sum payouts, or some combination of those alternatives.
Regardless, the primary focus remains on preparing the plan to terminate from a financial perspective. So when plans reach full funding on a plan termination basis, it surprises many plan sponsors how much data clean-up is left before the plan termination process can officially begin, the blog post said.
Clean data is key to a successful plan termination, so it’s important to know where your plan’s data stands. Through proactive data scrubbing, you can use existing staff to clean up the data over time, which reduces the need to hire outside resources to comb through files and archived electronic data.
By tackling data issues now, Milliman said, you can prioritize what needs to be done, avoid duplicative efforts common in last-minute exercises, uncover and remediate data gaps, and avoid costly delays resulting from attempts to fill data gaps in a short timeframe, the firm suggested.
Timeline for Termination
Not being able to complete the plan termination process in a timely manner can be costly, Milliman said. For example, capital markets can shift dramatically between when a plan starts the termination process to the point when it liquidates plan assets.
While liability-driven investing (LDI) strategies temper the risk of dramatic swings in funded status, it’s difficult to protect against all possible scenarios. Even a 1% change in funded status due to delayed plan termination can result in having to make millions of dollars of additional contributions to the plan.
Conversely, your plan can benefit from competitive annuity-provider pricing when you can react quickly to market conditions, a state that is made possible by being operationally ready, Milliman said.
If your plan is ready to take steps to prepare for termination, Milliman advises working with your actuary or pension plan administrator to:
- Assess your financial readiness for termination;
- Perform a plan termination data-quality analysis; and
- Articulate a strategy for how to close any data gaps.