The prevalence of defined benefit (DB) plans has been declining for decades as U.S. employers have moved to defined contribution (DC) plans. Just look at the numbers:
Type of retirement programs among private industry workers1 :
- 51% have only a DC plan
- 13% have both a DC and DB plan
- 4% have only a DB plan
- 32% have neither
Within these numbers, private sector DB plans are at different stages in their lifecycles. As of March 1, 20172:
- 63% of employees in pension plans were in active plans
- 25% were in soft-freeze plans (closed to new hires)
- 12% were in frozen plans
For plan sponsors that have resolved to terminate their plans, they typically turn their attention to two important factors: financial and operational readiness.
Is your plan financially and operationally ready to terminate?
When interest rates rise (typically leading to better funded status), the best-prepared plan sponsors are those that are both financially and operationally ready.
- 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) 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 you:
- Know 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
- Have complete beneficiary information
- Have identified all potential alternate payees under the plan
Have you begun the de-risking process?
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. Others are finding the right mix of contributions and investment risk to optimize volatility-adjusted returns in their plans. At any rate, the primary focus remains on preparing the plan to terminate from a financial perspective. Therefore, 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.
How clean is your data?
Clean data is key to a successful plan termination, so it’s important to know where you stand. Through proactive data scrubbing, you can use existing staff (if available) 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, you (1) put yourself in the driver’s seat to prioritize work, (2) avoid duplicative efforts common in last-minute exercises, (3) uncover and remediate data gaps, and (4) avoid costly delays resulting from attempts to fill data gaps in a compressed timeframe.
Does the timeline matter?
Not being able to complete the plan termination process in a timely manner can be costly. For example, capital markets can shift dramatically between when a plan starts the termination process to when it liquidates plan assets. While Liability Driven Investing (LDI) strategies mitigate 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 millions of additional contributions. On the flip side, you can benefit from competitive annuity provider pricing when you have the ability to react quickly to market conditions, which is made possible by being operationally ready.
Where do you start?
You can take steps today to begin preparing for termination, by working with your actuary or pension plan administrator to:
- Assess your financial readiness for termination
- Perform a plan termination data quality analysis
- Articulate a strategy for how to close any data gaps
To learn where your plan stands on the path-to-termination, email us.