PSNC 2023: DB Plan Design

2023 has, so far, been a positive year for defined benefit plan funded status, said speakers at the PLANSPONSOR National Conference in Orlando, Florida. 

About 13,000 private-sector defined benefit plans still exist in the U.S.—not including cash balance plans—and there is about $3 trillion of liability on a PBGC measurement basis, according to Mike Devlin, principal of BCG Pension Risk Consultants. However, there are fewer than 100 plans left that have over $5 billion in liabilities, he said.  

“Even though jumbo plans were the last ones to go, they’re starting to go by the wayside,” Devlin said. “But there’s still a big market out there. Half of that liability is actually retirees, as the Baby Boomers start retiring in big amounts. Most plans are starting to [lean] a little bit heavier toward the retiree risk.” 

Despite talk that defined benefit plans are dying, new plans are still forming—most commonly with small professional service organizations where high-earning doctors, lawyers and engineers are looking to put a large sum away for retirement, according to Chuck Williams, managing partner and CEO of Finspire. He added that typically a plan sponsor will have a defined contribution plan, that they feel it is not meeting their participants’ needs and will either switch to a DB plan or combine the two.  

Because of rising interest rates, however, it is also a favorable time for DB plan sponsors to terminate plans if the plans are already closed and frozen or if sponsors have been waiting for the right time to offer participants a lump sum payout, says BCG’s Devlin. 

“We’re in a really interesting time right now because a lot of equity losses from last year have recovered [and] bond markets have stabilized,” Devlin said.  

DB plans are in considerably better shape than they were in 2022 when there was a “double whammy” of double-digit losses in both the stock and bond markets, Devlin explained. But as interest rates hit higher levels at the end of 2022, liabilities shrunk.  

Even though many pension funds may have seen their assets drop, their liability also dropped, and Devlin said this means the lump sum a plan sponsor would owe to their participants would decrease. 

“This is the year to do a lump sum,” said according to Williams. “[It] would actually relieve [you] of significant holding costs [and] significant risk at a discount. October of 2022 is the highest [look back] rate that you can use, going back to probably 2008.” 

The interest rates used for determining the amount a participant is owed as lump sums are typically set, and held constant, for each plan year. As a result, the current high interest rate environment will result in lower lump-sum payments for the entire coming plan year. 

Moving Toward Termination 

Alternatively, if a pension fund is closed or frozen and is around 95% fully funded, Devlin recommends that plan sponsors begin to prepare for termination, as volatility in the market is a possibility that could harm funded status. 

“[Plan sponsors] really need to start to understand [their] data,” Devlin said. “Good data doesn’t mean ‘I know where everyone lives.’ It means that ‘I am able to certify the benefit calculations.’ You have to remember that eventually you have to play your hand to the regulatory agencies.” 

 Devlin said it is not uncommon for a plan sponsor to find out from its actuary that it could take another six months to a year to terminate a plan because of a need to verify historical information about participants. It is important for plan sponsors to maintain data from the pension plan’s creation to ensure the plan is prepared in the case of termination, according to Devlin. 

Additionally, because a plan sponsor that is terminating a plan will eventually need to transfer the liability over to an insurance carrier, Devlin said the sponsor does not need to wait until termination to work with the carrier. For participants with small, monthly pension payments, Devlin said the sponsor could move this liability over to the insurance carrier before terminating the plan completely. 

“Pension plans are inefficient vehicles to deliver a $100 check to a retiree,” Devlin said. “You’re paying PBGC $96, you’re paying the actuary $100, you’re paying $50 to issue a 1099 annual funding notice… and all of a sudden, you’re paying somebody $1,200 but it’s costing [you] $350. That liability can be moved to the insurance carrier.” 

On the investment side, a common mistake Devlin sees when a plan sponsor is approaching termination, and has a plan that is fully funded, is investing in cash. 

“Cash is not safe,” Devlin said. “If you go all cash, [and] interest rates go against you… that means is your liability starts to increase by 10%, and there goes your funding.” 

If a pension plan sponsor is considering annuitization, Devlin said it is important to be aware of the three regulatory agencies that will take an interest in the process: the Department of Labor, the Pension Benefit Guaranty Corporation and the IRS.  

The DOL will care most about the insurance carrier that the sponsor selects, and Devlin said there are currently 21 insurance carriers that satisfy the so-called 95-1 standard, named for a DOL bulletin that spells out the fiduciary standards under ERISA that a plan sponsor must follow when selecting an annuity provider.  

Impact on Participants 

When communicating the process of terminating a pension plan to employees, Devlin explained that there are three important mailings that plan sponsors should deliver. 

First, a plan sponsor should send a notice of intent to terminate. Once everyone is aware that the plan will terminate, a notice of plan benefits should be provided, which includes data about each participant’s benefits.  

The third communication, which is the information the participants are most anticipating, is the election package. Devlin said a sponsor could also send an additional notice of intended insurance carriers.