Despite the many different management tactics organizations can use to reduce risk, two distinct camps have developed when guiding the end goal of an organization’s defined benefit plan. Starting with these end goals in mind, however, can give plan sponsors more options for ensuring successful use of the plan.
In an analysis of the funded levels of the S&P 1500, 76% of the organizations experienced an increase in funded status during 2022. This trend, along with increase in interest rates through 2022, gave companies more options to fund their plans. According to a survey of 152 financial executives conducted by CFO Dive and Mercer, 86% said that they now contribute more than the minimum requirements to the plan.
This dynamic has encouraged two different camps: One camp of plan sponsors considers retaining a DB plan while the other has used current funding status to move forward with termination.
“You need to understand what the ultimate destination is for the plan,” said Scott Jarboe, U.S. defined benefit segment leader and partner at Mercer. “Once you have determined the destination, whether it’s keeping it accruing and retaining long term, terminating it or something in between, then you can figure out the best roadmap to get there.”
Depending on the camp your organization is in, it’s important to consider why and what you will do to ensure success.
What to consider when retaining a DB plan
Why have organizations shown a willingness to retain a DB plan? By and large, one overwhelming reason is to attract and retain talent. Nearly nine-in-ten (91%) of respondents to the survey said the DB plans serve as a valuable attraction and retention tool.
Employees recognize the value of the DB plans and value retirement income security. Their interest in such security drives their own employment decisions, resulting in a more loyal and stronger workforce.
If that’s the case, why do financial leaders hesitate to reinstate a DB plan? It’s due to the concerns over eliminating risk that the DB plan adds to the organization – investment and interest rate risks were the most commonly cited concerns.
Recognizing your biggest risks within a DB plan is a key factor in retaining it. By understanding the risk, you can then take steps to remove or reduce the risk. It’s a consideration that, if solved, plan sponsors could change their DB plan decision. When asked if they could eliminate their primary risk concern with a new design, would they consider reopening their plan, 88% replied in the affirmative.
While it’s not always possible to remove all the risk from a DB plan, and the desire to retain employees through its use persists, then options do exist to provide the retention tool.
What to consider when terminating a DB plan
While terminating a DB plan remains a popular option for organizations, the number of companies expecting to move forward with a termination has also fallen. According to the current survey, 63% of plan sponsors expect to fully terminate the plan in 10 years, which is down from 73% reported in the 2021 survey.
It’s understandable that organizations take this approach to the DB plan. Ongoing management of a DB plan involves significant costs and, in many cases, significant risks. Some costs to maintain a pension plan include operational, administrative, investment, longevity and, notably, Pension Benefit Guaranty Corporation (PBGC) premiums.
Termination can fully extinguish the company’s exposure to the DB plan.
The reasons for considering termination ranges from organization to organization, but some common themes arose from the survey, including current accounting implications (47%), cash funding implications (43%), current funded status of the plan (39%) and concerns over the impact on participants (35%). A less cited (but still common) reason for termination also included the quantity and quality of data surrounding the plan participants.
It's key, when considering termination, to ensure administrative readiness for a successful effort. Part of administrative readiness requires full insight into participant data to allow for accurate calculations throughout the process.
This data layer isn’t only required for internal purposes, but is also needed when working with insurance companies to manage the termination – they will demand pristine and accurate data for their own analysis.
In the data, you will also be able to determine the primary risk factors for the plan. With that in hand, whether you’re terminating the DB plan, keeping it, or something in-between, you’ll know it’s the right move for the company.
How to determine that risk factor, and ensure pristine data analysis, is something Mercer and CFO Dive delve further into in the 2022 survey of financial executives. You can download the full report, “Two emerging camps: US pension sponsors gaining clarity around sustaining vs. terminating their plans,” here.