Managing the challenges of frozen pension plans

In today’s highly competitive labor market, traditional pension plans are going the way of the dodo bird — headed toward extinction. Many employers are scrapping or freezing pensions in favor of more flexible total rewards programs that help them compete for and retain top talent.

That said, when it comes to pension plans, out of sight does not equal out of mind. In fact, freezing a pension plan often creates new and more challenging issues for plan sponsors as its time horizon and risk profile shift substantially.

The frozen plan will continue to exist for as long as there are assets to manage and benefits to be paid. Significant attention and resources are still needed, as annual valuations and a plethora of administrative tasks — accounting, reporting, compliance, fiduciary and investment oversight, and participant communications — are required to fulfill the plan’s obligations.

Common challenges
Regardless of whether a pension plan is active or frozen, sponsors routinely manage the following fundamental issues:
  • Calculating and making sufficient annual contributions to fund the plan’s current and future cash flows
  • Tracking, interpreting and accommodating changing federal laws and regulations
  • Understanding and calculating the effects of market returns and interest rate fluctuations
  • Protecting balance sheets from volatility

However, a frozen plan is different from an active plan, so it needs to be managed accordingly. Because a frozen plan has a finite life span, sponsors and their advisers find themselves grappling with new challenges:

  • Aligning annual cash contributions and year-end disclosures with broader business objectives and strategies for terminating the plan
  • Controlling — and even reducing — administrative costs over time due to the frozen nature of benefits
  • Increasing focus on marked-to-market asset and liability values
  • Charting and executing an exit strategy that both protects plan participants and releases sponsors (and their balance sheets) from future obligations

A frozen pension plan will evolve over time. With the ultimate goal of removing the plan and its associated liabilities from the books, any decision can affect timing. Factors such as changing demographics, the economic environment and investment returns can create variable costs related to formally terminating the plan, which are often greater than what can be covered by current assets.

Outside advisers, including your actuary, should help you get all of your ducks in a row so that you can pull the termination trigger when the time is right. In addition, your advisers and actuary should help you achieve acceptable levels of balance sheet and pension expense volatility and actual cash contributions.

Frozen plans present actuaries with unfamiliar challenges
The actuarial profession is known for high-quality work processes with core recurring services. So when it comes to the basic issues — planning contributions, calculating balances and helping manage balance sheet impacts — most actuaries do a respectable job.

Yet a frozen plan is a fundamentally different animal than an active plan. While an active plan is an HR tool designed to attract and retain valued employees, a frozen plan is a financial obligation that must be managed effectively.

The vast majority of actuarial firms function as captive business units of larger HR consulting organizations. As such, their focus is often on employee benefits as opposed to broader business objectives and financial implications.

In order to manage a frozen plan as a financial obligation, advisers and actuaries need expertise in new and expanded areas. It is essential that they:

  • Are able to balance the effect of funding and investment decisions tailored to a targeted plan exit date based on new and pending tax laws and regulations
  • Have financial statement expertise to understand potentially significant balance sheet impact upon plan termination

In addition, there are two other areas where the basic business interests of actuaries and their clients diverge: exit strategies and actuarial fees.

In the area of exit strategies, escaping a frozen plan is obviously in the sponsor’s best interest. Fully funded frozen plans allow the sponsor to terminate the plan and settle all the remaining benefit liabilities.

Yet successfully exited plans mean that ongoing actuarial services are no longer necessary. In essence, actuaries who help guide their clients to successful exits face losing long-term client relationships.

Likewise, the fees that actuaries charge are a similar point of conflict. Of course, actuaries expect to be fairly compensated for their work. However, we’ve found that many often charge their clients the same — or higher — fees as before the plans were frozen.

Evaluating your actuarial relationship
As with any professional services field, the service quality and capabilities you can expect, and fees you will pay, vary among actuaries. Some do excellent work, while others may only provide minimal services.

To help sponsors of frozen plans evaluate their actuarial relationships, we recommend sponsors ask their actuaries the following questions.

  • How familiar are you with my company’s business objectives and strategy? How does that understanding influence your planning and recommendations?
  • What is your expertise in corporate financial statements and related impacts due to pension plan volatility?
  • Do you have in-house experts who monitor and analyze the effects of pending IRS rules, as well as federal regulations and legislation?
  • What are you doing to help my company achieve a successful and timely exit from our frozen plan?

Finally, we advise plan sponsors to take a hard look at the fees they’re paying. Have they gone up or down in the past few years? Are they lower than when your plan was still active?

If you’re not satisfied with the answers to any of these questions, it may be time to consider a new actuary.

Brett Schwab
Director and Lead Actuary
Compensation and Benefits
Consulting Practice
T +1 312 602 8134

Phil Bonanno
Compensation and Benefits
Consulting Practice
T +1 212 624 5257