Defined benefit (DB) plans, once a popular tool to reward employees for their years of service and to help enable older employees to leave the workforce, have fallen out of favor for several reasons. However, the promise made by these plans was to provide lifetime benefits. Thus, even if a plan is frozen, a vested 30-year-old employee may easily be alive in 60 years, requiring retirement payments for decades. As a result, these plans do not disappear very quickly on their own, and plan sponsors are left wondering if termination is the answer.

Until they disappear, these plans must also pay Pension Benefit Guaranty Corporation (PBGC) premiums, investment advisors, actuaries, accountants, and someone to administer them, requiring skills that are not always common. The primary alternative is to purchase annuities through an insurance company to take over the responsibility of making the monthly payments to retirees. This option has its own costs, as the insurance companies charge a premium for taking the risks, for administering the plans, and for making a profit.

Many pension plans are not fully funded, and terminating one may require a cash infusion the plan sponsor is not prepared to make. In fact, most plan sponsors dislike paying money into frozen plans that are no longer benefiting their employees. What's more, most companies are now spending their scarce retirement dollars on contributions to 401(k) plans.

But how close are these plans to being able to terminate? In recent years, interest rates have been historically low, leading to higher liability measurements in pension plans. Stock returns have been good but have only benefited plans that were invested in the market. This combination left many plan sponsors in situations where they felt that their frozen plan assets should grow faster than the liabilities, and that, in time, there would be sufficient assets to terminate the plans without making additional contributions.

To get a sense of plans’ readiness, we gathered IRS Form 5500 data for frozen defined benefit plans included in Milliman’s Corporate Pension Funding Study and Index, which looks at the 100 U.S. public companies sponsoring the largest defined benefit pension plans. We made some assumptions about the costs of both continuing and terminating these plans, as well as their expected investment returns. Putting this together, we estimated how long it would take until there was likely to be sufficient assets to terminate them without making additional contributions.

We estimated that almost half (44%) of the plans would need to wait more than five years before they would be ready. About 14% of the plans would be ready in three to five years, and 22% would be ready in one to three years. Asset returns after the filing of those 5500s through 2021 have been generally quite good, depending on how the plans were invested. Now 2022 seems to be off to a rocky start, but they may still be progressing toward the point of being able to terminate.

*For assets to be sufficient for plan termination without future contributions

The final 20% of frozen plans not mentioned above appeared to be able to terminate immediately, without making contributions, which raises a question. If one in five plans had enough money on hand to terminate, why would plan sponsors wait? In fairness, perhaps some of them were preparing to terminate, but we have also found that some plan sponsors with well-funded plans are happy to hang on to their plans. Reasons vary, but we have heard sponsors indicate the following:

• We made this commitment to our employees; they are counting on us, not on an insurance company, to provide for their retirement.
• Why would we buy annuities at around 2% interest rates if we are confident we can earn 5%, 6%, or 7% returns on our investments over the long term?
• We would rather not “rock the boat” with the union.
• The plan is providing income on our income statement, so we are not in a hurry.
• Our assets are invested to help protect us against investment and interest rate risks.

Maybe it should not be surprising that well-funded plans are less distasteful to keep around than plans that might need future contributions. It is easy to see the success of current defined benefit retirees enjoying the benefits of a secure monthly pension, and perhaps some executives like that those payments are still associated with their company’s name.

Yet to be seen is the success of retirees who spent their careers gathering assets under only defined contribution (DC) plans and their ability to turn those savings into a secure retirement. So, while admittedly there are risks to keeping these defined benefit plans around, could they ever become popular again? “We may want to open the plan back up” is not included in the list above, but might one of these plan sponsors ever consider reopening these frozen plans and perhaps using excess assets to fund new defined benefit accruals?

In today’s market, if a defined benefit plan could help retain workers, that would certainly be a plus, as many companies are having a difficult time finding qualified workers. Defined benefit plans are arguably more efficient at focusing retirement dollars to long-term employees. Assets in a defined benefit plan can also be invested more efficiently than can (or at least are) assets in defined contribution plans.

Companies have understandably complained about the volatility of defined benefit plans on their financial statements, the volatility of contribution requirements, and the risks they must take. Cash balance plans are favored by some groups and address these concerns to some extent. Variable annuity pension plans go even further at allocating pension risks efficiently and essentially eliminate the volatility on financial statements, all while maintaining very predictable contribution requirements. Cash balance plans can, and variable annuity pension plans always, transfer the investment risk to the participants. Thus, there are defined benefit designs that can address employers’ concerns.

While we suspect that some frozen pension plans will eventually be terminated, looking for the proper timing and maybe even considering some other possibilities may lead many plan sponsors for years to come to continue to ask, “To terminate or not to terminate…”

Bruce Mitton is a consulting actuary at Milliman. The above material represents the opinion of the author and is not necessarily the view of Milliman. The ideas shared are intended to explore issues and possibilities associated with frozen defined benefit plans. Through publication of this article, we assume no duty of liability to any reader, each of whom is encouraged to seek the assistance of their own actuarial, investment, and legal advisors.