Thanks to current market conditions, many frozen pension plans closed to new participants are facing a “Goldilocks” moment: a unique opportunity to reopen their plan and leverage excess assets, a move with the potential to bolster a company’s financial position while offering an appealing retirement benefit to employees. As plan sponsors weigh their options, we answer some frequently asked questions (FAQs) about pension unfreezing.
1. Are plan sponsors really considering reopening frozen pension plans?
Yes—and, in fact, some have already done it. For example, Milliman has worked with several banks and a nonprofit organization that have restored defined benefit plans (DB) for their employees.
The highest-profile example in the retirement industry is IBM, which in 2024 replaced its 401(k) match with new benefit accruals within its reopened legacy DB plan via a cash balance design.
2. Why is now potentially a good time for pension unfreezing?
A trio of factors is contributing to the current “pension renaissance.”
The first is legislation, with the American Rescue Plan Act and the Infrastructure Investment and Jobs Act extending cash funding relief through the next decade.
The second is discount rates, which have more than doubled in recent years and reached 5.46% as of June 30, 2024—46 basis points up from the beginning of the year. Higher rates mean lower measured plan liabilities, and plans with a liability-driven investing (LDI) strategy can now lock in this comparatively high rate over a prolonged period to help protect against future interest rate and market volatility.
The third factor is the plans’ improved funding levels, which have been aided by the higher interest rates as well as strong investment returns over the past decade. In the 2024 Milliman Pension Funding Study, which analyzes the 100 largest corporate DB plans in the United States, 48 of the plans were fully funded or better. In fact, 36 plans were frozen plans with surplus assets.
3. Is reopening only an option for frozen DB plans with surplus funding?
No, surplus funding is not a requirement for this strategy. While plans with surplus funding are likely to be able to realize the largest savings in shifting retirement spending from their DC plan to their DB plan, companies that need to differentiate in a competitive job market can reopen a legacy underfunded plan or set up a brand new one with a risk profile similar to 401(k) plans using the latest DB designs. Plan sponsors do not have to reopen a DB plan with the same design; in fact, most companies that reopen their plans modify designs to fit their risk appetite.
In addition, many frozen pension plans that are not fully funded are on an LDI glide path, steadily increasing their fixed-income allocations as their funding percentage improves while maintaining smaller equity holdings to help close funding gaps going forward. Thanks to rate increases and investment gains, full funding is now in sight for them—meaning this may be an opportune time to consider reopening the plan or implementing a new hybrid plan design.
4. What kinds of plan designs are most prevalent for companies introducing new defined benefit retirement options?
New DB plans launched today tend not to be the “final average pay” design from decades ago. Instead, most plan sponsors are opting for hybrid defined benefit designs, particularly cash balance plans and variable annuity plans.
A cash balance plan includes a pay credit—based on an employee’s salary—and an interest credit, which may be tied to a Treasury rate or a market rate of return. The pay credit is akin to a 401(k) contribution, while the interest credit is akin to 401(k) investment earnings. Using a Treasury interest rate to determine the earnings on a cash balance account offers sponsors the ability to invest to outearn a low-risk benchmark (i.e., Treasuries) and offset the cost of the pay credits. However, the flexibility does not stop there. Sponsors may use the pension trust’s rate of return to determine the interest credits and, effectively, turn their cash balance plans into 401(k)-style accounts that go up and down with movement in the plan sponsor-directed retirement trust.
In a variable annuity plan, the benefits move up and down in tandem with investment returns. This limits volatility while ensuring full funding.
The optimal cash balance or variable annuity design depends on the degree of risk-sharing desired by the plan sponsor.
5. Is it an all-or-nothing approach, defined benefit or defined contribution (DC)? Or can a plan sponsor offer both retirement plan types?
It’s not all or nothing. Looking once more at IBM, the company now makes employer contributions only to the DB plan, and employees can continue to make their own contributions to their 401(k). However, plan sponsors don’t have to fully discontinue their employer matching contributions to their 401(k) plans.
To encourage employee investing while still offering the enhanced retirement security of a pension plan, employers may wish to split their contributions toward retirement benefits between a DB contribution and a matching contribution to DC accounts. Each plan sponsor should begin with a financial analysis to determine the best options for their organization and workforce.
A foundational reason for diversifying employee retirement assets between DB and DC plans can be found in many industry studies that show how DB trusts tend to outearn their DC counterparts. In this seminal study, the difference was 1% per year. That additional return over the lifetime of an employee can translate to significant additional retirement income.
6. What industries are a good fit for pension unfreezing?
Financial service firms, banks, and insurance companies tend to have been able to make regular cash contributions to their plans, even through challenging markets, and therefore may have frozen pension plans that are in a surplus funding position today. The presence of surplus pension assets makes them good candidates for pension unfreezing.
Healthcare organizations that have had trouble retaining staff since the COVID-19 pandemic may find that offering an active pension plan as a retirement benefit helps them stand out as an employer and enables them to better manage their workforce.
7. What are some barriers to entry if a plan sponsor wants to open a new DB plan or reopen its frozen plan?
One significant concern is Pension Benefit Guaranty Corporation (PBGC) premium rates. In this Milliman podcast, our experts discuss how widely these premiums can vary, even for a well-funded plan. PBGC premiums are viewed by some plan sponsors as, effectively, a tax on DB plan sponsorship, one that 401(k) sponsors do not have to contend with. While the PBGC provides important coverage for DB participants in the event of employer insolvency, premiums have historically proven to be a strong deterrent to providing retirement benefits through a DB arrangement.
Fully funded plans do not have to pay what is typically the larger portion of PBGC premiums, known as the “variable rate” premium component. Therefore, when reopening or launching a defined benefit plan, opting for a cash balance or variable annuity design that maintains full funding can help avoid the uncertainty and expense of the PBGC variable rate premium cost.
Regarding the future of PBGC premiums, it is worth noting that the PBGC’s Office of the Advocate is conducting stakeholder roundtables to synthesize input on how to promote DB plan sponsorship among U.S. employers. Naturally, with premiums being a large barrier to DB plan sponsorship, much of the industry discussion has focused on reforms that balance the importance of PBGC insurance coverage with the needs of employers to have a less costly path to sponsoring a DB plan.
In addition to PBGC premiums, another barrier to opening a new DB plan or reopening a frozen plan is the perception that DB plans are too risky or complex for a company to sponsor. Traditional DB designs can result in significant balance sheet volatility due to asset returns and changing rates in the bond markets. However, the latest plan designs, especially market-based cash balance (MBCB) designs and variable annuity plans, have addressed that perception. For example, MBCB plans look and feel like 401(k) plans and have a similar risk profile. For companies that still want to offer a traditional DB design, hedging strategies have evolved significantly to make it simpler to match assets and liabilities.
8. Can a plan reopening be done in conjunction with other pension risk management techniques?
Yes. Continued risk management approaches such as LDI, annuitizing a group of participants (such as retirees), and offering lump sums can be implemented alongside the reopening of a pension plan. In fact, these risk-management techniques are also utilized by currently active pension plans. IBM is a great example of a plan sponsor that has explored the various techniques within the wide spectrum of pension risk management.
9. What were some of the issues that led plan sponsors to freeze plans in the past, and how are those issues being addressed now?
Prior legislation dating back over the past two decades prevented plan sponsors from taking advantage of strong market returns and maintaining surplus funding positions. Thus, some plan sponsors increased benefits during bull markets but struggled to make cash contributions to the plan when funding requirements exceeded investment returns during market downturns. This happened when the 1990s dot-com bubble burst and again during the global financial crisis—with funding shortfalls forcing many plan sponsors to freeze their DB plan.
Furthermore, most plan sponsors allocated a substantial portion of their investments to riskier assets (primarily equities), with significant mismatch to their pension liabilities. This aggressive investment approach resulted in substantial funding shortfalls (unfunded liabilities) during market downturns. Decades ago, strategies like LDI and risk hedging were not as prevalent, which could have mitigated these drastic fluctuations in funded status. Nowadays, many plan sponsors employ these strategies effectively, thereby mitigating the risk of severe underfunding during periods of poor market performance.
10. Why might a plan sponsor not want to adopt a new plan or reopen a frozen DB plan?
It likely does not make sense for companies with a declining active employee base or with limited growth prospects to launch a new pension plan. Instead, these organizations, especially if they are hoping to be acquired, may be more concerned with improving their balance sheet—in which case they are likely to want to gradually shrink the size of their DB plan and ultimately remove it from their books.