A frozen defined benefit (DB) plan is one in which there are no more accruals—no more growth in benefit—for any individual, says Ari Jacobs, senior partner and global retirement solutions leader at Aon in Norwalk, Connecticut. He clarifies that this is different from a closed DB plan, in which there are still accruals for participants who were already in the plan before it was closed to new participants.
With frozen plans, for the most part, plan sponsors still have to do everything they had to do with an ongoing plan, says John Lowell, Atlanta-based actuary and partner with October Three Consulting LLC. “They don’t get a lot of breaks from that standpoint. That is where a lot of people go wrong; they think since they’re not giving anything to employees anymore, the staff they had dedicated to the plan is not necessary,” he says. “To a large extent, they stop paying attention to it. They’re really just relying almost entirely on what advisers, including actuaries and accountants, tell them to do.”
Lowell explains that DB plan sponsors may have relied heavily on advisers when their plans were open, but, when a plan is frozen, he says that is “a bit trickier.” He says consultant firms are generally looking for relationships that are going to generate long-term revenue for them and long-term profitability. “If they don’t think they will get that, the natural business reaction is to do what they can to generate revenue in the short-term,” he says. “If a client wants to terminate the DB plan in the next three years, and after three years, the consultant will not have the business, it can do one of two things: bring ideas likely to generate revenue or sit back and wait for the client to ask questions. It probably is not going to bring a lot of creative solutions in the hopes of building a relationship.”
A frozen DB plan still has a fixed set of promises based on when individuals will leave the company and get payments for life, Jacobs notes. Plan sponsors still need to continue to manage the risk associated with those promises, which he explains is the asset/liability mismatch. “Assets will move with the market and liabilities change with discount rate moves, and these can lead to changes in funded status,” Jacobs says. He adds that plan sponsors also need to make sure they understand their amount of underfunding and what cash is needed to put into the plan to fill the gap.
As for expectations from service providers, Jacobs says the biggest change is that calculations for growing benefits are no longer needed. In many cases, benefit calculations that would have had to be done over years could be completed early. However, Jacobs notes, plan sponsors will still need to make required contributions each year.
“There is only somewhat less work to do with a frozen plan than an ongoing plan. There is a limited amount of information still needed from service providers. But, generally, a frozen plan should be managed the same as an open plan,” he says.
A plan sponsor may have saved money by not having a person or department dedicated to its DB plan, but Lowell contends the costs of not having such a person or department far exceed what they saved. “For example, if the sponsor is not paying attention, it can miss out on strategies that might reduce PBGC [Pension Benefit Guaranty Corporation] premiums,” he says. “For some, there may be no cost or some cost because they are not paying variable premiums or they are getting advice and getting it right, for some small cost, but I’ve seen some paying millions of dollars in premiums a year that didn’t have to. If someone was paying attention to the plan, the costs would have been less.”
As another example, Lowell says companies that are tight on cash this year that don’t have a conversation about that with an actuary may get a recommendation from the actuary to put a lot of money into the plan. “Plan sponsors expect actuaries to ask questions and know how to advise them, but actuaries are expecting plan sponsors to ask questions. This wouldn’t occur if a portion of someone’s job was to maintain the pension plan,” Lowell says. “Unnecessary costs for frozen plans come from omissions, things plan sponsors are not thinking about that a dedicated person would think about.”
A plan with no internal staffing may also not be getting a highly proactive actuarial consultant, Lowell adds. “It’s not that the plan sponsor is not taking opportunities presented to it, it’s that it is not asking questions and the consultant is not asking questions to get to know the sponsor’s situation,” he says.
Lowell also warns about “random advice.” For example, a consultant company may push liability-driven investing (LDI) for all clients or push lump-sum windows. He says plan sponsors should ask, “Is that right for our plan? Why do you think so? Show me how you determined this is right for us.” Consultant companies have initiatives for every client, Lowell says, so plan sponsors should determine if the advice is for them or for random company X.
Over time, a frozen plan will get to the point where it is fully funded. Jacobs says plan sponsors need to think about when the time is right to reduce its liability by settling some of it through a lump-sum window or selling the liability to an insurance company. “It’s not a necessity, but plan sponsors would want to do that because, at some point, they will have something on their balance sheet that could be effectively managed by someone else,” he says. “Do they want to have that liability on their balance sheet and worry about investing and managing assets when there are organizations that do that for a living?”
Jacobs explains that there is limited difference on a plan sponsor’s balance sheet for a frozen versus an open plan. “There is a difference on the income statement because the service cost for accruing new value disappears for a frozen plan. But the promises of the plan still sit on the balance sheet the same way,” he says.
One challenge with keeping a frozen plan comes from what Jacobs calls a lack of “institutional knowledge.” The plan could be around a long time—until every participant is paid out, he notes. “Plan sponsors still need to adhere to government requirements and continue filings. As time goes on, fewer will know the plan and its requirements, and the risk of operating appropriately can’t be ignored.
“What we’ve seen is that most frozen plans fall on the bottom of plan sponsors’ to-do lists when there are still many solutions to work through,” Jacobs says. “There needs to still be interaction between finance and HR [human resources] to understand the ownership of the plan. It’s important that the focus on it doesn’t drop. Plan sponsors should continue a strategic focus on asset/liability matching solutions, funding solutions and settlement solutions.”
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