Study Warns DB Plan Freezing Doesn't Mitigate All Risks

December 8, 2005 (PLANSPONSOR.com) - Plan sponsors who freeze their traditional defined benefit pension plans have to fully understand the potential risks of making that move or they could end up in even more trouble.

That was a central conclusion of a research paper by SEI lead actuary John Waite on potential issues plan sponsors could face by freezing their program so participants immediately stop accruing benefits.

In recent years, a steady stream of plan sponsors has decided to move new employees from a DB to a DC plan. In most cases, the employers have frozen the DB plan as part of the changes.

“In fact if a plan sponsor downplays the importance of strategically managing a frozen plan, the overall state of the plan could end up worse than when it was initially frozen,” Waite asserted. “As more plan sponsors determine that freezing their pension plan is the best route for their organization, they must go down that path with a solid understanding of the risks involved. The key moving forward is to understand that organizations must successfully identify risks and goals for their frozen plans and then develop reasonable strategies around how they manage those risks and how they appropriately outsource certain duties. This is the way they can meet their end goals.”

Noting that plan sponsors often expect the plan freeze to reduce overall risk and volatility, “Freezing a pension plan might reduce some costs and liability growth, but a frozen plan is often wrought with just as much risk as an active plan,” Waite said.

One complicating factor is that plan sponsors often don’t have enough resources to manage the frozen plan. “Frozen plans no longer carry strategic priorities and plan sponsors often can not justify dedicating significant resources and expense towards the plan management process,” the study said. “The solution begins with plan sponsors first understanding the management needs of a frozen plan and then making strategic decisions regarding how they appropriately outsource certain duties to best manage the risks involved.”

Other findings included that:

  • Investment managers will prepare recommendations based either on very limited, out-of-date information from the actuary or from their own liability calculations based on the data available and their understanding of the plan.
  • Close alignment of actuary and investment manager, whether outsourced to a single organization or more closely coordinated by the plan sponsor, will allow the investment manager to better model the plan liabilities and to appropriately prepare asset allocation recommendations.
  • Best practices around managing frozen plans must be aimed at ensuring that investment and funding management considers all appropriate constraints. Plan sponsors need to consider the risk in the current portfolio relative to their overall corporate goals.
  • Companies managing a frozen pension plan could be in heightened danger of compliance issues because there is often a combination of less organizational focus and higher overall scrutiny.
  • Plan sponsors managing a frozen pension plan should focus on reducing organizational risk by centralizing all data. If the plan sponsor can successfully centralize data, the administrative function becomes streamlined and easier to manage.

Finally, plan sponsors need to make sure they are undertaking enough communication with participants – particularly between the time the plan is frozen and the months leading to final closeout, the study said.

A copy of the study is available by e-mailing seiresearch@seic.com .

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