Why Freezing a Pension Plan Doesn't Eliminate Pension Risk

Freezing a plan can be an important step toward reducing future pension risk. By stopping or limiting future benefit accruals, a freeze can make a plan more predictable and easier to manage. 

Even if a plan is frozen, it does not mean the risk has gone.  Benefits earned need to be paid, plan assets still need to be managed, and the plan sponsor remains exposed to changes in interest rates, investment performance, funding levels, and other factors that can affect the cost of a plan. 

For companies considering a pension freeze or already managing a frozen plan, risk is often a key reason for freezing the plan in the first place. So, what risks remain, and what can we do to address them? 

What Changes When a Plan is Frozen? 

Freezing a pension plan can help the sponsor better understand the plan's future obligations and reduce the uncertainty associated with ongoing benefit accruals Plan freezes generally come in two types, determined by whether current participants continue to accrue benefits or not. The two types are referred to as soft freezes and hard freezes: 

• Soft Freezes: Closes the plan to new employees but allows existing participants to continue earning benefits.  

• Hard Freezes: Closes the plan to new employees and stops all future benefit accruals for current participants.   

Regardless of the type of freeze, plan sponsors remain responsible for the benefits participants have already earned, and the plan continues to carry obligations and associated costs until those obligations are settled, and the plan is terminated. 

What Risks Remain After a Pension is Frozen? 

Even after a plan is frozen, sponsors continue to manage many of the same financial risks they faced before the freeze. These include: 

1. Investment Risk 

Pension assets remain invested until the plan's obligations are settled. If investment performance falls short, the plan sponsor may need to provide additional funding to close the gap.  

Frozen Plans: Freezing a plan can provide greater predictability, but as long as assets are invested, investment risk will remain a part of the plan.  

2. Interest Rate Risk 

Changes in interest rates can impact pension liabilities. When rates fall, the value of a plan's liabilities can increase, potentially reducing its funded status. When rates rise, liabilities generally decrease. 

Frozen Plans: Similar to investment risk, a frozen plan can be affected by changes in interest rates until its liabilities are settled. 

3. Longevity Risk 

Pension obligations are based in part on actuarial assumptions around how long participants will live and receive benefits. If participants live longer than expected, benefits may need to be paid for a longer period, increasing the plan's total cost. 

Frozen Plans: Freezing a plan stops future benefit accruals, but it does not eliminate existing benefit obligations. Sponsors remain exposed to uncertainty around how long those benefits will need to be paid. 

4. Ongoing Costs and Risks 

Pension plans require the support of various departments and professionals. Actuarial support, administration, investment, compliance, and other costs can continue for years. The sponsor also retains responsibility for overseeing the plan and making decisions about how its assets and liabilities should be managed.  The longer a frozen plan remains in place, the longer the organization must pay these maintenance costs and the longer it's exposed to the other risks on this list. 

Frozen Plans: A freeze can be an important step toward reducing future pension obligations, but it is not the same as eliminating the plan's financial risk. Until the plan is ultimately settled, sponsors continue to bear the costs, responsibilities, and risks associated with maintaining it. 

What Can Sponsors Do About the Remaining Risk? 

Freezing a pension plan is often the starting point for a long-term de-risking strategy. Once future benefit accruals are no longer added to the plan's obligations, sponsors can focus more on managing the remaining risks. 

There are several potential paths an organization could take after freezing their plan. A few of these include: 

• Transfer Some or All Pension Risk: A sponsor may be able to transfer pension obligations to an insurer, reducing its exposure to some of the risks associated with maintaining the plan. Overfunded plans may even use excess funds to stand up a new pension design, like a Cash Balance plan, retaining the reputational, recruiting, and retention advantages, while reducing some of the risks of a prior plan.  

• Terminate the Plan: Once a plan is appropriately funded and the necessary steps have been taken, plan termination can allow the sponsor to settle its pension obligations and eliminate the risks associated with the plan. 

• Further De-Risk the Plan: Sponsors may adjust their investment strategy or funding approach to reduce the plan's exposure to market volatility and improve the chances of funding the plan.  

• Continue Managing the Plan. A sponsor can maintain the plan and manage its assets and liabilities over time, accepting the ongoing costs and financial risks that come with doing so. 

The right path will depend on your organization's goals, funding status, and market conditions.  

Freezing Your Plan is Just the Start 

For sponsors who want to move beyond the risks of their pension plan, freezing is the first step toward your goal.  

If plan termination is your destination, every additional month spent getting there can mean another month of ongoing costs, financial exposure, and management burden. 

The next question to ask is how sponsors can move from managing pension risk to eliminating it. In our next article, we'll cover the difference between plan termination and pension risk transfer, which both offer ways to reduce your exposure through different methods. Click below to learn more 

Or, if you’re ready to jump in today, let’s connect to discuss your plan and explore how we can help you reduce risk for your pension plan.   

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Article Written By Mark Unhoch

Pension Risk Transfer Practice Leader

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