The Case for Freezing Pension Plans

March 22, 2006 (PLANSPONSOR.com) - New research from Towers Perrin looks into the challenges presented to employers by defined benefit pension plan risk, why employers are freezing plans and the unmet need for solutions to manage the risk.

The Case for Freezing Pension Plans

Interviews with over 100 senior and finance executives across various industries found that 57% of companies considered pension-related risk significant relative to other financial and operational risks they faced.  Though companies with plans that are well funded or whose cash contributions have minimal effect on earnings or cash flow view the risk as being manageable over the short term, most senior executives voiced concern for the potential effect of the plan on company credit ratings and cash flow.

The Case for Freezing Pension Plans

Many employers have responded to this risk threat by freezing their pension plans.  Thirty-two percent of the companies interviewed by Towers Perrin had closed their plans to new entrants.  However, freezing plans may not be desired by companies who still consider their DB plan a valuable employee recruiting and retention tool, and, as a recent study from SEI concluded, it does not alleviate all risks (See  Study Warns DB Plan Freezing Doesn't Mitigate All Risks).  Towers Perrin said in its report, "Freezing defined benefit plans, though popular, is a half-measure that slows the growth of the plan, but does little to alleviate the market and mortality risk associated with the legacy pension plan."

Other than company-specific factors such as the size of the pension deficit, maturity of the plan or overall company finances, companies are also freezing DB plans or considering freezing them due to recent and pending regulatory changes (See  Plan Sponsors Not Waiting for Reform to Consider Pension Options and  Poll: Pension Reform Will Contribute to Plan Terminations).

In the Towers Perrin research, 72% of executives with active plans said they would consider freezing their plan if the Financial Accounting Standards Board (FASB) were to eliminate accounting smoothing mechanisms, while 62% of respondents said they would consider freezing if tighter funding requirements were enforced.

The Towers Perrin study also indicated that employers choose to freeze their DB plans because they are generally dissatisfied with other options available to them.  Terminating the plan entirely through annuitization represents a cost-prohibitive option for even the best-funded plans due to the conservative market return and risk assumptions insurance companies use to price pension termination annuities.  Other options companies might consider, and their downside, include, according to Towers Perrin:

Senior financial executives feel the current choice of DB plan solutions are either too expensive or ineffective at managing risk.

 

Other Options

As part of Towers Perrin's research, the executives were asked to evaluate several potential solutions, some which are not widely available on the market today.  Their reactions demonstrate that an unmet need does indeed exist in the marketplace, as does a willingness to adopt new solutions, provided they have been validated and tested, Towers Perrin said.  

Suggested possible solutions, and respondents reactions, were:

More information can be obtained by emailing Matt Herrmann at Towers Perrin, matt.herrmann@towersperrin.com.

Rebecca Moore
editors@plansponsor.com

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