Perspectives : Asset Management | February 07, 2023

Pension plan design changes: Plan sponsors controlling costs

Read time: 3 minutes

Vanguard 2022 pension survey 
This is the second article based on our 2022 survey of corporate pension plan sponsors. The first looked at corporate pension plan sponsors' misperception of risk; this time, we’ll explore the trends in plan design.
Pension plans are changing
Source: Vanguard, 2023. 
Among the plan sponsors surveyed, 79% reported that they intended to change their plans, representing a steady increase from 44% in 2012. “The cost of defined benefit plans and their influence on corporate financial statements receive a lot of attention from corporate managers,” says Jim Gannon, Vanguard senior investment strategist and lead actuary. “Any change from what was expected—like a sharp drop in funded status, a larger than expected contribution, or an increase in plan expenses—could lead to questions about the plan’s future.”
Read the full report of our 2022 survey of corporate pension sponsors →

Why are pension plans changing? 

The three top reasons for change have remained consistent since 2010. As the chart shows, plan sponsors want to reduce the cost, the volatility of cost, and the effects of plan results on company financial statements. The rank order of these three has changed over time, but they have remained plan sponsors’ priorities. 
Top reasons for changing pension plans
Source: Vanguard, 2023. 

What are pensions plans changing?  

As the second chart shows, nearly half of the corporate pension plan sponsors surveyed intend to execute a risk transfer, meaning they expect to purchase annuities for retirees, offer lump sums to terminated vested participants, or fully terminate the plan. Each of these changes has more to do with transferring a plan’s liability and risk—either to insurance companies or to participants—than with changing how participants earn benefits. Changes such as offering a lump-sum window (cited by 20% of respondents) and purchasing a group annuity (12%) effectively reduce the size of the plan.
Expected changes to pension plans
Source: Vanguard, 2023. 
When changing their plans, plan sponsors should be cautious of unintended consequences. “Plan sponsors who are thinking about buying a group annuity or offering a lump-sum window should thoroughly analyze how these actions could affect the plan’s risk profile, cost savings, and asset allocation,” Jim says. “After any risk transfer transaction, the pension plan that remains is much different than the plan before the risk transfer. The remaining plan could be more difficult to manage because it actually has more risk, but that may not be obvious unless someone analyzes the new plan.”

The end of a trend?

The long-term trend has been toward closing pension plans to new participants and then freezing new benefit accruals. But we’ve noticed two developments running counter to that trend:

  1. According to government filings, the percentage of open and ongoing pension plans has begun to level off at about 50%. This leveling off may indicate that sponsors who maintained open and ongoing pension plans after the global financial crisis, the introduction of more stringent funding and reporting regulations, and the increases in Pension Benefit Guaranty Corporation premiums are “true believers” in defined benefit plans and more likely to maintain them in the future.
  2. We’ve noticed a large increase in the number of cash-balance pension plans covering a small number of participants. Anecdotal evidence suggests that this type of plan has become popular with partnership firms such as doctors, lawyers, and financial service professionals, allowing them to benefit from more favorable tax treatment and higher allowable contributions than defined contribution plans.      

How can an OCIO help with pension plan changes?

Plan sponsors reported that they don’t have sufficient expertise, staff, or time to devote to administering their pension plans. With more than 25 years of experience, Vanguard’s outsourced chief investment officer (OCIO) services for pensions can help plan sponsors navigate the regulatory and fiduciary considerations that come with managing—and changing—a pension plan.

All types of pension plan changes also affect how the plan’s assets should be managed before, during, and after the changes. An OCIO can help analyze, recommend, and implement asset allocation changes that should result from plan changes. As Vanguard Senior Investment Strategist Valerie Dion explains, “An OCIO provider is well positioned to understand and explain how the risks in a plan can be managed or can be challenging to manage depending on the plan design. Before deciding on changes, plan sponsors should get their OCIO provider’s perspective on the possible effects of the change.”

“Vanguard OCIO services can perform an asset liability study based on a pension plan’s pre- and post-change status,” Jim says. “We can recommend a post-change portfolio and help the plan sponsor transition from the current portfolio to the post-change portfolio.”

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Diversification does not ensure a profit or protect against a loss.
  • Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor.