Timely, relevant, and actionable investment perspective, best practices, and planning insights for institutional and wealth management clients from CAPTRUST's Consulting Research Group.

Advanced Filter

Planning for Termination

Creating a Plan for Asset and Liability De-Risking

Grant Verhaeghe
CAPTRUST Senior Director | Defined Benefit Practice Leader

In the third quarter 2010 Strategic Research Report, we wrote an article entitled “A Good Plan Today Is Better Than a Perfect Plan Tomorrow.” That article focused on developing and implementing a plan to remove unrewarded risk in pension plans. In the three years since its publication, many corporate pension plans have experienced dramatic increases in funded status. As a result, plan termination and pension risk transfer — which involves settling pension liabilities with lump sum payments or purchasing annuities for participants entitled to pension benefits — may be increasingly feasible. This article explores the environmental factors driving this change and outlines a three-phase process plan sponsors may want to consider as they develop and execute strategies to accomplish their endgames. According to a CFO Research and Prudential study released in July 2013, a large proportion of plan sponsors are interested in pursuing a form of benefit cessation or pension risk transfer in the next two years.1

The 2013 numbers are a dramatic change in planned behavior from the past; compared to a similar study published in 2011, the 2013 data indicates an 80 percent increase in respondents’ likelihood to close their defined benefit plan to new entrants and a 40 percent increase in their likelihood of freezing or terminating their plans.2

The natural question to ask is: Why have plan sponsors’ views changed so much? Here are some answers:

The combination of higher interest rates and strong asset performance in calendar year 2013 has led to material improvement in funded status. The Milliman 100 Index — which measures the funded status of the one hundred largest corporate pension plans in the U.S. — improved from 77.2 percent to 95.2 percent in 2013 alone.3

Interest rates — Most corporate pension plans measure liabilities by discounting future expected payment streams using high-quality, corporate bond interest rates. According to Milliman, discount rates moved from 4.16 percent on average in February 2013 to 4.83 percent in December 2013.4 Simply put, higher interest rates mean lower liabilities and improved funded status.

Asset performance — A plan with approximately 40 percent invested in fixed income and the remainder invested among equities, commodities, real estate, and other diversifying asset classes returned approximately 13 percent in 2013.5 These strong asset returns also served to improve pension funding.

Regulatory Environment
Legislation has increased the long-term cost of maintaining pension plans twice in the past two years. Both the Moving Ahead for Progress in the 21st Century Act (MAP 21) and the Bipartisan Budget Act of 2013 included provisions that increase fixed and variable rates for Pension Benefit Guarantee Corporation (PBGC) premiums.6

Mortality Improvement (increased longevity)
The Society of Actuaries (SOA) released its Mortality Improvement Scale MP-2014 Exposure Draft in February 2014, proposing an increase in the life expectancy measures used in pension liability calculations.7 Since actuaries determine funded status based upon estimates of how long participants will live (and collect benefit payments), the proposal will cause an increase in pension liabilities. The SOA draft is still open for comment, but actuaries and auditors will likely begin using the new standard for financial statements in 2014 and for funding, which will include lump sum calculations, in 2016 or 2017.

We have already seen revised estimates of benefit liabilities from several of our clients’ actuaries — some with increases as high as 8 percent. Needless to say, that magnitude of increase — and corresponding decline in funded status — may prompt plan sponsors to consider accelerating pension risk transfer transactions and, specifically, lump sum windows.

Now is a good time for plan sponsors to revisit their overall strategy in light of the aforementioned factors. We suggest a three-phase process of planning for and implementing plan termination and pension risk transfer.

PHASE ONE: Objective Setting and Fact Finding (Asset De-risking)

Termination may not be feasible in the short term for significantly underfunded plans. That should not, however, keep plan sponsors from developing a strategy for when conditions are right to move forward. Conditions can change quickly; many plan sponsors currently considering termination were likely in this phase prior to 2013 with funding levels below 85 percent.

Imperatives during this phase include identifying goals and long-term objectives and researching the decisions that need to be made for execution when the time comes. Below is a list of questions plan sponsors should ask themselves to sharpen their focus as they evaluate their goals and objectives:

What is the endgame for the pension plan?

Who are the right stakeholders to have at the table for these objective-setting discussions?

Which of the following risks or strategies should I rely on — and in what combination — to improve funded status?

Rising interest rates to lower benefit liabilities

Market risk to increase asset values

Contributions to close the funding gap

What additional data points do I need to agree on a long-term strategy and address known pain points?

What are the implications of these decisions for participants and how will I address them?

During this phase, a plan sponsor should explore development of a liability-driven investment (LDI) strategy, which gradually removes investment risk and aligns plan assets with liabilities as funding levels improve. LDI involves splitting a defined benefit plan’s investment portfolio between liability-matching assets and growth assets. The allocation to liability-matching assets gradually increases as funding thresholds are met; meanwhile the allocation to growth assets declines. This dynamic de-risking glidepath, as it is called, is designed based on capital market assumptions, interest rate perceptions, and overall risk tolerance.

While going through this objective-setting exercise may or may not lead to immediate portfolio changes, it should provide a framework for a strategy designed to attain your objectives and development of a dynamic de-risking glidepath that is the basis for the
next phase.

PHASE TWO: Investment and Contribution Strategy (Asset/Liability De-risking)

As funding levels push toward 100 percent, it is important to continue to improve funding levels while minimizing the potential for funding declines. Ideally, as this is happening, plan sponsors are further clarifying goals and objectives, documenting key fiduciary decisions, and engaging in early pension risk transfer activities.

This second phase of the process focuses on executing the dynamic de-risking glidepath and planning for the third and final phase of pension risk transfer and termination. Below is a list of questions that plan sponsors in this phase should begin to consider:

Do we have the right monitoring procedures to implement a dynamic de-risking strategy?

What triggers do we have in place to ensure that we execute the strategy in a timely fashion?

How often are we revisiting our strategy’s appropriateness?

What factors will lead to changes?

Do we have the right team in place to execute the next phase?

Are the committee and stakeholders educated on the termination process? 

A particular plan’s glidepath will be a function of the combination of contributions, market risk, and interest rate risk the plan sponsor chooses to rely on. As 2013 demonstrated, solid asset performance and rising interest rates can lead to very quick improvements in funded status. However, the capital markets do not always cooperate. In the end, the only factors plan sponsors can control are the contributions they make and the benefits they promise. This means that plan sponsors with a need for more certainty about the timing of plan termination may wish to focus on contributions rather than on interest rate and market risk.

During this phase, it is important to identify the advisors who will assist with the plan termination and pension risk transfer execution. A specialized team consisting of the company’s committee or stakeholders, investment consultant, actuary, ERISA counsel, single premium group annuity search provider, and asset managers all have a role to play. Active communication with these players will help ensure smooth execution when the time comes.

Plan sponsors may also want to begin exploring early-stage pension risk transfer strategies such as lump sum windows for terminated vested participants. Pension risk transfer strategies essentially look to reduce the liability amount that is subject to market forces by settling a portion of participant obligations. Lump sum windows may be more attractive if completed before 2016 due to changes in mortality scales. In preparation for the final phase, plan sponsors should educate themselves on the annuity placement process and procedures defined by the DOL Interpretive Bulletin 95-1 (IB 95-1) for annuity placement at termination.8  

Plan sponsors often define success in this phase by execution or modification of their investment strategy — perhaps to include an LDI component — and, lastly, planning and preparation for the final phase of liability defeasement.

PHASE THREE: Execution of Termination Strategy and Pension Risk Transfer (Liability De-risking)

This third phase is focused on execution — rather than planning — 
and may last from six to eighteen months, depending on a number of factors, including the amount of planning and preparation done in the earlier phases and response times of the PBGC and Internal Revenue Service (IRS) — if a determination letter is sought. Plan sponsors in this phase have arrived at an economic position that will allow them to terminate their plans. 

Their goals now shift toward alignment of risk management and investment strategies with a focus on hedging economic risk by reducing the probability of funding declines.

During this phase, plan sponsors should focus on executing on their plans and fulfilling the requirements associated with the termination process, including:

Developing communication strategies and following the strict filing requirements and timelines defined by the PBGC for plan termination. Additionally, a determination letter from the IRS ensures the plan is qualified at the time of termination, which creates additional timeline requirements.

• Engaging your annuity placement provider to guide the committee through the decision-making and bidding process, ensuring compliance with DOL IB 95-1, which requires plan sponsors to place annuities with the safest available insurance company — rather than focusing solely on the least expensive option.

Shifting investments toward more liquid hedging solutions in anticipation of the annuity placement and asset transfer. Depending on the transaction size, the portfolio may shift toward a target portfolio specified by the insurance companies in order to minimize transaction costs.

Improved pension funding levels resulting from rising equity markets, higher interest rates, and regulatory changes have created new conditions where pension termination may be economically feasible — or at least getting closer to it. Managing pension plans through this process involves evaluating sometimes complex, interrelated variables. It requires key stakeholders to define clear objectives and a framework to accomplish those objectives. Plan sponsors will likely attribute success of reaching final objectives to carefully defining, maintaining, and executing this framework. While the phases we outlined in this article may not tie directly to your specific situation, our intent was to divide the plan termination and pension risk transfer process into clearly defined, actionable, and attainable segments.

In coming quarters we will be providing additional thoughts and specific detail on the plan management process in these three phases. 


1CFO Research and Prudential, “Balancing Costs, Risks, and Rewards,” July 2013
2 CFO Research and Prudential, “Benefits Planning in a Challenging Environment,” March 2011

3 Pension Funding Index, Milliman, accessed March 28, 2014,
4 Milliman, “2014 Pension Funding Study,” March 2014
5 Zephyr Style Advisor, Diversified portfolio represents blend of 40% Lehman Brothers Aggregate Bond Index, 20% S&P 500 Index, 7% Russell Mid Cap index, 3% Russell 2000 Index, 13% MSCI EAFE Index, 3% MSCI Emerging Markets Index, 4% DJ UBS Commodities Index, 4% DJ US Select REIT Index, and 6% HFRI Conservative Fund of Funds Index
6 Premium Rates, Pension Benefit Guaranty Corporation, accessed April 3 ,
7 Society of Actuaries, “Mortality Improvement Scale MP-2014 Exposure Draft,” accessed April 3, 2014,
8EBSA Final Rule, Amendment to Interpretive Bulletin 95-1, U.S. Department of Labor, accessed April 3, 2014,



CAPTRUST’s Wes Collins on Financial Wellness at Work

PLANSPONSOR recently published an article written by Wes Collins, senior manager of participant advice services at CAPTRUST. Collins explains that plan sponsors should consider educational programs that help their workers understand what financial wellness looks like at different ages and career stages.

Read More