$20 billion club strategy series – Benefits policy

Executive summary:

  • The benefits policy is one of the key levers a plan sponsor can pull to impact a plan's outlook. This can range from minor tweaks to the plan’s benefit formula to major adjustments that close the plan to new hires or freeze the plan’s accrual for existing participants.
  • The trend toward closing and freezing DB plans is continuing, with the participant count in large DB plans down more than 34% from 2006 through 2022. In addition, 2023 saw the highest number of pension risk transfers to date.
  • At Russell Investments, we're agnostic on whether a plan is open, closed, or frozen. However, it’s important to recognize that each plan status inherently has different needs, objectives, and goals that should be carefully considered when contemplating any changes.

In the second installment of our deep-dive series into strategy insights among members of the $20 billion club—our term for the U.S.-listed pension plans with the largest liabilities—we’ll examine the latest trends in the benefits policies of these mega plans. Our first installment, which covered investment policies within the club, was published earlier this month and can be viewed here.

To recap, defined benefit (DB) plan sponsors have several major levers available to help successfully manage the costs, benefits, and risk of their plans. At the broadest level, we split these into three polices: investment, benefits, and funding policies. These levers are often closely intertwined and pulling one lever can lead to adjusting another. What each of these policies aims to achieve is:

1. Investment policy - This lays out how the assets and contributions go to work for the sponsor

2. Benefits policy - This directly impacts plan participants’ benefit accruals

3. Funding policy - This determines the contributions made by the sponsor to pay for those benefits

The intertwined nature of pension management can lead to wide ranges in how each of these policies is set and adapted.

The benefits policy is one of the key levers a plan sponsor can pull to impact the plan outlook. This can range from minor tweaks to the plan’s benefit formula to major adjustments that close the plan to new hires or freeze the plan’s accrual for existing participants.

The trend toward closing or freezing DB plans continues

During the past decade or so, there has been a broad trend in the industry toward closing and freezing DB plans. The reasoning behind this approach is myriad, complex, and non-linear. Regulations, funding hurdles, and workers’ preference toward benefits can be cited, but there is no single item that is the root cause. When the Pension Protection Act of 2006 (PPA) was passed, the DB landscape changed dramatically. While the resulting changes significantly increased protections for participants, the same changes increased the cost, governance, and burden on pension plan sponsors.

Since then, large DB plans have been on the decline, both in plan count and participant count. Total participant count is down more than 34% from 2006 to 2022, according to the Pension Benefit Guaranty Corporation (PBGC) data tables. This takes place through closing, freezing, and the subsequent natural attrition as participants leave the plan through cash-out or pass away, and can be accelerated by executing pension risk transfers. This is no different for the $20 billion club plans that have altered plan design by closing plans to new entrants and, in many cases, freezing benefit accruals altogether, followed by small to large pension risk transfers.

Like many of the trends we are bringing to light here, this has come up in the $20 billion club before and it is no surprise that it has continued in the past few years. Closing and/or freezing a DB plan will inherently reduce the risk that the plan poses to the plan sponsor due to the reduction in future uncertainty associated with benefit accruals for active participants. This, in turn, has an impact on the investment policy, which we detailed in the previous section. Exhibit 1 lists some notable activity in this space in 2023.

Exhibit 1: Notable activity in 2023

 Organization  Notable Activity
 UPS  Full freeze of 70,000 non-union participants became effective in 2023, as announced in 2017
 AT&T  $8.1B group annuity contract purchase
 Dow  $1.7B group annuity contract purchase
 Johnson & Johnson  $800M group annuity contract purchase
 Lockheed Martin  $400M lump sum window 
 IBM  Reopened DB plan to replace 401(k) employer contributions

2023 was another very strong year in the pension risk transfer market with over $45 billion in annuity purchases, the second most only to 2022 at over $50 billion, as seen in Exhibit 2. However, the number of transactions was the highest seen to date, which means that the risk transfer trend we’ve observed in the $20 billion club has truly made its way down to the smaller plan size.

In 2022, IBM took part in this trend by de-risking its pension plan with a $16 billion annuity purchase risk transfer. This was the second largest pension risk transfer, topped only by General Motors’ 2012 $25 billion annuity purchase, which arguably kicked off the high pace of annuity purchase risk transfers we see in the industry today. However, IBM made waves at the end of 2023 by reopening its DB plan to current active participants and new entrants. This unleashed a flurry of discussion on the future of DB plans and how much of a trend this would become. We will need to wait a little longer to see how this all plays out, but it’s something we’ll be tracking closely.

Exhibit 2: Annuity purchase history
Annuity purchase history

Source: LIMRA Secure Retirement Institute.

While the UPS freeze was announced several years ago, it’s worth noting that of the $20 billion club members, UPS had the highest service cost relative to PBO in 2022—a key metric when comparing open and closed plans. UPS was one of only two plans where this ratio was above 3% in 2022, with Johnson & Johnson being the other. The freeze to its non-union participants has since decreased this ratio for UPS, with the company no longer having the highest service-cost-to-PBO ratio among members in 2023.  With UPS in mind, let’s look more broadly at this key metric.

To further illustrate the trend of pension plans closing and freezing, we can look at the size of service cost relative to PBO across the $20 billion club. The service cost for a pension plan represents the annual cost associated with new benefit accruals for active participants. For an established and open plan, the service cost relative to the PBO will be consistent as active participants accrue benefits and inactive participants exit the plan through mortality (or otherwise). This ratio of service cost to PBO is generally between 3% and 5% for an open plan.

However, there has been a broad trend of plans closing to new entrants (soft freeze) and freezing benefit accruals altogether (hard freeze) for several years. For a soft-frozen plan, this ratio will decrease over time and will be 0% for a hard-frozen plan. Exhibit 3 illustrates the move of closing and freezing plans since the PPA was passed in 2006 through the decline of the service-cost-to-PBO ratio. In 2006, the service cost ratio among these companies ranged between 1.1% and 5.4%. In 2023, the range dropped to between 0% and 2.7%, with an average decrease of about 1.6% since 2006.

Exhibit 3: Service cost relative to PBO since 2006
Service cost

Source: SEC Form 10-K filings.

With the uptick in pension risk transfers, which focus on non-accruing participants (i.e., they have no service cost), it would be reasonable to expect that the service cost relative to PBO would increase as the PBO shrinks (e.g. AT&T’s ratio increased by 0.4% from 2022 to 2023, presumably in part due to its large risk transfer). However, even as plans have executed lump sum offers and annuity purchases, the ratio of service cost to PBO has continued to drop over the past few years, further emphasizing the impact of closing and freezing.

It should be noted that we have begun to see diverging paths within the $20 billion club membership with respect to this metric. The plans with higher service cost relative to PBO have been relatively flatter, or at least have a slower decline, than those plans now at the bottom of this exhibit that continue their steady trend toward zero. Similar to UPS, many of these freezes were implemented years ago and are continuing to come to fruition or have over the past few years. Other plans were closed many years ago and the plan’s service cost continues to tick down as active participants leave the plan. This is something we will continue to track.

What does this all mean for your DB plan?

As we’ve mentioned, the different levers available to plan sponsors are often intertwined, but the industry trend on benefits policy has leaned into closing and freezing plans and executing risk transfers. This reduces the overall risk of the plan through a shorter in-plan duration and the ability to lock things in when fully funded through hibernation as well as other concepts. However, there are considerations on how and when to do this. Choosing the right populations to annuitize with an insurer is already an important decision, but we believe it’s also critical to consider the implications on other levers, such as investment policy and corresponding asset allocation. Off-loading certain participant cohorts can look appealing at first blush, but the leftover plan can sometimes unintuitively lead to higher average contribution requirements. Or perhaps IBM is on the cutting edge and more DB plans will follow suit in reopening their own plans.

At Russell Investments, we are agnostic on whether your plan is open, closed, or frozen. However, each plan status inherently has different needs, objectives, and goals. Open plans will have a higher return hurdle rate to keep up with the service cost for actively accruing participants. Frozen plans have a finite timeline as participants leave service through termination, retirement, and ultimately, mortality. This means that plan sponsors may want to consider end-game planning and how to approach those specific concerns. Closed but unfrozen plans land somewhere in the middle with unique considerations and timelines. Add a layer of funded status to the mix and things can get complicated fast. We’re here to help with those complications and work through those details, whether it be picking the right return-seeking and liability-hedging mix, selecting the equity mix, or helping implement a completion mandate to reduce interest rate risk.

A note on $20 billion club membership

Over the past several years, inclusion in this group of mega-plans could have increased a few times due to falling interest rates, which caused liabilities to soar. However, we have kept this group stable in the past to maintain a certain level of consistency. While the last couple of years have been exceptional in many ways, the impacts have arguably been reflected more keenly in the DB plan space than in many other areas due to the dramatic decline in liabilities. We have used this as an opportunity to refresh the membership of our $20 billion club. The most recent list of 21 companies—many of which have long been members of the club—can be found in our 2024 update. We expect this list to continue to evolve over time.