The average pension plan sponsor kicked off 2023 in its best funding position since the 2008 financial crisis, with plans being just about fully funded. Going into 2024, plan sponsors have a few calls to action driven off some of the trends that developed in 2023. 

The Pension Roller Coaster Experienced Changes 

2023 was another volatile continuation of the pension plan roller coaster ride that results in large upticks and drops in funded status over time. Discount rates fell approximately 130 basis points (bps) to close the year after peaking in October 2023, and are down approximately 30 bps for the year. As a result, many plans reached peak levels of funded status in October 2023 then experienced pullbacks as liability increased in the fourth quarter. The average plan should still be up through the end of 2023, driven by equity markets, but careful consideration should be given for the path forward. 

Call to Action for Return-driven Plans 

Return-driven plan sponsors with higher allocations to equities or smaller allocations to long-duration bonds saw significant upticks in funded ratios over the last couple of years as rates increased. These types of plans have been encouraged to take risk off and lock in funded ratio improvements as they occurred. While the pullbacks in interest rates may have caused large drops in funded ratios later in 2023, there is still time to reduce risk in portfolios before additional potential pullbacks occur with plan funded levels. Liability-driven investment strategies designed to stabilize plan funded ratios started to have a larger impact in helping avoid losses during the fourth quarter. 

Pension Risk Transfer Activity Continues 

Pension risk transfer activity picked up during the year as funded levels were elevated. Some plans executed lump sum offers as interest rates used to calculate lump sums were higher than in previous years. Even more notable is that annuity buyouts were close to record levels in 2023. According to LIMRA, although the total dollar amount of sales declined, the number of annuity buyout contracts through the third quarter was 483, more than double the number of contracts sold in 2022. One of the drivers of the activity has been increasing PBGC (Pension Benefit Guaranty Corporation) premiums. PBGC premiums have more than doubled in the last 10 years and in 2024, reaches a high of $101 per plan participant and 5.2% of unfunded liability with a per-participant cap. Due to the high volume of transactions, insurance carriers experienced capacity constraints and we anticipate transactions to spill over into 2024.

Call to Action for Plans Paying High PBGC Premiums

In recent years, offering bulk lump sums at opportune times has been one technique to reduce participant counts and, ultimately, PBGC premiums. With discount rates still somewhat elevated compared with prior years, the value of lump sums paid to plan participants could be significantly lower in 2024 than previously. Plan sponsors with substantial terminated vested populations may want to consider the implications of offering lump sums. Those containing sizeable retiree populations with smaller benefits may want to evaluate annuity buyout implications for those groups. Aside from reducing participants, underfunded plans can also make discretionary contributions to reduce the PBGC variable rate premiums assessed on the unfunded portion of the liability. Plans considering lump sum windows should work with their providers to manage the investment strategy considering a sizable outflow of plan assets.

Pension Plan Comeback?

The industry reacted to IBM announcing a change to its retirement program never seen before in pension history. While IBM was recognized as one of the first large companies to freeze its defined benefit plan about 18 years ago when it shifted to a 401(k) structure, in 2023 it became one of the first organizations to freeze matches to its 401(k) and re-open its frozen defined benefit plan. While the timing of this change was opportune for IBM, as its pension’s existing surplus should be able to fund several years of future defined benefit plan accruals, there are several reasons participants could welcome such a shift. For example, defined benefit plans have more predictable benefits than participant-directed defined contribution (DC) plans, as the investment risk falls on the plan sponsor rather than on plan participants. Defined benefit plans also offer lifetime income options that are more cost effective than those that participants might be able to access under a DC plan structure, which has become an area of focus in recent years after the SECURE 2.0 Act opened the door for these options in DC plans. The move splits the responsibility for retirement saving so that participants have control and responsibility over participant contributions and investments in the 401(k) plan while receiving the security of a defined benefit from the cash balance plan.

Call to Action for Plan Sponsors Rethinking Participant Outcomes

The actions taken by IBM may or may not be a great fit for every plan sponsor; however, there is recognition that pension plans may be in a much better funding position than those seen in the last 15 years. Pension plans with surpluses and employee bases that value a defined benefit structure may consider reopening the plan for a cost-effective retirement solution. To apply lessons learned from the past, it is imperative that a plan sponsor manage the investments in a liability-centric framework to avoid the funded status roller coaster and maintain predictable costs for the defined benefit plan offered to active employees.