So You’ve Frozen Your DB plan – Now What? (Part 4)
Since this is my final blog in my “So You’ve Frozen Your DB plan – Now what?” series, I’m wondering if you are humming any songs in your head yet? Any guesses on what song I’m connecting these blogs to? I’ll give you two hints. Hint #1 – Sir Paul wrote it.
As I’ve been discussing, there are generally three steps a plan sponsor can consider when winding down their frozen defined benefit (DB) plan (that’s your #2 hint!). Today, I’d like to discuss the third step – develop an asset allocation strategy.
Step 3 – Develop an asset allocation strategy
The asset allocation of a DB plan will impact the amount of contributions needed to fund the plan to termination as well as the volatility of contributions from year to year. It can also help to protect any improvements in funded status as a plan sponsor moves toward a termination goal.
A best practice when determining an asset allocation strategy is to have an asset liability modeling (ALM) study prepared. In an ALM study, a DB plan’s assets and liabilities are modeled to help evaluate the effect of various asset allocations on a termination strategy.
These may include:
- The amount of annual contributions
- The termination-funding status
- The present value of expected contributions
An ALM study generates stochastic forecasts (meaning many variables) using multiple allocations between equity and fixed income—for example, the 75%/25% allocation as well as an allocation of 50% equity and 50% fixed income. The results of the forecasts would then be compared to view the potential impact on the amount and volatility of contributions from the present time until the desired plan termination date.
Using an ALM study can also help illustrate the possible odds – or chances – that a certain allocation strategy will be successful in the desired time frame and cost to terminate a DB plan.
Carrying out a termination strategy
If a plan sponsor considers the steps outlined in my past several blogs, they could be well on their way to developing a strategy for terminating a hard-frozen DB plan. A plan’s actuary and financial professional can help carry out these decisions and get a DB plan sponsor started down the path to plan termination.
However, it’s also important to note that termination may take years to complete, so monitoring progress is critical. A change in the markets may necessitate either a change in strategy or a change in the termination timetable, or possibly both. It is important to keep an eye on a DB plan’s progress toward termination and be prepared to make adjustments as needed.
Oh, and the song I’m humming – The Long and Winding Road by the Beatles.
In addition to blogging here, I also tweet regularly about DB topics of interest. Click to follow me on Twitter- @scottruba.
The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Asset allocation/diversification does not guarantee a profit or protect against a loss. Use of dynamic asset allocation does not guarantee improvement in plan funding status nor the timing of any improvement.
Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.
t13080901e6 – 8/2013