IN FOCUS6-8 min read

Congratulations! Your pension plan is fully funded…now what?

For the first time since the 2008 financial crisis, many defined benefit plans are fully or overfunded. These plan sponsors now face important decisions regarding their next steps and have the opportunity to consider a wide range of endgame strategies. In an era of regime shift brought about by the 3D Reset, is termination via a pension risk transfer to an insurance company still the optimal strategy?



Max Guimond, CFA
Solutions Manager

Since the 2008 financial crisis, plan sponsors have diligently worked towards fully funding their defined benefit plans, gradually de-risking as funded status improved. Having recently achieved this significant milestone of being fully funded, many now face important questions about the most appropriate next steps. Is termination via a pension risk transfer to an insurance company still the optimal endgame strategy? Are there alternative approaches worth considering, and what are the tradeoffs involved?

Instead of solely focusing on pension risk transfer (PRT), sponsors with a plan in surplus now have the opportunity to consider a broader set of endgame alternatives. Maintaining a plan in surplus not only has the potential to generate pension income but also increases balance sheet flexibility, and provides other significant advantages unavailable to an underfunded plan. This shift in mindset has prompted many pension plans to re-evaluate their endgame strategy and explore new investment strategies that can help preserve these additional benefits while still ensuring the financial security of their participants.

Evaluating endgame strategies

For many plan sponsors embarking on a de-risking journey, the thought had always been to terminate the plan once overfunded, moving the liabilities and assets to an insurer through a PRT. This approach has several benefits for the plan sponsor including reducing the size of the plan relative to the balance sheet and cost savings through the reduction of administrative, investment and PBGC expenses.  Additionally, the plan sponsor can better focus on managing their core business rather than managing the pension fund. Consequently, for many plan sponsors, the ultimate objective remains the termination of the plan.

However, some sponsors are seeing compelling benefits, both for the plan sponsor and participants, to maintaining a plan in surplus instead of pursuing a PRT. Sponsors opting for this route should first and foremost make sure the plan is self-sustaining to avoid the need for future contributions. By minimizing the potential mismatch between assets and liabilities with Liability-Driven Investment (LDI) techniques, sponsors can greatly reduce funded status volatility, while a careful review of the asset allocation must insure that the overall portfolio produces enough growth and income to cover all other implicit and explicit costs of running the plan.

The surplus advantage

The term “uncapturable surplus” is often used when discussing overfunded plans. However this is a bit of a misnomer. Yes, it is true that any reversion from the plan to the sponsor is subject to a 50% excise tax plus income tax, but there are ways to both reduce the excise tax and “capture” some of this surplus. In fact, plans that are overfunded can benefit the sponsor in a many ways and provide greater financial flexibility. Table 1 highlights several of these benefits.

Table 1: Benefits summary



Accounting: Income Statement

  • An overfunded plan can generate pension income instead of expense if the expected return on assets moderately exceeds the discount rate
  • The pension income flows directly to the corporate income statement increasing earnings per share

Accounting: Balance Sheet

  • The pension surplus appears on the balance sheet as an asset improving financial ratios

Pay retiree medical expenses

  • Transfer of the surplus assets to pay retiree medical expenses through 401(h) accounts as defined by Internal Revenue Code Section 420
  • SECURE 2.0 has lowered the surplus asset threshold for de minimus transfers of 1.75% of plan assets

Transfer assets into a Qualified Replacement Plan (QRP)

  • QRPs can be either DB or DC plans and must cover 95% of the active participants in the plan
  • If 25% or more of the surplus is moved into the QRP the 50% excise tax is reduced to 20% on assets reverted to the sponsor

Aid in mergers and acquisitions

  • Sponsor with an overfunded plan can use the surplus in M&A deals with a sponsor of an underfunded plan

Enhance current DB benefits

  • In order to attract to retain talent the sponsor could increase current benefit levels funded by the surplus

Source: Schroders, IRS, Treasury Department.

Of the above benefits, perhaps the most immediate benefit to the sponsor is the effect on the income statement. Consider a plan that has moved from fully funded to being overfunded by 10% (see Exhibit 1). Even with a relatively conservative asset allocation, EROA 100bps over the discount rate, the plan now generates pension income. At 100% funded, the plan was a $24mm expense on the income statement, dragging down earnings per share. Now, the plan contributes $36mm to earnings, a change of $60mm. This marks a direct benefit the sponsoring company’s shareholders.

Exhibit 1: Income statement impact

($ millions)

100% Funded

110% Funded

Projected benefit obligation



Market value of assets



Benefit payments



Discount rate



Expected return on plan assets (EROA)



Service cost



Interest cost



Expected return on plan assets



Amortization of prior service cost



Amortization of net (gain)/loss






Net periodic benefit cost/(income)



Source: Schroders. Shown for illustrative purposes only. The scenarios shown are hypothetical. Actual returns may vary.

The benefits to maintaining the overfunded plan extend to the overall corporate enterprise. This could be through accounting benefits, human capital benefits such as enhancing existing benefits or creating a QRP, or potential corporate actions such as a merger or acquisition. The endgame strategy should therefore look a bit further than the plan itself and determine if having essentially a “net asset” with the plan could assist in future aspirations of the corporation.

Revisiting the glidepath

Sponsors opting to continue to manage the plan should closely review and monitor the asset allocation, especially in the later stages of the de-risking glidepath. While minimizing funded status volatility should remain a key objective, increases in fixed income allocations originally prescribed for a fully funded plan may need to be amended when the plan becomes overfunded in order to avoid becoming over-hedged.

Overfunded plans more heavily allocated to fixed income can benefit from a more expansive LDI toolkit that includes shorter duration fixed income and other “liability-aware” strategies that can offer attractive diversification benefits in the context of an overall self-sufficiency strategy. In fact, this concept is not new as many life insurers who participate in the PRT market utilize a much broader and diverse set of fixed income strategies when managing against the same liabilities they take on their balance sheet (See Exhibit 2).

Exhibit 2: Fixed income asset breakdown for US life insurers

Fixed income asset breakdown for US life insurers

Source: National Association of Insurance Commissioners (NAIC) Capital Markets Bureau, Special Report. Year-end 2022 data.

The case for intermediate fixed income strategies

When a pension plan had a lower funding level and a smaller allocation to fixed income, the portfolio was forced to “work harder” to achieve the desired interest rate hedge. This was often achieved by extending the portfolio duration beyond that of the liability. However, with a better funded plan, the LDI portfolio can “relax” a bit, because there are more dollars available to achieve the same hedge. This means that the portfolio can achieve its objectives more easily and potentially with the inclusion of more intermediate-duration fixed income strategies.

Interestingly there is another reason that plans may want to consider intermediate strategies. DB plans began closing to new participants and/or freezing over 20 years ago. The lack of new participants or benefit accruals is beginning to show in the liability profile with the majority of projected benefit payments being much closer to the present day. Couple the shortening of the projected benefit payment stream with the current higher rate environment and the liability duration for many plans is closer to 10 years versus 13 to 15 years in the not too distant past. Unlike a liability profile, most long duration fixed income indices have a minimum maturity requirement (e.g. 10+ years) which renders them “evergreen”, so while the duration with fluctuate with rates, it will never dramatically shorten.

The case for alternative credit strategies

Analogous to the previous argument regarding duration, a similar consideration applies to corporate credit exposure. As the plan moves more money into fixed income there will be a point where the portfolio provides enough credit spread hedge against the liability. At this stage, it is important to avoid overconcentration in the corporate credit sector, which calls for the inclusion of other types of fixed income assets. Assets like securitized, asset-based finance, or private credit can offer valuable diversification benefits.

Suppose a plan with a duration of 10 years is 110% funded with 75% fixed income1, marking the end of the glidepath. A traditional LDI portfolio of 50% Long Corporate, 20% Intermediate Corporate, and 30% Long Treasury fully hedges the interest rate and credit spread risk with a 5.2% expected return and 1.6% funded status volatility2. Both the return and volatility are acceptable with the expected return being higher than the 5% discount rate on the liability. However, is this the optimal portfolio allocation?

A sponsor choosing to continue to manage the plan can potentially improve expected return and reduce funded status volatility with some allocation to alternative “liability-aware” fixed income strategies. As shown in Exhibit 3, the introduction of a basket of alternative strategies3 increases the expected return of the fixed income portfolio, but has an added benefit of diversification, potentially also reducing funded status volatility.

Point A in Exhibit 3 is the previously discussed traditional LDI portfolio. A 20% allocation to the basket of alternative strategies, keeping 80% in a pro-rata share of the LDI portfolio, reduces the volatility to 1.0%. a reduction of 60bps and increases yield 20bps, shown by Point B. If the sponsor is comfortable with the current funded status volatility level or 1.6%, a 35% allocation to the alternatives basket increases the expected return 40bps, shown by Point C.

Exhibit 3: Impact of adding a basket of alternative strategies in fixed income allocation

Impact of Securitized Credit

Source: Schroders, Bloomberg, FTSE[4]. The model is hypothetical. Returns are not guaranteed. Actual results will vary.

Revisiting the portfolio objectives for a self-sustaining plan of minimizing funded status volatility and providing sufficient growth and income, the introduction of alternative credit assets helps achieve both goals. The assets provided both diversification benefits and increase the fixed income portfolio’s expected return.


Plan sponsors who have achieved fully funded status in their defined benefit plan should carefully consider all available endgame alternatives and thoroughly understand the implications of each option. While a pension risk transfer may be preferable to some sponsors, it is important not to overlook the potential advantages of maintaining a plan in surplus. Preserving this status requires a change in mindset, from termination to one of self-sufficiency, where a more diverse set of fixed income “liability-aware” strategies can potentially help diversify sources of funded status volatility and improve portfolio expected returns. By implementing this approach, plan sponsors can pursue the potential benefits of maintaining the plan and most importantly ensure the promise of financial security of their participants.


[1]Typical endpoints for a glidepath are between 70% and 80% fixed income.

[2]We only consider the fixed income portfolio allocation against the total liability here in order to isolate the contribution from changes in hedging strategies.

[3]Equally-weighted basket of Long CMO, Real Estate Debt, AAA CLO, and Floating Rate ABS

[4]Past performance is no guarantee of future results. For illustrative purposes only. Data reflects hypothetical performance using yield as of June 30, 2023 as proxy for expected returns and a 10-year history of quarterly returns to estimate volatility and correlation assumptions.. The LDI portfolio is allocated to 50% BBG Long Corporate Index, 20% BBG Intermediate Corporate Index, 30% BBG Long Treasury Index. The alternatives basket is using the following indices: Long CMO is based on the ICE BofA 10+ Year US Agency CMO Excluding IO & PO Index, Real Estate Debt is based on the Gilberto-Levy GL1 Index, AAA CLO is based on the JPMorgan CLO AAA Index, Floating Rate ABS is based on the ICE BofA Floating Rate Asset Backed Securities Index. The liability used was created by Schroders to be representative of a 10-year duration profile. The hypothetical results shown must be considered as no more than an approximate representation of a portfolio’s performance, not as indicative of how it would have performed in the past or may perform in the future. It is the result of statistical modeling, with the benefit of hindsight, based on a number of assumptions and there are a number of material limitations on the retrospective reconstruction of any performance results from performance records.

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Max Guimond, CFA
Solutions Manager


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