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In the world of defined benefit (DB) pension plans, de-risking has become a bit of a buzzword.  Ask ten pension professionals what it means, and you’ll get eleven different answers.  And maybe that’s because “de-risking” isn’t one single strategy – it’s a spectrum.  It can be gradual or immediate.  Tactical or structural.  

So, what does de-risking really mean?

Ultimately, the term de-risking is not universally defined.  Rather, it is a broad term that refers to reducing or eliminating various risks within a pension plan.  At one end of the spectrum, it can mean making a relatively small change – like tweaking your investment strategy by tilting more heavily into long-term bonds.  On the other end, it’s a full-on exit strategy with annuity purchases, plan wind-ups, or even transitioning into a shared risk pension plan like the CAAT Pension Plan.

To some, de-risking means making tweaks to the plan design, such as closing the plan to new entrants or freezing benefits.  To others, de-risking means maintaining the plan “as is”, but aggressively hedging the liabilities.

Many different strategies fall under the de-risking umbrella.  However, at its core, de-risking involves adjusting aspects of the pension plan to better align assets and liabilities, thereby reducing exposures to market volatility, interest rate fluctuations, and longevity risk.  Such de-risking initiatives tend to reduce the volatility in the funding requirements, accounting expense, and in some cases even reduce the administrative burden of maintaining a pension plan.  At the end of the day, it’s all about giving the plan sponsor more certainty and reducing the worry that things won’t go as planned.

Depending on where your plan is in its lifecycle, de-risking may be a prudent next step – even if it feels like a leap into the unknown.  The questions a plan sponsor should ask are: is it the right strategy for their plan?  And if so, what strategy is best, and when is the right time to make a move?

Know Thy Plan (and Thyself)

First off, there are a few big questions that plan sponsor should consider prior to making a decision:

• What is the long-term strategy for the pension plan?  Understanding the timeframe and long-term strategy for providing your employees with pension benefits is key to developing a de-risking strategy.  More specifically, plan sponsors with active members accruing benefits might need to retain some risks to ensure the plan costs are manageable.  Alternatively, plans that are closed or frozen may be a better candidate for immediate de-risking to lock-in recent gains and shrink the funding and balance sheet risk.  
• How big is the plan relative to the sponsor?  If your pension plan is large compared to your business, the risk could be existential, with the volatility having a significant impact on the funding requirements and financial statements.  However, if your pension plan is small relative to your business, it may just be a rounding error, and attention may be better focussed elsewhere.
• How much risk can you tolerate?  Similar to the point above, the ability of the plan sponsor to withstand shocks in its funding requirements and accounting expense should be understood.  With the Plausible Adverse Scenario analysis now included in the funding valuation reports, this is a great place to start to understand the risk exposure of a plan – but it may be worthwhile to work with your consultant to better understand the various risks that your plan is exposed to.
• What’s your current funded status?  Being fully funded allows a plan sponsor to consider more options, particularly annuity purchases or plan wind-ups.  Specifically, plans that are fully funded may be able to afford to de-risk without incurring additional cash cost.  In contrast, plan sponsors with underfunded pension plans may feel compelled to take some risk until their funded status improves – although some may adopt a “glide path” approach to gradually de-risk as their funded status improves.
• Can you access surplus?  Jurisdictional rules and plan terms dictate whether a plan sponsor can access any surplus funds.  If a plan sponsor cannot access surplus, they may be more hesitant to over-fund a plan and more inclined to de-risk once surplus arises.
• What are the accounting implications?  Understanding the accounting implications of a de-risking strategy is key, as different strategies have different impacts on the expense and balance sheet.  In some instances, we see that plan sponsors wish to adopt a certain de-risking strategy, only to decide that the accounting implications make it unattractive to implement.
• Can you make a decision?  Finally, it’s one thing to talk about de-risking – it’s another to actually pull the trigger.  Some plan sponsors evaluate options for years without acting – the proverbial paralysis by analysis – or maybe just other business priorities taking up all the oxygen – or no decision to de-risk is simply a decision to stay risk-on.

Once a plan sponsor has considered the questions above, it’s time for them to consider which strategies are best for suited for their plan.  Generally speaking, de-risking strategies fall into two broad categories: investment-related strategies and settlement strategies.

Investment De-Risking Options

1. Asset Allocation Adjustments
   • Traditionally, DB pension plans have a diversified asset mix with significant equity exposure.  However, one route to de-risking is shifting a portion of assets toward liability-hedging instruments, like long-term bonds, which are more sensitive to interest rate movements and therefore better matched to the pension liabilities.
2. Liability-Driven Investment (LDI) Strategies
   • LDI strategies seek to closely align the plan’s asset returns with changes in its liabilities.  This could include partial LDI approaches or more comprehensive cash flow matching portfolios.  

As alluded to above, some sponsors will implement Asset Allocation Adjustments or an LDI Strategy immediately, whereas others may shift their asset mix using a “glide path” – which is a pre-determined schedule to incrementally shift the asset mix as the funded status improves.

Settlement Strategies

1. Annuity Purchase
   • An Annuity Purchase strategy involves using plan assets to buy a group annuity contract from an insurer, whereby the insurer assumes the obligation to make future pension payments to the retirees, beneficiaries, and potentially deferred members of the plan.  This offloads the longevity, investment, and interest rate risk on to the insurer for the members who are settled.
2. Full Wind-up
   • A Full Wind-up strategy involves the termination of the plan and the distribution of the assets of the pension fund.  In a plan wind-up, all non-retired members are usually given the option to elect either a commuted value lump sum payment from the Plan, or a deferred or immediate pension secured by an annuity; and retired members are required to have an annuity purchased on their behalf.  Distribution of the assets of the fund involves the payment of the lump sums to members who elect a commuted value, and the purchase of annuities from an insurance company for those who elect (or are deemed to elect) a deferred or immediate pension.  It should be noted that a Full Wind-up strategy is easier to consider for DB plans that are closed and frozen, as this strategy is more complicated for plans where members are still accruing benefits due to the constructive dismissal risks associated members losing future pension benefit accruals (speak to your lawyer about suitable notice periods for making changes).
3. Plan Merger
   • As an alternative to the de-risking options above, plan sponsors can also explore a merger with a Shared Risk Plan like the CAAT Pension Plan.  In such a merger, the assets are transferred, and the past-service liabilities become the responsibility of the CAAT Pension Plan.  A merger with the CAAT Pension Plan can be a viable and cost-effective pension plan exit strategy for plan sponsors who wish to maintain a DB pension benefit for their employees.  Plans like CAAT come with different risk reward tradeoffs than a traditional DB or DC plan so it’s important to understand these differences if a sponsor wishes to go down this road.

Is Now the Right Time to De-risk?

This is one of the most frequent questions sponsors ask – and unfortunately, there is no universally correct answer.  The right time to de-risk depends on a sponsor’s unique financial situation, risk tolerance, and long-term goals.  However, there are several reasons sponsors may wish to consider a de-risking strategy now:

• Improved Funded Status:  After several years of strong asset returns and a slight rise in interest rates, many pension plans are now at or above full funding.  De-risking at this point can help lock-in that surplus before market conditions shift.
• Market Uncertainty:  Ongoing economic and geopolitical uncertainty may lead some sponsors to seek greater stability.  Volatility in financial markets, the concern of rising costs, and unpredictable policy changes have all led to increased interest in de-risking strategies.
• Group Annuity Market Conditions:  While the group annuity market may be less active in 2025 compared to previous years, our experience is that pricing seems to remain competitive for plans looking to settle retiree liabilities.

Importantly, sponsors should not try to time the market.  Attempting to wait for the “perfect” moment to de-risk is a misguided strategy.  Instead, sponsors should focus on implementing their long-term strategy for providing pension benefits, work within their accepted level of risk tolerance, and then make decisions and act accordingly.

Case Study: Annuity Purchase for Ongoing Plans

For sponsors not ready to adopt a fully de-risked investment strategy, there are still partial de-risking steps that can meaningfully reduce risk.  One effective strategy is the purchase of annuities for retirees and deferred members, especially in plans that are over 100% funded.

One of our clients recently adopted this strategy, and it helped them to: 1) reduce the size of their plan, 2) improve the funded status of the plan for remaining members, 3) reduce the risk of future special payment contribution requirements, and 4) reduce the administrative burden.  

One key feature to this option is that it can be explored without commitment – as quotes can be obtained and analyzed, and the plan sponsor can then make a go/no-go decision based on actual market pricing and the plan’s estimated funded status at the that point in time.  That’s right – no obligation, and no pressure to transact.

Nevertheless, this strategy is not without challenges.  Sponsors must consider the settlement accounting implications of an annuity purchase, as well as the need to manage the investment strategy leading up to the transaction to avoid a mismatch between asset values and annuity pricing.

Final Thoughts

Whether through investment changes, partial annuity purchases, or full plan settlements, the right de-risking strategy can help plan sponsors reduce risk, improve stability, and position themselves for long-term success.

De-risking isn’t about predicting the future.  It’s about deciding what risks you’re willing to bear – and which ones you’re not.  The plan sponsors that do it well don’t try to outsmart the market, they just build a strategy that fits their goals, timelines, and tolerance for pain.

And maybe that’s the best advice we can give: understand your endgame, know your thresholds, and don’t be afraid to ask the hard questions – even if you don’t act right away.