Defined Benefit Plan Hidden Risks

There are various risks that come with sponsoring a defined benefit plan, including market volatility and liability risk. There are also operational risks which can result in operational defects, inaccurate data and miscalculated benefit obligations.

Most plan operations are outsourced to third-party service providers and with this significant outsourcing, plan governance and internal controls are often ignored. Third-party service providers take away the stress of day-to-day plan management, but plan sponsors cannot outsource ultimate responsibility for the plan and its operations. Most problems and defects in plan operations occur from lack of oversight and lack of attention to governing documents and service agreements. Plan sponsors should make every effort to understand plan provisions, limit reliance on third-party service providers, understand what data is necessary to be tracked and how benefits are calculated, assure actuaries have accurate data, and manage data transfers. The accuracy and validity of the actuarial analysis is dependent upon the quality of the data used. Actuaries use professional judgment when determining whether and how to refine data or make modifications within the analysis based upon the accuracy of the data.

For plan sponsors to focus on reducing risk in plan governance, it’s imperative that plan records are available, organized, accurate, and complete. Complete records should contain all participants as well as all demographic and benefit-specific provisions needed to determine eligibility, vesting, and ultimate benefits due.  The plan sponsor should maintain an executed version of the current plan document, all plan amendments, and current service agreements with third-party service providers.

Plan sponsors will greatly benefit from a “self-audit” to review different aspects of their plan to ensure that they are operating in accordance with the plan document. In a self-audit, plan sponsors or accountants/third parties review the overall policies and procedures of the plan compared to the plan document, test overall plan activity, and spot-check specific transactions. By performing a self-audit, plan sponsors can be proactive regarding any errors and confident in the accuracy of obligations, and prepare themselves appropriately for an IRS or DOL investigation. A self-audit can include assessing the accuracy and completeness of actuarial census data, recalculating a sample of benefit payments, and analyzing a selection of specific participants from the actuarial census to determine the accuracy of demographic data, annual compensation, location, position, and union status.

These steps serve to assist plan sponsors in reducing the risks that accompany plan sponsorship.

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