The Asset Allocation Mistake That Can Add Millions to a Plan Termination

One plan, two exposures, and why lump sums and annuities require different hedges.

Nearly every pension termination eventually produces the same question. The board has approved the termination, the Notice of Intent to Terminate is being prepared, and finance asks: Shouldn't we move to cash now and eliminate investment risk?

The instinct is understandable. The problem is that termination does not eliminate investment risk. It changes the liability the assets must track.

Before termination, the portfolio may be managed against a long-term return objective or an accounting liability. Once the plan is moving toward settlement, the relevant target is the cash needed to pay lump sums and purchase annuities. Terminating a plan doesn't remove investment risk. What it does is change what the portfolio is being measured against.

One thing to note: we don't set the allocation. That belongs to the plan's investment advisor and it should. But the allocation can only be as good as the liability information sitting behind it, and that part is ours. The two roles have to stay coordinated the whole way through, because the risk in a termination doesn't really sit inside either one of them. It sits in the space between them. In our experience the problem is almost never an advisor making a bad call. It's an advisor making a perfectly reasonable call on a liability that nobody bothered to decompose for them.

That error usually appears in one of two forms.

The flight to cash

The reasoning is intuitive enough. We're done investing, so move everything to cash equivalents, money market and the like, and wait for the checks to clear.

Cash is appropriate for obligations that are fixed in dollars and due soon. It is not a hedge for the annuity purchase. The expected annuity premium remains sensitive to interest rates and credit spreads until the carrier bid is locked. For a retiree-heavy annuity block with duration near eight, moving the supporting assets to cash creates a substantial negative duration mismatch.

Take a $150 million annuity purchase with duration eight. If relevant market yields decline 50 basis points, the expected premium increases by roughly $6 million, holding spreads and other pricing factors constant. Cash does not offset that movement, so the increase may flow directly into the sponsor's final contribution.

A shorter termination timeline reduces the period of exposure. Our process typically targets settlement in four to five months. That matters, but four months is still enough time for rates and spreads to move materially.

A compressed timeline reduces the risk. It does not hedge it.

Going all in on duration

Plans coming out of a mature LDI program can make the opposite mistake. Everyone understands that the annuity purchase price remains interest rate sensitive, so the portfolio is moved into duration matched fixed income. The problem is that the same hedge is often applied to the assets expected to fund lump sums.

Lump sum interest rates are fixed based on Section 417(e)(3) so the value of the lump sum payments are locked in before the termination process begins. The total cash requirement can still change as participants make their elections, but that is election risk, not interest rate risk. From an investment perspective, the expected lump sum payments have become near term cash obligations and should generally be backed by cash equivalents or other short duration assets.

Assume the plan expects $100 million in lump sums on a locked basis and a $150 million annuity purchase with a duration of eight. Only the $150 million annuity component still has duration. If the entire $250 million portfolio is invested at a duration of eight and rates rise 50 basis points, assets decline by roughly $10 million. The annuity estimate declines by only $6 million, while the lump sum obligation is unchanged. The plan is about $4 million worse off, before spread and convexity effects, and that difference may flow directly into the final contribution.

That is not de-risking. It is an overhedged position created by treating locked lump sum payments as though they still move with market interest rates.

The same mistake underneath

Moving everything to cash and extending everything into long duration bonds look like opposite strategies. Both result from treating the termination liability as a single number.

A terminating plan has two primary settlement exposures. Lump sums become near-term cash obligations as the Section 417(e)(3) basis and participant elections are locked. The annuity purchase remains sensitive to interest rates, credit spreads, and carrier pricing until the bid is locked.

The mix depends on the plan provisions, participant population, and actual elections. Give an advisor one blended liability and one blended duration, and the resulting portfolio may be reasonable for the information provided while still being wrong for settlement. The mismatch ultimately lands in the final contribution.

What the investment advisor needs from the termination actuary

An accounting report cannot provide this view. It must be developed from the plan terms, participant data, election strategy, and settlement market. At a minimum, the advisor should receive:

• Expected elections by cohort. Actives, terminated vested participants, and retirees offered a choice can behave differently. Translate take-rate assumptions into projected lump sum payments and residual annuity premium, and provide a reasonable range rather than a single point estimate.

• The lump sum basis and lock date. Identify the Section 417(e)(3) segment rates and mortality table, the plan's stability period and lookback month, and when those assumptions are fixed. With a calendar year stability period and November lookback, for example, 2026 lump sums use November 2025 rates. Later market moves do not change that rate basis.

• Annuity exposure on a settlement basis. PBO or funding target duration is not buyout duration. Estimate the residual annuity premium, interest rate duration, and relevant spread exposure using current market pricing.

• Regular refreshes. Data cleanup, deaths, retirements, and elections change the split. Update the projected cash flows, residual annuity premium, and funded position as new information arrives.

This is a two-way process. We need the actual allocation, portfolio liquidity, transition time, and implementation constraints. A liability target developed without that feedback is incomplete.

The objective is not to eliminate every source of pricing risk. Some carrier pricing and execution risk cannot be hedged precisely. The objective is to identify the exposures that can be managed and avoid introducing a mismatch the sponsor never intended.

Where this lands

From experience, we've seen too many actuaries and investment advisors operate in silos, even within the same firm. That disconnect can lead to misaligned strategies, missed opportunities, and unnecessary risk.

A more effective approach starts with clarity of roles. The actuarial function is not to select investments, but to define the timing, amount, and market sensitivity of each settlement cash flow, and to keep that view current through execution. Staying engaged with the advisor until lump sums are paid and annuity bids are finalized helps ensure the final contribution is managed proactively, not discovered at the end.

A fast termination can reduce exposure, but it does not replace the need for proper liability segmentation. At Quantum, our ongoing annuity placement work allows settlement estimates to reflect current carrier pricing rather than static accounting proxies. This gives advisors a clearer target, so portfolios can be aligned with the actual obligations the plan will settle. By working in coordination from the outset, we help deliver a more controlled and predictable outcome.