Dear Corporate Pension Actuary: I am on the board of a company with a defined benefit pension plan. After the Fed cut interest rates three times in 2025, should I be worried about the plan’s impact on our balance sheet? Will the company have to contribute more money to the plan?
— Curious about interest rate cuts
Dear Curious:
Great questions! It’s always important for fiduciaries to be aware of how external factors, such as changes in interest rates, can impact a company’s defined benefit (DB) plan.
In general, lower interest rates may increase DB plan costs. That’s because pension plans use interest rates to determine how much money is needed today to pay promised benefits in the future. When rates are lower, the present value of those future benefit payments increases because there is less earning potential on the assets supporting those payments. This may decrease a plan’s funded status, potentially resulting in the need for additional cash contributions and additional expense to be recorded on the company balance sheet. Although interest rates are trending down, plan sponsors with pension surpluses from higher rates and strong asset returns in previous years may still be able to capitalize on their favorable funding position in 2026. By implementing de-risking strategies, these sponsors may recognize gains on their financial statements and protect against future interest rate volatility.
However, it’s important to note that actions by the U.S. Federal Reserve (the Fed) affect short-term borrowing costs, while pension plans have a longer investing horizon and are more concerned with long-term discount rates. For example, although the Fed cut rates by a total of 75 basis points over the course of 2025, the Milliman Pension Funding Index found that the discount rates used to value pension liabilities rose by 13 basis points over the 12 months ended November 30, 2025. Plan sponsors may not always see a direct correlation between the Fed’s actions and the discount rates that affect plan calculations.
How pension plans can protect against interest rate changes
Still, DB plans wishing to protect against continued interest rate volatility may wish to consider the following proactive strategies:
1. Asset–liability management
Asset–liability management allows plan sponsors to coordinate investments with plan liabilities to achieve desired financial goals. By implementing a strategy that matches expected investment returns with future cash flow needs, plan sponsors can help reduce risk and the need for unplanned pension contributions.
2. Risk transfer via lump sums or annuity placements
Transferring pension liabilities can reduce the plan’s footprint and future volatility. This can be done through lump-sum offerings to participants or annuity placements with insurers. The transfer calculations are based on current and known economic conditions and remove the downside risk from future interest rate declines.
3. Funding policy changes
Implementing a stable funding policy that builds a cushion of surplus assets can help minimize the volatility in year-to-year cash contribution requirements.
4. PBGC premium calculations
There are two common methods for determining the variable-rate premium that pension plans owe to the Pension Benefit Guaranty Corporation (PBGC). It may be worth reviewing with your actuary the impact a switch in method could have on the premium in a decreasing interest rate environment. In addition, lump-sum payments or annuity placements can reduce participant counts, which can also decrease PBGC premiums.
5. Alternate plan designs
To help reduce retirement benefit costs, many companies in recent years have added hybrid plans such as cash balance plans. Hybrid plan designs can help reduce volatility and pension impact on the balance sheet while still helping the company attract and retain employees.
DB plan sponsors and fiduciaries like you should be informed and prepared to address any potential challenges from future changes in interest rates. Milliman actuaries have the expertise and tools to help you proactively manage future risk and optimize your retirement benefit programs.
— Your Milliman Actuary
This edition of Dear Actuary was written by Jack Chmielewski, FSA, EA, MAAA.