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The Amazing
  The Bosses' Cash
Balancing Act

"Not since companies dipped into pension funds in the 1980s to finance leveraged buyouts have corporate treasurers been so abuzz over a pension technique." Guess who loses?


Companies are cashing in on a perfectly legal means of pocketing millions of dollars in pension funds. Called cash balance this latest corporate scheme is costing thousands of long-service workers as much as half the value of their expected pensions.


IBM’s July 1 change in its pension plan became a ringing wake-up call for many of the company's employees. Faced with the loss of as much as 40 percent of their pension benefits, IBM workers are seriously looking at union organization for the first time.

Big Blue’s well-publicized changeover to a cash-balance plan is also sounding alarms for workers with union-negotiated defined benefit plans. Companies big and small are converting traditional pension plans into cash-balance plans.

"What started as a trickle in the 1980s has turned into a torrent of cash-balance conversions — costing untold thousands of mid-career employees as much as one-half of their expected pensions," says the AARP.

An estimated 500 plans covering as many as 3 million workers have been converted to cash-balance plans in recent years. "Not since companies dipped into pension funds in the 1980s to finance leveraged buyouts have corporate treasurers been so abuzz over a pension technique," reports the Wall Street Journal.

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Cash-balance plans combine features of defined-benefit and defined-contribution plans.

A defined-benefit pension plan pays out a specified amount based on a predetermined formula. In most traditional defined-benefit plans, benefits are figured on the basis of service and final years of pay. A defined-contribution plan — a 401(k), for example — provides an individual account for each participant, based only on money contributed or allocated to that account.

At the same time, cash-balance plans function like defined-contribution plans. "In a cash-balance plan, the company makes a defined contribution into an individual retirement account for each worker, and promises that the cash balance in that account will ‘earn’ a specific interest rate each year," explains UE Research Director David Alexander.

These accounts exist only on paper, however. Employers pool these "accounts" for investment.

As with defined-contribution plans, the benefits provided by cash-balance plans are portable.

That portability — and the relatively rapid accrual of benefits — makes cash-balance plans attractive to low-service and younger workers, particularly those workers who aren’t expecting a long career with the same company. For example, a 28-year-old worker earning $34,000 a year could walk away from a job after six years with close to $10,000 in pension benefits.

The same features of cash balance that seem attractive to younger workers now is what has long-service IBM and other workers up in arms. And today’s twenty-somethings may find themselves shortchanged as they approach retirement.

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Cash-balance plans offer career-average pensions — workers earn benefits linked to their current pay, averaged over their careers. This is in sharp contrast to the traditional defined-benefit pension plans that are a feature of UE contracts with General Electric and many other major employers. In these plans, benefits are determined by a formula that typically combines years of service with average pay in the last few years of work. Since pay is usually highest in the final years, workers in these plans earn most of their benefits towards the end of their working lives. Long-service workers are rewarded with larger benefits.

The conversion from traditional defined-benefit plans is devastating the retirement plans of many middle-aged and older workers, with losses of future benefits ranging from 20 to 50 percent. The conversions are occurring just as these workers reach the age where the old formula began to sharply raise the value of their future pension payouts.




Are cash-balance conversions motivated by employer attempts to rid themselves of long-service workers and decent pension benefits?

That assertion is strengthened by reports that a leading benefits consulting firm markets an "Aging Diagnostic" to help employers evaluate the cost of providing pensions to their work forces.

IBM hired that firm, Watson Wyatt Worldwide, to evaluate the impact of employees’ ages on its pension plan. IBM converted its traditional pension plan to a cash-balance plan in July.

"I am deeply concerned that serious age discrimination may be taking place," says U.S. Sen. Paul Wellstone (D., Minn.), who has called for an investigation of cash-balance plans.

"In my opinion, every single cash-balance plan... violates the age-discrimination," said pension lawyer William K. Carr in comments to the publication Pensions & Investments. Carr has represented plaintiffs in several lawsuits against companies that have switched to cash-balance plans.

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"It’s the amazing disappearing pension," comments Stephen Langlie, a 37-year employee of the Onan Corp., who saw his future benefit slashed from $1,100 to $424 a month. Onan is a Minnesota subsidiary of Cummins Engine.

Bill Syverson, a 49-year-old senior engineer for IBM was looking forward to a pension of $40,000 a year when he retired after 30 years’ service. Conversion to cash balance plan sliced that figure in half.

Here’s how conversion works: An opening account balance for each participant in a cash-balance plan is determined by computing the present value of the participant’s accrued pension benefit under the old plan.

Under law, workers are not supposed to lose any of the benefits that have accrued under the old plan, but future benefits are not protected. In conversions, long-service workers have not been getting the full value of their accrued defined benefit during the conversion process. And they are finding out that they may have to stay on the job longer to obtain benefits they once expected under the old pension plan.

"Some companies use one set of assumptions to figure the older worker’s lump sum for termination, but a worse set of assumptions to figure out the cash balance to put into the worker’s new account," observes UE’s Alexander. "It might take years of additional service to earn back the value of their built-up benefit at the time of conversion."

The process is confusing enough that many workers don’t learn until long after the fact how much they have lost as a result of cash-balance conversion.

Tapes of actuaries discussing cash balance that were played at a recent Congressional hearing illustrate the danger for workers — and benefits to employers. "Converting to a cash-balance plan does have an advantage as it masks a lot of the changes," says a Pricewaterhouse actuary. "It is not until they are ready to retire that they understand how little they are actually getting," says a Watson Wyatt Worldwide actuary, while another comments: The law doesn’t require you to say the words, "your rate of future-benefit accrual is being reduced."

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Profits —

The corporate cash-balance craze is the latest assault on decent, employer-funded retirement income. Companies have been steadily pushing defined-contribution plans, such as 401(k) as a substitution for defined-benefit plans which provide a more reliable form of retirement income.

"One might get the impression, from the rise of 401(k) retirement plans, that pensions are a dead species," said the Wall Street Journal last year. "In fact, nearly all large employers still have pension plans." With millions of baby-boomers moving into their peak pension-earning years, corporations are looking for a way of avoiding their pension obligations. The Wall Street Journal suggests that some companies are adopting cash-balance plans as an alternative to terminating pension plans outright.

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Company spokespersons and corporate apologists insist that cash-balance conversions are taking place mostly to improve employee benefits. And some companies say the new plans are designed to appeal to younger, technologically skilled workers in a tight labor market. But it is clear that the benefits to corporate bottom lines are enormous.

"Companies like these plans because it means they will never face the roll-up that comes with defined benefit plans — there is no increase in their pension costs for past service when workers negotiate higher wages or multipliers," says David Alexander. "If workers negotiate a higher contribution rate or higher interest rate, it will affect only the employer’s cost for future service, not past service as well.

"Companies also like the plans because they get to keep any interest earned on workers’ money above the established rate," Alexander continues. "If they play the markets well, the plans become self-funding. For these and other reasons, cash balance plans tend to be cheaper for companies than defined benefit plans."

IBM anticipated savings of $200 million a year from its cash-balance conversion. The Central and Southwest Corp. saved $20 million in pension costs the first year of conversion to cash balance. The year before, CSW had to set aside $30 million to fund its pension obligations. Once it made the switch, it didn’t have to advance a dime to fund the pension plan.

The new scheme, the Wall Street Journal report says, is "a restructuring that often makes it unnecessary ever to feed the plan again."

"The potential for using a cash-balance plan as a restructuring tool may be one reason it is gaining favor throughout corporate America," Michael J. Gulotta, chief executive officer of the consulting firm Actuarial Sciences Associates, wrote last year.

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Controversy over cash-balance conversions and their adverse impact on long-service workers, especially after the well-publicized IBM conversion, has fueled calls for greater government scrutiny.

The Internal Revenue Service has ordered field offices to confer with national headquarters before approving any new cash-balance plans. This directive, issued in mid-September, came after U.S. Rep. Bernie Sanders (I., Vt.) obtained an internal IRS memo raising questions about possible age discrimination in the plans.

A bill introduced by Sanders (HR 2902) would ensure that employers have a choice when companies seek to implement a cash-balance plan. That bill is now before the House Ways and Means and Education and Workforce Committees.

Choice is also stressed in legislation introduced by Sen. Paul Wellstone (D., Minn.) "Congress must act now to put transition safeguards in place to protect the retirement security of the American worker," Wellstone said. His bill would ensure workers’ right to know as well as a choice between pension plans.

Sen. Wellstone’s legislation would prevent company pension plans from giving participating employees an opening account balance that is lower than their already accrued pension benefits to date under the old plan — what’s known as "wear-away."

Meanwhile, various bipartisan bills and legislation introduced on behalf of the Clinton Administration would provide some guarantees that workers have the legal right to know when changes in pension plans reduce benefits. The Clinton bill has been slammed as "too little too late." Karen Friedman of The Pension Rights Center said the Administration’s Pension Reduction Disclosure Act is the equivalent of the "useless surgeon general’s warning;" it informs workers that cash-balance plans "may be hazardous to their wealth, but offers them no protections."

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If Your
Plan Is

If the employer talks about switching to a cash-balance plan:

Demand all the facts. How much money will the employer save? How will more senior workers’ pensions be affected? Workers facing a conversion to a cash balance plan can exercise their rights to receive a statement of their "vested accrued benefit" and compare it to the starting cash balance the company wants to put into their accounts.

Become educated. Understand how the new plan would really work.

Remember, employers cannot change the pension without bargaining with the union.

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Cash-balance accounts are attractive to short-service workers because of the greater accrual on the short-term, amounts expressed as lump sums which can be transferred from job to job. But what happens if today’s short-service worker becomes tomorrow’s long-service veteran of the same workplace?

He or she may well be shortchanged by a cash-balance pension plan.

Over the long term and after a certain age, cash balance offers less than traditional defined-benefit plans. The benefits of long service built into the traditional plans can dramatically exceed the payout promised by cash balance.

A number of major corporations will have laughed all the way to the bank again and again before a generation of workers discovers how their retirement prospects have been undermined by the trend to cash balance.

According to Labor Dept. statistics, half the workforce is 38.2 years old, the highest median age for workers in several decades — and that median is expected to hit 40.6 in 2006. Half the workers between 35 and 44 years are staying five years on their jobs, compared with 2.7 years for those in 25 to 34 age group. The Labor Dept. says mobility is no greater for people now over age 40 than for their parents’ generation.

Ironically, due to the sharp drop in the birth rate after the post-World War II baby boom, many companies might be forced into retaining older workers rather than forcing them out the door. "That makes you wonder how long the cash balance fad will last," muses a leading benefits consultant.

Vigilant union action, ultimately, will be the best means of ensuring that workers receive the best possible pensions.

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