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Politically incorrect

Derided as unfair to employees even before public outrage exploded about suddenly pensionless workers at such companies as WorldCom and Enron Corp., cash balance pension plans face an uncertain future.

Derided as unfair to employees even before public outrage exploded about suddenly pensionless workers at such companies as WorldCom and Enron Corp., cash balance pension plans face an uncertain future.

"They won't survive as we know them," says Janet Krueger, a former IBM Corp. software consultant who leads the IBM Employee Benefits Action Coalition, an employee group opposed to the computer giant's cash balance plan. But advocates of the plans say they do provide tangible benefits to workers and will proliferate again -- albeit with more carefully crafted features.

Back in the mid-1990s it would have been tough to imagine that this 401(k)­defined benefit hybrid would be under siege. Companies were pushing the cash balance account as a cost-effective pension alternative that addressed some of the limitations of traditional defined benefit programs.

Employees usually had to put in at least five years at their company before they were vested in a defined benefit plan; as a result, workers who changed jobs after a few years often walked away with no retirement savings. The cash balance plans allowed a worker to accrue savings almost immediately and then take them to the next job. Because they generally imposed more modest retirement obligations on plan sponsors when compared with defined benefit plans, cash balance accounts were popular with companies, which rushed to convert their defined benefit programs. By 1999 cash balance plan assets totaled roughly $330 billion.

That same year, however, cash balance conversions came under attack. Critics charged that the terms of the defined-benefit-to-cash-balance conversions represented an especially bad deal for older workers. Indeed, more than 800 employees and retirees have filed age discrimination charges against cash balance plan sponsors with the Equal Employment Opportunity Commission. In response to the bad publicity, legal threats and a government review, companies backed off; conversions to cash balance plans have slowed to a trickle since late 1999.

In recent months, with corporate governance under intense scrutiny, the prospects for a cash balance revival have become bleaker still.

A report by the inspector general of the Department of Labor, made public in late March, found that 13 of a representative sample of 60 companies were not fairly compensating their employees under the terms set by their own plans.

And in late July, spurred on by the push in Congress for increased financial regulation and oversight, the House of Representatives passed legislation, by a 308­121 vote, upholding current restrictions against the creation of new cash balance plans.

Authored by Representative Bernard Sanders, an independent from Vermont, the amendment would prevent the Internal Revenue Service from changing the rules that discourage plan sponsors from converting defined benefit plans into cash balance plans. Effectively, the amendment would strengthen what had been a moratorium by the IRS on issuing the requisite letters upholding the tax-qualified status of such proposed conversions.

The IRS had stopped issuing its tax-qualifying letters when several cash balance programs, most notably IBM's, stirred widespread opposition from employees and worker rights advocates. (IBM is also the largest single employer in Sanders' home state.)

Voting one day before the House passed corporate fraud legislation, which was signed into law by President George Bush last month, members of Congress clearly did not want to risk being labeled opponents of worker's rights. "By all accounts, pensions are becoming a more serious issue, within the larger issue of corporate responsibility," notes Joel Barkin, an aide to Representative Sanders.

The DoL's inspector general estimates that companies have converted somewhere between 300 and 700 defined benefit plans into cash balance arrangements. The same report pegs the number of American workers covered by such plans today at more than 8 million, with a total of some $334 billion in assets.

"The DoL report pushes the Pension and Welfare Benefits Administration and the Internal Revenue Service to figure out what they are doing with cash balance plans," says former IBM employee Krueger. A class-action suit against IBM alleges that the computer company's cash balance plan discriminates against older workers.

The critical difference between cash balance and defined benefit plans involves the way that benefits are determined. In traditional defined benefit plans, benefits are generally calculated on the basis of the employee's last few years of salary. Cash balance plans base the benefit level on the employee's salary over all his years of service. That's why older workers are usually better off with a traditional defined benefit plan.

In a cash balance plan, the accrual of benefits is notional -- and to figure a "cash balance" requires a pretty sophisticated actuarial calculation.

Benefits in a cash balance plan grow through an annual contribution from the plan sponsor, perhaps 4 or 5 percent of pay. The sponsor then guarantees that the money will grow at a certain rate each year, currently based on the yield of Treasury's new long bond substitute (created when the government stopped issuing 30-year securities). The interest is credited to each employee's account as his cash balance.

Even advocates of cash balance plans concede that old-fashioned pension plans represent a better deal for many older workers with long years of service. That's one reason why many of the companies who converted from defined benefit to cash balance plans -- Aetna, Citibank and Eastman Kodak Co., along with IBM -- offered older employees the option of remaining under the defined benefit plan.

Because they resemble standard pensions in that they guarantee a defined benefit and are similar to 401(k)s in their portability, cash balance plans have fallen between the regulatory cracks, the DoL report concludes. "The PWBA needs to take a more active role in protecting cash balance plan participant benefits," says the DoL's Office of Inspector General.

The DoL polled its 60 sample companies, which have nearly 210,000 participants and $17.4 billion in assets, between September 2000 and January 2002. According to the agency's report, 13 plan sponsors had collectively underpaid their participants by $17 million.

Extrapolating from the roughly 20 percent delinquency rate to the larger universe of between 300 and 700 cash balance plans, the Labor inspectors concluded, "We estimate that workers may be underpaid between $85 million and $199 million annually."

A common error, found in eight of the 13 plans cited by the DoL: Sponsors "misapplied" the basic concepts of calculating benefits for employees who were leaving the company before age 65 and wanted to take with them a lump sum payment. These underpayments came from the so-called whipsaw effect -- an industry term coined by Hubert Forcier, a lawyer with the Minneapolis-based firm of Faegre & Benson, which represents plan sponsors.

The whipsaw effect refers to the system of figuring early retirees' benefits as outlined in a 1996 IRS notice. To determine a lump-sum benefit for a job-switcher under a cash balance plan, the notice advises, a plan sponsor must calculate the present value of a retirement benefit at normal retirement age. The plan sponsor begins by estimating the value of a cash balance account by projecting forward to age 65. The example cited in the DoL report: A 30-year-old, about to switch jobs, has a $10,000 cash balance account. The sponsor uses the $10,000 as a base and projects that the account earns 6 percent a year, producing a $75,900 balance after 35 years.

Then the plan sponsor works backward to figure what the current present value of that $75,900 would be. He uses a 5 percent assumption to calculate the present value, coming up with a lump sum payment of $13,583 -- $3,583 more than the original $10,000 account balance.

Participant advocates argue that the IRS notice requires that the plan sponsor use this method to calculate the lump-sum figure. Plan sponsors, who would naturally prefer to hand over the $10,000 in the example cited above, counter that the IRS notice does not have the force of law. "We don't believe that the rules require you to project forward and discount back," says James Delaplane, a lobbyist for the American Benefits Council, an employer trade group. An IRS regulation certainly carries greater weight than a notice, but the service has not yet issued any regulations on cash balance plans.

The Sanders amendment steps into the breach and requires the IRS to uphold the cash balance rules outlined in the 1996 IRS notice. "It is now past time for the federal government to stand up to these companies and their CEOs and enforce the pension laws to protect the retirement benefits of American workers," Sanders said in introducing the amendment.

When the DoL report was made public, the 60 companies were not identified by name, but in late May Sanders released the names of the 13 companies cited for underpayment. With antibusiness sentiment running so high right now, this isn't a list any plan sponsor wants to join.