Cash Balance Plan - New Ruling?

[Guest jhilliard]

Has anyone heard about a new ruling for DB Cash Balance plans? I don't have any experience with DB or Cash Balance plans but we are looking for alternatives for some of our clients.

Any information would be helpful.........

[mbozek]

See thread on Adverse decision on IBM cash balance plan under DB plans topic for latest ct decisions.

[flosfur]

The IBM adverse ruling as well as other highly publicized cases are mostly related to conversion of a traditional DB plan to a Cash Balance plan.

Setting up a new Cash balance plan should not be a problem, especially a safe harbor cash balance plan (yes there is a safe harbor design).

Giving a free plug to ASPEN publisher - they just published the "Guide To Cash Balance Plans" which covers all aspects of cash balance plans - special emphasis on rules and regulations.

If your are looking for the actuarial aspects, then try the following two sources:

Cash Balance Plans Symposium Monograph at:

http://www.soa.org/library/monographs/reti...ofcontents.html

Actuarial Aspects of Cash Balance Plans at:

http://www.soa.org/research/actuarial_aspects.html

If you search for "Cash Balance Plans" on Google, you will have a lifetime and a half worth of material on the subject.

[Guest Harry O]

flosfur -

I hope you are not giving clients this advice!

You ought to actually read the IBM case.

It goes right to the heart of the DESIGN of cash balance and pension equity plans. If the IBM decision is upheld, cash balance and pension equity plans will be illegal -- conversion or no conversion.

[mbozek]

Given the recent decisons involving IBM and Xerox I think the term safe harbor cash balance plan is an oxymoron. My understanding is that Safe harbor design only applies to IRS approval- it does not protect the plan from lawsuits under ERISA for violations of the rules regarding the value of the lump sum distribution (Xerox) or the discrimination against older workers in the benefit formula (IBM). To comply with applicable law the plan would have to pay the lump sum value based on the current IRS interest rates if greater than the cash value of the participant's account in the plan and not increase the annual benefit credit by an interest component to normal retirement age to determine each year's accrued benefit. The plan could use a career average formula- benefit would be the sum of an annuity equal to x% of comp for each year of service e.g., yr 1 20,000 comp x1% = 200 annuity at 65, yr 2 comp 20,400 x 1%= 204 annuity at 65- total annuity benefit for 2 years = $404, etc, which could be converted to a lump sum cash value that meets the conversion values required for lump sums. I dont know whether this formula would be cost effective or provide an meaningful benefit.

[Guest tonymascia1]

The lawyers representing IBM should be ashamed of themselves.

This case was very poorly argued by the defendants (IBM). While a healthy debate may be made as to the specific design features of the IBM cash balance plan, those who claim this may be the death knell for cash balance plans in general are playing Chicken Little.

[MGB]

mbozek's statement: "My understanding is that Safe harbor design only applies to IRS approval- it does not protect the plan from lawsuits under ERISA for violations of the rules regarding the value of the lump sum distribution (Xerox) or the discrimination against older workers in the benefit formula (IBM)."

To be more precise, the safe harbor is purely for passing 401(a)(4) nondiscrimination tests. And, the statement is correct that the safe harbor design would have failed in all of these lawsuits, too. It also doesn't have anything to do with IRS approval for a determination letter.

[Guest Harry O]

Tony -

Can you provide some more insight as to why the case was poorly argued? What should have been done differently?

[Guest tonymascia1]

Harry,

Out of the many, many things that went wrong...

IBM could have easily moved the case out of the Southern District of Illinois court --- a known "pro-labor" court.

The judge, Patrick Murphy, is not known as a benefits/ERISA scholar, as opposed to Judge Laro, who tried the Booth and Neonatology cases regarding VEBAs and 419 Plans. The defendants could have made a compelling case Judge Murphy's lack of specific knowledge harmed their case. If you read some of his comments, they resemble more closely those of an uninformed consumer, rather than those of an enlightened jurist.

Kathi Cooper's (the plaintiff's) attorneys used information from an inflammatory Wall Street Journal article (first published in May 1999: "Actuaries Become Red-faced Over Recorded Pension Talk") to somehow compare IBM with Enron, WorldCom, and Tyco. There were excerpts from tapes of actuaries at SOA meetings saying cash balance plans disguised benefit reductions. Assuming these tapes should have been admitted at all, arguments should have been made of the (out of) context and the (lack of) relevance of the article and the tapes.

Plaintiff claimed $500 million in benefits were lost due to the conversion to cash balance. Rather than having spent too much time saying "no, that number's too high", Defendant's attorneys should have painted a better picture of the pre-Lou Gerstner IBM tail spin, and that the conversion to cash balance was the preferred alternative to freezing indefinitely the old DB plan --- or terminating it.

All in all, lots of "juris" without "prudence".

[Guest Harry O]

I know the attorneys who handled the case for IBM. Each of your points was addressed. What we had here was a pro-plaintiff judge. You can lead a horse to water but you can't make it drink. Lets see what happens on appeal. The judge's opinion wasn't overwhelming so it may not get much deference on appeal.

[MoJo]

No offense to anyone, but arguing over venue and "pro-labor" courts is really irrelevant. The court is the court, and judges rule on the basis of what is in front of them. What would be more productive is an analysis of the judges reasoning with respect to the facts presented to it. I've read the case, and "on its face" it follows that cash balance plans do discriminate against older workers because the rate of benefit accrual for older workers is less than the rate of benefit accruals for younger workers (which, if true, *IS* a violation of ERISA, possible other federal laws, and morally repugnant (ok, the latter is my personal opinion, being based upon the fact that I am on the cusp of being one of those "older workers)). The issue is - is it true? I haven't looked at the record (and probably won't) but it seems to me that the examples used by the judge may have some assumption errors, or foundational logic issues. That is, why is it that if a participant 25 years old works for next 10 years participating in cash balance plan accrues a benefit bigger than a 55 year old who works for the next 10 years participating in the plan? I think the obvious answer is that the future value of the younger worker's benefit at age 65 is going to include "interest accruals" post termination (i.e. its a simply future value calculation). Does that mean that the benefits received by the two participants are disparate, or are they actuarially equivalent? Looking at it another way, the immediate benefits payable to each of the participants would be equal - but would that not be problematic, as to the extent that there are equal, they are not "actuarially equivalent"? Just some musing to spur discussion.....

Michael

[MGB]

The argument is extremely simple and based on an ambiguity that results in two opposite opinions.

The problem is with the definition of "rate of accrual" because it is undefined in the law. If you believe that the only way to measure rate of accrual is in the context of an annuity payable at normal retirement age, then cash balance plans are age discriminatory. On the other hand, if you are allowed to define the rate of accrual as the addition to the notional account (i.e., the current value), then cash balance plans are not age discriminatory.

It all comes down to that argument. There is no need for checking assumptions or methodologies used by this judge. Obviously, this judge decided the only way to measure it is the annuity at retirement age. The problem is that the law does not define rate of accrual, so the courts are left to making their own decision. The Treasury Department, as shown by their proposed regulations, believes that rate of accrual can be on the current value. And, except for a small handful of very vocal dissenters, most in Congress also feel that way.

Note that in applying the ADEA to other benefit plans (e.g., health or life), there has always been the rule that discrimination may be measured in either one of two ways: either the cost of the benefit must be the same or the benefit itself must be the same. Using this logic (which shouldn't be used on a pension plan, but is being used here as an analogy), cash balance plans are not age discriminatory because they pass on the cost measurement.

[MoJo]

MGB - precisely my point (albeit far more concise and articulate). The judge took the position that annuity value was the only way to measure rate of benefit accrual (and if memory serves me correctly, had a rational for doing so based on language in ERISA).

[Guest Mike Melnick]

Mojo, you stated that you feel cash balance plans are "morally repugnant" because the rate of accrual when, expressed as an annuity, discriminates against older workers.

Do you feel that all Defined Contributions plans are morally repugnant? The rate of accrual in a defined contribution plan, when expressed as an annuity, also discriminates against older workers. The main difference (between a DC plan and a cash balance plan) is that employer is assuming the risk on the investments.

The position that all cash balance plans are inherently "morally repugnant" does not make sense to me. It depends on the details of how they are implemented, which is true of any type of plan. The cash balance concept itself was an innovative and important addition to the art of plan design. It would be a shame if the "baby was thrown out with the bath water".

[MoJo]

Mike: My "morally repugnant" comment was meant to be humorous - as I seem to have crossed over that line which separates "older workers" from "younger workers", and not to be taken seriously.... I do find some plan designs (not unique to cash balance plans) to be morally repugnant on philosophical grounds (in that I don't like my tax dollars subsidizing others' discriminatory benefit plans), but as a professional in the field, I realize that the Code defines "discrimination" in terms other than what others would believe it to be. In fact, I utilize those provision on behalf of my clients routinely. We could certainly argue whether those provisions are appropriate or not. From my perspective, they are probably necessary evils. That is, without certain incentives to the decision makers, in many case there would be no retirement plan offered by the employer....

[david rigby]

Hmm, so an apple is OK, and an orange is OK, but anything that cross-breeds them is not OK.

[Guest Harry O]

Why isn't a traditional, final average pay pension plan "morally repugnant" for the unfortunate employee who is terminated just before qualifying for an early retirement subsidy? The deferred vested benefit in most traditional plans is worth a fraction of the subsidized early retirement benefit. So why isn't it morally repugnant when the 54 year-old employee with 25 years of service terminated one year before the age 55 early retirement date? Or what about the poor employee who can't retire early and has to work through and beyond the subsidy years. He has "forfeited" these valuable benefits. Perhaps we ought to outlaw early retirement subsidies (or better yet, give them to everyone all the time!).

All plans have their warts. The problem with the cash balance protestors is they think they are "entitled" to a traditional plan formula forever. Nothing could (or should) be futher from the truth . . .

[Guest tonymascia1]

Harry,

Your last lines hit the sweet spot.

In an entitlement society, logical, reasoned arguments go right out the window (your boys arguing for IBM didn't catch sight of that) when individuals feel they "deserve" something.

[Guest mikeak]

Having experienced a cash balance conversion myself and helped administer others, I see two items at the center of concern: expectation and communication. Most participants understand a traditional DB plan is a nice-to-have goodie but if you've had it for a while then it becomes like any other modern goodie (cheap gas, hot showers, electricity): part of what you routinely expect. If it changes you may feel something has been 'taken away'; resentment soon sets in. Here is where companies generally (IBM is a classic case) do a lousy job of communicating what they are doing and why. Companies want to promote their benefits as attractive so they try to spin something like a c-b conversion into a 'win-win' situation, highlighting what they see as positive aspects for the participants while downplaying or ignoring what might be viewed as negative. They often end up looking foolish or at least arousing the suspicion of the skeptics in the crowd. They may rationalize the decision with some half-truths like 'now your benefit is portable' (even though many traditional plans allow lump sums at any age after termination) or mythic statements such as 'this is easier to understand, the traditional plan formula is so obscure and beyond most people's grasp' (most formulae are no worse than long division; you want obscure, try owning stock options that are affected by multiple spin-offs and then having to figure out what you've got afterwards - now that's obscure!). What's needed is a realistic admission of what's happening: 'Folks, we're changing the plan to work like this because it fits how we operate now. It will affect individuals differently, just as all benefits do depending on your situation. This is a business decision and we think it's a good one.' The participants would at least appreciate the honesty and maybe decide not to call a lawyer.

[MoJo]

Boy. Nobody around here can take a joke. My morally repugnant comment was meant as such, as a reference to the fact that I now fall into the "older employee" category.... Nothing more. Nothing less.

Nonetheless, while expectations may be inflated on the part of employees whose benefits are affected by a conversion to any alternate plan design, also consider that such changes affect "total compensation" and as such may be a unilateral modification of the employment agreement between employer and employee (which may be "legal" but nonetheless may be philosophically wrong). Not too long ago Schwab eliminated the match on their 401(k) plan - which they had every legal right to do - but it was a pay cut for participants in that plan. As I understand it (and I know many people who work at Schwab Retirement Plan Services) is that the explanation was take a pay cut in the form of a match elimination or face layoff lottery. An employer who promises to pay me x, plus y in benefits, who then changes y to y-z has reduced my pay. The employee can go elsewhere. But, if the employer induces the employee to the job with a DB plan that provides z% of pay after 30 years of service, and then after 25 years of service changes it something less has unilaterally adversely impacted that employee's ability to attain their financial goals, in many cases without any alternatives available to the employee to recover.

I consider my benefits as part of my compensation, and reductions in my compensation are morally repugnant to me - especially considering no comensurate decrease in my responsibilities (indeed, the converse typically is true), UNLESS the alternative is worse. Unfortunately, too many times I've experienced changes in benefits - including reductions in health care coverages and subsidies and a conversion to a cash balance plan - that had no explanation, other than to increase shareholder value at the expense of the employees. Maybe that's why employees no longer exhibit much loyalty to their employers as they did in decades past.

The issue nonetheless raised in my first post in this thread is whether the judge in the IBM case properly concluded that differences in rates of accrual of benefits (meaning the rate at which an age 65 annuity benefit is accrued) is a violation of ERISA. I must admit, that ASSUMING that the age 65 annuity benefit is the measure, then I agree with the judge, that differences in accrual rates are impermissable. The question then becomes whether the age 65 annuity benefit is the appropriate measure, and at first blush, I believe the judge has a reasonable basis for his decision....