[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
EXAMINING CASH BALANCE PENSION PLANS: SEPARATING MYTH FROM FACT
=======================================================================
HEARING
before the
COMMITTEE ON EDUCATION
AND THE WORKFORCE
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
July 7, 2004
__________
Serial No. 108-67
__________
Printed for the use of the Committee on Education and the Workforce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
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______
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COMMITTEE ON EDUCATION AND THE WORKFORCE
JOHN A. BOEHNER, Ohio, Chairman
Thomas E. Petri, Wisconsin, Vice George Miller, California
Chairman Dale E. Kildee, Michigan
Cass Ballenger, North Carolina Major R. Owens, New York
Peter Hoekstra, Michigan Donald M. Payne, New Jersey
Howard P. ``Buck'' McKeon, Robert E. Andrews, New Jersey
California Lynn C. Woolsey, California
Michael N. Castle, Delaware Ruben Hinojosa, Texas
Sam Johnson, Texas Carolyn McCarthy, New York
James C. Greenwood, Pennsylvania John F. Tierney, Massachusetts
Charlie Norwood, Georgia Ron Kind, Wisconsin
Fred Upton, Michigan Dennis J. Kucinich, Ohio
Vernon J. Ehlers, Michigan David Wu, Oregon
Jim DeMint, South Carolina Rush D. Holt, New Jersey
Johnny Isakson, Georgia Susan A. Davis, California
Judy Biggert, Illinois Betty McCollum, Minnesota
Todd Russell Platts, Pennsylvania Danny K. Davis, Illinois
Patrick J. Tiberi, Ohio Ed Case, Hawaii
Ric Keller, Florida Raul M. Grijalva, Arizona
Tom Osborne, Nebraska Denise L. Majette, Georgia
Joe Wilson, South Carolina Chris Van Hollen, Maryland
Tom Cole, Oklahoma Tim Ryan, Ohio
Jon C. Porter, Nevada Timothy H. Bishop, New York
John Kline, Minnesota
John R. Carter, Texas
Marilyn N. Musgrave, Colorado
Marsha Blackburn, Tennessee
Phil Gingrey, Georgia
Max Burns, Georgia
Paula Nowakowski, Staff Director
John Lawrence, Minority Staff Director
------
C O N T E N T S
----------
Page
Hearing held on July 7, 2004.....................................
Statement of Members:
Boehner, Hon. John A., Chairman, Committee on Education and
the Workforce.............................................. 1
Prepared statement of.................................... 4
Miller, Hon. George, Ranking Member, Committee on Education
and the Workforce.......................................... 5
Norwood, Hon. Charlie, a Representative in Congress from the
State of Georgia, statement submitted for the record....... 98
Porter, Hon. Jon, a Representative in Congress from the State
of Nevada, statement submitted for the record.............. 97
Statement of Witnesses:
Clark, Dr. Robert, Professor, College of Management, North
Carolina State University, Raleigh, NC..................... 30
Prepared statement of.................................... 31
Collier, Ellen, Director of Benefits, Eaton Corporation,
Cleveland, OH.............................................. 20
Prepared statement of.................................... 22
Delaplane, James, Jr., Esq., Attorney, American Benefits
Council, Washington, DC.................................... 9
Prepared statement of.................................... 10
Hill, Robert, Esq., Partner, Hill & Robbins, Denver, CO...... 40
Prepared statement of.................................... 42
Pfotenhauer, Nancy, President, Independent Women's Forum,
Washington, DC............................................. 47
Prepared statement of.................................... 49
Additional materials supplied:
AARP, letter submitted for the record........................ 117
American Federation of Labor and Congress of Industrial
Organizations, statement submitted for the record.......... 116
Bureau of Labor Statistics, U.S. Department of Labor, table
submitted for the record................................... 147
Committee on Education and the Workforce, fact sheets
submitted for the record................................... 73
Committee on Education and the Workforce, Democratic Staff,
press release submitted for the record..................... 151
Companies That Have Converted to Cash Balance Pension Plans,
submitted for the record................................... 140
Cutrone, Larry, statement submitted for the record........... 119
Employers Awaiting IRS Determination Letters Under the Cash
Balance Moratorium, submitted for the record............... 143
ERISA Industry Committee, statement submitted for the record. 87
Krueger, Janet, statement submitted for the record........... 120
National Association of Manufacturers, statement submitted
for the record............................................. 104
National Committee to Preserve Social Security and Medicare,
statement submitted for the record......................... 149
Tarlau, Jimmy, statement submitted for the record............ 122
Tax Notes, statement submitted for the record................ 124
The Principal Financial Group, statement submitted for the
record..................................................... 105
U.S. Chamber of Commerce, letter submitted for the record.... 83
U.S. Treasury Department, Office of Public Affairs, letter
submitted for the record................................... 132
Watson Wyatt, press releases submitted for the record........ 111
Winston, Janice, statement submitted for the record.......... 121
EXAMINING CASH BALANCE PENSION PLANS: SEPARATING MYTH FROM FACT
----------
Wednesday, July 7, 2004
U.S. House of Representatives
Committee on Education and the Workforce
Washington, DC
----------
The Committee met, pursuant to call, at 10:33 a.m., in room
2175, Rayburn House Office Building, Hon. John A. Boehner
(Chairman of the Committee) presiding.
Present: Representatives Boehner, Johnson, Isakson,
Osborne, Kline, Carter, Blackburn, Burns, Miller, Kildee,
Payne, Andrews, Woolsey, Tierney, Kind, Wu, McCollum, Van
Hollen, and Bishop.
Staff Present: Stacey Dion, Professional Staff Member;
Kevin Frank, Professional Staff Member; Ed Gilroy, Director of
Workforce Policy; Richard Hoar, Staff Assistant; Donald
McIntosh, Staff Assistant; Alexa Marrero, Press Secretary; Greg
Maurer, Coalitions Director for Workforce Policy; Jim Paretti,
Workforce Policy Counsel; Deborah L. Samantar, Committee Clerk/
Intern Coordinator; Kevin Smith, Communications Advisor; Jo-
Marie St. Martin, General Counsel; Jody Calemine, Minority
Counsel Employer-Employee Relations; Margo Hennigan, Minority
Legislative Assistant/Labor; Marsha Renwanz, Minority
Legislative Associate/Labor; and Michele Varnhagen, Minority
Labor Counsel/Coordinator.
Chairman Boehner. A quorum being present, the Committee on
Education and the Workforce will come to order.
We are holding this hearing today to hear testimony on
``Examining Cash Balance Pension Plans: Separating Myth from
Fact.'' under the Committee rules, opening statements are
limited to the Chairman and Ranking Member. Therefore, if other
Members have opening statements, they will be included in the
hearing record.
With that, I ask unanimous consent that the hearing record
remain open for 14 days to allow Members' statements and other
extraneous material referenced during the hearing to be
submitted in the official hearing record. Without objection, so
ordered.
STATEMENT OF HON. JOHN A. BOEHNER, CHAIRMAN, COMMITTEE ON
EDUCATION AND THE WORKFORCE
I want to thank everyone for coming to the eighth in our
series of hearings on defined benefits pension plans, a topic
that is fairly timely. Cash balance plans have received a lot
of attention recently, producing rhetoric that has often been
misleading, if not in fact false. Today we hope to separate
myth from fact about cash balance plans.
As we all know, the number of defined benefit plans has
declined significantly over the last 20 years from 114,000
plans in 1985 to 31,000 plans last year, and the entire defined
benefit system, I believe, remains at risk. Some experts have
suggested that cash balance plans, which are types of defined
benefit plans, offer today's workers the type of secure and
portable benefit that can help save and preserve the overall
system. Unfortunately, fewer and fewer companies are offering
cash balance plans because of a recent wave of litigation.
Before I talk about this specifically, I would like to
discuss some facts about how these plans work. Under cash
balance plans, workers earn portable benefits through monthly
pay and interest credits and benefits are earned more evenly
over a career span, not just at the end of the worker's career.
This can result in greater retirement savings for workers who
do not remain with the same employer for their entire career.
As a result, a broader group of employees, including lower
income workers and women, earn greater benefits with shorter
service under cash balance plans than traditional plans.
According to a study published by Watson Wyatt in 2000,
more than 80 percent of participants fare better with a cash
balance plan. The value of the benefit in a traditional plan
spikes for workers who qualify for an early retirement subsidy,
typically in their mid-50's, but then declines if they fail to
retire at a specific age and keep working. As a result,
traditional plans are advantageous only for the small
proportion of employees who work for the same employer for 20
to 30 years and retire in their mid-50's.
Conversely, traditional plans are disadvantageous for
younger employees, for workers who change jobs or interrupt
their careers, and for older workers who continue working after
early and normal retirement age.
The Employee Retirement Income Security Act, ERISA,
prohibits employers from cutting back or reducing any pension
benefits that have been earned by employees once they vest in
their pension plan. Despite this current law protection, some
critics have continued to express concern over cash balance
conversions despite the fact that a large majority of them have
been handled properly and legally.
The real issue here is about a small number of prospective
retirees' expectation of receiving the full value of early
retirement subsidies that have not yet been earned. This is not
about normal retirement benefits. Rather, I am concerned that
cash balance critics are focused not on providing meaningful
retirement benefits to our overall workforce, but solely on
protecting a small fraction of employees who could afford to
retire early.
It is important to note that under the voluntary pension
system, let me just repeat that one more time for everyone,
under our voluntary pension system, all defined benefit plan
sponsors may change benefit formulas prospectively to either
enhance or reduce future benefits that have not yet been earned
by an employee. All employers need the flexibility to determine
what is appropriate for the needs of their workers and their
business. If this flexibility is taken away or if Congress were
to unilaterally mandate certain pension benefits, employers
would leave the voluntary pension system altogether and the
defined benefit system would all but disappear.
The recent wave of litigation surrounding cash balance
plans has raised concerns from employers, workers, and
policymakers alike. One well-documented court case involves
IBM, but the initial ruling runs counter to, in my opinion,
existing law and a large body of other court decisions. In this
case the judge found the cash balance plan design inherently
age discriminatory because equal pay credits for younger
workers have a longer period of time to earn interest and
accrue benefits before retirement than the same pay credits for
older workers. This interpretation essentially means it would
be age discriminatory to make equal contributions on behalf of
workers with different ages. This is inconsistent with every
other pension design and this logic could make a basic savings
account, 401(k) plans, and even Social Security benefits
automatically age discriminatory. We are not here to debate the
IBM case specifically, but we also need to make sure cash
balance plans aren't forced into extinction at the expense of
the interests of American workers.
Most courts have ruled no age discrimination occurs with
cash balance plans if the pay and interest credits given to
older employee accounts are equal to or greater than those of
younger employees. The most recent ruling on this topic, issued
just last month in the Tootle case, agrees that cash balance
plans are not inherently age discriminatory.
I would like to dispel another myth about these plans. The
switch to cash balance plans is not motivated by cost savings,
but rather by pressures imposed by an increasingly mobile
workforce as well as fierce competition. Under current law,
employers can freeze or terminate their traditional plan
without the complexity or expense of converting to a cash
balance plan, and most actually spend more on retirement
benefits after the conversion as they did before. In a world
where most employees will not spend 20 to 30 years working for
the same employer, the steady accrual of benefits under a cash
balance plan provides greater retirement security than the
distant accrual of back-loaded benefits under a traditional
defined benefit plan.
Our ultimate goal here is to ensure cash balance plans
remain a viable option for employers who want to remain in the
defined benefit system, and I think most of the Members here
would agree that defined benefit systems, defined benefit plans
are an important components of a solid retirement security for
American workers.
It is my hope that we can move forward with reforms to
strengthen the cash balance plans for all workers as we craft a
comprehensive proposal to reform and strengthen the defined
benefit system.
With that, I look forward to hearing from our witnesses and
working with my colleagues on this issue as we move ahead. With
that, I yield to my friend and colleague the Ranking Member,
Mr. Miller.
[The prepared statement of Chairman Boehner follows:]
Statement of Hon. John Boehner, Chairman, Committee on Education and
the Workforce
I'd like to thank everyone for coming to the eighth in our series
of hearings on defined benefit pension plans for a topic that is
particularly timely. Cash balance plans have received a lot of
attention recently, producing rhetoric that has often been misleading
if not false. Today, we hope to separate myth from fact.
As we all know the number of defined benefit plans has declined
significantly over the last 20 years, from 114,000 in 1985 to 31,000
last year, and the entire defined benefit system remains at risk. Some
experts have suggested that cash balance plans, which are a type of
defined benefit plan, offer today's workers the type of secure and
portable benefit that can help save and preserve the overall system.
Unfortunately, fewer and fewer companies are offering cash balance
plans because of a recent wave of litigation.
Before I talk about this specifically, I'd like to discuss some
facts about how these plans work. Under cash balance plans, workers
earn portable benefits through monthly pay and interest credits, and
benefits are earned more evenly over a career span, not just at the end
of a worker's career. This can result in greater retirement savings for
workers who do not remain with the same employer for their entire
career. As a result, a broader group of employees--including lower-
income workers and women--earn greater benefits with shorter service
under cash balance plans than traditional plans. According to a study
published by Watson Wyatt in 2000, more than 80 percent of participants
fare better with a cash balance plan.
The value of the benefit in a traditional plan spikes for workers
who qualify for an early retirement subsidy, typically in their mid-
50s, but then declines if they fail to retire at a specific age and
keep working. As a result, traditional plans are advantageous only for
the small proportion of employees who work for the same employer for 20
to 30 years AND retire in their mid-50s. Conversely, traditional plans
are disadvantageous for younger employees, for workers who change jobs
or interrupt their careers, and for older workers who continue working
after early and normal retirement age.
The Employee Retirement Income Security Act (ERISA) prohibits
employers from cutting back or reducing any pension benefits that have
been earned by employees once they vest in their pension plan. Despite
this current law protection, some critics have continued to express
concern over cash balance conversions despite the fact a large majority
of them have been handled properly and legally.
The real issue here is about a small number of prospective
retirees'' expectation of receiving the full value of early retirement
subsidies that have not yet been earned. This is not about normal
retirement benefits. Rather, I'm concerned that cash balance critics
are focused not on providing meaningful retirement benefits to our
overall workforce, but solely on protecting a small fraction of
employees who can afford to retire early. It is important to note that
under the voluntary pension system all defined benefit plan sponsors
may change benefit formulas prospectively to either enhance or reduce
future benefits that have not yet been earned by an employee. All
employers need the flexibility to determine what is appropriate for the
needs of their workers and their business. If this flexibility is taken
away or if Congress were to unilaterally mandate certain pension
benefits, employers would leave the voluntary pension system altogether
and the defined benefit system would all but disappear.
The recent wave of litigation surrounding cash balance plans has
raised concerns from employers, workers, and policymakers alike. One
well-documented court case involves IBM, but the initial ruling runs
counter to existing law and a large body of other court decisions. In
this case, the judge found the cash balance plan design inherently age
discriminatory because equal pay credits for younger workers have a
longer period of time to earn interest and accrue benefits before
retirement than the same pay credits for older workers. This
interpretation essentially means it would be age discriminatory to make
equal contributions on behalf of workers with different ages. This is
inconsistent with every other pension design and this logic would make
a basic savings account, 401(k) plans, and even Social Security
benefits automatically age discriminatory. We're not here to debate the
IBM case, but we also need to make sure cash balance plans aren't
forced into extinction at the expense of the interests of workers.
Most courts have ruled no age discrimination occurs with cash
balance plans if the pay and interest credits given to older employee
accounts are equal to or greater than those of younger employees. The
most recent ruling on this topic, issued just last month in the Tootle
case, agrees that cash balance plans are not inherently age
discriminatory.
I'd like to dispel another myth about these plans. The switch to
cash balance plans is not motivated by cost savings, but rather
pressures imposed by an increasingly mobile workforce as well as fierce
competition. Under current law, employers can freeze or terminate their
traditional plan without the complexity or expense of converting to a
cash balance plan, and most actually spend more on retirement benefits
after the conversion as before. In a world where most employees will
not spend 20 to 30 years working for the same employer, the steady
accrual of benefits under a cash balance plan provides greater
retirement security than the distant accrual of back-loaded benefits
under a traditional plan.
Our ultimate goal is to ensure cash balance plans remain a viable
option for employers who want to remain in the defined benefit system
and workers who prefer the portable and secure benefit this option
provides. It's my hope we can move forward with reforms to strengthen
cash balance plans for all workers as we craft a comprehensive proposal
to reform and strengthen the defined benefit pension system. With that,
I look forward to hearing from our witnesses and working with my
colleagues on this issue as we move ahead.
______
STATEMENT OF HON. GEORGE MILLER, RANKING MEMBER, COMMITTEE ON
EDUCATION AND THE WORKFORCE
Mr. Miller. Thank you, Mr. Chairman, and I want to thank
you very much for holding this hearing. I think it is long
overdue. In many ways today's economy is hard on American
families. Blue collar and white collar employees alike are
being fired, outsourced, and downsized. Their real wages are
declining, and on top of that their health care and retirement
benefits are being reduced while costs are going up.
People who work hard every day year after year have dreams
about their retirement. They plan for it. But then with little
warning their employers tear up those retirement plans. That is
the context in which this hearing takes place.
For hard working middle-class families, our Nation's
pension system is in crisis. We all know that an increasing
number of employers are bailing out of the defined benefit
plan. That is their decision. Companies used to believe it was
the best way to attract and retain a qualified workforce. And
while I personally believe that companies and workers alike
benefit from a traditional benefit plan, Congress cannot
require these companies to provide one. But Congress can and
must require that companies abide by the law.
The question for Congress now is what exactly is the law
going to be when it comes to the new world of changing pension
plans. After the Enron debacle, the stock market downturn of
2000, 401(k) plans were no longer the golden child that we
thought they were. With median account balances of
approximately $13,000 it is highly unlikely that 401(k) plans
will provide adequate retirement benefits for a majority of
workers covered by them. But, then again, 401(k) plans were
never originally designed as a retirement plan. They were
designed to increase national savings.
There are many in Congress and the pension community who
argue that hybrid pension plans like the cash balance plans can
be the future of the retirement system. Congress needs to have
that debate. This debate must be fact based and honest and we
should begin by acknowledging that there is a lot we do and a
lot we do not know about cash balance pension plans. We know
that during the 1990's hundreds of large companies amended
their traditional defined benefit plans and adopted cash
balance pension plans instead. We know that over 8 million
workers and retirees were affected. We know that many workers
lost pension benefits that they had every reason to expect to
receive.
The General Accounting Office found that without transition
protection, older workers, workers over 45, can lose up to 50
percent of their expected pension benefits. What we do not
know, however, is whether all of these plans in these
conversions comply with the laws protecting workers' pensions
generally and are protecting them from age discrimination.
ERISA, our governing Federal pension law, does not recognize
cash balance plans since these plans did not exist when the law
was enacted in 1974.
During the time the cash balance plans were being created
no one ever came to Congress and asked us to amend ERISA to
include these plans. Congress was mostly unaware of how they
worked. The consultants who created cash balance plans sought
the approval of the Treasury Department and the IRS in
particular. The IRS approved most of these plans, although only
as far as their adherence to existing tax code. The IRS did not
examine the plans to see whether or not they were fair to older
workers or whether they violated provisions of law against age
discrimination in employee benefits. There was disagreement
within the IRS on the legality of these plans, and then along
came IBM, as you have noted, Mr. Chairman.
In 1999 IBM announced it intended to convert its
traditional plan to cash balance. IBM only gave its workers a
handful of weeks to prepare for that change. It only protected
workers who were 5 years from retirement or with 25 years of
service. IBM put a pension calculator on the company Web site
and pulled it when workers started figuring out that they would
lose benefits under the new plan.
The computer savvy workers that worked at IBM quickly used
the Internet to mobilize a grass roots army to express their
concerns to Congress and we ended up with a moratorium. In a
callous move, which many believe proposed serious dangers to
the retirement security of millions of employees, the Bush
administration in 2001 tried to overcome the controversy
surrounding the cash balance plans by issuing draft regulations
lifting the moratorium. Older workers can't earn enough under
cash balance plans and they don't have time to go to another
company and start again, particularly in an economy that is
producing too few jobs. These are the workers that Congress
needs to protect, and that was the concern that was raised when
the Bush plan was announced, that people would not have the
ability to protect the retirement that they had come to expect
upon. But the Congress on a bipartisan basis voted to stop the
regulations and require Treasury to propose legislation that
would protect older workers.
The administration finally relented to the congressional
public opinion and withdrew the proposed regulations, and that
is why we are here today. When the Treasury formally withdrew
the rejected regulations in June, it announced it would work
with Congress to achieve the legislation based upon the
framework President Bush put forth in his 2005 budget. But the
present proposal is still far off the mark when it comes to
protecting older workers and their pensions. That is the
challenge before us. How do we assure fair protection for older
workers and pension plans while allowing companies the
flexibility and employees the flexibility that they need?
Most of these workers are too old to start over again. They
may have given 20 or 30 years of their working life to the
companies and they are stuck. I think that is the issue that we
have tried to raise with Treasury, we tried to raise with the
administration and found bipartisan support, and that really is
that we have got to allow workers to have a choice in this and
to make a determination about their pension benefit that will
allow the company to change plans but at the same time protect
these individuals.
In many instances these are not mom and pop low-profit
margin companies when we discuss these issues. As you know, it
is AT&T, American Express, Citicorp, Compaq, CSX, Georgia
Pacific, Prudential and hundreds more. Congress needs to decide
what the future of these cash balance plans should be.
Representative Bernie Sanders and I and 134 other
Republicans and Democrats introduced legislation to require
workers at age 40 or older with 10 or more years of service to
be provided a choice between the old and new plans. Treasury
Secretary Snow readily admits this was very similar to what he
did when he was chief executive at CSX. CSX gave its workers a
choice between plans. I think I quote him correctly when he
said, I believe he was the director of Verizon when Verizon
made the decision to finally, after much turmoil, to give its
employees the choice.
It is what the Congress did when the Congress changed its
pension plans for Members. Members went down, they sat down
with an analyst, they decided which plan they thought would be
better for them given their expectations of how long they would
stay here, whether they would leave or what have you, and they
made that choice. I think that that is the kind of fairness
that we are seeking when we look forward to these changes in
the pension plans.
But it is important, Mr. Chairman, and I want to commend
you for giving the time and attention and resources of this
Committee to this issue, because it is absolutely fundamental
to the economic well-being of our country and to our families.
I would add one final note, that I think while we consider
whether or not people are going to make this choice and they
make the decisions whether they go into a 401(k) and how that
401(k) is administered, we must also look at those components
of it. We have seen too many headlines where there is a lack of
transparency, there is a difference in practices on fees that
are charged, the purpose of those fees. Again, this morning we
see the SEC has renewed and asked additional questions about
how 401(k) plans are put into different funds, to different
investment instruments without transparency. What are the
reasons for those fees they are paying? It adds up to about $10
billion a year that people are paying. Does it really, in fact,
benefit the investors?
I think that as we think about the ability of employers and
employees to utilize these other investment and retirement
instruments we have got to make sure that there is transparency
for the employer, for the employees, as they make those
decisions. Because it appears that more and more families are
going to be relying on their decisions about their retirement
and even in the case where the employer helps them with, that
we have got to make sure that they are not influenced, as was
reported in the paper today where they said there was
substantial evidence that certain mutual funds because of
payments they received from fund companies or their investor
advisers as part of sales agreements, that people were placed
in those investments to get high cost and poorly performing
funds into a 401(k) or similar retirement plans.
I think we have got to question those activities, and
employees and employers both have got to understand the risks
that are involved here and insist upon that kind of
transparency. Thank you.
Chairman Boehner. It is my pleasure to introduce our
distinguished panel of witnesses today. Our first witness is
Mr. James Delaplane, Jr., or as most of us know him, Jamie
Delaplane. He is a partner in the law firm of Davis & Harman,
LLP, where he serves as special counsel to the American
Benefits Council, which is the national association
representing the employee benefits interest of major U.S.
employers. Mr. Delaplane also represents financial
institutions, employers and employer coalitions, trade
associations, and public policy organizations on a full range
of legislative regulatory matters affecting employee benefits.
We will then hear from Ms. Ellen Collier. Ms. Collier is
the Director of Benefits for Eaton Corporation. Eaton has
51,000 employees worldwide and sells products to customers in
more than 100 countries. Ms. Collier is responsible for the
strategy, design, communication, legal compliance and delivery
of the employee benefits program for Eaton's 27,000 North
American employees.
We will then hear from Dr. Robert Clark. Dr. Clark is a
Professor of Economics and Business Management at North
Carolina State University. Professor Clark has conducted
research examining the retirement decisions, the choice between
defined benefit and defined contribution plans, the impact of
pension conversions to defined contribution and cash balance
plans, the role of information and communications on 401(k)
contributions, government regulation of pensions and Social
Security.
Then we will hear from Mr. Robert Hill. Mr. Hill is an
attorney in private practice in the Denver, Colorado, law firm
of Hill & Robbins. Mr. Hill has represented employees in
several lawsuits challenging the legality of conversions from
traditional defined benefit plans to cash balance plans,
including being the lead counsel for the plaintiffs in Cooper
vs. IBM.
Then we will hear from Ms. Nancy Mitchell Pfotenhauer. Ms.
Pfotenhauer joined the Independent Women's Forum as President
in 2001 from her previous position at Cook Industries where she
was Director of the Washington office. Ms. Pfotenhauer began
her career in Washington, D.C., in 1987 as a Senior Economist
at the Republican National Committee and was promoted to Chief
Economist in 1988. She was also selected by the Bush transition
team at age 24 where she served as the Economist for the
Independent Agencies Task Force for President-Elect George
Bush.
I want to welcome all of you, and I am sure someone has
explained to you how the lights work down there.
With that, Mr. Delaplane, you may begin.
STATEMENT OF JAMES DELAPLANE, JR., ESQ., ATTORNEY, AMERICAN
BENEFITS COUNCIL, WASHINGTON, D.C.
Mr. Delaplane. Thank you, Mr. Chairman, Ranking Member
Miller, I appreciate the opportunity to appear today. The
American Benefits Council is an organization representing
Fortune 500 employers and other entities that assist employers
in providing benefits to employees. Many of our members sponsor
cash balance or other hybrid defined benefit plans.
Rather than merely summarize my written statement, let me
ask all of you to put yourselves in the shoes of a chief
executive facing today's pension environment. Your firm
voluntarily sponsors a defined benefit plan even though most
competitors do not. You fund these benefits, bear the
investment risk, and pay insurance premiums to PBGC. You have
retooled your company to stay competitive and your workforce
has likewise changed. You have fewer career-long employees, you
make more mid-career hires and you face worker shortages in
several job categories. You realize that the company's
traditional pension was not delivering meaningful benefits to
this new workforce. As much as 75 percent of total benefits
were going to the small share of workers that stayed for a full
career.
In particular, you paid significant benefits to those who
retired at 55 under the plan's rich early retirement subsidy.
These subsidized benefits and the departures they encouraged
aggravated your labor shortages. After much analysis you and
your board decided to convert to cash balance and remove the
early retirement subsidy from the plan.
While earned benefits are protected absolutely, these
changes allowed you to reallocate dollars so that future
benefits were delivered more equitably to workers of all
tenures. The new plan offered the portability and transparency
that employees wanted and was more attractive to recruits. The
removal of additional early retirement incentives encouraged
skilled workers to stay. Following the conversion, some of your
workers experienced a plateau in their benefit levels for a
period. This plateau, which some call wear-away, is a natural
outgrowth of removing the early retirement subsidy. Any subsidy
employees have earned in your prior plan is legally protected
but you need not and did not include it in their cash balance
accounts. So for some period of time, the value of the
subsidized prior plan benefit exceeded the value of the new
account. Since these employees were entitled to this higher
benefit if they left, they experienced a benefit plateau until
their cash balance account caught up.
You disclosed this plateau to employees as part of your
comprehensive disclosure about the conversion. While they would
have preferred their benefits to keep growing without
interruption, they understood the plateau resulted from the
rich subsidies in the prior plan and that continuing to pay
productive workers to retire early made no sense.
They also understood you could have removed the subsidy
from the traditional plan and this too would have produced a
plateau. With your conversion successfully accomplished you
were eager to return your focus to growing your business, but
pension developments intervened. Despite significant legal
authority to the contrary, a single Federal judge rules that
the basic cash balance design is age discriminatory. Under this
theory, each of the 1,200 hybrid plans in the country is
illegal. Your general counsel tells you that damages in this
lawsuit are expected to run between $1 and $6 billion, and that
a growing list of companies faces copycat suits. You learn that
Congress has prevented the regulatory agencies from addressing
the age discrimination issues and is now considering
legislation that would for the first time grant employees a
legal entitlement to future benefits not yet earned.
Your company's board grows increasingly nervous. How can we
risk so much liability on something unrelated to our core
business, they ask. Why not have say a 401(k) plan only like
many of our competitors? Will proposals guarantee employees
pension expectations be extended to other benefit programs? You
and the board feel you have little choice but to freeze the
cash balance plan. New hires will get no pension benefits and
current employees will earn no additional benefits.
Mr. Chairman and Members of the Committee, as policymakers
dedicated to the retirement security of American families, we
cannot imagine this is the result you want. Yet this is
reality. Several clients of our firm have already frozen their
hybrid plans and 41 percent of hybrid sponsors say they will do
so within a year absent legal certainty. It is within your
power, however, to change this result.
First, make clear that the basic hybrid designs do not
violate age discrimination rules. Second, provide legal
certainty for employers that convert hybrid plans in good
faith. Third, avoid bans on benefit plateaus. And fourth,
reject mandates for future conversions that will discourage
employers from making new benefit commitments.
Thank you for the opportunity to appear today. I would be
please today answer your questions.
[The prepared statement of Mr. Delaplane follows:]
Statement of James M. Delaplane, Jr.,Esq., Attorney, American Benefits
Council, Washington, DC
Chairman Boehner, Ranking Member Miller, thank you very much for
the opportunity to appear before you today. My name is James Delaplane
and I am a partner with the Benefits Group of Davis and Harman LLP. I
serve as Special Counsel to the American Benefits Council (Council),
and I am appearing today on the Council's behalf. The Council is a
public policy organization representing principally Fortune 500
companies and other organizations that assist employers of all sizes in
providing benefits to employees. Collectively, the Council's members
either sponsor directly or provide services to retirement and health
plans covering more than 100 million Americans.
The Council is very pleased, Mr. Chairman, that you have called
this hearing to examine the important policy issues involving hybrid
defined benefit plans. Many of our members sponsor cash balance and
pension equity plans and the Council believes that the legal
uncertainty currently enveloping these hybrid defined benefit plans is
the most significant and pressing retirement policy issue presently
before Congress. Congressional action to provide legislative clarity
and certainty for hybrid plans is urgently needed to prevent (1) the
demise of these plans, (2) the resulting exit from the defined benefit
system by a large number of American employers, and (3) the harm to the
retirement income prospects of millions of American families that will
unquestionably result.
Mr. Chairman, we believe it is absolutely critical that the effort
to craft hybrid legislation be led by the congressional committees of
jurisdiction and we thank you for spearheading this effort. As you are
well aware, pension policy is a notoriously complex and technical area,
one in which it is easy to produce unintended results, such as
disincentives for employers to remain in our voluntary pension system.
The legislative process works best when those who are most
knowledgeable about an area are the ones to tackle the complex issues.
We applaud your commitment to avoid what has sometimes occurred in the
past with respect to hybrid plans--a haphazard and incomplete debate
pursued outside of the committees of jurisdiction and as part of the
appropriations process.
In my testimony today, I hope to convey the value of the defined
benefit system and hybrid plans specifically for millions of Americans
and their families. I will describe the current legal and regulatory
landscape that is endangering the continued existence of hybrid plans,
and set forth why the Council and its members believe congressional
action is urgently needed to prevent the extinction of these retirement
programs. Lastly, I will describe the Council's recommendations for
resolving this pension crisis.
The Value of the Defined Benefit System
The defined benefit pension system helps millions of Americans
achieve retirement security. It does this by providing employer-funded
retirement income that is guaranteed to last a lifetime. Employees are
not typically required to make any contributions toward their benefits
in these plans and the assets of the plan are managed by investment
professionals. Employers, rather than employees, bear the investment
risk of ensuring that plan assets are sufficient to pay promised
benefits. And insurance from the Pension Benefit Guaranty Corporation
means employees'' retirement benefits are guaranteed even if the plan
or the employer's business experiences financial trouble.
As of 1998 (the most recent year for which official Department of
Labor statistics have been published), more than 18 million retirees
were receiving benefits from defined benefit plans, with over $111
billion in benefits paid out in that year alone.\1\ Given that
America's personal savings rate remains one of the lowest among
industrialized nations \2\ and that average balances in 401(k) plans
are quite modest, \3\ there is no doubt that in the absence of defined
benefit pensions fewer Americans would be financially prepared for
retirement. Furthermore, the absence of defined benefit pensions would
result in increased strain on federal entitlement and income support
programs, not to mention an increase in the number of American seniors
living in poverty.
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\1\ U.S. Census Bureau, Statistical Abstract of the United States:
2002, No. 524 (Source: U.S. Department of Labor, Pension and Welfare
Benefits Administration, Private Pension Plan Bulletin, Number 10
winter 2001, and unpublished data).
\2\ The Organization for Economic Cooperation and Development, Main
Economic Indicators (Paris: OECD, January 2004).
\3\ In fact, data from the Employee Benefit Research Institute
shows that in 2001 the average 401(k) account balance (net of all plan
loans) was only $43,215 and the median (mid-point) 401(k) account
balance was a mere $12,810. Facts from EBRI, 401(k) Plan Account
Balances, Asset Allocation, and Loan Activity in 2001 (June 2003). Even
when looking at 401(k) plan participants in their 60s who had been at
their job for at least 30 years, the average account balance was only
$162,042. This would translate into a relatively meager monthly
lifetime annuity payment at retirement.
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Given these statistics, the value of defined benefit plans to many
American families is undeniable. Yet we have seen an alarming decline
in defined benefit plan sponsorship \4\ and today is a particularly
precarious time for the defined benefit system. Employers are
increasingly exiting the defined benefit system for a variety of
reasons, including uncertainty about how future pension liabilities
will be measured, a flawed pension funding regime marked by complexity
and volatility, potential changes to the rules governing pension
accounting, and, most relevant for our discussion today, legal
uncertainty surrounding hybrid defined benefit plans.\5\ Objective
observers agree that policymakers must take action to address these
threats or defined benefit plans and the income they provide to
American retirees will become increasingly scarce.\6\
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\4\ The total number of PBGC-insured defined benefit plans has
decreased from a high of more than 114,000 in 1985 to 32,321 in 2002.
PBGC Pension Insurance Data Book 2002, 44 & 72. This downward trend
becomes even more sobering if you look at just the past several years.
Not taking into account pension plan freezes (which are also on the
rise but not officially tracked by the government), the PBGC reported
that the number of defined benefit plans it insures has decreased by
7,000 (or 18%) in just the last four years. Id.
\5\ The Council recently released a white paper discussing in
detail each of these threats to the defined benefit system, along with
recommendations for ensuring that defined benefit pension plans remain
a viable retirement plan design. See American Benefits Council,
Pensions at the Precipice: The Multiple Threats Facing our Nation's
Defined Benefit Pension System (May 2004), available at http://
www.americanbenefitscouncil.org.
\6\ ``Policymakers should take action sooner rather than later in
order to create greater regulatory certainty for plan sponsors.
Decisions are needed on the status of cash balance pension plans,
permanent funding rules, and interest rates to be used in plan
calculations, accounting treatment related to using smoothing versus
mark-to-market for investment returns and interest rates, and rules and
premiums under Title IV of ERISA and the Pension Benefit Guaranty
Corporation. Until these kinds of policy decisions are made, further
erosion of the defined benefit system can be expected to continue.''
Jack VanDerhei and Craig Copeland, Employee Benefit Research Institute,
ERISA At 30: The Decline of Private-Sector Defined Benefit Promises and
Annuity Payments? What Will It Mean?, Issue Brief No. 269 (May 2004).
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Before going on, Mr. Chairman, I want to thank you and the members
of the Committee for enacting a temporary replacement for the 30-year
Treasury bond interest rate used for pension calculations. As you know,
one of the threats to the defined benefit system has been the required
use of an obsolete interest rate, and we sincerely appreciate your
leadership in enacting a corporate bond replacement rate for 2004 and
2005. The Council and its members look forward to working with you and
the Committee to find an appropriate permanent replacement for the 30-
year Treasury bond rate and enacting this replacement in the very near
future.
The Specific Advantages of Hybrid Defined Benefit Plans
Hybrid plans are defined benefit pensions that also incorporate
attractive features of defined contribution plans. The most popular
hybrid plans are the ``cash balance'' design and the ``pension equity''
design. In a cash balance plan, employers provide annual ``pay
credits'' to an employee's hypothetical account and ``interest
credits'' on the balance in the account. In a pension equity plan,
employers provide credits for each year of service and these credits
are multiplied by an employee's final pay to produce a lump sum figure.
Hybrid plans not only offer the security of employer funding and
assumption of investment risk, federal guarantees and required lifetime
and spousal benefit options, but also show account balances in lump sum
format, are portable, and provide for a more even benefit accrual
pattern across a worker's entire career.\7\ Hybrid plan participants
are able to reap these rewards typical of defined contribution plans
without bearing any concomitant loss of security (i.e., a decline in
account balance due to stock market conditions).
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\7\ Traditional defined benefit plans tend to provide the bulk of
earned benefits at the very end of a worker's career.
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Employers like hybrid plans primarily because the benefits in the
plans are so tangible to employees, resulting in greater appreciation
of the pension program. In fact, a survey published in 2000 found that
the dominant motives for employer conversions were employee
appreciation of the plan, facilitating communication with employees,
and the ability to show the benefit amount in a lump sum format.\8\
Many assume that conversions are pursued to cut employer pension costs.
While this has been the case for some companies, for most employers it
is neither the rationale for the conversion nor the reality that
results.\9\ We trust you will agree that, when employers do conclude
that costs must be reduced, it is better for them to retain an
affordable defined benefit plan (and one that fits the realities of the
modern workforce) than to not have one at all.
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\8\ Sylvester J. Schieber, et al., Watson Wyatt Worldwide, The
Unfolding of a Predictable Surprise: A Comprehensive Analysis of the
Shift from Traditional Pensions to Hybrid Plans 44 (February 2000) (96%
of respondents indicated employees'' appreciation of the plan was
either very important or important in the decision to convert to a
hybrid plan; 93% of respondents indicated facilitation of communication
and the ability to show the benefit amount in a lump sum format were
either very important or important in the decision to convert to a
hybrid plan).
\9\ Data released just this year shows that retirement plan costs
have increased an average of 2.2% following a conversion, and when
companies that were in severe financial distress were excluded from the
pool, this figure increased to 5.9%. Watson Wyatt Worldwide, Hybrid
Pension Conversions Post-1999: Meeting the Needs of a Mobile Workforce
3 (2004). In addition, conversions are often accompanied by
improvements to other benefit programs, such as 401(k) plans, bonuses,
and other post-retirement benefits. In fact, one recent survey found
that when these improvements are taken into account, 65% of respondents
expected the costs of providing retirement benefits following a cash
balance conversion to increase or remain the same. Mellon Financial
Corporation, 2004 Survey of Cash Balance Plans 15. Another survey,
conducted in 2000, also found that overall costs following a conversion
were expected to increase or remain the same in 67% of the cases.
PricewaterhouseCoopers, Cash Balance Notes 4 (May 2000).
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Hybrid plans and their level benefit accrual pattern are also
effective in helping employers attract and retain employees in today's
fluid job market where few individuals plan or expect to stay with one
employer for a career.\10\ Employees likewise appreciate hybrid plans
because they are more transparent, more portable, and deliver benefits
more equitably to short, medium and longer-service employees than
traditional pensions, while also retaining the favorable security
features of the defined benefit system.\11\
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\10\ Women rank promoting portable pensions as their top retirement
policy priority. Center for Policy Alternatives and Lifetime
Television, Survey: Women's Voices 2000.
\11\ The Federal Reserve, Cash Balance Pension Plan Conversions and
the New Economy 5 (Oct. 2003) (``[R]easons that workers may want
pensions include the desire to earn tax-favored returns, or to realize
economies of scale on the transaction costs of investment, although
both of these goals can be realized in a [defined contribution] plan as
well as a [defined benefit] plan. In a [defined benefit] plan workers
may also realize the opportunity to insure to some degree against
mortality, inflation, macroeconomic, and disability risks through
inter-and intra-generational risk sharing.'').
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The unique value of hybrid plans in meeting employee retirement
plan preferences is demonstrated in a new survey. The survey reveals
that workers prefer two retirement plan attributes above all others--
the portability of benefits and benefit guarantees.\12\ It is only
hybrid plans that can deliver both these advantages. Traditional
defined benefit plans typically do not provide for portability, and
benefits in 401(k) and other defined contribution plans are not
guaranteed. Indeed, if policymakers were today working from a blank
slate to produce the ideal retirement plan, it is a hybrid plan they
would likely develop. Clearly, preserving hybrid plans as a viable
pension design is critical if employers are to maintain retirement
programs that meet employee needs and preferences.
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\12\ Watson Wyatt Worldwide 2004, supra note 9 at 6.
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Perhaps most important of all, studies show that nearly 80% of
participants build higher retirement benefits under a hybrid plan than
a traditional plan of equal cost.\13\ Why? Traditional defined benefit
plans tend to award disproportionate benefits (often as much as 75% of
total benefits under the plan) to employees with extremely long
service. Yet very few employees spend a career with a single
employer.\14\ Hybrid plans were designed to respond to this reality.
The advantage of hybrid plans for most workers is confirmed by a recent
study that shows that if an employee changes jobs just three times in
the course of his career, she or he can expect to receive in excess of
17% more in retirement benefits from participating in cash balance
plans than had his or her employers provided traditional plans
instead.\15\
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\13\ Watson Wyatt Worldwide 2000, supra note 8 at 24-25.
\14\ Watson Wyatt Worldwide 2004, supra note 9 at 6 -7. In fact,
only 9.5% of employees work in the same job for 20 years or more.
Employee Benefit Research Institute.
\15\ Watson Wyatt Worldwide 2004, supra note 9 at 6. The Federal
Reserve has likewise reported that ``conversions have generally been
undertaken in competitive industries that are characterized by tight
and highly mobile labor markets. Since mobile workers benefit most from
such conversions, we conclude that this trend may have positive
implications for the eventual retirement wealth of participants.'' The
Federal Reserve, supra note 11 at 3.
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The advantages of the hybrid plan are not reserved for younger
workers. Even longer-service workers often fare better under a hybrid
plan.\16\ One of the many ways in which hybrid plan sponsors address
the needs of longer-service and older employees is by contributing pay
credits that increase with the age and service of employees. Recent
surveys show that 74% of cash balance plan sponsors provide pay credits
that increase with age or service, \17\ while 87% of pension equity
plan sponsors do the same.\18\
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\16\ Watson Wyatt Worldwide 2000, supra note 8 at 23-25 (February
2000) (Among the 78 plans studied, on average a worker age 50 with 20
years of service would have earned benefits 1.48 times as great if he
had participated in a cash balance plan rather than a traditional
plan).
\17\ Mellon Financial Corporation, supra note 9 at 12.
\18\ Watson Wyatt Worldwide 2004, supra note 9 at 2.
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Employers also devote significant energy and resources to
developing transition assistance programs to help older and longer-
service employees who may not accrue as much in benefits on a going
forward basis under a hybrid plan as they would under the prior plan.
Successful conversion assistance techniques vary, but generally include
one or more of the following: grandfathering some or all current
employees in the prior pension plan, allowing certain employees to
choose whether to remain in the traditional plan or move to the hybrid
plan, providing whichever benefit is greater under either the
traditional or new formula, providing additional transition pay credits
in an employee's account over some period of time, or making extra one-
time contributions to employees'' opening accounts. Employers draw from
these varying techniques and apply them to smaller or larger groups of
employees as appropriate to suit the needs of their workforce and carry
out the goals of the conversion. Studies conducted within the last few
years show that employers provide older and longer-service employees
with these special transition benefits in nearly all conversions.\19\
Indeed, employers'' already significant focus on the needs of older
workers has only increased in light of public and congressional
interest in the effect of conversions.
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\19\ Mellon Financial Corporation, supra note 9 at 11 (90% of
conversions contain special transition benefits); Watson Wyatt
Worldwide 2004, supra note 9 at 4 (89% of conversions contain special
transition benefits). In those instances where these special transition
benefits are not provided, it is usually because the business is in
financial distress at the time of the conversion.
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As this data reveals, hybrid plans are proving extremely successful
in delivering valuable, appreciated, and guaranteed retirement benefits
to employees of all ages.
The Legal and Regulatory Landscape
Let me now turn to a discussion of the history of hybrid plans and
how the current uncertainty in the legal and regulatory landscape came
about. The first cash balance plan was adopted in 1985 and the first
pension equity plan was adopted in 1993. For nearly fifteen years after
adoption of the first cash balance plan, the Internal Revenue Service
(IRS) regularly issued determination letters for hybrid plan
conversions indicating that the plans and conversions satisfied all
Internal Revenue Code requirements (including those related to age
discrimination). In 1999, however, the IRS announced a moratorium on
such letters partly in response to several high-profile conversions
that were receiving significant congressional and media scrutiny. As a
result of this scrutiny and after thorough review of the issues through
numerous congressional hearings in the committees of jurisdiction,
Congress in 2001 enacted legislation to require employers to provide a
more detailed and more understandable advance notice to participants
regarding any hybrid conversion (or any other defined benefit plan
amendment) that significantly reduced future benefit accruals.\20\ At
the time, some in Congress proposed various benefit mandates and design
restrictions as a response to cash balance conversions, but these
proposals were all rejected. Congress concluded that the best response
to the issues that had been raised was to ensure absolute transparency
for employees about how their benefits would be affected by hybrid plan
conversions.
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\20\ ERISA section 204(h); Notice of Significant Reduction in the
Rate of Future Benefit Accrual, 68 Fed. Reg. 17,277 (Apr. 9, 2003) (to
be codified at 26 C.F.R. pts. 1, 54, and 602).
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Benefit Plateaus (``Wear-Away''). Let me now turn to a discussion
of one of the conversion issues that has generated questions and
concerns throughout the congressional review of hybrid plans--so called
``wear-away.'' At the outset, it is important to understand that
parallel rules in ERISA and the Internal Revenue Code protect all
benefits that an employee has already earned for service to date.\21\
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\21\ ERISA section 204(g); Internal Revenue Code section 411(d)(6).
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Thus, despite assertions to the contrary, existing benefits are
never reduced in a hybrid plan conversion.
``Wear-away'' is the term used for the benefit plateau effect that
some employees can experience in conjunction with a cash balance
conversion. When employers convert to a cash balance plan, they
typically provide an opening balance in employees'' cash balance
account. A benefit plateau results if the value of the employee's cash
balance account is less than the value of the benefit he or she accrued
under the prior plan as of the date of the conversion. Until the value
of the cash balance account catches up to the value of the previously
accrued benefit, it is the higher accrued benefit to which the worker
is entitled if he or she departs the company--hence the plateau.\22\ We
believe that the term ``wear-away'' is, in fact, confusing and even
misleading, as the employee always receives the higher of the two
benefit levels and nothing earned is taken away. Thus, we use the term
benefit plateau throughout the discussion below.
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\22\ It is worth noting that the use of benefit plateaus as a
method of transitioning between benefit formulas has been expressly
approved under IRS pension regulations for many years. Indeed, plateau
periods can result from constructive and necessary plan changes, such
as updating plan mortality assumptions to provide more accurate
benefits, aligning the benefits of employees from different companies
in the wake of business acquisitions and mergers, or revising a plan to
meet new statutory requirements (such as legislative restrictions on
the amount of benefits that may be paid under a plan).
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There have been three leading causes of this plateau effect in the
conversion context.
First, the plateau can result simply from a change in the
rate of interest on 30-year Treasury bonds. Our pension laws require
that when benefits earned in a defined benefit plan are converted from
an annuity payable at retirement into a lump sum present value, this
calculation must be performed using the 30-year Treasury bond rate.\23\
As interest rates on 30-year bonds fall, the lump sum present value of
the benefit earned by the employee prior to the conversion will
increase.\24\ The result can be that although a worker's previously
earned benefit and opening cash balance account were both equal to
$50,000 at the time of conversion, a decrease in 30-year bond interest
rates can increase the value of the previously earned benefit to
$55,000. Until the cash balance account reaches $55,000, this worker
will experience a benefit plateau.
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\23\ ERISA section 205(g); Internal Revenue Code section 417(e).
This required use of the 30-year Treasury bond rate was not changed by
the recently enacted legislation replacing the 30-year rate for pension
funding calculations.
\24\ This is because one needs a larger pool of money today to grow
to an equivalent benefit at age 65 if that pool will be earning less in
interest.
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Second, benefit plateaus can result when employers
translate the previously accrued traditional benefit into an opening
cash balance account using an interest rate higher than the 30-year
bond rate. When this is done, the value of the opening cash balance
account will be lower than what the employee would be eligible to take
under the prior plan (since the present value of that benefit must be
calculated using the 30-year bond rate). The result is that workers
will plateau at the higher level until the cash balance account catches
up. Employers generally use a higher interest rate when they believe
the 30-year Treasury bond rate is historically low (which has been the
case in recent years).\25\ Yet because using a higher interest rate can
produce benefit plateaus and plateaus have been of concern to
employees, few employers have set opening balances in this way. The
clear trend has been for employers to determine opening account
balances using the Treasury rate or a rate more favorable for
employees.\26\ Thus, this use of higher interest rates is not a
frequent cause of benefit plateaus today.
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\25\ This is yet another reminder of how important it is for
Congress to move quickly to enact a permanent replacement for the 30-
year Treasury bond rate, including for calculations that determine lump
sum benefits in defined benefit plans.
\26\ In a 2000 study of cash balance conversions, Watson Wyatt
reports that of the 24 plans it reviewed that converted to a hybrid
design since 1994, 22 of them (92%) set opening account balances using
the Treasury rate or a rate more beneficial to employees. Watson Wyatt
Worldwide 2000, supra note 8 at 40; Mellon Financial Corporation, supra
note 9 at 6 (77% of 101 cash balance conversions did the same).
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Third, benefit plateaus can result when employers
eliminate early retirement subsidies (on a prospective basis) from the
pension.\27\ A plateau can result in this instance because workers who
have already earned a portion of an early retirement subsidy prior to a
conversion will typically have a previously earned benefit under the
prior plan that is higher than the opening cash balance account (which
is typically based on the normal retirement age benefit earned under
the prior plan as of the date of the conversion and does not include
the value of any early retirement subsidy).\28\ Elimination of the
early retirement subsidies on a prospective basis is the primary cause
of benefit plateaus in most conversion cases where plateaus are seen
today. It should be noted that benefit plateaus can also occur in cases
where early retirement subsidies are eliminated from traditional
defined benefit plans.
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\27\ An early retirement subsidy provides an enhanced benefit if
the employee leaves the company at a specified time prior to normal
retirement age. For example, a fully subsidized early retirement
benefit might provide an employee the same pension at age 55, say,
$1,500 per month for life, which he would not normally receive until
age 65. The ability to earn the higher pension without any actuarial
discount for the additional 10 years of payments provides a strong
financial incentive to retire at the earlier age. The value of such an
early retirement subsidy decreases every year until normal retirement
age, at which point no subsidy remains.
\28\ Opening account balances do not typically include the value of
early retirement subsidies because doing so would provide the value of
the subsidy to a large number of workers who will work until normal
retirement age and therefore not be entitled to the subsidized early
retirement benefits. Those few employers that have included some or all
of the subsidy in opening accounts have done so as a particular
conversion assistance technique.
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While some may be concerned about the plateau effect resulting from
subsidy removal, Mr. Chairman, we feel strongly that employers must
maintain their flexibility to eliminate these early retirement
subsidies on a going forward basis. Early retirement subsidies are
certainly a preferable alternative to layoffs and can help a company
manage its workforce in a humane way. But employers will never adopt
such a feature of their plan if policymakers make it difficult or
impossible to eliminate these subsidies prospectively when they no
longer make sense. Today, for example, given the significant shortages
that employers experience in certain job categories, it makes no sense
for them to continue to offer highly-productive employees rich
financial incentives to retire in their 50s. While current law protects
any subsidy that employees have already earned for their service to
date, it wisely allows employers to remove such incentives from their
plan going forward.
Moreover, any legislative requirement that employers maintain
ongoing early retirement subsidies in their pension plans--and this is
what a ban on plateaus would entail--would be out of step with
congressional actions regarding our nation's public pension system,
Social Security. With respect to Social Security, Congress has raised
the retirement age and repealed the earnings test in order to encourage
older Americans to work longer. Requiring employers to continue to
offer private pension plan incentives to retire early would be flatly
inconsistent with these actions.
Although we understand that benefit plateaus can be confusing and
even upsetting to some employees, they result from interest rate
anomalies and valid actions taken by employers to eliminate early
retirement subsidies. Nonetheless, given the employee concern, many
employers design their conversions to mitigate these plateaus or
eliminate them altogether. Moreover, the disclosure requirements
enacted by Congress in 2001 (and implemented by the Treasury Department
through regulations) ensure that employees are fully aware of the
possible benefit plateau effects of a conversion. The Council believes
these steps appropriately respond to the concerns that have been raised
about plateaus.
Age Discrimination Principles. Subsequent to Congress'' enactment
of disclosure legislation, the Treasury Department and IRS drafted
proposed regulations in consultation with the Equal Employment
Opportunity Commission addressing retirement plan design and age
discrimination principles. These proposed regulations were issued in
December 2002. Among other items, the proposed regulations established
the validity of the cash balance design under the pension age
discrimination statute and provided guidelines on how employers could
convert from traditional to hybrid pension designs in an age-
appropriate manner.
Disregarding the interpretation contained in the proposed
regulations and other legal authorities, one federal district court
judge dramatically shifted the focus of the debate surrounding hybrid
plans by declaring in July 2003 in the case of Cooper v. IBM that
hybrid plan designs were inherently age discriminatory.\29\ According
to the court's flawed logic, simple compound interest is illegal in the
context of defined benefit pension plans.\30\ Under the Cooper court's
reasoning, a pension design is discriminatory even if the employer
makes equal contributions to the plan on behalf of all its workers and,
ironically, even in many instances where the design provides greater
contributions for older workers. Such a conclusion flies in the face of
common sense.\31\ It would hold all 1,200 plus hybrid pension plans,
\32\ regardless of whether adopted as new plans or through conversion
from traditional plans, to be in violation of the pension age
discrimination laws.
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\29\ Cooper v. IBM Pers. Pension Plan, 274 F. Supp. 2d 1010 (S.D.
Ill. 2003). The pension age discrimination statute in question provides
that the rate of a participant's benefit accrual may not decline on
account of age. The district court interpreted this rule to mean that
the amount of annuity benefit received at age 65 for a year of service
cannot be less for an older worker than a younger worker. The
defendants in the case argued that it is nonsensical from an economic
perspective to compare the age 65 benefit accrual rate of a 25-year old
and a 64-year old because the 64-year old will receive his or her
benefit much sooner and have a much shorter period of time to accrue
interest. In other words, the ``time value'' of money must be taken
into account. The court itself acknowledges the strength of this
argument, stating, ``From an economist's perspective, Defendants have a
good argument.'' Nonetheless, the court goes on to argue incorrectly
that the age discrimination laws require rejection of basic economic
common sense.
\30\ The court's reading of the 1986 pension age discrimination
statute would invalidate a broad range of long-standing pension
designs, including contributory defined benefit plans (common in the
state and local government sector and among multiemployer plans), plans
that are integrated with Social Security and plans with pre-retirement
indexation to help protect employees from the effect of inflation.
These plans were all regarded as perfectly age appropriate when
Congress enacted the pension age statute.
\31\ If the Cooper court's reasoning were applied to the Social
Security program, even it would be considered age discriminatory.
\32\ The most recent government data indicates that as of the year
2000 there were 1,231 hybrid plans covering more than seven million
participants. PBGC, supra note 4 at 3-6.
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The conclusion that all hybrid plan designs are inherently age
discriminatory begs the question why the Internal Revenue Service
issued favorable determination letters for fifteen years blessing
hybrid plan designs and issued proposed regulations providing that the
cash balance plan design is not inherently age discriminatory. It is
surprising, at a minimum, that the Cooper decision completely ignored
this history. Even more astonishing is the fact that the Cooper
decision ignores the legislative history of the pension age
discrimination statute adopted in 1986. That legislative history makes
clear that the intent of Congress was limited to prohibiting the
practice of ceasing pension accruals once participants attained normal
retirement age.\33\ Moreover, an example in the 1986 legislative
history that clarifies a separate but related pension issue describes
approvingly a type of plan (a ``flat dollar'' plan) that would be
deemed age discriminatory under the Cooper decision.\34\ It makes
absolutely no sense that Congress would use as an example of a viable
pension design one that would fail the age discrimination prohibition
it was enacting at the very same time.\35\ Lastly, prior to the Cooper
decision, numerous other federal district courts addressed and rejected
charges that the basic hybrid plan designs were age discriminatory.\36\
These too were ignored in the Cooper decision. Importantly, another
federal district court decision decided subsequent to Cooper has
rejected its logic and concluded that the cash balance pension design
is age appropriate.\37\
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\33\ H.R. Conf. Rep. No. 1012, 99th Cong., 2d Sess. at 376-379. A
number of other federal district courts that have had the opportunity
to review this issue have likewise concluded that the pension age
discrimination statute is only applicable to benefit accruals after a
participant has reached normal retirement age. See Tootle v. ARINC,
Inc., Civ. Action No. CCB-03-1086 *15-16 (D. Md. June 10, 2004); Engers
v. AT & T Corp., No. 98-3660, letter op. at 9 (D. N.J. June 6, 2001);
Eaton v. Onan, 117 F. Supp. 2d 812, 827-29 (S.D. Ind. 2000).
\34\ H.R. Conf. Rep. No. 1012, 99th Cong., 2d Sess. at 381.
\35\ Eaton acknowledged this inconsistency and concluded it was
illogical to read the pension age discrimination statute in such a way
as to invalidate this example and with it a wide variety of defined
benefit plans. 117 F. Supp. 2d at 830, 834.
\36\ Campbell v. BankBoston, N.A., 206 F. Supp. 2d 70 (D. Mass.
2002) (rejecting the notion that hybrid plan designs are inherently age
discriminatory, the court stated that a ``claim based on the fact that
older workers will have a smaller amount of time for interest to accrue
on their retirement accounts--is not permitted under the [age
discrimination laws].'' ), aff'd 327 F.3d 1 (1st Cir. 2003); Eaton v.
Onan, 117 F. Supp. 2d 812, 826 (S.D. Ind. 2000) (in holding that the
cash balance pension design is not age discriminatory the court stated:
``Plaintiffs'' proposed interpretation would produce strange results
totally at odds with the intended goal of the OBRA 1986 pension age
discrimination provisions.'').
\37\ Tootle v. ARINC, Inc., Civ. Action No. CCB-03-1086 (D. Md.
June 10, 2004).
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Spurred on by the Cooper decision, cash balance critics in Congress
pushed through an appropriations prohibition preventing the Treasury
Department from finalizing its age regulations addressing hybrid plan
designs and conversions.\38\ Congress at the same time directed the
Treasury Department to make legislative recommendations regarding
conversions from traditional to cash balance plans.\39\ In the relevant
legislative history, however, Congress did make clear that ``[t]he
purpose of this prohibition is not to call into question the validity
of hybrid plan designs (cash balance and pension equity). The purpose
of the prohibition is to preserve the status quo with respect to
conversions through the entirety of fiscal year 2004 while the
applicable committees of jurisdiction review the Treasury Department's
legislative proposals.'' \40\
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\38\ See Section 205 of the fiscal year 2004 Omnibus Appropriations
Act (PL 108-199).
\39\ These recommendations were recently issued by the Treasury
Department as part of the Bush Administration's fiscal year 2005 budget
submission to Congress.
\40\ H.R. Conf. Rep. No 401, 108th Cong., 1st Sess. at 1185 (2003).
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While the Cooper decision is an isolated one, and there is clear
and significant authority to the contrary concluding that hybrid plans
are age appropriate, Cooper is a high-profile case that has led to
copycat class action lawsuits being filed against a number of employers
for the alleged discriminatory nature of their plan design. Applying
the rationale in the rulings to date in the Cooper case, ultimate
damages against the defendants are estimated to be between $1 and $6
billion dollars. It is this range of figures that are required to
overcome and ``correct for'' the natural operation of compound
interest. Employers are understandably extremely anxious about the
crippling effect of such lawsuits and potential damage awards, and are
concerned that they will be the next on the growing list of companies
targeted for class-action suits. While employers certainly expect the
anomalous Cooper decision ultimately to be overturned on appeal, such a
result is many years away and many hybrid plan sponsors may find the
intervening risks unbearable.
The Need for Congressional Action
Mr. Chairman, the operation of the hybrid pension system is at a
standstill. Employers cannot get determination letters from the IRS
regarding the compliance of their plans with legal guidelines. The
regulatory agencies that normally assist the smooth functioning of the
system through issuance of periodic interpretive guidance have been
told by Congress through the appropriations process not to do so. Any
final resolution of the age discrimination question by appellate courts
is years away at a minimum.
Moreover, the judicial system is not the appropriate forum for
resolving an issue of this sort, which has far-reaching public policy
ramifications. The very nature of the judicial process makes it
difficult for these types of broad public policy issues to receive
thorough examination much less appropriate handling. Not all
stakeholders are present before the court and the system-wide
ramifications are intentionally given less weight than the narrow legal
issues.
Perhaps some are tempted to view this current legal uncertainty and
regulatory standstill as a victory of sorts. Perhaps they will see the
slowdown in the number of hybrid plan conversions as a positive
development for employees. They should not. In a recent survey, 41% of
hybrid plan sponsors said they would freeze their plans if the legal
uncertainty was not resolved within a year.\41\ As we noted earlier,
other pressures in the defined benefit system are already prompting
employers to consider freezes or terminations. The hostile climate for
hybrid plans and the litigation risks and extreme damage potential are
unfortunately starting to make this an easier and easier decision for
corporate decision-makers.\42\ If employers are pushed to abandon
hybrid plans, we will lose a retirement vehicle that delivers higher
benefits to the vast majority of employees and meets workers'' key
retirement plan needs--for portability and benefit guarantees--all
while utilizing transition methods that protect older workers. How,
exactly, is this good for employees and their families?
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\41\ Hewitt Associates LLC, Current Retirement Plan Challenges:
Employer Perspectives 2 (2003).
\42\ A majority of companies have made it clear that if hybrid
plans become untenable they will be offering only a 401(k)/defined
contribution program going forward. They will not be reverting to a
traditional defined benefit plan design. Deloitte Consulting LLP,
Pension Crisis Prompting Majority of Surveyed Companies to Change or
Consider Changing Their Plans 2 (2004). While defined contribution
plans provide valuable retirement benefits, defined benefit plans
provide unique retirement security features for employees and their
families that are hard to replicate. Employees are typically best
served by the ability to participate in both types of plans. The
Council believes that our nation's retirement income policy should be
crafted to promote maximum flexibility so that employers and employees
can utilize the plan or plans that best suit their needs.
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The prospect of hybrid plan freezes and terminations poses another
risk--to the Pension Benefit Guaranty Corporation (PBGC). We must be
mindful that many of the companies that sponsor hybrid plans are
financially strong companies in healthy industries. These strong
companies today pay insurance premiums to the PBGC. If these employers
are forced to exit the defined benefit system, the loss of premiums
could aggravate the long-term financial challenges faced by the agency.
Hybrid plan participants comprise 21% of all plan participants
protected by the PBGC insurance program. Hence employer insurance
premiums on these participants comprise 21% of the revenue generated by
the PBGC through its per-participant premium program.\43\ If hybrid
plans were removed from the defined benefit system, future premiums to
the PBGC would be reduced significantly.
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\43\ This figure is derived from data collected by the PBGC
indicating that, as of the year 2000, the PBGC protected 34,342,000
single-employer defined benefit plan participants, 7,155,000 of whom
participate in hybrid plans. PBGC, supra note 4 at 6.
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Mr. Chairman, the situation today is distressingly clear. The harms
that result from today's legal uncertainty are unmistakable. The
regulatory agencies and courts are unable to act effectively to prevent
these harms. Only through prompt legislative action can Congress rescue
hybrid defined benefit plans and prevent the damage to the retirement
security of millions of American families that will unquestionably
result from their demise.
Recommendations
Clarify the Age Appropriateness of the Hybrid Plan Designs. The
first and most important step for Congress to take is to clarify that
the cash balance and pension equity designs satisfy current age
discrimination rules. Congress must make clear that the legal
interpretation holding these designs discriminatory merely because the
accounts of younger workers have more years to earn interest is
unfounded. Rather, Congress must clarify that age discrimination in
hybrid plans is measured by the pay credits contributed on workers''
behalf. If the pay credits for older workers are the same, or greater,
than the pay credits for younger workers, then the pension age
discrimination rules are satisfied.\44\ This clarification is
consistent with the legal authorities and with plain common sense. It
will end the needless legal jeopardy in which every hybrid plan sponsor
today finds itself and will preserve the important benefits that
millions of employees today earn under these plans.
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\44\ The hybrid plan proposals made by the Treasury Department in
the Bush Administration's fiscal year 05 budget contain a provision
recognizing that this is the appropriate way to evaluate age
discrimination for hybrid plans. However, this clarification regarding
the hybrid plan designs is prospective only in the Treasury
recommendations, leaving employers with hybrid plans already in
existence open to legal suit regarding the legality of their plan
designs.
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Provide Legal Certainty for Past Hybrid Conversions. In addition to
clarifying the age appropriateness of the hybrid plan designs, the
Council believes it is essential for Congress to provide legal
certainty for the hybrid plan conversions that have already taken
place. These conversions were pursued in good faith and in reliance on
the legal authorities in place at the time. Transition methods, such as
benefit plateaus, that have not given rise to concerns about age
discrimination in other contexts should not now do so merely because of
the context of hybrid plan conversions.
Resolve Legal Uncertainties with Anti-Employee Effects. Beyond
resolving the questions about the basic hybrid designs and the
treatment of past conversions, the Council believes Congress should
take a number of additional steps to provide legal clarity regarding
hybrid plans. Addressing these additional issues will very concretely
aid the employees who participate in hybrid plans.
Whipsaw. First, we recommend that you make clear that, so
long as a cash balance plan does not credit interest in excess of a
market rate of return, the proper benefit payment to a departing
employee is that employee's account balance. This will remedy the so-
called ``whipsaw'' problem that has forced employers to reduce the rate
of interest they pay on employees'' cash balance accounts.\45\
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\45\ Whipsaw is the term used to describe the anomaly that occurs
when employers must project a departing employee's cash balance account
forward to normal retirement age using the plan's interest crediting
rate and then must discount the resulting amount back to a present
value using the statutorily-mandated 30-year Treasury bond rate. When
an employer's interest crediting rate is higher than the 30-year rate,
this process results in a plan liability to the employee in an amount
greater than the employee's actual account balance. The only way to
avoid this ``whipsaw'' effect is to reduce a plan's interest crediting
rate to the same 30-year rate the law requires for discounting future
benefits into present value lump sums. In the wake of several court
decisions mandating this whipsaw effect, this is what cash balance
sponsors around the country have done to insulate themselves from
liability. However, the unfortunate result is that employees in cash
balance plans earn lower rates of interest on their accounts than would
otherwise be the case. Even a modestly lower rate of interest earned on
an account over the course of a career can translate into a significant
reduction in the ultimate account balance at retirement. The Treasury
Department helpfully included this same resolution of the whipsaw
problem in its legislative recommendations contained in the Bush
Administration's fiscal year 05 budget proposal. As with the provision
regarding hybrid plan design, however, the recommended whipsaw fix was
prospective only. This would require employers to continue to pay low
interest rates on employees'' existing cash balance accounts.
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Inclusion of Early Retirement Subsidies. Second, we
recommend that you make clear that employers may include some or all of
the value of early retirement subsidies in employees'' opening account
balances. A number of employers have chosen to do this as a conversion
technique to assist those nearing early retirement eligibility but some
in the regulatory agencies are suggesting that to do so is problematic
under our current pension age discrimination rules.
Protection of ``Greater Of'' Transition Method. Third, we
recommend that you make clear that employers that voluntarily choose to
offer employees the greater of the benefits in the prior traditional or
new hybrid plan do not run afoul of the pension back-loading rules.
Some regulators have suggested this ``greater of'' conversion approach
violates these rules.
Protection of Employee-Friendly Transition Techniques.
Fourth, some conversion approaches that employees and Members of
Congress have praised (choice, greater of, grandfathering in the prior
plan) are likely to violate the non-discrimination rules over time.
Why? The group of typically older employees who remain under the prior
plan formula will over time and very naturally have a greater and
greater proportion of so-called highly-compensated employees (those
making $90,000 and above) and may well be the only group eligible for
continued accrual of benefit features exclusive to the prior
traditional plan (e.g., early retirement subsidies). This creates a
problem under the non-discrimination rules. We urge you to make clear
that these employee-friendly conversion techniques can be pursued.
Reject Benefit Mandates That Prevent Employers from Modifying
Benefit Programs. Some in Congress are seeking to impose specific
benefit mandates when employers convert to hybrid pension plans. For
example, some would require that employers pay retiring employees the
greater of the benefits under the prior traditional or new hybrid
plan.\46\ Others would require employers to provide employees the
choice at the time of conversion between staying in the prior
traditional plan or moving to the new hybrid plan.\47\ Pursuant to a
directive from Congress, the Treasury Department has also made
legislative recommendations regarding requirements for hybrid plan
conversions undertaken in the future. The Treasury proposal would
require employers to pay benefits at least as high as were provided
under the prior traditional plan for a period of five years following
the conversion.
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\46\ See H.R. 1677, which has been introduced by Representative
Bernie Sanders (I-VT).
\47\ See H.R. 2101, which has been introduced by Representative
George Miller (D-CA).
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These proposals may perhaps sound innocuous to some, and indeed
some employers have voluntarily adopted the transition techniques that
would be mandated under these proposals, but each of the proposals
embraces a fundamental and truly radical shift in the rules of the game
for our nation's voluntary employer-sponsored benefits system. Under
these proposals, Congress would be (1) guaranteeing employees future
retirement plan benefits for service that the employees have not yet
performed, and (2) preventing employers from changing the benefit
programs they voluntarily offer. Indeed, Congress would be converting
the natural and understandable hopes and wishes of employees that their
benefits will remain the same into concrete legal rights. Such
enshrinement of expectations is a fundamental departure from the
existing rules of the voluntary benefits system. The Council believes
this would be an extremely unwise--and extremely counterproductive--
step for Congress to take.
Under such regimes, it is unfortunately clear what actions
employers will take. If they conclude that a traditional defined
benefit plan is no longer meeting business and employee needs, they
will not remain in the defined benefit system through conversion to a
hybrid plan. They will exit the defined benefit system altogether
knowing they can avoid these unprecedented mandates by simply utilizing
a defined contribution plan going forward. As discussed above, this is
typically not the response that best serves employees'' retirement
income needs.
Perhaps even more damaging than pushing employers from the defined
benefit system is the dangerous precedent that would be set by these
mandates that seek to enshrine expectations. Employers will naturally
ask themselves whether, if other developments in the benefits and
compensation landscape come in for heightened scrutiny, Congress will
respond by preventing them from making changes to those programs
(through imposition of greater of, mandated choice or hold-harmless
requirements). Will employers be unable to redesign their health plans?
Will they be unable to remove early retirement subsidies from their
traditional defined benefit plans? Will they be unable to reduce cash
bonuses? Will they be unable to shift from profit-sharing to matching
contributions in their defined contribution plans? Will they be unable
to reduce the degree of price discount in their stock purchase
programs? Where exactly will it end? There appears to us to be no
principled stopping point.
Given the extremely significant administrative burdens, financial
costs and legal exposure that already accompany voluntary employer
sponsorship of benefit programs today, we hope all who believe in
employer-provided benefits as we do will see that these are not the
questions you want stirring in the minds of corporate decision-makers.
They can only result in a world where employees are offered fewer
benefits.
Conclusion
The American Benefits Council believes that hybrid defined benefit
plans play an invaluable role in delivering retirement income security
to millions of Americans and their families. Nevertheless, hybrid plans
are facing legal uncertainties that threaten their continued existence.
Of these, the most pressing threat is a rogue judicial interpretation
that declares all hybrid plans in the nation illegal. To prevent
widespread abandonment of hybrid plans by employers and the resulting
harm to employees, we hope Congress will provide the legislative
certainty and clarity for hybrid pension plans we have recommended
above.
Thank you again, Mr. Chairman and Ranking Member Miller, for the
opportunity to appear today. I would be pleased to answer any questions
you may have.
______
Chairman Boehner. Ms. Collier.
STATEMENT OF ELLEN COLLIER, DIRECTOR OF BENEFITS, EATON
CORPORATION, CLEVELAND, OHIO
Ms. Collier. Chairman Boehner, Ranking Member Miller, thank
you for the opportunity to appear here today. My name is Ellen
Collier, and I am the Director of Benefits for Eaton
Corporation. Eaton is a diversified industrial manufacturer
with world headquarters in Cleveland, Ohio. We have over 51,000
employees worldwide, including 27,000 employees in more than 40
States.
I am appearing today on behalf of the Coalition to Preserve
the Defined Benefit System, a broad based employer coalition
that works exclusively on legislative and regulatory issues
related to hybrid pension designs.
This is a critical time for defined benefit pension plans
and hybrid plans in particular. Congressional action is
urgently needed to confirm the validity of cash balance and
pension equity designs. If Congress does not clarify the
current legal uncertainty, employers facing the threat of class
action lawsuits will increasingly be forced to abandon these
retirement programs. Given the success of hybrid plans in
delivering meaningful guaranteed retirement benefits to today's
workers, abandonment of these programs would be disastrous for
employees and for our Nation's retirement system. Employees
will not win if the current uncertainty persists.
Let me now discuss why we at Eaton concluded that a cash
balance plan was right for us. Eaton's diverse business nature
and acquisition activity created a challenge for our retirement
programs. Our challenge is to continually attract and retain
high level talent and to reduce the confusion resulting from
multiple pension structures.
Eaton began to examine pension plan alternatives in the
mid-90's. While this was under way, we acquired Aeroquip
Vickers, a company with about 5,000 nonrepresented employees.
These employees had no defined benefit pension plan, making the
development of a new pension design even more urgent.
We considered several options for a new pension design, but
in the end we decided that a cash balance plan was best for
Eaton and our employees. Why? The simplicity, visibility,
portability and ease in integrating acquired companies into
Eaton. Once we settled on an ongoing design we had to make sure
we responded to the needs of employees that were already in
existing pension designs. All new hires would enter the cash
balance plan on 1/1/02 as would the Aeroquip Vickers employees.
Fifteen thousand nonrepresented employees would get an informed
choice effective 1/1/03 between remaining in their existing
traditional plan and switching to the cash balance pension
plan.
Employee reaction to our cash balance design was
overwhelmingly positive. It is important to note that choice
may not make sense for all employers. Companies need to have
flexibility to modify their retirement plans to meet their
individual business needs.
Let me emphasize Eaton did not introduce a cash balance
plan to reduce costs. In fact, the cash balance design has
increased costs. Although the choice process required a
significant amount of money and resources, the cost of
congressional inaction would be far greater. If certain
proposed judicial remedies were applied to Eaton, the cost to
modify our plan could curtail discretionary spending in vital
areas like research and development. Furthermore, there would
be increased litigation, confusion and complexity if we were
forced to modify or freeze our plan at this time. The resulting
damage to employee morale and trust would greatly disrupt
Eaton's day-to-day manufacturing operations. Without
legislative action, the efforts to align our benefit structure
with our business needs will have been wasted.
Legislation is the only effective way to address today's
uncertainties surrounding the hybrid pension designs. Why?
Congress has indicated through the appropriations process that
it does not want these important policy issues being determined
by the agencies, and final resolution of the age discrimination
question by appellate courts is years away at a minimum. This
will be too late to address the litigation risks that are
already beginning to drive employers from the system. In the
meantime, the retirement security of millions of American
families will remain in limbo.
To prevent widespread abandonment of pension plans by
employers, Congress must clarify the legality of hybrid plans.
Thank you again for the opportunity to appear today. I would be
pleased to answer any questions.
[The prepared statement of Ms. Collier follows:]
Statement of Ellen Collier, Director of Benefits, Eaton Corporation,
Cleveland, OH
Chairman Boehner, Ranking Member Miller, thank you for the
opportunity to appear today. My name is Ellen Collier and I am the
Director of Benefits at Eaton Corporation. Eaton Corporation is a
diversified industrial manufacturer headquartered in Cleveland, Ohio.
We have over 50,000 employees worldwide, including over 27,000
employees in 100 locations in the U.S. The states with our greatest
concentration of employees are Michigan, Ohio, Pennsylvania, North
Carolina and South Carolina. In total, we have employees in over 40
states.
Eaton has four main business groups that manufacture highly-
engineered components: Fluid Power, which manufactures hydraulic
components, hoses and connectors, and Aerospace products; Electrical,
which manufactures residential and commercial power distribution
equipment; Automotive, which manufactures engine valves, lifters and
superchargers; and Truck, which manufactures transmissions for heavy
and medium duty trucks.
Our 2003 sales topped $8 billion, with sales in over 100 countries.
The business mix of the company has evolved significantly in the past
10 years as a result of over 50 acquisitions and 48 divestitures.
I am appearing today on behalf of the Coalition to Preserve the
Defined Benefit System, a broad-based employer coalition that works
exclusively on legislative and regulatory issues related to hybrid
plans. The Coalition's nearly 70 member companies, which range from
modest-size organizations to some of the largest corporations in the
U.S., sponsor hybrid defined benefit plans covering more than one
million participants.
Before I turn to the specifics of the hybrid issue, I want to thank
you Chairman Boehner, Ranking Member Miller and other members of the
Committee for your hard work earlier this year to enact a corporate
bond replacement for the obsolete 30-year Treasury bond rate. As you
know, we defined benefit plan sponsors face a range of challenges today
and having an appropriate replacement rate was critical to the
functioning of the pension system.
The Need for Legislative Action
I want to thank you for calling this hearing to address what is the
most pressing challenge today in the defined benefit system--the legal
uncertainty surrounding hybrid plans, and in particular the radical
judgment by a single court that hybrid plans are age discriminatory.
Congressional action is urgently needed to confirm the dominant view--
expressed by all other legal authorities--that the cash balance and
pension equity designs satisfy current age discrimination rules.\1\
Absent such action by Congress to clarify the current legal
environment, employers facing the threat of copycat class action
lawsuits over the validity of their plan designs will increasingly be
forced to abandon these important retirement programs. Given the
success of hybrid plans in delivering meaningful, guaranteed retirement
benefits to today's workers, \2\ abandonment of these programs would be
a disastrous result for employees and for our nation's retirement
system. None of us should kid ourselves that somehow employees win if
the current uncertainty persists. Nor should any of us assume that a
retreat from hybrid plans will be accompanied by a return to
traditional defined benefit plans. Indeed, it is far more likely that
employers will abandon defined benefit plans altogether.
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\1\ The Treasury Department recently withdrew proposed regulations
addressing hybrid plans and age discrimination, which had the potential
to provide the needed clarity. The Treasury acted in response to clear
indications--expressed through the congressional appropriations
process--that Congress did not want these issues definitively addressed
by the regulatory agencies. I.R.S. Announcement 2004-57, I.R.B. 2004-
27.
\2\ Nearly 80% of employees earn higher benefits under a hybrid
plan than a traditional plan of equal cost. Watson Wyatt Worldwide, The
Unfolding of a Predictable Surprise: A Comprehensive Analysis of the
Shift from Traditional Pensions to Hybrid Plans 24-25 (February 2000).
As discussed below, those employees who do better under a traditional
defined benefit plan are typically granted transition assistance and/or
remain under the traditional formula after the hybrid plan is
introduced.
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To give you a feel for the valuable role hybrid plans play, let me
now discuss why we at Eaton concluded that a cash balance plan was
right for us. Our experience is comparable to those of many other
companies in our Coalition.
The Need for a New Pension Design
Eaton's presence in various lines of business, and our substantial
acquisition activity, created a challenge for our retirement programs:
We needed to continue to attract and retain high-level talent to remain
competitive and continue our growth, and we also needed to reduce the
confusion and administrative cost resulting from multiple pension
structures inherited through various acquisitions. Through different
acquisitions and across different lines of business we had 6 ongoing
pension designs for 15,000 non-union represented employees. These
included two final average pay designs, one Social Security offset
design, two flat-dollar multiplier designs, and one cash balance
design. Based on employee survey results, we also knew we needed to
make our pension plans easier for employees to understand.\3\
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\3\ This correlates with the general experience of other employers.
Surveys show that improving communication about and employee
appreciation of the pension plan, as well as being able to show
benefits in a lump sum format, are the most important factors
underlying employer conversions to hybrid plans. Watson Wyatt Worldwide
2000, supra note 1 at 44.
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Eaton began to examine pension plan alternatives in the mid-1990's.
We knew the resulting design would need to be attractive to high-skills
talent, easy to understand, and suitable to a mobile workforce. This
attention to mobility was important--not only in the labor marketplace,
but also within Eaton, as we do have employees that transfer between
business groups with different pension plans. Under our existing
traditional designs, one employee could have benefits from two pension
plans, simply by transferring from Pittsburgh (headquarters of our
Electrical group) to Minneapolis (headquarters of our Fluid Power
group). Finally, any new retirement program would have to permit
seamless integration of new employees brought on as a result of
acquisitions. This was necessary in order to provide equitable and
uniform benefits across our workforce and to enhance Eaton's ability to
grow.
While the examination of pension plan alternatives was underway,
Eaton acquired Aeroquip Vickers, a company with about 5,000 non-union
represented employees. These employees had a defined contribution plan
from the prior owner, but no ongoing defined benefit plan--their
pension plan had been frozen many years before. We at Eaton felt
strongly that we wanted to provide these employees once again with the
security of a defined benefit plan--in addition to Eaton's 401(k) plan
(which has an employer match). We knew that employer funding and
assumption of investment risk, professional investment management and
federal insurance guarantees translated into tangible retirement income
and significant peace of mind for employees. Thus, the need to
integrate the Aeroquip Vickers employees into Eaton's benefit structure
made the development of a new pension design even more urgent.
Key Considerations
We considered several options for a new pension design, including a
final average pay plan, a pension equity plan, and a cash balance plan.
We even considered a defined contribution-only program (which we did
not prefer, since it lacked the security of a defined benefit plan). In
the end, the simplicity, visibility, portability, and ease with which
an acquired company could be integrated led us to choose a cash balance
design.\4\ Along the way, we kept abreast of all regulatory and
judicial developments to ensure we were designing a plan that would
meet the relevant legal standards. Like most other companies that
consider switching to a cash balance plan, Eaton engaged the top legal,
actuarial, and human resources consulting available to help with this
process.
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\4\ Once again, Eaton's reasons are consistent with those of other
employers that move to hybrid plans. Watson Wyatt Worldwide 2000, supra
note 2 at 44.
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Now that the basic hybrid designs have been called into question,
employers facing a set of circumstances similar to ours would have far
fewer options. One choice would be to stay with the traditional pension
design, which tends to deliver meaningful benefits to a relatively
small number of career-long workers, has limited value as a recruitment
device in today's marketplace and makes integration of new employees
difficult. The other alternative would be to exit the defined benefit
system and provide only a defined contribution plan, which while an
important and popular benefit offering, provides none of the security
guarantees inherent in defined benefit plans. Clearly, it is employees
that lose out as a result of today's uncertainty surrounding hybrid
plans.
As we at Eaton analyzed our specific situation, we took into
account the needs of employees that were already in our other pension
designs. We knew that a cash balance design might not meet the needs of
every current employee in our existing traditional plans. However, we
also knew that forcing current workers to remain in their existing
traditional defined benefit plan, while working side-by-side with new
workers who earned what might be perceived as a more valuable benefit
under the new cash balance design, was also not desirable.
Once we settled on cash balance as our ongoing design, we focused
on the particular transition approach we would adopt. We were aware of
the diversity of transition approaches and knew that each of these
transition techniques had proven successful at addressing the needs of
particular companies'' older workers. Such approaches include
grandfathering employees in the prior traditional plan, offering
employees the choice between the prior and new hybrid formulas,
providing the ``greater of'' the benefits under the prior or hybrid
plan, providing transition pay credits or making one-time additions to
employees'' opening cash balance accounts.
These special transition techniques are used in the vast majority
of conversions and the variety of approaches provides the flexibility
companies need to address their unique circumstances and employee
demographics.\5\ Indeed, congressional concerns about how older and
longer-service workers are treated during conversions have been
successfully addressed by employers through the use of the variety of
transition protections.\6\
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\5\ Mellon Financial Corporation, supra note 4 at 11 (90% of
employers provide special transition benefits); Watson Wyatt Worldwide,
Hybrid Pension Conversions Post-1999: Meeting the Needs of a Mobile
Workforce 4 (2004) (89% of employers provide special transition
benefits). Those employers that do not (and that solely convert the
prior accrued benefit into an opening account balance without
additional transition techniques) are typically experiencing financial
distress at the time of the conversions. Yet despite their financial
challenges, they are interested in retaining a defined benefit plan
that delivers meaningful benefits across their workforce.
\6\ This discussion of conversions highlights another reason why
legislative action is so urgently needed. Many employers that have
converted to hybrid plans using these successful and generous
conversion methods have nonetheless been unable to obtain a
determination letter from the Internal Revenue Service (IRS) stating
that their plan complies with the requirements of the Internal Revenue
Code. This is due to the fact that the IRS announced a moratorium on
issuance of such letters for hybrid conversions in September 1999
pending review of some of the hybrid issues by the IRS national office.
Memorandum from the Internal Revenue Service, to the EP/EO Division
Chiefs (Sept. 15, 1999). It has become clear that the IRS will not
begin issuing determination letters (for either past conversions caught
up in the moratorium or new conversions) until Congress resolves the
legal uncertainty surrounding hybrid plans.
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The absence of determination letters harms both employers and
employees. The determination letter process works as a partnership
between employers and the government to ensure that plans are
maintained in accordance with our nation's very complex pension
statutes and regulations. The fact that this process has broken down
means plans are not getting the definitive guidance they rely upon to
operate their plans in full compliance with the law.
We decided that all 15,000 current non-union employees--regardless
of age or service--would be able to choose whether to remain in their
existing traditional plan or earn a pension benefit under the cash
balance formula. This choice would be effective 01/01/03. All of the
recently acquired non-union Aeroquip Vickers employees would enter the
new cash balance plan on 01/01/02, and all non-union Eaton employees
hired on or after 01/01/02 would enter the new cash balance plan.
We should emphasize that Eaton did not introduce a cash balance
plan to reduce cost, and in fact the new plan increased costs in the
short-term, and will slightly increase plan costs in the long term.
This is described in more detail below.
Description of Plan Design
Our new cash balance design--the Eaton Personal Pension Account, or
EPPA--consists of several important features. Each participant earns
monthly pay credits based on the sum of their age and years of service
(including any service with an acquired company). These credits range
from 5% of pay up to 8%, increasing as the sum of age and years of
service increases. To reiterate, we contribute higher pay credits to
the cash balance account of older employees and those with longer
service. Indeed, providing pay credits that increase with age or
service is the typical approach in hybrid plans.\7\ Under Eaton's plan,
the pay credits accumulate, with interest based on the rate of interest
for 30-year Treasury bonds, to create the ``personal pension account.''
This design benefits employees of a company acquired by Eaton since it
recognizes past service with that company when calculating pay credits.
The cash balance design is also helpful in recruiting mid-career
talent, since age (and not just service) is a component in the
calculation of pay credits. Note that we received an IRS determination
letter for this basic cash balance design in November of 2002 as it
applied to the new Eaton hires and the Aeroquip Vickers employees (none
of whom experienced a conversion).\8\ We have also received
determination letters for our other active cash balance plan, and
another cash balance plan that has since been frozen due to a spin-off.
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\7\ Seventy-four percent of 146 employer respondents to a Mellon
survey provided pay credits in their cash balance plans that increased
with age or service. Mellon Financial Corporation, 2004 Survey of Cash
Balance Plans 9. Eighty-seven percent of pension equity plans analyzed
in a recent Watson Wyatt study provided pay credits that increased with
age or service. Watson Wyatt Worldwide 2004, supra note 4 at 2.
\8\ Due to the IRS moratorium on determination letters discussed
above, we do not have a determination letter for our core cash balance
conversion affecting Eaton employees as of 1/1/03.
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An employee who chose to switch to the new Eaton Personal Pension
Account would start with an opening account balance, equal to the value
of their pension benefit under the existing traditional pension plan--
including any early retirement subsidies or supplements.\9\ Since one
of our goals with the new design was to make our pension plan easier
for employees to understand, we felt that using an opening balance
approach, as opposed to using the existing traditional formula for past
benefits and a cash balance formula for future benefits (the so-called
``A+B'' approach), was appropriate. To calculate these opening
balances, we assumed a retirement date of the later of age 62 or 01/01/
06. Employees whose prior pension formula was tied to their final pay
(this included the vast majority of the employees eligible for making
an informed pension choice) also received indexing credits on the
opening balance amount for as long as they remained active employees.
These indexing credits were based on annual changes in the Consumer
Price Index (CPI) to mimic the effect that pay increases would have had
on the employees'' prior pension benefit. These indexing credits were
in addition to the ongoing interest and pay credits mentioned above.
So, each month a participant's balance would increase by pay credits,
interest credits on the prior balance (including any past pay credits),
and indexing credits (on the opening balance only).
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\9\ An early retirement subsidy in a pension plan provides a
financial bonus for employees to retire early. To provide a simple
example of a fully subsidized benefit, a worker retiring at age 55
might receive the full $1,000 per month pension benefit he would
normally only be entitled to at age 65. In other words, there is no
actuarial reduction in benefits for the early retirement date. One
thousand dollars per month for life beginning at age 55 is more
valuable than $1,000 per month for life beginning at age 65; hence the
subsidy. The subsidy declines in value if the employee remains at the
company beyond age 55 and has no remaining value if the employee works
until 65. In contrast, early retirement supplements are additional
temporary benefits payable until Social Security normal retirement age.
Employers have taken a variety of approaches to the question of whether
to include early retirement subsidies in employees'' opening account
balances. Some have chosen not to do so since it is impossible to know
at the time of conversion whether an employee will actually leave the
company at a time in the future when they would have qualified for the
subsidy. Others, like Eaton, have included some or all of the value of
the subsidy in the opening cash balance account as one technique to
minimize the effect of the conversion for employees nearing early
retirement eligibility. It is important to note that current law
protects any subsidy that an employee may have already earned at the
time of a conversion. To qualify for this subsidy, the employee must of
course retire at the retirement eligibility age. Of equal importance,
current law also allows employers to remove such incentives from their
plans on a going forward basis.
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A final, but important, note regarding this plan design change is
that we made several costly changes to the existing traditional plans
as well. Our intention was to remove certain differences in the plan
designs in order make the choice process even more equitable. For
instance, we added a non-spousal death benefit and an enhanced
disability pension provision to the traditional plans--both were
features of the new cash balance design--to ensure that an employee's
choice would not be skewed by concerns over unexpected death or
disability. We had concluded that the existing ``spouse-only'' death
benefit in our traditional plans was not meeting the needs of single
parents working at Eaton.
Along with changes in our pension plan, we also made important
changes in our 401(k) savings plan. These changes included permitting
diversification of the company stock matching contribution. The
decision to permit diversification had been made prior to news reports
of troubled company savings plans, such as Enron. Under the changes we
have adopted, all company stock matching amounts will be fully
diversifiable by the end of 2004.
Informed Choice Process
After deciding on the design, and to give existing employees
choice, we had to ensure that the new plan, and the choice, were
communicated clearly to all affected participants. For the recently
acquired Aeroquip Vickers employees, who would be receiving a new
pension for the first time since joining Eaton, we issued Summary Plan
Descriptions, held on-site meetings, and created a website where
employees could model future EPPA benefits under a variety of economic
assumptions.
For the choice process, we drafted written communication materials
with the intent of satisfying--and, in fact, exceeding--ERISA section
204(h).\10\ Each employee received a detailed Decision Guide, an
individualized Personal Choice Statement, and an easy-to-read Quick
Comparison Chart. In developing these materials, we kept in mind the
high standard that had been set by Kodak--whom Senator Moynihan
publicly cited as the ``gold standard'' for hybrid conversion
communications--during its choice process, and strived to meet or
exceed it. In addition, we made continual use of employee focus group
feedback to refine these materials.
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\10\ Section 204(h) of ERISA requires employers to provide advance
notice of amendments to defined benefit plans that provide for a
significant reduction in the rate of future benefit accrual. Congress
amended section 204(h) as part of the Economic Growth and Tax Relief
Reconciliation Act of 2001 to require employers to provide a more
detailed and more understandable notice of any hybrid conversion or
other plan amendment that significantly reduces future accruals. This
reflected Congress'' view that the appropriate response to the issues
that had been raised about cash balance conversions was to ensure
transparency rather than to impose benefit mandates on employers. The
Treasury Department has subsequently issued regulations carrying out
this expanded notice requirement. Notice of Significant Reduction in
the Rate of Future Benefit Accrual, 68 Fed. Reg. 17,277 (Apr. 9, 2003)
(to be codified at 26 C.F.R. pts. 1, 54, and 602).
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The Decision Guide explained, in detail, the features of the
participant's existing traditional plan and the EPPA, including details
regarding the calculation of the opening balance. This document
displayed charts of both options--the current plan and the EPPA--and
how they compared at future ages under a certain set of assumptions,
using hypothetical examples. In addition, we explained the concept of
wear-away, \11\ and graphically described the effect it could have on
employees. The Quick Comparison Chart was a side-by-side comparison of
the main provisions of each option. We should note that Eaton's
approach minimized the effect of wear-away. The inclusion of early
retirement supplements and subsidies, as well as the effect of indexing
credits, mitigated the effect of, and shortened the duration of, wear-
away in most cases. In fact, often it was the inclusion of early
retirement supplements in the value of the protected benefit under the
existing current design--which is not required by law--that caused an
appearance of wear-away.\12\
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\11\ Wear-away is the benefit plateau effect that some employees
can experience incident to a cash balance conversion. When employers
change to a cash balance plan, they typically provide an opening
account balance in the cash balance account. A benefit plateau results
if the value of the employee's cash balance account is less than the
value of the benefit he accrued under the prior plan as of the time of
the conversion. Until the value of the cash balance account catches up
to the value of the previously accrued benefit, it is the higher
accrued benefit to which the worker is entitled--hence, the term
``plateau.'' This benefit plateau typically results from the fact that
the prior accrued benefit includes an early retirement subsidy while
the opening account balance does not. It should be noted that wear-away
has long been approved by the regulatory agencies as a valid method for
transitioning between benefit formulas.
\12\ Those employees who experienced a wear-away as part of the
conversion process did so only because they chose the new cash balance
formula, concluding that even with some period of wear-away the new
cash balance design was best for them.
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The Personal Choice Statement used actual individualized
participant data so that each employee could compare their estimated
future benefit accruals under each option, under a certain set of
assumptions. The data used for these statements was audited in advance
of, and in anticipation of, this project. In particular, each of the
15,000 eligible employees was asked to review and confirm or correct
their work history so that accurate service data was used for any
estimate.
After the written materials were sent out, we held over 250
educational meetings and web casts at all 100 U.S. and Puerto Rico
locations. Spouses and financial advisors of employees were also
invited to attend these meetings, which were led by independent third-
party pension experts.
We also developed a website where employees could model
individualized scenarios based on their own differing economic
assumptions, including salary increases and interest rate assumptions.
In addition, the Choice Website contained all the educational
information that was included in the written materials.
If employees had questions, they could call the Pension Choice
Helpline, where independent third-party pension experts answered
questions about the different plans and ran individualized comparisons
on the spot. If there was a question that the Pension Choice Helpline
representatives could not answer, we made sure the employee was
connected to someone at Eaton who could answer his or her question.
If an employee did not make a choice, he or she remained in his or
her existing traditional plan. In addition, we permitted employees to
make a one-time change in their initial choice during a ``grace
period.''
The Reception
At the end of the day, we wanted to make sure that all participants
had enough information to make an informed choice. Based on the
overwhelmingly positive reaction we received from employees, we believe
we accomplished that goal.
Across the board, employee reaction was very positive regarding the
pension choice process. The vast majority of employees said that the
materials provided helped them make an informed decision. In fact,
employee feedback indicates that this process helped employees
understand their existing traditional pension plan as well as the new
cash balance option. In addition, we received many comments that this
process only strengthened the trust that existed between Eaton and its
employees. We received no letters of complaint, and encountered no
disruption in daily business operations during the conversion process.
In the end, about one-third of eligible employees chose the EPPA.
The breakdown by age and service went as expected. Of the employees
more than 20 years away from retirement, over 60% elected to switch to
the EPPA. Of the employees at retirement age, or within 10 years of
retirement, over 80% elected to remain in their existing traditional
pension plan. However, there were several instances where, after
modeling personalized scenarios and reviewing examples in the Decision
Guide, employees close to or at retirement eligibility chose the EPPA.
It was not unusual for the EPPA to provide a greater benefit for a
retirement eligible employee some years in the future, largely due to
the inclusion of early retirement supplements and subsidies in the
opening balance and the application of indexing credits. Had we kept
these employees in their current pension design, we would have deprived
them of a chance to increase their pension benefit, even at a point
late in their careers. Of the employees between 10 and 20 years from
retirement, over 40% switched to the EPPA.
I was in the ``in-between'' group mentioned above, and although I
chose to remain in the existing traditional plan, both benefit designs
had distinct advantages depending on my expectations regarding my
future career path. Before joining Eaton I worked at a company where I
participated in a cash balance plan for 12 years. As a mid-career hire
at Eaton, and as a full-time working mother, it's important to me to
have retirement benefits that fit my needs. The employee reaction to
Eaton's decision to implement a cash balance plan and provide an
informed choice was overwhelmingly positive. This, along with similar
data from numerous surveys, indicates that employees understand and
appreciate the need for companies to have flexible retirement programs
that fit the needs of today's workforce.
All in all, the choice process set a new standard at Eaton for
communicating change throughout the company. However, we recognize that
choice may not be the right answer for other businesses and other
employee populations and, under different circumstances, it might have
been the wrong answer for Eaton. Some employers, for example, have
focused on grandfathering employees or pursuing a ``greater of''
approach rather than asking their employees to choose between the
plans. Other companies, while scrupulously protecting benefits already
earned (as current law requires), have been limited by economic
circumstances in the degree of special transition benefits they can
provide.
Our Coalition believes it would be extremely unwise to mandate
particular transition techniques for future conversions, as some in
Congress have proposed to do, since a broad range of methods is
available to ensure that employees are treated fairly in the transition
process. One mandated conversion method--or even several--would deny
employers needed flexibility to customize their transition approaches
to their particular workforce. Such conversion mandates--to pay the
greater of the traditional or hybrid benefits or to offer choice, for
example--also provide employees with a guaranteed right to future
benefits that have not yet been earned.
These mandates would represent a disturbing shift in the basic
norms of American industrial relations. Employee hopes or expectations
as to future benefits would be converted into explicit legal
entitlements. This profound change from existing principles suggests
that the terms and conditions of a worker's employment may not be
revised from those in existence at the time the employee is hired. Such
a regime would rob employers of the ability to adapt to changed
circumstances and would undermine the business flexibility on which
America's prosperity and robust employment are built. Presumably,
policymakers would not restrict employers from being able to alter--on
a prospective basis--their 401(k) match level or the design of their
health plan--but this is exactly the kind of restriction that mandated
conversion techniques impose. Our Coalition sees no end to the harm if
Congress goes down the path of converting expectations into legal
rights. Certainly, employers will be extremely reluctant to institute
any new benefit program in the future, and those employers that today
do not offer pension or health plan coverage for their employees will
be extremely unlikely to do so.
The Cost
It is very important to note that Eaton did not introduce a cash
balance plan to reduce costs. In fact, the long-term ongoing cost of
the EPPA is slightly higher than the steady-state costs of the prior
plan designs. In addition, we incurred higher short-term costs due to
the fact that most participants maximized their benefits, and therefore
the cost to Eaton, when they made their individual pension choice.
Outside of plan-related costs, Eaton spent several million dollars in
the overall choice effort, including consulting fees, communication
materials and pension modeling tools, as well as lost work hours due to
employee meetings.
Based on press accounts about cash balance conversions, one might
expect that Eaton's cost experience is atypical. This is not the case.
Recent surveys confirm that conversions to hybrid plans typically
increase costs. Recent data from a Watson Wyatt Worldwide study
examining 55 large companies that have recently converted from
traditional defined benefit plans to hybrid plans shows that retirement
plan costs increased by an average of 2.2% following a conversion.\14\
This figure further increased to 5.9% when seven companies that were in
severe financial distress were excluded from the pool.\15\
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\14\ Watson Wyatt Worldwide 2004, supra note 4 at 3.
\15\ Id. In addition, conversions are often accompanied by
improvements to other benefit programs, such as 401(k) plans, bonuses,
and other post-retirement benefits. In fact, one very recent survey
found that when these improvements are taken into account, 65% of
respondents expected the costs of providing retirement benefits
following a cash balance conversion to increase or remain the same.
Mellon Financial Corporation, supra note 4 at 15. Another survey,
conducted in 2000, also found that overall costs following a conversion
were expected to increase or remain the same in 67% of the cases.
PricewaterhouseCoopers, Cash Balance Notes 4 (May 2000).
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The Ramifications if Congress Does Not Provide Clarity
If Congress does not move quickly to provide legal certainty for
hybrid plans, many Americans may soon lose valuable retirement
benefits. The current legal landscape is ominous. One rogue judicial
decision has made the threat of age discrimination class action
litigation a very real concern for employers.\16\ Potential damage
awards from such suits could reach astronomical figures--into the
hundreds of millions or even billions of dollars--and the potential
amounts of these awards continue to grow the longer the plans remain in
effect. In Eaton's case, the cost to modify our plan for alleged ``age
discrimination'' in its design could curtail our ability to commit
funds for other important functions, such as for research and
development--and this is for a plan that has not yet been in existence
for 3 years!
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\16\ This decision, Cooper v. IBM Pers. Pension Plan, 274 F. Supp.
2d 1010 (S.D. IL 2003), held that the cash balance and pension equity
hybrid designs were inherently age discriminatory. The court concluded
that such pension designs violate the pension age discrimination
statute which provides that the rate of a participant's benefit accrual
may not decline on account of age. The court interpreted the pension
age discrimination statute to mean that the amount of annuity benefit
received at normal retirement age for a period of service (e.g., 1
year) cannot be less for an older worker than a younger worker. Such a
conclusion is clearly contrary to the basic ``time value of money''
principle that a younger worker will have a longer period of time to
accrue interest, and thus will have a larger benefit amount at
retirement based on an equal contribution today. Under this decision,
any pension plan that contains a compound interest feature is
inherently age discriminatory. This misguided logic not only impugns
hybrid plans, but also contributory defined benefit plans (common among
state and local government employers), plans that are integrated with
social security and plans that provide indexing of benefits to guard
against inflation. All other federal courts that have addressed this
issue, including those decided subsequent to the Cooper case, have
reached the opposite conclusion and indicated that the cash balance
design is age appropriate. Tootle v. ARINC, Inc., Civ. Action No. CCB-
03-1086 (D. MD June 10, 2004); Campbell v. BankBoston, N.A., 206 F.
Supp. 2d 70 (D. MA 2002); Eaton v. Onan, 117 F. Supp. 2d 812 (S.D. IN
2000). See also Godinez v. CBS Corp., 31 Employee Benefits Cas. (BNA)
2218 (C.D. CA 2002), afff'd, No. 02-56148, 2003 U.S. App. LEXIS 23923
(9th Cir. 2003); Engers v. AT&T, No. 98-3660 (D. NJ June 6, 2001).
Nonetheless, a number of employers have now been sued for the alleged
discriminatory nature of their plan design based on the Cooper
decision.
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Beyond the cost in dollars, there would be increased complexity in
the administration of our benefit programs and the programs would be
harder to understand should we have to ``correct'' for the natural
effect of compound interest. Moreover, any change to our well-received
conversion process would greatly disrupt our day-to-day business
operations. If a remedy would require Eaton to redo the choice process,
there would be even more confusion, complexity and business disruption.
Worst of all, there would be a huge impact on employee morale and
employee trust. Eaton prides itself on building trust with its
employees, and we believe that the cash balance conversion experience
strengthened that trust.
Like the majority of other employers who switch to a cash balance
design, Eaton made every effort to act in ``good faith'' during this
conversion. As opposed to adopting a less costly, less secure and less
controversial defined contribution design, Eaton incurred additional
cost through the conversion process, provided a variety of
communications materials and tools, used a fair conversion method, and
minimized the effects of wear-away. While Eaton was able to provide a
generous ``choice'' conversion, it is by no means the only suitable
method by which employers can change benefit designs, and does not
reflect the business realities for all companies. Without legislative
clarification that our cash balance design is age appropriate, the
efforts we made to align our benefit structure with our business needs,
while at the same time enhancing benefits for and strengthening trust
with our employees, will have been wasted.
In today's economic climate, prudent business leaders seek to
minimize corporate risks not associated with the company's core
business. Absent congressional action to mitigate such risks associated
with hybrid plan sponsorship, these leaders will likely be forced to
terminate or freeze hybrid pension plans in order to limit exposure to
class-action litigation with 9 or 10 figure damage awards. In an
October 2003 survey, 41% of hybrid plan sponsors said they would freeze
their plans if the legal uncertainty surrounding hybrid plans was not
resolved within a year.\17\ Based on the most recent government data
available, this translates into approximately 506 hybrid plan
terminations or freezes, which could affect as many as 3 million
participants and their families.\18\ It should be noted that the bulk
of these employers have concluded that the traditional pension design
no longer meets the needs of large numbers of their current and future
employees. Thus, these employers are extremely unlikely to return to a
traditional defined benefit plan after freezing or terminating their
hybrid plan. This unfortunate reality of widespread freezes and
terminations will only become more stark should legislative resolution
take longer.
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\17\ Hewitt Associates LLC, Current Retirement Plan Challenges:
Employer Perspectives 2 (2003).
\18\ These figures are based on data from the Pension Benefit
Guaranty Corporation (PBGC) indicating that, as of the year 2000, there
were 1,231 hybrid plans in existence with 7,155,000 participants. PBGC,
Pension Insurance Data Book 2002, at 5-6.
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Why must Congress be the one to act to clarify the validity of the
hybrid designs? First, Congress has indicated through the
appropriations process that it does not want these important policy
issues being determined by the regulatory agencies. As a result, the
Treasury Department has withdrawn its proposed regulations addressing
hybrid plans and age discrimination principles, which had the potential
to settle the open issues regarding hybrid plans. Second, final
resolution of the age discrimination question by appellate courts is
years away at a minimum, too late to address the litigation risks that
are beginning to drive employers from hybrid plans and the defined
benefit system. Neither are the courts the appropriate forum to
consider the broad public-policy ramifications (for employees and their
families, for employers, and for our nation's retirement policy) of
holding the cash balance and pension equity designs to be age
discriminatory.
In order to prevent widespread abandonment of hybrid plans by
employers--and the loss of retirement security this would produce for
millions of American families--Congress must clarify that the cash
balance and pension equity designs are age appropriate under current
law. Congress should also provide legal protection for the hybrid plan
conversions that have already taken place in good faith reliance on the
legal authorities operative at that time. Finally, should Congress
decide to establish rules to govern future conversions, our Coalition
strongly recommends that it avoid the mandates guaranteeing future
benefits that will merely accelerate employers'' departure from the
defined benefit system.
Conclusion
Mr. Chairman, I want to thank you once again for calling this
hearing. Legislation is the only effective way to address today's
uncertainty surrounding hybrid pension designs and prevent further
erosion of the retirement benefits of American families. Our Coalition
looks forward to working with you and members of the Committee to
achieve this objective.
Thank you, again, for the opportunity to appear today. I would be
pleased to answer any questions you may have.
______
Chairman Boehner. Professor Clark.
STATEMENT OF DR. ROBERT L. CLARK, PROFESSOR, COLLEGE OF
MANAGEMENT, NORTH CAROLINA STATE UNIVERSITY, RALEIGH, NORTH
CAROLINA
Dr. Clark. Mr. Chairman, Members of the Committee, ladies
and gentlemen, I appreciate the opportunity to testify today on
characteristics of cash balance plans. Over the past 5 years I
have written a series of papers examining advantages and
disadvantages of hybrid plans and the impact of the transition
from traditional defined benefit plans to cash balance plans.
The Committee staff has reviewed many of these papers.
My comments today will focus on three important issues that
form the basis of the current policy debate on cash balance
plans. First, starting a new cash balance plan where there was
none previous to that, what are the primary issues and are
there concerns; second, converting a traditional defined
benefit plan to a cash balance plan; and, third, the presence
of the present value of pension benefits, how does it change
with continued work and what is this wear-away issue?
First, starting a new pension plan, Table 1, which is in
the testimony I think available to all the Members, illustrates
the different characteristics of defined benefit plans, defined
contribution plans, and hybrid plans. By looking at this, even
a cursory review of these characteristics would convince us
that most workers, some workers, and some firms are likely to
prefer traditional defined benefit plans. Other workers and
other firms are likely to prefer defined contribution plans.
And some other workers will prefer cash balance or their hybrid
plans. It is this choice that makes our system work in many
regards.
Cash balance plans, for example, do not have some of the
characteristics of defined contribution plans that worry many
policy analysts. Cash balance plans tend to cover all workers,
participation is not voluntary. Investment risk is primarily
borne by the firm and not individual workers. They provide an
annuity option. In addition, cash balance plans provide the
portability that is lacking in most traditional defined benefit
plans. So workers in firms can choose what kind of pension plan
most directly fits their own preferences and needs.
Thus, I do not see any social policy reason for excluding
cash balance plans as an option for firms and workers when they
are first considering the adoption of their plans.
Second, converting existing defined benefit plans. In fact
most of the adverse reaction to cash balance plans has come not
from new startup plans but from conversion of traditional plans
and the potential loss expected by senior workers. I would just
reiterate the comments of Mr. Miller, who used very carefully
the words ``can lose unexpected benefits.'' these are not
earned benefits, they are not promised benefits, as he must
well know, instead the potential to gain these benefits.
In a series of papers I have examined the change in pension
wealth associated with plan conversions. Virtually all of these
studies show that plan conversions are likely to increase the
lifetime pension wealth of most workers covered by pension
plans on their current jobs. This finding is due primarily to
the portability or the various lack of portability inherent in
defined benefit plans.
In contrast, traditional defined benefit plans also
subsidize the long tenured senior workers while penalizing
mobile workers. As a result of this subsidy most senior workers
who expect to remain with the company until early retirement
will, in fact, face a decline in potential retirement benefits.
Please note I use the word ``potential.''
It is important to consider what relevant comparisons
should be used in assessing the impact of plan conversions.
Most discussion has assumed that the relevant counter-factual
is that the worker would remain with the firm, the old pension
would remain in place, and wage growth would continue. This
perception is in part due to some of the ways that companies
have in the past communicated their information to their
workers.
Again, Mr. Miller mentioned the pension calculators that
companies use, that actually assume, make those assumptions.
But are these assumptions consistent with the reality that we
face today? Again Mr. Miller went through a long list of
problems in our economy today that make those assumptions seem
less reasonable or less likely.
First, a worker could be fired or laid off from their job.
Second, the plant could close. Third, the company could be
facing difficult financial problems and terminate a plan
without starting a new plan. Fourth, the company could be
facing difficult financial problems and reduce the rate of
growth of earnings. Fifth, the company could terminate the
defined benefit plan and start a defined contribution plan.
Sixth, the worker could leave for personal reasons. If any of
these events were to happen, they would have essentially the
same impact as the company converting from a traditional
defined benefit plan to a cash balance plan.
So one would have to then question why would you pick out
one of these options and have legislation restricting it when
all of these other events would have essentially the same
effect.
In several papers I have shown that the potential loss in
pension wealth is basically the same as the early retirement
subsidy in these plans. And as Mr. Delaplane pointed out, this
is certainly a key in the future with population aging, concern
about Social Security financing, and other issues related to
our slowly growing labor force. The idea that companies want to
restrict or encourage workers to leave is going to be less
important. They may actually be trying to encourage them to
stay in the traditional defined benefit plan when the early
retirement subsidies are certainly not consistent with that.
Thank you, Mr. Chairman.
[The prepared statement of Dr. Clark follows:]
Statement of Dr. Robert L. Clark, Professor, College of Management,
North Carolina State University, Raleigh, NC
INTRODUCTION
Coverage of employees by traditional defined benefit plans has been
declining for almost three decades. Initially, the shift was away from
traditional defined benefit plans to greater coverage by defined
contribution plans, especially 401 (k) plans. This trend was most
prominent among small employers (Clark and McDermed, 1990). Beginning
in the 1980s, many large employers began converting their traditional
defined benefit plans to hybrid plans, primarily cash balance plans.
Interestingly, the conversion to cash balance plans has generated a
major policy debate while the more comprehensive shift to defined
contribution plans has continued with relatively little controversy.
In my testimony today, I will address key aspects of the plan
conversion process and why changes in pension plans are being made. In
addition, I will review the policy issues associated with these
conversions and place them in the broader context of labor market
policies in the U.S. Two questions seem paramount. First, should
federal regulations allow traditional defined benefit plans, defined
contribution plans, and cash balance plans to continue to exist?
Second, are new regulations needed to deter plan conversions for
workers covered by an existing defined benefit plan or at least to
compensate these workers for potential loses incurred by the plan
conversion? Given the current discussion in Congress and the on-going
judicial review, it is important to understand the pros and cons of
each type of pension plan and to determine whether these plans help
working Americans to achieve an adequate retirement income.
CHOOSING A PENSION PLAN TYPE
The value of participation in any type of pension plan is a
function of lifetime working patterns, rates of growth in annual
earnings, risk preferences, tax rates, and retirement ages. Employers
offer pensions to help attract, retain, motivate, and then retire
workers. Both employers and employees are interested in the cost of
providing a dollar of pension benefits. In a free labor market, workers
search for the firm and the compensation package that best meets their
preferences while companies use pensions (or the lack their of) to
entice individuals with the desired employment characteristics to
become part of their workforce.
Workers who expect to change employers frequently will desire jobs
that have a higher percentage of total compensation in earnings and
pensions that are portable. Employees who believe that they will remain
with a company for their entire career will be satisfied with pensions
that penalize turnover and are based on their final earnings. Companies
that offer noncompetitive compensation packages will tend to have more
difficulty hiring and retaining quality workers. Employers must attempt
to provide the compensation package that provides the greatest value to
workers per dollar of cost.
Over time, events can change the pension plan that workers and
firms find most desirable. Changes in regulatory costs, shifts in labor
demand, and the changing composition of the labor force will affect the
type of pension that provides the highest value per dollar of cost to
workers. In response, companies may (1) transform traditional defined
benefit plans to cash balance plans, (2) terminate the defined benefit
plan and establish a defined contribution plan, or (3) terminate the
defined benefit plan and offer no pension plan. Any of these changes
will have an impact on current workers and in general, a change in
pension plan will make some workers better off while potentially having
an adverse impact on others. My testimony today examines the three
basic choices of pension plans that are currently available in the U.S.
labor market. The basic premise is that some workers and some firms
will prefer traditional defined benefit plans while other workers and
firms will find greater value in defined contribution and cash balance
plans.
Employers offer pension plans to their employees because they help
in the management of human resources. Retirement policies are integral
components of employment contracts. Some individuals will seek out
firms that provide pension plans and alter their careers to remain with
these employers, while other workers have a higher preference for
current income and will select employers who do not provide deferred
compensation. Traditional defined benefit plans impose financial
penalties on workers who leave ``too early'' and thus these firms will
tend to have lower turnover rates than companies with defined
contribution and cash balance plans.
Most traditional defined benefit plans also provide substantial
early retirement subsidies. These subsidies to retire at ages as early
as 50 or 55 have been a major determinants of retirement ages in these
firms. Early retirement subsidies are one of the major differences
between traditional defined benefit plans and cash balance plans and it
is the elimination of these subsidies that is often at the core of the
debate over plan conversions.
TYPES OF PENSION PLANS
Pension plans have traditionally been divided into two basic types:
defined benefit and defined contribution plans; however, in the past
decade many large employers have converted their traditional defined
benefit plans into cash balance plans. These three plan types differ
substantially in the manner in which benefits are determined, their
methods of funding, who bears the investment risk associated with the
pension portfolio, the portability of benefits from one company to
another, and the regulatory status of the two types of plans. The basic
characteristics of defined benefit plans, defined contribution plans,
and cash balance plans are shown in Table 1.
In general, defined benefit plans promise a specified benefit based
on years of service, average earnings over the last three or five years
of employment, and a generosity parameter chosen by the firm.\1\ These
plans typically provide significant retirement benefits to career
employees but award much smaller benefits to employees who remain with
the company for a shorter period. In defined contribution plans,
employers and employees make periodic contributions into individual
accounts for each worker. Workers often determine the size of their
annual contributions and they decide how their pension funds will be
invested. Cash balance plans are legally defined benefit plans but have
many characteristics of defined contribution plans. The benefit in
these plans is specified as a lump sum that workers may claim when they
leave the firm.
Each type of plan has advantages and disadvantages for workers and
for the plan sponsor. Which plan type is best for employees? The
highest value plan for a worker will depend on individual risk
preferences and expected lifetime work patterns. None of the three plan
types dominates the other two for all workers. Some workers and firms
will be better off with traditional defined benefit plans while others
will have greater lifetime income if they participate in a defined
contribution or cash balance plan.
The major disadvantage to workers of participation in defined
benefit plans is the lack of portability of the pension benefits.
Workers who change jobs frequently will have significantly lower
benefits than those that remain with a single firm throughout their
careers. Lower total retirement benefits are the result of final pay
benefit formulas. Final earnings for workers who leave before
retirement are not indexed to prices or future wage growth. Individuals
who leave a pension-covered job relatively early in their careers will
have retirement benefits from their first job based on average earnings
many years in the past.
A key point for policy makers to understand is that defined benefit
plans systematically provide greater benefits to senior workers with
long years of service while providing only minimal benefits to mobile
workers who expect to remain with the company for only a few years.
Advocates that argue that traditional defined benefit plans are the
``best'' type of pension tend to ignore the limited benefits that these
plans provide to short-term workers. The more frequent transitions of
working women means that they are most vulnerable to suffering repeated
losses in potential pension wealth throughout their working careers.
Another disadvantage of defined benefit plans is that the method of
benefit accrual and the value of benefits are more difficult to
understand compared to the value of individual accounts under defined
contribution plans. Managers report that workers often do not
understand the difference between the current and future value of these
pensions, the annual gain in value or cost associated with the plans,
and the impact of job changes on ultimate retirement benefits (Clark
and Munzenmaier, 2000). The difficulty in communicating the value of
defined benefit plans has led many employers to conclude that their
employees do not give them sufficient credit for the costs of defined
benefit pensions. This implies that workers do not correctly assess the
cost and value of defined benefit plans. Managers often give this as a
reason for converting traditional defined benefit plans to cash balance
plans with individual accounts that are easier to explain to their
workers (Clark, Haley, and Schieber, 2001).
The retirement benefit for participants in defined contribution
plans depends on the size of employer and employee contributions
throughout the work life and the returns to the investments made with
the pension funds. Under these plans, the value of the pension at any
point in time is the account balance. If contributions are made at a
relatively even rate throughout a worker's career, the value of the
account will grow more proportionately than under a defined benefit
plan of comparable generosity. An important advantage of these pension
plans is that the benefits are portable and can be taken with the
workers when they change jobs.
Potential disadvantages of defined contribution plans for employees
are contributions are often voluntary, workers bear the investment risk
of these plans, and the benefits are typically paid in the form of lump
sum distributions. Many defined contribution plans require workers to
decide if they will make a pension contribution. Employer contributions
may be contingent on employee contributions. Workers who are myopic may
decide not to make pension contributions early in their careers and
will therefore accumulate relatively low retirement accounts. In
defined contribution plans, workers generally must make decisions
concerning how to invest their funds. Some participants may invest too
conservatively while others may make more risky choices that affect the
size of their ultimate retirement accounts.
Primary policy concerns with the growing incidence of defined
contribution plans include their reliance on worker decisions on when
to participate and the level of contributions, the financial market
risk that the worker must bear, and use of lump sum distributions.
Thus, workers may start contributing late in their working lives and
accumulate relatively low retirement benefits, they may contribute too
little and thus have only small retirement accounts, or they may make
bad investment choices that could dramatically lower retirement
benefits. The lack of annuitization also raises the possibility that
workers and spouses could outlive their retirement income.
In the past decade, many large employers have increasingly
converted traditional defined benefit plans into cash balance plans
(Brown, et al, 2000). In many regards, the conversion of traditional
defined benefit plans into cash balance plans by employers is an
attempt to offer workers a pension plan that combines desirable
features of both defined benefit and defined contribution plans. Cash
balance plans are legally defined benefit plans but they contain many
of the features of defined contribution plans that workers seem to
prefer.
In cash balance plans, all qualified workers are covered by the
plan and the firm typically makes all of the contributions into the
pension fund. The firm is responsible for insuring that sufficient
monies are in the pension account to pay all promised benefits and the
plans are regulated as defined benefit plans. Benefits are specified as
an account balance similar to defined contribution plans. Upon leaving
the firm, the worker receives the full value of the pension account.
The account grows each year from new contributions and from the
crediting of a specified return on the existing monies in the account.
In addition, cash balance plans tend to be more age neutral in their
retirement incentives compared to defined benefit plans.
Compared to traditional defined benefit plans, cash balance plans
provide the advantage of distributing benefits more equally across
years of service, are easier to explain to workers, and provide
portable benefits to mobile workers. Compared to defined contribution
plans, cash balance plans typically provide universal coverage to
qualified workers, keep the investment risk with the employer, and
offer a choice of an annuity or a lump sum distribution.
Given the differences in plan characteristics and how they affect
ultimate retirement benefits, it is easy to see why some workers and
firms will prefer each type of pension plan. Consider an economy where
employer-based pensions were previously banned. Now let this legal
restriction be eliminated and assume that firms could choose to
establish a traditional defined benefit plan, a cash balance plan or a
defined contribution plan. It is likely that we would observe a
distribution of plan types that would reflect the human resource
objectives of firms and the preferences of their workers. Plan choices
would maximize the well being of workers and their employers.
ESTABLISHING NEW PENSION PLANS
Based on this analysis, it is difficult to understand why anyone
would oppose limiting the choice of pension plan types that are
available to workers and firms provided that they are consistent with
broad national retirement objectives and federal regulations. Each of
the three plan options provides value to workers; however, workers with
different characteristics will benefit more or less under various plan
options. Individuals who remain with a single firm for many years,
especially those that stay with the company until they retire are the
big winners in traditional defined benefit plans. In contrast, more
mobile workers accumulate far less benefits and are the big losers in
defined benefit plans.
The trend toward greater use of defined contribution plans and the
transition toward cash balance plans clearly indicates changes in the
composition of the labor force and the emergence of workers who do not
expect to remain with the same company over their entire career. In
addition, workers are now leery about accepting the implicit promise of
lifetime employment that many larger firms formerly offered. In the
past, many workers employed by large industrial corporations thought
they had lifetime jobs and were willing to accept benefits that were
based on that premise. With the recent history of significant layoffs
of senior workers, many of these corporate giants have lost their
traditional aura as companies where workers, even highly productive
ones, can expect to spend an entire career. Thus, workers are much less
willing to participate in defined benefit plans and are much more
likely to demand cash balance plans or defined contribution plans.
Thus, in answer to my first question, I believe that a reasonable
public policy is one that allows employers and employees to choose from
among these three types of retirement plans when first considering the
establishment of a pension. This range of choices should be good for
employers and allow workers to select the type of pension plans that
maximizes their chances of saving for retirement.
In fact, it is not the establishment of new cash balance plans that
has spawned the rebellion against these plans. Instead, worker
criticism and the demand for policy actions to restrict the use of cash
balance plans has been the result of companies converting existing
defined benefit plans into cash balance plans. It is in the conversions
where winners and losers are most clearly identified. One can only
wonder why critics have focused on conversions to cash balance plans
while devoting much less attention to the much large trend of
terminating defined benefit plans and establishing defined contribution
plans. All of the issues are the same concerning the lost opportunities
to earn future pension benefits based on final earnings and how
starting values or termination benefits are determined. Yet for almost
30 years, the trend away from defined benefit plans toward defined
contribution plans went basically unchallenged while the more recent
movement toward cash balance plans has been aggressively opposed.
Consider an economy much like that prevailing in the United States
prior to 1975 in which defined benefit plans dominated. Now allow the
economic, demographic, and regulatory environments to change. Other
changes follow. Congress imposes significant new government
regulations, there are major changes in the composition and growth rate
of the labor force, and domestic employers face increased global
competition. In response to these new conditions, turnover rates
increase and job tenure declines. In such a changing economic
environment, it is not surprising that workers and firms consider
amending their pension plans. These shifts provide choices to workers
just entering the labor market but also have important implications for
current employees who have been participants in existing defined
benefit plans. Current employees, especially senior workers who are
nearing early and normal retirement ages face the potential of
reductions in future pension benefits. It is these potential adverse
affects that are now considered.
ACCUMULATING PENSION BENEFITS IN DEFINED BENEFIT PLANS
A defined benefit pension plan promises a stream of future income
in exchange for the current labor of plan participants. When employees
leave the firm or the company terminates a pension plan, the plan
sponsor is legally required to pay workers the value of all vested
benefits based on the existing benefit formula, earnings to date, and
their years of service. This is the benefit that would be paid when the
worker reaches the normal retirement if she were to quit the company
today. In the case of a plan termination, this is the benefit that the
firm is legally required to pay the worker at the normal retirement
age.
The present value of vested benefits beginning at the normal
retirement age discounted back to the current age or the termination
date can be found. This is the present value of the legally vested
pension accrued to date. Changes in this value with continued
employment represent annual benefit accruals. It is easily shown that
the accrued benefit rises with increases in years of service, increases
in annual earnings, and as the age of retirement approaches (Kotlikoff
and Wise, 1985, 1989). The present value of vested benefits increases
as a proportion of earnings as the individual remains with the firm and
approaches retirement. A worker who remains with the firm with a
traditional defined benefit plan will see pension wealth and pension
compensation grow rapidly with continued employment. A worker who quits
loses the opportunity to achieve this higher pension at older ages.
Most defined benefit plans offer early retirement benefits.
Typically, the there is a sharp increase in the value of pension
benefits when the worker reaches the early retirement age. This occurs
because plans usually do not actuarially reduce benefits when they are
started between the early and normal retirement ages. Instead these
benefits provide a higher level of lifetime pension benefits than if
the receipt of benefits was delayed until the normal retirement age.
This early retirement subside provide a strong incentive for workers to
retire at the earliest possible age and many employees choose to retire
at that time.
Prior to reaching the age of early retirement, each additional year
of service produces increases in future benefits that progressively
increase in absolute value and as a percent of annual compensation. The
present value of benefits is also increasing with additional years of
employment. This pattern of benefit accrual is often called
``backloading'' and is the reason that defined benefit plans provide
higher benefits to workers who remain with a single company compared to
more mobile workers who change jobs throughout their careers. If the
worker continues to work after the early retirement, the gain in future
benefits is substantially reduced in a form of wear away of pension
benefits. It is possible that continued employment would ultimately
result in a decline in the present value of lifetime benefits, yet
another form of wear away in existing plans.
The shift to cash balance plans has sometimes been characterized as
plan sponsors reneging on their employment and pension contract. If the
company simply provides workers their vested benefit as required by
law, the workers will suffer the same pension loss as if they had
voluntarily left their employer or if they had been laid off. It is
important to recognize that the effect on the present value of pension
benefits is the same whether the plan is terminated, converted to a
cash balance or defined contribution plan, the worker quits to take a
new job, the company lays off the worker, or there is a plant closing.
In most conversions to cash balance plans, plan sponsors have used a
combination of grandfathering and other transition provisions to
eliminate or reduce the extent to which workers are adversely affected
by plan changes.
Virtually all traditional defined benefit plans have subsidized
early retirement provisions. These plan characteristics have been an
integral component of company retirement policies since the 1960s or
1970s and have been used to encourage workers to retire at specified
ages. The economic expansion of the 1990s was accompanied by a slowing
in the growth the labor force. The twin forces of rapid economic growth
accompanied by very low unemployment rates and a relatively slow growth
in the labor force meant that many firms were having difficulty
attracting the desired number of young, quality workers. These same
companies observed that they had in place policies that encouraged
skilled older workers to retire. In response, many large companies
converted their traditional defined benefit plans to cash balance plans
that do not have these early retirement incentives (Clark and Schieber,
2002).
Eliminating the early retirement subsidy is an important part of
human resources policies for many firms in the twenty-first century as
firm adapt to an aging labor force. Extending worklife is also part of
our national retirement policy and increasing labor force participation
among older persons would help ease the funding problems of Social
Security. Ending these subsidies is also consistent with Congressional
action that does not provide subsidized Social Security benefit taken
prior to the normal retirement age. One should also note that companies
could eliminate the early retirement subsidies in the current plans
without converting to cash balance plans.
PENSION VALUES AFTER PLAN CONVERSIONS
The level and composition of labor compensation are the products of
worker preferences and the desire of firms to attract and retain
quality workers. Changes in the labor market and other economic
conditions can alter the equilibrium level of compensation and the
characteristics of employee benefits. In recent years, there has been a
dramatic shift away from traditional defined benefit plans as many
companies have terminated their existing plans and established new
defined contribution plans or transform the old defined benefit plans
into cash balance plans. We now turn to the impact of plan conversions
on real and expected pension benefits and identify the winners and
losers in the plan conversion process.
There are two major questions associated with the conversion of
pension plans:
1. How is the opening balance in the new accounts for current
employees determined?
2. Are current workers, especially senior employees, given an
option to continue in the old plan until they retire?
When all workers are given a choice of remaining in the old plan or
shifting to the new plan, there typically is little opposition or
objection to plan conversions. However, this option implies that the
company may have to continue to manage the old plan for as much as 40
years into the future. In actuality, most young workers with relatively
few years of experience are likely to opt for the new cash balance plan
or a new defined contribution plan because the expected value of
participation in these plans will be greater than continued coverage by
the traditional defined benefit plan. While relatively few employers
have given all workers a choice, many companies have given this option
to senior workers who are close to the normal retirement age in the
plan. Depending on the age and service requirements associated with
this option, companies can avoid most objections to the plan
conversion; however, this does require the continued management of the
plan for 10 to 20 additional years.
The closeout value from the old defined benefit plan and/or the
starting balance in the new pension plan is a crucial component of any
plan conversion. Companies can decide if they want to roll the closeout
account balance from the old plan into the new plan or start the new
account balance at zero. The closeout value from the old pension is the
legally accrued benefit as specified in the plan's benefit formula.
This is the benefit that would be paid when the worker reaches the
normal retirement if she were to quit the company. In the case of a
plan termination, this is the benefit that the firm is legally required
to pay the worker at the normal retirement age. Having determined the
value of participation in the old defined benefit plan, firms could pay
the workers this value or transfer it to individual accounts under the
new cash balance or defined contribution plan. The closeout value and
the start up amounts are at the heart of workers'' views on whether
they have been treated fairly.
Some critics of cash balance plans have argued that this form of
evaluation imposes significant losses on senior workers and thus,
should not be allowed. In effect, the argument is that once a firm
establishes a traditional defined benefit pension plan it must guaranty
all workers enrolled in this plan the right to remain in that plan
until they retire as long as the company retains a defined benefit
plan. Interestingly, few analysts question the right of firms to
eliminate an existing defined benefit plan without instituting any new
plan. Also, there have been few questions raised when companies have
terminated a traditional defined benefit plan and established a new
defined contribution plan. Why then has the animosity been aimed at
almost exclusively at cash balance plans?
In fact, the conversion of a traditional defined benefit plan to a
cash balance does impose ``potential'' losses on senior workers. These
losses would occur if that the firm retained the pension plan and the
worker stayed with the company until retirement age. Neither of these
conditions is a certainty. First, some individuals may choose to quit
their current job and move to another firm. In this case, they would
receive only the legally required value of their pension. Second, the
company could terminate the worker due to adverse economic conditions
or for cause. Once again, the worker would likely receive only the
legally required benefit (of course, the company could offer a greater
benefit through an early retirement plan). Third, the company could
terminate the plan and not start a new plan. Here again, the worker
would only be guaranteed the legally required benefit. All of these
possibilities are legal and all have occurred throughout the American
economy during the past three decades. It is important to remember that
no company is required to offer a pension and once established, a
company has the legal right to terminate the plan provided it pays all
vested workers the benefits that they are legally owned.
If workers receive the amount that they are legally guaranteed, why
do they feel that they have been treated unfairly? The answer follows
from expectations concerning future employment, earnings growth, and
the formula under the old defined benefit plan. Workers expectations
are a function of the information provided by employers. Many employers
may have provided their employees access to benefit calculators that
show workers the retirement benefits that they could expect prior to
the plan conversion. After a plan conversion, senior workers making the
same type of conditional projections of future benefits would find that
they can now expect smaller benefits if they remain with the company
until retirement. Thus, some senior workers could easily reach the
conclusion that they have been mistreated. The potential response by
senior employees highlights the need for full and detailed
communication with workers during the termination/conversions
process.\2\ This assessment should also be a warning to companies that
still provide traditional defined benefit plans that they should
improve their communications to better illustrate retirement benefits
conditional on staying with the firm and if the worker were to leave at
various ages. Of course, no worker is guaranteed employment until the
specified retirement age and there is no promise of a specific rate of
earnings growth. Obviously, employment conditions have been changed by
the conversion of the pension plan.
Studies by Clark and Schieber (2000, 2002, 2004 forthcoming) have
shown that a large majority of workers under age 40 will ultimately
have higher total benefits under a new cash balance plan. The primary
reason for this is the mobility risk described earlier and the prospect
of a plan termination or layoff in the future. In general, the closer
workers are to the early retirement age specified in the plan, the more
likely they are to be losers after the plan conversion. This is primary
reason that most companies have attempted to provide some additional
benefits or choice to their senior workers. However, studies have shown
that many senior workers also will gain from a transition to a cash
balance because of the uncertainty of future employment with their
career firm.
A final issue is that much of the potential loss in pension wealth
for senior workers in a conversion to a cash balance plan occurs due to
the elimination of early retirement subsidies. It should be noted that
a company could eliminate these early retirement subsidy by requiring
an actuarial reduction of benefits at early retirement. Thus, the
existing defined benefit plan could be retained without a subsidized
early retirement benefit. Clark and Schieber (2002) have shown that
many cash balance conversion impose less severe reductions in benefits
than if companies simply eliminated the early retirement subsidy.
DETERMINING WINNERS AND LOSERS IN PLAN CONVERSIONS
Calculating the impact of plans on the lifetime value of retirement
benefits for specific workers requires a series of assumptions
including: the probability that a worker will remain with the firm
until retirement, the probability that the firm will remain in
business, the rate of growth of future earnings, the probability that
the current pension plan will be terminated at some future date, and
the probability that the parameters of the current and/or the new plan
will be changed in the future. In addition, we need to know the cost
implications of the conversion process including: whether the firm is
attempting to reduce its total pension cost or simply altering the
distribution of pension benefits and whether the firm is attempting to
reduce its total labor costs or restructuring expenditures away from
pension contributions while increasing earnings, stock options, or
payments to health plans. Another key to understanding the impact of
plan conversions on specific workers is whether the company provides
transition benefits to some or all of its current workers to offset
potential losses in pension wealth.
Clark and Schieber (2002) examined 77 companies that converted
traditional defined benefit plans to cash balance plans or another type
of hybrid pension plan between 1985 and 2000. They simulated the impact
of plan conversions on workers of different ages of first employment,
age at the time of the conversion, and level of pay. Their underlying
assumption was to assume that the company will remain in business for
the working life of their employees, either the old plan would have
remain unchanged until all current workers reached retirement or the
new plan would remain unchanged during this period, and that earnings
growth would be unaffected by changes in the economic climate or by the
change in pension plan. They applied age-specific turnover
probabilities that reflected the experience of large clients of Watson
Wyatt.
The results of Clark and Schieber's analysis indicate that the vast
majority of workers who quit or are laid off before age 55 could expect
to receive greater benefits under the new cash balance or hybrid plans
compared to their continued participation in the traditional defined
benefit plans. Workers who remained on the job past age 55 would expect
to receive considerably lower benefits under the new plan. Obviously,
older workers at the time of the plan transition are more likely to
anticipate that they would still be with the company at age 55. Thus,
it is senior workers that are most likely to be adversely affected by
the transition and most likely to oppose these changes in the
employment contract.
It should be noted that Clark and Schieber's analysis focuses
solely on the mobility risk associated with these plans and ignored
other risks associated with economic fluctuations such as significant
declines in the number of workers needed by the company due to adverse
economic conditions, future changes in pension characteristics, and the
possible termination of the pension plan at some future date.
Explicitly modeling these risks would in most cases reduce any
projected losses associated with converting a traditional defined
benefit plan to a cash balance plan.\3\
While there have been relatively few studies of plan transitions
and their impact on actual workers, the basic designs of the plan types
have unmistakable implications for current and future workers.
Adjusting for mobility risk, most newly hired workers will be better
off working for companies with cash balance and defined contribution
plans. Among existing employees, senior workers are more likely to be
adversely affected while younger workers are likely to gain from plan
conversions. Of course, all comparisons depend on the level of
generosity that is provided by either the defined benefit plan or the
cash balance plan.
The potential impact of plan conversions to cash balance plans or
defined contribution plans is well known to both workers and firms. In
recognition of this, many companies provide significantly higher
benefits to senior workers. Such transition benefits reduce the
potential loss in pension wealth associated with the plan conversion
and typically, result in many fewer complaints. High quality human
resource planning is a key to the plan conversion process.
In response to the second question I raised earlier, policy makers
must remember that the pension system is voluntary and employers have
many choices. A key concern is what is the appropriate counterfactual
if conversions to cash balance plans are not allowed. If cash balance
plans are not an option, firms my terminate their defined benefit plans
and have no new plan, they might terminate their defined benefit plans
and establish a new defined contribution plan, or them may retain the
current plan but change the benefit formulas to reduce or eliminate the
early retirement subsidies. Would the opponents of cash balance plans
prefer one of these options? With this caveat in mind, regulations that
are only aimed at preventing cash balance conversions would seem unwise
and unlikely to achieve the desired results..
CONCLUSIONS
Employer-sponsored pension plans are an important component of
retirement income for many Americans and a significant part of total
compensation for many workers. In the U.S., our pension system is
voluntary. No company is required to offer a pension plan and no
company is required to retain a plan forever. Pension regulations and
the accompanying administrative costs alter the pension choices of
workers and firms. A policy to preclude the establishment of cash
balance plans would restrict pension choices and adversely affect
American workers. A policy that would not allow companies to convert
traditional defined benefit plans to cash balance plans would likely
result in other forms for changes in retirement plans that would have
similar effects on pension benefits of senior workers.
Comprehensive analysis of the impact of plan conversions indicates
that most workers will have higher lifetime pension benefits in a world
of cash balance plans (and defined contribution plans) compared to
traditional defined benefit plans. Turnover and the lack of portability
is the primary determinant of this finding. Senior workers who are near
retirement do face the potential loss in lifetime pension benefits;
however, this loss is only realized if the worker remains with the
company until the age of early retirement. It should also be remembered
that layoffs, plant closings, voluntary quits, firings, and plan
terminations have the same impact on senior workers as conversion to
cash balance plans. It is unlikely that all of these options will be
restricted.
Finally, the primary reason for the loss in pension wealth with
plan conversions is the prevalence of early retirement subsidies in
current defined benefit plans. In the coming years, it is highly likely
that firms will continue to try to eliminate these subsidies as they
compete for workers. The aging population and the projected slow growth
of the labor force will increase the value of senior workers to the
firm. Why pay highly valuable senior workers to leave at relatively
young ages only to have to search for new workers? Ending early
retirement subsidies is also consistent with our emerging national
retirement policies and the need to promote greater labor force
participation among older persons.
REFERENCES
Brown, Kyle, Gordon Goodfellow, Tomeka Hill, Richard Joss, Richard
Luss, Lex Miller, and Sylvester Schieber. 2000. The Unfolding
of a Predictable Surprise, Bethesda: Watson Wyatt.
Clark, Robert, John Haley, and Sylvester Schieber. 2001. ``Adopting
Hybrid Pension Plans: Financial and Communication Issues,''
Benefit Quarterly, first quarter, 7-17.
Clark, Robert and Ann McDermed. 1990. The Choice of Pension Plans in a
Changing Regulatory Environment, Washington: American
Enterprise Institute.
Clark, Robert and Fred Munzenmaier. 2000. ``Impact of Replacing a
Defined Benefit Plan with a Defined Contribution or a Cash
Balance Plan.''
Clark, Robert and Melinda Pitts. 1999. ``Faculty Choice of a Pension
Plan: Defined Benefit vs. Defined Contribution,'' Industrial
Relations 38:1, 18-45.
Clark, Robert and Sylvester Schieber. 2000. ``The Shifting Sands of
Retirement Plans,'' WorldatWork Journal, fourth quarter 9:4, 6-
14.
Clark, Robert and Sylvester Schieber. 2002. ``Taking the Subsidy Out of
Early Retirement: Converting to Hybrid Pensions,'' in Olivia
Mitchell, Zvi Bodie, Brett Hammond, and Steve Zeldes (eds.)
Innovations in Retirement Financing, Philadelphia: University
of Pennsylvania Press, 149-174.
Clark, Robert and Sylvester Schieber. 2004 forthcoming. ``An Empirical
Analysis of the Transition to Hybrid Pension Plans in the
United States,'' in William Gale, John Shoven, and Mark
Warshawsky (eds.), Public Policies and Private Pensions,
Washington: The Brookings Institution.
Kotlikoff, Laurence and David Wise. 1985. ``Labor Compensation and the
Structure of Private Pension Plans: Evidence for Contractual
Versus Spot Labor Markets,'' in David Wise (ed.), Pensions,
Labor, and Individual Choice, Chicago: University of Chicago
Press, 55-85.
Kotlikoff, Laurence and David Wise. 1989. The Wage Carrot and the
Pension Stick, Kalamazoo, MI: Upjohn Institute for Employment
Research.
Samwick, Andrew and Jonathan Skinner. 2003. ``How Will 401(k) Pension
Plans Affect Retirement Income?'' Unpublished working paper.
ENDNOTES
\1\ Some plans have benefit formulas that specify benefits as a
dollar amount per year of service. These formulas are most commonly
found in plans that are part of collectively bargained contracts.
\2\ Communications with workers concerning the reasons for plan
changes and the impact of these changes on worker benefits is essential
to plan terminations and conversions. Clark, Haley, and Schieber (2001)
and Clark and Munzenmaier (2001) examine the important role of
communications in plan conversions.
\3\ Samwick and Skinner (2003) focus on the differences in
financial market risks and earnings growth risks between defined
benefit plans and 401(k) plans. They could that 401(k) plans are
preferred to defined benefit plans by all workers, except those with
the highest risk aversion.
[GRAPHIC] [TIFF OMITTED] T4751.001
______
Chairman Boehner. Mr. Hill.
STATEMENT OF ROBERT F. HILL, ESQ., PARTNER, HILL & ROBBINS,
DENVER, COLORADO
Mr. Hill. Good morning, Mr. Chairman and distinguished
Members of the Committee. Thank you for the invitation to share
my views regarding cash balance plans. I am an attorney in
private practice in Denver, Colorado, with the law firm of Hill
& Robbins, and we represent employees in cases involving cash
balance plans.
The adverse impact that cash balance plans have had on
older employees has been well documented. I won't repeat that.
But I will say that that only begins to tell the story of the
hardship that cash balance plans have imposed on those older
workers. All too often the cash balance plan arrives long after
these employees have made employment retirement and saving
decisions based on the promise of a traditional defined benefit
plan, leaving them absolutely no practical ability to make that
up in their remaining working years.
Equally egregious, older workers often experience what is
referred to as wear-away, which means that even though they
continue working for their long established employer, they do
not continue to generate additional retirement or pension
benefits.
The title of this session today I think is well chosen,
separating myth from fact, and I have found that a challenge as
I have approached this issue from the outside and tried to
become acquainted with it. Cash balance advocates frequently
suggest that employers are motivated by the increased, quote,
mobility, closed quote, in the workforce. But the facts
indicate otherwise. All available studies indicate that baby
boomers have been staying on the job as long as or longer than
their parents and grandparents when you look at people in the
same age. There is also, I have found, a public and a private
face when you try to understand what the pension consultants
have been recommending to employers in this arena, and this
Committee to properly legislate needs to go behind the public
veneer.
Thus, while cash balance advocates publicly contend that
cost savings is not a significant factor in the rise of cash
balance plans, in private and professional society meetings and
other organizational meetings such as this they acknowledge
that cash balance plans would hardly exist at all if it weren't
for cost savings. While they also publicly cite the need for
competitiveness in private they acknowledge that although
combativeness sounds important, it is rarely an issue in the
decisionmaking process. In private, these same cash balance
advocates concede that conversions are often used to camouflage
or mask, and those are quotes, a benefit cutback or to remove
early retirement subsidies.
Even the most aggressive of these proponents concede that
in the early days many benefit consultants panned cash balance
plans as a gimmick and contended that they couldn't satisfy the
rules. There has been talk about clarification. The law is as
Congress has pronounced it, and the law is the same as it has
been for a long time. For example, following a meeting of what
later became known as the Cash Balance Practitioners Group,
attendees, which included representatives from four large
pension consulting firms and two major law firms, circulated a
memorandum. I remind you this is in 1990. They circulated a
memorandum acknowledging that, quote, it is well known that a
cash balance plan is at risk under a little reading of the age
discrimination laws. For that reason the group focused on the
need for a, quote, legislative fix, closed quote, a prospect
that the group did not view with optimism.
In 1996 and in 1997 warning signs became dramatically clear
regarding the age discrimination issues raised by cash balance
plans. These came from the Treasury Department notice. They
came from the filing of employee lawsuits. They came from a
letter from an Internal Revenue district office indicating that
a proposed cash balance plan was age discriminatory because
the, quote, benefit accrual rate decreases as a participant
attains each additional year of age, closed quote.
Despite those warning signs, the number of employees
covered by cash balance plans more than quintupled from 1997 to
2000, and I would suggest that against that background it is
impossible to suggest that most employers entered into these
conversions ignorant of the risks that cash balance plans
violated the age discrimination laws.
While I would suggest that in addition to the well-
documented cost savings and the desire of many employers to use
the conversions to mask benefit cutbacks, it now appears that
many of the cash balance plans were motivated by accounting
rules that allow publicly held companies to use cash balance
plans to present a more attractive financial picture to the
investing public, something sometimes referred to as accounting
gimmicks.
I would comment that William Sweetnam, then a member of the
Senate Finance Committee staff and now Treasury Department Tax
Benefit Council, acknowledged in 1998 that, quote, the primary
reason cash balance plans are financially advantageous is the
accounting treatments of all cash balance plans versus final
average earnings plans. The reason that cash balance plans are
better is that they make the corporation's financial statement
look better since pension liabilities are less, closed quote.
To understand and deal with cash pension plans you need to
understand both the public and the private face. You need to
separate myth from fact. I thank you for giving us an
opportunity to share our views on that the subject.
[The prepared statement of Mr. Hill follows:]
Statement of Robert F. Hill, Esq., Partner, Hill & Robbins, Denver, CO
Mr. Chairman and distinguished Members of the Committee:
I am an attorney in private practice in Denver, Colorado with the
law firm of Hill & Robbins, P.C. Our law firm has represented employees
in several law suits challenging the legality of conversions from
traditional defined benefit plans to cash balance plans. These cases
include the IBM Pension Litigation in the United States District Court
for the Southern District of Illinois in which Chief Judge Murphy
entered an order last year finding that IBM's cash balance formula
violated ERISA's age discrimination rules.
The adverse impact cash balance plans have on long-term older
employees has been well documented. Even cash balance supporters have
acknowledged that ``it is not unusual in some cash balance conversions
for the 40 to 50 year old employee to lose one-third to as much as one-
half of his expected pension.'' \1\
---------------------------------------------------------------------------
\1\ Shapiro & Rachal, Litigation Issues in Cash Balance Plans,
Benefits Link, (1999), http://benefitslink.com/articles/
cashbalance.html .
---------------------------------------------------------------------------
The dramatic reduction in benefits for older workers created by the
adoption of a cash balance plan was confirmed by a detailed report
submitted to this Committee by the General Accounting Office in
September 2002. Under the model of a typical conversion used for the
GAO study,
a 45-year old worker at the time of conversion receives an
annual annuity of about $18,500 at retirement from the cash
balance plan instead of the $39,800 annuity the worker could
have received from the defined benefit plan with a final
average pay formula. Likewise, a worker 50 years old at
conversion receives an annual annuity of about $17,800 from the
cash balance plan rather than the $35,100 annuity the final
average pay formula would have provided.\2\
---------------------------------------------------------------------------
\2\ U.S. General Accounting Office, PRIVATE PENSIONS--Implications
of Conversions to Cash Balance Plans, GAO/HEHS-00-185, at 24-25 (Sept.
2000) (hereinafter ``GAO Report'') http://www.gao.gov/new.items/
he00185.pdf
---------------------------------------------------------------------------
But that only begins to tell the story of the hardship that cash
balance plans impose on older workers. These are employees who have
labored long and hard for an employer based on the promise of benefits
under a traditional defined benefit plan where the value of benefits
increase significantly in the later years of their career. Suddenly,
after decades on the job, the promise of increasing age 65 benefits
based on years of service and final pay is withdrawn and replaced by a
benefit formula that benefits younger workers at the expense of older
workers. A chart included in the GAO report illustrates this
phenomenon:
[GRAPHIC] [TIFF OMITTED] T4751.002
As shown, due to the conversion, older workers, generally those
over age 40, end up with the worst of both worlds.
The findings in an ERISA Advisory Group study submitted to the
Department of Labor in 1999 aptly describes this problem:
When a pension plan is converted to a plan design that gives
lower benefit accruals to older, longer-service employees,
without appropriate transition protections there is a
takeaway--a loss of expected future benefits--which is felt
much more sharply than if the employer were simply adding a new
benefit that tended to offer more to younger employees.
The loss that older employees experience in some cash balance
conversions is especially profound in companies that had
previously invested the most in promoting their traditional
pension plan to employees as a valuable component of the
employees'' compensation, encouraging employees to build
careers in reliance on what they viewed as a retirement income
promise.\3\
---------------------------------------------------------------------------
\3\ U.S. Dept. of Labor, Report of the Working Group Studying the
Trend in the Defined Benefit Market to Hybrid Plans, Findings 3(a) and
3(c) (November 10, 1999, http://www.efast.dol.gov/ebsa/publications/
cbalinfo.htm ). (hereinafter ``Working Group Study'').
---------------------------------------------------------------------------
As that same study recognized, all too often the cash balance plan
comes at a time in the employees'' lives when they have long ago made
employment, retirement and savings decisions based on the promise of a
traditional defined benefit plan only to find their reasonable
expectations dashed with no practical ability to make up for that loss
in their remaining working years.
Some cash balance proponents point to ``grandfathering'' and other
types of transition relief as a means to address this problem. However
a study of actual cash balance conversions conducted by the actuarial
firm Towers & Perrin determined that in over one-third of the
conversions the employers provided no grandfathering or other form of
transition benefit.\4\ And even when transition relief is provided for
some workers, the vast bulk of conversions leave many adversely
impacted workers unprotected.
---------------------------------------------------------------------------
\4\ Arcady & Mellors, Cash Balance Conversions, JOURNAL OF
ACCOUNTANCY, February 2000, http://www.aicpa.org/pubs/jofa/feb2000/
arcady.htm.
---------------------------------------------------------------------------
Equally egregious, in many conversions older workers experience
what is referred to as ``wearaway,'' which means that even though they
continue working they earn no additional pension benefits until the
amount in their cash balance plan reaches the amount they had already
earned under their traditional defined benefit plan. The GAO found that
the amount of wearaway any employee experiences is tied directly to
age, with older workers suffering the longest periods of wearaway,
sometime many years. For example, a typical conversion scenario
``generated a 2-year lump sum wearaway for a 35-year old worker, a 4-
year wearaway for a 45-year old worker, and an 11-year wearaway for a
55-year old worker at conversion.'' \5\ In such an instance,
shockingly, the 55-year old would earn no additional pension benefit
before reaching normal retirement age.
---------------------------------------------------------------------------
\5\ GAO Report, at 28.
---------------------------------------------------------------------------
During the past seven years, a significant number of employers have
converted from traditional defined benefit plans to cash balance
plans--thereby adversely impacting millions of older workers in the
ways described by the GAO Report. We are before the Committee today
because employers and employer related groups want Congress to provide
exemptions for cash balance plans from the current law that applies to
defined benefit plans, including the present prohibition against age
discrimination.
Cash balance plans have often been described as ``a defined benefit
plan masquerading as a defined contribution'' plan.\6\ While no one
disputes that cash balance plans are defined benefit plans, cash
balance proponents essentially want the best of both worlds--they want
to avoid the income and excise taxes that a change from a defined
benefit plan to a defined contribution plan would entail and to retain
the funding flexibility of the defined benefit plan, but they also want
cash balance plans treated as defined contribution plans for purposes
of the ERISA vesting and age discrimination rules.
---------------------------------------------------------------------------
\6\ Remarks of Eric Lofgren, Vol 12. No 1 Report of the Society of
Actuaries, at 419 (1986)(hereinafter ``Lofgren 1986'')(copy attached).
---------------------------------------------------------------------------
However Congress has enacted very specific and very different legal
frameworks for defined benefit plans and defined contribution plans.
These rules were designed with a recognition that taxpayers pay
hundreds of millions of dollars to subsidize the private tax-qualified
pension system--to assure that employees were treated fairly and to
avoid abusive practices that undermine the promises made to employees
and the employees'' reasonable expectations. The Joint Committee on
Taxation has estimated that in 2004 taxpayers will pay about $89
billion in foregone taxes to subsidize the private tax-qualified
pension system.\7\ It is only right and proper that Congress assure
that the taxpayers'' monies provide a system that is fair to all
workers, including older workers.
---------------------------------------------------------------------------
\7\ Joint Committee on Taxation, Estimates of Federal Tax
Expenditures for fiscal years 2000-2004 p. 23, JCS-13-99, December 22,
1999) http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=1999--
joint--committee--on--taxation&docid=f:54622.pdf.
---------------------------------------------------------------------------
Cash balance plans are the very creative invention of a handful of
professional consultants who sell their services to employers. While
these proponents have publicly advanced a number of lofty motivations
for the conversion of traditional plans to cash balance plans, none of
their claims justify the harm cash balance plans have imposed on older
workers.
Cash balance advocates frequently suggest that employers are
motivated to adopt cash balance plans by the increased ``mobility'' in
the workforce. The facts indicate otherwise. Indeed, a prominent cash
balance proponent has acknowledged that baby boomers ``have been
staying on the job longer, actually, than their parents and
grandparents.'' \8\ Similarly, a study conducted in 1998 by the Watson
Wyatt actuarial firm concluded that this phenomenon applied as well to
younger workers, age 25 to 34, who in 1996 spent a considerably longer
time, on average, with one employer than did workers in that same age
group in the 1950's.\9\
---------------------------------------------------------------------------
\8\ Remarks of Eric Lofgren, New York Annual Meeting of Society of
Actuaries, October 18-21, 1998, reported at p.14, Record of Society of
Actuaries, Vol. 24, No. 3 (hereinafter ``Lofgren 1998'') (copy
attached).
\9\ Workforce Management: The Cultural Shift, Watson Wyatt Insider,
Vol. 8, Issue 8, (August 1998).
---------------------------------------------------------------------------
Some employers and actuaries also publicly cite the need for
competitiveness as a reason for cash balance plans. However in private
they acknowledge that although competitiveness sounds important, it is
rarely a real issue in the decision making process.\10\
---------------------------------------------------------------------------
\10\ Lofgren 1998 at 10--11.
---------------------------------------------------------------------------
The more likely reason for many conversions, as many cash balance
advocates concede, is that conversions are often used to disguise a
cutback in benefits. In 1986, when cash balance plans first began to
receive attention, Eric Lofgren, an actuary with Watson Wyatt, outlined
for a conference of actuaries that a primary objective of conversion to
a cash balance plan was to ``to camouflage a benefit cutback, or remove
early retirement subsidies.'' \11\ Similarly, an actuary with Towers
Perrin told a conference of actuaries that ``the way the plan is
presented to employees looks so dramatically different than the defined
benefit plan that the employees are used to that, and the change can be
used to mask a benefit cutback.'' \12\ This advantage was still being
touted in 1998, when an actuary with PriceWaterhouse-Coopers noted to
the annual meeting of the Society of Actuaries that ``converting to a
cash balance plan does have an advantage of it masks a lot of the
changes.'' \13\
---------------------------------------------------------------------------
\11\ Lofgren 1986 at 419.
\12\ Remarks of Gary Hallenback, 1986 Conference of Consulting
Actuaries, quoted in Ward, Eating their Words, Plan Sponsor Magazine
(March, 2000). http://www.plansponsor.com/magazine--type1/?RECORD--
ID=13766
\13\ Remarks of William Torrie, 1998 Society of Actuaries Annual
Meeting, quoted in Ward, Eating their Words, Plan Sponsor Magazine
(March, 2000)
---------------------------------------------------------------------------
Mr. Lofgren candidly noted that a company converting to a cash
balance plan could use two very different definitions to announce the
same new cash balance plan. The upbeat version most commonly used to
announce a conversion optimistically touts the purported virtues of a
cash balance plan, describing it as ``an exciting, modern, flexible new
plan design with the advantages of both defined benefit and defined
contribution.'' He also proposed what he described as an equally
accurate, but more candid, definition:
``Dear Employee: We've got for you a cash balance pension plan.
It's our way to disguise the cutbacks in your benefits. First
we're going to change it to career average. We'll express the
benefits as lump sum so we can highlight the use of the CPI, a
sub-market interest rate. What money is left in the plan will
be directed towards employees who leave after just a few years.
Just to make sure, we'll reduce early retirement subsidies.''
\14\
---------------------------------------------------------------------------
\14\ Lofgren 1986 at 419.
---------------------------------------------------------------------------
While cash balance advocates publicly contend that cost savings are
not a significant factor in the rise of cash balance plans, in private
they consistently acknowledge that ``cash balance plans would hardly
exist at all if it weren't for cost.'' \15\ Most employers with an
existing, overfunded, defined benefit plan who want to cut pension
costs by moving to a defined contribution model are not willing to pay
the cost of terminating the defined benefit plan, which arises
primarily from the excise tax payable on the surplus, and then creating
a defined contribution plan. A 2002 empirical study of cash balance
conversions concluded that:
---------------------------------------------------------------------------
\15\ Lofgren 1998 at 10.
---------------------------------------------------------------------------
If instead the firm converts to a cash balance plan, it can use
all of the excess pension assets to fund future benefits.
Therefore, among firms that plan to switch from a traditional
defined benefit plan to a defined contribution-type plan, the
likelihood of choosing a cash balance plan increases with the
plan's overfunding.\16\
---------------------------------------------------------------------------
\16\ Niehaus & Yu, Cash Balance Conversions: Evidence of the Excise
Tax Avoidance Hypothesis, (2002) http://www.cba.uri.edu/tong/cash-
balance.pdf
---------------------------------------------------------------------------
Employers seek to avoid this tax by creating a cash balance plan
instead, which has the advantage of both looking to employees like a
defined contribution plan and at the same time allowing the employer to
cut their benefit obligations and use the plan surplus to forestall the
need to make future plan contributions.\17\
---------------------------------------------------------------------------
\17\ Working Group Study.
---------------------------------------------------------------------------
As an additional justification for asking Congress to exempt cash
balance plans from defined benefit law, including the prohibition
against age discrimination, proponents currently contend that hundreds
of employers have adopted such plans, in the good-faith belief that
they complied with existing law. According to this argument,
``fairness'' to the expectations of employers requires special
treatment for cash balance plans, regardless of any resulting
unfairness to older workers who expected to earn most of their benefits
in their later years under the traditional plans in place for decades.
No such unfairness to employers exists. Even the most aggressive
cash balance proponents have conceded that in the early days of cash
balance plans, many benefits consultants panned cash balance plans as a
gimmick and argued that they couldn't satisfy the rules.\18\
---------------------------------------------------------------------------
\18\ Comments of Richard Shea, 1999 Enrolled Actuaries Meeting,
Session 605: Cash Balance Plans--Current Issues (March 14-17, 1999)
(copy attached).
---------------------------------------------------------------------------
For example, following a 1990 meeting of what later became known as
the Cash Balance Practitioner's Group, attendees--which included
representatives from four large pension consulting firms and two major
law firms--circulated a memorandum acknowledging that ``it is well
known that a [cash balance] plan is at risk under a literal reading
of'' the age discrimination laws.\19\ The Practitioners Group
memorandum acknowledged that the practitioners had ``heard
representatives of the [Internal Revenue] Service express concern that
because the benefits under cash balance plans are frontloaded, such
plans may violate a literal reading of'' the age discrimination
laws.\20\ In addition, the Report noted that a ``number of
practitioners believe that there is a very significant risk that the
Service will ultimately take the view that it cannot avoid a literal
interpretation of the statute.'' \21\ For that reason, the group
focused on the need for a ``legislative fix a prospect that the group
did not view with great optimism. Finally, the practitioners warned
that, absent a legislative change, ``the potential employer exposure is
extremely high--potentially increasing the plan liabilities four or
five times.'' \22\
---------------------------------------------------------------------------
\19\ October 23, `1990 Letter from Hugh Forcier regarding Cash
Balance Memorandum, at p. 2(copy attached).
\20\ Memorandum, Cash Balance Plans: Compliance with the
``qualification'' requirements of the Internal Revenue Code of 1986, as
amended, at 24 (Oct. 23, 1990) (copy attached).
\21\ Id.
\22\ Id.
---------------------------------------------------------------------------
Despite these legal concerns, and despite the failure of proponents
to obtain legislation exempting cash balance plans from the age
discrimination laws applicable to all defined benefit plans, a few
employers went forward with conversions from traditional plans to cash
balance plans in the early 1990's. However, according to a Department
of Labor survey, even by 1996-97 only 4% of U. S. workers covered by a
defined benefit plan were participants in cash balance plans.\23\
---------------------------------------------------------------------------
\23\ U.S. Bureau of Labor Statistics, Employee Benefits in Medium
and Large Private Establishments in 1997, p. 103. http://www.bls.gov/
ncs/ebs/sp/ebbl0017.pdf
---------------------------------------------------------------------------
It was only after 1997 that the dramatic increase in the adoption
of cash balance plans took place--and the resulting adverse impact on
millions of older workers. Employers, eager to exploit the pension fund
surpluses created by the booming stock market, rushed to adopt them,
despite both the much earlier recognition of their risk and further
warning signs that arose in 1996 and 1997. On January 18, 1996, the
Treasury Department issued Notice 96-8, which clearly indicated that
cash balance plans were subject to the same benefit accrual rules
applicable to all defined benefit plans.\24\ Also in 1996, the first
employee lawsuit challenging age discrimination in cash balance plans
was filed: a second was filed in May of 1997. In July of 1997, an
Internal Revenue District Office concluded that a proposed cash balance
plan violated the age discrimination prohibitions of the Internal
Revenue Code because the ``benefit accrual rate decreases as a
participant attains each additional year of age.'' \25\
---------------------------------------------------------------------------
\24\ www.irs.ustreas.gov/pub/irs-irbs/irb96-06.pdf
\25\ Letter from Andrew J. Fedders, IRS Cincinnati District Office,
Government's Position, No. 1 (July 28, 1997) (``The plan does not
satisfy the clear and straightforward requirement of section
411(b)(1)(H) of the Code because the plan's benefit accrual rate
decreases as a participant attains each additional year of age.'')
(copy attached).
---------------------------------------------------------------------------
In spite of all of these warning signs, the number of employees
covered by cash balance plans more than quintupled between 1997 and
2000, from 4% to 23%.\26\ Against this background, it is impossible for
the vast bulk of employers to credibly claim that they adopted cash
balance plans ignorant of the risks that they violated the age
discrimination laws.
---------------------------------------------------------------------------
\26\ U.S. Bureau of Labor Statistics, National Compensation Survey:
Employee Benefits in Private Industry in the United States, 2000, p.
58. http://www.bls.gov/ncs/ebs/sp/ebbl0019.pdf
---------------------------------------------------------------------------
Clearly there had to be powerful factors motivating this dramatic
increase in the adoption of cash balance plans in the late 1990's. In
addition to the well documented cost savings and the desire of many
employers to use the conversions to mask benefits cutbacks to older
workers, it now appears that many of these conversions were either
primarily or incidentally motivated by accounting rules that allow
publicly held corporations to use cash balance conversions to further
inflate surpluses and generate ``pension income,'' thereby presenting a
more attractive financial picture to the investing public. As one
consulting actuary puts it: ``Pension funds are becoming a major profit
center.'' \27\
---------------------------------------------------------------------------
\27\ Pesek, Hidden Asset: For Many Companies, Pension Plans Are
Bolstering Profits, BARRON'S (May 27, 2000)(quoting Adam Reese, Towers
Perrin).
---------------------------------------------------------------------------
Because of the way opening account balances are determined in a
conversion from a traditional defined benefit plan to a cash balance
plan, the conversion typically reduces the plan's Projected Benefit
Obligation. Under the financial accounting standards in FASB Statement
No. 87, the effect of this type of ``negative amendment'' can be spread
out over several years, which reduces the plan's annual benefit cost
for financial statement purposes in those years. Thus, as Mark Beilke,
the current Chairman of the Academy of Actuaries Pension Accounting
Committee, recently observed, ``gains [from cash balance conversions
are] mostly derived from ``accounting gimmicks.'' \28\
---------------------------------------------------------------------------
\28\ Comments posted as ``MGB'' on Benefits Link Cash Balance
Discussion Forum, May 13, 2003. http://benefitslink.com/boards/
index.php?act=Print&client=printer&f=22&t=19682
---------------------------------------------------------------------------
Employers and their advisors have long privately acknowledged the
powerful motivation these accounting devices have provided to fuel the
increased number of conversions. William Sweetnam, then a member of the
Senate Finance Committee staff and now Treasury Department Tax Benefits
Counsel, acknowledged in 1998 that the
``primary reason cash balance plans are financially
advantageous is the accounting treatment of cash balance plans
versus final average earnings plans . . . With final average
earnings plan [sic], you must book as a liability on your
financial statements the value of pension benefit assuming
future earning growth for participant's benefit. With a cash
balance plan, you don't have to include future earnings growth
you only have to book your current liability for account
balances. This reduces the liability in all circumstances--even
if the plan grandfathers the old final average earnings benefit
for older workers. So the reason that cash balance plans are
better is that they make the corporations [sic] financial
statement look better since pension liabilities are less.''
\29\
---------------------------------------------------------------------------
\29\ E-mail from ``Bill'' Sweetnam dated 12-22-98(copy attached);
See also, Actuarial Aspects of Cash Balance Plans, Society of Actuaries
Conference (July 07, 2000) http://www.soa.org/ccm/cms-service/stream/
asset?asset--id=1052150.
---------------------------------------------------------------------------
This accounting treatment of cash balance conversions can create
substantial increases in a company's reported income--increases that
compound the already misleading impressions that can arise from the
inclusion of ``phantom'' pension income as part of a company's bottom
line.\30\ In 1999, an accounting expert at Bear Stearns, conducted a
study showing that 25% of the companies in the Standard & Poor's 500-
stock index reported pension income in 1998, that overall pension
income accounted for 3% of 1998 operating income of the companies
overall, and that for 15 of those companies pension income represented
10% or more of their total operating income for the year.\31\
---------------------------------------------------------------------------
\30\ Warren Buffet has described the growing practice by some
companies of creating ``phantom'' pension income to inflate reported
income as a misrepresentation that ``dwarfs the lies of Enron and
WorldCom.'' Buffet, Who Really Cooks the Books?, New York Times,
Section A, Page 19 (July 24, 2002).
\31\ Singh, Feathering the Nest Egg, CFO Magazine (October 1, 2000)
http://www.cfo.com:8080/article/1%2C5309%2C1006/8/A/7/7%2C00.html ;
McGough & Schultz, How Pension Surpluses Lift Companies' Profits, Wall
Street Journal (September 21, 1999) http://acct.tamu.edu/loudder/
private/647--Readings/How%20Pension%20Surpluses.htm ;
---------------------------------------------------------------------------
While the debate over the motivations of employers to implement
cash balance plans in the absence of clear legal authorization will no
doubt continue, there is no debate regarding the dramatic and adverse
impact of these plans on older workers. It punishes--in some cases
brutally and without the ability to recover older workers who have
worked for a company for decades based on an unequivocal promise of an
increasing age 65 retirement benefit determined by reference to years
of service and higher income in their later years.
Equally importantly, cash balance plans often come long after these
employees made irreversible decisions regarding employment and savings
based on their understandable reliance on their employers'' promises
only to have them suddenly dashed by the announcement of a change to a
newly created pension scheme--the cash balance plan.
That is precisely the kind of abuse of the American work force that
our pension laws were intended to prohibit. And it is even more
unacceptable when the adverse impacts are due to discrimination based
on age.
As the Committee considers any possible legislation addressing the
legal issues raised by cash balance plans, I strongly encourage you to
keep the need to protect these loyal, long-term older workers in the
forefront. At their age and position these abrupt and unfair changes
often dramatically and irreversibly adversely impact their remaining
years.
These employees are the backbone of our nation's economic engine
and they deserve far better and fairer treatment. Congress should
continue to assure that if taxpayers are to subsidize the private
pension system, employers must treat their workers fairly and without
discrimination based on age.
______
Chairman Boehner. Ms. Pfotenhauer.
STATEMENT OF NANCY M. PFOTENHAUER, PRESIDENT, INDEPENDENT
WOMEN'S FORUM, WASHINGTON, D.C.
Ms. Pfotenhauer. Thank you, Mr. Chairman and distinguished
Members of the Committee. I am grateful to have the opportunity
to appear here today. As the Chairman said, my name is Nancy
Mitchell Pfotenhauer, and I am president of IWF. However, my
background is in the field of economics. I have served as
Economic Counsel to a former Member of the Senate Republican
leadership who sat on the Budget and Banking and Finance
Committees. I have also served as Chief Economist as the
cabinet level regulatory review body.
As you probably know, the labor force participation rates
of women, unlike men, have been increasing across all age
groups. This comes as no surprise to us and probably no
surprise to the Committee. The Bureau of Census and the Bureau
of Labor Statistics simply provide the quantitative evidence of
what we have observed in American society. Simply put, more
women are working more often while balancing the pressures of
home and family, often taking time out of the workforce to care
for children and for elderly parents.
Why has IWF got even into this debate over pension policy?
Because the national poverty rate for women 65 and older is
almost twice that of men. The average age of widowhood in the
United States is 56 years old. Fully 80 percent of widows now
living in poverty weren't poor when their husbands were alive.
The likelihood of poverty increases with age, particularly for
minority women.
Right now several specific factors drive the discrepancy
between men and women in their later years. First and perhaps
most importantly, we live longer. To put it bluntly we may
outlive our savings. The average life expectancy at 60 years of
age for women is 83 and for men it is 78.
Perhaps most relevant for this discussion, however, is the
fact that women change jobs more frequently than men. We
average 4.8 years with each employer and, therefore, may not
stay on the job long enough to be vested in traditional
retirement plans. Because women are more likely to leave the
job market to handle family responsibilities, we average 11.5
years out of the workforce compared to 1.3 years for men. With
our earning record interrupted we not only lose the opportunity
to vest but we have fewer years in which to contribute to
retirement plans.
Traditional retirement and pension approaches simply fail
to meet the needs of our changing society. Succinctly, they do
not reflect the work patterns and demographics of American
women. Luckily, pension innovations in the private sector hold
promise. Cash balance pension equity and other hybrid pension
plans combine attractive features of a traditional defined
benefit plan with attractive features of a defined contribution
plan. These modernized arrangements have evolved to suit
today's more mobile workforce and to respond to employee
preferences for transparency, portability and accrual of a more
meaningful benefit earlier in one's career.
We believe the emergence of hybrid plans is encouraging
news for many, but is a cause for particular hope for women. In
fact, one benchmark study done in 1998 by the Society of
Actuaries found that an amazing 77 percent of women do better
under a cash balance system. They are better off under the
system because they move in and out of the workforce in order
to balance family needs and because they cannot afford to
retire early.
Despite this promise it is clear that controversy exists
about how firms should transition to hybrid plans, and many
have questioned the fairness of changing pension approaches for
employees over 40 years of age. An alternative perspective, and
one that we believe has credence, is that any adoption of
restrictions that effectively limit the abilities of companies
to transition to hybrid plans places the financial well-being
of the relatively few employees who have the luxury of staying
with one company for a long period of time, usually decades,
have the luxury of taking early retirement, and have the luxury
of taking their pension benefit in the form of an annuity
rather than a lump sum, ahead of all the employees who do not
have these options.
So regardless of one's perspective, any discussion about
transition is appropriately done within the context of a clear
understanding that these plans are voluntarily sponsored by
employers. As such, an employer currently could decide to
freeze benefit accruals or completely terminate plans
altogether if costs become too burdensome, and experience has
shown us that many more plans have fallen victim to this fate
over the past decade than have transitioned to hybrid plans.
The problem before this Committee is complex and worthy of
an objective analysis that is focused on providing a solution
that fits the changing nature of America's economy and
workforce. The Independent Women's Forum believes that
portability is a real and growing need as we look to the future
of working women in this country. As such, we strongly urge
Congress to act in the manner that recognizes the attributes of
new approaches like the cash balance and other hybrid plans and
keeps in mind that the one law that cannot be amended is the
law of unintended consequences.
Thank you.
[The prepared statement of Ms. Pfotenhauer follows:]
Statement of Nancy M. Pfotenhauer, President, Independent Women's
Forum, Washington, DC
Mr. Chairman and distinguished members of the Committee, thank you
very much for the opportunity to be here today. My name is Nancy
Mitchell Pfotenhauer and I am president of the Independent Women's
Forum. IWF is a non-profit, non-partisan public policy organization
that focuses on issues of importance to women.
To give you some context, our organization was founded more than a
decade ago, and counts among its National Advisory Board women who have
served at the highest levels in federal office. In fact, Department of
Labor Secretary Elaine Chao, Undersecretary of State Paula Dobriansky,
and Assistant Attorney General for Tax Policy Eileen O Connor have all
served on our National Advisory Board. Our Board of Directors and
Advisors have run divisions of OMB, the Treasury Department, and
chaired and served on several independent regulatory agencies.
I personally have served as Economic Counsel to a member of the
Senate Leadership who sat on the Budget, Banking and Finance
Committees. Subsequent to that, I was the Chief Economist of a Cabinet-
level regulatory review body. After serving time as Director of the
Washington office of a $48 billion diversified energy company, I
transitioned from IWF's Board of Directors into my current position.
Let me begin by explaining what IWF is not. It is not a grassroots
organization focused on mobilizing large numbers of our fellow
citizens. Rather we are a group whose members are legal scholars,
economists, academicians, historians and foreign policy experts who
hope to apply our professional experience to impact the formulation of
public policy. As such, again let me thank you for the opportunity to
appear before this committee and participate in a candid and
constructive discussion concerning cash balance pension plans.
As you probably know, the labor force participation rates of
women--unlike men--have been increasing across age groups. Women in the
45- to 54- age group saw the greatest jump in their participation
during the 1980-90 timeframe, clocking in with an increase of almost 11
percent. This same cohort again saw the greatest increase in
participation in the 1990-2000 (when they were aged 55-64). It is
important to note, however, that for the 2000-2010 period, this group
will lose their title to a group of younger women aged 25-34.
This comes as no surprise to the Independent Women's Forum--and
probably no surprise to this committee. The combined work of the Bureau
of Census and the Bureau of Labor Statistics simply provides the
quantitative evidence of what we have all observed in American society.
Simply put, more women are working more often while still balancing the
pressures of home and family.
And, by and large, this is a truly positive indication of the
tremendous progress women have made in our country. Presently, women
earn the majority of the undergraduate degrees, the majority of
master's degrees and--within the next decade--are expected to earn the
majority of Ph.Ds. Right now, young women comprise roughly sixty
percent of the students attending law school here in the United States.
So, the upside of this story is that women are achieving
educational and professional goals only dreamed of in other countries.
The challenge from a retirement security standpoint, however, is that
we refuse to compromise our roles as mothers and caregivers on the
altar of professional accolades. Specifically, women still tend to take
time out of the workforce in much greater numbers than men in order to
care for young children or elderly members of our family. Having five
children between the ages of 10 and 16, this particular point really
strikes home with me.
Why has IWF gotten involved in this debate over pension policy?
Because the national poverty rate for women 65 and older is almost
twice that of men. The average age of widowhood in the United States is
56; fully eighty percent (80%) of widows now living in poverty weren't
poor when their husbands were alive. The likelihood of poverty
increases with age, particularly for minority women. The gap between
Social Security benefits for women and men is slowly narrowing, but the
difference between pension benefits is increasing rapidly.
What is driving this phenomenon? We fundamentally reject the notion
that our current systems were somehow designed to be biased against
women. In fact, historical records reveal that the social security
system was, if anything, originally designed to benefit women.
Unfortunately, through no ill-intent, the framers of that system failed
to accurately predict societal trends and future workforce
demographics.
Right now, several specific factors drive the discrepancy between
men and women in their later years. First, and perhaps most
importantly, women live longer then men. To put it bluntly, we may
outlive our savings. The average life expectancy at 60 years of age for
women is 83 and for men is78. By 2050, five percent of the baby-boomer
population will be more than 100.
Despite our relative longevity, or perhaps because of it, women
tend to have more chronic health problems than men, resulting in higher
health care costs during retirement. And, if a woman hasn't seen her
financial health plummet because her husband died, she's likely to be
hit hard through a divorce. Statistics have shown that immediately
following divorce, women 50 and older experience a 39 percent decline
in income, whereas men's incomes fall only 14 percent. One year after
divorce, fully 40 percent of men have regained their pre-divorce
incomes; about half that percentage (21) of women have climbed back.
Perhaps most relevant for this discussion, however, is the fact
that women change jobs more often then men. We average 4.8 years with
each employer and, therefore, may not stay at a job long enough to be
vested in traditional retirement plans. Because women are more likely
to leave the job market to handle family responsibilities, we average
11.5 years out of the workforce compared to 1.3 years for men. With our
earning record interrupted, we not only lose the opportunity to vest,
but we have fewer years in which to contribute to retirement plans.
In the opinion of the Independent Women's Forum, traditional
retirement and pension approaches simply fail to meet the needs of our
changing society. Succinctly, they do not reflect the work patterns and
demographics of American women. Whether it's the Wall Street Journal or
Family Circle magazine, today's commentators agree that movement in and
out of the workforce for American mothers has become the ``new
normal.'' In fact, many are noting a current trend of mothers going
back home when their children become teenagers. In earlier times, moms
simply stayed home when their children were young--now we're worried
about the lack of oversight of our teenage children in an increasingly
complex culture. Regardless of the reason, this phenomenon, called
``sequencing,'' appears here to stay.
Luckily, pension innovations in the private sector hold promise.
Cash balance, pension equity and other hybrid pension plans combine
attractive features of a traditional defined benefit plan (employer
funding, employer assumption of risk of poor investment, government
insurance and spousal protections) with attractive features of a
defined contribution plan (individual accounts, an easily understood
benefit formula and portability).
These modernized pension arrangements have evolved to suit today's
more mobile workforce and respond to employee preferences for
transparency, portability and the accrual of more meaningful benefits
earlier in a career.
As you know, unlike traditional defined benefit plans where a
significant portion of the benefits go to the relatively few workers
with very long service, benefits in so-called hybrid plans grow more
evenly over a worker's career and are distributed more equitably across
short-, medium-, and long-service workers. For the vast majority of
employees who no longer spend a full career with one employer, a hybrid
plan will produce higher benefit levels than a traditional benefit plan
at equal cost.
We believe the emergence of hybrid plans is encouraging news for
many and a cause for particular hope among women. In fact, one
benchmark study done in 1998 by the Society of Actuaries found that an
amazing 77% of women do better under a cash balance approach. They are
better off under a cash balance system because they move in and out of
the workforce in order to balance family needs and because they cannot
afford to take early retirement \1\. Despite this promise, it is clear
that controversy exists about how firms should transition to hybrid
plans. Many have questioned the fairness of changing pension approaches
for employees over 40 years of age.
---------------------------------------------------------------------------
\1\ Kopp and Scher. Society of Actuaries. ``A Benefit Value
Comparison of a Cash Balance Plan with a Traditional Average Pay
Defined Benefit Plan.'' October, 1998.
---------------------------------------------------------------------------
An alternative perspective, and one that IWF believes has credence,
is that any adoption of restrictions that effectively limit the ability
of companies to transition to hybrid plans places the financial well-
being of the relatively few employees who have had the luxury of
staying with one company for a long period of time (decades), have the
luxury of taking early retirement, and have the luxury of taking their
pension benefit in the form of an annuity rather than as a lump sum,
ahead of all of the employees who do not have these options.
Regardless of one's perspective, any discussion about transition is
appropriately done within the context of a clear understanding that
these plans are voluntarily sponsored by employers. As such, an
employer currently could decide to freeze benefit accruals or
completely terminate plans altogether if costs become too burdensome.
Experience has shown us that many more plans have fallen victim to this
fate over the past decade than have transitioned to hybrid plans.
As such, an overarching concern we have in making these new
approaches viable is that Congress avoid the seductive panacea of
mandating choice between traditional defined benefit and cash balance
plans. Unfortunately, some analysts believe that mandating choice in
such a manner could result in employees being faced with a ``worst of
both worlds'' situation. Specifically, employers could make changes to
their traditional plans that remove aspects most valued by some of
their employees, while ironically being constrained from offering the
off-setting attributes of a cash balance plan.
As pointed out by pension experts Olivia Mitchell and Janemarie
Mulvey at the University of Pennsylvania's Wharton School, under an
approach that mandates choice in circumstances when an employer seeks
to convert to a hybrid plan (but not other changes), an employer could
eliminate early retirement subsidies without providing choice, but the
employer ``could not at the same time provide the more portable and
more understandable cash balance benefit without offering employees a
choice to keep early retirement subsidies.'' \2\
---------------------------------------------------------------------------
\2\ Mitchell, Olivia S. and Janemarie Mulvey. Working paper/PRC WP
2003-25. ``Possible Implications of Mandating Choice in Corporate
Defined Benefit Plans.'' Pension Research Council, The Wharton School,
University of Pennsylvania: 17.
---------------------------------------------------------------------------
Obviously the solution does not rest in mandating choice for every
plan change. To do so would only facilitate the death of the defined
benefit system--a system which offers noted attributes in the form of
employer contributions and employer assumption of risk.
The problem before this committee is complex and worthy of
objective analysis focused on providing a solution that fits the
changing nature of America's economy and workforce. The Independent
Women's Forum believes that portability is a real and growing need as
we look to the future of working women in this country. As such, we
strongly urge Congress to act in a manner that recognizes the
attributes of new approaches like the cash balance and other hybrid
plans, and keeps in mind that the one law that cannot be amended is the
law of unintended consequences.
Thank you again for your time and your attention to this very
important matter.
______
Chairman Boehner. Let me thank all of the witnesses for
your excellent testimony. It is a very important subject, and
having this hearing less than 5 months before a Presidential
election and an election for all of the Members of the House
and a third of the Members for the Senate probably poses some
risk that politics may enter into the debate.
But having said that, this is very important. The
retirement security of American workers is at risk. We have
seen the number of defined benefit plans, the decline that has
occurred over the last 20 years, we know the cost of operating
the defined benefit plan is very expensive and we know that
especially among younger workers they want more portability
with their retirement benefits. While you see this explosive
growth in 401(k) plans and, for that matter, the growth that we
have seen in cash balance conversions, and for the Members on
both sides of the aisle who are serious about our voluntary
retirement system, we know that cash balance conversions are an
important component to maintaining defined benefit plans, there
is just no other way in my view that you can turn the clock
back. And given the uncertainty that is out there, given the
inability of the regulators to act, we have to open the door
for those who want to come in and make some money. And I think
we are causing more concern among employers, we are going to
see less plans offered, and we are going to see more freezes in
the future.
It is pretty clear Congress must act, and I am here to say
to all of you today that Congress will act. It is our
responsibility as health legislators and public policymakers to
make clear what the law is and what it isn't, and too many
times we turn over to the agencies the regulatory ability,
which in many cases turns into a responsibility for them, to
make serious policy decisions as well. But I believe that the
Congress has sat back far too long on this cash balance issue
and it is time for us to act. And as we look at a comprehensive
reform of the defined benefit rules and regulations, the rules
and regulations surrounding cash balance plans must be dealt
with and will be dealt with.
Having said that, Mr. Delaplane, Ms. Collier, Professor
Clark, you heard Mr. Hill's comments about why we have cash
balance conversions, what they are intended or not intended to
do. What do you think?
Mr. Delaplane. Mr. Chairman, I would have to take a
different perspective. My guess is that Mr. Hill has not
actually been in too many of those employer meetings where the
reasons for cash balance conversions have been discussed. If
you look at objective studies from folks like the Federal
Reserve, they have clearly said hybrid plans have been adopted
in industries where labor mobility has increased, and so we are
clearly seeing the evidence that tenures are shorter in the
companies that have these plans, and these plans, as you
highlighted clearly, deliver higher benefits to employees.
So I disagree with that characterization. I also think you
folks very appropriately in 2001 enacted some expanded
disclosure requirements. The Treasury has issued very detailed
regulations there under. It is not even possible if anybody
even wanted to hide the ball to do so. Frankly, when Mr. Hill
testified in 1999 that was his focus, that we should do more on
the disclosure front. You have done that. The information that
employees get is very explicit, very clear as to how they will
be affected.
So I think you have addressed the issues that have been out
there. I take issue with the characterization.
Chairman Boehner. Ms. Collier.
Ms. Collier. Thank you, Mr. Chairman. In Eaton's case also
we are experiencing mobility, both internally and external to
the company. We have some critical skill sets such as
engineering that we want to maintain. We go to great lengths to
recruit those individuals. We find that the cash balance plan
has already begun to help us in that recruiting process and in
retention of these employees.
Similarly, we did not convert our plan in order to save
money. I think that is another misconception, and I hope we can
clear that up a little bit here today.
Lastly, I think that employers go through extensive
communication campaigns. As Mr. Delaplane said, you did revise
those disclosure requirements in 2001 in order to prevent
companies from camouflaging, as the term was used, any benefit
changes and decreases in benefits.
Mr. Delaplane. If I could also mention the issue of cost
reduction. There have been instances where employers have
decided they need to spend less resources on their pension plan
overall. That is nothing we should run from. If companies
decide their programs need to be reduced and that is how to
stay competitive and grow their business and add jobs that may
be a perfectly appropriate reason to make a pension change. Of
course, pension costs can be reduced in many ways. I assume
most members would prefer that a company remain in the defined
benefit system and have a plan that better delivers benefits to
their workforce as opposed to leave the system all together.
So, again, I don't want to act as if cost reduction on a
prospective basis is some horrible thing that automatically
dams the employer that has gone that route.
Chairman Boehner. Professor Clark, how would you react to
Mr. Hill's testimony?
Dr. Clark. Thank you, Mr. Chairman. It is certainly clear
that in an economy like ours companies have to respond both to
their own interest and to workers' interest in our labor force
that has been changing both in terms of age structure and
gender and minority status in lots of different ways, and that
has encouraged companies to think about how they are going to
offer their compensation and in what form.
So companies are in the business of looking at their
compensation and trying to determine what is it that their
workers want because for every dollar a company spends, they
want the worker to get the most value out of that worker
wherever that level is.
It is certainly true that companies must use their benefits
as well as their cash compensation to help them attract,
retain, and motivate workers. As the worker preferences change,
as the worker composition changes, companies must change that
as well.
I would come back fundamentally to the issue of what is the
relevant comparison. As Jamie just said, companies reducing one
type of compensation happens all the time. Companies change
their policies, health care policies are changing all the time.
You could go back and say are you going to hold constant health
care plans over time or are you going to allow companies to
restrict them and change them. Certainly the U.S. Congress
changes Social Security and changes Medicare. We don't give
workers choices about which ones they are going to take in
terms of whether they want to stay in the old Social Security
system right now, could they still get full benefits at 65.
Workers didn't get that choice. Congress made it for them.
So the government and the companies are in the business of
trying to appeal to the workforce, trying to set their policies
in such a way as to get the maximum value from hiring their
workers, and wages go up and they go down.
Chairman Boehner. Professor Clark, do you believe that the
concept of compounding interest is inherently age
discriminatory?
Dr. Clark. No. How it is specified in the law, I am not a
lawyer, I do not come to talk with you about what is age
discriminatory or not in terms of the legal approach to it, but
certainly it seems to me that a dollar in a person's pocket
whether they be 25, 45 or 65 is an equal treatment of that
worker. Everybody gets the same dollar, everybody gets the same
percentage of their compensation.
Chairman Boehner. The Chair recognizes the gentleman from
New Jersey, Mr. Andrews.
Mr. Andrews. Mr. Kildee was here first.
Chairman Boehner. The Chair is happy to recognize Mr.
Kildee.
Mr. Kildee. Thank you, Mr. Chairman. First of all, Mr.
Chairman, since we were allowed to have only one witness, the
minority had one witness, I would like unanimous consent to
submit to the record some documentation to complete the record.
Chairman Boehner. Without objection.
Mr. Kildee. I thank the Chairman. I would like to direct a
question first of all to Mr. Hill and then the others may want
to comment on that. There is a bill, Sanders-Miller bill, of
which I am cosponsor, H.R. 1677, which would first of all give
a choice to the employee between the traditional and the cash
balance plan and also would ban the wear-away provision.
Could you comment on that?
Mr. Hill. Yes, I will be glad to comment on that.
It is truly clear that some of the most virulent, if you
will, or the most emotional reactions to cash balance plans
have come in the conversion process, and two of the issues that
have caused the most concern among older workers are addressed
in that bill. One is, and Dr. Clark has written about it, the
nature of the relationship between the employer and the
employee. When an employer has essentially entered into what is
perceived by them to be a long-term contract, they sacrifice
current income in return for later increasing benefits. Having
made that choice and having lived with that choice for a
decade, two decades, in some cases three decades, only to find
that bargain dramatically altered overnight, has been an
enormous blow to them, particularly as it comes long after they
have made decisions about savings and their future.
That bill would address that very, very serious concern.
Mr. Kildee. On that point pensions really are an earned
deferred income, are they not? They are not just a gift from
the employer.
Mr. Hill. I have never met an employee yet who didn't
consider it to be a part of their incomes. When you talk to
employees who chose to forgo other kinds of plans, chose to
forgo higher employment pay on a current basis, chose to forgo
stock options during the late 1990's, they certainly thought
they made that choice. They lived with that employer and they
benefited that employer, and the employer made those promises
with that intention.
I mean, those promises are made to attract the kind of
workers those employers wish to attract.
The second issue that has hit older workers so severely is
also the wear-away which, as the GAO study acknowledged, could
impact people to the point where at 55 when their charges
occurred, they might go the rest of their professional career
without changing their pension benefits, even though they might
have been with that employer for 30 years. So that is clearly
the case and that bill would address two of the most serious
concerns that have arisen.
There are employees--employers, excuse me--and Eaton, I
know, only from what I have heard from Ms. Collier--that have
taken what I would call a more appropriate response in making a
conversion. But I would note that according to the recent study
done by Mellon that I being Eaton would fall in a category of 6
percent who have made similar kinds of conversion opportunities
available to their employees.
So from the perspective of any one company, any one of
these issues may be, I will say, slight or more serious or less
serious. However, from the broad breadth of employees, the 7
million or so that have been impacted by this, clearly those
two issues are at the forefront of their concerns.
Mr. Delaplane. If I might just comment on that, Mr. Kildee.
Mr. Kildee. Surely.
Mr. Delaplane. I want to reiterate something that Chairman
Boehner said. We have a provision of law today which ensures
and requires that no benefit earned for service today can be
taken away. So promises made by employers are promises kept,
and that provision of law ensures that. I want to be clear
about that.
In addition, let us recognize that when employees
experience a significant wear-away, it tends to be because this
early retirement benefit under the prior plan was very, very
generous. These, again, are some of the richest benefit plans
in the country. Many workers would be envious to have such a
subsidy in their plan. So that is what really explains this
wear-way, the very generosity of the plan prior.
With respect to the legislation you referenced, here is
why----
Mr. Kildee. But their wages may have been generous too. You
are not asking them to give some of the wages back through the
years, are you?
Mr. Delaplane. What I am saying is what Professor Clark has
said. In the future for days not yet worked, conditions can
change. So I think we go down a very slippery slope with a bill
like H.R. 1677 which basically says we are going to guarantee
employees future benefit expectations. We are going to turn
them into legal rights. Because if I as an employee decide I do
not like a pension change, I just choose my way out of it. The
problem with that is a very slippery slope. Why are we singling
out cash balance conversions for these kinds of changes? And
employers are very concerned that quickly we are going to say
that you can't change your traditional plan without a choice,
you can't change your health plan without a choice, you can't
change your 401(k) match without a choice. We are not clear
where it ends and we worry that that creates very significant
problems for employers, minimizes their ability to be flexible.
That is our real policy concern with a bill like H.R. 1677.
Mr. Kildee. My time has expired. Let me say as one who
recognizes the fact that you cannot have employees without
employers, I want to have a balanced bill. And I think that
H.R. 1677 tries to achieve that balance and give some
protection to the employee, while recognizing some of the needs
of the employers.
We have tried to achieve that balance and I hope if we
report a bill out of here, that some of the wisdom from this
side of the aisle might be coupled with some of the ideas on
your side of the aisle.
Ms. Pfotenhauer. Congressman Kildee, there is a very
interesting working paper that is being authored by Olivia
Mitchell and Janemarie Mulvey at the Wharton School, entitled
``Possible Implications of Mandating Choice in Corporate
Defined Benefit Plans.'' it is just a working paper and does
not speak directly to the legislation that you mentioned. But
it heightens my concerns about unintended consequences of doing
this type of thing, and I would highly recommend that your
staff take a look at this and see whether they think those
concerns are relevant.
Mr. Kildee. We will do that. Thank you very much.
Ms. Collier. Mr. Kildee, I believe you asked me to comment
on Mr. Hill's testimony as well, and I would like to do that.
Although it was, I think he used the word ``appropriate,'' that
we had an appropriate conversion and that was appropriate, but
it was appropriate for Eaton. I have also worked at a prior
employer and been involved in two cash balance conversions at
that employer and we also had conversion techniques but they
did not involve choice. There are a lot of different techniques
out there and a lot of valid techniques out there that should
be appropriate for that company.
Secondly, you asked me to speak--oh, and your study also,
Mr. Hill, mentioned the 6 percent. I think that is specific
just to choice. There are other conversion techniques out there
that are either in the Mellon study or in the Watson Wyatt
study. I think the number is larger than that when you include
all techniques.
And as far as wear-away, we did some have some wear-away in
our plan but we took great steps to mitigate that. And also we
had 11 percent of our employees over 55 choose the cash balance
plan because wear-away is often a temporary condition. And
those employees who expect to work longer in their careers were
actually better served choosing the cash balance plan.
Mr. Kildee. Thank you, Mr. Chairman. I thank the witnesses.
Mr. Johnson. [Presiding] Thank you. And you know we will
take your remarks into consideration in everything we do.
Especially Rob down there. Mr. Delaplane, if certain mandates
were required in the voluntary employer-sponsored system to
mandate employees' expectations of benefits, could these
mandates affect employment practices and America's overall
competitiveness in the world economy?
Mr. Delaplane. Mr. Chairman, I think you raise a very
important caution about those sorts of proposals. As I
mentioned in my earlier response, it is not clear where the
line will be drawn and why all benefit changes would not be
subject to this protection of expectations. Part of the reason
that we have had robust employment in our country is that
employers have had the flexibility, prospectively, to alter
their benefit programs, alter their comp structure, and be
nimble and move in the economy accordingly.
If you contrast that with more of a European model where it
is very, very difficult for employers ever to change the
conditions of employment from the day the employee began, you
see much less robust employment sort of systemically. And I
think the concern is if we layer on these protections of
expectations and we prevent employers from being able to make
changes, that is the direction we are going to go. Employers
are going to be much less willing to add people to the payroll,
knowing that it would be virtually impossible to change their
pay and benefits going forward. So I think it is a very
significant risk to competitiveness.
Mr. Johnson. Thank you. You all talk about lump sum
payments. That seems to hurt more than helps. Would you all
comment on that and can you tell us whether we should even
address that issue or not?
Mr. Delaplane. It has certainly been one of the attractive
features of the hybrid design for most employees. They value
the fact that the benefit can be taken as a lump sum.
Mr. Johnson. But they do not have retirement for the long
term.
Mr. Delaplane. By law, luckily the hybrid plans, like the
defined benefit plans, are required to offer the benefits also
in the form of a joint and survivor annuity. So unlike the
defined contribution 401(k) world where that is not a
requirement, for hybrid plans it is a requirement to offer an
annuity. Part of the reason here----
Mr. Johnson. But it is still the employee's choice.
Mr. Delaplane. Still the employee's choice. One thing that
may address your concern is that employees can take that lump
sum from a hybrid, roll it over to an IRA and continue to
invest it and have it build more in earnings today, before
retirement. And that actually protects from the harms of
inflation. In a lot of traditional plans where you can't take a
lump sum, your benefit is a fixed dollar amount over time and
becomes less valuable over time. The hybrids help respond to
that problem. At least the lump sums continue to be invested
and rolled over and grow all the way to retirement age.
Mr. Johnson. Yes, sir?
Dr. Clark. Thank you, Mr. Chairman. In comparing what
companies might do, certainly many companies might, as has been
suggested here, close their defined benefit plans and open a
401(k) plan as many companies have done over the last 30 years.
And when you start thinking about are cash balance plans better
than that alternative as opposed to are cash balance plans
better than retaining the traditional plan, you have to
consider, because clearly that is an option that many companies
have followed.
And the annuitization issue is certainly one that is very
important in that choice, as is the investment risk. One thing
about annuitization and lump sums, though, whether you are
looking at the U.S. or Japan or anywhere around the world where
lump sum options are offered, people take them.
Mr. Johnson. Generally speaking, though, they spend it. It
is not there for their long-term retirement.
Mr. Delaplane. And one issue that you folks have addressed,
recently the 30-year Treasury bonds, which you very helpfully
provided a replacement rate for 2 years. A piece of that issue
we have not yet confronted is the use of the 30-year Treasury
rate in valuing lump sums from defined benefit plans. The fact
that we still have to use this low 30-year Treasury rate means
that the lump sums are artificially inflated and we are tipping
the playing field toward employees taking the lump sums today.
They are more valuable than the equivalent annuity. And
obviously that is one of the issues you are hoping to address
long term, but that contributes to the problem that you are
raising.
Mr. Johnson. That is a great point. Thank you.
Mr. Hill. Could I respond to your question earlier about
international competitiveness? I think employees and employers
are mutually concerned about international competitiveness. And
as with so many of the issues that you have addressed
congressionally in terms of public policy, the question is
striking the proper balance.
We are, after all, sitting here talking about Congress
having mandated a prohibition against age discrimination in
context of certain tax-incentivized private pension plans. I
think this year it is going to cost about $90 billion for the
taxpayers to have this, quote, private retirement system we are
talking about. We are all concerned about that and we are
concerned about modifying a prohibition against age
discrimination.
If we were talking about modifying a prohibition against
sexual discrimination or racial discrimination, I think we
would not be talking about the cost of that in terms of
international competitiveness. Each of those bears some cost
arguably. But I think we as a country have decided those things
are sufficiently important to us that we are going to value the
prohibitions against sexual discrimination or racial
discrimination or any other kind of discrimination that you
have chosen as a public policy.
So what we are really talking about is whether there is a
modification of the current prohibition in the tax-incentivized
private system for pensions. And that is all we are talking
about here at the core.
Mr. Delaplane. Mr. Chairman, if I might real quickly. As
Mr. Hill knows, the legislative history of that pension age
prohibition in 1986 was very clear that the practice Congress
was focused on was employers who were ceasing continuing
accruals when somebody hit normal retirement age at 65. That is
in the title of the provision in the statute and in the
legislative history. I do not think--I sort of challenge the
idea that you are walking away from some commitment that you
made. It was very clear that was the fact pattern that Congress
was focused on, which wouldn't even reach to the issue of what
is happening to pre-65 employees.
Mr. Johnson. Thank you. You know, this is an interesting
discussion. I appreciate all of you participating. Did you want
to make a comment?
Ms. Pfotenhauer. If I might. Since the Society of Actuaries
has done the analysis in 1998 that showed that 77 percent of
women are better off under cash balance plans, I don't think it
is outrageous to contemplate a scenario where people like me
might feel that any action of Congress that made it less likely
that a cash benefit plan was going to be available was actually
gender discriminatory.
Mr. Johnson. Thank you. Mr. Andrews, you are recognized for
5 minutes.
Mr. Andrews. Thank you, Mr. Chairman. I want to thank the
witnesses for their very substantive additions to helping us
solve this difficult problem. Thank you. I have enjoyed reading
what you had to say and listening. Solving difficult problems
almost always requires us to compromise and to find middle
ground between two very defensible positions. The first is the
fairness to employees who reasonably rely upon a set of
expectations in their lives and in their family budgets, and
the second is to make sure that employers who are voluntarily
providing pensions can do so in a way that is consistent with
the competitiveness and success of their business. I don't
think that those are mutually exclusive goals and we are trying
to find the common ground between the two of them.
Mr. Delaplane, I wanted to ask you on this question of
choice prospectively. That is to say, where an employer is
considering make conversion from a defined benefit plan to a
cash balance plan. I think I heard you say that you oppose the
idea that employees would be permitted to choose whether to go
into the cash balance plan or keep the traditional plan. Is
that your position?
Mr. Delaplane. We would oppose that as a mandate; correct.
Mr. Andrews. Under what circumstances would the employer be
disadvantaged if an employee chose to stay in the traditional
defined benefit plan? What is wrong with that from the
employer's point of view?
Mr. Delaplane. There may be nothing wrong with that. It
depends, obviously, on the demographics of your workforce. I
think part of the problem is if that is a worker who will not
be with the firm for an entire career, you are likely to see
disappointing benefits under the traditional formula because it
is so backloaded to the end of a career. If you are as an
employer trying to say how can I most equitably use my benefits
budget to deliver meaningful benefits to the people who work
for me, the traditional plan for many employees is not the way
to do that.
Mr. Andrews. If I may, that is a disappointment for the
employee and he or she has made that choice. People are
sometimes a little irrational, but if you have chosen to stay
in the defined benefit plan, you do not have a lot of grounds
to complain that it is not as good for anything else you might
have opted for.
Mr. Delaplane. I understand. But employers are trying to do
right by their folks. The traditional plan may have these very,
very rich early retirement subsidies, and again a lot of
employers have job shortages in certain categories.
Mr. Andrews. But if I understand correctly, the legislation
Mr. Kildee referred to would not prohibit the employer from
modifying those retirement subsidies. If you kept your DB plan
and chose to modify your early retirement subsidies, there is
nothing in that legislation to preclude that. That is a
separate question from choosing not to go into the cash
balance.
Mr. Delaplane. The bill has another provision on wear-away,
which Mr. Kildee mentioned, which makes more complicated the
effort to strip out the subsidies. So there is a piece to that
issue. But I think the primary concern is that you are not--it
is really the precedent. Why are we elevating this particular
kind of benefit change above all others for this brand-new kind
of----
Mr. Andrews. I think the answer would be because it is the
only kind of benefit change I could think of where the employee
might wind up poorer than he or she would otherwise be. I
cannot think of any other conversion where that would be the
case.
Mr. Delaplane. What about the incidents that happened Mr.
Andrews where employers have concluded they have to suspend
their matching contributions to their 401(k) plan. And
employers have had to do that. So that the only money going
into the 401(k) at that time is the employee money. The
employer contributions which would normally be triggered are
not occurring.
Mr. Andrews. But that is not a plan conversion. That
presumably flows off of economic difficulties that the employer
is having generally.
Mr. Delaplane. I guess what I would say is that we do not
see a principal distinction why, if Congress believes that
protecting the expectations is right for the traditional plan,
it is also right for the----
Mr. Andrews. Here is how I see the difference. I certainly
do not support something where we require someone to keep a
promise that they did not make. If we passed a law that said we
have to keep the employer match under the 401(k) no matter what
is happening to your business, that is a promise that the
employer did not make.
On the other hand, when an employer enrolls someone in a
defined benefit plan and says if you work a certain number of
years and make a certain amount of money and retire at a
certain age, this is what you are going to get, I know the
legality of that promise is subject to dispute but the morality
is not, and it seems to me that it is important.
Can I ask Mr. Hill a quick question? I know that you do not
seem to like the cash balance plans at all. At least I derive
that from your testimony. I do not agree with you on that. I
don't think there is anything inherently wrong with these
plans. I would ask you to submit for the record your thoughts
on what a fair conversion might look like. It is clear what you
think an unfair conversion looks like. I would be interested in
your thoughts as to what you think a fair conversion looks
like.
Mr. Hill. Would submit that. It is unfair to ask a lawyer
to do that. We all the time take directions from you and then
we argue about what you meant.
Mr. Andrews. I know it is unfair. I am a lawyer; that is
why I asked you the question.
Mr. Hill. I respect that. I was going to suggest you were
getting it back in kind. We normally can dump off and impose on
you----
Mr. Andrews. It is a professional discourtesy, I guess.
Chairman Boehner. [Presiding] Thank goodness I am not a
lawyer. The gentleman's time has expired. The Chair recognizes
Mr. Burns.
Mr. Burns. Thank you, Mr. Chairman. I too share your
challenge, not being a lawyer. So I will join this discussion a
bit and seek to get more input.
As an individual who worked for an organization for 20
years and enjoyed a defined benefit plan, and having a choice
late in that career to change, chose not to because, as you
suggest, maybe that would be to my personal best interest.
The first question is if you look at defined contribution
plans versus defined benefit plans, do we agree on which
theoretically is better? Do we agree theoretically, Ms.
Collier?
Ms. Collier. I actually think they serve different
purposes. Someone earlier stated that savings plans, the 401(k)
plans were never intended to be one's sole source of
retirement. So in our case we use them to encourage employees
to save and we do that by matching at one of the safe harbor
generous employer match.
Mr. Burns. If you look at any growth curve--if I started at
25 and stayed to 65, is a defined contribution plan a superior
plan?
Ms. Collier. No, not necessarily. The defined benefit plan
offers security. It offers a guaranteed interest rate. The cash
balance plan I am speaking of in this case.
Mr. Burns. Are we really arguing about conversion issues
and about the early retirement boost that many--not many, but
some plans offer?
Ms. Collier. I think that is one aspect. But I think we are
also concerned about the general legality of the age
discrimination.
Mr. Burns. Age discrimination has come into the discussion
and it has clouded and muddied the water fairly substantially.
Dr. Clark. Mr. Burns, if you look at the three types of
plans and you line them up and you offer them to different
workers, some workers would clearly prefer the traditional
defined benefit plans, others would clearly prefer the cash
balance plans, and others would clearly prefer the defined
contribution plans. In my view, they are all relevant
retirement plans that can provide an adequate retirement
income, provided that the person follows through or the company
follows through on particular decisions.
The characteristics of those plans appeal to different
people based on their risk aversion, their career paths, and
all of these others, which is why I would say that it is
important to have all types of plans out there. And the other
thing we have to keep in mind is that the employer and the
employee are both interested in the value that they get out of
the plan for every dollar that is put into the plan. And that
includes all of the costs of managing the plan and operating
the plan as well as the net rate of return, then.
And when there are events that happen that increase the
costs to any one particular plan, workers and firms are likely
to move from one plan to another. And that is basically what
has happened with the defined benefit world, is that Congress
raised the price of that plan relative to the other types of
plans and companies and workers were choosing increasingly
defined contribution plans. It does not make it inherently
better; it just means that at the current prices, more people
are choosing this plan versus the other.
Mr. Burns. I have an inherent problem with mandating
volunteer participation. And one of the questions I have, if
Congress was to mandate early retirement subsidies in a
conversion program, what impact would that have on businesses?
And really providing benefits to employees that maybe they were
not entitled to?
Dr. Clark. I think that early retirement subsidies were put
into the traditional defined benefit plans in an era when
companies wanted to encourage older workers to leave. That was
in the period of rapid labor force growth and a period of more
homogeneous worker force. Lots of reasons why companies chose
that as an optimal human resource policy.
In today's climate that is not happening. Instead, more and
more companies are going to be looking at a slowly growing
labor force. Valuable workers with good experience, these are
productive senior workers. There is no reason to encourage them
to leave. I believe that companies around the country will
ultimately be moving more and more in the direction of looking
at their entire human resource policies and trying to figure
out how to keep older workers on rather than trying to push
them out. And certainly the elimination of early retirement
subsidies is consistent with that public policy and consistent
with the objectives of Congress as we look at Social Security
and other areas of fiscal certain.
Mr. Burns. Ms. Collier would you address that point?
Ms. Collier. Yes. You mentioned specifically the mandate
issue and that is what concerns me the most. While we were
undergoing our conversion process, a lot of people would call
me from around the country, different companies, and ask how we
were doing and what the appropriate--how we were converting and
what our communication strategy was, et cetera.
Since 2003, even with the threat of mandates and the
introduction of proposed legislation, those calls have changed
dramatically in content. The employers are calling but they are
not changing from one defined benefit plan to another. Rather,
they are either freezing or terminating or converting their
defined benefit plan and having a defined contribution plan
only for the future. It is already starting to take effect in
my personal experience.
Chairman Boehner. The Chair recognizes the gentlewoman from
California, Ms. Woolsey.
Ms. Woolsey. Thank you, Mr. Chairman. And thank you to this
panel.
We were talking about conversions and that we can take care
of the current older workers, and that is possible by letting
them grandfather/grandmother and stay in their plans. But you
know our responsibility up here is to all workers and all
employers and looking at the longterm for retirement. And
somebody, one of you, and it may have been you, Mr. Delaplane,
said that employers are constantly changing their benefit plans
because they are fluid. I am a human resources specialist
professional for 20 years before getting here. And that is
true. They are, and they have that right.
But sitting up here, the Federal Government, I mean, what
we do, if we change Medicare, if we change Social Security and
drastically pull the carpet out from what people know that they
can count on, we get fired. The CEO does not get fired by the
employees when they decide that the company wants to cut costs.
We will get fired.
And what we are counting on when we have Social Security
is--the minimum base of what a worker gets is that they are
building on top of that. So when we talk about--and I have a
question for you, Ms. Pfotenhauer, Nancy, I want to call you
Nancy. When we talk about unintended consequences it is not
just on the employer. We are looking at this long-term woman
that worked. You said that she was lucky enough to be working
longterm for the same employer. Wrong. The employer is lucky
enough to have had an experienced, long-term, loyal employee.
The unintended consequence is to even think about removing
her benefits and pulling the rug out from under her. We need to
protect those workers. We need to encourage long-term loyalty.
So I want to ask you how you think that can happen. And at the
same time, I want all of you, if you will, to answer me about
more portability, mobility, with these cash balance plans 5
years to vest. How is that more mobile and more portable?
So I will start with unintended consequences.
Ms. Pfotenhauer. Let me start with why someone is lucky if
they are able to maintain employment for two decades. We are
struggling right now. It takes two working parents to support a
family. Many women are finding themselves in a position of
being single parents where they are providing most of the
financial support for themselves and their children.
And frankly I think women, as well as the employers who
employ them, are lucky if they find a job situation that works
out for two decades. It is clearly not happening for the
majority of women who stay on a job less than 5 years. And they
do that for different reasons and the data does not allow us to
imply why. But it seems to strongly support the contention that
women tend to take more time out of the workforce as they try
to do that balancing act to take care of children and elderly
parents.
So basically I think someone is very, very lucky, male or
female, if they are able to find a workable employment
situation.
Ms. Woolsey. Absolutely. So I am going to take back my time
a little bit and have a discussion with you. Therefore, we
should be using that as the way we want to go, not to make it
harder for them. Five years, if they are in and out of the
workforce and 5 years vesting?
Ms. Pfotenhauer. They are averaging 4.8 years. And what you
find and what the data clearly shows is that this trend of
women going in and out of the workforce is not going away. And
I am not sure it is the job of this Committee to try to make it
go away. Because what is happening is something called
sequencing in labor patterns where women are not just taking
time out when their children are first born, but are actually
taking time out again when they are in high school, because
there has been a resurgence of concerns.
Ms. Woolsey. Actually, you are a great straight person for
me, because I have legislation called The Balancing Act to
Bridge Work and Family. Ms. Collier, did you want to respond to
this?
Ms. Collier. Yes, I want, thank you. In regards to
mobility, I think I mentioned mobility is also an issue for us
internally to the company with over 100 locations in 40 States.
We have a lot of people that were transferring from one
location to another. And in doing so, they were often turning
us down perhaps because of the difference in pension plans. So
we solved that problem internally as well by doing our choice
program.
In addition, as far as vesting, we voluntarily vest our
401(k) match immediately. And then we want to continue to have
an incentive for some of these highly recruited employees, be
it in engineering, HR--we have an H.R. developmental program--
supply resource management, IT, what have you, we would like to
have an incentive to keep them for 5 years. There is a
considerable amount of training, as you know, that goes into
building someone's career skills in the first 5 years, and by
doing so we hope to continue to entice them to remain with us
by having a plan that is very visible and attractive to these
employees.
Ms. Woolsey. Just a minute Mr. Delaplane. I want to thank
you. I really think we ought to use Eaton as one of our model
companies unless there is something I am missing here. But you
do know that not all employers are as responsible as you are.
Mr. Delaplane.
Mr. Delaplane. Just a couple of quick points about vesting
when an employee stays with a company for 5 years or 6 years.
Under a hybrid plan they will depart with a much higher benefit
than they would have departed with under a traditional plan. So
you have to make it to that vesting threshold, obviously. But
the way the benefits accrue in a cash balance plan, you leave
with a much more significant benefit. So that is the advantage.
Ms. Woolsey. If you stay 5 years.
Mr. Delaplane. If you stay 5 years. And Ms. Woolsey, as an
employer organization, we want to emphasize a lot of common
ground with you. We do want to see as many employees as
possible enjoy those defined benefit plan benefits. They are
employer funded, they are backed by Federal guarantees, they
have spousal protections. And I think our perspective is that
we do want employees to be able to remain in that system. A
traditional plan or a hybrid.
And to your point about conversions, I think Eaton has
become close to the norm. If you look at the data we cite in
our written statement, 9 out of 10 employers provide very
significant conversion assistance of one sort or another to
their older workers, whether that is choice, whether that is
grandfathering. It is the unusual employer in financial
distress who may not do those additional conversion benefits.
Frankly, I think many of the key concerns many have had about
conversion has been addressed in the marketplace.
Ms. Woolsey. Dr. Clark?
Dr. Clark. I think the fundamental principle of a lot of
the discussion that we are having today is the difference
between the exit pension, or what has legally been earned, and
the expectation of workers from their pension. And as Mr.
Delaplane just said, if you are leaving from 5 years out to 20
years, you are typically going to leave with a much bigger
benefit under a cash balance plan or a defined contribution
plan than you would with a defined benefit plan.
If you stay all the way to early retirement, if you stay
all the way to early retirement, if the company keeps the
pension plan, if the company does not convert to a defined
benefit plan, if they do not do away with the early retirement
subsidy, then you would get a bigger benefit. One of the
problems that companies have with workers is trying to explain
what the benefit that they do have under the defined benefit
plan is. And the benefit calculators that were mentioned by Mr.
Miller earlier is one way that they try to show that, but that
is really based on all of these expectations that you might get
there, and it certainly leads to the impression that it is a
guaranteed benefit even when it is not.
And so how do you explain this? Communication is a very
important key for an ongoing plan, but it is essential when you
are making a conversion. And those companies that have
converted pension plans, that have had good communication
strategy, have had the transitional benefits, have made these
transitions with essentially no adverse reactions, no need for
lots of lawyers involved, and the plan has gone forward.
Those companies that had bad communication plans or did not
have transitional benefits, or smaller ones, had more problems.
That is the issue. What is the benefit that people have earned?
What do they think they have earned? And what is the legal
benefit that they actually have earned?
Ms. Woolsey. In the long run, the more healthy our benefit
plans are, the better the retirement benefits, the healthier
this Nation is. Because somebody is going to be supporting
older Americans.
Chairman Boehner. The gentlewoman's time has expired. The
Chair recognizes the gentleman from Georgia, Mr. Isakson.
Mr. Isakson. Thank you, Mr. Chairman. I want to
congratulate Ms. Pfotenhauer on what I think may be the hearing
quote of the decade when she admonished us that the only thing
we cannot amend is the law of unintended consequences. I
thought that was a great line and I would like to follow up on
that line by asking you a question.
It appears to me if the Cooper versus IBM decision stands
unaddressed by Congress statutorily, that the unintended
consequence vis-a-vis the age discrimination interpretation in
that case would be that there are not going to be many defined
benefit or cash balance plans and everything is going to be
defined contribution. Would you comment on that?
Ms. Pfotenhauer. That is really why I am here today. That
is our greatest concern. As I said, this is not a Republican or
Democratic cut on the issue. It is just clearly there in the
numbers, and that is that women benefit much more under a cash
balance approach than they do under the traditional approaches.
And it is not just because of their traffic in and out of the
workforce. It is that other point. It is that we rarely can
afford to take the option for early retirement.
So we think that we are a relatively small organization. We
choose our issues carefully. We think this is dramatically
important to our constituency in term of what we work on for
retirement security.
Mr. Isakson. Mr. Hill, would you agree with my reasoning
that if Cooper stands and Congress does not address the issue
of age discrimination and the time value of money, that in the
future for workers coming into the workplace there is a
likelihood the only thing you are going to see is the defined
contribution plan?
Mr. Hill. I do not agree with it but I recognize it is
speculation as we are all speculating about something that
other people would do in the future. The point I would make,
though, is that with far less expense than converting to a cash
balance plan, if employers wish to address the women's issues--
--
Mr. Isakson. I am letting you handle the men's side. She is
to address the women's side. I want you to address the men's
side. We do not live as long and all of that stuff. But the
absence or the unintended consequence of reducing the
availability of defined benefit or cash option or hybrid plans
seems to be inevitable if Cooper is not addressed by this
Congress. My question to you is, does that not seem pretty
apparent to you too?
Mr. Hill. No, it does not. What Congress has done is define
two different worlds, a defined benefit plan and a defined
contribution plan at this time, and that is what you have done.
And you have imposed uniform obligation in each of those
categories that differ because of the different structure, the
risk analysis, who is taking and making investment decisions,
and all of those kinds of things.
It seems to me that if we were properly presented with this
issue, it would have been those who wish to see changes made
that would be more receptive, for example, to some of the
issues that are raised--and I do not disagree that those are
valid policy issues for this Congress to address--would have
come before Congress and asked for the creation of a third
category where these kinds of public issues would have been
debated, where the balancing that you are talking about--and I
agree it is a proper balancing--would take place.
That is not what happened. Rather, without that kind of
consent in the face, I would say, of mandatory age
discrimination language in the statute, they chose on their own
to go off and come up with plans that have some of the aspects
of both the defined benefit plan but also want to have some of
the essentially legal defenses and legal authorizations of a
defined contribution plan. And that is not the current law.
But the way to come back with that would be for Congress to
address this in the first instance with a policy balance that
if you agreed, for example, with Dr. Clark that there should be
a third type of plan in the marketplace, you would then do that
and you would address it in that fashion.
I would suggest also employers can address those same
issues regarding women and deal with it in a far less expensive
plan than cash plans if that is truly their motivation.
Mr. Isakson. Your case, well stated, presumes your obvious
agreement in Cooper in regards to age discrimination and the
compounding of interest. My comment to you would be the
following: Yesterday by happenstance, not by plan, I spoke to
80 employees of a major company in my district, but it is a
national company whose company last year, 2003, adopted--gave
them choice on defined benefit or to a hybrid cash balance
plan. And the concerns expressed to me in that meeting about
the uncertainty based in that case on failure of Congress to
deal, puts in jeopardy those types of choices in the future and
ends up having the unintended consequence--if you look at
business and the environment we are in today--of employees
really getting less options in the future than they have today.
And I am making a statement here. I am really not asking a
question, I apologize Mr. Chairman. But it seems--the argument
to me on the comparison of the 25-year-old worker and the 55-
year-old worker and the compounding of interest and that being
age discrimination is to me ludicrous. But it is more ludicrous
that we would sit here as a Congress do nothing and create an
environment where the opportunity for benefits for employees,
valuable employees working, just diminished because of the
consequence of our inaction. Thanks for letting me make a
statement.
Chairman Boehner. The Chair recognizes the gentleman from
Oregon, Mr. Wu.
Mr. Wu. Thank you very much Mr. Chairman.
This is a truly challenging issue, and one of the
challenges of this job is trying to drill down deeply while
covering the breadth that we need to do. My reading on this was
done one or more years ago. My recollection from the CRS, the
Congressional Research Service materials that I read at that
time, is that if you look at graphs, if you change jobs a
certain number of times, at some point based on job change and
number of job changes or period between job changes, there is a
crossover point between the traditional defined benefit plans
and the cash balance plans. Do I recall that properly?
Mr. Delaplane. Mr. Wu, we actually cite in our written
statement an analysis that looks at a person who changed jobs
three times in a career as opposed to a person whose changed
none, no times. And for the person who changes over three
times, which is less than a lot of people do, the hybrid plan
would produce 17 percent higher benefits than the traditional
plan. And for many employees just a single job change can yield
the hybrid plan producing a higher benefit.
Mr. Wu. Conservatively speaking, if there are three to five
job changes in a career in a working lifetime, your assertion
would be that cash balance plans would better serve the
financial needs of that particular employee.
Mr. Delaplane. Absolutely.
Mr. Wu. OK. Having established that, it was my Republican
law partner when we were looking at our benefits plans and I
thought that we would have a vesting period of 1, 2, or 3
years, and it was my Republican law partner who said having an
employee stick around just to vest is probably the worst idea
there is and we ought to just vest people on Day One.
If we do assume that people move around from job to job and
if hanging on purely to vest is a bad idea, then what is the
matter with pushing the vesting envelope so that instead of
vesting at 5 years--we had a discussion in this Committee of
whether the vesting period should be 1 year or 3 years under
different legislation. What would be any meaningful problem or
any significant problem with vesting--with pushing that vesting
envelope so that instead of 5 years it was 3 or 1, or even
vesting as Eaton does with its defined contribution plan?
Chairman Boehner. If the gentleman would yield, as you know
under the defined contribution plans, the limit, the maximum
limit is 3 years. It could be zero. For defined benefit plans,
the maximum vesting period is 5 years. Could be far shorter
than that at the election of the employer.
Mr. Wu. I understand, Mr. Chairman. And we have had
discussions on this topic which I have enjoyed, and the
question is whether that upper limit should be legitimately
pushed down from 5 to 3 to 1, perhaps approaching zero. Are
there any problems with that?
Ms. Collier. Well, someone mentioned earlier there are only
so many benefit dollars a corporation has to spend. My fear is
there is obviously a cost increase there. There is also
employee retention. We do vest our defined contribution
participants immediately, but we do have an interest in getting
the most out of these new recruits. And 3 years does not even
give enough return on our investment, if you will, for the new
employees. It is both the cost of the benefits and the ability
to retain people for those first 5 years, and hopefully then
they will see that their career path is with Eaton and not
another company. We do not want to train employees who then go
on to other companies after a few years.
Mr. Delaplane. Mr. Wu, as I think you know, many of the--as
a matter of fact, the vast majority of employers who have
adopted hybrid plans also offer a defined contribution plan,
like Eaton does. So we have got a variety of techniques to use.
And you are seeing, not just as a legislative matter but as a
voluntary matter, that the vesting schedules in those defined
contribution plans have been coming down.
It is a balancing act. You do want to get benefits to
people quickly, recognizing the patterns in the workplace
today. But as Ms. Collier referenced, you want to have some
incentive--not necessarily to be there for 30 years, but to
stay to 5, to stay to 7, to stay to 10. And it is a balancing
act and Congress has obviously tried to set that balancing act
appropriately, as employers do.
Ms. Collier. And it is also something that I don't hear
about from my employees. They are not expressing an urgent need
for it. Congresswoman Woolsey, you were an H.R. professional.
You hear about aspects of a benefit plan that are not popular
and we are not hearing it.
Mr. Wu. Mr. Chairman, since I yielded a part of my time, if
I could finish this part of the analysis. It seems to me that
most of the surveys show that pay is an important factor, but
not the top factor, and probably benefits is behind pay in
terms of retention and people's decisions about where they
choose to work.
And that being the case, this being such an important
policy arena to provide for secure retirement, you are probably
not getting that good a leverage from the vesting efforts. At
least the competitive philosophy that I have always used, that
I picked up from our high-tech clientele that we used to serve
before I came here, and the competitive philosophy that we
still use on the congressional staff is that we want to provide
the absolute most conducive working environment to give
satisfaction to our employees in terms of what they want to do
with their lives. And as long as they are adding value to the
team and the team is adding value to them, then it makes sense
for us to stick together. And that some of these other
considerations get in the way of a secure retirement, but they
may not be very effective in terms of retention policy.
And I just want to submit that for your consideration and
your written comment. And, Professor, if you have something to
add, I am sure that the Chairman will indulge you.
Dr. Clark. Well, the only thing I would add out of that is
I think that if you calculated the present value of a defined
benefit plan from working 1 year, it would be infinitesimally
small; so the value to the worker in a traditional defined
benefit plan of working less than 5 years, like, say, 1 year or
immediate, would not be that great. You are calculating the
value way out and discounting it back.
That is why you don't hear about it from the younger
workers. They look at it and say, even if I had this it
wouldn't be worth anything to me today.
Mr. Wu. I may change my mind as I get older also.
Dr. Clark. Value to you would be greater if you were older
and closer to retirement and had more years of service.
Mr. Wu. Thank you, Mr. Chairman. Thank you to the
panelists.
Chairman Boehner. Mr. Payne. The Chair recognizes the
gentleman from New Jersey.
Mr. Payne. I am sorry that I missed--this is an area that I
have had a lot of interest in over the years. Being older, I am
more familiar with the defined benefit because many, many years
ago, as all of you know, that was the type of thing that most
workers had. You knew you were going to work 40 years at one
place, retire, you were going to get X-amount of dollars and
that was it. Of course the advent of the 401(k) and the change
in the way that employers decided to provide for retirement
security changed a bit. And of course this cash balance plan is
something that I am less familiar with.
But I might ask Mr. Hill, I know you are strongly opposed
to it. And I wonder if you could--I am sure you did in your
testimony, but in maybe a minute or two, tick off the two or
three reasons why you feel that this would not be wise to
advocate this type of plan. I know the discrimination between
older workers and younger, but if you could just give me a
thumbnail sketch.
Mr. Hill. Certainly. One of the concerns at the forefront
that I have, and it goes to the question of myth or fact: why
these plans have become popular when they were popular, given
the warning signs that were out there about the age
discrimination issues. And I would respectfully submit that a
significant motivating factor would be what I would call the
financial accounting issues, the ability to present the company
in a more attractive financial way as a result of these
changes.
If that is the case, then a lot of the things that we are
talking about here today really become far less significant
because they are not really what is motivating these changes in
terms of the employer-employee relationship.
A second concern I had--and there was a reference back to 5
years ago when I testified regarding disclosure--even with the
current disclosure requirements, what has happened is that the
implementation or the conversion to a cash balance plan, which
is the most controversial portion of them, has come in an
environment where they are often masking other changes.
For example, there has been suggestion that one of the
impacts has been the elimination of early retirement subsidies
and a suggestion that perhaps in the future companies will
simply come out and announce: We are going to eliminate early
retirement subsidies because we want to keep our older workers.
I would be more comfortable from an employee's perspective
if the employer wishing to do that simply did that and said, to
the extent you have protected rights in these early retirement
subsidies, I am going to keep them, and to the extent that you
do not have protected rights in them, I am abolishing them. The
employees would understand that and understand what is being
done to them and why it is being done and they could act
accordingly and make their decisions. They may be disappointed,
I do not disagree. But at least they would knowledgeably know
and they can make decisions going forward.
The same way with regard to more overall benefits levels.
The fact that you can implement it through a cash balance plan
and have this, I will say, very positive announcement of this
wonderful new gadget that has been developed, as opposed to
coming along and saying--and I have an example where one
actuary talked about how you could announce these two different
ways, one in very glowing terms and one in negative terms.
Obviously the negative term is not used, even under the new
disclosure requirements. It is still the optimistic terms.
If we are going to have employers and employees working in
a free market society making decisions based upon the
information made available to them, the employees should be
candidly told what is happening. And I would respectfully
submit if you take away some of these other motivational
factors, we wouldn't be seeing the kind of movement to cash
balance plans that we have seen in the past. And we will not
see it in the future, no matter what, as the Financial
Accounting Standards Boards and other entities move to require
more appropriate accounting for these.
I always figure I am in good stead when I have got Warren
Buffet on my side, and it so happens on this issue he has
sounded the early alarm about pension reporting of income. And
that is a major issue and I would suggest that is a major
factor in this issue. So to that extent, I do not disagree.
That is, there are some employees who have chosen, either
because of life's necessities or chosen because of lifestyles,
it might be preferable to have a cash balance plan. And I could
imagine that Congress should fashion, just as you have
fashioned to date a defined benefit plan and a defined
contribution plan, there could be a fashioning of something
similar to a hybrid or cash balance plan that would be
appropriate to employees and to which I would not object to on
a policy assistant point. I don't know if that gives you a
background from my perspective.
Mr. Delaplane. In terms of the disclosure requirements that
Mr. Hill would like to see with regard to early retirement
subsidies, he is actually describing current law. When Congress
in 2001 changed the disclosure requirements to require more
specific and detailed disclosure, they added to the series of
things that needed to be disclosed by employers any reductions
in early retirement subsidies.
So I think you folks have anticipated that concern and the
current requirement and the current regulations actually
require employers in that special notice in ERISA to discuss
the early retirement subsidy issue and the wear-away issue. I
think we have that issue behind it.
Mr. Hill. I should add, that was implemented by Congress, I
believe against Mr. Delaplane and his client's objections. I
recall testifying the last time on that issue.
Mr. Delaplane. We certainly support disclosure. We had some
specific challenges in the hearing that Mr. Hill is referencing
with the particular bill. That was the not the bill that
ultimately was enacted into law. We think the disclosure is an
appropriate response to concerns that employees have been
raising.
Ms. Collier. I would like to comment on a couple of things
Mr. Hill has brought on, that the employers went on despite
warnings, and they went off on their own and designed these
plans. Eaton had had some cash balance programs prior to this
conversion and both of those plans did not receive IRS
determination letters, as did our cash balance plan that we put
in in 2002, and we received that prior to finalizing our choice
process for our employees. Employers do not do this willy
nilly. We have been seeking the best expert legal advice in
this area that we could as we embarked on these plans.
Mr. Payne. Let me thank you all for your--he is going to
cut me off anyway. I would just like to say before he does cut
me off that I have noticed that employers have, over the years,
when you would think that benefits would be improved and that
companies would become more--I do not want to say liberal, but
more supportive of their employees, especially long-time
employees, that we have seen sort of a lessening of employee
benefits, it seems to me, whether it be protection in the
workplace in some of our OSHA laws, we have seen a reduction in
protection. We have certainly seen the stagnation of wages in a
lot of instances.
And so as I mentioned in my first remarks is that the
defined benefit, when 75 years ago a person worked for
Westinghouse or RCA or a refrigerator company, when the time
came they knew that there was a defined benefit that they would
get. And I think that we have actually seen an erosion in
employers' responsibility to employees over the years. And that
is, I guess, because the world has become global--it has always
been global, but business is global, and as we see jobs going
offshore for companies to remain competitive here, I think this
is a part of the whole almost ratcheting in the wrong direction
the employees' benefits.
But thank you all. Thank you, Mr. Chairman, for allowing me
the extra time.
Chairman Boehner. I want to thank our witnesses for your
excellent discipline, your willingness to shed some light on
cash balance plans and what they do and do not do, and what
they mean for workers today and tomorrow. And I can assure all
of you that the Committee is going to continue to proceed with
a comprehensive overhaul of our defined benefit rules and will
act to make clear what the rules are for the cash balance plans
and the conversions to cash balance plans.
With that, this hearing is adjourned.
[Whereupon, at 12:25 p.m., the Committee was adjourned.]
[Additional material submitted for the record follows:]
Committee on Education and the Workforce, Fact Sheets, Submitted for
the Record
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Statement of the ERISA Industry Committee, Submitted for the Record
Introduction
The ERISA Industry Committee (``ERIC'') is pleased to submit this
statement to the Committee on Education and the Workforce for the
Committee's consideration in connection with its hearing on cash
balance pension plans.
ERIC commends Chairman Boehner, Ranking Minority Member Miller, and
all the members of the Committee for holding this hearing. This hearing
is a welcome step toward developing an informed understanding of what
cash balance and pension equity plans (``hybrid plans'') are, the
benefits they provide, and the people who benefit from them. We
strongly support the Committee's effort to get at the facts and to
distinguish myth from reality.
The issues are vital. The future of the private defined benefit
plan system is at stake.
The defined benefit plan system is already in decline. Employers
that have converted traditional defined benefit plans to hybrid plans
have determined that a traditional defined benefit formula does not
work for them or their employees. These employers are not likely to
return to a traditional pension formula. If Congress errs in its
treatment of hybrid plans, employers will have additional incentives to
abandon defined benefit plans in greater numbers and at an accelerated
rate, disrupting the lives and financial security of the millions of
working Americans and their families who now rely on these plans and
placing even greater strains on Social Security and other public
programs. The consequences will be tragic and unnecessary--not only for
the participants and beneficiaries involved but for the Nation as a
whole.
Only by carefully studying the issues can Congress avoid
potentially irrevocable and calamitous results. We look forward to
working with the Committee and its staff as they study these critical
issues
Executive Summary
When Congress considers legislation regarding hybrid
plans, it has a responsibility to understand fully how the legislation
will affect employers'' willingness and ability to sponsor these plans
and the benefits that employees will receive from them. We look forward
to working with the Committee to expand the knowledge base regarding
hybrid plans.
Voluntary defined benefit retirement plans meet critical
retirement security and economic needs.
In recent years, federal law has not fostered the
formation, continuation, and expansion of voluntary defined benefit
retirement plans. Future legislation should insure that the formation,
continuation, and expansion of voluntary defined benefit plans are
viable options for employers.
It is imperative that an employer's ability to make
prospective changes in benefit plan design be preserved if defined
benefit plans are to flourish in the future. If employers lose the
ability to change their benefit plans in order to respond to changing
business circumstances, they will have an even greater incentive to
abandon their benefit plans.
Hybrid plans respond to the needs of a changing economy.
They work well for many employers, employees, and the entire Nation.
Hybrid plans do not invariably reduce benefits.
Hybrid plans are not age discriminatory.
Treasury Department guidance has confirmed the lawfulness
of hybrid plans.
ERIC looks forward to working with the Committee on
proposals to ensure that defined benefit plans, including hybrid plans,
remain a viable retirement security option for employees and retirees
in the future.
ERIC
ERIC is a nonprofit association committed to the advancement of the
employee retirement, health, welfare benefit, and incentive plans of
America's largest employers. ERIC's members provide comprehensive
retirement, health care coverage, incentive, and other economic
security benefits directly to some 25 million active and retired
workers and their families. ERIC has a strong interest in proposals
affecting its members'' ability to deliver those benefits, their cost
and effectiveness, and the role of those benefits in the American
economy.
ERIC has played a leadership role in advocating responsible
solutions to the critical retirement and health care coverage issues
that face our Nation. ERIC has published policy papers and studies that
have received wide acclaim and have been instrumental in the
formulation of legislative and regulatory policy. These include, among
others--
- The Vital Connection: An Analysis of the Impact of Social
Security Reform on Employer-Sponsored Retirement Plans,
- Getting the Job Done: A White Paper on Emerging Pension Issues,
and
- Policy Statement on Health Care Quality and Consumer Protection.
ERIC and its members have worked for approximately 30 years to
resolve important policy questions and to devise practical solutions to
the often vexing problems facing the Committee and the country.
Voluntary Defined Benefit Retirement Plans Meet Critical Retirement
Security And Economic Needs.
Before we address the specific subject of this hearing--cash
balance and plans and pension equity plans--it is important to
emphasize the important role of voluntary defined benefit retirement
plans in our Nation's economy.
It is also important to emphasize that the strength of the
employer-sponsored benefit plan system depends on the system remaining
voluntary. Employers are not required to provide retirement plans for
their employees. Employers provide retirement plans voluntarily because
it is in both their employees'' interest and their own interest to do
so.
Defined benefit retirement plans have played a critical role in
helping to meet many employees'' retirement security needs, a role that
differentiates defined benefit plans from defined contribution plans:
They provide a reliable source of retirement income to
plan participants and their beneficiaries.
They act as a form of automatic savings: benefits accrue
automatically under most defined benefit plans.
Employees are sheltered from investment and other risks
that can reduce individual retirement savings.
Once vested, the employee is virtually guaranteed
whatever benefit he or she has earned under the plan.
The employer is responsible for funding the plan. If the
employer becomes bankrupt, the Pension Benefit Guaranty Corporation
(``PBGC'') guarantees payment of most benefits.
Defined benefit plans make benefits available as an
annuity. If a retiree takes an annuity, the plan, not the retiree,
bears the risk that the retiree will outlive his or her life
expectancy.
Defined benefit plans also help many employers to attract, retain,
and motivate employees. In addition, defined benefit plans are major
investors in the economy and make major contributions to national
savings, investment, and economic growth.\1\
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\1\ As of December 31, 2001, private-sector defined benefit plans
held assets valued at $1.81 trillion. Staff, Joint Committee on
Taxation, Present Law and Background Relating to Employer-Sponsored
Defined Benefit Plans, at 33-34 (JCX-71-02) (June 18, 2002).
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The Decline in Defined Benefit Plan Coverage.
Although defined benefit plans provide valuable retirement security
benefits to the millions of employees who participate in them, the
coverage of these plans is declining:
Between 1979 and 1998, the number of defined benefit plan
participants fell by over 22%, from 29.4 million to 22.9 million.\2\
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\2\ U.S. Dep't of Labor, Pension & Welfare Benefits Administration,
Private Pension Plan Bulletin: Abstract of 1998 Form 5500 Annual
Reports No. 11, at Table E8 (Winter 2001-2002).
---------------------------------------------------------------------------
Between 1985 and 2000, the number of active participants
in PBGC-insured defined benefit plans fell by about 15%, from almost 27
million to less than 23 million--notwithstanding the expansion of the
total workforce during this period.\3\
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\3\ Pension Benefit Guaranty Corporation, 2002 Annual Report, at 14
(``The number of active workers PBGC insures actually fell from almost
27 million in 1985 to less than 23 million in 2000. Meanwhile, the
labor force has grown. Now only about 20 percent of private-sector wage
and salaried workers are covered by PBGC-insured defined benefit
pension plans, down from 30 percent in 1985. If the trend continues,
active participants will constitute less than half of PBGC-insured
participants in 2003.'').
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Why has this happened? From the early 1980s until 1994, Congress
piled law on top of law in an effort to meet Congressional budgetary
targets by squeezing as much ``tax revenue'' out of defined benefit
plans as it could. Through these laws, Congress created a regulatory
climate that not only micro-managed these plans, but also strangled
employers'' ability to fund these plans for the future. The result was
to subject defined benefit plans to a bewildering array of complex,
rigid, and inconsistent legal requirements.
The resulting legal regime has been excessive, oppressive, and
convoluted. Its primary effect has been a decline in retirement
security, as employees have found the rules to be bewildering and as
employers have found sponsoring a plan to be increasingly burdensome
and unwieldy. It has discouraged employers from adopting new plans and
encouraged many to terminate their existing plans. For example:
Restrictive, complex, and frequently amended legal
requirements, including compensation and benefit limits and
distribution rules have required plans to invest a substantial portion
of their resources in legal compliance and plan administration, rather
than in providing benefits to participants and beneficiaries.
New short-sighted funding rules have subjected employers
to unrealistic funding assumptions, ignored the long-term nature of
pension obligations, and limited employers'' ability to fund their
defined benefit plans until late in their employees'' careers.
Rigid restrictions on the use of pension assets have
converted a defined benefit plan into a ``black hole'' from which
contributions cannot emerge--even if the plan's assets vastly exceed
the amount required to fund the plan's benefits.
This regime has weakened retirement security by restricting funding
opportunities when employers are most able to fund, by increasing
funding requirements when employers are least able to fund, by
subjecting employers to highly volatile funding requirements that are
difficult, if not impossible, for employers to predict, by subjecting
plans to excessive administrative costs, by confusing employees, and,
in the aggregate, by making it less attractive for employers to
maintain and contribute to defined benefit plans. It is difficult to
imagine a regime less likely to encourage the establishment and
continuation of defined benefit plans.
The decline in defined benefit plan coverage has substantially
weakened the retirement security of our Nation's workforce.
Federal Law Should Ensure That The Formation, Continuation, And
Expansion Of Voluntary Defined Benefit Retirement Plans Are
Viable Options For Employers.
Federal law must create an environment that is conducive to plan
formation, continuation, and expansion. If federal law makes it too
costly or impractical to maintain a plan, or subjects plans to
irrational or counterproductive rules, employers will refrain from
creating new plans and will be encouraged to terminate or curtail the
growth of existing plans. If federal law makes it difficult or
impossible for an employer to modify an existing plan--if adopting a
voluntary plan locks an employer into a permanent commitment to
maintain the plan without change--employers will be loathe to adopt
these plans. If an employee benefit plan becomes a straight jacket from
which there is no escape, employers will respond by not adopting plans.
The drafters of ERISA understood this well. As the late Senator Jacob
Javits (R-N.Y.) observed:
``The problem, as perceived by those who were with me on this
issue in the Congress, was how to maintain the voluntary growth
of private plans while at the same time making needed
structural reforms in such areas as vesting, funding,
termination, etc., so as to safeguard workers . . . [T]he new
law represents an overall effort to strike a balance between
the clearly-demonstrated needs of workers for greater
protection and the desirability of avoiding the homogenization
of pension plans into a federally-dictated structure that would
discourage voluntary initiatives for further expansion and
improvement.'' \4\
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\4\ Address by Senator Jacob K. Javits, Briefing Conference on
Pension and Employee Benefits, New York State School of Industrial and
Labor Relations, Cornell University and Federal Bar Association,
Washington, D.C. (Sept. 19, 1974).
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The Employer's Ability To Change The Design Of Its Retirement Plan Must
Be Preserved.
One of the great strengths of our Nation's retirement security
system is the flexibility it currently provides to an employer to
design and adjust its plans to respond to changing business
circumstances and to the changing needs of the employer and its
employees.
The rapid emergence of new technologies and the obsolescence of old
products and services are reshaping many industries, forcing companies
in those industries to adapt quickly or--like buggy whip manufacturers
in the age of internal combustion engines--die. Businesses change their
ways of doing business, move into new businesses, merge, form joint
ventures, acquire other companies or are themselves acquired, and
divest old lines of business or are themselves divested as they adjust
to challenges and opportunities in today's highly competitive
international marketplace. New global competition and competition from
emerging companies have made it essential for employers to change their
employee rewards programs.
If employers lose the right to change their retirement plans to
respond to changing business conditions, the consequences will be
disastrous for employers, employees, and the U.S. economy.
Employees And The Economy As A Whole Will Be Harmed If Employers Are
Prevented From Changing Their Plans To Respond To Changing
Business Circumstances.
Under current law, employers may not amend their plans to reduce
benefits that have already accrued. But employers have always had the
right to change their plans prospectively--to change the terms
governing benefits that have not yet been earned.
The employer's right to make prospective changes in benefits is
essential to the vitality of the U.S. economy and to new and expanded
employment opportunities. It is also essential to our voluntary benefit
system. As we have explained, elimination of the right to make
prospective benefit changes will deter employers from adopting benefit
plans. If the right to make prospective changes is eliminated, the
principal victims will be employees and their families--who will no
longer receive the critical benefits that these plans provide. The
harmful consequences are predictable: less retirement savings, less
retirement security, greater poverty among the elderly, greater
pressure on older employees to continue working, increased financial
catastrophes for workers of all ages, greater demands on public
assistance programs, greater demands on Social Security, and less
investment capital for the economy.
Moreover, if employers lose the right to change the terms on which
benefits will be earned in the future, employers that have benefit
plans will have their options severely limited. When subject to
financial pressures, employers will not be able to reduce costs by
reducing future benefit levels and will be forced to adopt alternative
measures such as reductions in pay levels, cutbacks in health benefits,
layoffs, and outsourcing. Under these conditions, employers with
retirement plans will be at a severe competitive disadvantage vis a vis
employers that do not have them. The impact on these employers, their
employees and retirees, and the economy as a whole will be devastating.
Many employers will decide to terminate their plans rather than allow
themselves to be in this position.
Most Traditional Defined Benefit Plans Focus Most Of Their Benefits On
A Small Group Of Employees.
Under most traditional defined benefit plans, employees earn most
of their benefits only after completing 20 to 30 years of service with
the same employer. The value of their benefits spikes after they
qualify for subsidized early retirement benefits, typically in their
mid-50's or later, but then declines if they choose not to retire and
keep working. Although the dollar amount of the plan's monthly
retirement benefit typically does not decline, the economic value of
the retirement benefit does decline if the employee delays retirement;
this is because the value of the plan's early retirement subsidy
declines as the employee approaches the plan's normal retirement age.
As a result, traditional defined benefit plans are most
advantageous to the relatively small group of employees who work for
the same employer for 20 to 30 years and retire at the plan's early
retirement age. They are far less beneficial for others--for employees
who change jobs or interrupt their careers and for older employees who
continue to work after early or normal retirement age.\5\ Indeed, this
has been a major criticism of defined benefit plans for many years.
---------------------------------------------------------------------------
\5\ ``Overall, defined benefit pension wealth--the present value of
the expected future stream of [traditional] pension benefits--grows
slowly early on in an individual's career, increases rapidly near the
end, and then declines at older ages.'' Johnson & Uccello, Urban
Institute, Can Cash Balance Plans Improve Retirement Security for
Today's Workers?, at 2 (2002). ``[T]raditional DB pensions have imposed
large benefit cuts on employees who left the firm prior to retirement
age. This is because most traditional DB formulas usually link
retirement payments to final pay at the company . . . .'' Mitchell &
Mulvey, Pension Research Council, Wharton School, University of
Pennsylvania, Possible Implications of Mandating Choice in Corporate
Defined Benefit Plans, at 3 (2003). ``[P]ension accruals in traditional
DB plans are minimal at younger ages, grow rapidly in the later 40s and
50s as workers approach retirement age, and then become negative as
workers lose pension wealth when they remain at work past the plan's
retirement age. For workers in their early 60s who have participated in
the DB plan since age 25, for example, pension wealth declines on
average by about 14 percent of annual salary each year.'' Johnson &
Steurle, Pension Research Council, Wharton School, University of
Pennsylvania, Promoting Work at Older Ages: The Role of Hybrid Pension
Plans in an Aging Population, at 21 & Fig. 12 (2003).
---------------------------------------------------------------------------
Although traditional defined benefit plans are appropriate for some
employers and some work forces, they do not meet the needs of many
employers and employees.
Hybrid Plans Respond To A Changing Economy.
Many workers in changing industries no longer look forward to a
lifetime career with one employer. They expect to change employers more
frequently than their parents and grandparents did. A retirement plan
that requires workers to stay with the same company and wait for a big
bump-up in the value of their pension benefits in the last few years of
employment penalizes workers who, for one reason or another, leave an
employer early or in mid-career and offers little incentive to join an
employer recruiting for top talent.
Recently, new hybrid plan designs, such as cash balance defined
benefit plans and pension equity plans, have been embraced by employers
and employees alike who need benefit plans that match the new
environment in which they work. In contrast to traditional defined
benefit plans, hybrid plan designs have stimulated great interest in
retaining and expanding defined benefit plans.\6\
---------------------------------------------------------------------------
\6\ ``During the middle and late 1990s, hybrid plans, primarily
cash balance plans, became a growing percentage of the plans PBGC
insures. . . . In 2000, hybrid plans contained an estimated 20 percent
of all PBGC-insured single-employer plan participants.'' Pension
Benefit Guaranty Corporation, 2002 Annual Report, at 14.
---------------------------------------------------------------------------
The growth and popularity of these new defined benefit arrangements
is supported by the findings of numerous independent analysts, as
illustrated by the following conclusions:
``[G]iven the emergence of vehicles such as 401(k) plans and
hybrid plans, retirement plans today match the reality of the
work experience for most Americans better than at any time in
the past.'' \7\
---------------------------------------------------------------------------
\7\ Yakoboski, Employee Benefits Research Institute, Debunking the
Retirement Policy Myth: Lifetime Jobs Never Existed for Most Workers,
at 1 (1998).
---------------------------------------------------------------------------
***
``[W]orkers employed by more than one employer during their
career can receive more retirement income under multiple cash
balance plans than under multiple traditional defined benefit
plans. . . . [In one example, the] benefit earned by the worker
who changed employment under multiple cash balance plans will
accrue a retirement benefit that is almost 22 percent larger
than the benefit received by the workers under multiple [final
average pay] plans.'' \8\
---------------------------------------------------------------------------
\8\ General Accounting Office, Cash Balance Plans: Implications for
Retirement Income, at 26-27 (2000).
---------------------------------------------------------------------------
***
``Median lifetime pension wealth would increase under cash
balance plans because these new plans distribute pension wealth
more equally across the covered population.'' \9\
---------------------------------------------------------------------------
\9\ Johnson & Uccello, Urban Institute, Can Cash Balance Pension
Plans Improve Retirement Security for Today's Workers?, at 3 (2002).
---------------------------------------------------------------------------
See also Appendix.
Hybrid Plans Meet Employee Needs.
Benefits Are Understandable: Unlike traditional defined benefit
plans, cash balance plans provide an easily understood account balance
for each participant. Employees--who are accustomed to dealing with
bank account balances, Sec. 401(k) account balances, and IRA balances--
are comfortable with a retirement plan that provides a benefit in the
form of an account balance.
Savings Accrue Automatically: Unlike Sec. 401(k) plans, amounts are
added automatically to the accounts of all employees eligible to
participate in a hybrid plan. The employee does not have to make an
affirmative choice to participate or make often difficult decisions
about how much of his or her current income to defer.
The Employer Bears The Risk: Like traditional defined benefit
plans, but unlike defined contribution plans (e.g., Sec. 401(k), money
purchase plans, or profit sharing plans), investment risks are borne by
the employer. Sudden or even prolonged downturns in the equity or bond
markets do not affect the defined benefit promised to the participant.
Benefits Are Guaranteed: Like traditional defined benefit plans,
but unlike defined contribution plans, benefits are insured by the
PBGC, a government agency.
Greater Benefits For Short-Service Employees: An employee typically
earns most of his or her benefit under a traditional defined benefit
plan in the last few years before retirement. By contrast, a hybrid
plan delivers benefits more evenly over the employee's career, and an
employee who leaves before retirement can roll over his or her benefit,
on a tax-deferred basis, to an IRA or a new employer's plan. Thus,
hybrid plans are especially attractive in new industries that tend to
attract highly talented, mobile workers as well as in industries that
are undergoing significant changes.
Women Benefit: Hybrid plan designs offer significant advantages to
women (who are most threatened by impoverishment in old age) and others
who tend to move in and out of the workforce. In fact, all mobile
workers--not just women--are more likely to accrue a significant and
secure retirement benefit under cash balance plans than under many
other plan designs.\10\
---------------------------------------------------------------------------
\10\ ``Compared with traditional pensions, cash balance plans
generate retirement wealth more evenly over time for a couple of
reasons: Contributions made early on earn interest for many years, and
lifetime earnings rather than final earnings determine benefits.
Consequently, a worker changing jobs incurs only a small penalty. For
women, who tend to have higher turnover rates than men, the ability to
change jobs without jeopardizing pension wealth may be particularly
important.'' Johnson & Uccello, Urban Institute, Can Cash Balance
Pension Plans Improve Retirement Security for Today's Workers?, at 2
(2002).
---------------------------------------------------------------------------
Older Workers Benefit: The advantages of a hybrid balance plan
design are not limited to mobile workers, however. For example, the
value of the benefit for an older worker participating in a hybrid plan
increases at the same rate both before and after normal retirement age
(and , in some plans, increases at a higher rate as the employee
accrues additional years of age or service). By contrast, under a
traditional defined benefit plan, particularly those that offer
subsidized early retirement benefits, the economic value of an
employee's benefit actually declines when an employee works past the
plan's early or normal retirement age.\11\
---------------------------------------------------------------------------
\11\ ``[P]ension accruals in traditional DB plans are minimal at
young ages, grow rapidly in the late 40s and 50s as workers approach
retirement age, and then become negative as workers lose pension wealth
when they remain at work past the plan's retirement age. For workers in
their early 60s who have participated in the DB plan since age 25, for
example, pension wealth declines on average about 14 percent of annual
salary each year. . . . In effect, DB plans favor a select group of
longer-term employees, often in late middle-age, but disfavor both
younger and older workers. Unlike traditional DB plans, hybrid pension
plans, such as cash balance plans and pension equity plans, often
reward work at older ages at least as much as work at younger ages,
because workers in hybrid plans do not forgo a year of benefits for
every year they remain on the job past the retirement age.'' Johnson &
Steurle, Pension Research Council, Wharton School, University of
Pennsylvania, Promoting Work at Older Ages: The Role of Hybrid Pension
Plans in an Aging Population, at 21, 24 & Fig. 12 (2003).
---------------------------------------------------------------------------
Portability: Hybrid plans provide portable benefits that can be
rolled over to another employer's plan or an IRA, on a tax-deferred
basis, for continued retirement savings. In addition, when companies
are merged, acquired, or form joint ventures, the benefits are easily
transferred to a new plan, making continuity more attractive to the new
employer and making it more likely that affected employees will achieve
retirement security.
Employee Control: Since the amounts payable under hybrid plan
benefits are more easily understood by employees than are the benefits
under many traditional defined benefit plans, employees are more likely
to take responsibility for their retirement and their future, resulting
in greater personal and national savings.
No Penalties: Unlike many traditional defined benefit plans, hybrid
plans do not penalize employees who wish to move on to other jobs
before reaching retirement eligibility:
``Traditional DB plans generally encourage early retirement, by
offering early retirement subsidies and delayed retirement
penalties. As a result, DB plan sponsors seeking to keep their
older workers on the job found that their traditional plans did
not serve business objectives. By contrast, hybrid plans
eliminate early retirement incentives and do not have a
``spike'' in accrual rates shortly before normal retirement
age. Thus workers who leave early are not penalized as was the
case of most DB plans, which provided larger accruals for
longer tenured employees close to retirement.'' \12\
---------------------------------------------------------------------------
\12\ Mitchell & Mulvey, Pension Research Council, Wharton School,
University of Pennsylvania, Possible Implications of Mandating Choice
in Corporate Defined Benefit Pension Plans, at 4 (2003) (citation
omitted).
---------------------------------------------------------------------------
Annuities Are Available: Since annuities must be offered by a
hybrid pension plan, participants who want to receive their retirement
benefit as a stream of income avoid the increased cost and difficulty
of purchasing annuities in the individual market. By contrast, if an
employee who participates in a defined contribution plan wishes to
receive the balance in his or her defined contribution account as an
annuity, the employee must approach one or more insurance companies and
purchase an annuity on whatever terms are then available to an
individual purchaser in the annuity market.
Hybrid Plans Meet Employer Needs.
Appropriate Employment And Retirement Incentives: Because hybrid
plans deliver benefits evenly throughout an employee's career, they do
not provide undue incentives for employees to keep working for the same
employer until reaching retirement age or to retire immediately when
they do qualify for retirement.
Improved Employee Communication: Because benefits in hybrid designs
are more understandable, retirement benefits and the need to save are
more easily and effectively communicated to all employees, including
those who ordinarily do not pay much attention to retirement issues.
Improved Employee Recruitment and Retention: Hybrid plans are an
effective tool for attracting new employees and retaining and rewarding
current employees.
Enhanced Benefit Coordination: Hybrid plans are easily coordinated
with the employer's savings or profit-sharing plan.
Neutral Impact On Enterprise Decisions: Because cash balance and
hybrid plan designs of different companies can be coordinated
relatively easily, they offer a stable ``platform'' to retain employees
for companies engaged in mergers and acquisitions.
Hybrid Plans Benefit The Nation.
Capital Accumulation: Defined benefit plans--which include hybrid
designs--have for decades been an engine of capital accumulation,
making available secure sources of capital for business start-ups and
economic expansion that have been responsible for the outstanding
success of the American economy.
More Efficient Retirement Savings: Because of the longer investment
horizon available under a defined benefit plan, a hybrid plan can
invest its assets more aggressively and can better withstand market
downturns while still providing a full benefit than can an individual
participating in a defined contribution plan, who must bear all of the
investment risk under the plan.
Increased Retirement Savings: Under hybrid plans, more workers
build larger savings earlier in their careers, increasing their
opportunity to accumulate significant retirement savings and reducing
the pressure on government programs in their retirement years.
Increased Pension Participation: All eligible employees
automatically accrue benefits under hybrid defined benefit plans.
Because benefit accrual does not depend on an employee's election to
participate, more employees whose employers provide a defined benefit
pension plan will actually benefit from the plan.
More Compatible Workplace For Women: The design of a hybrid plan
can enable an employer to offer a total compensation package that
allocates value more equitably between long-service employees and women
and others who tend to move in and out of the workforce. Hybrid plans
will help to address the phenomena of the considerable number of
elderly poor women with insufficient pension resources and the
resulting pressure to increase targeted entitlements.
Less Pressure On Government Programs: By providing a reliable
source of retirement income, defined benefit plans, including hybrid
plans, reduce pressure on government entitlement programs for the
elderly.
Employers Have Always Reserved The Right To Revise Their Benefit Plans.
Employers have always had the right to change the retirement plans
they provide to their employees. It is a fundamental principle of
ERISA. Although current law protects an employee's accrued benefit
(including early retirement rights related to the employee's accrued
benefit), the law has always allowed an employer to change the terms on
which retirement benefits will be earned in the future. As we have
explained, if an employer did not have the right to make such changes,
employers would be deterred from voluntarily adopting retirement plans
in the first place.
Employers frequently make changes in their retirement plans--both
major and minor--to accommodate changing employee preferences, to
respond to changing competitive, financial, and other conditions, and
to achieve specific business objectives. Employees are well aware of
the employer's right to change the plan, and have frequently benefited
from those changes.
Employees are adequately protected by current law. The law not only
prohibits an employer from amending a plan to reduce the pension
benefits that employees have already earned, but also requires the
plan, after it has been amended, to continue to give employees credit
for their service for purposes of qualifying for any early retirement
subsidy that applies to the pension benefits that the employees had
earned at the time of the plan amendment. For example, if an employer
amends a pension plan to provide that pension benefits earned in the
future will not include an early retirement subsidy, employees are
still entitled, after the amendment, to continue to earn service credit
for purposes of qualifying for any early retirement subsidy that
applies to the pension benefits they have already earned.
Hybrid Plans Do Not Inherently Reduce Benefits.
Some critics of hybrid plans have claimed that employees will earn
retirement benefits under these plans that are less than the benefits
that those employees would have earned if the prior plan formula had
remained in effect without change. However, independent studies debunk
this claim:
``. . . [I]t does not appear that most firms are seeking to
reduce benefit generosity. . . . Cash balance conversions
appear to be largely driven by labor market conditions. . . .
[T]he move toward DC-like pensions is likely the result of
increased worker mobility.'' \13\
---------------------------------------------------------------------------
\13\ Coronado & Copeland, Pension Research Council, Wharton School,
The University of Pennsylvania, Cash Balance Pension Plan Conversions
and the New Economy, at 23 (2003).
---------------------------------------------------------------------------
Ultimately, any comparison between the benefits provided by a
hybrid plan and the benefits provided by a traditional defined benefit
plan depends on the terms of the plans. Hybrid plans do not inherently
provide benefits that are greater or less than the benefits provided by
traditional plans. Also, as explained earlier, current law prevents a
plan amendment from causing an employee to lose any part of the accrued
benefit that he or she has already earned.
In addition, hybrid plans tend to distribute the benefits accrued
by plan participants more evenly among employees than do traditional
defined benefit retirement plans:
``By distributing pension wealth more equally across the
population than [traditional defined benefit] plans, cash
balance plans would increase median lifetime pension wealth in
the total covered population and more people would gain pension
wealth than lose.'' \14\
---------------------------------------------------------------------------
\14\ Johnson & Uccello, Urban Institute, The Potential Effects of
Cash Balance Plans on the Distribution of Pension Wealth at Midlife, at
29 (2001).
---------------------------------------------------------------------------
Hybrid Plans Are Not Age Discriminatory.
Claims have been made that hybrid plans invariably violate the Age
Discrimination in Employment Act (``ADEA''). These claims lack merit.
Of the four federal district courts that have considered the issue,
three have rejected the claim that hybrid plans are age discriminatory.
Although one court reached a contrary conclusion, that court's
conclusion was subsequently rejected by another federal district court
last month.\15\
---------------------------------------------------------------------------
\15\ Compare Tootle v. ARINC, INC., Civ. Act. No. CCB-03-1086
(D.Md. June 10, 2004) (rejecting age discrimination claim), Engers v.
AT&T, Civ. Act. No. 98-CV-3660 (NHP) (D.N.J. June 6, 2001) (same), and
Eaton v. Onan Corp., 117 F. Supp. 2d 812 (S.D. Ind. 2000) (same), with
Cooper v. IBM, 274 F. Supp. 2d 1010 (S.D. Ill. 2003) (accepting age
discrimination claim). See also Campbell v. BankBoston, N.A., 327 F.3d
1, 10 (1st Cir. 2003) (recognizing problems with age discrimination
theory) (dictum).
---------------------------------------------------------------------------
On its face, a cash balance plan is not age-discriminatory. Each
participant, regardless of age, receives the same percentage-of-
compensation pay credit--except for the many plans that provide higher
pay credits to older workers. The rate at which interest credits are
calculated on the participant's cash balance account is age-
neutral.\16\ Under a pension equity plan, an employee's rate of benefit
accrual commonly increases with additional years of age or service.
---------------------------------------------------------------------------
\16\ ``By contrast, many employers today prefer hybrid plans
because they smooth compensation differentials by age and soften the
incentives for early retirement. As a consequence of the new plan
elements, hybrid plans are in fact less age discriminatory than many
traditional DB plans.'' Mitchell & Mulvey, Pension Research Council,
Wharton School, University of Pennsylvania, Possible Implications of
Mandating Choice in Corporate Defined Benefit Plans, at 18 (2003)
(emphasis original).
---------------------------------------------------------------------------
Claims that hybrid plans are age-discriminatory are based on the
theory that because a younger employee will benefit, when the employee
reaches retirement age, from a longer period of interest-compounding on
his or her account balance than will an older employee, the plan
discriminates in favor of the younger employee. What these claims gloss
over is that the younger employee must wait longer in order to receive
the benefit of the longer period of interest-compounding. The
accumulation of interest credits for a longer period of time merely
compensates the employee for having to wait longer to collect a benefit
from the plan at retirement age.
Cash balance plans are not age-discriminatory for the same reason
that Social Security is not age-discriminatory. Both plans index
employees'' pension benefits prior to retirement: cash balance plan
benefits are indexed with interest, while Social Security benefits are
indexed for increases in average national wages and the cost of living.
These pre-retirement indexing features protect employees against
inflation; they are not age-discriminatory.
Some have claimed that when a traditional defined benefit
retirement plan is converted to a hybrid plan design, the ``wear-away''
feature used to transition from the old formula to the hybrid plan
formula discriminates against older workers. Where wear-away occurs, an
employee who participates in the plan at the time of conversion
typically receives the greater of two benefits: (1) the employee's
accrued benefit under the old formula at the time of conversion or (2)
a benefit based solely on the plan's new hybrid plan formula plus
interest.
Depending on the details of the two formulas, an employee with a
very substantial accrued benefit under the plan's old formula might
find that he or she has no increase in benefits, especially early
retirement benefits, for some period of time, while a more recently-
hired employee might begin to accrue additional benefits immediately.
However, this is not the result of age discrimination. If neither the
plan's old formula nor the plan's new formula is age-discriminatory,
there is no basis for claiming that a plan that provides an employee
with the greater of the benefits provided by the two formulas is age-
discriminatory. Indeed, in the past, Congress and the Treasury
Department have both required and permitted plans to provide
participants with the greater of their previously accrued benefits
under the old plan formula or the benefits they accrued under a new
plan formula.\17\
---------------------------------------------------------------------------
\17\ See, e.g., Tax Reform Act of 1986, Pub. L. No. 99-514,
Sec. 1106(i)(3), 100 Stat. 2085, 2425-26 (1986); Tax Equity and Fiscal
Responsibility Act of 1982, Pub. L. No. 97-248, Sec. 235(g)(4), 96
Stat. 324, 508-09 (1982); ERISA, Pub. L. No. 93-406, Sec. 2004(d)(2),
88 Stat. 829, 987 (1974); S. Rep. No. 575, 98th Cong., 2d Sess. 29
(1984) (a participant who meets the criteria for an early retirement
subsidy that was previously eliminated by a plan amendment is entitled
to the greater of the portion of the subsidy attributable to service
before the plan amendment or the retirement benefit provided under the
plan as amended); Treas. Reg. Sec. Sec. 1.401(a)(4)-13(c)(4) (listing
permissible ``fresh-start'' formulas), 1.401(a)(17)-1(e) (applying
``fresh-start'' formulas where Code Sec. 401(a)(17) limits were
reduced); Notice 88-131, 1988-2 C.B. 546 (Alternative IID) (providing
that certain participants may be entitled to the greater of the benefit
accrued under pre-existing plan provisions or benefits accrued under
amendments adopted to comply with the Tax Reform Act of 1986); Rev.
Rul. 81-12, 1981-1 C.B. 228 (addressing changes in actuarial
assumptions).
---------------------------------------------------------------------------
Treasury Department Guidance Has Confirmed The Lawfulness of Cash
Balance Plans.
Hybrid plans have been on the scene for nearly 20 years, and the
Government has indicated on numerous occasions that hybrid plans are
lawful. Employers have reasonably relied on Government guidance in
adopting hybrid plans:
Preamble to the Final Sec. 401(a)(4) Regulations: In the preamble
to the final regulations creating a safe harbor for cash balance plans
from the restrictions on discrimination in favor of highly compensated
employees, the Internal Revenue Service stated unequivocally that cash
balance plans were not age-discriminatory:
``The fact that interest adjustments through normal retirement
age are accrued in the year of the related hypothetical
allocation [i.e., the pay credit] will not cause a cash balance
plan to fail to satisfy the requirements of [Code] section
411(b)(1)(H), relating to age-based reductions in the rate at
which benefits accrue under a plan.'' \18\
---------------------------------------------------------------------------
\18\ 56 Fed. Reg. 47,528 (Sept. 19, 1991).
---------------------------------------------------------------------------
Regulatory Safe Harbor for Cash Balance Plans: The IRS safe harbor
for cash balance plans strongly implied that such plans were lawful.
Surely, the IRS would not have created a safe harbor for cash balance
plans unless it believed that these plans were lawful.\19\ In fact, as
the preamble explained, the IRS had concluded that cash balance plans
were lawful.
---------------------------------------------------------------------------
\19\ See Treas. Reg. Sec. 1.401(a)(4)-8(c)(3).
---------------------------------------------------------------------------
Notice 96-8: The Internal Revenue Service announced its intention
to propose regulations regarding lump-sum distributions from cash
balance plans.\20\ Because it contemplated the issuance of guidance on
how lump-sum benefits from cash balance plans should be calculated,
Notice 96-8 gave employers every reason to believe that cash balance
plans were lawful.
---------------------------------------------------------------------------
\20\ 1996-1 C.B. 359.
---------------------------------------------------------------------------
Determination Letters: The Internal Revenue Service has issued
favorable determination letters to many hybrid plans, including both
cash balance plans and pension equity plans. Indeed, the Service today
continues to issue favorable determination letters to cash balance
plans that were not the subjects of conversions. Surely, the Service
would not have done this in the past or be doing this today if it
believed that these plans violate the Internal Revenue Code's age
discrimination provisions.
We are currently working on the development of a legislative
proposal that will address the issues relating to hybrid plans. We will
be pleased to share our proposal with the Committee when our work on
the proposal is completed.
We very much appreciate the opportunity to submit this statement,
and hope that it will be helpful to the Committee. We look forward to
working with the Chairman, the members of the Committee, and the
Committee staff on the issues addressed at this hearing.
For more information on cash balance plans and pension equity
plans, we invite you to visit ERIC's web site at www.eric.org.
APPENDIX
``To show how DB and cash balance pension wealth would be
influenced by job changing, we posit two hypothetical workers, one of
whom holds three jobs over his career, and another who remains with an
employer for his entire career. . . . [In our hypothetical example,
the] DB normal retirement benefit, payable as an annuity from age 65,
is worth 1.1 percent of his final five-year average salary, times his
years of service at termination (retirement). If the worker were to
retire early, the benefit would be reduced by 2 percent per year
between ages 62 and 65, 4 percent from 60 to 62, and 5 percent for
retirement from age 55 to 60. Since this formula embodies an early
retirement reduction rate that is smaller than the actuarially fair
rate (which would be around 6-8 percent per year) , the DB plan
embodies an early retirement subsidy. By contrast, the cash balance
plan [in our hypothetical example] has a much smoother accrual rate,
with pay credits of 4 percent per year during the worker's first decade
of service, 5 percent for the next ten years, and 5.75 percent for
service of 20 years or more. There were no early retirement reductions,
and contributions are credited with a 7 percent interest credit per
year.
****
``. . . . . If a young worker knew that he would remain with a
single employer his entire career and retire at age 65, his anticipated
accumulation in the DB plan would be one-third higher than the cash
balance plan. But certainty regarding the mobility prospects is
unlikely since the average American holds several jobs over his career.
In fact, using data from personnel files from 65 large companies we
found that only 7 percent of workers were likely to stay with one
employer for their entire career. Thus, when we compute the expected
value of the two plans based on the likelihood of a worker actually
staying to full retirement and receiving the full defined benefit
plan[,] the expected value of the benefit from the hybrid plan is 11
percent higher than the expected value of the defined benefit plan.
Beyond the expected value of the benefit, for those employees who
changed jobs three times over their work life, their pension wealth
from the hybrid plan would be nearly 18 percent higher than what they
would have received from three different DB plans.''
Mitchell & Mulvey, Pension Research Council, Wharton School,
University of Pennsylvania, Possible Implications of Mandating Choice
in Corporate Defined Benefit Plans, at 5-6 (2003) (citations omitted &
emphasis added).
______
Statement of Hon. Jon Porter, a Representative in Congress from the
State of Nevada
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Statement of Hon. Charlie Norwood, a Representative in Congress from
the State of Georgia
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Statement of the National Association of Manufacturers, Submitted for
the Record
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Statement of The Principal Financial Group, Submitted for the Record
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Watson Wyatt, Press Releases, Submitted for the Record
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Statement of the American Federation of Labor and Congress of
Industrial Organizations, Submitted for the Record
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Letter from AARP, Submitted for the Record
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Statement of Larry Cutrone, Submitted for the Record
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Statement of Janet Krueger, Submitted for the Record
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Statement of Janice Winston, Submitted for the Record
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Statement of Jimmy Tarlau, Submitted for the Record
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Tax Notes, Submitted for the Record
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U.S. Treasury Department, Office of Public Affairs, Submitted for the
Record
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Companies That Have Converted to Cash Balance Pension Plans, Submitted
for the Record
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Employers Awaiting IRS Determination Letters Under the Cash Balance
Moratorium, Submitted for the Record
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Bureau of Labor Statistics, U.S. Department of Labor, Table Submitted
for the Record
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Statement of the National Committee to Preserve Social Security and
Medicare, Submitted for the Record
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Committee on Education and the Workforce, Democratic Staff, Press
Release, Submitted for the Record
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______
The Following Items Have Been Placed in the Permanent Archive Files:
1. Hewitt, Survey Findings, Current Retirement Plan Challenges:
Employer Perspectives, 2003
2. Possible Implications of Mandating Choice in Corporate Defined
Benefit Plans, Olivia S. Mitchell and Janemarie Mulvey, Pension
Research Council Working Paper, The Wharton School, University of
Pennsylvania, PRC WP 2003-25
3. An Empirical Analysis of the Transitions to Hybrid Pension
Plans in the United States, Robert L. Clark North Carolina State
University, and Sylvester J. Schieber, Watson Wyatt Worldwide,
Sponsored by The Brookings Institution, Stanford Institute for Economic
Policy Research and TIAA-CREF Institute, Washington, D.C., 9/21/00
4. Dan C. Tootle v. ARINC, Inc. et al., Civil Action No. CCB-03-
1086, In The United States District Court For The District of Maryland,
6/10/04
5. Eaton v. Onan Corporation, Cause No. IP97-0814-C-H/G, United
States District Court Southern District of Indiana, Indianapolis
Division, 9/29/00
6. E-mail from Jane Banfield, 7/6/04, with newspaper clipping from
The Reporter
7. E-mail from Brian D. McCarthy, 2/26/04
8. GAO Report, September 2000, GAO/HEHS-00-185, Private Pensions,
Implications of Conversions to Cash Balance Plans
9. U.S. Department of Labor, Office of Inspector General, PWBA
Needs to Improve Oversight of Cash Balance Plan Lump Sum Distribution,
Report No. 09-02-001-12-121, 3/29/02
10. Congressional Research Service, Memorandum to Hon. Bernie
Sanders, Estimated Benefit Under A Cash Balance Plan, 2/11/03
11. Testimony of J. Mark Iwry, Subcommittee on Employer-Employee
Relations, Committee on Education and the Workforce, 7/1/03
12. H.R. 1677, 108th Congress, lst Session
13. Cooper, Harrington and Hillesheim, et al. v. The IBM Personal
Pension Plan and IBM Corporation, Civil No. 99-829-GPM, U.S. District
Court for the Southern District of Illinois, 7/31/03
14. The Wall Street Journal, Ellen Schultz with permission, (1)
Ins and Outs of Cash-Balance Plan-Employees will need to Know What
Effects the New Setup Could Have on their Pensions, 12/4/98, (2) Some
Workers Facing Pension Hit-Longtime Employees May Find Themselves on
Long ``Plateau'' As Companies Make Switch, 12/18/98, (3) Older Workers
Fight ``Cash Balance'' Plans, 2/11/99, (4) Your Pension May Be
Changing; Go Figure How If You Can, 3/3/99, (5) New Pensions May Hurt
Young Professionals, 12/16/99, (6)Pension Paternity: How A Single
Sentence By IRS Paved the Way To Cash-Balance Plans-Age Bias Was No
Concern, It Said, Offering Comfort To Firms and Consultants-Treasury
Official's Key Role, 12/28/99