Staying off the Cover of Time
Until recently conversions of defined benefit pensions to cash balance and other hybrid pension plans received little attention. That changed, however, when IBM's problems captured headlines and landed the company on the cover of Time and other magazines in 1999. IBM's decision to switch its plan for U.S. workers met widespread employee resistance, ultimately leading the company to modify its original proposal. Criticism of cash balance conversions prompted several members of Congress to introduce legislation that would increase scrutiny of future conversions, and the IRS invited public comment on cash balance plans. Despite IBM's travails, other companies have converted their defined benefit plans without negative publicity. "For the most part, conversions have gone extremely well--that's why these plans were around for 12 years before any issues arose," says Eric Lofgren, director of the benefits consulting group with consultants Watson Wyatt Worldwide in Philadelphia. "For instance, probably 30 large banks have put in cash balance plans. But have you heard a peep about them?" Although a plan conversion may generate some employee anxiety, the companies interviewed for this article reported that their transitions went smoothly and resulted in improved employee morale, not turmoil. They achieved this outcome by addressing two critical issues: the wear-away problem and effective communication. (For an explanation of the technical aspects of cash balance plans and how they work, see "Cash Balance Conversions," page 22.) THE WEAR-AWAY PROBLEM Why did the IBM conversion encounter so much resistance from its workforce? Without specifically mentioning IBM, Lofgren says it takes a unique set of circumstances to rouse employees' ire. "For a conversion to become a problem, you need a switch that results in an extreme decrease in benefits. Then you need a population that happens to have a large amount of people caught around the 40/20 mark: 40 years of age with 20 years of service." Lofgren's comments point to the Achilles' heel of cash balance conversions: Although conversions generally benefit younger workers, midcareer employees may experience a reduction in their future retirement benefits under the new plan. As a result, those employees will face a choice: Accept a lesser benefit if they decide to retire in the near future or work longer to reach their previously projected pension levels. The period of time when workers no longer earn additional retirement benefits for their service has been dubbed the "wear-away" period and is a major source of contention in plan conversions. It's worth emphasizing that these employees have not lost actual accrued benefits; instead, the conversion results in a reduction in projected benefits. This means the benefits an employee has already earned do not change. What might change are the benefits the employee was projected to earn at retirement. For example, if a 57-year-old employee had accrued a $1,200 benefit starting at age 62, she would receive that amount--starting in five years--if she left the company at 62. If she worked five more years and her salary remained the same her projected benefit under the old plan would increase to $1,500. With the implementation of a cash balance plan, there is no guarantee the employee will see her projected benefit increase to the same level. "I think some of the news articles have taken the wrong bent by saying people lost pension benefits," says Ray Berry, an enrolled actuary and employee benefits manager with Grant Thornton in Chicago. "No one has lost benefits. What they've lost, if anything, is the right to future benefits accruals at a higher rate. Accrued benefits to date have not been lost." MAKING THE TRANSITION Employers have no legal obligation to provide transition benefits or to replace a terminated defined benefit plan, but industry consultants see a risk in filling to do so. …