Pension Advocates Prepare to Battle Conversions

A few years ago, when IBM Corp. was contemplating a major change in its pension program, the threat of losing millions of dollars in promised benefits galvanized workers. They organized, protested and persuaded the company to alter its plans.

Millions of other American workers who are covered by traditional pensions may face a similar battle in 2003. That’s because the federal government last week issued a proposal that could end a three-year moratorium on the type of changes IBM had sought -- specifically, the conversion of traditional “defined benefit” pensions to so-called cash-balance plans.

Unlike a traditional pension, which guarantees a monthly payment that’s based on the participant’s age, years of service and final income at a company, cash-balance plans provide each participant with a personal account, similar to a 401(k).

The amount a cash-balance retirement plan eventually will pay in pension benefits hinges on how much the company contributes to the plan and the rate of return the company guarantees the money will earn over time.

For older workers, that can mean sharply reduced pension payments compared with traditional defined-benefit plans.

That is one of the big reasons many companies are interested in making the shift to cash-balance programs: Firms can save huge sums in pension funding.

Even though the number of traditional pension plans has shrunk over the last two decades, about 42 million Americans still were covered by the plans as of 1998, the last year for which data is available, according to the Employee Benefit Research Institute.

“This is something that mobilized IBM workers,” said Jimmy Leas, an IBM employee in South Burlington, Vt., who was involved in the fight when IBM proposed converting to a cash-balance plan. “We picketed. We wrote letters. People stopped working, and they forced the company to make a change” in its proposal, he said. “American workers can put a stop to this.”

The government’s concern about the fairness of cash-balance plans led to the moratorium on conversions of traditional pensions starting in 1999.

But last week, the Treasury Department issued proposed rules addressing age-discrimination issues that arise with cash-balance plans. The rules, if finalized, could end the moratorium and open the floodgates to a wave of pension-plan conversions, experts said.

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Conversion Backlog

“The whole world is not going to turn to cash balance, because different companies have different needs,” said Eric Lofgren, global director of the benefits consulting group at Watson Wyatt Worldwide.

Even so, he said, “there is a backup of companies that wanted to go cash balance but didn’t want to do it until things were more certain. We will see a big wave of conversions.”

Experts note that cash-balance plans have advantages for some workers, particularly younger ones who are likely to switch jobs at least several times in their careers.

Younger workers are at a disadvantage with traditional pensions, because those plans are back-loaded -- that is, those who remain with the company the longest get the biggest pension payments.

Cash-balance plans, by contrast, usually promise all workers identical annual percentage rates of growth in pension-account assets, regardless of age. That can allow younger workers to accrue benefits faster than under traditional plans.

Moreover, cash-balance plans are portable. Though a vested participant eventually will get his or her earned pension benefits no matter whether the pension is traditional or a cash-balance plan, the structure of the latter allows that transfer to occur at the termination of employment rather than at retirement. (The money can be paid out in a lump sum, and rolled over into an IRA, for example.)

But for older workers, any new conversions of traditional plans to cash-balance plans could be costly, despite the government’s proposals to address the fairness issue, experts said.

The leveling out of pension accruals under cash-balance plans hurts longtime workers who have relied on the traditional pension system that rewards seniority with richer pensions. When that promise is taken away at 35, the participant probably has time to save enough to make up the difference. But when it’s taken away at 50 or 55, it’s another story, experts said.

“The people who get caught in the middle are often getting a bad deal,” said David Certner, director of federal affairs for the American Assn. of Retired Persons in Washington.

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Complex Formula

Moreover, the complexity of the pension-conversion formula can open the door to abuses, and the government’s proposed rule change does little to eliminate that possibility, Certner said.

Federal law bars companies from taking away pension benefits that already have been earned by an employee.

However, figuring out the exact amount that each employee is due from an old pension plan requires a complicated calculation whereby the company determines the monthly retirement annuity that the participant already has earned (based on age, service and salary); calculates the lump sum required to generate that monthly annuity at age 65; and then applies a “discount” rate to determine the present value of those future benefits.

The discount rate assumption in the calculation is key. The higher the assumed rate of the money’s growth, the smaller the present value of the benefits.

Pension law currently says companies should use the 30-year Treasury bond yield, which is roughly 5% today, as the discount rate, to be conservative.

But the proposed rule allows companies to calculate the present value of future benefits based on any “reasonable” interest rate assumption. Using even a slightly higher rate can have a dramatic effect on the value ascribed to employees’ already vested benefits in pension plan conversions.

Consider a 50-year-old woman entitled to a $2,000 monthly benefit at age 65. Using a 5% discount rate, this woman would start the conversion process with $165,033 in already-earned benefits.

But if the assumed discount rate was 7%, the present value of her benefit would be roughly 25% less -- $122,442.

Additionally, the proposed rule allows for something called “wearaway.” In a nutshell, this means that an older employee could go several years without earning additional pension benefits.

A quick explanation of how wearaway occurs: When a cash-balance plan is created, each participant would have two separate accounts. One would equal the present value of the vested pension benefits in the old plan; the other would be the participant’s opening balance in the new cash-balance plan.

If an employee quits, he or she would be entitled to whichever account had the higher balance. However, for an employee who stays with the company, the present value of the vested pension would stay constant while the cash-balance account would continue to accumulate company contributions.

Assume the company is contributing $5,000 a year to the employee’s new cash-balance plan. If the present value of the old pension is $200,000 and the opening sum in the cash-balance account is $100,000, it would take years for the cash-balance account to exceed the old pension’s value, even if the credited rate of return is substantial.

The government said it doesn’t consider a period of wearaway to be discriminatory, assuming the present value of the old pension plan was figured fairly.

“What happens to a mid-career worker, who has put a number of years into a defined-benefit plan and then has the formula changed?” Certner asked. “We were disappointed that the Treasury didn’t do more to protect employees.”

Because pension issues can be so complex, workers at companies that are contemplating a shift to cash-balance plans often don’t understand what they’ve lost until long after it’s been taken away, said Douglas Sprong, a St. Louis attorney representing employees who are suing over cash-balance conversions.

“IBM had the smartest workforce that the world has ever known, so they figured it out,” Sprong said. But in the past, companies have presented cash-balance conversions with documents emphasizing the portability of the plans, without detailed discussion of how much some workers could lose in the end.

Pension advocates had hoped that the Treasury would require companies to use the currently low statutory discount rate when calculating the present value of pension benefits in a conversion.

They also wanted longtime workers to be eligible for some type of grandfathering -- either the ability to stick with the old plan through retirement, or be given another assurance that their benefits wouldn’t be drastically slashed when they were on the doorstep of retirement.

Neither was included in the proposal, though it’s possible individual companies could choose to grandfather older workers or provide other credit for service already earned.

IBM allowed mid-career workers with a certain level of seniority to choose which pension plan they preferred.

For pension advocates, the battle is just beginning: A group of individuals and organizations that fought cash-balance plans in the past met Friday to plot their next move, said Karen Ferguson, director of the Pension Rights Center in Washington and a longtime critic of cash-balance plans.

They’re hoping to fuel a large public response to the possible lifting of the moratorium on plan conversions.

The proposed rules are subject to a 90-day comment period and public hearings before they’re made final.

“Employees should raise this issue in their workplace, with their members of Congress and with President Bush,” said Rep. George Miller (D-Calif.). “If they do not, the issue will fade and with it the annual value of their pension.”

“We are at a time when there is incredible insecurity -- when people are tremendously worried about their income in retirement,” Ferguson said. “We think there is going to be a tremendous outpouring of outrage from affected employees.”

Individuals can send comments to: Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044.

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Kathy M. Kristof can be reached at kathy.kristof@latimes.com.