DukeEmployees.com - Duke Energy Employee Advocate
Pensions - Page 5 - 2000
Duke Energy Employee Advocate - October 9, 2000
Various members of The American Bar Association have discussed the following topics:
Here are some excerpts from the lengthy discussion:
"Some employers view cash balance conversions as an alternative to freezing or terminating their defined benefit pension plans."
What rot! It is evident that the employer shill groups have had their influence upon these members. This feeble, empty threat is designed to frighten everyone into humbly accepting any and all benefit destruction that the companies wish to inflict. The predatory companies love cash balance conversion, because they get to help themselves to money that would otherwise go to pay employee's pensions. The predatory companies actually profit off of their own employees! With a plan termination, there would be no profits for the companies, but tax penalties to pay. This is NOT what they had in mind. Also, the employees would receive the full amount due them at the time of termination, not the meager, "hypothetical" amount. The companies could not very well hide their true intentions, as they attempted to do with the conversions. In the present tight labor market, terminating a pension plan would probably not be the brightest move for any company to make. The company shill groups have said "boo." No one jumped.
"In some cases, employers have reduced overall benefit expenses in connection with adopting a cash balance plan…"
We know, we know.
"In many conversions, some workers receive less valuable pension benefits than they would have received had the plans not converted, and this effect hurts older workers more than younger workers in the same plan."
"It shall be unlawful for an employer-
"Although the law on this issue is still developing,…"
There are many unresolved issues. Issues that could just as well be resolved in the employee's favor.
"Even though the declining annuity at normal retirement age is not an inherent feature of cash balance plans, as different patterns of pay-based credits or interest credits or a different assumption as to salary increases or normal retirement age could eliminate the effect, the declining annuity has been the focus of the age discrimination analysis."
"No court has yet decided how to read section 411(b)(1)(H) of the Code in light of Hazen Paper,8 and no court has yet examined the accrual of future interest credits under a cash balance plan against the requirements of the ADEA."
"To avoid complaints about failing to grandfather participants who would have benefited from such a provision, some employers have offered all or a group of participants the right to remain under the old plan formula or convert to the new benefit structure. Although the choice feature may raise other concerns, it would appear to eliminate many age discrimination issues, provided that the consequences of participant choice were explained adequately to each participant. It should be noted that the choice feature itself is possibly a benefit, right, or feature which could be implicated in an age discrimination analysis; in the most extreme analysis choice would have to be offered to every worker over age 40, unless some service component were part of the eligibility criteria as well."
"Despite the advantages of defined benefit plans, many employers see them as too expensive to administer with design options that are too inflexible, and believe that many employees do not appreciate or understand defined benefit plans."
These are more lobbyist lies! Did you ever hear of employees protesting the old pension plan? They need to get real on this point. Some companies wanted to drain the pension plans, and were "grasping at straws" for reason why.
"Moreover, because the Supreme Court may ultimately decide whether disparate impact claims exist under ADEA, the agencies may want to issue guidance that distinguishes pensions or even cash balance plans as separate cases, so that any guidance will be applicable regardless of any ultimate Supreme Court decision of this issue."
The entire cash balance issue could very well end up in the Supreme Court.
Those who are well rested and have some time on their hands, can read the full discussion by clicking the link below:
Green Light to Cash Balance Conversions
University of Oklahoma College of Law - By Jonathan Barry Forman - October 2, 2000
One of the hottest issues in the pension world today involves companies replacing their traditional pension plans with cash balance pension plans. A cash balance plan is a defined benefit plan that looks like a bank account or a 401(k) plan. A cash balance plan accumulates, with interest, a hypothetical account balance for each worker. The individual account balances are determined by the plan's benefit formula and consist of two components: an annual cash balance credit and an interest credit.
For example, a simple cash balance plan might allocate 5 percent of salary to each worker's account each year and credit the account with 7 percent interest on the balance in the account. Under such a plan, a worker who earned $60,000 in a given year would get an annual cash balance credit of $3,000 (5 percent x $60,000), plus an interest credit equal to 7 percent of the balance in his hypothetical account…
So what's the problem? Simply put, replacing a traditional pension plan with a cash balance plan will reduce the expected pension benefits of older workers. As a result, older workers can see their future pensions cut -- in some cases deeply. These workers can get the worst of both plans -- the lower early accruals provided by the traditional pension plan and the lower late accruals provided by the cash balance plan. Worse still, after some cash balance conversions, some workers will see no increase in the value of their retirement benefits for several years. This result has been dubbed the "wear away" (or "benefit plateau"), and it is one of the most contentious features of cash balance conversions.
Not surprisingly, many of these older workers have felt cheated. They have complained to Congress, to the Executive Branch, and to the media; and they have filed a number of lawsuits challenging these cash balance conversions.
Now the Senate Finance Committee has entered the fray. In early September, the committee reported out its version of the Retirement Security and Savings Act of 2000 (H.R. 1102). Included in its bill are a number of provisions that would have an impact on cash balance conversions.
The principal provision would require more disclosure with respect to any plan amendment that results in a significant decrease in a worker's projected pension benefits. Specifically, the bill would require the plan to give workers written notice concerning any plan amendment that provides for a significant reduction in the rate of future benefit accrual, including any elimination or reduction of an early retirement subsidy. Moreover, in the case of a cash balance conversion, the plan must provide workers with a "benefit estimation tool kit" that lets them figure out the impact of the amendment on their future benefit accruals. Far more interesting, however, is the provision that the committee report says is "designed to prevent the use of 'wear away' provisions under which participants earn no additional benefits for a period of time after a conversion of a traditional defined benefit plan to a cash balance plan."
To illustrate the wear away problem, and the Senate Finance Committee's purported solution, consider the following example. Employer has a traditional defined benefit pension plan that allows workers to retire with full benefits at age 65 and provides an early retirement subsidy for workers who retire at ages as early as 55. For example, consider a typical 55-year-old worker who makes $60,000 this year and who has already earned the right to an annual pension of $30,000 a year for life starting at age 65 (i.e., 50 percent times final pay).
Under an early retirement option, the plan might provide this worker with an unsubsidized early retirement benefit of, say, $10,000 a year for life, starting at age 55. This reduced annual benefit would recognize that a worker retiring at age 55 begins receiving payments immediately and receives those payments for 10 years longer than if he waits until age 65 to retire.
Instead, however, this plan provides a subsidized early retirement benefit. For example, assume that it lets a 55-year-old worker retire with an annual benefit equal to two-thirds of his normal retirement benefit. So our 55-year-old could retire and immediately start drawing $20,000 a year for life. That's twice as large as the unsubsidized early retirement benefit (i.e., the actuarially reduced benefit of $10,000 a year starting at age 55). Put differently, at age 55, our worker's early retirement benefit is twice as valuable as his normal retirement benefit.
Needless to say, such early retirement subsidies are valuable benefits for employees. At the same time, however, they can be quite costly for employers. In the past, employers added such early retirement subsidies to their plans to push expensive older workers into early retirement. Indeed, according to one estimate, some 80 percent of Fortune 500 companies have used early retirement subsidies. Now, however, many employers want to get rid of those built-in early retirement subsidies and cut their pension costs. The problem is that once you've promised your workers a retirement benefit, it's hard to take it away. Indeed, that is exactly what federal pension law is all about. The Employee Retirement Income Security Act of 1974 (ERISA) was enacted primarily to ensure that workers will get the retirement benefits that employers have promised them, including any early retirement benefits.
Does that mean that an employer can never change its pension plan? No. An employer is generally free to terminate its pension plan or amend its plan to reduce future benefit accruals. But, under ERISA's so-called "anti-cutback rule," an employer can never take away the retirement benefits that a worker has already earned.
So can our hypothetical employer replace its traditional pension plan with a cash balance plan and simultaneously get rid of its early retirement subsidy? Yes and no. Yes, our hypothetical employer can change to a cash balance formula for future benefit accruals; but, no, it cannot take away any retirement benefits that its workers have already earned, including any early retirement benefits.
To see how the cash balance conversion will work, let's reconsider our hypothetical 55-year-old worker. This worker has already earned a subsidized early retirement benefit of $20,000 a year for life starting at age 55. At age 55, it costs about $12.50 to produce $1 of annuity income for the rest of the worker's life, so the present value of this worker's early retirement benefit is around $250,000. Our hypothetical 55-year-old has also already earned a normal retirement benefit of $30,000 a year for life starting at age 65, and recall that the present value of this normal retirement benefit is equal to about half of the present value of his early retirement benefit. Consequently, the present value of his normal retirement benefit, as of age 55, is about $125,000.
In a cash balance conversion, the employer typically sets the opening balance in a worker's cash balance account equal to the present value of the worker's normal retirement benefit under the original plan. The value of the worker's already-accrued early retirement benefit is ignored. Consequently, after the cash balance conversion, the starting balance in our 55-year-old worker's cash balance account will be $125,000. If he retires now, however, he will be entitled to start drawing his $20,000 a year early retirement benefit (and the plan might even include a provision that allows him to take the full $250,000 in a lump sum distribution).
Assume further that, after the conversion, the employer's cash balance plan allocates 5 percent of salary to each worker's account each year and credits each worker's account with 7 percent interest on the balance in his account. Consequently, if our 55-year-old worker stays with the company for another year, the balance in his cash balance account will increase to $136,750. That's because his starting balance of $125,000 will have added to it a $3,000 pay credit (5 percent x $60,000) and an $8,750 interest credit (7 percent x $125,000). At this rate, however, it will be years before the balance in his cash balance account is larger than the value of his already-accrued early retirement benefit (worth $250,000 at age 55). That's the wear away period.
Needless to say, workers faced with a cash balance conversion like this one will feel cheated. Not only will they get the worst of both plans -- the lower early benefit accruals provided by the traditional pension and the lower future accruals provided by the cash balance plan, but also for many years after the conversion, they will not see any increase in the present value of their retirement benefits…
Of course, a recent report by Watson Wyatt Worldwide suggests that most of the wear aways in cash balance conversions result from the elimination of early retirement subsidies. 1 Consequently, it's pretty clear that the Senate Finance Committee bill would not have much impact on the typical cash balance conversion.
The obvious alternative to the Senate Finance Committee's approach would be to instead require that the "minimum benefit" include the value of any already-earned early retirement benefit. For example, employer might be required to give our hypothetical 55-year- old worker a starting balance of $250,000 to reflect the present value of his early retirement benefit. Future benefit accruals could still be based on the slower cash balance formula (rather than the more generous benefit accrual formula of the original plan), but there would be no wear away period with zero net benefit accruals…
CFO Magazine - By Laurie Kaplan Singh - October 1, 2000
Pension surpluses are a boon to corporate bottom lines. But are efforts to expand them going too far?
These sure seem like good times for pension plan assets. Thanks mainly to the long bull market, many corporate plans are brimming with surpluses. Sherwin- Williams Co., for example, has pension plan assets almost three times greater than its pension obligations. General Electric Co.'s pension assets of $50 billion are nearly double its liabilities. And the pension plans of Bank of New York, Westvaco, and Cincinnati Financial Corp. are also overfunded by nearly 100 percent, according to Bear, Stearns & Co.'s 1998 estimates.
And thanks to the prevailing accounting methodology, a significant portion of those surpluses are boosting corporate bottom lines. According to Bear, Stearns, 25 percent of the companies in the S&P 500 reported income from their defined benefit plans in 1998. And for 15 of those companies, including USXUS Steel, Unocal, Northrop Grumman, Westvaco, and Peoples Energy, pension income represented 10 percent or more of total 1998 operating income. In fact, says Jack Ciesielski, publisher of The Analyst's Accounting Observer, for many companies, "pension plans--in their ability to contribute to earnings--are becoming almost as significant as operating assets."
It's no surprise, then, that more and more corporations are devising new ways to preserve and expand their pension surpluses. Such efforts have included everything from lobbying for legislative changes to reducing pension benefits to, most recently, Bank of America's novel idea of channeling 401(k) monies into defined benefit plans.
But some analysts contend that using pension surpluses to boost earnings distorts financial reality. For one, the growth rates are not sustainable. "You can do these things, but only for so long," says Ashwinpaul "Tony" Sondhi, president of A.C. Sondhi & Associates, a financial advisory firm in Maplewood, New Jersey, and chairman of the Financial Accounting Policy Committee of the Association of Investment Management and Research. For another, the earnings aren't real. Because of Employee Retirement Income Security Act (ERISA) requirements, a company can't access the assets in its pension plans for purposes other than providing benefits to plan participants. "It cannot use this money to finance capital projects, to buy back stock, or to pay dividends," says Ciesielski. "It does nothing to increase or decrease cash flow." Moreover, the mushrooming surpluses--which have to be fully disclosed only in the footnotes of a company's annual report--have raised the ire of the Securities and Exchange Commission, which is taking a hard look at broadening pension disclosure requirements. In addition, labor unions and retirees, concerned about the lengths to which companies will go to increase the surpluses, are reviving debate over the proper use of pension plan assets. Little wonder, then, that some analysts are wondering if the surpluses might be too much of a good thing.
Multiple Options That hasn't stopped efforts to expand the surpluses, however. On Capitol Hill, the Senate is considering a bill that would repeal the limits on deductible employer contributions to pension plans. A similar version passed in the House of Representatives in July. But whether a final version will pass muster with the Clinton Administration remains to be seen.
Even without legislative change, employers are finding many ways to boost their plans' assets. That's mostly because "the accounting methodology [for pensions] is chock-full of assumptions that can be tweaked to achieve a desired result," says Ciesielski.
That methodology--Statement of Financial Accounting Standards No. 87, or FAS 87--requires companies to record surplus pension assets as a credit to pension expenses. Simultaneously, it gives companies some flexibility in making actuarial assumptions. Consequently, each year pension plan officers revise the discount rate used to value their plans' liabilities. The higher the assumed interest rate, the lower the present value of a plan's liabilities, the higher its surplus, and the higher the company's earnings. Similarly, pension plan officers revise the assumed rate of return used to estimate plan assets. "Even minute adjustments to these estimates can cause a big swing in a large pension plan's surplus," says James Turpin, vice president for pensions at the American Academy of Actuaries.
How much tweaking is actually going on, however, is subject to debate. Because of the bull market, says Ciesielski, "firms haven't had to resort to the skulduggery of tinkering with expected rate-of-return assumptions to improve earnings. The positive earnings effects are even more likely to be the result of the accounting model itself rather than its outright manipulation."
Companies have, however, become creative in keeping their plans as funded as possible. Bank of America blazed a new trail in July when it offered participants in its $4.7 billion 401(k) plan a one-time option to roll their accounts into the company's $8 billion defined benefit plan. The advantage to employees who make the switch is that they will be able to allocate the money among "virtual" mutual funds, hypothetical portfolios that track returns on the bank's in-house funds. But for Bank of America, the windfall is potentially much larger: its investment returns could be greater than the amount the company will be obligated to pay out to employees. Other companies are surely waiting to see if Bank of America runs into regulatory problems. If it doesn't, it's likely that there will be a flood of asset transfers from 401(k) programs into pension plans.
But not all companies are waiting patiently for the go-ahead to increase assets. Many are also attacking the issue from the liability side of the balance sheet and simply reducing benefits. Many major corporations--including IBM, Ameritech, Duke Energy, Kmart, and Lucent, to name just a few--have implemented pension cuts in recent years. In some cases, the changes have been in the form of subtle modifications to the compensation and benefits formulas, such as a reduction in the rate at which benefits are accrued. Increasingly, however, employers' efforts to boost pension plan surpluses--and corporate earnings--have been far less subtle, consisting of the outright elimination of specific benefits, such as early retirement subsidies.
Historically, companies cut benefits when business is bad. But these are prosperous times, and most pension plans are fully funded, if not overfunded. "[FAS 87] has given companies the ability to realize the economic value of pension plan assets without actually going through a reversion," says Richard P. Hinz, director of the Office of Policy and Research at the Pension and Welfare Benefits Administration. As a result, he says, pension plans are now effectively a profit center.
Could it Backfire? All of this maneuvering has provided considerable short-term benefits to companies. But many experts fear that corporations' increasing reliance on growth in pension plan surpluses will backfire over the long term. Sooner or later, the stock market will stop performing as spectacularly as it has in recent years. At that time, says Sondhi, "not only are companies going to have to make pension contributions, [but] they will no longer be able to recognize the credit." In this scenario, pension plans easily could become a cost center again. "[They are], after all, a cost of doing business," says Sondhi. "Right now, [they're] not showing up as a cost of doing business because [they're] shielded by a confluence of events--the market's performance and changes in assumptions."
A change in the current environment, say analysts, may also reveal subpar growth in income from certain companies' primary businesses. "Pension plan returns are far in excess of the return on assets of their sponsors," says Ciesielski, noting that according to his estimates, 32 of the 87 S&P 100 firms with defined benefit pension plans had pension plan returns in excess of their operating returns in 1999. Still, Gaston Kent, vice president of investor relations at Northrop Grumman, maintains that as long as firms adequately disclose their pension income, pension fund accounting should not be an issue. "Every shareholder that I talk to is fully aware of it," he says. "And there are also some fairly significant noncash expenses."
While many analysts believe that companies should be required to treat pension income the same way they treat earnings on investment--as nonoperating income--no one expects any changes in the accounting rules anytime soon. While the Financial Accounting Standards Board acknowledges the validity of some of the recent criticisms about pension accounting, it currently has no agenda item scheduled to address the issue. "There is obviously a lot going on in a pension plan," says Jim Kroeker, a FASB fellow. "But it seems that all of the necessary information is available in the footnotes to the financial statements."
The SEC, however, is trying to get pension surplus information out of the footnotes and into the spotlight. Although the commission does not plan to organize a task force or propose new rules on the issue, it is "sensitive to the disclosure of pension fund details," says a senior official. Most recently, in December chief accountant Lynn Turner sent an audit risk alert letter to the American Institute of Certified Public Accountants, letting accountants know that any gains or losses on pension fund investments that are "reasonably likely to have a material impact on financial condition, liquidity, or results of operations of the company" should be included in the management discussion portion of a company's filings. Changes in types of plans must also be discussed, the letter said.
The Other Shoe The continuing desire of corporations to maintain pension surpluses, say some observers, is the force behind the recent spate of cash-balance plan conversions. An estimated 500 defined benefit pension plans in the United States have been converted to such plans in recent years.
By definition, a cash-balance plan conversion does not have to mean lower benefits for employees and retirees. "There are valid reasons for switching to a cash-balance plan," notes Turpin of the American Academy of Actuaries. In theory, it can be structured to provide employees and retirees with long-term retirement benefits equivalent to those in the old defined benefit plan, while also meeting the portability needs of today's workforce. In practice, however, the conversion generally produces significant reductions in the employers' total pension liabilities by reducing benefits for many employees. Last year, for example, when IBM converted to such a plan, one of the company's engineers calculated that he would lose $212,000 when he retired in 10 years after 30 years of service. "The purpose of IBM's cash-balance plan conversion was to slash obligations to employees, increase the pension plan surplus, increase the company's operating income, and drive up its stock prices," says James Marc Leas, an advisory engineer and patent lawyer at IBM's Burlington, Vermont, semiconductor fabrication plant. As has been widely reported, IBM employees didn't take the conversion lying down. After months of protests, Leas and 329 other shareholders submitted a shareholder resolution calling on IBM to give all employees, regardless of age, the same pension choice and retirement medical plan as older employees were given. And although the resolution did not pass, it captured 28.4 percent of the shareholder vote--far more than the 3 percent needed for employees to win the right to bring the issue up again at next year's annual shareholder meeting. And, largely in response to the protests of employees at IBM and other companies, a Senate panel, the Internal Revenue Service, the Equal Employment Opportunity Commission, the Department of Labor, and the Pension Benefit Guaranty Corp. are all in the process of reviewing cash-balance plan conversions to determine if, among other things, they violate U.S. age-discrimination laws.
Meanwhile, General Electric's huge surplus, and the $4 billion it has contributed to earnings in the past five years, have also stirred up dissent. At demonstrations throughout the country, GE retirees and union representatives have been pressing for permanent cost-of-living increases. And at GE's last two annual meetings, union workers and retirees proposed resolutions seeking shareholder approval of top executives' benefits. Although the resolutions didn't pass, they appear to be gaining institutional investor support. GE retiree groups are also uniting with retiree groups from IBM and four other corporations to seek protection from benefit reductions in the event of a merger.
Such protests from retirees and labor could be the main price companies pay for increasing their pension assets. "There's no question that this has made employees more cognizant of pension trusts and where they sit in the overall spectrum of the employer's assets," says Bob Patrician, a research economist at Communications Workers of America. Retirees are also more likely to push for cost-of-living increases and, in the process, revive the decades-old debate over the proper use of surplus pension plan assets. "The only thing that will stop this is political intervention," says Norman Stein, a professor at the University of Alabama School of Law. "The idea is now too well entrenched that this money belongs to the shareholders, not the employees, and [companies] are going to give as little of it as possible to the employees--even though it was supposedly put aside for their retirement." Laurie Kaplan Singh is a freelance writer based in Winnetka, Illinois.
The Deductible Debate
On July 19, the House of Representatives overwhelmingly passed the Comprehensive Retirement Security and Pension Reform Act of 1999 (H.R. 1102), introduced by Reps. Rob Portman (ROhio) and Ben Cardin (DMd.). A key provision of the proposed legislation is the repeal of the funding limit. Employers currently cannot deduct contributions to a defined benefit plan once the plan's assets exceed 150 percent of its liability. As a result, many corporations haven't made contributions to their pension plans in years (General Electric Co., for example, hasn't contributed to its pension plan since 1987). Under the current law, the funding limit will be raised to 170 percent by 2005.
The Portman-Cardin bill, in contrast, phases out the ceiling on deductible contributions more quickly and eliminates it entirely after December 31, 2003. If passed by the Senate (a vote was expected at the end of September), the bill would also raise the existing percentage of salary limitations on employee contributions to qualified savings plans (defined contribution plans, 401(k) plans, and individual retirement accounts), relax existing antidiscrimination and "top-heavy" protections, and provide some anticutback relief to employers under specific circumstances.
The bill's opponents, which include the Clinton Administration, say it primarily benefits higher-paid employees while relaxing the nondiscrimination rules designed to protect lower-wage workers. Some also fear that it includes language that could have the unintended consequence of giving employers greater leeway to cut benefits, such as early retirement subsidies. In addition, the bill is likely to cost the U.S. Treasury tens of billions of dollars in revenue losses…