by Alvin D. Lurie

GAO Critiques Cash Balance Plan Conversions–AAA Critiques GAO Right Back

GAO-06-42 may sound to the baby-boomer generation of moviegoers like a high-tech warrior from Star Wars; but it is far more prosaic, being the official designation the General Accountability Office has assigned to its report with the understated title "Information on Cash Balance Plans", issued in November to three congressmen who had authored legislation advancing their anti-cash-balance bias, Senator Tom Harkin and Representatives Bernard Sanders and George Miller, and were obviously looking to the Congress’ auditing arm to undergird their continuing efforts to protect workers from their skinflint employers, who, the Congressmen obviously believed, were employing the mechanism of converting traditional defined benefit plans into cash balance plans for the specific purpose of cutting back on their workers’ pension benefits.

It is doubtful the legislative trio got what they were expecting, in a report that underscored the "long-term decline" of the defined benefit pension system, pointedly noting that some analysts have identified hybrid DB plans like the cash balance variety "as a possible means to revitalize this declining system." Indeed, in the concluding passage of the report, the GAO cites "a crucial balance between protecting workers benefit expectations with unduly burdensome requirements that could exacerbate the exodus of plan sponsors from the DB system", and calls upon Congress "to protect the benefits promised to millions of workers and eliminate the legal uncertainty surrounding CB plans... (by) craft(ing) balanced reforms that could stabilize and possibly permit the long-term revival of the DB system."

That exhortation to put cash balance plans on a stable footing, as a way of sustaining the very defined benefit system, didn’t stop Rep. Sanders from immediately trumpeting the GAO report as "further proof of the need to stop companies from slashing the pension benefits of older workers through cash balance schemes." One could be forgiven for seeing the congressman as too soon made glad by the report, or maybe simply as having engaged in the Beltway game of spin. After all, that is the same Rep. Sanders who has authored riders to the Treasury appropriations bills in recent years to stop the Treasury and IRS from entering the appeal of the suit won in the trial court by the workers attacking the IBM cash balance plan, and from Treasury’s issuing a long-stalled regulation validating the cash balance format. (The depth of Sanders’ hostility to the cash balance design is not easy to fathom, but presumably stems from a plant closing several years ago by IBM in Vermont, the congressman’s home state, whose conversion of its traditional DB plan into a cash balance plan has proved to be the lightning rod that galvanized the anti-cash balance movement.) There can be no doubt that the IBM decision by the federal district court is most responsible for the legal uncertainty surrounding the cash balance format and the resultant pall that has hung over the cash balance community for the past couple of years. The decision is now on appeal in the 7th federal circuit court of appeals.

Others have also read the report as a knock on cash balance plans, most notably Ellen Schultz, whose Wall Street Journal pieces for years have been on the case of IBM and other large corporate sponsors of cash balance plans for supposedly leading their employees down a path of lost benefits, "wearaways", "whipsaws", and age discrimination. Less apparent than what lies at the seat of Congressman Sanders’s passion is why Ms. Schultz has made CBs her bete noir, as can readily be discerned once again from her recent story on the GAO report, where her lead sentence informs readers: "A government study concludes that most workers – regardless of age – receive lower retirement benefits when their employers switch from traditional pension plans to cash- balance plans." Coupled with the headline on her story –

Workers of All Ages Lose Benefits

In Switch to Cash-Balance Plans

– her words tell the reader (even as the headline writer inferred) that benefits are actually taken away on conversion to a CB plan and that even the government says so.

That is obviously not so, and the government study doesn’t say otherwise.. A loss of expectation of the benefits to be enjoyed were the original, traditional DB plan to have continued in force until retirement will certainly occur for some participants, mostly older, long-service workers nearing their retirement years when under many DB plans – principally final average pay designs intended to reward participants for their long tenure – benefits escalate disproportionately. The cash balance design, by contrast, usually causes benefits to accrue for all participants at the same rate each year (although even CB formulas can take age and service into account to enhance benefits for seniors). However, even that would not produce a reduction of benefits previously earned under the DB plan. In fact, present law prohibits actual cutbacks of accrued benefits.

The report at several places states very explicitly that the replacement of a traditional DB plan with a typical CB plan produces a greater benefit for all workers than if the DB plan were to be terminated without conversion to a CB. For example, in the opening paragraphs summarizing the GAO’s findings, there is this: "In comparing a typical CB plan to a terminated FAP (final average pay) plan, all vested workers would do better under the CB plan." (italics added) As the report also notes, even where the incremental benefits following the CB conversion would be less for older workers, 30-year-old participants in a majority of cases would enjoy benefit increases; and, of course, even older workers would not lose expected benefits disproportionately to younger workers where the former’s DB plan benefit expectations were grandfathered.

The report states unequivocally:

*most converted plans also used some form of ongoing weighted pay credit

But the key point is that a loss of expected benefits attributable to post-conversion

services is a far cry from an actual reduction of benefits due to pre-conversion services. The latter is illegal. The former is the employer’s prerogative, even to the point of terminating retirement benefit completely for future services; although the exercise of that prerogative is not without extra-legal repercussions of various sorts; and, in fact, the report bears witness to the fact that plan sponsors have generally refrained from exercising their right to reduce benefits precipitously on the occasion of a CB conversion, let alone terminate them prospectively. In fact, as we shall momentarily see, the report appears to have overstated the reduction of benefits attendant on a conversion, failing to take note of an actual increase in the cost of providing benefits that can be gleaned from some extant studies.

The report does take cognizance of the difficulty in tracking the actual implications of CB conversions for workers generally from the available data (one might add, from any kind of data that could be collected). It only states the obvious in the following passage: "The effects of a conversion depend on a variety of factors including the generosity of the CB plan itself, transition provisions that might limit any adverse effects on current employees, and firm-specific employee demographics." The GAO acknowledges the paucity of research available on how participants are likely to fare under a CB plan compared to the traditional DB plan that is being replaced..

Most interestingly, the report obliquely refutes the frequent canard of the anti-cash-balance club, such as is typified by the above stated charge of Rep. Sanders that benefits of older workers are being "slashed...through cash balance schemes", when it states: "The pension and economic literature provides little conclusive evidence about the effects on benefits and other aspects of CB plans conversions, particularly with regard to why sponsors convert to CB plans in the first instance."

The three congressmen whose request for information from the GAO prompted the report had tasked the agency with answering these questions: (1) what can be gleaned from the current research about the implications of CB conversions for workers’ benefits; (2) what is the prevalence and types of transition provisions to protect workers’ benefits in past conversions; (3) how do individual participants fare under a hypothetical conversion to a typical CB plan compared to the typical FAP plan? In an appendix to the report the authors cite various deficiencies in the literature that limit the utility of available resources, e.g.: the literature is in its infancy; the limited availability of empirical studies possessing data permitting the examination of actual conversions; the range of factors unique to each conversion that influence the final impact on workers, making it difficult to extend the results recounted in the literature to the actual experience of individual workers.; the focus of many studies on "hypothetical" or "prototypical" workers, rather than actual employees.

In almost a throw-away line, the authors note that a couple of the studies they examined, prepared by two of the top-drawer financial institutions in the country, had to be "interpreted with caution" because over half of the plans therein evaluated were those for which the institutions were the primary design consultants, suggesting a potential for bias. That only went, of course, to substantiate the care with which the GAO researchers picked over the available materials, not to denigrate the cited studies, and certainly not to reflect on the plan sponsors whose plans were discussed therein (to say nothing of the many other plan sponsors whose actions and motivations provided the grist for the GAO report). One can only guess why, then, the Schultz article, reporting on the 68-page GAO report, devotes one of its 10 inches in print to recounting this little tidbit.

There is a certain irony in the concerns expressed by the report’s authors that the results from the just noted surveys "may not be representative of the population of CB plan conversions", and even suffer from "methodological limitations". The American Academy of Actuaries, in a letter dated November 28^th to the Comptroller General, who heads the GAO, leveled essentially the same charge at the GAO report, especially in reference to the manner in which it derived its "typical" FAP plan, with the result that "the GAO typical final pay benefit formula is far more generous than prevailing FAP formulas" , by about 40 percent.

The AAA letter also faults the GAO report for its methodology in determining the effect of a conversion on the sponsor’s plan costs, leading to a possible distortion of the proper reading of certain data suggesting that, far from a reduction of such costs incident to a conversion, average costs have actually risen. The AAA noted that the GAO acknowledged it might have used another research approach to arrive at its conclusions, but that the GAO researchers had dismissed that alternate approach as "outside the scope of our study." The AAA’s response: "We don’t view this as an alternate approach, but as the best approach....especially in light of the overstated FAP plan used to represent traditional plans."

The letter goes on to state that, "just because some employers combined their conversion to a cash balance plan with a reduction in their pension costs...it does not follow that cash balance plans are inherently less valuable than traditional final average pay DB plans." In fact, the AAA points out persuasively, "It seems logical to conclude that had those companies not changed to a cash balance plan, they would have reduced costs in some other way, in many instances by reducing benefit levels or making other changes to their DB plans." (Are you as surprised as I to find our colleagues in the actuarial discipline abandoning their statistical methodology and mathematical assumptions long enough to smell the roses growing in the real world ?)

In any case, for these and other reasons cited in the letter, the actuaries ask the GAO to revise or supplement its report "in order to provide the best information available in the important public policy debate on cash balance plans." To which I can only say, "Amen". The honorable MOCs to whom the report was addressed may rue the day they asked GAO to answer their questions. To which I can only add, so may it be.