by Alvin D. Lurie

On the Rebirth of Cash Balance Plans

The recent decision by the 7th Circuit Court of Appeals in the IBM cash balance litigation, reversing the notorious trial court decision, was like a breath of fresh air, blowing away the fetid odor that has been suffocating the development of cash balance pension plans ever since, three years ago, the lower court had ruled such plans inherently age discriminatory, by interpreting an undefined term in ERISA (the pension statute) to mean that interest credits - which are integral to the benefit design of such plans - would of necessity disfavor older plan participants. The trial judge reached this result by importing into the age discrimination provision, as an interpretive guide, a statutory provision that had nothing to do with it, and then reading the statute, as so defined by him, to bar the interest factor notwithstanding that it fairly tracked the relative time values of benefits paid to younger participants versus older ones.

That his decision, long on literalism, short on policy, would be fatal to cash balance plans, and thereby contribute to the death of defined benefit plans generally, did not deter the judge one whit, but mightily deterred sponsors of such plans in being and those poised to come into being. This was surprising inasmuch as the decision went against the conclusion of every other court, before or since its issuance (but for one very recent opinion that addressed the issue, not in a final disposition of the case, but only to deny the plan sponsor's motion to dismiss the cause of action), and against even a proposed regulation from the Treasury and IRS that would have affirmed the legitimacy of the cash balance format, as well as the Bush Administration's budget proposals in recent years that included legislation to a similar end.

Until that lower court decision the cash balance plan had been steadily growing in popularity among the Fortune 500 crowd, and even in the pension universe generally, at the very time that the traditional defined benefit plan has been losing favor rapidly among both employers and employees: for plan sponsors because of high funding costs, dramatized by the effects of sinking interest rates and simultaneous stock market declines at the time of the "perfect storm" that descended upon the economy, with devastating effects on finding liabilities; for participants whose mobile work patterns were not well accommodated by the back-ended benefits build-ups and post-retirement pay-outs that characterized traditional defined benefit plans generally. The cash balance format overcame these drawbacks while preserving the defined benefit plan's powerful security advantages deriving from the employer's guaranty of benefits, backed by the government guaranty provided by the Pension Benefit Guaranty Corporation.

Nevertheless, the threat of substantial damage awards (IBM estimated its exposure from the litigation at $6 billion!), and tax disqualification of the plan that could result from an IBM copycat decision, caused many employers to terminate or freeze their plans, and many others who had been on the verge of switching to such plans to decide otherwise, and to leave still other employers in a quandry. This state of affairs continued even during the last half of 2005 and the early months of this year, when it became apparent that cash balance plans would receive Congressional imprimatur from the pension reform legislation that was then working its way through both Houses and ultimately a conference committee. But it appeared that even this expected endorsement of theses plans would leave in limbo the fate of plans that had already been adopted, since efforts in some quarters to make the legislation retroactive were unable the make headway in the conference. Indeed, it suddenly became problematic whether any legislation would pass, when proposals emerged to package into the pension reform bill, that the conference had finally agreed upon, estate tax repeal and a minimum wage boost that the Republicans and Democrats, respectively, wanted, but with each party strongly opposed to the other's pet.

To make matters worse for prospects of a bill before the November elections, all these gyrations were occurring with each House preparing to depart from the Capitol for the summer break. Then a remarkable thing happened. In the 11 days from July 28 to August 7: the House leadership took up on July 28, its last working day before the recess, a stripped down bill shorn of everything but the pension provisions (prospective only) in the form approved in the conference committee and passed it; five days later the Senate on August 3 (ditto its last pre-recess session) passed the identical bill (thereby averting the need to form a new conference committee); and on August 7 the 7th Circuit announced its reversal of the IBM decision, obviously with retroactive force since it pertained to plan years before the new legislation. The President's signing of the pension reform bill 10 days after that was anticlimactic, albeit necessary to make the cheese binding.

Suddenly the cash balance plan was reborn, forward, backward, sideways - well, maybe not sideways. The IBM decision is presently only the law in the 7th Circuit, a geographical domain centered in Chicago. The nation is divided into 10 judicial circuits, each with its own court of appeals; and technically, if a case were to reach any of those other circuits from a district court within its territorial boundaries, the IBM decision would not be binding (of course the new legislation would be, but only prospectively). And there is even the possibility of the IBM case itself would going up to the Supreme Court on certiorari, once again putting the resurrection (to mix my metaphor) on hold. But that would require another circuit court to first have reached a contrary decision, and presently there is no such decision. Moreover, the unanimous opinion in the 7th Circuit is so powerful as to make unlikely its acceptance for review by the High Court, let alone its reversal in such eventuality.

Indeed, so inevitable does the decision appear to be from a reading of the opinion as to make one wonder how there could ever have been doubt as to the outcome (although I will admit that some (few) commentators whose expertise I respect were surprisingly (to me) seduced by the lower court's mechanical, albeit unwise, reading of the governing statute). The appeals court made short shrift of that reading, and struck unequivocally at the foundations of the trial court's reasoning, as in this passage undercutting bloodlessly the judge's time-value rationale: "Nothing in the language or background of ...[here the court cites the statute in issue] suggests that Congress set out to legislate against the fact that younger workers have (statistically [so in the opinion]) more time left before retirement and thus a greater opportunity to earn interest on each year's retirement savings. Treating the time value of money as a form of discrimination is not sensible."

The opinion abounds in that kind of common sense. It is free of the convolutions, casuistries, indeed confusions, that marked the trial opinion. It is at once elegant in its succinctness and its very simplicity, demonstrable best by simply quoting the court's own words: "Litigation cannot compel an employer to make plans more attractive (employers can achieve equality more cheaply by reducing the highest benefits than by increasing the lowest ones). It is possible, though, for litigation about pension plans to make everyone worse off. After the district court's decision IBM eliminated the cash-balance plan for new workers and confined them to pure defined-contribution plans. Whether that is good or bad (for employees or society as a whole) is not for us to say. What we can and do conclude, however, is that the decision may again be made freely, governed by private choice rather than legal constraints." There is no doubt in this observer's mind that pension practitioners and their clients throughout the country will read this decision as an emancipation proclamation, a new birth of freedom to develop creative pension plans that best serve their several constituencies.