Pension pros begin to favor cash balance


Alternative to defined-benefit plans increasingly considered, as MeadWestvaco and SunTrust make the switch

By Susan Kelly
February 26, 2007

The legal clouds that have hovered over cash-balance plans for years are dissipating, thanks to a new law and a couple of recent court decisions.

As a result, pension consultants say, more companies concerned about the balance-sheet impact or funding problems associated with traditional defined-benefit pensions are considering the cash-balance alternative. The hybrid plans may be an even better choice, for employers as well as employees, than defined-contribution plans such as 401(k)s, according to the consultants.

The Pension Protection Act of 2006 gave companies contemplating switching to cash-balance plans some legal protection against age-discrimination suits. And two U.S. appellate courts have ruled that the plans are not age-discriminatory, partly easing the legal concerns of companies that started cash-balance plans prior to the PPA’s effective date.

In the wake of the PPA, companies that are thinking of moving away from a traditional pension plan “definitely have cash-balance plans on the radar screen,” said Stewart D. Lawrence, national retirement practice leader at the Segal Co. “The clients I’m working with have in general leaned toward cash-balance plans rather than conventional [defined-contribution] plans.”

A recent Hewitt Associates survey of 145 large companies also points to some pickup of interest. The survey, conducted in November and December, found that 6% of companies were considering converting from a traditional defined-benefit plan to either a cash-balance plan or a pension-equity plan, another form of hybrid, up from 2% in the previous year’s survey.

“PPA cleared up the concerns about litigation,” said Allison Borland, a senior benefits consultant at Hewitt. “We’re not seeing a mass rush to hybrid plans, but it looks as if they’re now a viable option.”

The Hewitt survey also showed that just 6% of the companies surveyed plan to close their plans to new entrants, down from 15% the previous year, which Ms. Borland said might also be related to the increase in the number of companies planning to switch to hybrid plans.

Still, there’s no visible stampede to adopt cash-balance plans.

Consultants do say, however, that it takes companies some time to do the analysis that precedes pension plan changes. Since the PPA was enacted, just two companies, MeadWestvaco Corp. and SunTrust Banks, have announced conversions of traditional pension plans to a cash-balance plans, and MeadWestvaco has said that it had been considering a conversion for more than two years. Another company, Phoenix Cos., said it will convert its traditional plan to a pension-equity plan.

In a cash-balance plan, the company credits each employee’s account with a percentage of his or her salary each year, and the account earns interest at a set rate. Pension-equity plans also feature annual contributions to employees’ accounts, but the final benefit is calculated using a percentage of the employee’s final salary and the number of years of service. Pension consultants say such plans offer advantages to both companies and their workers.

Employers do the investing in a cash-balance plan, unlike in a 401(k), freeing employees from the chore of deciding on investments, as well as the risk of making a bad choice. And because cash-balance plans offer an annuity option at retirement, they also provide employees with some protection against outliving their assets.

For an employer, hybrids like cash-balance plans pose less of a balance-sheet concern. In a traditional plan that pays retirees a percentage of their pay over their final five years of work, the company’s liability reflects not only the benefits workers have accrued to date but also the effect of future pay increases.

Mr. Lawrence argued that a cash-balance plan can end up costing a company less than a 401(k) if the return it earns on the plan’s assets is greater than the interest rate it credits to employees’ accounts.

He added that if a company closes a traditional pension plan and the closed plan develops a surplus, the company has no way to use the surplus funds. If the company converts a traditional pension plan to a cash-balance plan, any surplus can be used for the cash-balance plan.

Ethan Kra, chief actuary for retirement at Mercer Human Resource Consulting, argued that the cash-balance plan option will stem the decline in the number of companies with defined-benefit pension plans. “There are going to be fewer departures from the defined-benefit system,” Mr. Kra said. FW

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