IT'S NOT YOUR FATHER'S PENSION PLANPosted On: Oct. 29, 1997 12:00 AM CST
An employer drive to make pension plans more visible and meaningful to an ever more mobile workforce is transforming the defined benefit plan landscape.
Amid demographic changes and a growing recognition that employees didn't understand or appreciate their defined benefit pension plans, hundreds of large employers since the mid-1980s have converted their old-line final average pay plans into a new generation of pension hybrids.
The hybrids, which include cash balance, pension equity and lifecycle plans, are named for their unique designs, which are intended to combine the best features of defined contribution and defined benefit plans.
From defined contribution plans -- especially 401(k) plans -- the hybrids borrow the account balance feature in which benefits are expressed as a lump sum. That allows employees to know instantly the cash value of their benefits rather than try to figure out a complicated formula with several unknowns, such as future salary.
Like 401(k) plans, many of the hybrids feature benefit portability, allowing employees who quit their jobs to take their account balances as a lump sum. That gives employees the flexibility to receive cash or roll the money into individual retirement accounts or their new employers' pension plans.
That flexibility is a major difference from traditional plans in which employees -- regardless of their ages when they stop working -- must wait until they reach normal retirement age to receive a benefit in the form of a monthly annuity.
In addition, through their design, the hybrids give much richer benefits for an employee's first few years of employment compared with traditional final average pay plans. That is a big attraction to a workforce that has become conditioned to short tenures and multiple employers.
While having defined contribution plan features -- individual account statements and usually benefit portability -- hybrids still are defined benefit plans. They promise employees a specific benefit. If the employer makes poor investment decisions and the plan assets are insufficient to pay promised benefits, the employer will have to make additional contributions to the plan.
That is a fundamental difference from defined contribution plans, such as 401(k) plans, in which employers agree to make a specific contribution to the plan. But if the value of employees' accounts declines because of employees' investment decisions, the employer does not have to make additional contributions.
By merging the best features of defined contribution and defined benefit plans, hybrid plans, especially cash balance plans, have become the new star performer in the defined benefit plan universe.
In a cash balance plan, employees receive credits based on a percentage of pay, such as 7% of pay. This amount is expressed as an account balance, which is increased by a predetermined interest rate, such as the one-year U.S. Treasury bill rate plus 1%.
In a pension equity plan, employees earn credits, expressed as percentages, for each year they work. The percentages typically increase with age. The percentages are added up to come up with a percentage, such as 150%, that is multiplied by final average pay. For example, someone with 150% and a final average salary of $50,000 would get a $75,000 benefit, resulting from the final average pay multiplied by 150%.
In a lifecycle plan, an employee's years of service are multiplied by final average pay. The sum is then multiplied by a percentage based on the addition of employee's age and service. This amount is divided by a so-called conversion factor. The conversion factor is based on the employee's age when benefits begin to be paid. The result is the employee's benefit.
Assume a woman retires at 65 after 30 years of service and final average pay of $35,000 a year. The example assumes the percentage based on age and service is 9% and the conversion factor, based on the age at which benefits begin, is 9. In this example, the 30 years of service would be multiplied by $35,000, with that sum multiplied by 9%. That amount, $1,050,000 in this example, would be multiplied by the percentage -- 9% in this case, based on age and service -- resulting in a figure of $94,500. That amount would be divided by the conversion factor of 9, resulting in an annual benefit of $10,500, or $875 a month.
Roughly 300 employers have established hybrid plans since the mid-1980s.
Employers switching to hybrid plans are a virtual "Who's Who in Corporate America," including Ameritech Corp., Bell Atlantic Corp., Georgia-Pacific Corp., International Business Machines Corp., RJR Nabisco Inc., and UNUM Corp.
On Jan. 1, AT&T Corp. will convert its traditional plan for management employees to a cash balance plan. With 58,000 active participants and $10.4 billion in plan assets, AT&T will become the largest employer to adopt a hybrid plan.
Making pension plans more visible and understandable was a key motive in adopting hybrid plans, employers say.
"It is real. It is visible. It is tangible. Employees can see its value grow," said Jean LaVecchia, senior vp-organization development at New Haven, Conn.-based Southern New England Telephone Corp., which set up a cash balance plan in 1996.
"Each quarter, employees see their account balances increase based on pay credits and interest credits. And the benefit always is expressed as a lump sum. The reaction has been very positive," said J. Richard Brophy, corporate retirement programs manager at Maynard, Mass.-based Digital Equipment Corp., which adopted a cash balance plan last year.
A growing recognition that employees no longer expect to spend their careers at one company also has driven the growth of hybrid plans. Those plans, especially cash balance plans, give much greater benefits to employees' first years of service compared with traditional final average pay plans, whose design is sharply skewed in favor of long-service employees.
"Our plan is a positive for recruitment. It will attract people because they don't have to stay here before earning a meaningful benefit," said Mary Beth Clifton, acting manager of benefits and workers compensation at Juno Beach, Fla.-based Florida Power & Light Co., which has a cash balance plan.
Other employers say the appeal of hybrid plans has been the smoother accrual of benefits throughout a worker's employment so that certain events, such as turning 55 or completing 30 years of service, wouldn't drive employee decisions on when to leave.
"We wanted to smooth the (benefit) curve so the design of the plan wouldn't motivate employee behavior to retire or not. Instead, personal career decisions and business decisions would become more of a driver," said Robert Cornett, vp-human resources at Portland, Maine-based insurer UNUM Corp., which has a lifecycle plan.
Even with hundreds of employers moving to hybrid plans, the plans still constitute only a small proportion -- less than 1% of all corporate-sponsored defined benefit plans. But given the size of many hybrid plan sponsors, perhaps as many as 10% of defined benefit plan participants are in hybrid plans.
That percentage could grow substantially in the years ahead.
"Many, many of our clients are considering installing cash balance plans or a variant. If an employer is considering a design change, the probability is high that it will move to a cash balance" or other type of hybrid plan, said Michael Gulotta, president of benefit consultant ASA Inc. in Somerset, N.J.
"If you look at the Fortune 1,000, by 2020 perhaps only 20% will have a traditional final average pay plan," said Robert Byrne, managing principal of The Kwasha Lipton Group of Fort Lee, N.J., which designed the first cash balance plan.
"Gradually, (traditional) plans will become extinct. I have 36 years of service. Younger people are not likely to stay that long," and pension plans have to change to accommodate that more mobile workforce, said Richard Quinn, director of performance and rewards for Public Service Enterprise Group, a Newark, N.J.-based utility, which put in a cash balance plan last year.
Others aren't so sure.
William Miner, a consultant and principal with Watson Wyatt Worldwide in Chicago, said there always will be a role for traditional final average pay plans at companies that want to encourage long service through plan design.
But no longer will plan design be a case of "one size fits all," Mr. Miner said.