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Cash balance pension plans returning to favor

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Cash balance pension plans are staging a comeback.

Last week, Dow Chemical Co. announced it is adopting a cash balance plan for new employees, making it the largest employer to do so since Congress passed legislation last year that protects new cash balance plans from age discrimination suits.

Under the cash balance plan design, employees will receive annual credits equal to 5% of pay, and their cash balance plan accounts will be credited with interest based on a spread above an index of U.S. Treasury bill rates. The plan will be offered to U.S. salaried employees hired as of Jan. 1, 2008.

Current employees will continue to earn benefits through a final average pay plan design known as a pension equity plan. Dow made other changes to its benefits offerings as well (see story, page 25).

Employees "want to be able to take the funds with them if they choose to leave the company. That's exactly the need our new program satisfies and why we're taking this next step in our benefits evolution," said Janet VanAlsten, global benefits director for Midland, Mich.-based Dow.

In addition, an increasingly mobile workforce appreciates that benefits accrue faster in a cash balance plan--which is based on career average pay--than they do in a traditional defined benefit plan, in which employees have to work many years before accruing significant benefits, Dow executives say.

"We know that prospective employees want benefits that accumulate throughout their career rather than concentrate on the last years of their careers," Ms. VanAlsten said.

Dow, which last year had more than $49 billion in sales and 43,000 worldwide employees, including 21,500 in the United States, and whose pension trust has more than $11 billion in assets, is at least the third major employer--and the first Fortune 50 company--to adopt a cash balance plan since enactment of the Pension Protection Act (see chart).

More employers are certain to follow, say benefit consultants.

"For the first time in years, employers are actively considering and evaluating these plans," said Kevin Wagner, a consultant in the Atlanta office of Watson Wyatt Worldwide, which worked with Dow in evaluating different pension plan options.

"We've seen a resurgence of interest in cash balance plans," said Mike Pollack, a principal with Towers Perrin in Stamford, Conn.

The driving force behind the renewed interest in cash balance plans was the passage of the PPA, which gave employers the go-ahead to set up new plans without the fear of facing litigation. That was a comfort to employers who wanted to set up new plans, as several dozen employers who established plans years ago were later sued for age discrimination.

"A lot of companies were waiting until the PPA passed," Mr. Pollack said.

"The PPA was critical in giving new plans a green light," said Ethan Kra, chief actuary with Mercer Human Resource Consulting in New York.

Indeed, Dow's Ms. VanAlsten said the enactment of the PPA "opened the door for us to consider a cash balance plan."

That employers again are considering forming cash balance plans is a big change from just a few years ago, when the future of the plans, once the fastest growing type of defined benefit plan, seemed dim.

Employer interest in the plans, which appealed to both employers and employees, rapidly chilled following a 2003 decision by a federal judge in Southern Illinois that said IBM Corp.'s cash balance plan violated age discrimination law.

But last year, the tide began to turn. First, Congress passed the PPA. Then, on the legal front, a federal appeals court ruled that cash balance plans in general and IBM's plan in particular do not violate age discrimination laws. A second appeals court, in a case involving PNC Financial Services Group Inc., later also ruled that the plans are not age discriminatory.

"The legal climate has become much friendlier," Mr. Wagner said.

At the same time, more employers have started to question whether it makes sense to phase out their defined benefit plans and switch to an all-defined contribution plan approach, in which employees bear all the investment risk. That could result in employees having inadequate retirement income if they invest poorly, forcing them to work longer than they or their employers anticipated, consultants say.

In fact, Dow's Ms. VanAlsten said a combination of a 401(k) plan and a cash balance plan is a much more balanced approach than one relying solely on the defined contribution model.

Still, while more employers are likely to follow Dow's lead, consultants don't expect a surge of new plan formations until federal regulators issue more guidance for cash balance and other types of pension plans, as required by last year's pension law.

"It really is difficult to move forward when you are not sure what all the rules are," said Larry Sher, a principal and director of research with Buck Consultants L.L.C. in New York.