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Cash balance pension plans get boost from law change

Popularity returning in four years since age bias fears allayed

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Four years after Congress removed a huge roadblock that had threatened to bring a permanent halt to the formation of cash balance pension plans, employers again are setting up the once-popular plans.

Since the passage of legislation in 2006 that protected new plans from age discrimination suits, nearly a dozen large employers, including some of the nation's best-known companies, and many small and professional firms, have adopted the plans.

Fortune 500 employers that have established the plans since 2006 include MeadWestvaco Corp., the Richmond, Va.-based paper packaging and office products manufacturer; Atlanta-based SunTrust Banks Inc.; Dow Chemical Co. in Midland, Mich.; and more recently, beverage giant Coca-Cola Co. of Atlanta, and Marathon Oil Co. and Marathon Petroleum Co. L.L.C., which are subsidiaries of Houston-based Marathon Oil Corp.

Other employers, such as package delivery giant FedEx Corp. in Memphis, Tenn., and Gainesville, Fla.-based Shands HealthCare, a private health care system affiliated with the University of Florida Health Science Center, have expanded existing cash balance plans to cover more employees.

The uptick in plan formation is modest compared with the late 1980s and early 1990s when dozens of employers each year set up the plans, typically by converting existing traditional final average pay plans. In all, more than 1,000 employers set up the plans, including such corporate giants as trailblazer Bank of America Corp.—which in 1986 established the first plan—CIGNA Corp., IBM Corp., Hewlett-Packard Co. and Wells Fargo & Co.

Then and now, a prime reason employers embraced the plans was their easy-to-understand benefit design.

“The benefits are easier to communicate and so employees understand and appreciate them,” said Ray Hoskavich, Shands HealthCare's senior director of human resources.

The cash balance model is “easy to understand. In our case, it's basically 3% of your salary accumulated as credits within an account,” said Joseph Molloy, corporate director of benefits at Lake Success, N.Y.-based North Shore-LIJ Health System, which moved to a cash balance plan just over a decade ago.

The benefit design of the plans is simple: Employees are credited with a benefit equal to a percentage of their current pay. In addition, interest is calculated at a set rate—for example, the rate for one-year Treasury notes plus one percentage point—and is added to the accumulated benefit.

The accumulated benefit is expressed as a cash lump sum. As a result, plan participants always know the value of their benefit.

“An account-based plan is something everyone can relate to,” said Alan Glickstein, a senior consultant with Towers Watson & Co. in Dallas.

Another plan attraction is the way benefits are earned. As career-average pay plans, benefits build more rapidly compared with traditional plans, making them more appealing to a younger, more mobile workforce, employers said.

But the plans began to lose their luster in 1999. That was when a highly publicized lawsuit was filed against IBM, alleging that the plan's design discriminated against older employees, triggering a wave of copycat suits against other employers with the plans.

The Treasury Department stopped issuing determination letters—which are a kind of seal of approval—at about the same time the IBM suit was filed.

The appeal of the plans dimmed further in 2003 when, in the first decision in that direction, a U.S. district court judge ruled that cash balance plans in general, and IBM's plan in particular, were age-discriminatory because the same benefit provided to a younger employee would be worth more—expressed as a retirement age annuity—than that of an older worker.

That ruling was probably the nadir for the plans and their sponsors, but over time the climate brightened. Federal lawmakers, concerned about the rise in the number of employers freezing defined benefit plans, including cash balance plans, approved a pension funding reform measure in 2006 with provisions that protected new cash balance plans from age discrimination suits.

Almost simultaneous with the enactment of the pension funding measure, the 7th U.S. Circuit Court of Appeals in Chicago overturned the lower court ruling in the IBM case. Four other appeals courts were to follow with the same finding in suits involving plans sponsored by other employers.

With legal uncertainties removed, employers again began to set up new plans, with MeadWestvaco the first to do so after the passage of 2006 legislation.

But it isn't just big employers who have set up new plans since 2006. Very small employers also have moved to the plans. “We have seen much more interest in cash balance plans in the small professional market,” said Tom Foster, vp and national spokesman for retirement plans for Hartford Financial Services Group Inc.'s Retirement Plans Group in Simsbury, Conn.

“The growth has come from professional firms and partnerships,” said Jack Abraham, a principal with PricewaterhouseCoopers L.L.P. in Chicago.

A key appeal of the plans to small professional firms is that top executives can fund much bigger benefits for themselves compared with defined contribution plans, such as 401(k) plans, experts say.

Still, the passage of legislation and favorable court rulings have not ended all uncertainty about cash balance plans and that uncertainty is holding up plan growth. The biggest uncertainty is a provision in the 2006 law that gives plan sponsors the option to use a “market rate” to credit interest on participants' account balances. The Internal Revenue Service, though, has yet to provide definitive guidance on what would be considered a market rate.

The lack of guidance is an “impediment” hampering plan adoption, said Jay Rosenberg, a director with Buck Consultants L.L.C. in Secaucus, N.J. “You want to set up a new plan, but you don't know what the parameters are” of the market-rate interest issue, he added.