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In 1989, BP America Inc. converted its existing final average pay pension plan to a cash balance plan, becoming one of the first major employers to adopt what was then a still relatively new plan design.
More than 20 years after BP made the switch, the appeal of the plan remains powerful, says Rick Dorazil, BP's vp-total reward, Western Hemisphere.
“One doesn't have to wait until the end of his or her career to build a significant balance, as is the case with a final average pay plan. Cash balance plans provide a more even accrual of benefits,” Mr. Dorazil said.
That steadier buildup of benefits means employees can earn a significant benefit after just a few years of service, Mr. Dorazil said, an advantage as the workforce becomes more mobile.
And since the benefit is expressed as a lump sum, it is highly visible and thus appreciated by plan participants, he said. “I can see my vested balance. I know what I am going to walk away with,” Mr. Dorazil said.
Many other employers, though, have frozen defined benefit plans, including cash balance plans. Indeed, a Towers Watson & Co. analysis published last year found that 40% of Fortune 1000 companies with defined benefit plans had frozen at least one of those plans, up from just over 7% as recently as 2004.
But BP is sticking with its cash balance plan for several reasons. Pragmatically, BP's major competitors still offer pension plans. But just as important, BP's pension plan is highly valued by both new and veteran employees, Mr. Dorazil said.
And the time may come when employers may be at a competitive disadvantage if they do not offer a pension plan, he said.
“The under-age-35 population is starting to connect the dots. They understand that with a 401(k) plan, all the investment risk is on them,” he said. And that younger generation saw the consequences of that risk during the economic downturn that began in 2008, when the value of many employees' 401(k) account balances plunged along with the stock market, he said.
“They (younger employees) saw what happened to their parents,” Mr. Dorazil said.
Unlike many other employers, BP's cash balance plan is fully funded, Mr. Dorazil said. Recently, the company moved to an investment strategy in which more plan assets are invested in bonds and other fixed income investments, and less in equities.
That shift has reduced investment volatility, with the maturity of fixed income investments linked to meeting the plan's cash needs to pay benefits.
Under the plan, employees receive pay-related credits. In addition, they also receive interest credits. Interest on employees' account balances is tied to the interest rate on 30-year U.S. Treasury bonds, with a minimum annual 5% interest credit.
“If managed correctly, a cash balance plan will provide tremendous value to employees, while providing funding flexibility for the company,” Mr. Dorazil said.