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Hybrid (Cash Balance) Pension Plans

Testimony Before the Subcommittee On Retirement Security And Aging

Unlike reductions in benefit formulas in which everyone may feel the pain equally, a conversion to a cash balance plan (absent special transition relief) produces clear winners and losers (the losers being the older, longer-serving employees). And, in some cases, this has been done in a manner that has masked the actual negative effects (as discussed earlier), at least for a time.


The wearaway period often associated with cash balance conversions - the period of time after the conversion when no benefits are earned - is an unlawful and impermissible reduction or cessation in benefit accruals based on age. Because calculation of a wearaway following a conversion is based directly on age, it violates the pension accrual laws. While age is not the only factor in determining wearaway, it is always an essential element. See Appendix A.


The harm to older workers caused by cash balance conversions has given rise to outrage on the part of older and longer-service employees who have been affected and a higher level of awareness by other employees, including those potentially affected by future conversions. (In some cases, employee anger has been exacerbated by the fact that some conversions have imposed painful reductions in future benefits - including wearaways on older workers -- even when the plan had substantial surplus assets, and the gains in pension surplus associated with this "pension pay cut" were used to improve reported corporate earnings and consequently increase performance-based executive pay.) The damage caused by conversions that pulled the rug out from older and longer-serving employees has also generated considerable adverse publicity, public and employee relations problems for plan sponsors, and major court challenges to the legitimacy of cash balance plans and practices.

As controversy erupted over cash balance conversions, the Internal Revenue Service in the fall of 1999 suspended its issuance of determination letters approving cash balance plan conversion amendments. Treasury and IRS announced that they were reviewing the age discrimination and associated legal issues raised by conversions, and received hundreds of public comments.

This controversy and related developments convinced many plan sponsors to address the transition problems raised by conversions. While conversions in previous years were often unprotective, many employers have more recently addressed the transition issue by providing relief to their older, longer-service workers. More and more companies - fearful of negative media attention and the reaction of a more knowledgeable workforce, and concerned that their actions might be age discriminatory or otherwise unlawful - have designed more and better transition protection. This protection has come in a number of forms. Many companies have simply permitted their older employees the option of staying under the old formula, while others have automatically grandfathered older and/or longer-serving employees in the old formula. Some, like CSX, whose CEO at the time was Treasury Secretary John Snow, did not apply the conversion to any existing employees. Other companies have provided added benefit protections such as significantly higher pay credits or opening balances for older workers. In short, many in the private sector have responded to the problems with cash balance conversions by raising the bar for transition protection.


In December 2002, Treasury and IRS proposed regulations that would have given a green light to plan sponsors to again convert their traditional plans to cash balance plans without adequate protection for employees. (67 Fed. Reg. 76123).    

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