Most cash balance plans would be illegal if a federal judge's opinion that IBM Corp.'s plan violates federal age discrimination laws is upheld and becomes the accepted legal standard.
On July 31, U.S. District Judge G. Patrick Murphy of the Southern District of Illinois, East St. Louis, held that IBM's plan violated the age discrimination provisions of the Employee Retirement Income Security Act of 1974.
Steve Kerstein, leader of the global retirement practice for Towers Perrin, Stamford, Conn., said if the IBM case did become the standard, "it would make nearly all cash balance and many other hybrid plans illegal, significantly harming the U.S. pension system and millions of plan participants."
But the IBM case might be an anomaly, rather than a precedent, because of its notoriety and long history.
"I wouldn't think this case would have too much impact on existing plans," said Robert Clark, professor of labor economics at North Carolina State University, Raleigh. "IBM may have been a unique circumstance. It has had such a long history of promising no layoffs. People may have had a particular mindset at IBM that led to this. I also believe their communication (to employees about the cash balance plan) has been lacking."
Industry and legal experts don't expect the estimated 600 existing plans to become unlawful anytime soon, but neither do they suggest companies rush to convert existing defined benefit plans to cash balance plans.
Indeed, the IBM decision will create a chilling effect for cash balance plan conversions until the age discrimination cloud is cleared up either by congressional action or by regulatory mandate.
"I wouldn't put one (cash balance plan) in right now," said Eric Lofgren, global director of benefit consulting at Watson Wyatt Worldwide, Philadelphia. "This ruling has the potential to cause great harm to the U.S. private pension system. In the short term, it bodes uncertainty for the cash balance industry. Plan sponsors should not panic but understand the issues and realize that there is an element of risk."
The IBM ruling goes to the heart of the controversy surrounding cash balance plans by claiming the benefit accrual rate declines with an employee's age, in violation of age discrimination laws.
That argument has dogged the controversial plans from the start. Age discrimination arguments generally are framed around the ERISA prohibition against ceasing or reducing "the rate of an employee's benefit accrual ... because of the attainment of any age." Cash balance plans are technically defined benefit plans, and defined benefit rules also look at a normal retirement benefit, usually age 65, to determine the benefit accrued in a given year.
Opponents of cash balance plans continually claim these plans violate that rule because of their interest accrual methods. For example, a 5% cash balance pay credit to a 65-year-old participant would "purchase" a lower age-65 annuity than a 5% credit to a 30-year-old participant because the 30-year-old will be credited with 35 years of interest.
Profit-sharing and most defined contribution plans operate in much the same way, but do not face the discrimination issue because they are not required to look at the age 65 benefit. A contribution is just a contribution.
Proponents of cash balance plans say the IBM opinion is just one judge's view, but one that bears close attention. While most industry sources expect the IBM opinion to be overturned, nearly all believe the federal government also needs to clarify age discrimination issues. Their best hope, they say, lies with the Treasury Department, which is expected to issue final regulations by the end of the year.
Proposed regulations issued by the Treasury Department last year stated unequivocally that cash balance plans do not discriminate against older workers (Pensions & Investments, Dec. 9). If the final regulations stick to that policy, according to labor lawyers, the courts would have a hard time finding plans illegal.
"We are working on the regulations and hope to get them out as soon as possible," said a Treasury spokeswoman.
Plan sponsors and others are trying to determine what effect the IBM decision will have on existing plans.
"We are concerned about it conceptually," said Jim Wilhite, director of compensation, benefits and corporate human resources at Baker Hughes Inc., Houston, which started a cash balance plan last year.
Mr. Wilhite said Baker Hughes avoided the problems IBM faced because it did not convert its defined benefit plan to a cash balance plan. He said the plan, which now has about $18 million in assets, provided age-weighted contributions that favored midcareer and older workers.
"Existing plans must be thinking three things," said Edward A. Zelinsky, a law professor at Yeshiva University's Benjamin N. Cardozo School of Law, New York, who has written several legal articles and whose research was cited in the IBM case.
"First, there will be a lot of support for the IBM lawyers in their appeal. There will be a lot of amicus (friend of the court) briefs from throughout the industry. They also will be pressing the Treasury Department very hard and will be trying to have the statutes changed; they will be looking very hard at the regulations," said Mr. Zelinsky.
Lost in the uproar following the IBM opinion is the ruling nearly four years ago involving Onan Corp., Fridley, Minn., that said cash balance plans are not discriminatory. David F. Hamilton, U.S. District Court judge for the Southern District of Indiana, concluded that pension age discrimination provisions prohibit the elimination or reduction of pension accruals after normal retirement age, not before - as alleged by plaintiffs in that case as well as in the IBM case.
Plans may be frozen
Industry experts predict many plan sponsors would freeze their defined benefit plans and shift toward defined contribution plans if the IBM case is upheld.
Watson Wyatt's Mr. Lofgren said one of two things will now occur: either the IBM decision is reversed on appeal, or many plan sponsors will freeze their defined benefit plans and offer only a 401(k) plan. That would shift all investment risk to employees.
Since they are defined benefit plans, redesigning the cash balance plan to avoid age discrimination issues would not be easily accomplished, according to cash balance experts.
"I don't see an easy solution," said Mr. Zelinsky.
IBM officials and most industry experts have contended opponents of cash balance plans ignored the fact younger workers would get larger payments because they had longer to wait for retirement. Hugh Forcier, an employee benefits attorney with the firm of Faegre & Benson LLP, Minneapolis, who has just published a legal textbook on cash balance plans, said that to call such a plan discriminatory makes no sense and "ignores the concept of the time value of money."
Judge Murphy disagreed: "From an economist's perspective, defendants have a good argument. A dollar today is worth more than the promise of a dollar a year from now. This does not mean, however, that the (cash balance formula) is legal," the judge said in his decision.
"No one can agree with the economics (of the IBM ruling)," said Larry Sher, principal and director of research at Buck Consultants, New York, who served as an expert witness in the case. "Even the judge said that despite the economics, the law requires a non-economic result and because `this is a defined benefit plan, this is the way it must be viewed.' Does the law force a non-economic outcome? The judge says yes."
Deference to regulations
Mr. Sher said if the final Treasury regulations follow proposed regulations issued last year, courts would have a difficult time finding cash balance plans discriminatory.
"They would have to claim the regulations are an unreasonable interpretation of congressional intent and not consistent with the law," he said. "And normally the courts grant wide deference to federal regulations."
If the Treasury Department's final regulations follow its previously stated policy, "it would go a long way to solving this problem. If they are finalized as proposed, that's at least a reasonable interpretation of the statutes ... and the chance of a successful challenge would be remote," said Mr. Forcier
In the absence of Treasury regulations or congressional action, Mr. Forcier sees little chance of cash balance plans being redesigned to eliminate charges of age discrimination.