IBM’s decision to freeze its plan may accelerate trend to drop DB

ARMONK, N.Y. — International Business Machines Inc.'s decision to freeze its U.S. pension plan and enrich its 401(k) plan makes it the biggest retirement sponsor to take such action.

Observers say IBM's move likely will accelerate the trend of companies freezing or closing defined benefit plans. It also may reflect the end of the effort by companies to convert defined benefit plans to cash balance plans, a middle ground between traditional defined benefit and defined contribution retirement plans.

IBM announced Jan. 5 it will freeze its $48 billion cash balance plan and enhance its $26 billion 401(k), plan effective Jan. 1, 2008.

IBM ranks second in U.S. corporate retirement assets, only behind General Motors Corp. with $114.27 billion as of Sept. 30.

According to a company news release, IBM seeks to move "toward the more predictable cost structure of a 401(k), or defined contribution, plan and away from its legacy defined benefit pension equity and cash balance plans."

James H. Rich, senior investment strategist, who helps oversee retirement assets, referred any inquiry to IBM's media center. A call to the media center was directed to Kendra R. Collins, director-corporate media relations, and Edward Barbini, a spokesman, neither of whom returned the call.

According to the statement, IBM will boost its 401(k) plan "to make it one of the richest in U.S. business" by:

• Doubling the current company match to dollar-for-dollar up to 6% of salary deferrals. Cash balance plan participants, for instance, will receive a 6% match. Employees hired after Dec. 31, 2004, will receive a 5% match. Some other participants will receive a 4% match.

• Making additional automatic contributions of 1% to 4% of employees' pay into their 401(k) accounts. Cash balance participants will receive, for example, a 2% automatic company contribution. Employees hired after Dec. 31, 2004, will receive a 1% automatic company contribution after one year of service.

• Helping certain employees to save more by providing an annual special award of 5% of pay to their 401(k) savings accounts in addition to the company-funded contribution of up to 10% of pay.

• Opening accounts for employees who do not contribute to the plan, and annually depositing the automatic company contribution of 1% to 4% of their pay directly into those accounts.

IBM has 117,000 U.S. employees that could be affected by the change, said Candice Johnson, spokeswoman for the Communication Workers of America, Washington, which is seeking to represent some IBM employees. The changes don't affect 125,000 current U.S. retirees, former employees with vested benefits or employees who retire prior to 2008, according to the IBM statement.

"IBM expects the U.S. plan changes … along with 2006 retirement plan changes under consideration in several other countries, will result in worldwide retirement-related expense savings of $450 (million) to $500 million for 2006, and $2.5 (billion) to $3 billion for the period 2006 through 2010, based on year-end 2005 pension assumptions," the company release said. Information was unavailable on what changes IBM is contemplating in other countries.

The company "still expects worldwide 2006 retirement-related plan expenses will continue to increase over 2005 levels by $400 (million) to $500 million, excluding the impact of 2005 one-time charges" of $270 million in the fourth quarter, the statement said.

Unlike some recent freezes or terminations of underfunded pension plans at major companies like United Airlines Inc., the IBM pension plan was overfunded by $208 million as of Jan 1, 2004, according to its annual report.

IBM contributed $700 million to its U.S. defined benefit plan and paid out $2.7 billion in benefits in 2004, according to the report.

The employee and employer contribution to its defined contribution plan total $1.8 billion in the most recent year, according to data IBM submitted to Pensions & Investments for the period ended Sept. 30. In 2004, the company alone contributed $338 million for its defined contribution plan, according to its annual report.

IBM had already taken a step in curtailing its pension plan, closing it to new employees, effective Jan. 1, 2005.

The IBM statement blamed a flattening interest rate yield curve for increasing expenses, both raising the annual short-term crediting rate to participants' accounts and lowering the long-term discount rate that, in turn, increases pension liabilities and pension costs.

"The 2006 U.S. cash balance interest crediting rate will be 5%, up from 3.1% for 2005, driving approximately $200 million of incremental expense in 2006," the statement said.

But because of long-term interest rate declines, IBM set its discount rate for 2005 at 5.5%, down 25 basis points from 2004.

Because of the two rate changes, "2006 retirement-related expenses were projected to increase over 2005 levels by $900 million — an increase of $400 million over the previous estimate," the statement noted.

The company also blamed uncertain and conflicting legislative and regulatory directions about defined benefit plans.

Ethan Kra, chief actuary at Mercer Human Resource Consulting Inc., New York, declined to comment about IBM directly but said that generally, "I think there will be acceleration of freezes going on now."

"In the 1990s, companies could convert their defined benefit plans to cash balance plans. But because of regulatory, legislative and judicial risk with cash balance plans, companies that have them are getting out and companies that could have had them are (instead) freezing their (DB) plans," Mr. Kra said.

"If Congress would adopt legislation that makes it clear cash balance plans don't break the law, I think you would see a subsiding of these freezes.

"Companies have decided the traditional final-pay plan doesn't work for them," Mr. Kra added.

IBM has been engaged in defending its cash balance plan in age-bias lawsuits.

"IBM's freeze is unlikely, by itself, to cause other companies to freeze their plans, but (it) may accelerate the process," said Michael Peskin, managing director, global capital markets, Morgan Stanley, New York. "Globalization of the economy for products, services and labor, and the rapid pace of change, are causing many companies to rethink whether they are the natural provider of long-dated promises like defined benefit pensions.

Consultants said the corporate cost and participant benefits of a 401(k) plan compared to a defined benefit plan are difficult to determine, depending on how generous the sponsor is in contributing to it and in what stage a person is in his or her career when taking benefits.

"It depends on how you design it," Mr. Kra said.

[email protected], an effort by the Communications Workers of America to gain IBM collective bargaining recognition, said in a statement that the group "is deeply concerned that, considering the volatility of the stock market and recent downturns that have wiped out retirement for many, the move to retirement based on 401(k) savings could be disastrous for many employees, especially those not savvy in investing."

Lee Conrad, national coordinator of the [email protected], said in the statement that "IBM, like so many other companies, is either eliminating or not offering the stability of a pension plan, or even basic benefits. The signs are already there that the next generation of workers will be in worse shape financially than this one."