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Pension Plans Wade Into Murky Water
Ari Weinberg, 08.06.03, 12:00 PM ET

Is the tide of pension accounting turning again?

In the last few years, many U.S. public and private employers moved to so-called cash-balance plans. But recent judicial decisions concerning retirement funds at IBM and Xerox now have companies with these plans wondering whether they need to rethink them.

Cash-balance plans, unlike traditional plans that pay benefits based on the employee's average wages at the end of their tenure, create a retirement account that is funded every year. The amount, based on a percentage of the worker's salary, aggregates and accrues interest. That makes the plans similar to a 401(k) account, except that the employee makes no actual contribution to them.

Those recent judicial decisions, for different reasons, could cause both companies to make unexpected pension fund contributions. IBM (nyse: IBM - news - people ), which switched all employees to a cash-balance plan in 1999, is said to have discriminated against older workers. Xerox (nyse: XRX - news - people ) was found to have miscalculated payouts under its plan. Both companies plan to appeal. But if Congress and the U.S. Treasury make certain moves, appeals could be moot.

The summer began with the legislative and executive branches ready to ease up on pension accounting. A bill in the House of Representatives was set to shift the rate used in forecasting pension obligations to a corporate bond rate from a currently used rate based on the 30-year bond. The White House, via the Treasury, went one step further in suggesting a corporate yield curve for estimating liabilities. Proponents argue that using the no-longer-issued 30-year creates an overstatement of obligations. They say a yield curve based on corporate notes would be more transparent and less subject to government whim.

Companies with older workforces, however, could be disadvantaged by the switch. Long-term corporate bonds provide a higher return than treasuries. Companies with oversized short-term obligations would have to stuff their assets to meet the new return expectations.

Those firms with cash-balance plans could see obligations expand even more, if judicial decisions stand. Employees felt that that, in the transfer from traditional plans to cash-balance plans, they were shorted millions in retirement pay. Most plan transitions tried to accommodate older workers by building a greater cash-balance base--allowing the worker to eventually realize the same amount at retirement. Workers at IBM and Xerox felt things didn't add up.

Not all cash-balance plans are flawed. In fact, for younger employees with more years to go until retirement, cash-balance plans can provide better returns. Companies such as Eastman Kodak (nyse: EK - news - people ) that provide older employees an option to chose between traditional and cash-balance plans should be in the clear from lawsuits. But that won't prevent plaintiffs, and plaintiff attorneys, from chasing anything labeled "cash balance."

"Critics of cash balance will try to seize upon the [IBM] decision," says James Klein, president of the Washington, D.C.-based American Benefits Council, a trade association of plan sponsors and administrators. "It really flies in the face of other court decisions."

Cash-balance plans, though considered a hybrid between traditional and 401(k) or defined contribution plans, are of direct concern to the feds because they are covered by the Pension Benefit Guaranty Corporation, which collects pension data and picks up the tab for failed plans. The PBGC currently is watching out for 44 million workers and retirees, covered by 33,000 plans.

While the advance of cash-balance plans has slowed--the Internal Revenue Service has placed a moratorium on approving new plans until it makes a judgment on the discriminatory nature of the plans--that doesn't prevent corporations from implementing them, according to Stu Lawrence, a retirement consultant with The Segal Company in New York.

"Many were put in place with the noble intent to better accommodate a mobile workforce," says Lawrence. "But it's time for employers to push for clarity in the rules."

With the recent judicial decisions, expect the cash-balance pensioners--33% of the top 100 U.S. companies by revenue--to start lobbying. If they don't, their employees will do it for them.

Largest Plans That Offer Cash-Balance Pensions

Company

Pension Assets ($mil)

Assumed Return On Assets

Pension Obligation ($mil)

Assumed Discount Rate

IBM (nyse: IBM - news - people )*

$36,984

8.50%

$38,357

6.75%

Lucent Technologies (nyse: LU - news - people )

28,598

8.75

30,312

6.50

SBC Communications (nyse: SBC - news - people )

24,999

8.50

26,148

6.75

BellSouth (nyse: BLS - news - people )

13,338

8.50

11,386

6.75

Xerox (nyse: XRX - news - people )**

5,963

8.30

7,931

6.20

Eastman Kodak (nyse: EK - news - people )*

5,790

9.00

6,213

6.50

Dana (nyse: DCN - news - people )

2,121

8.75

2,808

6.75

*For U.S. only **Worldwide Source: Company 10-K and annual reports for year ended Dec. 31, 2002. Lucent fiscal year ended Sept. 30, 2002.