GAO Finds Problems, Potential in CB Designs

November 4, 2005 ( - With pension reform proposals swirling in Washington, and the topic of cash balance plans as controversial as ever, the Government Accountability Office (GAO) has offered an assessment of the plan design, and its impact on worker pensions.

The GAO report was developed at the request of Congressmen George Miller (D-California) and Bernie Sanders (I-Vermont) and Senator Tom Harkin (D-Iowa) – all vocal and long-time critics of the cash balance concept.    Sanders particularly has made stopping cash balance plans a crusade of sorts following IBM’s (Vermont’s largest employer) controversial replacement of its traditional defined benefit plan with a cash balance model (see  House Approves Measure Blocking Treasury Cash Balance Intervention ).

The GAO report noted that the pension and economic literature provides little conclusive evidence about the effects on benefits and other aspects of CB plan conversions, particularly with regard to why sponsors convert to CB plans in the first place.    It also noted that in many cases, data and other methodological issues limit the generalization of results – and that the effects of a conversion depend on a variety of factors including “the generosity of the CB plan itself, transition provisions that might limit any adverse effects on current employees, and firm-specific employee demographics.”  

The report attempted to address three elements regarding the “incidence, features, and effects” of cash balance conversions; (1) What does the current research say about the implications of CB plan conversions for workers’ benefits? (2) What is the prevalence and types of transition provisions provided to protect workers’ benefits in past conversions to CB plans?, and (3) How do individual participants fare under a hypothetical conversion to a typical CB plan compared to the typical final average pay (FAP) plan?  

Transition Terms

The GAO noted that most plans provided some form of transition provisions to mitigate the potential adverse effects of a conversion on workers’ expected benefits for at least some employees, and that nearly half (about 47%) of all conversions used some form of grandfathering that was applied to at least some of the employees in the former traditional DB plan (in most cases, such grandfathering was limited to employees meeting a specified minimum age or years of service or both).   The GAO also noted that most conversions also used some form of ongoing weighted pay credit.

Ultimately, however, the GAO’s comparison of a typical FAP plan that is converted to a typical CB plan finds that, regardless of a worker’s age, more workers would have received greater benefits under the FAP than under the typical CB plan.   Those who received less benefits under the CB plan saw median benefit decreases range from $59 per month at age 30 to $238 per month at age 50.   Those who saw benefits increase experienced median benefit increases ranging from $15 per month at age 30 to $27 per month at age 50. 

In comparing a conversion to a typical CB plan with a terminated FAP, GAO said that all vested workers would do better under the CB plan. It also noted that under a traditional FAP plan conversion to an equal cost CB plan, larger numbers of workers at all ages have benefit increases than under the typical CB plan/FAP plan scenario.    The report noted that grandfathering protects the benefits of those older workers who were covered, but it cautioned that while more workers who are converted at age 30 fare better under the CB plan, this was not true at other ages.  

Mismatch Catch

GAO said its analysis illustrates one of the difficult choices facing the Congress in crafting comprehensive DB pension reform legislation, and notes that the current confusion concerning CB plans is “largely a consequence of the present mismatch between the ongoing developments in pension plan design and a regulatory framework that has failed to adapt to these designs.”   The study’s authors noted, that “Although CB plans legally are DB plans, they do not fit neatly within the existing regulatory structure governing DB plans. This mismatch has resulted in considerable regulatory uncertainty for employers as well as litigation with potentially significant financial liabilities. For many workers, this mismatch has raised questions about the confidence they may have in the level of income they expect at retirement, confidence that has already been shaken by the termination of large pension plans by some bankrupt employers.”

As proponents have long argued in support of the design, GAO acknowledged that “CB plans may provide more understandable benefits and larger accruals to workers earlier in their careers, advantages that may be appealing to a mobile workforce.”    However, the GAO also acknowledged the concern of opponents – that conversions of traditional FAP plans to CB plans can result in benefit cuts for workers, particularly longer-tenured workers.   Nonetheless, the report authors said their simulations indicate that grandfathering not only can protect those expected benefits, but that “…such protections, in some form, are fairly common in conversions.”   The GAO noted that its simulations show that, “…without such mitigation, many workers can receive less than their expected benefits when converted from a traditional FAP plan, even in cases where the CB plan is of equal cost to the FAP plan it is replacing.”   As a result, the report says that additional protections are needed to address “…the potential adverse outcomes stemming from the conversion to CB plans.”  

Vested “Interests”

The GAO noted that workers in an ongoing DB plan only receive benefits if they are vested, and while appealing to a mobile workforce would seem to place an even greater significance on pension portability, even CB plans, which often feature lump sum provisions in their design, do not address this issue because they typically have similar vesting requirements as traditional FAPs.    The GAO also noted that under its simulations, vested workers under either a typical or equal cost CB plan still fare better than if the FAP plan is terminated – and that there is “a crucial balance between protecting workers’ benefit expectations with unduly burdensome requirements that could exacerbate the exodus of plan sponsors from the DB system.”  

“Congress, as it grapples with the broader components of pension reform, has the opportunity not only to protect the benefits promised to millions of workers and eliminate the legal uncertainty surrounding CB plans that employers face, but also to craft balanced reforms that could stabilize and possibly permit the long-term revival of the DB system.”

In conducting its evaluation, GAO said it worked with the 2001 Form 5500 to identify and examine CB plan conversions for their design features.  They first identified all 843 plans with 100 or more participants that indicated a CB or hybrid plan component on Form 5500, and then selected a random sample of 205 of these plans.    The sample was comprised of the 45 largest plans (the smallest of which has about 17,500 participants) and a random sample of 160 other plans.  

Nonetheless, the GAO analysis of plan conversions determined that most conversions occurred between 1990 and 1999, and primarily in the manufacturing, health care, finance and insurance industries. Most conversions set participants’ opening account balances equal to the present value of their accrued benefits under the previous plan, although the interest rate used to calculate the balance varied plus or minus 1% of the 30-year Treasury bond rate.  

The GAO said it planned to provide copies of this report to the Secretaries of the Department of Labor and the Department of Treasury and to the Pension Benefit Guaranty Corporation and interested congressional offices.  

It is available online at