IMHO: The Rest of the Story

November 9, 2005 ( - On Friday, the Government Accountability Office, or GAO, issued a report reflecting its analysis of cash balance plans and their impact on worker pensions. That same afternoon, the "mainstream" media published their analysis of that analysis - but seemed to be selective in the parts they chose to highlight.

Before turning to the results of that report, we should start with some basic points of understanding.    Simply stated, cash balance programs are widely described as “hybrid” benefit plans – technically a defined benefit plan, but with many of the characteristics of defined contribution plans.   Like DB plans, they are typically employer-funded and insured by the Pension Benefit Guaranty Corporation (PBGC).   They are like DC plans in that the benefit is a function of interest credited to your account each year, there is generally a regular statement of your account, and there is a lump sum payment option.   The GAO report acknowledged, “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, most of the controversy around these plans revolves not around the plan design per se, but around how companies with existing pension plans have converted to the cash balance design.

The headlines regarding the GAO report were fairly consistent:   “Workers lose in cash balance plans,” “GAO: Pension Plan Switch Hurts Employees,” “Cash-Balance Pensions Criticized.”   And in fact, the report did note that, in its comparison of a typical pension plan (which it termed a final average pay, or FAP) converted to a cash balance (CB) plan, more workers would have received greater benefits under the FAP than under the typical CB plan.   Those comparisons are complicated, of course, a point acknowledged by the GAO, even if the mainstream press coverage didn’t.  

The GAO noted 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 GAO went on to note that most plans it studied 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 other words, if employers had simply done a straight conversion from a traditional pension to a cash balance, most workers would have lost benefits – but most employers didn’t do a straight conversion.   Realizing the impact, they took special steps to mitigate, if not eliminate, that potential shortfall.

What the GAO report also noted was that, under its simulations, vested workers under either a typical or equal cost CB plan still fare better than if the pension plan is terminated – and let’s face it, with all the uncertainty and expense of running a traditional pension plan (not to mention its lack of design appeal to many in today’s private sector workforce), eliminating the benefit altogether is an increasingly viable option for employers.   Indeed, the GAO report noted the importance of striking “a crucial balance between protecting workers’ benefit expectations with unduly burdensome requirements that could exacerbate the exodus of plan sponsors from the DB system.”

Ultimately, what the GAO report tells us is this, IMHO:   It tells us that conversions from a traditional pension to a cash balance plan can result in reduced benefits – but generally don’t because employers have taken steps to mitigate that impact – – on their own and without legislative mandate.   It tells us that having a cash balance plan benefit is better than having no benefit at all.   And it tells us that there is a fine line between an honest evaluation of these programs and driving employers away from offering their benefits altogether.