Most Firms See No Cost Savings With Cash Balance Plans

May 19, 2004 ( - Conversion from tradition defined benefit plans to cash balance schemes does not add up to a reduction in costs for employers.

Employer accounting costs were expected to remain about the same or even increase in nearly two-thirds (65%) of the conversions to cash balance plans, which takes into account the shifting of costs to other retiree programs as well, according to Mellon Financial Corporation’s Human Resources & Investor Solutions (HR&IS) business 2004 Survey of Cash Balance Plans. Of the companies canvassed that indicated changes to their retiree programs in connection with the introduction of cash balance benefits, the most common change was to introduce or increase the 401(k)/403(b) match, done by 62% of the respondents. Other changes included changes to post-retirement medical benefits (19%) and accelerated vesting in employer contributions to 401(k)/403(b) plans (12%).

Our findings on the employer’s cost impact are contrary to the common assertion that cash balance plan conversions are motivated primarily by cost savings,” said Larry Sher, principal and chief actuary of the retirement practice at HR&IS.

Mellon’s survey backs up similar data aggregated by consulting house Watson Wyatt. In their March survey, Watson Wyatt found c ash balance conversion increases retirement plan costs an average of 2.2% (See Cash Balance Conversions Increase Retirement Plan Costs ).

Other Mellon Findings

Once converted, Mellon’s study found i n the vast majority of cases (82%), all plan participants at the time of conversion became covered by the cash balance formula. The vast majority (87%) also established opening account balances for employees upon conversion to the cash balance plan to reflect past service with the employer.

To determine the opening balances, most employers (48%) used an interest rate assumption considered “in range,” no less than the lowest, and no more than the highest, monthly rate on 30-year Treasury bonds during the nine-month period before the date of conversion. By comparison, 23% of employers used an interest rate assumption that was above range and the rest (29%) used one below range.

Examining other assumption used by employer converting to a cash balance option, Mellon found seven out of 10 plans included pre-retirement mortality rates in determining opening balances – the assumed mortality between the employee’s age at conversion and the employee’s assumed date of retirement. As for the assumed age at retirement, Mellon found 72% of plans using 65, followed by:

  • 60 – 64 (11%)
  • current age if retirement eligible (6%)
  • 55 – 59 (5%)
  • others, including variable (5%)

Plan Transition

Additionally, Mellon’s survey of 150 plans that introduced cash balance benefits since 1985 found 90% provided transition protection when converting to the cash balance format. The most common approaches include:

  • grandfather benefits (34%);
  • transition credits (21%);
  • grandfather benefits combined with transition credits (16%);
  • the choice or requirement to remain in the prior plan (13%).

Further elaborating on grandfather benefits, Mellon found the eligibility basis for such benefits to be determined by age and service in 37% of plans, all employees eligible (27%), age or service (11%), age only (10%), age plus service (10%) and other (6%). The most common age bracket used in the stratification of these benefits was 50 to 54, used by 28% of respondents with a minimum eligibility age for grandfather benefits.

Once converted, Mellon found 33% of cash balance plans integrated with Social Security benefits, compared with 70% of plans that integrated prior to conversion. Eliminating this integration, such as providing benefits credits higher on pay above a plan’s specified “integration level,” provides more benefits to lower workers, Mellon said.

“Cash balance plans deliver retirement benefits broadly across an employer’s workforce, providing meaningful benefits to shorter-service, lower-paid employees,” Sher added. “Our survey shows that, compared to the benefit formulas they replaced, cash balance formulas tended to provide proportionately more benefits to lower paid workers through elimination of ‘Social Security integration’.”