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11.11
20 Years of Pension “Improvements”
By George F. McClure
The traditional defined benefit
pension served as the gold standard for
retirement security, where the employer took the
risk in delivering the promised benefit. But
over the past two decades many firms have turned
the risk over to the employees, to provide for
their own retirement security through prudent
investing of shrinking retirement assets.
The story of how pension funds
became profit centers for corporations is
detailed in a new book by Ellen E. Schultz,
Retirement Heist — How Companies Plunder and
Profit from the Nest Eggs of American Workers.
Ms. Schultz, a reporter for the Wall Street
Journal, painstakingly dug through corporate
financial reports (the footnotes in Forms 10-K)
to piece the story together. She has been
reporting on these developments over the past
decade.
For her work she received the
2001 IEEE-USA Distinguished Literary
Contributions Furthering Engineering
Professionalism Award.
Because many engineers change
jobs often, as contracts and projects are
completed, pension portability has been a
popular goal. This implies a lump-sum
distribution of pension benefits from previous
employers so that the engineer can control the
investing of his retirement assets himself.
Assets left with previous employer were usually
frozen in value until they were collected in
retirement. Most pension plans provide for
vesting in five years, but there is no further
pension credit after an employee leaves the
company. So there could be long periods where
an employer-held benefit did not grow in value
after the employee had left the firm. Another
issue was the net present value computation of
the lump sum, which would be less than the
typical lifetime of monthly pension checks.
Sometimes Human Resources low-balled the
calculation. Schultz describes one example in
her book, where the retiree was exceptionally
tenacious and persevered for correction which
occurred just before his death.
With traditional defined benefit
pension plans, the biggest credit builds up in
the last few years of service. Typically, the
last five years are used to calculate the
benefit (percentage times years times final
average salary). But with an aging workforce
the pension liability would increase rapidly.
To offset this, companies offered early
retirement inducements. With a combination of
good growth in pension funds during the 1990s
and reduced liability owing to early
retirements, employers were able to reduce
contributions to pension funds and even withdraw
excess contributions.
Innovations in pensions, touted
as new and improved, actually provided lower
benefits. The Pension Equity Plan used a lower
interest rate for older employees that reduced
the benefit. This rate could be a tenth that
used for younger employees. The Cash-Balance
Plan, still a defined benefit plan, gave
employees individual “accounts”, but computed
benefits over the working lifetime (Career
Average Salary) rather than last few years
(Final Average Salary).
As the liabilities diminished
with lower benefits, there was more money left
in pension funds to fall to the bottom line. So
pension plans could become profit centers,
increasing apparent corporate earnings.
The cash-balance plan was first
used by Bank of America in 1985. It credited
each vested employee with a balance each year
based on that year’s salary; added to other
years’ balances that formed a benefit tied to
career average salary, perhaps 40 percent less
than for a defined benefit plan.
The benefit claimed for the
cash-balance plan was that it provided pension
portability and thus met the needs of a more
mobile workforce. Younger workers liked the
fact that each year they saw a growing balance,
available as a lump sum when they left the
company. In fact, however, two-thirds of young
workers leave their jobs without vesting in
their pensions, so their balances were
forfeited, and remained in the plan.
Conversion from a defined
benefit plan to a cash-balance plan hurt
mid-career employees because it could be several
years before their pension credit grew beyond
what they had at conversion. This was called
wear-away, caused by the lower career average
salary computation compared to the earlier final
average salary figure. Schultz cites one case
where it took ten years for pension growth to
occur again after conversion. Engineers were
usually the first to deduce what was happening
to their retirement security.
As employees learned what was
happening to their “improved” pension plans they
urged Congress to hold hearings. One result was
that some firms, such as Eastman Kodak, gave
older workers a choice between their old defined
benefit plan and the new cash balance plan. One
high-profile town hall meeting occurred in Essex
Junction, Vermont, where IBM produced disk
drives. It was convened by then-Representative
Bernie Sanders.
Wear-away was banned in the
Pension Protection Act of 2006, for
cash-balance plans set up later.
In 1987, the Financial
Accounting Standards Board issued standard FAS
87 which provided for the treatment of excess
funds in pension funds to be treated as income,
paper gains that appear to increase earnings.
In 1999 IBM reduced its pension obligation by
$450 million — an amount it could (and did) add
to income over years or all at once. It took
$200 million of these gains in 1999.
Pensions were often adversely
affected by bankruptcy. Even though a
government agency — the Pension Benefit Guaranty
Corporation (PBGC) —backstops pension payouts in
the event of corporate bankruptcy, it has low
limits and covers only
IRS-qualified pension plans, not
including early retirement subsidies. When
Delta Air Lines filed for bankruptcy in 2005 it
terminated the pension plan for 5,500 pilots.
One retired pilot found his monthly pension of
$1,939 reduced to $95 per month. Supplemental
pension plans are not covered at all. Another
pilot lost $7,000 per month in a supplemental
pension and $1,197 from the regular pension
plan.
Health benefits are not covered
by the Employment Retirement Income Security Act
(ERISA) that regulates pensions. As the cost of
retiree health benefits rose, many employers
capped their contributions so that all premium
increases had to be paid by the retirees.
Schultz describes how Lucent, the AT&T spin-off,
was able to limit its exposure to retiree health
liability. It used pension funds for retiree
health coverage, as long as the pension plan was
in surplus. When this wouldn’t work any longer,
Lucent cut health care, dental coverage, death
benefits, spousal coverage, Medicare Part B
premiums, and telephone discounts. Lucent
nevertheless was able to move $400 million from
employee benefits to executive bonuses.
Often firms were able to
reallocate their pension funds, so that as the
liability for rank-and-file employee pensions
was reduced through plan changes, they could
enrich executive pension plans with the savings.
Another innovation was “Janitors
Insurance” later called “Managers Insurance”.
Some employers took out insurance policies on
their employees, often without employees knowing
the details. Schultz described these as
equivalent to a giant IRA, where assets grew
tax-deferred then were distributed tax-free on
the death of the covered employee (or former
employee). Further, as cash values built up in
these policies, the owning companies were able
to borrow on them and deduct the interest as a
business expense. Policies could be continued
in force even after the employee left the firm.
The policies were often used to fund executive
benefits, tax-free. There were sometimes
questions about whether the employer had an
insurable interest in the employee, but it was
often chalked up to funding employee benefits.
The supermarket chain Winn-Dixie had taken tax
deductions for loans from policies covering
56,000 workers. The company was on track to
save $2 billion in taxes over 60 years. But in
a court case the interest deduction was
disallowed. The IRS had found that some seven
hundred companies had leveraged Corporate Owned
Life Insurance (COLI) on employees with no real
business purpose. A similar category was Bank
Owned Life Insurance (BOLI), which grew during
the sub-prime mortgage crisis.
Some traditional defined benefit
pension plans were frozen and replaced with
cash-balance plans, usually linked to 401(k)
plans, or simply with enriched 401(k) defined
contribution plans. A survey of pension plans
[8] showed the growth of cash-balance plans.
In 2001, cash-balance plans made up 2.9 percent
of all defined benefit plans. The Pension
Protection Act of 2006 gave added impetus to the
switchover. By 2008, this fraction had grown to
11 percent, and was projected to grow to 15
percent by 2010. There were 5,840 cash-balance
plans in existence in the U.S. in 2009. For
small businesses (under 100 employees) that have
a pension plan, 82 percent have cash-balance
plans.
Schultz has extensive source
notes in her book, which is recommended.
Other resources
1.
Related information, on a web site set up
by IBM employees, makes interesting reading.
See
http://www.ibmemployee.com/
2.
A 52-minute video with author Ellen E.
Schultz is found at
http://www.cspan.orgwww.booktv.org/Watch/12833/
Retirement+Heist+How+Companies+Plunder+and
+Profit+from+the+Nest+Eggs+of+American+Workers.aspx
3.
The Concise Library of Economics:
Pensions.
http://www.econlib.org/library/Enc/Pensions.html
4.
Excess Pension Plan Assets Can Be Put to
Various Uses. http://www.winston.com/siteFiles/publications/ExcessPension.pdf
5.
The Low Down on Cash Balance Plans
http://biz.yahoo.com/edu/rt/sm_rt8.sm.html
6.
The Effects of Adopting Cash-Balance
Pension Plans
http://www.ibmemployee.com/PDFs/BusinessHorizons.pdf
7.
Private Pensions: Implications of
Conversion to Cash-Balance Plans, GAO, 2000.
http://www.gao.gov/new.items/he00185.pdf
8.
Cash Balance Design — Kravitz survey of
all qualified pension plans.
http://www.cashbalancedesign.com/articles/
documents/NationalCashBalanceResearchReport2011.pdf
George F. McClure, an IEEE
Life Fellow, is Technology Policy Editor for
Today’s Engineer and a resource member of the
IEEE-USA Career and Workforce Policy Committee
Comments may be submitted to
todaysengineer@ieee.org.
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