Private Pensions: Information on Cash Balance Pension Plans
Published: 2005-11-03T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The nation's private defined benefit (DB) pension system, a key contributor to the financial security of millions of Americans, is in long-term decline. Since 1980, the number of active participants in Pension Benefit Guaranty Corporation (PBGC) insured single employer DB plans has dropped from 27.3 percent of all national private wage and salary workers in 1980, to about 15 percent in 2002, and more recently the PBGC has assumed billions of dollars in unfunded benefit obligations from bankrupt plan sponsors. Some analysts have identified hybrid DB plans like cash balance (CB) plans as a possible means to revitalize this declining system. However, conversions from traditional DB plans to CB plans have sometimes been controversial because of the effect conversions may have on the benefits of workers of different ages. As House and Senate committees consider comprehensive pension reform legislation that includes efforts to resolve uncertainties about CB plans, GAO was asked to (1) review current research about the implications of CB conversions for employee benefits, (2) describe the prevalence and type of transition provisions used to protect workers' benefits in past CB conversions, and (3) estimate the effects of CB conversions on the benefits of individual participants under a hypothetical conversion to a typical CB plan from a typical traditional DB plan.
section_title: What GAO Found
paragraphs: Current pension and economic literature provides little conclusive evidence about the effects of CB plan conversions on benefits. In many cases, data and other methodological issues (e.g., sampling methods) limit the generalization of results. Nonetheless, cash balance research indicates that the effects of a conversion depend on many factors, including the generosity of the CB plan, transition provisions that might limit any adverse effects on current employees, and firm-specific employee demographics. CB plan conversions are posited to have distributional effects on expected pension wealth: younger, more mobile workers usually benefit while older workers with long job tenure are likelier to experience a loss, particularly if they are nearly eligible for early retirement. GAO's analysis of a representative sample 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 benefits accrued under the previous plan, although the interest rate used to calculate the balance varied around the 30-year Treasury bond rate. 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. About 47 percent of all conversions grandfathered at least some of the employees into the former traditional DB plan. In most cases, grandfathering eligibility was limited to employees meeting a specified minimum age and/or years of service. GAO's simulations of the effects of conversions on pension benefits show that in conversions from a traditional DB plan to a typical CB plan, most workers, regardless of age, would have received greater benefits under the DB plan. Unless grandfathered into the former plan, older workers experience a greater loss of expected benefits than younger workers. Further, in comparing a typical CB plan to a terminated FAP plan, all vested workers would do better under the CB plan. Also, in conversions from a traditional DB plan to a CB plan of equal cost to the sponsor and more generous than the typical CB plan, while more workers at age 30 have benefit increases under the CB plan, this was not true for those at age 40 and 50. Moreover, in comparing a equal cost CB plan to a terminated FAP plan, again all vested workers would do better under the CB plan. Finally, GAO's comparisons focusing on the lifetime present value of benefits did not change the basic findings of GAO's analysis of monthly benefits.

section_title: Letter
paragraphs: The nation’s private defined benefit (DB) pension system, a key  contributor to the financial security of millions of American workers and  their families, is in long-term decline. The number of single employer DB  plans has declined dramatically over the past several decades, from over  95,000 in 1980 to less than 35,000 in 2002, with the number of active  participants in such plans dropping from 27.3 percent of all national  private wage and salary workers in 1980, to about 15 percent in 2002.  Structural problems in industries like airlines, steel, and auto parts have  led to large bankrupt firms terminating their DB plans, with thousands of  workers losing some of their benefits and saddling the Pension Benefit  Guaranty Corporation (PBGC) with billions of dollars in unfunded benefit  guarantees. In response, several congressional committees have proposed  comprehensive pension reform legislation that, among other issues, would  address the underfunding of single employer defined benefit plans.
Some analysts have identified hybrid DB plans like cash balance (CB)  plans as a possible means to revitalize this declining system. CB plans are  referred to as hybrid plans because legally they are DB plans but contain  certain features that resemble defined contribution plans. Similar to  traditional DB plans, CB plans use a formula to determine pension  benefits. However, unlike traditional final average pay (FAP) plans that  pay retirement benefits on the basis of an annuity amount calculated using  years of service and earnings, CB plans express benefits as a hypothetical  individual account balance that is based on pay credits (percentage of  salary or compensation) and interest credits, rather than an annuity.
In the late 1990s, many pension plan sponsors converted their traditional  final average pay plans to CB plans. Conversions to CB plans have been  controversial because of the effect they may have on pension benefits of  workers of different ages and years of service. In particular, CB plan  conversions can sometimes result in so-called “wearaway” situations  where some workers do not earn additional pension benefits while other  workers continue to do so. The legality of CB plans has recently been  questioned in a court ruling regarding whether a CB plan is age  discriminatory. Employers report this legal uncertainty has made CB plan  conversions less popular than in the past. In 2000, we reported on the  implications of conversions to CB plans and recommended legislative and  executive agency actions to address the regulatory uncertainty concerning  CB plans and to improve disclosure to affected participants.
In response to the problems facing the DB system, committees in both the  House and the Senate have recently proposed legislation that would  address many issues facing defined benefit plans, including the legal  uncertainty regarding the formation of new CB plans or the conversion of  traditional DB plans to CB plans. To help in your deliberations, you asked  us to provide information on the incidence, features, and effects of CB  plan conversions. More specifically, you asked: (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? (3)  How do individual participants fare under a hypothetical conversion to a  typical CB plan compared to the typical FAP plan? On September 1, 2005,  and again on October 12, 2005, we briefed your staff on the results of our  analysis. This report formally conveys the information provided during  those briefings. (See app. I).
To determine the results of current research, we conducted a review of  academic and business literature regarding CB plans and the conversion of  traditional DB plans to CB plans. To identify the prevalence and types of  transition provisions in CB plans, we worked with the 2001 Form 5500 to  identify and examine CB plan conversions for their design features. We  first identified all 843 plans with 100 or more participants that indicated a  CB or hybrid plan component on Form 5500. We then  selected a random  sample of 205 of these plans. Our 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. Of these 205 plans, we identified 31 large plans  and 102 smaller plans as conversions from traditional DB plans to CB  plans. (For our methodology, see apps. II, III and IV.)
To analyze the effects of a CB plan conversion on individual workers, we  used a pension policy microsimulation model (PENSIM). PENSIM  simulates lifetime retirement benefits for over 100,000 participants in the  1955 birth cohort. We calculated and compared monthly retirement  income for workers from the 1955 birth cohort who are projected to be  alive at age 68, and vested in a job covered by a typical FAP plan that is  converted to a CB plan. The model allows comparison of benefits received  from CB plans and ongoing traditional FAP plans, as well as terminated  FAP plans.
We conducted four simulations:  typical CB plan versus typical FAP plan,  typical CB plan versus terminated FAP plan,    equal cost CB plan versus typical FAP plan, and    equal cost CB plan versus terminated FAP plan.
Plan characteristics for the traditional FAP plan and typical CB plan were  based on Bureau of Labor Statistics’ (BLS) employee compensation and  benefit data, our analysis of CB conversions as designated in the 2001  Form 5500 data base and discussions with industry actuaries and  consultants knowledgeable about CB plans and DB plans generally. We  developed the features of our equal cost CB plan by starting with the  design features of the typical CB plan and then increasing both the base  pay credit and the weighted pay credits (a percentage of pay that increases  as an employee’s age and/or years of service increase) until the cost was  equivalent with a traditional FAP plan with a workforce of identical  actuarial, demographic, and labor market characteristics. (See slides 19 to  25 in app. I.) We conducted our work between September 2004 and  September 2005 in accordance with generally accepted government  auditing standards.
In summary, we found the following:    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. (See slides 9 and 10.) In many cases, data and  other methodological issues (e.g., sampling methods) limit the  generalization of results. 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. CB plan  conversions are posited to have distributional effects on expected  pension wealth: younger, more mobile workers usually benefit while  older workers with long job tenure are more likely to experience a loss,  particularly if they are near the age and service requirements for early  retirement. Less research is available on the actual benefit  distributional effects of such conversions, e.g., how participants are  likely to fare under a CB plan compared to the traditional DB plan that  is being replaced.
Our 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 percent of the  30-year Treasury bond rate. (See slides 11 to 18.) The use of interest  rates above the 30-year Treasury rate is more likely to result in a  wearaway situation, unless otherwise mitigated. 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. About 47 percent 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, grandfathering  eligibility was limited to employees meeting a specified minimum age  or years of service or both. Most conversions also used some form of  ongoing weighted pay credit.
Our 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. (See slides 26 to 28.) For workers who receive less under the CB  conversion, median benefit decreases range from $59 per month at age  30 to $238 per month at age 50. For the workers who receive more  under the conversion, median benefit increases range from $15 per  month at age 30 to $27 per month at age 50. Those who experience  either benefit increases or decreases are more likely to be men, except  for those at the age 50 conversion, where they are more likely to be  women.
In comparing a conversion to a typical CB plan with a terminated FAP,  all vested workers would do better under the CB plan. Median monthly  benefits increase at conversion ages 30, 40, and 50, with increases  ranging from $150 per month for conversions at age 30 to $305 per  month for conversions at age 50. (See slides 29 to 30.) The increase in  benefits for older workers is because grandfathered benefits are  included in these results.  Although the analysis focuses on vested  workers at the time of conversion, under a terminated FAP plan, by law  all previously unvested workers (those with less than 5 years service)  are immediately vested.
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. (See slides 33 to 35.)  Grandfathering again protects the benefits of those older workers who  were covered. However, while more workers who are converted at age  30 fare better under the CB plan, this was not true at other ages. A key  factor is the greater generosity of the equal cost CB plan compared to  the typical CB plan we also simulated. Under the equal cost scenario,  median reductions range from $75 per month for conversions at age 30  to $128 per month for conversions at age 50, while median increases  range from $90 per month for conversions at age 30 to $29 per month  for conversions at age 50. For all conversion ages, those with longer job  tenure and who are not covered by grandfathering protections are  more likely to lose than those workers with shorter tenure. At each  conversion age, a greater percentage of those who are more likely to  experience benefit increases are men rather than women.
In comparing a conversion to an equal cost CB plan with a terminated  FAP plan, again all vested workers do better under the CB plan. Median  increases range from $283 per month for conversions at age 30 to $396  per month for conversions at age 50. (See slides 36 to 37.) The increase  in benefits for older workers comes about because grandfathered  benefits are included in these results.
subsections: section_title: Concluding Observations
paragraphs: Our analysis illustrates one of the difficult choices facing the Congress in  crafting comprehensive DB pension reform legislation, including the  controversial issues surrounding the legal status of CB plans, and  particularly CB conversions. 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. 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.
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, conversions of traditional FAP plans to CB  plans redistribute benefits among groups of workers and can result in  benefits for workers, particularly those who are longer tenured, that fall  short of those anticipated under the prior FAP plan. Our simulations  suggest that grandfathering plan participants who are being converted can  protect those workers’ expected benefits, and, in fact, such protections, in  some form, are fairly common in conversions. Our simulations also 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, as we noted in our 2000 report, additional protections are  needed to address the potential adverse outcomes stemming from the  conversion to CB plans. For example, requirements for setting opening  account balances could protect plan participants, especially older  workers, from experiencing periods of no new pension accruals after  conversion while other workers continue to earn benefits.
Our simulated comparison of CB plans with the termination of a FAP plan  leads to several important observations. First, the immediate vesting of all  unvested workers requirement in a plan termination actually leads to a  greater number of workers getting some retirement benefits and highlights  the portability limitation of DB plans. Workers in an ongoing DB plan only  receive benefits if they are vested. Appealing to a mobile workforce would  seem to place an even greater significance on pension portability. Yet 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.
In our simulations, vested workers under either a typical or equal cost CB  plan still fare better than if the FAP plan is terminated. We note further  that some sponsors of CB plans have already exited the DB system, a  system that has been declining in sponsorship and participation for several  decades now. 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.
section_title: Agency Comments
paragraphs: We provided a draft of this report to the departments of Labor, Treasury,  and the PBGC.  No written comments were provided by these agencies.   They did, however, provide technical comments, which we incorporated  as appropriate.
We plan 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. We  will make copies available to others upon request. In addition, the report  will be available at no charge on the GAO Web site at http://www.gao.gov.
If you have any questions concerning this request please contact me at  (202) 512-5932. Other major contributors to the report are listed in  appendix VI.
section_title: Appendix I: Information on Cash Balance Pension Plans
subsections: section_title: Summary of Findings
paragraphs: I.
Literature provides few generalizable conclusions,  particularly with regard to: why sponsors convert to CB plans  the benefit distributional effects of such conversions.
II. Analyzed plan conversions show most, but not all: converted accrued benefits into an opening account  balance and offered some form of transition provisions. had age and service eligibility restrictions on transition  provisions.
section_title: Summary of Findings, cont.
paragraphs: III. Regardless of age, workers who were converted from an  FAP plan to a typical CB plan generally had reductions  from expected FAP benefits.  A majority of younger  workers received larger benefits under a conversion to an  equal cost CB plan.
Analysis of lifetime benefits under a conversion to an  equal cost CB plan does not change basic findings. Vested workers receive larger benefits under a CB  conversion of either type compared to benefits received  under termination of an FAP.
section_title: Research Provides Limited Evidence to
subsections: section_title: Data and other methodological issues
paragraphs: Data and other methodological issues (e.g., sampling  methods) limit generalization of results.   limit generalization of results.
Conversion impact depends on a variety of factors  including plan generosity, transition provisions, and firm  specific employee demographics.
Also, because of the different accrual patterns in a CB  plan compared to a FAP plan, for a variety of workers,  the impact of a conversion varies.
section_title: Research Provides Limited Evidence to Generalize About CB Conversions, cont.
subsections: section_title: Current research provides limited evidence as to: Current research provides limited evidence as to:
paragraphs: Why sponsors convert to CB plans. Why sponsors convert to CB plans. How participants are likely to fare under a CB plan   How participants are likely to fare under a CB plan  relative to the traditional DB plan that is being replaced. relative to the traditional DB plan that is being replaced.
CB plan conversions have distributional effects on pension   Younger, more mobile workers who vest usually benefit.  Older workers with long job tenure likely to experience a  loss, particularly if they are near age and service  requirements for early retirement.
subsections: section_title: II. Plan Analysis
section_title: II. Plan Analysis
paragraphs: There were 2 primary methods for setting the opening account  1. Present Value (PV) of old accrual:  account balance is based  on accrued benefit at conversion; or  2. A+B:  (A) preserves prior benefits as annuities + (B) CB  opening balance is $0.
Opening account balance depends on a formula that may include  factors such as interest rates, employer-added incentives, early  retirement benefits, & other assumptions.
section_title: II. Plan Analysis
paragraphs: 23 of 39 plans with data available used conversion interest rates  within 1% of the prior month’s 30-year Treasury rate  Wearaway may occur when a participant’s hypothetical opening  account balance is set at less than the present value of its accrued  benefits using 30-year Treasury rate, as specified under the Internal  Revenue Code.
Transition provisions (e.g., grandfathering, transition pay credits)  are important factors in mitigating wearaway.
Grandfathering prevents wearaway for participants who  continue to accrue benefits under the prior plan formula.
section_title: About Half of Plans Offered Some Form
subsections: section_title: Grandfathering was offered in 47% of all conversions
paragraphs: and in 55% of the largest converted plans, although  most of these provisions had some form of age or  service restrictions.
Eligibility requirements in plans offering   age plus service   all employees  age or service  Age plus service was the method most often used.
subsections: section_title: II. Plan Analysis
paragraphs: 62% of all conversions used some form of weighted  pay credits (those that increase based on the  participant’s age and/or service).   36% of all conversions used level pay credits (those  that are a level function of salary).
About 42% of large conversions used an age plus  service method for providing ongoing pay credits.
Weighted pay credits tend to benefit older and longer- tenured workers relatively more than level pay credits.
section_title: II. Plan Analysis
section_title: Compare monthly and lifetime retirement income for workers from
section_title: III. Simulations
paragraphs: Immediate eligibility and 5-year cliff vesting and normal retirement  age 65, early retirement age 55 with 10 years of service with early  retirement benefit reduction of 5 percent per year. Immediate disability retirement benefits for those vested, no  survivors benefits or joint-and-survivor annuities.
Benefits paid as a nominal annuity (i.e., no benefit COLA).  Terminal earnings (final pay) is final five-year average.  Benefits formula is excess integrated with base rate of 1.5 percent  of final pay per year of service and has a rate of 0.45 percent of  final pay per year of service for those amounts in excess of the social security maximum.
Typical FAP plan design based on prior GAO reports, literature  reviews, and discussions with pension actuaries, consultants  knowledgeable about DB plans.
section_title: III. Simulations
paragraphs: Immediate eligibility and five-year cliff vesting; base pay credit of 3.0  percent of salary for employee with age-plus-service (APS) ≤ 35.
Pay credit rises gradually until it is 6.0 percentage points above the base  pay credit for employee with APS ≥ 70.
Cash-balance account crediting rate is the Treasury rate.  Employee rolls over account balance at separation and earns Treasury  rate. Balances converted to nominal single-life annuity at retirement using  the Treasury rate and the GAM 83 mortality table adjusted to the pertinent  year.
Typical CB plan design is based on plans analyzed in GAO’s Form 5500  data, and confirmed by pension actuaries, consultants knowledgeable  about CB plans.
section_title: III. Simulations
paragraphs: Same assumptions as the typical CB plan except:  Base pay credit of 7.35 percent of salary for employee  with age-plus-service (APS) ≤ 35.
Pay credit rises gradually until it is 6.0 percentage points  above the base pay credit for employee with APS ≥ 70.
Equal cost CB plan used for our simulations is:   More generous pay credits than virtually all plans in our   More generous than those specified in pension research   Though not explicitly modeled, to some extent, our equal  cost cash balance plan could be considered to implicitly  include other enhancements made by employers to other  benefits, such as those provided by a DC plan, for  example.
section_title: Plan Characteristics: Cash-Balance Plan
subsections: section_title: Typical CB Plan Conversion vs. Terminated Typical
paragraphs: Regardless of age, all vested workers who converted to  a typical CB plan experienced monthly benefit increases  compared to a terminated FAP plan.
At conversion ages 30, 40, and 50, increases range  from $150 per month for conversions at age 30 to $305  per month at age 50. Grandfathered benefits for those  eligible under the CB plan greatly impact results shown  for older workers.(See figure 7.)
Terminated plan benefits are shown for only those  participants who were vested in the typical CB plan.
subsections: section_title: III. Simulations
paragraphs: Workers Converted to Typical CB Plan from Typical  FAP at Earlier Ages Generally Receive Reduced    Comparison of lifetime benefits for typical CB plan and  typical FAP plan does not change basic findings from  monthly benefit comparisons.
Regardless of age at conversion, more workers who  are converted from a FAP plan to the typical CB plan  have lower present value of lifetime benefits. (See  figure 8.)
Nearly half of workers experiencing a conversion at  age 50 are grandfathered in their FAP benefit.
section_title: III. Simulations
paragraphs: Grandfathering protects eligible older workers’ benefits converted to  an equal cost CB Plan from a FAP Plan (See figure 9.)
More workers who converted from a FAP plan to an equal cost CB  at age 30 generally experience monthly benefit increases   Increases range from $90 per month for conversions at age 30  to $29 per month for conversions at age 50. (See figure 10.)
Reductions range from $75 per month for conversions at age  30 to $128 per month for conversions at age 50.
section_title: Comparisons of Median Monthly Retirement Income: Equal Cost CB Plan vs. Terminated Typical FAP Plan
section_title: Regardless of age, all vested workers who converted to
paragraphs: an equal cost CB plan experience benefit gains  compared to a terminated FAP.
Median increases range from $283 per month for  conversions at age 30 to $396 per month for  conversions at age 50.  Grandfathered benefits for older  workers under the CB greatly impact results.(See figure  11.)
Terminated plan benefits are shown for only those  participants who were vested in the equal cost CB  plan.
subsections: section_title: III. Simulations
paragraphs: Comparison of lifetime benefits for equal cost CB plan and typical  FAP plan consistent with basic findings from monthly benefit  comparisons (See figure 12).
More workers converted to an equal cost CB plan from a typical  FAP at age 30 receive greater present value of lifetime benefits through conversion than would at later conversion ages.
Nearly half of workers experiencing a conversion at age 50 are  grandfathered in their FAP benefit, while a significant number  (41%) of unprotected workers converted at age 50 experience a  lower present value of lifetime benefits.
Outside of grandfather protections, results show a redistribution  of benefits from older workers to younger workers.
section_title: III. Simulations
paragraphs: GAO compiled a comprehensive list of the academic literature on CB  pension plans since our last reports on the subject issued in 2000,  focusing on those studies that contained original and material empirical  work on the issue. After constructing a list of the relevant literature, we  eliminated partial or incomplete studies, those that did not contain  material empirical work and those that exhibited serious methodological  concerns. We then conducted a more detailed review of the remaining  studies, including several surveys of CB plans. The review concentrated on  the studies’ findings and on the methodological issues that may limit  conclusions that can be reached. There is a list of the studies and surveys  reviewed for this report at the end of this appendix.
Although there are academic studies that attempt to go beyond anecdotal  information, the literature remains in its infancy. Data and other  methodological issues often limit the conclusions that the empirical  studies examining the impact of plan conversions can reach and, the  ability to generalize their results. In general, the results of all studies are  sensitive to assumptions regarding earnings growth, interest rates,  investment returns, and turnover rates. Because some specifics of the  simulations presented in some studies do not include sufficient detail, it is  difficult to evaluate the quality of the estimates in some cases.
subsections: section_title: Lack of Available Data Limits Empirical Studies
paragraphs: Because of the limited availability of data on actual conversions and on  the workforce associated with a particular conversion, few empirical  studies have the ability to examine actual conversions. Because a range of  factors that are unique to each conversion influence the final impact on  workers—including demographic characteristics, the transition benefits  offered during the conversion and the generosity of the new CB plan  relative to the old plan it is replacing—it is difficult to extend the results of  the literature to the actual experience of workers. For example, in the  conversion to a new plan, a sponsor may eliminate early retirement  subsidies—a significant reason why older workers may receive lower  benefits. Similarly, some employers may offer transition benefits that can  help to ameliorate the adverse effects of plan changes on the more senior  segment of the workforce, while others do not. Other studies focus on  “hypothetical” or “prototypical” workers instead of actual employees and  therefore cannot make definitive statements about many segments of the  population or actual workers in the plans analyzed.
In addition, the majority of the research simulates the effects of plan  conversions on the workforce assuming that the conversion is cost neutral  (the cost of the new CB plan is equal to the cost of the old DB plan so that  overall pension benefits remain constant). However, some research  suggests that the retirement benefit implications due to a shift to a less  generous CB plan differ materially from the effects of a cost-neutral  conversion. Moreover, several studies were limited to plans that include  transition benefits that often ensure that existing workers do not suffer  significant losses in pension wealth during plan conversions and exclude  pension wealth on previous jobs. Thus, their inclusion/omission may lead  to a bias in the empirical findings either in favor or against CB plan  designs.
section_title: Small Sample Size Limits Survey Reports
paragraphs: Some studies examine only a few plan conversions or rely on assumptions  based upon information extracted from the limited surveys discussed  below. Since the plans analyzed may not be representative, the outcomes  may not generalize to the typical CB conversion or related to the broader  workforce.
A few widely cited studies which use survey data in an attempt to  determine the reasons why employers initiate CB plan conversions contain  methodological limitations and base their conclusions on employers’ self  perceptions along with additional biases, and cannot be extended beyond  the small samples of firms studied. For example, one study is limited by a  low response rate (20 percent) and insufficient information about the  population and sampling method, survey instrument and its development,  while the others raise concerns over the potential for sample bias and/or  the additional bias due to the fact that over half of the plans evaluated  were those for which the researchers were the primary design  consultants. In general, we determined that the results from these  surveys may not be representative of the population of CB plan  conversions and methodological limitations suggest that the results should  be interpreted with caution.
section_title: Studies and Surveys Reviewed
paragraphs: Clark, Robert. “Pension Plan Options: Preferences, Choices and the  Distribution of Benefits.” Pension Research Council Working Paper, PRC  WP. 2003-24.
Clark, Robert, and Fred W. Munzenmaier. “Impact of Replacing a Defined  Benefit Pension with a Defined Contribution Plan or a Cash Balance Plan.”  North American Actuarial Journal, 5 (1). (2003-4): 32-56.
Clark, Robert, and Sylvester Schieber. “The Transition to Hybrid Pension  Plans in the United States: An Empirical Analysis.” Private Pensions and  Public Policies, eds. W. Gale et al. Washington, D.C.: Brookings  Institution. 2004.
Coronado, Julia, and Philip Copeland. “Cash Balance Pension Plan  Conversions and the New Economy.” Federal Reserve Board Working  Paper. November 2003.
D’Souza, Julia, John Jacob, and Barbara Lougee. Why Do Firms Convert to  Cash Balance Pension Plans? An Empirical Investigation. Cornell  University, December 2004.
Johnson, R.W., and C. Uccello. “Cash Balance Plans and the Distribution of  Pension Wealth.” Industrial Relations, 42(4) (2003): 745-773.
Mellon Financial Corporation. 2004 Survey of Cash Balance Plans.  Secaucus, N.J.: 2004.
Niehaus, Greg, and Tong Yu. “Cash-Balance Plan Conversions: Evidence  on Excise Taxes and Implicit Contracts.” The Journal of Risk and  Insurance, 72(2). 2005.
PriceWaterhouseCoopers. Survey of Conversions from Traditional  Pension Plans to Cash Balance Plans. July 2000.
Purcell, Patrick. Pension Issues: Cash Balance Plans. Washington, D.C.:  Congressional Research Service, August 2003.
Rao, A., L. Higgins, and S. Taylor. “Cash Balance Pension Plans: Good  News or Bad News.” Journal of Applied Business Research, 18 (3).  2002.
Samwick, Andrew, and Jonathan Skinner. “How will 401(k) Plans Affect  Retirement Income?.” American Economic Review, Vol. 94, No.1. March  2004.
Schieber, Sylvester. “The Shift to Hybrid Pensions by U.S. Employers: An  Empirical Analysis of Actual Plan Conversions.” Pension Research  Council Working Paper, PRC WP. 2003-23.
Watson Wyatt Worldwide. The Unfolding of a Predictable Surprise: A  Comprehensive Analysis of the Shift from Traditional to Hybrid Plans.  2000.
section_title: Appendix III: Analysis of Form 5500 Data on Cash Balance Plans
subsections: section_title: Sample of Cash Balance Plans
paragraphs: To obtain information about CB plan conversions, we reviewed 2001 Form  5500 data for a random sample of CB plans. We drew this sample from the  population of plan sponsors that indicated on their Form 5500 that they  sponsored a CB plan. The study population consisted of all CB plans as of  2001 having at least 100 active participants, supplemented with an  additional 96 CB plans that were identified by PBGC based on 2002 and  2003 data not yet available to the GAO. For the purpose of this report, we  excluded plans having fewer than 100 participants in order to focus on the  plans with the greatest number of participants. This resulted in a total of  843 plans in our study population.
We used the Form 5500 as our primary source of information for analyzing  the prevalence of transition provisions used by plan sponsors when they  converted to a CB plan because it was a cost effective way of obtaining  conversion information for a large number of plans. It would have been  optimal to obtain summary plan descriptions (SPD) from plan sponsors.  However, since plan sponsors are no longer required to file SPDs, direct  contact with such a large number of plan sponsors would have been cost  prohibitive.
Although it is the most comprehensive pension data available, using Form  5500 data also presented limitations and weaknesses. We had limited  ability to determine the full scope of conversions beyond tax year 2001  since this was the most current and complete 5500 data publicly available  from the Department of Labor (Labor) when we began our analysis. In  addition, we also had difficulty obtaining Form 5500 filings for some years,  particularly from the early 1990s and before. As previously reported by  GAO, statutory reporting requirements, processing issues, and current  Labor practices affect the timeliness of the release of available Form 5500  information, in some cases, resulting in a 3-year lag between data  reporting and its release. In addition, information provided on the form  and attachments proved, in some instances, to be inconsistent from one  plan sponsor to another. This inconsistency hampered our data collection  efforts, and subsequently, we were unable to provide meaningful results  on all of the information our data collection instrument was designed to  capture. For example, we found that not all plans reported having a lump  sum feature for those who separate before retirement although we  believed some of those plans did so. In addition, some plans provided  extensive details on discount rates and formulas used in their opening  account balance calculations while others provided no information. In  situations where we could not find information on the form or its  attachments, we recorded this as “information not found.” Finally,  although the Form 5500 provides information on the number of active  participants in the entire plan, it was often impossible to determine how  many of those participants were converted to the CB plan in instances  where only certain employee groups were converted. Nevertheless, our  estimates are based on plan-level data.
section_title: Sample Design
paragraphs: The sample design for this study was a stratified random sample of CB  plans, with the 45 largest plans comprising the first stratum, and an  additional 160 plans selected from the remaining plans, producing a total  sample of 205 plans. Of these sampled plans, we obtained sufficient plan  information for 165, we found 21 plans to be out-of-scope for our study  (not CB plans), and for 19 plans we could not obtain sufficient information  on the plans.  Also, of these 205 sampled plans, 7 plans started a new CB  plan only for the new employees, while keeping their existing employees  in the traditional DB plan.  We did not include these plans in our analysis  since they were start-up CB plans and not converted CB plans.
This sample disposition information is summarized in table 1.
section_title: Description of the Review
paragraphs: After obtaining Form 5500s, attachments, and summary plan descriptions  where available for sampled plans, we recorded plan features on a  standardized instrument containing 51 questions designed to capture  information about    characteristics of the traditional DB plan, such as the conversion date  and the type of DB plan in place before the conversion;  the conversion such as when it took place, which employees were  affected, and the type of transition provisions used; and  the ongoing features of the CB plan, such as pay credits and interest  credits provided at the time of conversion.
subsections: section_title: Estimates
paragraphs: Estimates of converted CB plans were based on our sample of CB plans.  Estimates for this target population were formed by weighting the survey  data to account for both the sample design and the completion rate.
section_title: Sampling Error
paragraphs: Because we surveyed a sample of CB plans, our estimates are subject to  sampling errors that are associated with samples of this size and type. A  different random sample could produce slightly different estimates. Our  confidence in the precision of the results from this sample is expressed in  95 percent confidence intervals. The 95 percent confidence intervals are  expected to include the actual results for 95 percent of the samples of this  type. We calculated confidence intervals for our study results using  methods that are appropriate for a stratified, probability sample. For the  percentages presented in this report, we are 95 percent confident that the  results we would have obtained if we had studied the entire study  population are within ± 9 or fewer percentage points of our results. For  example, we estimate that 47 percent of the CB plan conversions offered  some form of grandfathering. The 95 percent confidence interval for this  estimate would be no wider than ± 9 percent, or from 38 percent to 56  percent.
section_title: Nonsampling Error
paragraphs: In addition to sampling error, the practical difficulties in conducting  sample file reviews of this type may introduce other types of errors,  commonly referred to as nonsampling errors. For example, questions may  be misinterpreted, or errors could be made in keying questionnaire data.  We took several steps to reduce these errors.
To minimize some of these errors, each completed data collection  instrument was verified for accuracy, and a process of content analysis  was undertaken to resolve interpretation differences. We performed 100  percent verification of all keypunched questionnaire data. We also traced  and verified the data collection instrument to descriptive statistics and  output generated by GAO data analyst staff. In the event of changes, the  entire verification process was again performed which included 100  percent verification of the new keypunched data, additional content  analysis to verify the change being made, and reverifying the output  generated by the data analyst staff.
In addition, we were only to record a plan as having a characteristic if  evidence of that characteristic was found in the file review. For example, it  is possible that some CB plans had transition provisions at conversion that  were not clearly indicated in the 5500 files and attachments. We can only  conclude that evidence of transition provisions being offered was not  found in the 5500 data for this plan.
section_title: Appendix IV: Analysis of Simulated Cash Balance Plans and Traditional Final Average Pay Plans
paragraphs: To analyze the effects of a CB plan conversion on individual workers, we  used a pension policy simulation model PENSIM. PENSIM is a dynamic  microsimulation model for analysis of the retirement income implication  of government policies affecting employer-sponsored pensions. The model  has been developed by the Policy Simulation Group (PSG) since 1997 with  funding by the Office of Policy and Research at the EBSA of the U.S.  Department of Labor.  To meet GAO’s needs for this project the model  includes several enhancements that permit the analysis of CB plan  conversions.
PENSIM uses discrete event simulation methods to generate a sample of  life histories that reflect the effects of individual risks (mortality,  disability, earnings, etc.). The likelihood and timing of simulated life  events are represented by a variety of probability models, including hazard  functions and multinomial logit models that have been estimated using  various survey data sets. The timing of job history events and employer  pension sponsorship are estimated using longitudinal SIPP data and  longer-term longitudinal PSID data. Simulated life histories contain  information on educational attainment, disability, mortality, and a  complete job history that includes details on earnings and pension  accumulation for each job. Details of pension plan(s) covering a worker  on a job are assigned using a pension characteristics imputation model,  which has been estimated with late-1990s BLS Employee Benefit Survey  data. Life histories simulated by PENSIM generate social security benefit  and payroll tax results similar to those generated by the Congressional  Budget Office’s long-term social security model (CBOLT).
PENSIM simulates the pension accruals of employees as they move from  job to job over their lifetime and estimates their retirement income from a  lifetime of pension coverage. With its CB plan analysis capability, PENSIM  can also simulate changes in retirement income caused by conversions  from traditional defined benefit pension plans to CB pension plans.  PENSIM produces a large random sample of simulated life histories for  people born in a given year and for their spouses who may have been born  in a different year. For our report, we do not include spousal benefits in  the analysis. The members of the birth cohort sample experience  demographic and economic events, the incidence and timing of which vary  by age, gender, education, disability, and employment status. The types of  life events that are simulated in PENSIM include    demographic events (birth, death);    schooling events (leaving school at a certain age, receiving a certain  educational credential);  family events (marriage, divorce, childbirth);  initial job placement;  job mobility events (earnings increases while on a job, duration of a  job, movement to a new job, or out of the labor force);    pension events (becoming eligible for plan participation, choosing to  participate, becoming vested, etc.); and  retirement events.
This broad scope of simulated life events is necessary in order to simulate  lifetime pension accruals with any realism.
subsections: section_title: Simulated Pension Plans
paragraphs: Three pension plans are used in this study to simulate several kinds of  private-sector plan conversions and terminations. The baseline from which  the conversion/termination analysis starts is a typical final-pay defined  benefit pension plan (“typical FAP”). This typical FAP plan has common  private-sector characteristics and a benefit formula that produce an  employer cost of providing the pension equal to the average cost of the full  variety of final-pay plans observed in BLS Employee Benefit Survey data.  The second plan considered in the analysis is a typical CB pension plan  (“typical CB”) that has been specified to have characteristics found to be  typical of the plans we analyzed in the GAO Form 5500 data collection  conducted as part of this study. The third plan is a more generous version  of the typical CB pension plan (“equal-cost CB”) that has been constructed  to have the same employer cost as the typical FP plan.
The typical FAP plan has the following characteristics    5-year cliff vesting;    normal retirement age of 65;    early retirement age of 55 with 10 years of service with benefits  reduced by five percent for each year of early retirement (i.e., fifty  percent reduction at age 55);  immediate unreduced disability retirement benefit for those who are  vested;    no survivors’ benefit for those who die on the job;    selection of single-life annuity at retirement (no selection of joint and  survivor annuity because study ignores survivors’ benefits);    benefit paid as a nominal annuity (i.e., no benefit COLA);    FAP is the highest consecutive five-year average; and    benefit formula is excess integrated with a base rate of 1.5 percent of  final pay per year of service and has a rate of  0.45 percent of final pay  per year of service for those amounts over the social security  maximum.
The typical CB plan has the following characteristics    5-year cliff vesting;    base pay credit of 3.0 percent of salary for employee with age plus  service of less than or equal to 35;    pay credit rises gradually until it is 6.0 percentage points above the  base pay credit for employee with age plus service greater than or  equal to 70 (this results in a maximum pay credit of 9.0 percent of  salary);  interest credit is calculated using current 30-year Treasury rate;    employee always rolls over full account balance into an IRA at job  termination;  rollover account earns current 30 year Treasury rate each year;    account balances are converted to a nominal single-life annuity at  retirement using the treasury rate, current projected mortality rates,  and projections of future reductions in mortality.  An annuity loading  fee was used such that it ensures the provider is solvent (i.e., 1.5  percent for women and 3.0 percent for men);     at conversion, opening account balance is equal to the statutory  present value of accrued benefit under old plan;     at conversion, employee with age plus service greater than or equal to  60 is grandfathered in old plan so that benefit at job end can never be  lower than it would have been if the old plan had continued operating  The equal-cost CB plan has the following characteristics    same characteristics as the typical CB plan except the base pay credit  is 7.35 percent of salary for employee with age-plus-service (APS) ≤ 35,  rather than the 3.0 percent of salary in the typical CB plan, and    pay credit rises gradually until it reaches a maximum of 6 percentage  points above the base pay credit for employee with age plus service  greater than or equal to 70.
These three plans are used to simulate the following conversion and  termination situations  typical CB plan versus typical FAP plan;  typical CB plan versus FAP plan that is terminated with no replacement  of any kind;    equal cost CB plan versus typical FAP plan; and    equal cost CB plan versus FAP plan that is terminated with no  replacement of any kind.
section_title: Simulation Assumptions
paragraphs: All PENSIM runs conducted for this study simulate a 3 percent sample of  the 1955 birth cohort using historical information through the present and  2004 OASDI Trustees Report intermediate-cost assumptions for the future  projection. The resulting cohort sample consists of 151,263 individuals  born in 1955 either in the U.S. or elsewhere (and immigrated to the U.S. in  a subsequent year).
The PENSIM runs differ only in their assumptions concerning private- sector sponsorship of the typical FAP plan (which is assumed to be  offered by all private-sector employers who are simulated to offer a FAP  DB plan) and the typical or equal-cost CB plan (which is assumed to be  offered by all private-sector employers who are simulated to offer a CB DB  plan). The employment history of each individual and  coverage/participation in employer-sponsored DB and DC plans are a key  component to determining the lifetime benefits for each individual.  Pension benefits accumulated as a result of movement to different  employers during a person’s entire work history is included in reported  results.  Pension coverage across a lifetime may include participation in a  variety of DB and DC plans or no coverage at all. Workers who are not  covered under either a private sector FAP or a CB pension plan are  excluded from the study analysis. Most of the study analysis focuses on  those who have vested in at least one private-sector FAP or CB plan.  Public-sector FAP plans are assumed to be unchanged across all runs, and  all other types of DB plans (i.e., other than FAP or CB) and all types of DC  pension plans in all sectors are assumed to be unchanged across all the  runs. Additionally, all the PENSIM runs used in this study contain the  exact same life histories and job careers for the cohort sample. That is, the  only change that takes place in all PENSIM runs is whether the private  sector DB plan is a FAP or a CB plan.  The simulation analysis provides  the following general results about the cohort sample    sample individuals who had at least one private-sector FAP or CB  pension plan: 57,049 (100.0 percent);    sample individuals who never vest in such a plan: 20,274 (35.5 percent);    sample individuals who vest in such a plan but die before age 68: 6882  (12.1 percent);    sample individuals who vest in such a plan and live to age 68: 29,893  (52.4 percent);    of the 29,893, 87.0 percent vest in just one FAP or CB pension plan over  their lifetime, while 12.3 percent vest in two plans, and all but three of  the rest vest in three such plans; and    of the 26,018 who vest in just one FAP or CB pension plan, only 10.2  percent accumulate thirty years or more of service on that job.
The study makes four pair-wise comparisons between PENSIM runs: (1)  typical CB plan versus ongoing typical FAP plan, (2) equal-cost CB plan  versus ongoing typical FAP plan, (3) typical CB plan versus terminated  typical FAP plan, and (4) equal-cost CB plan versus terminated typical  FAP plan. In each comparison, the difference in lifetime pension income  between the two runs is calculated for each sample individual. Lifetime  pension income includes all pension benefits earned during a person’s  career even if they are unaffected by the assumed change in employer  pension sponsorship between the two runs. Lifetime pension income is  expressed in one of two ways: the present value of all pension income  received over the individual’s lifetime or the monthly pension income  received at age 68. In both cases, the monetary amounts are expressed in  2004 dollars.
The conversion/termination of the typical FAP plan is assumed to occur at  one of eight ages: 25, 30, 35, 40, 45, 50, 55, and 60. The entire cohort sample  was put through eight separate simulation runs -- one simulation run for  each age.  Results are shown for those who were vested in a job that was  caught in a conversion. The conversion provisions (opening balance and  grandfathering) described above for the typical and equal-cost CB plans  were found to be typical in our analysis of the Form 5500 sample drawn  for this study. Based on our Form 5500 sample plan analysis and meetings  with consultants who are experts on CB plans, there was concurrence that  the opening CB would be equal to the present value of accrued benefit  under the old plan at the conversion date. The expected present value of  the accrued benefit is calculated using a GAM83 mortality table adjusted  to the proper year and the current Treasury rate as the discount rate. If  eligible for grandfathering, an individual receives the higher of two  amounts at job termination: the accumulated CB under the new plan and  the expected present value of the benefit the individual would have  received if the typical FAP plan had not been converted. The expected  present value is calculated using the same mortality and discount  assumptions as used in the opening balance calculation. All individuals  affected by a conversion or termination are covered under the federal  anticutback rules. The PENSIM runs use these same mortality and  discount assumptions for the anticutback calculations.
section_title: Employer Cost Estimates
paragraphs: The employer cost of sponsoring a pension plan is defined as the  percentage ratio of the present value of benefits paid to all individuals who  worked on a job where that pension plan was sponsored and the present  value of earnings paid to all individuals who worked on a job where that  pension plan was sponsored. The present value calculations use Treasury  rates to discount both the benefit and earnings cash flows. For a FAP plan,  the benefit cash flow is the annuity payment stream. For a CB plan, the  benefit cash flow is the CB amount paid at job termination.
All employer cost estimates are for the 1955 birth cohort. Using a younger  birth cohort would produce a higher employer cost rate for the typical  FAP plan because of rising life expectancy and about the same employer  cost rate for the typical CB plan because of its earnings-based benefit  formula. The estimated employer cost rates are as follows    equal-cost CB plan with averaged conversion costs: 7.547 percent.
This is an estimate of the ongoing cost of the typical CB plan after all conversion costs  have been paid.
section_title: Comparison of Estimated Employer Cost of the Typical CB Plan Immediately After the Conversion with the Estimated Employer Cost of the Typical FAP Plan
paragraphs: There are several reasons why the estimated employer cost of the typical  CB plan immediately after the conversion of 5.870 percent is below the  estimated employer cost of the typical FAP plan of 7.545 percent by about  22 percent. First, the typical FAP plan has been constructed to reflect the  full variety of private-sector FAP plans contained in the BLS Employee  Benefits Survey data used to impute plan characteristics in PENSIM. The  characteristics of the typical CB plan are drawn from the Form 5500  sample used for this study and from discussions with pension experts and  actuaries who confirmed that the characteristics were in the range of what  they believe was typical for CB plans. This sample of CB plans is the  largest available sample, and the only sample to be drawn using statistical  sampling methods.
The difference in the estimated employer cost rates for these two plans is  consistent with prior research. Specifically, the cost difference reported  here is somewhat smaller than the cost difference for typical plan  conversions reported in a widely cited study by Watson Wyatt  Worldwide. In the Watson Wyatt study, the employers who convert  typical (i.e., middle of the cost distribution) FAP plans to CB plans—the 20  percent in deciles 5 and 6 in table 9—experience an immediate defined- benefit pension employer cost reduction of about 19 percent (18.72  percent in fifth decile and 19.76 percent in sixth decile). However, the 22  percent cost reduction estimated in this study and the 19 percent cost  reduction estimated in the Watson Wyatt study are not comparable  because of differences in the Watson Wyatt life history simulations, which  ignore disability events, and therefore, underestimate the cost of the FAP  plans. To make our estimates comparable to the Watson Wyatt estimates,  we subtracted the 0.487 percent disability costs from 7.545 percent  yielding a without-disability employer cost estimate for the typical FAP  plan of 7.058 percent. Our estimate of the immediate cost of the typical CB  plan is 5.870 percent, which is about 17 percent below the 7.058 percent  without-disability estimate. This 17 percent immediate employer defined- benefit cost reduction is about the same as the 19 percent reduction found  in the Watson Wyatt study.
section_title: Appendix V: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: The following staff members made major contributions to this report:  Charles A. Jeszeck, Assistant Director, Kimberley M. Granger, Analyst-in- Charge, Joseph Applebaum, Kevin Averyt, Richard Burkard, Virginia  Chanley, Tamara Cross, David Eisenstadt, Lawrence Evans Jr., Benjamin  Federlein, Nila Garces-Osorio, Sharon Hermes, Jason Holsclaw, Gene  Kuehneman Jr., Michael Maslowski, Amanda Miller, Michael Morris, Luann  Moy, Macdonald Phillips, Mark Ramage, Tovah Rom, Nyree Ryder, George  Scott, and Roger Thomas.