The communications campaign was successful. Janice Amara, a lawyer in Cigna’s compliance department, didn’t learn that she had not actually been receiving any additional benefits until September 2000, when she ran into Cigna’s chief actuary, Mark Lynch, at a farewell party for two other Cigna employees. “Jan, you would be sick if you knew” how Cigna was calculating her pension, she recalled him telling her. “Frankly, I
Cigna was a relative latecomer to the hide-the-ball approach to pension cuts. The cash-balance plan it implemented was initially developed by Kwasha Lipton, a boutique benefits-consulting firm in Fort Lee, New Jersey, as a way to cut pensions without making it obvious to employees.
Helping employers hang on to pension assets had been a Kwasha Lipton specialty for years. In the early 1980s, Kwasha Lipton helped companies like Great Atlantic & Pacific Tea Co. kill their pension plans to capture the surpluses. Pension raiding became more difficult as Congress began implementing excise taxes on the surplus assets taken from the plans, so Kwasha devised the cash-balance plan as a new way for employers to capture the surplus.
Changing to a cash-balance pension plan was a way to boost surplus because it reduced the growth rate of employees’ pensions, and thus their total pensions. Unlike a traditional pension plan that multiplies salary by years of service, producing rapid growth at the end of a career, a cash-balance plan grows as though it were a savings account. Every year, the pension grows at a flat rate, such as 4 percent of pay a year. At a benefits conference in 1984, a Kwasha Lipton partner stated that converting to this formula would “immediately reduce pension costs about 25 percent to 40 percent.”
Bank of America was the first company to test-drive the new pension plan, in 1985. The bank was cash- strapped because of soured Latin American loans and didn’t want to have to contribute to its pension plan. The pension change saved the company $75 million.
The bank’s employees didn’t complain when their pension growth slowed, because they didn’t notice. “One feature which might come in handy is that it is difficult for employees to compare prior pension benefit formulas to the account balance approach,” wrote Robert S. Byrne, a Kwasha Lipton partner, in a letter to a client in 1989.
The cuts were difficult for employees to detect because they didn’t understand how pensions are calculated, let alone these newfangled versions, which appeared deceptively simple.
In reality, cash-balance plans are complex. When companies convert their traditional pensions to cash- balance plans, they essentially freeze the old pension, ending its growth. They then convert the frozen pension to a lump sum, which they call the “opening account balance.” The lump-sum amount (i.e., the “balance”) doesn’t grow each year by multiplying years and pay, both of which would be growing, and thus generating the leveraged growth seen in a traditional pension. Instead, the pension “balance” grows by a flat percentage of an employee’s pay each year, say, 4 percent. Voila: no more leveraged growth.
Ironically, employers were able to capitalize on the growing popularity of 401(k)s by presenting cash-balance plans as merely 401(k)-style pensions. Cigna told employees that the new cash-balance plan was like a 401(k), only better, because the company made all the contributions and departing employees could cash out their accounts or roll the money into IRAs. Employees didn’t realize that there was no actual “account” receiving actual employer “contributions” or “interest”—just a frozen pension, and a new pension that had a formula producing very low growth, with no leverage. The pension plan was still one big pool of assets, and the only thing that was changing was the formula used to determine how much each employee would get.
In other words, after a company changed to a cash-balance plan, most employees were no better off than if they had changed jobs or been laid off (which would have stopped their old pension from growing) and now had only a 401(k) at their new job, growing at only 4 percent a year.
But it was even worse than that at Cigna and other companies: Older workers weren’t even getting the annual increase. That’s because at many companies the “opening account balance” was worth less than the value of the lump sum. For example, if at the time of the pension change someone had earned the equivalent of a $300,000 payout, the opening account balance might be only $250,000. Consequently, it could take years for the pay credits to build the “balance” back up to where it had been when the pension change was made. As a result, following the change to a cash-balance plan, the pensions of older workers were frozen—in some cases for the rest of their careers. Employees didn’t notice because the amounts on their “account statements” always appeared to be growing.
In the pension world, this period of zero pension growth is called “wear-away,” because a person has to wear away his old benefit before his benefit begins growing again. Creating a wear-away is an employer’s way of saying, “We should have had this less generous pension all along, and if we had, your pension would be smaller. Bottom line: You’ve been overpaid and won’t get any pension until you’ve worked off the debt.”
It was little different from an employer cutting someone’s pay, then telling him he wouldn’t get a paycheck for five years, because he should have been paid less all along. Employees would notice if their pay was frozen, but they didn’t notice that their pensions weren’t growing because the opening account balance had been lowballed. Amara’s opening balance was $91,124, instead of the $184,000 she had earned. Under the new formula, she wouldn’t begin to build a new benefit until 2008. Essentially, wear-away is like a retroactive pension cut.
Under pension law, it’s illegal to retroactively cut someone’s pension (though employers can slow the pension growth or end it altogether by freezing the pension plan). Cash-balance plans provide a way around this prohibition against retroactive pension cuts because if employees leave before their accounts have caught up to their old pensions, they always receive at least the value of the benefit they had when the pension was changed. In this case, Amara would receive the lump sum of $184,000 if she left; but if she didn’t, she could work another ten years with no increase in her pension.
Gerald Smit, a longtime AT&T employee, was forty-seven when AT&T changed its pension plan in 1998. At the time, his pension would have been worth $1,985 a month when he reached age fifty-five. Though he continued to work at AT&T for eight more years, when he left, his pension was still worth just $1,985 a month. For other employees, the waiting period could be longer. Minutes of a 1997 meeting of AT&T’s pension consultants noted that “employees in their 40s could lose, [and] have to wait 10 years for benefits. By contrast, the benefit would build “immediately for younger employees.” (The benefits for younger employees and new hires would grow immediately, because they had accumulated little or nothing under the old pension.)
From the beginning, the cash-balance plan’s ability to disguise the pension cuts was one of its selling points with employers. In 1986, Eric Lofgren, an actuary and principal with Mercer-Meidinger (later called Mercer), discussed the newfangled cash-balance plans on a panel discussing new kinds of pension plans at an actuaries conference. The cash-balance plan, he explained, was a pension plan “masquerading as a defined contribution” savings plan, like a 401(k). It was, he commented, “a very worthy concept.”
Lofgren went on to provide two definitions of the cash-balance plan. “Both definitions are true, but they slant in different directions,” he said. “The first definition is the upbeat definition: ‘Dear employee: A cash-balance plan is an exciting, modern, flexible new plan designed with the advantages of both defined benefit and defined contribution. Easy to understand, each employee quickly vests in a portable lump sum account which is guaranteed to increase at the CPI [consumer price index] for inflation protection. There are many benefit options at retirement.’ ”
He continued: “The second definition goes like this: ‘Dear employee: We’ve got for you a cash-balance pension plan. It’s our way to disguise the cutbacks in your benefits. First we’re going to change it to career average [meaning that the benefit would be based on an average of one’s salary, not the highest amount, as in a traditional pension]. We’ll express the benefits as a lump sum so we can highlight the use of the CPI, a submarket interest rate. What money is left in the plan will be directed towards employees who leave after just a few years. Just to make sure, we’ll reduce early-retirement subsidies.’ ” These subsidies allow a person to retire at age fifty-five or sixty with roughly the same pension as if they’d stayed to age sixty-five. Taking away the subsidy could reduce a pension by 20 percent or more.
The desired effect of the pension change, from the employer’s point of view, was not just that it froze the pensions of older employees, but redirected some of the savings to younger workers. Publicly, employers emphasized that the new pension was better for “young, mobile workers” (a phrase that appeared in virtually every piece of marketing material issued by a company to help explain why it had changed the plan). In fact, two-thirds of young workers leave their jobs without vesting in their pensions, meaning that they got nothing. The forfeited amounts remained in the plan.
