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Most Conversions to Cash Balance Pensions Are Cost-Neutral -- and 80 Percent of Employees Actually Fare Better

WASHINGTON, April 7, 2003 — As the debate over cash balance and pension equity plans heats up following the release of proposed new rules governing these plans, experts at Watson Wyatt warn that common misperceptions still abound.

"Critics try to paint all conversions to cash balance plans as attempts by companies to cut costs at the expense of workers, but the facts simply do not support these assertions," said Sylvester Schieber, vice president of research at Watson Wyatt.

According to a landmark study published by Watson Wyatt in 2000:

• The typical company realizes little, if any, net cost savings when it shifts from a traditional pension to a cash balance or other hybrid plan design.
• When employer costs remain neutral, almost 80 percent of participants do better under the hybrid plan formula
  

"With traditional pension plans, more than three-quarters of benefits can go to only 10 percent of workers and, naturally enough, that 10 percent would like to keep them," said Eric Lofgren, global director of benefits consulting at Watson Wyatt. "But how is that fairer than newer designs that seek to distribute benefits more democratically among workers?"

It is important to separate the distinct issues of pension plan type and the amount of cost savings, according to Lofgren. "No one type of pension plan is inherently more costly than another, and the oft stated equation that cash balance plans reduce benefits by 20 to 50 percent is proved false by our research," he said "An employer can just as easily design a rich cash balance plan or a stingy traditional pension."

Actually, the Watson Wyatt study found that the majority of employers (55 percent) experienced a minimal effect on costs or saw costs increase during hybrid plan conversions, while less than half (45 percent) realized cost savings. The average employer cost savings was just 1.4 percent -- not 20 percent to 50 percent -- after factoring in enhancements that some employers made simultaneously to their 401(k) plans.

The Watson Wyatt study was based on a detailed analysis and financial modeling of the benefit provisions in 78 hybrid plans, representing approximately one-fifth of such plans in existence at the time. The study also included an opinion survey of 79 employers that had made the shift to a hybrid plan to provide additional perspective on motivations for adopting one of these plans.

The study found that when companies reduced costs in the conversion it was largely due to the prospective elimination of subsidies for early retirement, which typically augment benefits at around age 55. The effect on normal retirement benefits was much more muted.

"Employers generally don’t suddenly reduce retirement benefits for those close to normal retirement age," said Schieber. "And most employers that converted to a hybrid design protected early retirement benefits for those nearing early retirement as well."

The vast majority of plan sponsors studied (88 percent) included transition benefits to minimize the effect of the transition for these longer tenured workers. In nearly two-thirds of the cases analyzed, workers age 50 with 25 years of service would have received an equivalent or higher benefit at 55 after the transition than if they retired at age 55 under the prior plan. Nearly another third would have had some benefit reduction but were at least partially protected by a transition benefit.

"Companies need to make trade-offs, and the question comes down to the fair distribution of a limited number of benefit dollars," said Schieber. "Many employers no longer can afford to give almost all the retirement benefits to just 10 percent of their employees."

The IRS has scheduled a public hearing regarding the proposed pension regulations for April 9-10, 2003. Eric Lofgren and Sylvester Schieber of Watson Wyatt will testify on April 9. To obtain copies of the testimony, contact Ed Emerman at 609-452-5967 or eemerman@eaglepr.com.Copies of the research report, The Unfolding of a Predictable Surprise: A Comprehensive Analysis of the Shift from Traditional Pensions to Hybrid Plans, can be downloaded by clicking here.

About Watson Wyatt

Watson Wyatt & Company, the primary subsidiary of Watson Wyatt & Company Holdings (NYSE: WW), is an international human capital consulting firm that provides services in the areas of employee benefits, human resources technologies and human capital strategies. The firm is headquartered in Washington, D.C., and has more than 4,200 associates in 62 offices in the Americas and Asia-Pacific. Together with Watson Wyatt LLP, a leading European-based consulting partnership, the firm operates globally as Watson Wyatt Worldwide. Watson Wyatt Worldwide has more than 6,300 associates in 89 offices in 30 countries.

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