Cash balance pension plans: A case of standard-setting inadequacy

Critical Perspectives on Accounting 20 (2009) 228–254

Cash balance pension plans: A case ofstandard-setting inadequacy

Paula B. Thomas a,1, Paul F. Williams b,∗a Department of Accounting, PO Box 50, Middle Tennessee State University,

Murfreesboro, TN 37132, USAb Department of Accounting, Box 8113, North Carolina State University,

Raleigh, NC 27695-8113, USA

Received 8 September 2006; received in revised form 14 July 2007; accepted 15 September 2007

Abstract

Accounting for and ownership of U.S. private employee pensions has long been a controversial andpolitically contested terrain. The uniqueness in the U.S. of using employers as the principal provider ofpensions makes the reporting of pensions more problematic since the corporate employers providingpensions are not strictly accountable to only the pensioners. Over the last quarter century there hasbeen a marked swing in power toward management and away from employees making it possiblefor increasing numbers of U.S. companies to switch from conventional defined benefit plans to cashbalance plans. This paper provides a “case” study of how accounting standard-setters framed thepension reporting problem vis-a-vis how they frame the “reporting problem” in general. Utilizingvarious sources of commentary about the phenomenon of cash-balance conversions, we triangulateon the pension problem to demonstrate how current FASB disclosure rules fail to satisfy the conditionof neutrality and how those rules have facilitated the shifting of economic risk from shareholders toemployees.© 2007 Elsevier Ltd. All rights reserved.

Keywords: Cash balance pensions; Financial reporting; Disclosure

∗ Corresponding author. Tel.: +1 919 515 4436; fax: +1 919 515 4446.E-mail addresses: [email protected] (P.B. Thomas), paul [email protected] (P.F. Williams).

1 Tel.: +1 615 898 5655; fax: +1 615 898 5839.

1045-2354/$ – see front matter © 2007 Elsevier Ltd. All rights reserved.doi:10.1016/j.cpa.2007.09.003

mailto:[email protected]

mailto:[email protected]

dx.doi.org/10.1016/j.cpa.2007.09.003

P.B. Thomas, P.F. Williams / Critical Perspectives on Accounting 20 (2009) 228–254 229

1. Introduction

How employer provided pensions are accounted for, who is the primary recipient ofsuch accountings, and who actually owns pension funds have long been controversial in theU.S. Considerable research has focused on assessing effects of current accounting rules,or on examining forces affecting how standards setters establish the rules (e.g., Daleyand Tranter, 1990; Francis, 1987). Other researchers have focused on whether pensionliabilities or “excesses” (as defined by applicable accounting standards) are impounded inequity prices and debt prices (e.g., Barth, 1991; Pontiff et al., 1990; Reiter, 1991; Tinkerand Ghicas, 1993). Historically, the controversy over pension accounting in the U.S. centersaround ownership of pension funds, and the role of accounting in this issue.

Cash balance plans emerged as one of the newest developments in the pension saga.2

Extensive press coverage of employees’ concerns that arose when companies changed fromtraditional defined benefit pension plans to cash balance plans illustrate how accountingrules facilitated or failed to facilitate informing employees about the consequences of thetransition. In SFAC #1 the FASB purports to provide for the information needs of variousstakeholders, but pension accounting provides a case study of how accounting and disclosurerequirements promulgated by FASB fall far short of serving the needs of employees, anotably important corporate stakeholder.

The remainder of the paper is divided into six sections. The next section will providethe rationale for the method of analyses we employed. This will be followed by a sectionproviding the context for provision of pension benefits in the U.S. Next we discuss theFASB’s self-described role in the issue of pensions and provide a critique of the shortcomingsof that view. We follow this with a brief summary of the current rules governing pensionreporting, then a section describing cash balance plans and how the pension problem wasconstructed around the issue of cash balance conversions. The paper concludes with adiscussion of the political resolution that currently prevails and some final observations.

2. Perspective of the analysis

The FASB has de facto power to make public policy in the U.S. through the franchise ithas to write the rules of financial reporting for publicly traded companies. These rules are inthe form of “standards.” Thus, each standard represents a “case” of financial reporting policy,i.e., an example of the FASB exercising its franchise. Among putative users of financialinformation indicated in SFAC #1 (FASB, 1978, par. 24) as primary are “. . .investors,lenders, suppliers and employees (emphasis added). . .” The FASB based its objectives onthe acknowledgement that the aforementioned users shared in common a characteristic thatthey “. . .lack the authority to prescribe the financial information they want from an enterpriseand therefore must use the information that management communicates to them (FASB,

2 Cash balance plans are a hybrid that in substance provides for a defined contribution type pension whilepreserving the tax status of a defined benefit plan. An increasing number of firms are simply abandoning definedbenefit plans in any form and simply offering 401(k) type plans or entirely eliminating pension plans (Gosselin,2007).

230 P.B. Thomas, P.F. Williams / Critical Perspectives on Accounting 20 (2009) 228–254

1978, par. 28).” Thus, the implied responsibility of the FASB embedded in its objectivesis that it act to provide the primary users the power to know that which management, byvirtue of its power, might choose to withhold. Unacknowledged in the FASB statement isthat there is also conflict and differential amounts of authority (political, legal, ethical) evenamong those who have the least authority.

The advent of cash balance pension plans created for employees of companies thatproposed their adoption a need for information that would enable them to assess the con-sequences of the conversion. The cash balance issue provides a vivid case for assessingwhether financial reporting policy made by FASB satisfies FASB’s avowed objective ofempowering those with the least power to command information to receive the informationthey need.

We take the perspective that we are trying to learn something about the FASB’s effec-tiveness as a policy maker. Our perspective in this paper is that adumbrated by Flyvbjerg:“Predictive theories and universals cannot be found in the study of human affairs. Concrete,context dependent knowledge is therefore more valuable than the vain search for predictivetheories (2001, p. 73).”

Our aim in this paper is not to test any general theory of policy-making, but to considerone particular context in which FASB policy could be assessed. Extensive business presscoverage of cash balance conversions provides a rich, context specific source of informationwith which to evaluate affects of FASB policy in a very specific case. We also consultedmultiple information sources – media reports, annual reports, employee emails, etc. – inorder to represent the multiple perspectives from which the “problem” of cash balancepension plans was viewed. The multiplicity of perspectives on this particular issue illustratesthe inadequacy in practice of the FASB’s expressed objective of providing policy for thecreation of neutral, general-purpose financial information.

3. Social welfare benefits in the United States

The two largest social welfare benefits provided to citizens in the Western industrial-ized nations are health care and pensions. Among these countries, the U.S. stands apartfrom the others because these fundamental social benefits are provided by private meansto a much greater extent than in other OECD countries. The U.S., alone among economi-cally advanced nations, has no universal health insurance for working age adults and theirchildren, instead relying on employer provided private insurance as the primary means bywhich health benefits are made available. The elderly and the poor are insured through anational health insurance program, but the working age population relies upon employerprovided private plans for health benefits. This employer based private system leaves manyU.S. citizens without health insurance. Currently approximately 45–50 million citizens arewithout insurance and, thus, without access to reasonable levels of health care services.

Likewise, pensions are much more extensively a private affair in the U.S. than in otherwestern countries. How that came to pass is a rather complex series of historical events.Hacker (2002) provides a historical analysis of the development of pension benefits in theU.S. Institutions and the policy choices about welfare benefits they make through timedetermine what the configuration of those benefits will be. The historical path leading to the


current state of the distribution of welfare benefits is often directed in certain ways by theearly choices made and the subsequent extent to which large institutions with vested interestsare erected to accommodate the policies. This path-dependent nature of the provision ofpension benefits in the U.S. is traced by Hacker (2002) commencing with the passage ofSocial Security legislation as part of Franklin Roosevelt’s “New Deal” programs to helpthe U.S. recover from the Great Depression. It is not the purpose of this paper to delveextensively into the historical circumstances leading to the current state of pension provisionin the U.S. Essentially, the advent of Social Security, which provided only a minimum levelof retirement income, has led to the U.S. system of old-age income provision. This systemis more extensively skewed toward private provision of pension benefits than in any otherwestern country. Consequently, benefits are more extensively skewed toward the highestincome earners.

The distribution of pension benefits among the populace of different countries is deter-mined by the institutional structures of the various welfare states. The U.S. model ofretirement income provision is one described by Korpi and Palme (1998) as one of “basicsecurity,” i.e., everyone pays a flat rate and is guaranteed minimum benefits. Other mod-els exist: “targeted,” i.e., social insurance aimed at only the poorest citizens; “voluntarystate-subsidized;” “corporatist,” i.e., earnings related by occupational category with laborforce participation in governance; and “encompassing,” i.e., both a flat rate and earningsrelated, which is the Scandinavian model (Korpi and Palme, 1998, p. 666). As Korpi andPalme report on their comprehensive study of the distribution effects of various models,there is a paradox in the re-distributive effects associated with the various models. Becausethe encompassing model links the interests of the poor and the middle classes to the samepension system, the end result is less poverty and income inequality than in those systemswhere the focus of the government provided program is on only provision of minimal meansfor all. As Korpi and Palme (1998, p. 671) state it,

We hypothesize that the structure of social insurance institutions can emphasize dif-ferences in risks and resources by increasing homogeneity within risk pools in termsof their socioeconomic composition, or they can play down these differences by pool-ing resources and sharing risks across socioeconomically heterogeneous categories.Social insurance institutions thereby can shape the processes of defining interests andidentities among citizens, the rational choices citizens are likely to make, and theways in which they are likely to combine for collective action.

Consistent with their hypothesis, Korpi and Palme, using data from 1985, found thatincome inequality and poverty rates for the elderly were lowest in those countries employingan encompassing model and highest in those countries employing a basic security model(Korpi and Palme, 1998, p. 678). Of the eleven OECD countries included in the study,the U.S. had the highest Gini coefficient (a measure of income inequality) and the highestpoverty rate (defined as the percentage of the population below 50% of the median income).

The position of the U.S. relative to other nations re-retirement incomes is to a considerabledegree a function of the extensiveness with which social benefits are privatized. As notedabove, no other country relies to such a great extent on private protection for the twofundamental risks that every citizen faces—sickness and subsistence beyond the age ofemployment. Providing for health care and old-age income are political decisions; they are


not inevitably the result of natural capitalistic economic order since there is diversity amongcapitalist nations in the means and, consequently, the distribution of these risks among allof the citizens. Hacker (2002, p. xiii) describes the consequence of privatized social benefitsin terms of their political ramifications:

The politics of private social benefits. . .is “subterranean” politics—far less visibleto the broad public, far more favorable to the privileged, far less constrained by thefeatures of American politics that routinely stymie major social reforms, and far moredominated by conservative actors than the making of public social programs.

In the U.S. these privatized benefits for retirement income are provided, for the mostpart, only by corporate employers, if at all.

Two salient consequences of privatized pensions provided by employers have been that,(1) lower paid workers are much more likely not to be included in a plan and, (2) sinceinstitutionally the provider and recipients have conflicting interests with respect to theprovision of benefits, there has been a recent movement to shift risk more toward recipients(employees). As corporate interests come to increasingly dominate the U.S. political process(Bakan, 2004; Drutman and Cray, 2004; Kelly, 2001; Nace, 2003; Phillips, 2002), employershave shifted risks from themselves onto employees. The recent increase in the number ofemployers switching to cash balance pension plans is symptomatic of this risk-shiftingphenomenon.

According to Hacker (2006) the neoliberal revolution in U.S. politics commencing withthe election of Ronald Reagan in 1980 has dramatically altered the economic landscape forthe majority of American workers. Reaganism (and Thatcherism in Britain) was a retreatfrom the New Deal (Labour) consensus of the politics of social welfare for every citizen.The rhetoric employed by the neoliberals Hacker (2006, p. 58) describes as “The PersonalResponsibility Crusade.” For “insurance” this meant a much greater emphasis on individualresponsibility for health care, retirement income provision, etc. and a rapid retreat from thenotion of shared risk. The U.S. is most unique in this respect since most other OECDcountries have retained policies of social, rather than private, insurance for health care andretirement income. The economic consequences of this politics of risk shifting are familiar.Baker (2007) provides a list of the salient ones:

• Wage inequality, greatest in the U.S. among 14 advanced economies even in 1980, grewmore by 2005 than in any of those countries. Wage inequality is now substantially greaterin the U.S. than in any other economically advanced country (Baker, 2007, p. 6).

• The U.S. has dropped to last place among OECD countries in average life expectancy atthe same time spending a higher percentage of GDP on health care than any other OECDcountry (Baker, 2007, pp. 14-15).

• In 2004, Americans worked more hours per year than workers in any other OECD country(Baker, 2007, p. 25).

During this period the basic labor contract between U.S. workers and their employersunderwent a dramatic change. According to Hacker: “The essence of the new contractwas the idea that workers should be constantly pitted against what economists call the ‘spotmarket’ for labor—the amount they could command at a particular moment given particularskills and the particular contours of the economy at that time (Hacker, 2006, p. 66).”


Further: “The old contract was about shared fate (emphasis in original)—workers andtheir companies rose and fell together. The new contract was about individual gain (emphasisin original)—workers and company stayed together when it was beneficial to both, and onlyso long as it was beneficial to both (Hacker, 2006).”3

Evidence of this shifting of risk is provided by Copeland (2002) who found that though theshare of workers with pension coverage on their current job has remained fairly consistentlyat about 45% over the past 20 years, the type of coverage has changed dramatically. Uponretirement, defined benefit plans promise workers lifetime annuities with benefits typicallyexpressed as a multiple of years of service and career high earnings. The amount due is setby formula and the risk of ensuring that funds are available to pay these retirement benefitsrests with the employer. In contrast, employers sponsoring defined contribution pensionplans promise only to make contributions to retirement plans, so the risk falls upon theworker/retiree. The historically dominant defined benefit pension plan has been replacedin large amount by defined contribution plans. From 1980 to 1998, the share of coveredprivate wage and salary workers with a primary defined benefit plan fell from 83 to 44%(U.S. Pension and Welfare Benefits Administration, 2001–2002).

The net result of this major change in the employment contract has been a shiftingof income risk, employment risk, and retirement income risk from the employer to theemployee. The increasing risk faced by employees makes it even more important for employ-ees to have information that allows for the assessment of such risks. Unlike the past whenthe employer was the insurer against uncertainty of income in old age, U.S. employersare now a direct source of uncertainty re-old age income making it more important foremployees to be a focus of disclosure for reporting rules than may have been true in thepast.

4. Perspectives on pension accounting

4.1. FASB views

Standard setters and regulators purport to be increasing efforts toward “transparency”in financial reporting. The FASB describes its role as, “Serving the investing publicthrough transparent (emphasis added) information resulting from high quality finan-cial reporting standards developed in an independent, private-sector, open due process”(FASB, 2001).

The Financial Accounting Standards Board has consistently portrayed the role ofaccounting as a neutral one. In its Conceptual Framework, the FASB states that, “Neu-trality means that either in formulating or implementing standards, the primary concernshould be the relevance and reliability of the information that results, not the effect thatthe new rule may have on a particular interest” (FASB, 1980, paragraph 98). The FASB

3 The change in the employment contract was abetted by a deliberate shift in government policy, i.e, “UnderPresident Reagan, the NLRB [National Labor Relations Board] became substantially more tilted toward manage-ment. Far more cases were decided in management’s favor than under prior boards appointed by either Democraticor Republican administrations (Baker, 2007, p. 35)”.


accentuates this point by including a quote from then-Securities and Exchange Commissionchair Harold Williams noting that,

“If it becomes accepted or expected that accounting principles are determined ormodified in order to secure purposes other than economic measurement. . . we assumea grave risk that confidence in the credibility of our financial information system willbe undermined (FASB, 1980, paragraph 104).”

The FASB’s public position that accounting is a neutral arbiter is a doubtful one since,by its very nature, accounting plays a major role in constructing reality rather than por-traying reality (Chua, 1986; Morgan, 1988; Tinker, 1988). Arnold (1998) argues for theview that accounting is a social construct. Standard setting has been described as a highlypolitical process (Chung, 1999). Zeff (2005) notes that the rising importance of account-ing standards has led to increased special-interest lobbying for accounting standards withcharacteristics compatible with the desired outcomes. By serving an idealized, imaginary“investor” located in an idealized “efficient” market (Young, 2006), the FASB claims to beperforming a valuable social role by mandating the provision of information that results inthe economically efficient allocation of society’s resources. However, society is also politi-cal terrain, particularly when the issues are the provision and distribution of social benefitslike health care and retirement income and that terrain is constantly changing. Investors arenot the only constituency with something at stake. Since accounting characterizes employeepensions as a “cost” to investors, investors’ interests are in conflict with those of employees.How pensions are accounted for from the perspective of investors might be quite differentwere we to assume the perspective of employees. The “general purpose” served by GeneralPurpose Financial Statements likely does not exist.

A thought experiment suggested by Kelly (2001) illustrates the way accounting rulemakers gloss the essential political nature of its alleged economic naturalism. As Kelly(2001, p. 21) succinctly puts it, “A primary bias built into financial statements is the notionthat stockholders are to be paid as much as possible, whereas employees are to paid aslittle as possible. Income for one group is declared good, and income for another group isdeclared bad.” Obviously, a neutral system of accounting rules would be indifferent to whichconstituency’s interests were more important. But, as Kelly illustrates, this preference forone constituency is embedded in the way rule makers valorize profit in the simple profitequation, Profit = Revenues − Expenses. Profit is understood by accounting rule makers assynonymous with “capital income.” Since employee income (including pension benefits) isregarded as an expense, the profit model that informs the FASB’s alleged neutrality becomes:Capital income = Revenues − (Employee income + other factor costs).4 However, simplealgebra permits us to retain the arithmetic identity by rearranging terms to yield, Employeeincome = Revenues − (Capital income + other factor costs). That is, maximizing employeeincome could be as equally valid an objective for corporate management as maximizingshareholder income.

The early history of corporations in the U.S. illustrates that corporations were charteredby states to perform only functions that met the criterion of being in the public interest, e.g.,

4 The following series of equations are adapted from Kelly’s (2001, p. 22).


construction of canals, highways, etc. (Nace, 2003). Corporate charters were permissionto do limited, specific things and were subject to periodic renewal and were frequentlyrevoked (Nace, 2003). However, by the late 19th century, through the successful use of the14th amendment to the U.S. Constitution, corporations achieved “personhood” that resultedin the current legal status of shareholder wealth maximization being the only role for suchcorporate persons (Bakan, 2004). The history of the corporate form in the U.S. illustrateshow any financial reporting model about them commences with a value judgement and thevalues served are ethical and political problems and not simply economic ones.

5. Research findings re-pension reporting rules

We can observe the inherent bias in the rule making process via the fact that the definitionand measurement of corporate pension obligations has long been contested territory. Were itsimply a matter of “faithful representation,” the coherent, cognitive foundation accountingwould have established over the past century should unambiguously point to a reliablemeasurement rule.5 But the nature of just what is the pension promised to employeesremains an unresolved issue.

Because of the politically contested nature of the pension agreement, perceptions ofmarket players and stakeholders become important. Reiter (1992) found that participantsin debt markets view pension contracts in terms of implicit agreements to continue plansinto the future, i.e., as obligations in the form of a permanent covenant with employees.Reiter’s research added to the work of Pesando (1985) and Ippolito (1985) who found thatparticipants in labor and equity markets view pension agreements this way (implicit con-tract model), rather than merely termination obligations (explicit contract model). Barth’s(1991) work provides further support that investors view pension obligations, including pro-jected future salary progressions, as firm liabilities resulting from a continuing employmentpromise, a view that the new employment contract renders untenable.

Tinker and Ghicas (1993) analyzed the constitutive role of accounting by asserting thataccounting practice is consistently biased against employee interests and may help constituteconflicts. Specifically, they found that pension “excesses” motivated a significant numberof corporate takeovers between 1981 and 1985.6

5.1. Current U.S. pension accounting rules

U.S. pension accounting rules have increasingly come under fire, not only for theirlack of transparency in the cash balance arena, but for a broader array of concerns.Arthur Levitt, former Chairman of the U.S. Securities and Exchange Commission (SEC),called for immediate action “to bring accuracy, transparency and accountability to pension

5 That accounting lacks such a coherent cognitive foundation has been cogently argued recently by West (2003).6 In its background discussion of SFAS 87, the FASB acknowledges the contested nature of the ownership of

pension assets. In addressing the notion that pensions do not belong to the employer, the Board observes that,“numerous recent situations in which significant amounts of assets have been withdrawn by employers providecompelling evidence that rebuts that argument” (FASB, 1985, paragraph 112).


accounting” (Levitt, 2005). Levitt was concerned about increasing claims on the Pen-sion Benefit Guaranty Corporation (PBGC) resulting from a wave of pension defaults.Specifically, he believed that SFAS 87 accounting rules allowed companies to hide their“true financial health,” and obscure the need for making additional contributions to thePBGC that would be necessitated under a more realistic view of the pension’s fundingstatus, i.e., information was insufficient for making important political decisions. Con-cerns of this nature led the FASB to issue new pension accounting rules (SFAS 158) thatresult in companies moving pension obligations from footnote disclosures to balance sheetrecognition.

The FASB’s Emerging Issues Task Force initially considered a narrow view of cash-balance plan issues in 2003. The potential effects on employees and their need fortransparency to assess those effects was never considered by the rule-makers. In partialresponse to criticisms described above, the FASB added a broader project to their agendato re-visit key pension accounting issues (FASB, 2005).

Current U.S. pension accounting and reporting rules relevant to this paper are governedby the following pronouncements:

• Statement of Financial Accounting Standards 158, “Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans”

• Statement of Financial Accounting Standards 132, “Employers’ Disclosures about Pen-sions and Other Postretirement Benefits”

• Statement of Financial Accounting Standards 87, “Employers’ Accounting forPensions”7

SFAS 132 was issued to provide additional disclosures because of concerns expressedover information missing from SFAS 87’s disclosure requirements. The recently issuedSFAS 158 does not change the measurement of pension cost as set forth by SFAS 87 (anddiscussed further later in the paper), but changes how the assets and liabilities are reportedin the financial statements. Before SFAS 158, the funded status of defined benefit plans wasnot reported on the balance sheet, and any reported pension asset or liability virtually alwaysdiffered from the plan’s funded status. SFAS 158 has replaced SFAS 87’s reported pensionasset or liability by requiring recognition of the plan’s actual funded/unfunded status (asmeasured by the difference between the fair value of plan assets and the PBO) rather thanfootnote disclosure. This additional recognition also affects comprehensive income, butdoes not alter reported earnings (FASB, 2006).

The FASB sets forth six components of pension expense in SFAS 87. When companieschange from traditional defined benefit plans to cash balance plans, some components ofpension expense may be affected to varying degrees. Those components that have potentialimplications re-cash balance conversions are:

• Service Cost. The FASB defines service cost as, “the actuarial present value of benefitsattributed by the plan’s benefit formula to services rendered by employees during the

7 SFAS 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans andfor Termination Benefits,” provides accounting rules for events noted in its title. However, that pronouncementis not relevant for this research because cash balance conversions generally represent neither settlements norcurtailments.


period” (FASB, 1985, paragraph 16). Because conversion to cash balance plans consti-tutes a change in the benefit formula, and benefit formulas drive service cost, the servicecost component may be affected. Since most traditional defined benefit plans utilize final-pay or career-average pay, the bulk of expense tends to be recognized in the later periodsof employment, i.e., older workers create the bulk of the expense. Current accountingrules contain no requirement to disclose changes in service cost when plan formulas arealtered.

• Return on Plan Assets. Return on plan assets is a negative component of pension expense(it serves to reduce this cost). Though this return is not directly impacted when companieschange plan types, there are potential indirect implications.

• Unrecognized Prior Service Cost. When companies alter existing plans, SFAS 87 gener-ally requires amortization of the net impact of the change as prior service cost. Conversionfrom traditional defined benefit plans to cash balance plans typically constitutes a neg-ative plan amendment, thereby reducing the firm’s PBO, so the benefit is amortizedprospectively (Arcady and Mellors, 2000).

Not only have the pension rules been under fire, but companies face increasing pressureabout the accuracy of assumptions inherent in applying the rules used to generate pensionnumbers. The SEC is probing whether companies tweaked key pension assumptions toenhance the appearance of their pension plans. Specifically, the SEC questions whethersome companies may have first determined desired results, and then backed into assump-tions required to achieve those results (Solomon and Hawkins, 2005). Minor differences inassumptions can have a substantial impact on both income and other pension measures. Forexample, General Motors discloses that a 25 basis point decrease in the estimated discountrate would have increased pre-tax pension expense in 2005 by $160 million, and wouldhave increased the PBO by $2.3 billion (Anon., 2005).

6. Cash balance plans and constructing the pension problem

Starting in the late 1990s, companies in the United States attracted publicity in both thepopular and financial press by changing their traditional defined benefit pension plans tocash balance plans. Although estimates of cash balance plans are imprecise because the dataare incomplete, various measures indicate that these plans are gaining popularity.8 Sixteenof the 100 largest U.S. companies had cash balance plans in 1999; none of this group hadthese plans a decade earlier (Oppel, 1999b). A GAO study (00-185, p. 9) reported that asof July 2000, about 19% of the Fortune 1000 sponsored cash balance plans. Accordingto Mercer Human Resource Consulting, approximately 40% of assets in single-employer,non-union defined-benefit plans in the United States are held by cash-balance or similarplans (Rafter, 2004). This measure is supported by Coronado and Copeland (2003) whoreport that cash balance plans hold more than 40% of all defined benefit pension assets. TheWall Street Journal reports that over seven million people are covered by a cash balancepension plan (Schultz, 2004).

8 Equally significant recently has been the movement to simple, defined contribution plans, which shift the riskof retirement income provision completely to the employee.


Though legally cash balance pensions are classified as defined benefit plans, these plansinvolve changes to the corporate pension formula so that they resemble defined contribu-tion pensions. Most traditional defined benefit plans base pension payments to retirees on aformula that combines a percentage of final pay (or highest final average pay) with the num-ber of years worked (GAO, 2000b, pp. 6-7). Under typical cash balance plans, companiescontribute a percentage of an employee’s pay to an account every year, and then guaranteethat money will grow at a certain rate, e.g., the yield on a U.S. Treasury bill. A GAO study(2000b, p. 15) found that 80% of companies surveyed tied interest rate credits to the returnon a Treasury security. At retirement, or when employment is terminated (if vesting require-ments are met), the amount in that account is the pension. Cash balance plans are subjectto the same ERISA funding regulations as traditional benefit plans (Rohrer, 1995), and alsoare insured by the Pension Benefit Guaranty Corporation (Stewart and Yaffe, 1989).

One of the more controversial accounting and reporting aspects of cash balance pen-sion conversion is determining the beginning balance in each employee’s account. Firmsare legally prohibited from amending a plan’s benefit formula to reduce benefits that havealready accrued. Prior to the passage of the Pension Protection Act of 2006, the law did notgovern how companies set opening account balances, and it did not protect future benefitaccruals (GAO, 2000a, pp. 11-12). Conversions to cash balance plans frequently resulted insituations, called “wearaway” periods, where some workers did not earn additional benefitsfor several years after conversion. A wearaway period occurred when the employee’s open-ing cash balance amount at conversion was less than the present value of his/her accruedbenefits. During this wearaway period, pay and interest credit contributions did not reallyresult in “new” pension benefit accruals until the cash balance account exceeded the valueof benefits accrued under the previous formula. Workers who left during this wearawayperiod were entitled by law to receive the higher benefit accrued under the earlier pensionbenefit formula. Companies were free to set the opening balances with any discount rateand set of mortality assumptions they chose (GAO, 2000b, pp. 28–30), thus whether or nota wearaway period existed was a function of employers’ decisions at the time of conversion.The recently passed Pension Protection Act of 2006 bans wearaway, thus, protecting olderworkers from this abusive aspect of cash-balance plans.

The ease with which so many firms converted to cash balance plans evidences the tiltingof power from labor to management. A primary appeal for companies implementing cashbalance plans is that these plans are less costly than traditional defined benefit plans. TheNew York Times reports that cash balance plans often save companies millions of dollars ayear (Oppel, 1999b). A PriceWaterhouseCoopers survey (2000) finds that 56% of employersanticipated their accounting costs would decrease in the short-term following a cash balanceconversion. According to a GAO survey (2000b, p. 12) several of the Fortune 1000 citedfinancial implications of changing to a cash balance plan as a key reason for their decision.A major allure is that companies can benefit without incurring the costs related to plantermination.

The public declarations of why companies make cash balance conversions are instructive.Some companies candidly acknowledge the cost-saving motivation generated by switchingto cash balance plans. ”Reducing front-end costs was one reason Thompson ConsumerElectronics. . . switched from a traditional defined benefit to a cash balance plan. . . Wecould not afford the final average earning plan,“says Linda Wych, pension fund manager


for Thompson’s U.S. division (Elgin, 1991). When CBS switched from its conventionalpension plan to a cash balance plan, it openly acknowledged that the cash balance pensionplan would save the company money and reduce employee pensions (Schultz and Pope,1999). IBM’s initial approach when converting was to give all Canadian workers (who havemore effective legal leverage against employers than do U.S. workers), but only certainU.S. workers, the right to remain in the old pension plan. When asked the rationale for suchdisparate treatment, J. Thomas Bouchard, IBM’s senior vice president for human resources,said it ”simply would have cost too much“to allow all employees to remain in the originalplan (Burkins, 1999). IBM subsequently altered its stance to include more U.S. workers.

In late 2002, Delta Air Lines announced that it would switch its 56,000 non-union workersto a cash balance system. Workers who retired within the next 7 years would be allowed tochoose either the old plan or the new one. Delta notes that the switch will result in a savingsof approximately $500 million during the next 5 years. According to Delta executive vicepresident Bob Colman, “Unless these steps are taken, Delta’s retirement expenses wouldincrease at an unsustainable rate.” (Revell, 2003).9

Corporations also recognized the potential benefit of utilizing pension assets to generateearnings in excess of those promised and paid to employees. Interest arbitrage is possiblebecause from the employee perspective, cash balance plans are made to appear similarto defined contribution plans. However, many companies anticipate that actual return onpension assets will exceed the return promised to employees (and credited to their pensionaccounts), thus, firms can keep the excess amount earned (Gold, 2000; Rohrer, 1995). Somecompanies intend to set the rate paid below the rate of anticipated investment return, therebyallowing the company to reduce future contributions to the pension fund (Anand, 1999a;Stewart and Yaffe, 1989).

NationsBank Corp. (now Bank of America) took a somewhat different arbitrage strategy.Instead of guaranteeing a specified rate of return, the plan allows participants to direct cashbalance pay credits to as many as 11 investment options. An employee’s cash balance planaccount is then credited with the rate of return earned by the chosen funds, even if thatreturn is negative. But because the cash balance plan is a defined benefit plan, NationsBankhas the right to invest those contributions as it sees fit, which may differ from investmentoptions selected by employees. While NationsBank would not discuss the matter, those whohave studied the plan and plan documents say NationsBank believes its actual investmentswill earn a higher rate of return than the options selected by employees. And that, in turn,will mean lower future pension contributions by NationsBank” (Anon., 2007a). This, onceagain, clearly illustrates the risk shifting that occurs from shareholders to employees.

Bank of America’s atypical method of crediting returns has resulted in a class-actionlawsuit. Plan participants filed a lawsuit in 2004 alleging that the bank violated federalpension rules in an effort to make profits at the expense of employees (Rothacker, 2004).

Were the old employment contract still operative, because of the extreme importanceof private pension benefits to employees, one would expect managers to verbalize lessshareholder-serving rationales than “cost cutting” for altering pension plans. Analogous

9 The Pension Protection Act of 2006 provides special treatment for both Delta and Northwest Airlines becauseit allows airlines currently in bankruptcy court an extra decade beyond the seven year requirement specified in thelaw for bringing retirement plans to a financially sound basis (Abram, 2006. p.2).


to what Arnold and Oakes (1998) concluded about the discursive construction of retire-ment health benefits, we find parallels in how the corporate sector constructed the pensionproblem. Companies offered numerous employee-centered rationales to suggest that cashbalance plans would be more appealing to younger employees, with the subtle messagethat this appeal to younger workers is implicitly more desirable. The apparent logic is thattraditional defined benefit plans were designed for a workforce where employees spent thebulk of their career with one company, and that this model no longer portrays today’s econ-omy. “Cash balance plans are often seen as damaging to people on the brink of retirement,but there’s a pro side to that—they are also enormously beneficial to younger workers,”according to Richard Thau, executive director of The Third Millennium, a New York-basednon-partisan research organization working on issues of concern to Generation X (Anand,1999b).

Employer rhetoric emphasizes the ethic of “personal responsibility” in the claim thatcash balance plans are advantageous for employees both because they promote a betterunderstanding/appreciation of retirement benefits and because they are portable. GordonGould, chief actuary at Towers Perrin, says that cash balance plans can be an effective wayfor companies to attract younger workers who are likely to change jobs frequently (Dugas,1999), an explicit acknowledgement that the employee now faces greater employment risk.According to the legislative bulletin for the Erisa Industry Committee, a group of employers,law firms and actuarial consultants, “Cash-balance designs offer significant advantages [tothose] who move in and out of the workforce. [Such employees] are more likely to accruea significant and secure retirement benefit under cash balance plans than under many otherdesigns,” (Schultz, 1999a). A spokesperson for Casual Corner Group says, “With a youngwork force with high turnover, the cash-balance plan provides a significantly bigger benefitfor younger associates” (Schultz, 1999a). Lucent supported establishing a cash balance planfor non-union workers hired after January 1, 1999 because “younger workers prefer thesehybrid plans to stodgy traditional pension plans” (Anand, 1999a).

However, evidence suggests what is the rhetorical ploy that underlies this appeal toyounger employees. Despite the espoused advantages of these plans for today’s workforce,many young employees would not benefit from cash balance plans because companiestypically do not change the vesting requirement. According to Labor Department datacurrent with the onset of adoption of cash balance plans, the median job tenure for workersaged 25–34 was 2.7 years (Schultz, 1999a). Since a majority of firms had 5-year cliff-vestingrequirements (GAO, 00-185, p. 14), it is clear that substantial numbers of employees wouldnot benefit from the much-touted portability feature of cash balance plans. For example, atSBC Corporation’s Southern New England Telephone unit, 54% of unionized employeeswho were in cash balance plans (but had not yet vested) left the company in 1997. AtMCI Communications, 57% of those who were in the plan but had not yet vested leftin 1997. Based on a review of pension documents filed with the IRS for 1997, The WallStreet Journal also reports that the 5-year vesting requirement prevents countless youngeremployees from gaining any benefit at all from cash balance plans (Schultz, 1999a). In arecent study, D’Souza et al. (2004) tested the portability rationale versus the cost cuttingrationale and found that rather than promoting portability the decision to convert to cashbalance plans “. . .represent cost reduction measures that reduce benefits implicitly promisedto employees” (D’Souza et al., 2004, p. 1). This is why the Pension Protection Act of 2006


mandates a 3-year vesting period. It sets the legal vesting period at nearly the average tenureof young workers.

Companies also frequently tout the perceived simplicity of cash balance plans comparedto traditional defined benefit plans. The BOC Group notes that, ”Instead of an esoteric for-mula, participants see a straight dollar amount, and they understand that better. This allowsparticipants to appreciate the value of the pension benefit that the company is providing tothem” (Murray and Murphy, 1997, p. 33). David Clements, director of compensation andbenefits for Catholic Health Corporation, asserts that employees like the cash balance planbecause it is similar to having a savings account with a balance that they can watch grow(Elgin, 1991).

While cash balance plans per se may be easier to understand, comparing benefits beforeand after cash balance conversions is far from clear. When Central & South West Corporationannounced its changeover to cash balance plans, Jim Bruggeman, a company engineer, spentabout a year trying to understand the new system (Anon., 2007b). Schultz notes that, ”Shortof hiring an actuary, you probably can’t figure out whether you’re better or worse off ifyou’re a veteran at your company” (Schultz, December 4, 1998).

More recently, efforts have been made to quantify the impact of cash balance conversions.When analyzing the impact of these conversions on older workers, Schiever (2003) foundthat benefits declined in 78% of the conversions among workers who separated with 30 yearsof service at age 60; mean benefits for this same group fell by 22% after the conversion. AU.S. GAO (2005) study found that workers of all ages experience significant cuts to theirretirement benefits when employers switch from traditional pension plans to cash balanceplans. Specifically, the study found that over 85% of 30-year-olds, 90% of 40-year-olds,and half of 50-year-olds experience deep cuts in their retirement benefits if they are shiftedinto a cash balance plan without protections from retirement benefits losses that resultfrom the transition. The average monthly benefit cuts were $59 for 30-year-olds, $188 for40-year-olds, and $238 for 50-year-olds. Based on these analyses, the Pension ProtectionAct of 2006 now mandates that employees must receive the benefit they accrued as of theconversion plus the amounts accrued under the new plan. Thus, Congress has preventedemployers from henceforth depriving employees of earned benefits through conversion tohybrid plans (Wyatt, 2006).

Schultz observes that the impact of cash balance plans increasingly extends beyondunionized labor to the executive floor (Schultz, 1999d). Generally, employers can unilat-erally reduce or eliminate future pension benefits for nonunionized workers. In contrast,collectively bargained employees typically have the option of rejecting cash balance plansor negotiating better provisions—if they understand the issues. When Niagara MohawkPower Corporation adopted a cash balance plan for salaried employees in 1999, it con-vinced the International Brotherhood of Electrical Workers union that it was good for thoseworkers as well. Several union members subsequently filed charges against the companyand the union with the National Labor Relations Board, charging that the company did notprovide sufficient information for the union to make an informed decision. At the sametime, midlevel managers at the utility were trying to determine how their benefits under thenew plan compared to benefits under the old plan. A group of managers worked with theunion to construct computer models, and they estimated that pensions for some longtimeemployees had been reduced by 40% (Schultz, 1999g). These situations are indicative of the


lower visibility and traceability of private versus public benefits (Hacker, 2002, p. 42). Forexample, with the U.S. government Social Security program the visibility is pronounced.A fixed amount is withheld from pay every pay period and the benefits of this policy areeasily traceable because the Social Security Administration provides each citizen with anaccounting of what his/her expected benefit will be. Private plans lack the visibility andtraceability of public ones as evidenced by the cases noted where individual employeeswere able to assess consequences only through great effort. Also, this major change inpension policy is affected through thousands of employers, so the ability of employees toquestion the policy as national policy is limited because the policy appears to be isolatedto each employer. Specifically, employees of IBM and Bank of America had a much moredifficult time understanding they have mutual interests vis a vis U.S. pension policy thanthey will understanding their mutual interests vis a vis Social Security. Cash balance con-versions illustrate how inadequately pension accounting rules provide sufficient reportingto one of the primary users alleged to be served by the FASB. The labor market may be justas important to over all well being of the U.S. economy as the securities market, but labormarket participants were not well served by FASB reporting standards in the case of cashbalance conversions.

6.1. Review of financial statement disclosures

Current accounting rules fail to portray cash balance conversions that inform the personsmost directly affected. To further assess the extent to which conversions were or were not ren-dered visible by accounting rules, we analyzed financial statement disclosures for companiesthat converted to cash balance plans. In addition, we provide text conversations between theauthors and employees to illustrate the degree to which financial disclosures were inadequateto enable them to understand the ramifications of the cash balance conversions.

Since cash balance conversions are not required financial reporting disclosures, an obsta-cle in exploring disclosures for this study was identifying companies that converted tothese plans. The authors consulted a website (http://www.cashpensions.org) that served asa repository for cash balance pension plan information for employees whose employers hador were contemplating conversions. The website contained a link listing companies withcash balance pension plans or other hybrid plans; that listing of 101 companies constitutesthe population for the financial statement analysis.

To obtain the pension disclosures, we searched individual corporate websites for annualreports. Some companies’ financial statements were not available using this approach;we searched the SEC’s EDGAR database for that group. If conversions were disclosed,the disclosure for the year of the change was used, if noted. When conversions were notdisclosed, earlier financial statements were searched to the extent that they were availablevia any online format.

Of the 101 companies, 57 made no reference to any sort of pension plan amendment orconversion. Three companies referenced other types of conversions (e.g., pension equity orpension savings) not encompassed by this study. Four companies referenced cash balanceconversions, but were unusable for this study. The remaining 37 companies discussed ornoted a cash balance conversion; these disclosures were reviewed to further explore theamount of information provided.

http://www.cashpensions.org/


Table 1Companies with cash balance conversions

Companies with no reference to cash balance pension conversions 57Companies that referenced cash balance conversions 37Companies with reference to other types of conversions 3Companies that referenced cash balance conversions, but were unusable 4

Total companies listed 101

Clearly, the majority of companies made no mention of conversions in their pensionfootnotes. As noted in Table 1, even among the disclosing group, little information wasprovided that would allow any user to assess the impact of the change. Specifically, twocompanies described the conversion as immaterial to their financial statements, ten describedthe conversion as material, and 25 made no reference to the impact of the change.

The 10 companies that addressed materiality of the conversions clearly provided moreinformation than others in the population (Table 2). But even from the disclosing compa-nies, users would generally find it difficult to gain any substantive insights regarding howthese changes impact future cash flows, pension costs, or pension benefits. Given the smallnumber of companies involved in this subset, disclosures for each company individuallyare provided.

• American Express disclosed in its 1996 annual report that the “initial consequence ofthe changes [to a cash balance plan] was to decrease significantly the Plan’s projectedbenefit obligation and annual pension cost.”

• Central and South West reported that it “realized a savings in 1997 of approximately $20million in pension expense and will also realize significant ongoing reductions.”

• Hannaford disclosed the impact of conversion as an amendment in the beginning andending benefit obligation reconciliation in its 1998 financial statements.

• Herman Miller disclosed that, “The amendment converting the plan to the cash-balanceformula was the primary reason for the 43.9 million change in the projected benefitobligation in 1998.” (Not stated was that the “change” was a decrease.)

• National City Corp disclosed both the impact on the PBO and on pension costs in its1998 annual report. Specifically, the company reported a decrease of $95.8 million in thePBO, and a reduction of $14.9 in pension costs resulting from the cash balance plan.

• Niagara Mohawk disclosed a net curtailment/settlement gain of $35.3 million in its 1999financial statements. However, this gain results from a combination of factors, and thecompany did not provide disclosure that would allow users to isolate the impact of thecash balance conversion.

Table 2Disclosures of cash balance conversions

Companies with no reference to materiality of conversions 25Conversion described as material 10Conversion described as not material 2



• Owens Corning reported that the pension plan amendment to a cash balance formularesulted in a reduction in the PBO of $20 million. The company also reported that itexpected “a reduction in future pension expense through the amortization of the reductionin the projected benefit obligation, reduced service cost and reduced interest cost on theprojected benefit obligation.”

• Reliant Energy reported a $161 million decline in the projected benefit obligation in its1999 financial statements.

• Tektronix reported a reduction in the projected benefit obligation of $38.9 million in its1998 financial statements.

• U.S. Bancorp, after describing the conversion in its 1998 financial statements, reportedonly that the changes “resulted in a reduction in the benefit obligation during 1998.”

Clearly, the disclosures vary greatly in terms of information provided. Some companiesaddress the impact on the PBO—the accounting measure designed to report the obligation.Others focus on earnings by noting the impact on pension expense. Still others note thesignificance of the change, but provide no dollar estimate of the amount. None noted anybenefit of these conversions to employees.

Next the disclosures for information regarding approaches used to credit interest toparticipant accounts were searched. There was far too little detail describing how interestwas credited to participant accounts to allow for any substantive analysis. Specifically, ofthe 37 companies disclosing cash balance conversions, 11 made no mention of how interestis credited to participant accounts and only six disclosed specific interest credit formulas.Twenty companies use a combination of factors, including experience and interest credits,which render specific calculations of amounts credited to employee accounts impossible.Since only six companies disclosed the interest credit formula, those, too, are describedindividually (Table 3):

• Alliant Energy credits each participant’s account with a benefit credit equal to 5% of basepay as well as a guaranteed minimum interest credit equal to 4%.

• Allmerica Financial notes that in 1997–1999, eligible participants were allocated 7.0%of their salary.

• Bank of America allows participants to select various investment vehicles that determineearnings credited to individual accounts.

• Dun & Bradstreet notes that the percentage of compensation allocated annually to partici-pants’ retirement accounts ranges from 3 to 12.5%, based on age and service. Participantsalso receive interest credits based on 30-year Treasury Bonds with a minimum interestcredit rate of 3%.

Table 3Disclosures of interest credits

Combination of factors—cannot directly calculate 20Not disclosed 11Formula disclosed 6



• Eastman Kodak credits employees’ accounts with an amount equal to 4% of their pay,plus interest based on the 30-year Treasury bond rate.

• Reliant Energy allocates credits annually based on a percentage of participant’s pay. Italso discloses that the rate for 1999 and 2000 was 4%.

The above six companies disclosed the most information regarding how interest is allo-cated to individual accounts, yet without substantive additional assumptions, analyses, andreviews of documents outside the financial reporting process, information is not disclosedthat would allow users to assess the existence or impact of interest arbitrage strategies.

It is clear from the results of this review that current FASB pension disclosure rulesgoverning annual reports and SEC filings shed little light on the impact of cash balanceconversions. Even employing the limited FASB-designated capital provider perspective,our analysis of annual reports indicates that most companies do not disclose cash balanceconversions through the financial reporting process. Of those that disclose, there is noconsistency in the disclosures, and few provide sufficient information that would allowcapital providers to assess the impact on future cash flows.

6.2. Popular and financial press

Though accounting rules were inadequate to render visible the firm specific consequencesof cash balance conversions, there was general information provided through the media.Press coverage focused on the impact of cash balance conversions from a global perspective.The New York Times reported that cash balance plans reduce the money older workers receivein retirement by one-third or more (Oppel, 1999b). The Wall Street Journal reported thatfor older workers near the end of their careers, switching to cash balance plans can mean aloss in some cases of as much as 50% of the value of their pensions (Hitt, 1999a; Schultz,1999b).

Other examples of press coverage highlighted the plight of workers at specific com-panies. When both SmithKline and Aetna converted to cash balance pension plans in1999, the Wall Street Journal reported that the companies were phasing out generous earlyretirement subsidies built into the pension plans. The Journal further noted that Aetnasoftened the impact on affected workers by providing the better of the old or new benefitfor vested employees who left the company within the subsequent 8 years. In contrast,SmithKline provided no transition benefits for workers over the age of 60 years (Schultz,1999f).

The June 15, 1999 issue of The Wall Street Journal described the case of Cheryl Cle-venger, a 50-year old widow with two dependent children who had worked at Mercantile’sdepartment store for 12 years and planned to work there until retirement. After Mercan-tile was purchased by Dillard’s, the new owner terminated the over-funded pension fund.Ms. Clevenger got a lump sum for the pension’s current worth of approximately $6000and lost her job. Dillard’s exploited a loophole in the tax code allowing companies topay only a 20% excise tax (rather than the 50% excise tax) if one-fourth of the plan’ssurplus went into a “replacement plan.” Even after paying the 20% excise tax, Dillard’swas still left with nearly $117 million of former pension assets to use for any purpose(Schultz, 1999e).


The controversial switch to a cash balance plan led four older employees at Onan Corp.,a Cummins Engine company, to file suit in 1997 alleging that the cash balance plan adoptedin 1989 discriminates in favor of younger employees. The suit was originally expected togo to trial in December 1999 (Corry, 1999). However, the courts certified the case as a classaction under the age-discrimination and pension laws, and the trial date was postponedas the case expanded to include about 1450 workers. The Internal Revenue Service (IRS)sided with employees and asked the court to disqualify Onan’s pension plan (Schultz etal., 1999). A federal judge ruled that the Onan conversion did not violate age discrimi-nation laws, while simultaneously leaving unanswered the question of whether or not theplan violated federal retirement income laws. A settlement was reached in 2001 requir-ing Onan to pay between $23 and $53 million to workers, depending on their benefitschoices. Jim Eaton, one of the original four plaintiffs, notes that, “We got the company tomodify the plan, to go back and, I guess one would say, give us what was rightly ours”(Hughlett, 2001).

When Prudential agreed to sell its Prudential HealthCare unit to Aetna, many longer-service Prudential employees realized that their pensions would be cut by as much as 40%.After vigorous employee complaints, the company agreed to allow departing employees toremain eligible for an early retirement subsidy that workers usually lose when their unitsare spun off to new owners (Schultz, 1999d).

AT&T adopted cash balance pension plans as part of a strategy initially designed to elim-inate about one-fourth of its 50,000 manager population during 1998. Only approximately3% of the management population was over age 55 and thus eligible to retire under the olddefined benefit plan. Even if all employees over 55 elected to leave, targeted downsizingstill would not have been achieved, so AT&T exposed a broader group of people to an earlyretirement incentive program. According to the transition plan, for employees with at least5 years of service who voluntarily decided between 1 April and 22 May 1998 to leave (ata later date), the company agreed to place a specified percentage of eligible pay per yearof service into that employee’s cash balance account. This strategy allowed AT&T to usepension assets instead of operating cash to encourage early retirements (Burlingame andGulotta, 1998). Employees were clearly dissatisfied with the change; a class-action suit wasfiled against AT&T (Schultz et al., 1999).

A 2003 issue of Fortune magazine provided several examples of worker pension benefitreductions. In an unusual example of a happy ending without litigation, Janice Winstonsuccessfully lobbied her former employer, Verizon Communications, to reverse its plannedtransition to a cash balance pension plan and allow many employees to remain in the com-pany’s traditional plan. Ms. Winston initiated a grassroots campaign to force Bell Atlantic(which later merged with GTE to form Verizon) to return to the old plan. She conducted ane-mail campaign with management, and even flew from her Philadelphia home to the annualshareholders meeting in Denver at her own expense to press the issue. Ms. Winston’s vic-tory resulted in a payout of $400,000—in contrast to the $195,000 she would have receivedunder the proposed cash balance plan (Revell, 2003). Ironically, a more recent example ofemployee litigation in the cash-balance arena is a suit filed against PricewaterhouseCoopers,a firm that has been closely involved with cash balance pension planning for their clients.The suit, filed in early 2005 by a former employee, alleges that the firm deliberately violatedage- and income-discrimination provisions of federal pension law (Anand, 2005.)


6.3. Employee activists

The interviews with employees emerged only after one of the author’s earlier worksin the cash balance pension area was presented at an Interdisciplinary Perspectives onAccounting Conference, and subsequently posted on the website as part of the ConferenceProceedings (http://www.les1.man.ac.uk/ipa/). A few months after the conference, theauthor began receiving a barrage of e-mail from employees and retirees who had beennegatively affected by their employer’s cash balance pension conversion. These workerswere generally delighted that the inequity of cash balance pension conversions was finallyreceiving attention from the academic community. Many messages were focused on ensur-ing that the author was exposed to the “real,” or “human” side of cash balance conversions.Their individual stories provided valuable insights to the pension problem that are obscuredby the pension = cost model utilized by accounting standard setters.

A retired Boeing engineer and self-labeled activist on pension issues believes that themuch-touted portability aspect of cash balance plans is “a near myth” at Boeing. If employ-ees leave the company before the earliest possible retirement date (age 55), Boeing does notallow employees to take money out of the plan, even if the employee has vested. He notesthat they “stick it in an account, pay you an interest rate until you are of age to draw it, thenconvert the cash balance to an annuity, with severe penalty re age at first draw if below 65.”

A representative of SBC Employees for Retirement Fairness echoes the portabilityfeature’s lack of usefulness:

It has been my experience that most employers continue to retain a vesting requirement(5 years is the norm), effectively removing the portability benefit from being appliedto a ”job-hopper“(the last I read, a job hopper isn’t likely to remain with the samecompany for longer than 3 years).

Another retiree shares an additional concern about cash balance conversions:

I read with some interest your paper on Cash Balance and the role accounting playsin this issue. I have done a significant amount of work in this area and want to pointout a more subtle issue, which goes to the heart of the matter. While Cash Balance isdriven by accounting changes, the true issue is based on statistics. It can be shown thatif an employee can reach a retirement age of 65, Cash Balance still pays a generousretirement benefit similar to what might have been possible under a previous traditiondefined benefit plan. The architects of the Cash Balance plan point to this reality as if tosay nothing has been lost. What they fail to mention is the statistical probabilities thatanyone will actually reach age 65 in this new age work environment [a direct referenceto the new employment contract]. This is the issue that most people have missed. Thearchitects knew of this issue since they were sitting on the statistics of the numberof employees who would reach age 65. The also saw the future downsizings throughoutsourcing and mergers that even if an employee did not leave their appointed job,they were bound to lose the job under the old company to some new company andthereby lose the availability of the pension. Accounting changes in the rate of accrualfrom the implementation of Cash Balance was only the tool to implement this plan.It was truly the next closest thing to complete elimination of a pension plan without

http://www.les1.man.ac.uk/ipa/


the associated tax liabilities. Please don’t think that age discrimination would preventthis. In reality, no employee could ever point to their own personal discrimination. Itis simply a statistics game. Even if an occasional employee slips into the higher agebracket of their 60’s, the reality of large numbers missing the target is all that matters.So the bottom line is, accounting was the tool, statistics were the motivation, higherprofits were the outcome.

A former IBM employee focuses on the inequity of the cash balance plan. Following ishis story:

At the time of the conversion, I was a multi-degreed professional at IBM for 18 yrsworking in fields ranging from Space Shuttle onboard flight guidance software tobusiness intelligence datamining. My wife, an ordained minister, was active in herdenomination for 8 yrs (2 of them part-time) and earned a CB-like pension benefit. Herministerial 8-yr pension was valued at $75,478; my 18-yr IBM pension was valuedat $66,117. So, in summary, I worked over ten years longer for a benefit nearly $10Kless than what a minister earned. Is it a wonder IBMers were outraged?

Another former IBM employee, now with IBM Employee Benefits Action Coalition,shares the following story:

I am one of the victims of cash balance conversions; as a 23-year veteran of IBM in1999, I saw over half a million dollars of my projected pension benefits evaporate ina plan amendment. I’m now the head of a coalition of IBM employees dedicated tofinding every legal means possible to reverse the changes and preserve the remainingpension benefits.

The litmus test on this claim [cash balance plans helping attract young skilled work-ers], in my mind, is whether the employers use the newly revamped plans in any oftheir recruitment materials. The answer, gleaned from searching both the recruitingsections of their web sites and the brochures they mail to prospective employees, isclear. The new cash balance plans either aren’t mentioned at all, or are so deeplyburied in the literature that you can’t find them. . .

As clearly illustrated by these individual stories, IBM was the subject of employeeoutrage when it converted its pension plan. An employee coalition dissatisfied with thechange sponsored a plane with a banner reading, “IBM’s pension theft could happen toyou!” to fly over the Minnesota State Fair (Anderson, 1999). This outrage is symptomaticof the new employment contract and the consequent shifting of income risk from capitalto labor. Because of employee protests, IBM altered its initial decision and decided thatanyone 40 years old or older with at least 10 years of service could remain in the oldplan; this doubled the number of employees who had a choice. This action did not satisfyall employees’ concerns; Kathi Cooper (IBM employee) filed a class action suit againstIBM. The heart of Ms. Cooper’s argument is that the formula IBM used to convert to acash-balance plan discriminated against older workers in violation of federal pension laws.

In July 2003, a U.S. District Court ruled in favor of Cooper and the 140,000 IBMemployees included in the class action suit. IBM appealed the ruling, and the 7th CircuitCourt of Appeals reversed the District court’s ruling. The appeals court held that IBM’s


cash balance conversion did not violate ERISA provisions prohibiting age discrimination,and noted that removing a plan feature that provides extra benefits to older workers isdifferent than discriminating against older workers. This finding, reinforced by the U.S.Supreme Court’s recent decision not to hear an appeal against IBM, is expected to causemore companies to convert to cash balance plans (Bianchi, 2006; Donlan, 2007; Schultzand Francis, 2006).

In many of these situations, employee activists changed corporate positions. They gath-ered information on their own, and working collectively, to determine the impact of thecash balance conversion. In other cases, employees are still fighting for what they believeto be the pension rights they have earned. Information needed for all of these struggled wasnot available through any financial reporting process, but was gleaned from other sources,frequently only after media attention identified conversions as problematic.

7. Financial reporting: political after all

In late 1998, the U.S. Senate began to draft legislation tightening disclosure rules foremployers shifting from traditional pensions to cash balance plans. Senate staffers notedthat their concerns arose following a series of Wall Street Journal articles reporting thatthese conversions could significantly reduce pension benefits for longer-term employees(“Senate Bill,” 1998).

In early 1999, legislation to address these concerns was introduced into both the U.S.House and Senate. Senators Daniel Patrick Moynihan, Chuck Robb, and Bob Kerrey (allDemocrats) introduced the Pension Right to Know Act, which would require companies toprovide greater disclosure when making changes to pension plans. A companion bill wasintroduced in the House of Representatives by Jerry Weller, a Republican, and Representa-tive Ken Bentsen, a Democrat. The legislation would have required employers who makechanges to their pension plan to provide individualized benefits statements for employeescomparing their pensions before and after the changes over various periods: on the date ofconversion; 3, 5 and 10 years after conversion; and at normal retirement age (Anon., 1999).(These bills were referred to committee, and through a series of comprises emerged as therecently passed Pension Protection Act of 2006.)

The Clinton administration also proposed in mid-1999 that companies changing fromtraditional plans to new plans be required to tell workers roughly how much retirementmoney they stand to lose. The Administration’s proposal required companies to providespecific examples of how the change would affect different groups of workers. In addition tothe Right to Know legislation, Senator William V. Roth (Republican) considered introducingcash balance disclosure language as part of a tax bill. Bill Archer, chair of the House Waysand Means Committee, included language in his tax bill requiring that employees be given”sufficient information“to understand the effect of conversions when companies change tocash balance plans (Oppel, 1999b).

The Internal Revenue Service and the Equal Employment Opportunity Commission werealso drawn into the debate. In August 1999, the Justice Department (representing the IRS)filed an amicus brief on behalf of employees of Georgia-Pacific Corporation. The workershad sued their employer alleging that it had miscalculated when it made lump-sum payments


from the cash balance plan to departing employees. A footnote to the brief states that, ”Adetermination letter from the IRS applied only to the tax consequences and is meaninglessas to participant litigation.” The Justice Department’s position is that it does not matter thatthe plan received an IRS letter confirming tax-favored status; these plans still might violatepension laws (Schultz, 1999c).

The IRS’s concern over age discrimination is a critical issue because the IRS is the gov-ernment body responsible for granting tax-deferred status to pension plans (Hitt, 1999b;Oppel, 1999a). The IRS withdrew earlier proposed regulations on cash balance age discrim-ination issues, and indicated that it would not issue any further guidance while these issuesare under consideration by Congress (Rosenbaum and Scheidt, 2004). The IRS recentlylifted its 7-year moratorium following passage of the Pension Protection Act of 2006. Thatlegislation made clear that new cash balance plans will not be considered age discrimina-tory as long as they meet certain standards, including granting at least the same benefitand interest credits to older employees as to younger employees (Geisel, 2006; Gonzalez,2007).

The debate over cash balance pension plans also found its way into the rhetoric of the2000 U.S. presidential election. Candidates Al Gore (Democrat) and Gary Bauer (”socialconservative“Republican) aired concern regarding the American people’s pervasive uneasesurrounding their financial security at retirement. Gore spokesman Chris Lehane says, ”Itmight not dominate the front page of the paper, but it’s an issue people talk about at thebreakfast table. . . . We’re at the breakfast table“(Hitt, 1999a). Bauer says, ”The move byIBM and others violates basic American fairness. . . In fact, it is kind of like changing therules of the game in the third quarter” (Hitt, 1999a).

Additional pension legislation was introduced into both the U.S. Senate and Houseof Representatives in 2005. Specifically, the Pension Fairness and Full Disclosure Actof 2005 would have amended the Employee Retirement Income Security Act of 1974(ERISA) to establish a termination fairness standard limiting availability of benefits underan employer’s nonqualified plan if the defined benefit pension plan is subjected to eithera termination based on bankruptcy organization or conversion to a cash balance plan. Thelegislation would have also prohibited funding nonqualified deferred compensation planswhile maintaining under-funded defined benefit plans. It was in a Senate committee andHouse subcommittee for over a year before emerging as the Pension Protection Act of 2006,passed by Congress on August 17, 2006 and sent to President Bush for his signature. It took8 years for Congress to finally pass a law pertaining to the problems long recognized withemployer provided pensions. Congress’ principal motivation for reaching a compromiseat this juncture was mainly a fiscal decision. The growing deficit in the Pension BenefitGuarantee Corporation fund required some action to prevent companies from just allowingtax payers to assume the responsibility of their failures to properly fund their pensionplans (Abrams, 2006).

The recently passed Pension Protection Act of 2006 contains provisions that increase thedisclosure requirements. Plan participants now must be provided annual funding notices. Inaddition, annual reports must now contain an explanation of the actuarial assumptions usedto project future retirements and asset allocations (Wyatt, 2006). This represents yet anotherexample of accounting rule-makers failure to provide transparency to a wider audience ofstakeholders, and provides another dent in the FASB’s claims of neutrality.


8. Concluding observations and implications

While failure to provide insight is always a disquieting issue for the accounting profes-sion, it is particularly disturbing given the pervasiveness of public concern and social welfarein the pension arena. This lack of performance on the part of the FASB is attributable both toFASB’s focus on the interests of shareholders and to the impossibility of “general interest”financial statements prepared “neutrally.” The pension issue seems clearly to illustrate theinadequacy of the facile assumption that information produced to serve capital providersserves others equally as well. Accounting rule-makers construct accounting problems with-out appropriate consideration given to their role in constructing the context within whichfinancial reporting problems emerge in all of their context specific complexity (Lee, 2006).Financial reporting required of corporations might better serve if it was driven by consid-eration of providing information to citizens who have to make decisions in the world theyactually occupy. Even a Congress controlled by the party most sympathetic to corporateinterests has been forced to write disclosure rules that a standard setter genuinely neutraland concerned with transparency would have written years ago.

Over the last generation there has been a dramatic shifting of economic risk downwardto employees even as income has been shifted dramatically upward. Employee benefits arebeing reduced, and accounting standards provide a paucity of information to illuminatethis reduction. Employees in companies that have changed to cash balance plans and otherstakeholders in this domain have relied upon internal calculations and analyses, politicians,or the courts to adjudicate the contested nature of the pension promise. Absent press coverageand employee activism, it appears doubtful that any legal or regulatory remedies to protectemployee interests would be pursued. Financial reporting is about political decision making,as well.

Acknowledgements

The authors wish to thank participants at the 2005 Critical Management Studies Con-ference for helpful comments received. Paula Thomas also gratefully acknowledges thesupport of Middle Tennessee State University’s Summer Research Grant program.

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Cash balance pension plans: A case of standard-setting inadequacy

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