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June 22, 2004
Cash Balance Conversions Increase Costs, Study Says

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When companies began converting existing defined benefit pension plans to cash balance plans, critics cried "foul." Among other charges, they claimed companies were making the conversions only to save money. An analysis by Watson Wyatt Worldwide, which looked at conversions in 1999 and earlier, did indeed find that companies saved money--1.4 percent on average.

A recent Watson Wyatt update of the earlier study, which looked at 55 large companies (out of a known universe of about 80) that have converted to cash balance plans, had a different result. The recently released study showed that costs actually increased for companies making the conversion, roughly 2.2 percent.

The earlier study showed that companies contributed average pay credits of 5.1 percent of salary toward employees' retirement benefits. The new study revealed almost no change--5.0 percent--yet costs to the company have increased.

Most of the companies participating in the study took measures to protect workers from possible adverse effects, the cost of which are included in the 2.2 percent cost increase. Thirty-three percent of employers gave workers the choice of staying with the old plan or opting for the new. Thirty-one percent grandfathered workers under the old formula. And 13 percent guaranteed workers the better of the old or the new formula.

Those measures dispute the idea that cash balance plans adversely affect long-term, older participants. The U.S. Treasury Department and others have worried that the conversions would leave such workers with less financial security than they would have had under a standard pension plan. They argue that additional mandates would solve the problem. However, Janemarie Mulvey, assistant director of research at Watson Wyatt and an author of the study, points out the steady decline in the number of cash balance conversions in the last 5 years. "While opponents might cheer this trend," she says, "what goes underreported are the thousands of companies that have simply frozen their defined benefit plans in recent years. Unduly restricting the hybrid plan option will only cause more companies to offer a stand-alone defined contribution plan, leaving workers with none of the security of defined benefit pensions."

Steve Mirante, managing consultant of Watson Wyatt's New Jersey office, believes employers are taking care of potential problems themselves. "Added mandates would certainly drive more employers out of the defined benefit system," he says.

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