COMMENTS CONCERNING
AGE DISCRIMINATION ISSUES IN
CASH BALANCE PENSION PLANS
I | II | III | IV | VI | VII
V. Basic Conversion Issue
- Issue: Does a conversion of a final average pay defined benefit plan to a cash balance
plan discriminate because of age?
Under a final average pay plan, participants tend
to accrue a significant percentage of their benefits in their final few years of service.
In a cash balance plan, the rate of accrual is more even over a participant’s career
with an employer. As a result, some participants in traditional plans which convert to
cash balance plans who stay with the employer sponsoring such a plan until retirement can
end up with smaller benefits than they would have received if the plan had not converted
to cash balance. Some participants’ expectations to benefits may be upset in
the conversion. While many conversions have included generous transition provisions for
participants most affected by the conversion, other conversions have offered no transition
benefits. As a result, a concern has been raised by some that conversions might inherently
discriminate against older workers because of age.
- Analysis
Traditional final average pay plans provide for the accrual of a
substantial portion of participants’ benefits in their final years of service. This
effect results from pay increases towards the end of a participant’s career as well
as the effect of additional years of credited service under a final average pay formula.
In contrast, cash balance plans intentionally provide for more level accruals over a
participant’s career.9
The Society of Actuaries study cited at Footnote
4 provides ample evidence for the point that cash balance benefits are often better
for participants with shorter periods of employment with an employer, while final average
pay plans are often better for employees with longer periods of service with a single
employer. To mitigate the effect of the transition to a more even accrual pattern, many
employers have offered some type of transition benefits to some or all active
participants, effectively allowing them to stay in the old plan. These additional benefits
tend to be offered to some or all of the longer service workers, as these workers will
often not have the opportunity to accumulate the more significant benefits available in
the cash balance formula over a longer remaining time to presumed payment date.
These transition provisions vary from plan to plan, but at least three types are
relatively common. One type involves giving additional pay credits to some group of longer
service employees. Another involves keeping participants with long service and/or older
participants in the old formula. Another transition involves allowing some or all
participants to choose between staying in the old formula or moving to the new cash
balance plan. Usually, some combination of age and service is used for eligibility for
transition benefits, so that older longer service workers are eligible.
Conversions involve plan redesign considerations which may be motivated by numerous and
varied reasons: a desire to reduce costs, to better align benefits design with a more
mobile workforce, to offer a plan that is more easily communicated to workers, to provide
a plan that easily accommodates acquired groups of employees, or other permissible
reasons. Conversions do not inherently single out older workers for benefit reduction.
Accordingly, under Hazen Paper, a disparate treatment claim would be inapplicable
to the typical cash balance plan conversion. In fact, Hazen Paper was fundamentally
a case about employees’ upset expectations regarding future benefit payments. An
employer fired an employee a few weeks before he vested, and this employer action was held
to be illegal under section 510 of ERISA but did not present an ADEA violation because the
action was intended to reduce benefits, not reinforce a stereotype. As Justice
O’Connor wrote,
The decision [to fire the employee] would not be the result of inaccurate and
denigrating generalizations about age, but would rather represent an accurate judgment
about the employee—that he indeed is "close to vesting." 507 U.S. 604 at
612.
Conversions generally provide that the rate of benefit accrual for all workers will be
based on a new uniform formula after a certain date; if the new cash balance formula
complies with section 411(b)(1)(H) of the Code and if there are no issues with
"wear-away" (see discussion below), then age discrimination concerns disparate
impact – that an effect of the conversion is that older workers receive worse
benefits than they would have had the plan remained in effect, and that they are injured
more than similarly situated younger workers in this regard. As we have seen, a disparate
impact theory should not be available in age discrimination cases. Conversions tend to
have multiple business purposes, and courts have consistently ruled against plaintiffs in
disparate impact cases where a valid business necessity exists for the employer policy or
act.
The loss of expected benefits may have a greater impact on longer service workers (who
may be also older workers), depending on the design of the conversion. If this impact were
prohibited, no defined benefit plan could be terminated or have a reduction in future
rates of accrual. To date, the United States has had a voluntary employer sponsored
pension system, and protecting expectations in addition to protecting accrued benefits
would be inconsistent with the entire legal framework of the voluntary system.
- Recommendation
Current law would not support a regulation that would prohibit
all conversions on the ground that any program that had an adverse impact on older workers
is per se age discriminatory. As we have seen, prohibition of employer conduct on
disparate treatment grounds requires proof of bad intent, and a regulation or other
Service interpretation that would adopt a disparate impact theory would extend the law
beyond its current scope. Accordingly, additional guidance from the applicable agencies
should confirm that a conversion of a traditional final average pay plan to a cash balance
plan is not, without more, discriminatory because of age.
VI. Optional Forms and Ancillary Benefits in Conversions
- Issue: If optional forms and ancillary benefits are offered under the new formula, but a
grandfathered group is ineligible for such features, does the plan design discriminate
because of age?
Sometimes, employers converting plans to cash balance require some
group of older longer service employees to remain in the prior plan and do not permit them
to be eligible for the cash balance formula. Typically, these employers believe that these
employees would most likely be adversely affected by an immediate change to the cash
balance formula and would generally be better off under the old formula or reach this
result de facto through grandfathering and providing the greater of the account or the old
plan formula. However, cash balance formulas often provide for lump sum distributions
which are unavailable in traditional plans, and often provide death benefits equal to 100
percent of the account payable to any beneficiary, whereas many final average pay plans
provide a lesser death benefit payable only to spouses. One issue this structure raises is
whether employees in the "protected" group are discriminated against because of
age because they were not offered the lump sum option or the greater death benefit.
- Analysis
Where the composition of the grandfathered group is not based solely
on age (i.e., where there is a service requirement as well), it would seem that a
disparate treatment concern would not be present under Hazen Paper, and that the
questions regarding whether a disparate impact claim may be brought under ADEA would still
be present.
Moreover, there are general non-age related reasons for limiting the new features to
the cash balance formula and not adding them to the final average pay plan as well. The
availability of lump sums in a cash balance plan is extremely common, but is less common
in a final average pay plan because of several drawbacks. Single sum distributions in
final average pay plans can be very sensitive to interest rates, and accordingly,
participants can find it very difficult to plan for retirement if this feature exists;
moreover, employers find it very difficult to explain the potentially significant changes
in value that can occur as a result of interest rate changes.
To avoid complaints about failing to grandfather participants who would have benefited
from such a provision, some employers have offered all or a group of participants the
right to remain under the old plan formula or convert to the new benefit structure.
Although the choice feature may raise other concerns, it would appear to eliminate many
age discrimination issues, provided that the consequences of participant choice were
explained adequately to each participant. It should be noted that the choice feature
itself is possibly a benefit, right, or feature which could be implicated in an age
discrimination analysis; in the most extreme analysis choice would have to be offered to
every worker over age 40, unless some service component were part of the eligibility
criteria as well.
- Recommendation
Guidance should provide a "safe harbor" for defining
grandfathered groups, such that if there is one significant non-age related element (such
as service), no age discrimination would be present.
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