GAO Cash Balance Study Questioned

A recent Government Accountability Office study concluded that cash balance plans hurt all workers, not just older ones. Benefits analysts beg to differ.

November 29, 2005
A recent Government Accountability Office study found that all workers—even younger ones—fare worse in cash-balance pension plans than in traditional defined-benefit programs. Now the analysts whose cash-balance study was criticized by the GAO contend that the agency’s critique is not grounded in reality.

In the report released in early November, the GAO concluded that after a conversion from a traditional plan to cash balance, the median benefit decrease ranged from $59 per month at age 30 to $238 per month at age 50, according to a survey of 205 plans.

But consultants at Watson Wyatt Worldwide disputed the GAO’s methodology, asserting that it used a rich traditional plan for comparison purposes. That approach did not take into account that such plans are becoming extinct because of high costs and changing workforce demographics.

Studies like the GAO analysis "hinge critically on the counter-factual," says Julia Coronado, senior research analyst at Watson Wyatt. In today’s marketplace, the alternative to cash balance is not a generous defined-benefit plan. It’s a defined-contribution plan—or nothing at all.

Policy toward cash-balance conversions has been prominent in the pension reform debate on Capitol Hill. Democrats embraced the critical GAO report, which they requested. One day before the GAO report came out, Republicans circulated a letter to their House colleagues praising cash-balance plans and citing consulting firm studies.

A cash-balance plan, set up as a hypothetical individual account based on a percentage of a worker’s salary and interest credits, is designed to be most valuable to someone who works for an employer for 10 years or fewer, Coronado says. A traditional defined-benefit plan becomes more valuable as the employee nears the end of a long career with one company.

The portability of cash-balance plans makes them more attractive to today’s mobile workforce, proponents say. "Anybody who is planning on staying with one employer to retirement loses in any conversion," Coronado says. The GAO report says the portability of cash-balance plans is overstated.

Although it asserts that all workers suffer in the cash balance switch, the GAO did find that some form of benefit protection was offered in 47 percent of all conversions. That was the case at Eaton Corp. in 2002.

"It’s been overwhelmingly positive," says Ellen Collier, director of benefits at the Cleveland industrial manufacturer, describing the company’s transition to cash balance. "People understood their benefits for the first time because we did such a detailed, individualized communication campaign." Employees are able to track the value of their pensions each day online.

During the conversion, about 35 percent of employees chose to retain their traditional plan. Since then, new hires have automatically been given cash-balance plans.

The cash-balance approach makes it easier to integrate employees acquired in mergers into the pension system—and move them around to different operations, Collier says. She doubts that companies intend to reduce pension benefits in a conversion. "No one wants bad employee relations, and no one wants lawsuits," she says.

Meanwhile, the GAO report is unlikely to settle an issue vexing Washington—whether to make cash-balance plans retroactively legal.

At a November 9 hearing, House Ways and Means Committee Chairman Bill Thomas, R-California, resisted adding to the panel’s pension reform bill a measure that would have done that. He said Congress should assure legality "on a prospective basis and not disrupt the process in the courts."

Mark Schoeff Jr.