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Report to Congressional Requesters: 

United States Government Accountability Office: 

GAO: 

October 2005: 

Private Pensions: 

Information on Cash Balance Pension Plans: 

GAO-06-42: 

GAO Highlights: 

Highlights of GAO-06-42, a report to congressional requesters: 

Why GAO Did This Study: 

The nation’s private defined benefit (DB) pension system, a key 
contributor to the financial security of millions of Americans, is in 
long-term decline. Since 1980, the number of active participants in 
Pension Benefit Guaranty Corporation (PBGC) insured single employer DB 
plans has dropped from 27.3 percent of all national private wage and 
salary workers in 1980, to about 15 percent in 2002, and more recently 
the PBGC has assumed billions of dollars in unfunded benefit 
obligations from bankrupt plan sponsors. Some analysts have identified 
hybrid DB plans like cash balance (CB) plans as a possible means to 
revitalize this declining system. However, conversions from traditional 
DB plans to CB plans have sometimes been controversial because of the 
effect conversions may have on the benefits of workers of different 
ages. 

As House and Senate committees consider comprehensive pension reform 
legislation that includes efforts to resolve uncertainties about CB 
plans, GAO was asked to (1) review current research about the 
implications of CB conversions for employee benefits, (2) describe the 
prevalence and type of transition provisions used to protect workers’ 
benefits in past CB conversions, and (3) estimate the effects of CB 
conversions on the benefits of individual participants under a 
hypothetical conversion to a typical CB plan from a typical traditional 
DB plan. 

What GAO Found: 

Current pension and economic literature provides little conclusive 
evidence about the effects of CB plan conversions on benefits. In many 
cases, data and other methodological issues (e.g., sampling methods) 
limit the generalization of results. Nonetheless, cash balance research 
indicates that the effects of a conversion depend on many factors, 
including the generosity of the CB plan, transition provisions that 
might limit any adverse effects on current employees, and firm-specific 
employee demographics. CB plan conversions are posited to have 
distributional effects on expected pension wealth: younger, more mobile 
workers usually benefit while older workers with long job tenure are 
likelier to experience a loss, particularly if they are nearly eligible 
for early retirement. 

GAO’s analysis of a representative sample of plan conversions 
determined that most conversions occurred between 1990 and 1999 and 
primarily in the manufacturing, health care, finance and insurance 
industries. Most conversions set participants’ opening account balances 
equal to the present value of benefits accrued under the previous plan, 
although the interest rate used to calculate the balance varied around 
the 30-year Treasury bond rate. Most plans provided some form of 
transition provisions to mitigate the potential adverse effects of a 
conversion on workers’ expected benefits for at least some employees. 
About 47 percent of all conversions grandfathered at least some of the 
employees into the former traditional DB plan. In most cases, 
grandfathering eligibility was limited to employees meeting a specified 
minimum age and/or years of service. 

GAO’s simulations of the effects of conversions on pension benefits 
show the following:
* In conversions from a traditional DB plan to a typical CB plan, most 
workers, regardless of age, would have received greater benefits under 
the DB plan. Unless grandfathered into the former plan, older workers 
experience a greater loss of expected benefits than younger workers.
* In comparing a typical CB plan to a terminated FAP plan, all vested 
workers would do better under the CB plan. 
* In conversions from a traditional DB plan to a CB plan of equal cost 
to the sponsor and more generous than the typical CB plan, while more 
workers at age 30 have benefit increases under the CB plan, this was 
not true for those at age 40 and 50.
* In comparing a equal cost CB plan to a terminated FAP plan, again all 
vested workers would do better under the CB plan. 
GAO’s comparisons focusing on the lifetime present value of benefits 
did not change the basic findings of GAO’s analysis of monthly 
benefits. 

www.gao.gov/cgi-bin/getrpt?GAO-06-42. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Barbara Bovbjerg at (202) 
512-7215 or bovbjergb@gao.gov. 

[End of section] 

Contents: 

Letter: 

Concluding Observations: 

Agency Comments: 

Appendix I: Information on Cash Balance Pension Plans: 

Appendix II: Review of Literature on Cash Balance Plans: 

Appendix III: Analysis of Form 5500 Data on Cash Balance Plans: 

Appendix IV: Analysis of Simulated Cash Balance Plans and Traditional 
Final Average Pay Plans: 

Appendix VGAO Contacts and Staff Acknowledgments: 

Tables: 

Table 1: Cash Balance Plan Sample Disposition: 

Table 2: Conversions Costs of Typical Cash Balance Plan by Conversion 
Age: 

Abbreviations: 

APS: age plus service: 

BLS: Bureau of Labor Statistics: 

CB: cash balance: 

CBOLT: Congressional Budget Office's long-term social security model: 

DB: defined benefit: 

DC: defined contribution: 

LABOR: Department of Labor: 

GAM: Group Annuitant Mortality: 

FAP: final average pay: 

PBGC: Pension Benefit Guaranty Corporation: 

PENSIM: pension policy microsimulation model: 

PSG: Policy Simulation Group: 

PSID: Panel Study of Income Dynamics: 

SIPP: Survey of Income and Program Participation: 

SPD: summary plan description: 

United States Government Accountability Office: 

Washington, DC 20548: 

October 27, 2005: 

The Honorable George Miller: 
Ranking Minority Member: 
Committee on Education and the Workforce: 
United States House of Representatives: 

The Honorable Bernard Sanders: 
Ranking Minority Member: 
Subcommittee on Financial Institutions and Consumer Credit: 
Committee on Financial Services: 
United States House of Representatives: 

The Honorable Tom Harkin: 
United States Senate: 

The nation's private defined benefit (DB) pension system,[Footnote 1] a 
key contributor to the financial security of millions of American 
workers and their families, is in long-term decline. The number of 
single employer DB plans has declined dramatically over the past 
several decades,[Footnote 2] from over 95,000 in 1980 to less than 
35,000 in 2002, with the number of active participants in such plans 
dropping from 27.3 percent of all national private wage and salary 
workers in 1980, to about 15 percent in 2002.[Footnote 3] Structural 
problems in industries like airlines, steel, and auto parts have led to 
large bankrupt firms terminating their DB plans, with thousands of 
workers losing some of their benefits and saddling the Pension Benefit 
Guaranty Corporation (PBGC) with billions of dollars in unfunded 
benefit guarantees.[Footnote 4] In response, several congressional 
committees have proposed comprehensive pension reform legislation that, 
among other issues, would address the underfunding of single employer 
defined benefit plans.[Footnote 5] 

Some analysts have identified hybrid DB plans like cash balance (CB) 
plans as a possible means to revitalize this declining system. CB plans 
are referred to as hybrid plans because legally they are DB plans but 
contain certain features that resemble defined contribution plans. 
Similar to traditional DB plans, CB plans use a formula to determine 
pension benefits. However, unlike traditional final average pay (FAP) 
plans that pay retirement benefits on the basis of an annuity amount 
calculated using years of service and earnings, CB plans express 
benefits as a hypothetical individual account balance that is based on 
pay credits (percentage of salary or compensation) and interest 
credits, rather than an annuity. 

In the late 1990s, many pension plan sponsors converted their 
traditional final average pay plans to CB plans. Conversions to CB 
plans have been controversial because of the effect they may have on 
pension benefits of workers of different ages and years of 
service.[Footnote 6] In particular, CB plan conversions can sometimes 
result in so-called "wearaway" situations where some workers do not 
earn additional pension benefits while other workers continue to do 
so.[Footnote 7] The legality of CB plans has recently been questioned 
in a court ruling regarding whether a CB plan is age 
discriminatory.[Footnote 8] Employers report this legal uncertainty has 
made CB plan conversions less popular than in the past. In 2000, we 
reported on the implications of conversions to CB plans and recommended 
legislative and executive agency actions to address the regulatory 
uncertainty concerning CB plans and to improve disclosure to affected 
participants.[Footnote 9] 

In response to the problems facing the DB system, committees in both 
the House and the Senate have recently proposed legislation that would 
address many issues facing defined benefit plans, including the legal 
uncertainty regarding the formation of new CB plans or the conversion 
of traditional DB plans to CB plans.[Footnote 10] To help in your 
deliberations, you asked us to provide information on the incidence, 
features, and effects of CB plan conversions. More specifically, you 
asked: (1) What does the current research say about the implications of 
CB plan conversions for workers' benefits? (2) What is the prevalence 
and types of transition provisions provided to protect workers' 
benefits in past conversions to CB plans? (3) How do individual 
participants fare under a hypothetical conversion to a typical CB plan 
compared to the typical FAP plan? On September 1, 2005, and again on 
October 12, 2005, we briefed your staff on the results of our analysis. 
This report formally conveys the information provided during those 
briefings. (See app. I). 

To determine the results of current research, we conducted a review of 
academic and business literature regarding CB plans and the conversion 
of traditional DB plans to CB plans. To identify the prevalence and 
types of transition provisions in CB plans, we worked with the 2001 
Form 5500 to identify and examine CB plan conversions for their design 
features.[Footnote 11] We first identified all 843 plans with 100 or 
more participants that indicated a CB or hybrid plan component on Form 
5500. We then selected a random sample of 205 of these plans. Our 
sample was comprised of the 45 largest plans (the smallest of which has 
about 17,500 participants) and a random sample of 160 other 
plans.[Footnote 12] Of these 205 plans, we identified 31 large plans 
and 102 smaller plans as conversions from traditional DB plans to CB 
plans. (For our methodology, see apps. II, III and IV.) 

To analyze the effects of a CB plan conversion on individual workers, 
we used a pension policy microsimulation model (PENSIM). PENSIM 
simulates lifetime retirement benefits for over 100,000 participants in 
the 1955 birth cohort. We calculated and compared monthly retirement 
income for workers from the 1955 birth cohort who are projected to be 
alive at age 68, and vested in a job covered by a typical FAP plan that 
is converted to a CB plan. The model allows comparison of benefits 
received from CB plans and ongoing traditional FAP plans, as well as 
terminated FAP plans. 

We conducted four simulations: 

* typical CB plan versus typical FAP plan, 

* typical CB plan versus terminated FAP plan, 

* equal cost CB plan versus typical FAP plan, and: 

* equal cost CB plan versus terminated FAP plan. 

Plan characteristics for the traditional FAP plan and typical CB plan 
were based on Bureau of Labor Statistics' (BLS) employee compensation 
and benefit data, our analysis of CB conversions as designated in the 
2001 Form 5500 data base and discussions with industry actuaries and 
consultants knowledgeable about CB plans and DB plans generally. We 
developed the features of our equal cost CB plan by starting with the 
design features of the typical CB plan and then increasing both the 
base pay credit and the weighted pay credits (a percentage of pay that 
increases as an employee's age and/or years of service increase) until 
the cost was equivalent with a traditional FAP plan with a workforce of 
identical actuarial, demographic, and labor market characteristics. 
(See slides 19 to 25 in app. I.) We conducted our work between 
September 2004 and September 2005 in accordance with generally accepted 
government auditing standards. 

In summary, we found the following: 

* The pension and economic literature provides little conclusive 
evidence about the effects on benefits and other aspects of CB plan 
conversions, particularly with regard to why sponsors convert to CB 
plans in the first place. (See slides 9 and 10.) In many cases, data 
and other methodological issues (e.g., sampling methods) limit the 
generalization of results. The effects of a conversion depend on a 
variety of factors including the generosity of the CB plan itself, 
transition provisions that might limit any adverse effects on current 
employees,[Footnote 13] and firm-specific employee demographics. CB 
plan conversions are posited to have distributional effects on expected 
pension wealth: younger, more mobile workers usually benefit while 
older workers with long job tenure are more likely to experience a 
loss, particularly if they are near the age and service requirements 
for early retirement. Less research is available on the actual benefit 
distributional effects of such conversions, e.g., how participants are 
likely to fare under a CB plan compared to the traditional DB plan that 
is being replaced. 

* Our analysis of plan conversions determined that most conversions 
occurred between 1990 and 1999, and primarily in the manufacturing, 
health care, finance and insurance industries. Most conversions set 
participants' opening account balances equal to the present value of 
their accrued benefits under the previous plan, although the interest 
rate used to calculate the balance varied plus or minus 1 percent of 
the 30-year Treasury bond rate. (See slides 11 to 18.)[Footnote 14] The 
use of interest rates above the 30-year Treasury rate is more likely to 
result in a wearaway situation, unless otherwise mitigated. Most plans 
provided some form of transition provisions to mitigate the potential 
adverse effects of a conversion on workers' expected benefits for at 
least some employees. About 47 percent of all conversions used some 
form of grandfathering that was applied to at least some of the 
employees in the former traditional DB plan.[Footnote 15] In most 
cases, grandfathering eligibility was limited to employees meeting a 
specified minimum age or years of service or both. Most conversions 
also used some form of ongoing weighted pay credit. 

* Our comparison of a typical FAP plan that is converted to a typical 
CB plan finds that, regardless of a worker's age, more workers would 
have received greater benefits under the FAP than under the typical CB 
plan.[Footnote 16] (See slides 26 to 28.) For workers who receive less 
under the CB conversion, median benefit decreases range from $59 per 
month at age 30 to $238 per month at age 50. For the workers who 
receive more under the conversion, median benefit increases range from 
$15 per month at age 30 to $27 per month at age 50.[Footnote 17] Those 
who experience either benefit increases or decreases are more likely to 
be men, except for those at the age 50 conversion, where they are more 
likely to be women. 

* In comparing a conversion to a typical CB plan with a terminated FAP, 
all vested workers would do better under the CB plan. Median monthly 
benefits increase at conversion ages 30, 40, and 50, with increases 
ranging from $150 per month for conversions at age 30 to $305 per month 
for conversions at age 50. (See slides 29 to 30.) The increase in 
benefits for older workers is because grandfathered benefits are 
included in these results. Although the analysis focuses on vested 
workers at the time of conversion, under a terminated FAP plan, by law 
all previously unvested workers (those with less than 5 years service) 
are immediately vested[Footnote 18]. 

* Under a traditional FAP plan conversion to an equal cost CB plan, 
larger numbers of workers at all ages have benefit increases than under 
the typical CB plan/FAP plan scenario.[Footnote 19] (See slides 33 to 
35.) Grandfathering again protects the benefits of those older workers 
who were covered. However, while more workers who are converted at age 
30 fare better under the CB plan, this was not true at other ages. A 
key factor is the greater generosity of the equal cost CB plan compared 
to the typical CB plan we also simulated.[Footnote 20] Under the equal 
cost scenario, median reductions range from $75 per month for 
conversions at age 30 to $128 per month for conversions at age 50, 
while median increases range from $90 per month for conversions at age 
30 to $29 per month for conversions at age 50. For all conversion ages, 
those with longer job tenure and who are not covered by grandfathering 
protections are more likely to lose than those workers with shorter 
tenure. At each conversion age, a greater percentage of those who are 
more likely to experience benefit increases are men rather than women. 

* In comparing a conversion to an equal cost CB plan with a terminated 
FAP plan, again all vested workers do better under the CB plan. Median 
increases range from $283 per month for conversions at age 30 to $396 
per month for conversions at age 50. (See slides 36 to 37.) The 
increase in benefits for older workers comes about because 
grandfathered benefits are included in these results. 

Concluding Observations: 

Our analysis illustrates one of the difficult choices facing the 
Congress in crafting comprehensive DB pension reform legislation, 
including the controversial issues surrounding the legal status of CB 
plans, and particularly CB conversions. The current confusion 
concerning CB plans is largely a consequence of the present mismatch 
between the ongoing developments in pension plan design and a 
regulatory framework that has failed to adapt to these designs. 
Although CB plans legally are DB plans, they do not fit neatly within 
the existing regulatory structure governing DB plans. This mismatch has 
resulted in considerable regulatory uncertainty for employers as well 
as litigation with potentially significant financial liabilities. For 
many workers, this mismatch has raised questions about the confidence 
they may have in the level of income they expect at retirement, 
confidence that has already been shaken by the termination of large 
pension plans by some bankrupt employers.[Footnote 21] 

CB plans may provide more understandable benefits and larger accruals 
to workers earlier in their careers, advantages that may be appealing 
to a mobile workforce. However, conversions of traditional FAP plans to 
CB plans redistribute benefits among groups of workers and can result 
in benefits for workers, particularly those who are longer tenured, 
that fall short of those anticipated under the prior FAP plan. Our 
simulations suggest that grandfathering plan participants who are being 
converted can protect those workers' expected benefits, and, in fact, 
such protections, in some form, are fairly common in conversions. Our 
simulations also show that without such mitigation, many workers can 
receive less than their expected benefits when converted from a 
traditional FAP plan, even in cases where the CB plan is of equal cost 
to the FAP plan it is replacing. As a result, as we noted in our 2000 
report,[Footnote 22] additional protections are needed to address the 
potential adverse outcomes stemming from the conversion to CB plans. 
For example, requirements for setting opening account balances could 
protect plan participants, especially older workers, from experiencing 
periods of no new pension accruals after conversion while other workers 
continue to earn benefits. 

Our simulated comparison of CB plans with the termination of a FAP plan 
leads to several important observations. First, the immediate vesting 
of all unvested workers requirement in a plan termination actually 
leads to a greater number of workers getting some retirement benefits 
and highlights the portability limitation of DB plans. Workers in an 
ongoing DB plan only receive benefits if they are vested. Appealing to 
a mobile workforce would seem to place an even greater significance on 
pension portability. Yet even CB plans, which often feature lump sum 
provisions in their design, do not address this issue because they 
typically have similar vesting requirements as traditional FAPs. 

In our simulations, vested workers under either a typical or equal cost 
CB plan still fare better than if the FAP plan is terminated. We note 
further that some sponsors of CB plans have already exited the DB 
system, a system that has been declining in sponsorship and 
participation for several decades now. There is a crucial balance 
between protecting workers' benefit expectations with unduly burdensome 
requirements that could exacerbate the exodus of plan sponsors from the 
DB system. Congress, as it grapples with the broader components of 
pension reform, has the opportunity not only to protect the benefits 
promised to millions of workers and eliminate the legal uncertainty 
surrounding CB plans that employers face, but also to craft balanced 
reforms that could stabilize and possibly permit the long-term revival 
of the DB system. 

Agency Comments: 

We provided a draft of this report to the departments of Labor, 
Treasury, and the PBGC. No written comments were provided by these 
agencies. They did, however, provide technical comments, which we 
incorporated as appropriate. 

We plan to provide copies of this report to the Secretaries of the 
Department of Labor and the Department of Treasury and to the Pension 
Benefit Guaranty Corporation and interested congressional offices. We 
will make copies available to others upon request. In addition, the 
report will be available at no charge on the GAO Web site at 
http://www.gao.gov. 

If you have any questions concerning this request please contact me at 
(202) 512-5932. Other major contributors to the report are listed in 
appendix VI. 

Signed by: 

Barbara D. Bovbjerg: 
Director, Education, Workforce and Income Security Issues: 

[End of section] 

Appendix I: Information on Cash Balance Pension Plans: 

Objectives: 

I. Literature Review: Evaluate current research on the implications of 
cash balance (CB) plan conversions: 

II. Plan Analysis: Review CB plans for the prevalence and types of 
transition provisions provided to protect workers' benefits when 
converting to CB plans: 

III. Simulations: Analyze how participants may fare under hypothetical 
CB plan conversions compared to the typical final average pay (FAP) 
plan and to a terminated FAP plan. 

Background: 

CB pension plans: 

* Are a type of hybrid defined benefit (DB) plan that expresses 
benefits as a hypothetical account balance based on pay, service, and 
interest credits. 

* Are classified as DB plans because participants' benefits are 
determined by a benefit formula. 

* FAP plans are a type of DB plan where participants' benefits are 
derived from a formula that is based, in part, on the employee's final 
average pay. 

Some conversions to CB plans have been controversial because of the 
effect they may have on pension benefits of workers with different ages 
and years of service. At the same time, CB plans have been noted for 
providing lump sum benefits that can be rolled over upon separation and 
providing benefit accruals based on pay and length of service. 

Wearaway periods: CB plan conversions can sometimes result in 
situations where some workers do not earn additional pension benefits 
while other workers continue to do so. 

Wearaway can occur for a variety of reasons. Examples of when wearaway 
can occur are: 

* At conversion when a participant's hypothetical opening account 
balance is set at less than the present value of the prior accrue 
benefits (the level of benefits received if paid out as a lump sum). 

* After conversion because of a fall in the federally mandated discount 
rate used to determine a lump sum amount. 

* In relation to annuity benefits earned as of conversion. It is 
dependent on the the form of annuity selected by the participant and 
the design of early retirement benefits in the prior plan's formula. 

During wearaway, pay and interest credits do not represent new benefit 
accruals until the CB account exceeds the value of benefits that could 
be paid under the old plan. 

Wear-away periods tend to be longer for older workers. 

Status of CB plans has been questioned after a court's ruling that at 
least one CB plan is age discriminatory. In late 1999, the Treasury 
Department stopped issuing IRS determination letters approving CB plan 
conversions. 

Proposed pension reform legislation includes provisions that could 
clarify some legal issues concerning CB plans. 

Some analysts believe that CB plans represent a potential opportunity 
to stem the decline or even revitalize the declining DB system. 

Methodology: 

I. Conducted review of academic and business literature. 

II. Analyzed Form 5500 [NOTE 1] information and attachments from 2003 
and earlier years capturing design features of CB plan conversions at 
the point of the initial conversion. Initial conversions from a 
traditional DB plan to a CB plan with most covering the period from 
early 1990s to 2003 with a few plan conversions in the mid 1980s. 
Subsequent changes to CB plans' design were not part of the analysis 
nor were changes made to other plan benefits. 

* Identified 843 plans with 100+ participants that indicated CB on Form 
5500; 

* Selected the 45 largest plans (1.8 million participants) and a random 
sample of 160 other plans; 

* Of these 205 plans, 31 large plans and 102 smaller plans met criteria 
as conversions. 

* Estimates are based on a random sample of plans, so slightly 
different estimates could result from a different random sample. We are 
95% confident that the true population values are within +/-9 
percentage points of the estimate percentages based on our sample. 

NOTE: 

[1] The Form 5500 Report, which is completed and filed by the Plan 
sponsor, is the primary source of information for both the federal 
government and the private sector regarding the operation, funding, 
assets, and investments of private pension plans and other employee 
benefit plans. The Form 5500 does not provide enough detail to 
determine the number of participants affected by a conversion. 

III. Simulate effects of a conversion to a CB plan and other 
scenarios - Used a pension policy micro-simulation model (PENSIM). 

* Model simulates lifetime retirement benefits for over 100,000 
participants in the 1955 birth cohort. Lifetime and monthly retirement 
income is analyzed for those who are: 

- projected to be alive at age 68, and: 

- vested in a job covered by a typical FAP plan that is converted to a 
CB plan (typical or equal cost). 

* Model allows comparison of benefits received from CB plans, ongoing 
traditional final average pay plans, and terminated FAPs. 

* See appendixes II, III, and IV for a discussion of our methodology. 

Summary of Findings: 

I. Literature provides few generalizable conclusions, particularly with 
regard to: 

* why sponsors convert to CB plans; 

* the benefit distributional effects of such conversions. 

II. Analyzed plan conversions show most, but not all: 

* converted accrued benefits into an opening account balance and 
offered some form of transition provisions. 

* had age and service eligibility restrictions on transition 
provisions. 

III. Regardless of age, workers who were converted from an FAP plan to 
a typical CB plan generally had reductions from expected FAP benefits. 
A majority of younger workers received larger benefits under a 
conversion to an equal cost CB plan. 

* Analysis of lifetime benefits under a conversion to an equal cost CB 
plan does not change basic findings. 

* Vested workers receive larger benefits under a CB conversion of 
either type compared to benefits received under termination of an FAP. 

I. Literature Review: 

Research Provides Limited Evidence to Generalize About CB Conversions: 

Data and other methodological issues (e.g., sampling methods) limit 
generalization of results. 

Conversion impact depends on a variety of factors including plan 
generosity, transition provisions, and firm specific employee 
demographics. 

Also, because of the different accrual patterns in a CB plan compared 
to a FAP plan, for a variety of workers, the impact of a conversion 
varies. 

Current research provides limited evidence as to: 

* Why sponsors convert to CB plans. 

* How participants are likely to fare under a CB plan relative to the 
traditional DB plan that is being replaced. 

CB plan conversions have distributional effects on pension wealth: 

* Younger, more mobile workers who vest usually benefit. 

* Older workers with long job tenure likely to experience a loss, 
particularly if they are near age and service requirements for early 
retirement. 

Note: About 36 percent of our sampled individuals (57,049) who 
participated in at least one private sector FAP or CB plan 10 never 
vested in such plans. 

II. Plan Analysis: 

Figure 1: Characteristics of Conversions: 

[See PDF for image] 

Source: GAO Form 5500 data analysis. 

Note: IRS froze determination letter issuance in 1999. 

[End of figure] 

Methods for Determining Opening Account Balances at Conversion: 

There were 2 primary methods for setting the opening account balance: 

1. Present Value (PV) of old accrual: account balance is based on 
accrued benefit at conversion; or: 

2. A+B: (A) preserves prior benefits as annuities + (B) CB opening 
balance is $0. 

Opening account balance depends on a formula that may include factors 
such as interest rates, employer-added incentives, early retirement 
benefits, & other assumptions. 

Figure 2: Most Conversions Set Opening Account Balance at Present Value 
of Old Accrual: 

[See PDF for image] --graphic text: 

Pie chart with three items. 

PV of old accrual: 75%; 
A+B: 17%; 
Other/Don't Know: 8%. 

Source: GAO Form 5500 data analysis. 

[End of figure] 

Conversion Interest Rates and Transition Provisions Are Key Factors in 
Wearaway: 

23 of 39 plans with data available used conversion interest rates 
within 1 % of the prior month's 30-year Treasury rate: 

Wearaway may occur when a participant's hypothetical opening account 
balance is set at less than the present value of its accrued benefits 
using 30-year Treasury rate, as specified under the Internal Revenue 
Code. 

Transition provisions (e.g., grandfathering, transition pay credits) 
are important factors in mitigating wearaway. 

* Grandfathering prevents wearaway for participants who continue to 
accrue benefits under the prior plan formula. 

Figure 3: Most Sponsors Included Some Form of Transition Provisions: 

[See PDF for image] 

[End of figure] 

About Half of Plans Offered Some Form of Grandfathering: 

Grandfathering was offered in 47% of all conversions and in 55% of the 
largest converted plans, although most of these provisions had some 
form of age or service restrictions. 

* Eligibility requirements in plans offering grandfathering included: 

- age plus service; 
- all employees; 
- age or service.  

* Age plus service was the method most often used. 

Most Conversions Used Weighted Ongoing Pay Credits: 

62% of all conversions used some form of weighted pay credits (those 
that increase based on the participant's age and/or service). 

36% of all conversions used level pay credits (those that are a level 
function of salary). 

About 42% of large conversions used an age plus service method for 
providing ongoing pay credits. 

Weighted pay credits tend to benefit older and longer-tenured workers 
relatively more than level pay credits. 

Figure 4: 36 Percent of All Conversions Used Level Pay Credits: 

[See PDF for image] 

[End of figure] 

III. Simulations: 

Simulations of Plan Conversions: 

Compare monthly and lifetime retirement income for workers from the 
1955 birth cohort who were converted at different ages to a CB plan and 
were either: 

* Not vested in a typical, traditional FAP plan at the time of 
conversion but stay on the job and later vest; or: 

* vested at the time of conversion in a typical, traditional FAP plan; 

4 Simulations: 

* Typical CB plan vs. typical FAP plan; 
* Typical CB plan vs. terminated FAP plan; 
* Equal cost CB plan vs. typical FAP plan; 
* Equal cost CB plan vs. terminated FAP plan. 

Plan Characteristics: Typical Final Average Pay Plan: 

Immediate eligibility and 5-year cliff vesting and normal retirement 
age 65, early retirement age 55 with 10 years of service with early 
retirement benefit reduction of 5 percent per year. 

Immediate disability retirement benefits for those vested, no survivors 
benefits or joint-and-survivor annuities. 

Benefits paid as a nominal annuity (i.e., no benefit COLA). Terminal 
earnings (final pay) is final five-year average. 

Benefits formula is excess integrated with base rate of 1.5 percent of 
final pay per year of service and has a rate of 0.45 percent of final 
pay per year of service for those amounts in excess of the social 
security maximum. 

Typical FAP plan design based on prior GAO reports, literature reviews, 
and discussions with pension actuaries, consultants knowledgeable about 
DB plans. 

Plan Characteristics: Typical Cash-Balance Plan: 

Immediate eligibility and five-year cliff vesting; base pay credit of 
3.0 percent of salary for employee with age-plus-service (APS) less 
than or equal to 35. 

Pay credit rises gradually until it is 6.0 percentage points above the 
base pay credit for employee with APS greater than or equal to 70. 

Cash-balance account crediting rate is the Treasury rate. 

Employee rolls over account balance at separation and earns Treasury 
rate. Balances converted to nominal single-life annuity at retirement 
using the Treasury rate and the GAM 83 mortality table adjusted to the 
pertinent year. 

Typical CB plan design is based on plans analyzed in GAO's Form 5500 
data, and confirmed by pension actuaries, consultants knowledgeable 
about CB plans. 

Some typical CB plan design features may have changed in light of 
recent court decisions and congressional interest: 

Plan Characteristics: Equal Cost Cash Balance Plan: 

Same assumptions as the typical CB plan except: 

* Base pay credit of 7.35 percent of salary for employee with age-plus- 
service (APS) less than or equal to 35. 

* Pay credit rises gradually until it is 6.0 percentage points above 
the base pay credit for employee with APS greater than or equal to 70. 

Equal cost CB plan used for our simulations is: 

* More generous pay credits than virtually all plans in our Form 5500 
analysis; 

* More generous than those specified in pension research;  

* Though not explicitly modeled, to some extent, our equal cost cash 
balance plan could be considered to implicitly include other 
enhancements made by employers to other benefits, such as those 
provided by a DC plan, for example. 

Plan Characteristics: Cash-Balance Plan Conversions: 

Opening cash balance equal to the present value of accrued final-pay 
benefit at plan conversion date. Discount rate is the 30-year Treasury 
rate. Mortality table is GAM 83 projected for mortality improvements to 
the pertinent year. 

Employees who meet an age-plus-service (APS) greater than or equal to 
60 eligibility requirement at plan conversion date are grandfathered 
under the FAP plan and receive benefits according to that plan's 
provisions. 

Treatment of early retirement benefits: 

* The FAP plan considered in this report has a modest early retirement 
subsidy: benefits are reduced by 5 percent for each year benefits are 
claimed before age 65. 

* Federal anti-cutback rules are simulated correctly in that when a FAP 
plan is converted or terminated, employees who remain with the firm 
until early retirement age are eligible for early retirement benefits 
under the old plan. 

Plan Characteristics: Terminated FAP Plan: 

Same assumptions as the typical FAP plan and: 

* Terminated FAP plan has immediate cessation of additional benefit 
accrual. 

* Current law on plan terminations requires "immediate vesting" for 
"non- vested" workers regardless of years of service. This results in 
previously ineligible workers now receiving a small benefit. 

Analysis focuses on "vested" workers only --those with at least five 
years service. 

FAP plan and termination scenarios provide benchmark range of possible 
comparisons, including plan freezes: 

Monthly Retirement Income Results vs. Lifetime Benefits Results: 

Results are shown in terms of present value of lifetime benefits for 
those alive at age 68 and monthly retirement income for those alive at 
age 68. Age 68 is the age when the largest number of individuals are 
retired and alive in our sample. 

Monthly benefit and lifetime benefit comparisons for those alive at age 
68 will have slightly different results: 

* For example, vested workers under CB plans who typical l separate 
earlier in their careers may start benefits at a different age compared 
to similar workers who separate from an FAP plan. 

* Thus, the present value of lifetime benefits paid to these workers 
under CB plans may be distributed over a different time period than for 
similar workers under FAP plans. So monthly benefits may be slightly 
different. 

Comparisons of Median Monthly Retirement Income: Typical CB Plan vs. 
Typical FAP Plan: 

Regardless of age at conversion, more workers who are converted from a 
FAP plan to the typical CB plan experience benefit reductions. (See 
figure 5). 

* Key factor is lack of generosity of the typical CB plan. 
* Grandfathering protects those workers who meet eligibility 
requirements. 

For those not grandfathered, at conversion ages 30, 40, and 50: (See 
figure 6): 

* Reductions in median monthly income range from $59 for conversions at 
age 30 to $238 for conversions at age 5D. 

* Increases range from $15 per month for conversions at age 30 to $27 
per month for conversions at age 50. 

Those who benefit as well as those who lose from conversion at ages 30 
and 40 are more likely to be men and at age 50 are more likely to be 
women. 

At all conversion ages, those experiencing greater benefits from 
conversion are generally more highly educated and have higher incomes. 

Figure 5: All Conversion Ages in Typical CB Plan More Likely to Have 
Lower Monthly Benefits Compared to Typical FAP: 

[See PDF for image] 

[End of figure] 

Figure 6: Median Monthly Difference in Retirement Income For Those Not 
Covered By Grandfathering Under Selected Conversion Ages: 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

Median benefits before conversion at age 30 is $809, at age 40 is 
$1083, and at age 50 is $1323. 

[End of figure] 

Comparisons of Median Monthly Retirement Income: Typical CB Plan 
Conversion vs. Terminated Typical FAP Plan: 

Regardless of age, all vested workers who converted to a typical CB 
plan experienced monthly benefit increases compared to a terminated FAP 
plan. 

At conversion ages 30, 40, and 50, increases range from $150 per month 
for conversions at age 30 to $305 per month at age 50. Grandfathered 
benefits for those eligible under the CB plan greatly impact results 
shown for older workers.(See figure 7.) 

* Terminated plan benefits are shown for only those participants who 
were vested in the typical CB plan. 

Figure 7: Median Monthly Benefits Greater for Typical CB Plan 
Conversion Than Terminated FAP Plan: 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

Median benefits before conversion at age 30 is $390, at age 40 is $454, 
and at age 50 is $742. These results include grandfathered benefits for 
30 those with APS >=60. 

[End of figure] 

Workers Converted to Typical CB Plan from Typical FAP at Earlier Ages 
Generally Receive Reduced Lifetime Benefits: 

Comparison of lifetime benefits for typical CB plan and typical FAP 
plan does not change basic findings from monthly benefit comparisons. 

* Regardless of age at conversion, more workers who are converted from 
a FAP plan to the typical CB plan have lower present value of lifetime 
benefits. (See figure 8.) 

* Nearly half of workers experiencing a conversion at age 50 are 
grandfathered in their FAP benefit. 

Figure 8: Present Value of Lifetime Benefits Comparison of Typical FAP 
vs. Typical CB: 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

[End of figure] 

Grandfathering Protects Eligible Older Workers' Monthly Benefits When 
Converted to an Equal Cost CB Plan from a Typical FAP Plan: 

Grandfathering protects eligible older workers' benefits converted to 
an equal cost CB Plan from a FAP Plan (See figure 9.) 

More workers who converted from a FAP plan to an equal cost CB at age 
30 generally experience monthly benefit increases: 

* Increases range from $90 per month for conversions at age 30 to $29 
per month for conversions at age 50. (See figure 10.) 

* Reductions range from $75 per month for conversions at age 30 to $128 
per month for conversions at age 50. 

For all conversion ages, those with a longer job tenure and who are not 
covered by grandfathering protections are more likely to experience 
lower benefits than those with shorter tenure: 

Figure 9: Workers Who Convert at Age 30 More Likely to Have Higher 
Monthly Benefits under Conversion to Equal Cost CB Plan from Typical 
FAP: 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

[End of figure] 

Figure 10: Median Monthly Difference in Retirement Income for Those 
with No Grandfathering Protection under Various Conversion Ages (2004 
$): 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

Median benefits before conversion at age 30 is $809, at age 40 is 
$1083, and at age 50 is $1323. 

[End of figure] 

Comparisons of Median Monthly Retirement Income: Equal Cost CB Plan vs. 
Terminated Typical FAP Plan: 

Regardless of age, all vested workers who converted to an equal cost CB 
plan experience benefit gains compared to a terminated FAP. 

Median increases range from $283 per month for conversions at age 30 to 
$396 per month for conversions at age 50. Grandfathered benefits for 
older workers under the CB greatly impact results.(See figure 11.) 

* Terminated plan benefits are shown for only those participants who 
were vested in the equal cost CB plan. 

Figure 11: Median Monthly Retirement Income Greater under Equal Cost CB 
Plan Conversion Than Terminated FAP Plan: 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

Median benefits before conversion at age 30 is $390, at age 40 is $454, 
and at age 50 is $742. These results include grandfathered benefits for 
those with APS >= 60. 

[End of figure] 

Workers Converted to Equal Cost CB Plan from Typical FAP at Age 30 
Receive Greater Lifetime Benefits: 

Comparison of lifetime benefits for equal cost CB plan and typical FAP 
plan consistent with basic findings from monthly benefit comparisons 
(See figure 12). 

* More workers converted to an equal cost CB plan from a typical FAP at 
age 30 receive greater present value of lifetime benefits through 
conversion than would at later conversion ages. 

* Nearly half of workers experiencing a conversion at age 50 are 
grandfathered in their FAP benefit, while a significant number (41 %) 
of unprotected workers converted at age 50 experience a lower present 
value of lifetime benefits. 

* Outside of grandfather protections, results show a redistribution of 
benefits from older workers to younger workers. 

Figure 12: Present Value of Lifetime Benefits Comparison of Equal Cost 
CB vs. Typical FAP: 

[See PDF for image] 

Source: GAO's analysis using the PENSIM model. 

[End of figure] 

[End of slide presentation] 

[End of section] 

Appendix II: Review of Literature on Cash Balance Plans: 

GAO compiled a comprehensive list of the academic literature on CB 
pension plans since our last reports on the subject issued in 
2000,[Footnote 23] focusing on those studies that contained original 
and material empirical work on the issue. After constructing a list of 
the relevant literature, we eliminated partial or incomplete studies, 
those that did not contain material empirical work and those that 
exhibited serious methodological concerns. We then conducted a more 
detailed review of the remaining studies, including several surveys of 
CB plans. The review concentrated on the studies' findings and on the 
methodological issues that may limit conclusions that can be reached. 
There is a list of the studies and surveys reviewed for this report at 
the end of this appendix.[Footnote 24] 

Although there are academic studies that attempt to go beyond anecdotal 
information, the literature remains in its infancy. Data and other 
methodological issues often limit the conclusions that the empirical 
studies examining the impact of plan conversions can reach and, the 
ability to generalize their results. In general, the results of all 
studies are sensitive to assumptions regarding earnings growth, 
interest rates, investment returns, and turnover rates. Because some 
specifics of the simulations presented in some studies do not include 
sufficient detail, it is difficult to evaluate the quality of the 
estimates in some cases.[Footnote 25] 

Lack of Available Data Limits Empirical Studies: 

Because of the limited availability of data on actual conversions and 
on the workforce associated with a particular conversion, few empirical 
studies have the ability to examine actual conversions.[Footnote 26] 
Because a range of factors that are unique to each conversion influence 
the final impact on workers--including demographic characteristics, the 
transition benefits offered during the conversion and the generosity of 
the new CB plan relative to the old plan it is replacing--it is 
difficult to extend the results of the literature to the actual 
experience of workers. For example, in the conversion to a new plan, a 
sponsor may eliminate early retirement subsidies--a significant reason 
why older workers may receive lower benefits. Similarly, some employers 
may offer transition benefits that can help to ameliorate the adverse 
effects of plan changes on the more senior segment of the workforce, 
while others do not. Other studies focus on "hypothetical" or 
"prototypical" workers instead of actual employees and therefore cannot 
make definitive statements about many segments of the population or 
actual workers in the plans analyzed.[Footnote 27] 

In addition, the majority of the research simulates the effects of plan 
conversions on the workforce assuming that the conversion is cost 
neutral (the cost of the new CB plan is equal to the cost of the old DB 
plan so that overall pension benefits remain constant). However, some 
research suggests that the retirement benefit implications due to a 
shift to a less generous CB plan differ materially from the effects of 
a cost-neutral conversion.[Footnote 28] Moreover, several studies were 
limited to plans that include transition benefits that often ensure 
that existing workers do not suffer significant losses in pension 
wealth during plan conversions and exclude pension wealth on previous 
jobs.[Footnote 29] Thus, their inclusion/omission may lead to a bias in 
the empirical findings either in favor or against CB plan designs. 

Small Sample Size Limits Survey Reports: 

Some studies examine only a few plan conversions or rely on assumptions 
based upon information extracted from the limited surveys discussed 
below. Since the plans analyzed may not be representative, the outcomes 
may not generalize to the typical CB conversion or related to the 
broader workforce.[Footnote 30] 

A few widely cited studies which use survey data in an attempt to 
determine the reasons why employers initiate CB plan conversions 
contain methodological limitations and base their conclusions on 
employers' self perceptions along with additional biases, and cannot be 
extended beyond the small samples of firms studied.[Footnote 31] For 
example, one study is limited by a low response rate (20 percent) and 
insufficient information about the population and sampling method, 
survey instrument and its development, while the others raise concerns 
over the potential for sample bias and/or the additional bias due to 
the fact that over half of the plans evaluated were those for which the 
researchers were the primary design consultants.[Footnote 32] In 
general, we determined that the results from these surveys may not be 
representative of the population of CB plan conversions and 
methodological limitations suggest that the results should be 
interpreted with caution. 

Studies and Surveys Reviewed: 

Clark, Robert. "Pension Plan Options: Preferences, Choices and the 
Distribution of Benefits." Pension Research Council Working Paper, PRC 
WP. 2003-24. 

Clark, Robert, and Fred W. Munzenmaier. "Impact of Replacing a Defined 
Benefit Pension with a Defined Contribution Plan or a Cash Balance 
Plan." North American Actuarial Journal, 5 (1). (2003-4): 32-56. 

Clark, Robert, and Sylvester Schieber. "The Transition to Hybrid 
Pension Plans in the United States: An Empirical Analysis." Private 
Pensions and Public Policies, eds. W. Gale et al. Washington, D.C. 
Brookings Institution. 2004. 

Coronado, Julia, and Philip Copeland. "Cash Balance Pension Plan 
Conversions and the New Economy." Federal Reserve Board Working Paper. 
November 2003. 

D'Souza, Julia, John Jacob, and Barbara Lougee. Why Do Firms Convert to 
Cash Balance Pension Plans? An Empirical Investigation. Cornell 
University, December 2004. 

Johnson, R.W., and C. Uccello. "Cash Balance Plans and the Distribution 
of Pension Wealth." Industrial Relations, 42(4) (2003): 745-773. 

Mellon Financial Corporation. 2004 Survey of Cash Balance Plans. 
Secaucus, N.J. 2004. 

Niehaus, Greg, and Tong Yu. "Cash-Balance Plan Conversions: Evidence on 
Excise Taxes and Implicit Contracts." The Journal of Risk and 
Insurance, 72(2). 2005. 

PriceWaterhouseCoopers. Survey of Conversions from Traditional Pension 
Plans to Cash Balance Plans. July 2000. 

Purcell, Patrick. Pension Issues: Cash Balance Plans. Washington, D.C. 
Congressional Research Service, August 2003. 

Rao, A., L. Higgins, and S. Taylor. "Cash Balance Pension Plans: Good 
News or Bad News." Journal of Applied Business Research, 18 (3). 2002. 

Samwick, Andrew, and Jonathan Skinner. "How will 401(k) Plans Affect 
Retirement Income?" American Economic Review, Vol. 94, No.1. March 
2004. [Footnote 33] 

Schieber, Sylvester. "The Shift to Hybrid Pensions by U.S. Employers: 
An Empirical Analysis of Actual Plan Conversions." Pension Research 
Council Working Paper, PRC WP. 2003-23. 

Watson Wyatt Worldwide. The Unfolding of a Predictable Surprise: A 
Comprehensive Analysis of the Shift from Traditional to Hybrid Plans. 
2000.[Footnote 34] 

[End of section] 

Appendix III: Analysis of Form 5500 Data on Cash Balance Plans: 

Sample of Cash Balance Plans: 

To obtain information about CB plan conversions, we reviewed 2001 Form 
5500 data for a random sample of CB plans. We drew this sample from the 
population of plan sponsors that indicated on their Form 5500 that they 
sponsored a CB plan.[Footnote 35] The study population consisted of all 
CB plans as of 2001 having at least 100 active participants, 
supplemented with an additional 96 CB plans that were identified by 
PBGC based on 2002 and 2003 data not yet available to the GAO. For the 
purpose of this report, we excluded plans having fewer than 100 
participants in order to focus on the plans with the greatest number of 
participants.[Footnote 36] This resulted in a total of 843 plans in our 
study population. 

We used the Form 5500 as our primary source of information for 
analyzing the prevalence of transition provisions used by plan sponsors 
when they converted to a CB plan because it was a cost effective way of 
obtaining conversion information for a large number of plans. It would 
have been optimal to obtain summary plan descriptions (SPD) from plan 
sponsors. However, since plan sponsors are no longer required to file 
SPDs, direct contact with such a large number of plan sponsors would 
have been cost prohibitive.[Footnote 37] 

Although it is the most comprehensive pension data available, using 
Form 5500 data also presented limitations and weaknesses. We had 
limited ability to determine the full scope of conversions beyond tax 
year 2001 since this was the most current and complete 5500 data 
publicly available from the Department of Labor (Labor) when we began 
our analysis. In addition, we also had difficulty obtaining Form 5500 
filings for some years, particularly from the early 1990s and before. 
As previously reported by GAO,[Footnote 38] statutory reporting 
requirements, processing issues, and current Labor practices affect the 
timeliness of the release of available Form 5500 information, in some 
cases, resulting in a 3-year lag between data reporting and its 
release. In addition, information provided on the form and attachments 
proved, in some instances, to be inconsistent from one plan sponsor to 
another. This inconsistency hampered our data collection efforts, and 
subsequently, we were unable to provide meaningful results on all of 
the information our data collection instrument was designed to capture. 
For example, we found that not all plans reported having a lump sum 
feature for those who separate before retirement although we believed 
some of those plans did so. In addition, some plans provided extensive 
details on discount rates and formulas used in their opening account 
balance calculations while others provided no information. In 
situations where we could not find information on the form or its 
attachments, we recorded this as "information not found." Finally, 
although the Form 5500 provides information on the number of active 
participants in the entire plan, it was often impossible to determine 
how many of those participants were converted to the CB plan in 
instances where only certain employee groups were converted. 
Nevertheless, our estimates are based on plan-level data. 

Sample Design: 

The sample design for this study was a stratified random sample of CB 
plans, with the 45 largest plans comprising the first stratum, and an 
additional 160 plans selected from the remaining plans, producing a 
total sample of 205 plans. Of these sampled plans, we obtained 
sufficient plan information for 165, we found 21 plans to be out-of- 
scope for our study (not CB plans), and for 19 plans we could not 
obtain sufficient information on the plans. Also, of these 205 sampled 
plans, 7 plans started a new CB plan only for the new employees, while 
keeping their existing employees in the traditional DB plan. We did not 
include these plans in our analysis since they were start-up CB plans 
and not converted CB plans. 

This sample disposition information is summarized in table 1. 

Table 1: Cash Balance Plan Sample Disposition: 

Stratum: 1. Largest 45 plans; 
Population: 45; 
Sample: 45; 
Not CB plan[A]: 2; 
Sufficient information: 40; 
Converted plan: 31; 
Insufficient information: 3; 
Completion rate: 93%. 

Stratum: 2. Rest of plans; 
Population: 798; 
Sample: 160; 
Not CB plan[A]: 19; 
Sufficient information: 125; 
Converted plan: 102; 
Insufficient information: 16; 
Completion rate: 90%. 

Total; 
Population: 843; 
Sample: 205; 
Not CB plan[A]: 21; 
Sufficient information: 165; 
Converted plan: 133; 
Insufficient information: 19. 

Source: GAO analysis of sampled Form 5500 data: 

[A] Sampled plans that were determined to be hybrid plans other than CB 
plans were outside the scope of this study. 

[End of table] 

Description of the Review: 

After obtaining Form 5500s, attachments, and summary plan descriptions 
where available[Footnote 39] for sampled plans, we recorded plan 
features on a standardized instrument containing 51 questions designed 
to capture information about: 

* characteristics of the traditional DB plan, such as the conversion 
date and the type of DB plan in place before the conversion; 

* the conversion such as when it took place, which employees were 
affected, and the type of transition provisions used; and: 

* the ongoing features of the CB plan, such as pay credits and interest 
credits provided at the time of conversion. 

Estimates: 

Estimates of converted CB plans were based on our sample of CB plans. 
Estimates for this target population were formed by weighting the 
survey data to account for both the sample design and the completion 
rate. 

Sampling Error: 

Because we surveyed a sample of CB plans, our estimates are subject to 
sampling errors that are associated with samples of this size and type. 
A different random sample could produce slightly different estimates. 
Our confidence in the precision of the results from this sample is 
expressed in 95 percent confidence intervals. The 95 percent confidence 
intervals are expected to include the actual results for 95 percent of 
the samples of this type. We calculated confidence intervals for our 
study results using methods that are appropriate for a stratified, 
probability sample. For the percentages presented in this report, we 
are 95 percent confident that the results we would have obtained if we 
had studied the entire study population are within ± 9 or fewer 
percentage points of our results. For example, we estimate that 47 
percent of the CB plan conversions offered some form of grandfathering. 
The 95 percent confidence interval for this estimate would be no wider 
than ± 9 percent, or from 38 percent to 56 percent. 

Nonsampling Error: 

In addition to sampling error, the practical difficulties in conducting 
sample file reviews of this type may introduce other types of errors, 
commonly referred to as nonsampling errors. For example, questions may 
be misinterpreted, or errors could be made in keying questionnaire 
data. We took several steps to reduce these errors. 

To minimize some of these errors, each completed data collection 
instrument was verified for accuracy, and a process of content analysis 
was undertaken to resolve interpretation differences. We performed 100 
percent verification of all keypunched questionnaire data. We also 
traced and verified the data collection instrument to descriptive 
statistics and output generated by GAO data analyst staff. In the event 
of changes, the entire verification process was again performed which 
included 100 percent verification of the new keypunched data, 
additional content analysis to verify the change being made, and 
reverifying the output generated by the data analyst staff. 

In addition, we were only to record a plan as having a characteristic 
if evidence of that characteristic was found in the file review. For 
example, it is possible that some CB plans had transition provisions at 
conversion that were not clearly indicated in the 5500 files and 
attachments. We can only conclude that evidence of transition 
provisions being offered was not found in the 5500 data for this plan. 

[End of section] 

Appendix IV: Analysis of Simulated Cash Balance Plans and Traditional 
Final Average Pay Plans: 

To analyze the effects of a CB plan conversion on individual workers, 
we used a pension policy simulation model PENSIM.[Footnote 40] PENSIM 
is a dynamic microsimulation model for analysis of the retirement 
income implication of government policies affecting employer-sponsored 
pensions. The model has been developed by the Policy Simulation Group 
(PSG) since 1997 with funding by the Office of Policy and Research at 
the EBSA of the U.S. Department of Labor. To meet GAO's needs for this 
project the model includes several enhancements that permit the 
analysis of CB plan conversions. 

PENSIM uses discrete event simulation methods to generate a sample of 
life histories that reflect the effects of individual risks (mortality, 
disability, earnings, etc.) The likelihood and timing of simulated life 
events are represented by a variety of probability models, including 
hazard functions and multinomial logit models that have been estimated 
using various survey data sets. The timing of job history events and 
employer pension sponsorship are estimated using longitudinal SIPP data 
and longer-term longitudinal PSID data. Simulated life histories 
contain information on educational attainment, disability, mortality, 
and a complete job history that includes details on earnings and 
pension accumulation for each job. Details of pension plan(s) covering 
a worker on a job are assigned using a pension characteristics 
imputation model, which has been estimated with late- 1990s BLS 
Employee Benefit Survey data.[Footnote 41] Life histories simulated by 
PENSIM generate social security benefit and payroll tax results similar 
to those generated by the Congressional Budget Office's long-term 
social security model (CBOLT). 

PENSIM simulates the pension accruals of employees as they move from 
job to job over their lifetime and estimates their retirement income 
from a lifetime of pension coverage. With its CB plan analysis 
capability, PENSIM can also simulate changes in retirement income 
caused by conversions from traditional defined benefit pension plans to 
CB pension plans. PENSIM produces a large random sample of simulated 
life histories for people born in a given year and for their spouses 
who may have been born in a different year. For our report, we do not 
include spousal benefits in the analysis. The members of the birth 
cohort sample experience demographic and economic events, the incidence 
and timing of which vary by age, gender, education, disability, and 
employment status. The types of life events that are simulated in 
PENSIM include: 

* demographic events (birth, death); 

* schooling events (leaving school at a certain age, receiving a 
certain educational credential); 

* family events (marriage, divorce, childbirth); 

* disability events; 

* initial job placement; 

* job mobility events (earnings increases while on a job, duration of a 
job, movement to a new job, or out of the labor force); 

* pension events (becoming eligible for plan participation, choosing to 
participate, becoming vested, etc.); and: 

* retirement events. 

This broad scope of simulated life events is necessary in order to 
simulate lifetime pension accruals with any realism. 

Simulated Pension Plans: 

Three pension plans are used in this study to simulate several kinds of 
private-sector plan conversions and terminations. The baseline from 
which the conversion/termination analysis starts is a typical final-pay 
defined benefit pension plan ("typical FAP"). This typical FAP plan has 
common private-sector characteristics and a benefit formula that 
produce an employer cost of providing the pension equal to the average 
cost of the full variety of final-pay plans observed in BLS Employee 
Benefit Survey data.[Footnote 42] The second plan considered in the 
analysis is a typical CB pension plan ("typical CB") that has been 
specified to have characteristics found to be typical of the plans we 
analyzed in the GAO Form 5500 data collection conducted as part of this 
study.[Footnote 43] The third plan is a more generous version of the 
typical CB pension plan ("equal-cost CB") that has been constructed to 
have the same employer cost as the typical FP plan. 

The typical FAP plan has the following characteristics: 

* immediate eligibility; 

* 5-year cliff vesting; 

* normal retirement age of 65; 

* early retirement age of 55 with 10 years of service with benefits 
reduced by five percent for each year of early retirement (i.e., fifty 
percent reduction at age 55); 

* immediate unreduced disability retirement benefit for those who are 
vested; 

* no survivors' benefit for those who die on the job; 

* selection of single-life annuity at retirement (no selection of joint 
and survivor annuity because study ignores survivors' benefits); 

* benefit paid as a nominal annuity (i.e., no benefit COLA); 

* FAP is the highest consecutive five-year average; and: 

* benefit formula is excess integrated with a base rate of 1.5 percent 
of final pay per year of service and has a rate of 0.45 percent of 
final pay per year of service for those amounts over the social 
security maximum. 

The typical CB plan has the following characteristics: 

* immediate eligibility; 

* 5-year cliff vesting; 

* base pay credit of 3.0 percent of salary for employee with age plus 
service of less than or equal to 35; 

* pay credit rises gradually until it is 6.0 percentage points above 
the base pay credit for employee with age plus service greater than or 
equal to 70 (this results in a maximum pay credit of 9.0 percent of 
salary); 

* interest credit is calculated using current 30-year Treasury rate; 

* employee always rolls over full account balance into an IRA at job 
termination;[Footnote 44] 

* rollover account earns current 30 year Treasury rate each year; 

* account balances are converted to a nominal single-life annuity at 
retirement using the treasury rate, current projected mortality rates, 
and projections of future reductions in mortality. An annuity loading 
fee was used such that it ensures the provider is solvent (i.e., 1.5 
percent for women and 3.0 percent for men); 

* at conversion, opening account balance is equal to the statutory 
present value of accrued benefit under old plan; 

* at conversion, employee with age plus service greater than or equal 
to 60 is grandfathered in old plan so that benefit at job end can never 
be lower than it would have been if the old plan had continued 
operating: 

The equal-cost CB plan has the following characteristics: 

* same characteristics as the typical CB plan except the base pay 
credit is 7.35 percent of salary for employee with age-plus-service 
(APS) £ 35, rather than the 3.0 percent of salary in the typical CB 
plan, and: 

* pay credit rises gradually until it reaches a maximum of 6 percentage 
points above the base pay credit for employee with age plus service 
greater than or equal to 70. 

These three plans are used to simulate the following conversion and 
termination situations: 

* typical CB plan versus typical FAP plan; 

* typical CB plan versus FAP plan that is terminated with no 
replacement of any kind; 

* equal cost CB plan versus typical FAP plan; and: 

* equal cost CB plan versus FAP plan that is terminated with no 
replacement of any kind. 

Simulation Assumptions: 

All PENSIM runs conducted for this study simulate a 3 percent sample of 
the 1955 birth cohort using historical information through the present 
and 2004 OASDI Trustees Report intermediate-cost assumptions for the 
future projection. The resulting cohort sample consists of 151,263 
individuals born in 1955 either in the U.S. or elsewhere (and 
immigrated to the U.S. in a subsequent year). 

The PENSIM runs differ only in their assumptions concerning private- 
sector sponsorship of the typical FAP plan (which is assumed to be 
offered by all private-sector employers who are simulated to offer a 
FAP DB plan) and the typical or equal-cost CB plan (which is assumed to 
be offered by all private-sector employers who are simulated to offer a 
CB DB plan). The employment history of each individual and 
coverage/participation in employer-sponsored DB and DC plans are a key 
component to determining the lifetime benefits for each individual. 
Pension benefits accumulated as a result of movement to different 
employers during a person's entire work history is included in reported 
results. Pension coverage across a lifetime may include participation 
in a variety of DB and DC plans or no coverage at all. Workers who are 
not covered under either a private sector FAP or a CB pension plan are 
excluded from the study analysis. Most of the study analysis focuses on 
those who have vested in at least one private-sector FAP or CB plan. 
Public-sector FAP plans are assumed to be unchanged across all runs, 
and all other types of DB plans (i.e., other than FAP or CB) and all 
types of DC pension plans in all sectors are assumed to be unchanged 
across all the runs. Additionally, all the PENSIM runs used in this 
study contain the exact same life histories and job careers for the 
cohort sample. That is, the only change that takes place in all PENSIM 
runs is whether the private sector DB plan is a FAP or a CB 
plan.[Footnote 45] The simulation analysis provides the following 
general results about the cohort sample: 

* sample individuals who had at least one private-sector FAP or CB 
pension plan: 57,049 (100.0 percent); 

* sample individuals who never vest in such a plan: 20,274 (35.5 
percent); 

* sample individuals who vest in such a plan but die before age 68: 
6882 (12.1 percent); 

* sample individuals who vest in such a plan and live to age 68: 29,893 
(52.4 percent); 

* of the 29,893, 87.0 percent vest in just one FAP or CB pension plan 
over their lifetime, while 12.3 percent vest in two plans, and all but 
three of the rest vest in three such plans; and: 

* of the 26,018 who vest in just one FAP or CB pension plan, only 10.2 
percent accumulate thirty years or more of service on that job. 

The study makes four pair-wise comparisons between PENSIM runs: (1) 
typical CB plan versus ongoing typical FAP plan, (2) equal-cost CB plan 
versus ongoing typical FAP plan, (3) typical CB plan versus terminated 
typical FAP plan, and (4) equal-cost CB plan versus terminated typical 
FAP plan. In each comparison, the difference in lifetime pension income 
between the two runs is calculated for each sample individual. Lifetime 
pension income includes all pension benefits earned during a person's 
career even if they are unaffected by the assumed change in employer 
pension sponsorship between the two runs. Lifetime pension income is 
expressed in one of two ways: the present value of all pension income 
received over the individual's lifetime or the monthly pension income 
received at age 68. In both cases, the monetary amounts are expressed 
in 2004 dollars. 

The conversion/termination of the typical FAP plan is assumed to occur 
at one of eight ages: 25, 30, 35, 40, 45, 50, 55, and 60. The entire 
cohort sample was put through eight separate simulation runs --one 
simulation run for each age. Results are shown for those who were 
vested in a job that was caught in a conversion. The conversion 
provisions (opening balance and grandfathering) described above for the 
typical and equal-cost CB plans were found to be typical in our 
analysis of the Form 5500 sample drawn for this study. Based on our 
Form 5500 sample plan analysis and meetings with consultants who are 
experts on CB plans, there was concurrence that the opening CB would be 
equal to the present value of accrued benefit under the old plan at the 
conversion date. The expected present value of the accrued benefit is 
calculated using a GAM83 mortality table adjusted to the proper year 
and the current Treasury rate as the discount rate.[Footnote 46] If 
eligible for grandfathering, an individual receives the higher of two 
amounts at job termination: the accumulated CB under the new plan and 
the expected present value of the benefit the individual would have 
received if the typical FAP plan had not been converted. The expected 
present value is calculated using the same mortality and discount 
assumptions as used in the opening balance calculation. All individuals 
affected by a conversion or termination are covered under the federal 
anticutback rules. The PENSIM runs use these same mortality and 
discount assumptions for the anticutback calculations. 

Employer Cost Estimates: 

The employer cost of sponsoring a pension plan is defined as the 
percentage ratio of the present value of benefits paid to all 
individuals who worked on a job where that pension plan was sponsored 
and the present value of earnings paid to all individuals who worked on 
a job where that pension plan was sponsored. The present value 
calculations use Treasury rates to discount both the benefit and 
earnings cash flows. For a FAP plan, the benefit cash flow is the 
annuity payment stream. For a CB plan, the benefit cash flow is the CB 
amount paid at job termination. 

All employer cost estimates are for the 1955 birth cohort. Using a 
younger birth cohort would produce a higher employer cost rate for the 
typical FAP plan because of rising life expectancy and about the same 
employer cost rate for the typical CB plan because of its earnings- 
based benefit formula. The estimated employer cost rates are as 
follows: 

* full variety of private-sector final-pay plans in BLS data: 7.547 
percent; 

* typical FAP plan: 7.545 percent (by construction equal to cost of 
full variety) Note: the employer cost of providing disability 
retirement benefits in the typical FAP plan to the 1955 birth cohort is 
0.487 percent out of 7.545 percent. Note: in order to simplify the 
study presentation, the typical FAP plan is assumed to have no survivor 
benefits, which are actually a typical benefit under FAP plans, and 
thus the 7.545 percent is an underestimate of a typical FAP plan's 
cost; 

* typical CB plan with no conversion costs: 5.006 percent (i.e., 
conversion age 15);[Footnote 47] 

* typical CB plan with conversion costs by conversion age (see table 
2); and: 

* equal-cost CB plan with averaged conversion costs: 7.547 
percent.[Footnote 48] 

Table 2: Conversions Costs of Typical Cash Balance Plan by Conversion 
Age: 

Conversion age: 25; 
Percent: 4.843. 

Conversion age: 30; 
Percent: 4.645. 

Conversion age: 35; 
Percent: 4.464. 

Conversion age: 40; 
Percent: 4.680. 

Conversion age: 45; 
Percent: 5.602. 

Conversion age: 50; 
Percent: 6.937. 

Conversion age: 55; 
Percent: 7.925. 

Conversion age: 60; 
Percent: 7.866. 

Conversion age: Cost averaged over 8 conversions ages[A,B]; 
Percent: 5.870. 

Source: GAO analysis using the PENSIM Model. 

[A] Note that calculating a simple average of the eight cost rates 
assumes a uniform conversion-age distribution, which is analogous to 
assuming a uniform employee age distribution at the plan conversion 
date. While this assumption may not be exactly true for individual 
plans, there is no publicly available data that provide information 
that would support an assumption of a nonuniform employee age 
distribution for all plan conversions. 

[B] This 5.870 percent is an estimate of employer cost immediately 
after the conversion from the typical FAP plan to the typical CB plan 
when conversion costs are being paid. Given the widespread belief that 
typical cash balance conversions have not produced substantial 
immediate pension cost savings for employers, the reasons for the 
difference between the 7.545 percent and 5.870 percent are discussed 
below. 

[End of table] 

Comparison of Estimated Employer Cost of the Typical CB Plan 
Immediately After the Conversion with the Estimated Employer Cost of 
the Typical FAP Plan: 

There are several reasons why the estimated employer cost of the 
typical CB plan immediately after the conversion of 5.870 percent is 
below the estimated employer cost of the typical FAP plan of 7.545 
percent by about 22 percent. First, the typical FAP plan has been 
constructed to reflect the full variety of private-sector FAP plans 
contained in the BLS Employee Benefits Survey data used to impute plan 
characteristics in PENSIM. The characteristics of the typical CB plan 
are drawn from the Form 5500 sample used for this study and from 
discussions with pension experts and actuaries who confirmed that the 
characteristics were in the range of what they believe was typical for 
CB plans. This sample of CB plans is the largest available sample, and 
the only sample to be drawn using statistical sampling methods. 

The difference in the estimated employer cost rates for these two plans 
is consistent with prior research. Specifically, the cost difference 
reported here is somewhat smaller than the cost difference for typical 
plan conversions reported in a widely cited study by Watson Wyatt 
Worldwide.[Footnote 49] In the Watson Wyatt study, the employers who 
convert typical (i.e., middle of the cost distribution) FAP plans to CB 
plans--the 20 percent in deciles 5 and 6 in table 9--experience an 
immediate defined-benefit pension employer cost reduction of about 19 
percent (18.72 percent in fifth decile and 19.76 percent in sixth 
decile). However, the 22 percent cost reduction estimated in this study 
and the 19 percent cost reduction estimated in the Watson Wyatt study 
are not comparable because of differences in the Watson Wyatt life 
history simulations, which ignore disability events, and therefore, 
underestimate the cost of the FAP plans. To make our estimates 
comparable to the Watson Wyatt estimates, we subtracted the 0.487 
percent disability costs from 7.545 percent yielding a without- 
disability employer cost estimate for the typical FAP plan of 7.058 
percent. Our estimate of the immediate cost of the typical CB plan is 
5.870 percent, which is about 17 percent below the 7.058 percent 
without-disability estimate. This 17 percent immediate employer defined-
benefit cost reduction is about the same as the 19 percent reduction 
found in the Watson Wyatt study. 

[End of section] 

Appendix V: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Barbara D. Bovbjerg, Director (202) 512-7215: 

Staff Acknowledgments: 

The following staff members made major contributions to this report: 
Charles A. Jeszeck, Assistant Director, Kimberley M. Granger, Analyst- 
in-Charge, Joseph Applebaum, Kevin Averyt, Richard Burkard, Virginia 
Chanley, Tamara Cross, David Eisenstadt, Lawrence Evans Jr., Benjamin 
Federlein, Nila Garces-Osorio, Sharon Hermes, Jason Holsclaw, Gene 
Kuehneman Jr., Michael Maslowski, Amanda Miller, Michael Morris, Luann 
Moy, Macdonald Phillips, Mark Ramage, Tovah Rom, Nyree Ryder, George 
Scott, and Roger Thomas. 

FOOTNOTES 

[1] In DB plans, formulas set by the employer determine employee 
benefits. DB plan formulas vary widely, but benefits are frequently 
based on participant pay and years of service. 

[2] Single employer plans provide benefits to employees of one employer 
or, if under common control, employees of several related employers. 
Multiemployer plans are DB plans created by collective bargaining 
agreements covering more than one employer and generally operate under 
the joint trusteeship of labor and management. These plans cover over 
9.7 million participants or about 22 percent of all workers and 
retirees insured by the Pension Benefit Guaranty Corporation (PBGC). 
See GAO, Private Pensions: Multiemployer Plans Face Short and Long-Term 
Challenges, GAO 04-423 (Washington, D.C. Mar. 26, 2004). 

[3] Pension Benefit Guaranty Corporation, Pension Insurance Data Book, 
(Washington, D.C., 2004). 

[4] The PBGC is the federal corporation that insures certain benefits 
of vested participants in DB plans. PBGC insures both single employer 
and multiemployer defined benefit plans. As of the end of fiscal year 
2004, PBGC reported an accumulated deficit in its single employer 
program of $23.3 billion. See GAO, Private Pensions: Recent Experiences 
of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules, 
GAO-05-294 (Washington, D.C. May 31, 2005). 

[5] For example, see H.R. 2830 and S. 1783. 

[6] As we noted in past GAO work, plan participants could benefit from 
receiving clearer information regarding the conversions they face. See 
GAO, Private Pensions: Implications of Conversions to Cash Balance 
Plans, GAO/HEHS-00-185 (Washington, D.C. Sept. 29, 2000) and Cash 
Balance Plans: Implications for Retirement Income, GAO/HEHS-00-207 
(Washington, D.C. Sept. 29, 2000). 

[7] See GAO, Private Pensions: Implications of Conversions to Cash 
Balance Plans, GAO/HEHS-00-185 (Washington, D.C. Sept. 29, 2000). 

[8] See Cooper v. IBM Pers. Pension Plan, 274 F.Supp.2d 1010 (S.D. Ill. 
2003). Compounding this uncertainty, in September 1999, the Internal 
Revenue Service announced that it would begin requiring that 
applications for the approval of cash balance formula designs be 
forwarded to its headquarters for technical review, resulting in an 
effective moratorium on approving conversions to cash balance plans. 

[9] For more information, see GAO/HEHS-00-185 and GAO, Cash Balance 
Plans: Implications for Retirement Income, GAO/HEHS-00-207 (Washington, 
D.C. Sept. 29, 2000). 

[10] See for example, H.R. 2830 and S.1783. 

[11] The Form 5500 contains considerable information on plan assets, 
liabilities, contributions, design features, including whether a plan 
is a cash balance plan. Although the Form 5500 provides the most 
comprehensive data, its problems are well documented. Our analysis 
focused on the features of the CB plan at the time of conversion and 
thus would not include information on how these plans might have been 
amended since that date. It is possible that some sponsors have amended 
their plans since the initial conversion, in light of employee 
reactions and recent court decisions. Also, it is possible that some 
sponsors have changed other employee benefit plans to help mitigate the 
potential reduction in some workers' future benefits resulting from a 
CB plan conversion, but determining the nature and extent of such 
changes was outside the scope of our work. 

[12] Estimates based on our random sample of plans are subject to 
sampling error. We are 95 percent confident that the true population 
values are within +/-9 percentage points of the estimated percentages. 

[13] Some firms protected workers against a potential reduction in 
future benefits by grandfathering, at the time of conversion, all or 
some plan participants. Grandfathering allows eligible participants to 
continue to accrue benefits under the prior formula or entails 
operating both formulas and providing eligible participants with the 
greater benefit. Grandfathering can be implemented in various ways, 
affecting different groups of workers. 

[14] IRC section 417(e)(3) stipulates that DB sponsors that permit lump 
sum distributions must, among other conditions, calculate distributions 
to departing participants using an interest rate no greater than 30- 
year Treasury rate. Using a higher interest rate would result in a 
lower lump sum distribution. 

[15] There is a range of types of grandfathering that can be used by 
plan sponsors. They can include provisions such as giving employees a 
choice of whether to stay in the old FAP plan or join the new CB plan, 
providing a minimum benefit where the employee is guaranteed to at 
least earn the benefit of their former plan until a future specified 
date, or making grandfathering available to only some or all employees 
in the former plan. 

[16] These comparisons are based on amounts of annuity benefits and do 
not take into account death benefit coverage before an annuity begins. 
For the purpose of this report, it is recognized that participants do 
not have an entitlement to future or expected benefits. 

[17] We also conducted a comparison of lifetime benefits for workers 
under a traditional FAP and those converted to a typical CB plan as 
well as to an equal cost CB plan. In these cases, while the number of 
workers faring better under the CB plans is greater at each age 
compared to the numbers in the monthly benefits calculation, the basic 
results found under the monthly benefit comparison are not changed in 
either case. (See slides 31-32, 38-39.) 

[18] In our simulations, about 36 percent of our sampled individuals 
(57,049) who participated in at least one private sector FAP or CB plan 
never vested in such plans. 

[19] Again, these comparisons are based on amounts of annuity benefits 
and do not take into account death benefit coverage before an annuity 
begins. 

[20] This plan's pay credits were more generous than virtually all of 
the 136 plan conversions we analyzed. 

[21] See GAO-05-294. 

[22] See GAO/HEHS--00-185. 

[23] See GAO, Cash Balance Plans: Implications for Retirement Income, 
HEHS-00-207 (Washington, D.C. Sept. 29, 2000) and GAO, Private 
Pensions: Implications of Conversions to Cash Balance Plans, HEHS-00- 
185 (Washington, D.C. Sept. 29, 2000). 

[24] Since we focused on empirical literature produced since 2000, we 
did not include one older study that is cited in the literature in our 
detailed review (Kopp and Sher, "A Benefit Value Comparison of a Cash 
Balance Plan with a Traditional Average Pay Defined Benefit Plan," The 
Pension Forum [Society of Actuaries, October 1998]). The study contains 
data and other methodological limitations, as well as making similar 
conclusions. For example, because the study examines hypothetical 
rather than actual plan conversions, it is not clear that the results 
extend to the broader workforce. Additional limitations include that 
fact that the authors had limited wage information and therefore relied 
on simple wage assumptions rather than actual wage histories and did 
not test the sensitivity of the results to the assumptions made 
regarding key variables. 

[25] See for example, Watson Wyatt Worldwide, The Unfolding of a 
Predictable Surprise: A Comprehensive Analysis of the Shift from 
Traditional to Hybrid Plans (2000) and Robert Clark, and Sylvester 
Schieber, "The Transition to Hybrid Pension Plans in the United States: 
An Empirical Analysis," Private Pensions and Public Policies, eds. W. 
Gale et al. (Washington, D.C. Brookings Institution, 2004). 

[26] Virtually all researchers studying this issue, including GAO, have 
suffered these data limitations. 

[27] The use of hypothetical workers is also a limitation of prior GAO 
reports on cash balance plans. See GAO-02-207 and GAO-00-185. 

[28] See, for example, Watson Wyatt Worldwide (2000). In simulating the 
effects of one conversion to a cost-reducing cash balance plan, the 
authors find that the majority of workers receive lower benefits. 
However, another simulation of a shift to a cost neutral plan finds 
that the majority of the workers receive higher benefits and, although 
the losses are disproportionately borne by the older workers, they are 
lower than the losses experienced in the cost-reducing case. 

[29] This pertains to the majority of the literature we reviewed. 
Although Johnson and Uccello (R.W. Johnson, and C. Uccello, "Cash 
Balance Plans and the Distribution of Pension Wealth," Industrial 
Relations, 42(4) [2003], 745-773) include pension wealth on previous 
jobs, analyze actual workers and capture a greater diversity of 
outcomes, the results do not generalize to cost-reducing plan 
conversions or conversions where the defined benefit plan incorporated 
early retirement incentives (see below for more on the cost neutral 
assumption). Moreover, the pension wealth in cash balance plans may be 
exaggerated because of issues with the data and the assumptions 
regarding turnover rates. 

[30] For example, see several studies conducted by Schieber (including 
Clark and Schieber [2004]) which are derived from data on 77 plans 
collected and analyzed initially by Watson Wyatt Worldwide in their 
2000 study. Given estimates of the number of actual cash balance 
conversions and their growth since 2000, it is not clear that this work 
can be used as a reliable guide to gauging the impact of a typical cash 
balance conversion on workers. Moreover, GAO found other research 
studies that were based on significantly fewer cash balance 
conversions, e.g., Clark and F.W. Munzenmaier (R. Clark, and F.W. 
Munzenmaier. "Impact of Replacing a Defined Benefit Pension with a 
Defined Contribution Plan or a Cash Balance Plan." North American 
Actuarial Journal, 5 (1). (2003-4): 32-56. (2001). 

[31] See, for example, Watson Wyatt Worldwide (2000); 
PriceWaterhouseCoopers, Survey of Conversions from Traditional Pension 
Plans to Cash Balance Plans (2000); and Mellon Financial Corporation, 
2004 Survey of Cash Balance Plans (Secaucus, N.J. 2004). 

[32] PriceWaterhouseCoopers (2000). 

[33] Findings of this paper are not directly discussed in this appendix 
as it involves an assessment of plan conversions from traditional 
defined benefit plans to defined contribution plans. 

[34] Looking at 78 plan conversions, Watson Wyatt Worldwide (2000) 
found that 56.4 percent of the plans were cost-reducing, 20.5 percent 
were cost-neutral and 23.1 were cost-increasing. However, when the 
authors assumed workers took full advantage of the enhancements to the 
defined contribution plan that occurred contemporaneously with the 
transition, 44.9 percent of the plans were cost reducing, 17.9 percent 
were cost neutral and 37.2 percent were cost increasing. This work has 
led some researchers to deduce that the average cash balance conversion 
is cost neutral, since the majority of the plans (55.1 percent) were 
cost-neutral or increasing. However, as we indicated earlier, it is not 
clear that this small sample of conversions is representative. Also, 
some recent statistics do not support the assumption of full 
participation used by Watson Wyatt to incorporate these enhancements. 
For example, some estimates suggest that a significant percentage of 
employees do not participate in their 401(k) program at all, and the 
majority of those that do participate do not maximize the value of the 
plan. See Congressional Research Service, Automatic Enrollment in 
Section 401(k) Plans (Washington, D.C., Oct. 14, 2004). The CRS found 
that because enrollment in most §401(k) plans is voluntary, not all 
workers whose employers offer a plan choose to participate. 'The Bureau 
of Labor Statistics reports that in 2003, 51 percent of workers in the 
private sector were employed at establishments that offered a defined 
contribution plan, but just 40 percent of employees at private 
establishments participated in a plan. Consequently, the participation 
rate among employees whose employer offered a DC plan was 78 percent." 
Also see Alicia H. Munnell and Annika Sundén, Coming Up Short: The 
Challenge of 401(k) Plans (Washington, D.C. Brookings Institution 
Press, 2004). 

The authors conclude that one in four employees do not participate in a 
401(k) plan, and less than 10 percent contribute the maximum. 

[35] The Form 5500 is a disclosure form that private sector employers 
with qualified pension plans are required to file with the Internal 
Revenue Service (IRS), Labor's Employee Benefit Security Administration 
(EBSA), and Pension Benefit Guaranty Corporation (PBGC). This dataset 
contains all private sector single employer DB plans that are insured 
by the PBGC. 

[36] There were 1590 plans of any participant size that indicated they 
were cash balance plans in the Form 5500. 

[37] Effective August 5, 1997, with the passage of the Taxpayer Relief 
Act of 1997, plan sponsors were no longer required to file summary plan 
descriptions or related documents with the Department of Labor. 
Instead, plans are required to furnish this information only upon 
request. 

[38] See GAO, Private Pensions: Government Actions Could Improve the 
Timeliness and Content of Form 5500 Pension Information, GAO-05-491 
(Washington, D.C. June 2005). 

[39] We had some summary plan descriptions available to us as a result 
of past GAO work on cash balance issues. See GAO, Private Pensions: 
Implications of Conversions to Cash Balance Plans, GAO/HEHS-00-185 
(Washington D.C. September 2000) and GAO, Cash Balance Plans: 
Implications for Retirement Income, GAO/HEHS-00-207 (Washington D.C. 
September 2000). We determined that some plans that had supplied 
summary plan descriptions reviewed in those studies were also included 
in the sample of this study. In addition, for this study a few plan 
sponsors provided plan documents upon our request for additional 
information and information on a few other plans was available via the 
Internet. 

[40] For more information on PENSIM, go to 
http://www.polsim.com/PENSIM.html. 

[41] For more information on the pension characteristics imputation 
model, go to http://www.polsim.com/penchar.pdf. 

[42] We chose to evaluate the effects of converting or terminating a 
typical FAP to determine the changes in benefits that would be 
experienced by those currently participating in a FAP plan. An 
alternate approach would be to base the typical plan on characteristics 
of FAP plans that elected to convert or terminate. However, this would 
have required additional information and analysis related to the 
individual circumstances of such FAP plans that were outside of the 
scope of our study. While such an alternative could be used to evaluate 
the effect of past conversions and terminations on affected 
participants, the results would be limited in predicting the effect of 
future conversions or terminations on those currently covered by a FAP 
pension plan. 

[43] The typical CB plan features derived from GAO's Form 5500 data 
were, in part, established by employee and sample selection weighting. 
As stated previously in this report, it is not known how many 
participants of the plan were actually affected by the conversion to a 
CB plan. However, for the purposes of construction, we applied the 
employee weights assuming 100 percent of participants were affected. 
Results for how participants will fare under our typical CB plan, when 
taken in conjunction with our equal cost CB plan, provide two polar 
views of how a distribution of individuals may be affected when 
converted. 

[44] One claimed benefit for CB plans is the ability to rollover 
account balances upon separation. Our simulation model fully captures 
this feature. This contrasts with a traditional FAP plan where a 
participant who leaves before early retirement loses both future final 
pay increases and the early retirement subsidy. 

[45] We did not attempt to model any changes in employee behavior that 
may affect job tenure as a result of a conversion to a CB plan. 

[46] We have no wearaway--neither initial nor inadvertent wearaway, or 
any other form--in our modeling. 

[47] This is an estimate of the ongoing cost of the typical CB plan 
after all conversion costs have been paid. 

[48] The base pay credit rate of the equal-cost CB plan has been 
adjusted so that the plan's employer cost equals that of the typical 
FAP plan. 

[49] See Watson Wyatt Worldwide, The Unfolding of a Predictable 
Surprise: A Comprehensive Analysis of the Shift from Traditional 
Pensions to Hybrid Plans (2000), 18-19. 

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