Cash Balance Plans Research Articles

What are Cash-Balance Pension Plans and How Do They Compare

We offer a comprehensive explanation of cash-balance pension plans in the public sector, including a comparison to defined-benefit and defined-contribution plans. Comparisons are made with respect to design, management, costs, and long-term viability. Three important aspects of pension fund management are discussed: pension benefits and contributions, pension governance and reasons for cash-balance plan adoption, and pension funding. Four unique cases – Nebraska Public Employees Retirement System (NPERS), Kansas Public Employees Retirement System (KPERS), Kentucky Public Pensions Authority (KPPA), and Texas Municipal Retirement System (TMRS) – help to illustrate these three important points.

Optimal Choice between Defined Contribution and Cash Balance Pension Schemes: Balancing Interests of Employers and Workers

In the context of pension plans, the employer and the worker have distinct interests and face different risks. The worker seeks higher retirement benefits, while the employer aims to minimize the cost of fulfilling his obligations. To address these diverse needs, the defined contribution plan managed with participating life insurance (DC-PL) and the cash balance plan managed with unit-linked insurance (CB-UL) serve as suitable choices. The multi-criteria analysis is conducted using the cumulative prospect theory model to measure the utility of the parties involved toward a mixed product combining these two pension plans. By assigning weights to risk measures and maximizing utilities, the paper employs both additive utility and Nash equilibrium approaches. The results reveal that the CB-UL plan aligns with employers’ interests, offering potential financial gains, while the DC-PL plan attracts workers due to its profit-sharing aspect. Significantly, when equal importance is given to both parties, the CB-UL plan emerges as the prevailing choice. This study contributes to the understanding of pension plan design and decision-making dynamics between employers and workers, providing valuable insights for achieving a balance between retirement benefits and cost management.

Valuing Losses of Pension Benefits

Valuing Losses of Pension Benefits

Reforming Teacher Pension Plans: The Case of Kansas, the First Teacher Cash Balance Plan

Abstract The ongoing crisis in teacher pension funding has led states to consider various reforms in plan design to replace the traditional benefit formulas, based on years of service and final average salary (FAS). One such design is a cash balance (CB) plan, long deployed in the private sector, and increasingly considered, but rarely yet adopted, for teachers. Such plans are structured with individual 401(k)-type retirement accounts, but with guaranteed returns. In this paper I examine how the nation's first CB plan for teachers, in Kansas, has played out for system costs, and the level and distribution of individual benefits, compared with the FAS plan it replaced. My key findings are: (1) employer-funded benefits were modestly reduced, despite the surface appearance of more generous employer contribution matches; (2) more importantly, the cost of the pension guarantee, which is off-the-books under standard actuarial accounting, was reduced quite substantially. In addition, benefits are more equitably distributed between short-term teachers and career teachers than under the back-loaded structure of benefits characteristic of FAS plans. The key to the plan's cost reduction is that the guaranteed return approximates a low-risk market return, considerably lower than the assumed return on risky assets.

From Stand-Alone Pensions to Alternative Retirement Plans: Examining State and Local Governments

Defined benefit (DB) pension plans are the dominant retirement program for state and local governments in the United States. However, in the last 15 years, some have given new employees a choice of alternatives to stand-alone DB pension plans such as cash balance (CB), defined contribution (DC), and hybrid retirement plans. This article examines this shift through survival analysis using panel data of 190 state and local pension plans across the United States. From 2001 to 2019, we modeled five change factors found in the pension reform literature, namely, financial constraints, interest group influence, plan membership, and liability, along with other state factors. Our analysis shows that all five of these factors impacted the shift to alternative retirement plans from stand-alone DB plans. Notable findings are that well-funded pensions were more likely to shift to alternative retirement plans, and interest groups such as police, fire, and teachers were more likely to keep stand-alone plans.

Hybrid Cash Balance and Pension Equity Plans: Origins and Development

It is widely recognized that there has been a massive shift from defined-benefit (DB) to defined-contribution pension plans. However, the full extent of that shift from fully functioning DB plans is generally understated. This article measures and relates the extent of that understatement and its importance for retirement income. It then discusses the increasing importance of cash balance and pension equity plans and their legality. It then conducts an in-depth discussion of large (Fortune 500) employers, small- and medium-sized employers, and then very small employers (25 or fewer active participants). It concludes that retirement income plans in the United States are far from static. Indeed, they have evolved throughout the era and will continue to do so in the future.

Cross-Subsidization of Teacher Pension Costs: The Case of California

The value of pension benefits varies widely, by a teacher's age of entry and exit. This variation is masked by the uniform rate of annual contributions, as a percent of pay, to fund benefits for all. For the first time, we unmask that variation by calculating annual costs at the individual level. In California, we find that the value of a teacher's benefits ranges from about 4 to 22 percent of pay, and exhibits some idiosyncratic patterns, as is endemic to traditional pension plans. The variation in individual cost rates generates an extensive but hidden array of cross-subsidies, as winners receive benefits worth more than the uniform contribution rate, and losers receive less. Almost two thirds of all entering teachers, past and present, are losers in California. By contrast, a prominently invoked study finds that nearly all active teachers are winners there. That result is shown to be highly skewed by excluding the losses of prior entrants who left early, thereby violating the funding fact that the gains and losses of winners and losers must offset each other. Our main policy conclusion is that cash balance plans can rationalize or eliminate the current system of cross-subsidies and provide the transparency lacking in traditional plans.

How Do California Teachers Fare under CalSTRS? Applying Workforce Tenure Analysis and Counterfactual Benefit Modeling to Retirement Benefit Evaluation

Most public school teachers in the United States are covered by traditional defined benefit (DB) pensions designed to reward long service. Numerous recent studies, including several focused on California, use high attrition rates among new hires to argue that teachers would be better off with a defined contribution (DC) plan or a cash balance (CB) plan. These studies fail to address tenure patterns in the teaching workforce—for example, how long the average teacher currently working in the profession can expect to stay. In this study, we ask whether most teachers currently working in California public schools can expect to stay long enough to accrue higher benefits under their pension than under alternative retirement plans with the same expected cost and the same capital market assumptions. Based on an analysis of CalSTRS membership and actuarial data and our counterfactual benefit modeling, we find that 73% of teachers currently working in California can expect to work at least 20 years, and 46% can expect to work at least 30 years. At least 82% of the California teacher population will stay until age 55, the early retirement age. On an entering-cohort basis, nearly half of current new-hire teachers in California (50%) are better off with the DB pension than the idealized DC plan. Critically, 85% of California’s teaching population will accrue higher benefits under the CalSTRS DB pension than through an idealized 401(k), and 76% will accrue higher benefits than through a generous CB plan. <b>TOPICS:</b>Retirement, legal/regulatory/public policy, simulations, pension funds

Pension Plans 2014

Pension Plans 2014 discusses the popular cash balance plan, floor offset plan and cross tested plan from an actuarial viewpoint. Many retirement plan could be upgraded to take into account from a pension plan if they were understood. Contributions to these plans are made on a benefits basis as opposed to a contribution basis. The plan will favor older highly compensated employees with less time to fund for retirement. These plans are popular with professionals who understand them even though they are not as simple as a 401(k) plan.

Administering Cash Balance Pension Plans to Conform With Qualified Divorce Orders

This article provides an overview of the unique issues that normally arise under a cash balance pension plan to conform with qualified domestic relations orders (or QDRO). Presently, many plan administrators treat a cash balance plan just like a defined contribution plan only to find that the benefits within a cash balance plan are not as easily divided as those within a defined contribution plan. The apparent similarity of hypothetical account balances in a cash balance plan and the actual account balances in a 401(k) plan can result in mishandled QDROs. The similarities between a cash balance plan and a traditional defined benefit plan can also confound plan administrators, particularly when a defined benefit plan was subsequently converted to cash balance plan. Then all or a part of a participant’s benefit subject to a QDRO has the option to be determined under a traditional defined benefit formula, such as a percentage of final average pay. And while a QDRO administered under a pure cash balance plan can split the benefit in a fashion similar to that used for 401(k) plans, QDROs remain distinct and involve important differences between a cash balance plan and a 401(k) or other defined contribution plans. These unique features of a cash balance plan can drastically affect the monetary impact on alternate payees. To fulfill the duties prescribed under both ERISA and the IRC, plan administrators must engage in a very targeted fact-specific analysis involving the participant (employee), alternate payee and the Plan within a taut web of federal laws, regulations and mandates.

Pension Conversion, Termination, and Wealth Transfers

AbstractThis article explores the motivation to change their defined benefit pension plan by either terminating the plan and replacing it with a defined contribution plan or converting it to a cash balance plan. Using Form 5500 data as well as firm financial data, we find firms wishing to change their defined benefit plans are motivated by potential wealth transfer and tax implications. Firms terminating pension plans tend to have lower potential wealth transfers and lower taxes than firms converting to a cash balance plan, indicating a desire to modify the implicit contract instead of terminating the plan.

Cash Balance Pension Plan Conversions: An Analysis Of Motivations And Pension Costs

In recent years, many corporations have replaced their traditional defined benefit (DB) pension plans with cash balance (CB) plans, which share many of the characteristics of defined contribution plans. This study provides empirical evidence on the characteristics of CB converters and the behavior of pension costs and obligations pre- and post-conversion. We find that CB converters are larger than firms that retain traditional DB plans as well as those that terminate DB plans. They are less profitable than the former, but more profitable than the latter. CB conversions are not associated with proxies for greater labor mobility (e.g., firm-specific employee turnover rate). They are associated with a workforce that is closer to retirement, on average, lending credence to the breach of implicit contract rather than the labor market hypothesis as a motivator of CB conversions. Consistent with this intuition, we document that CB converters recognize a reduction of unrecognized prior service costs in the year of conversion, consistent with a negative plan amendment. Unlike pre-conversion, pension costs and obligations are significantly lower for CB firms post-conversion than for a matched sample of firms retaining traditional DB plans. CB conversions are more popular than DB plan terminations among firms with overfunded pension plans in periods when expected return on plan assets is likely to be high, with a consequent positive effect on reported income.

Could Different Retirement Benefits Result in More Effective Teachers?

We evaluate the chance that changing retirement benefits will lead to greater teacher effectiveness. Changing from defined benefit pensions to defined contribution or cash balance plans would raise initial compensation and effectiveness, while it would increase turnover and thus lower effectiveness. We simulate the effects of higher initial compensation and greater turnover on teacher effectiveness from changing retirement plans and calculate the potential transition costs. There is a 60–70 percent chance that effectiveness would fall if retirement benefits are changed. Transition costs could amount to 0.8 percent of payroll in the third decade after changing retirement benefits.

Changes in Firm Pension Policy: Trends Away from Traditional Defined Benefit Plans

In light of the recent concerns regarding the solvency of Social Security’s Old-Age, Survivors and Disability Insurance (OASDI), private pensions may play an increasingly important role in retirement welfare of US retirees. However, the private pension landscape has evolved in ways that may result in lower private pension wealth for retirees. One recent such phenomenon involves the conversion of traditional defined benefit pension plans to cash balance plans, which results in lower pension benefits for many workers. In this study, I investigated how characteristics of the firm’s workforce influenced whether the firm converted their traditional pension plan to a cash balance plan and how these characteristics related to the firm’s pension plan policy more generally. Using the Longitudinal Employer-Household Data and pension plan data from the Department of Labor/Internal Revenue Service and the Pension Benefit Guaranty Corporation, I found little evidence of workforce age distribution effects on the likelihood of DB plan conversion to a cash balance plan in the 1990s. More generally, I consistently found positive associations between firms with older and more female workforces and defined contribution plans during the same time.

Life After Defined Benefit Plans

Employers have moved from traditional pension plans to cash balance and other alternative defined benefit plans. However, it may be that the best approach lies beyond defined benefit plans completely. The Employee Retirement Income Security Act of 1974 (ERISA) was enacted to protect workers. Its focus was on the defined benefit plan, which at that time meant a traditional pension plan that provided lifetime income to retired workers. Over the years traditional pension plans have declined in number, often due to their increasing costs. Many of these plans have been replaced by the 401(k) plan, a profit-sharing plan partly or wholly funded by employee contributions. There has also been a rise in hybrid plans, plans that have features of both defined benefit and defined contribution plans. Recent developments highlight the weaknesses in traditional pension plans. Replacing a traditional pension plan with a cash balance plan, a hybrid plan that qualifies as a defined benefit plan, does not fully address all the problems. It may be that there is limited advantage to the continued emphasis on defined benefit plans. Instead, defined contribution plans that contain some features of defined benefit plans may better address the current retirement-plan issues.

Changes in Firm Pension Policy: Trends Away from Traditional Defined Benefit Plans

In light of the recent concerns regarding the solvency of Social Security’s Old-Age, Survivors, and Disability Insurance (OASDI), private pensions may play an increasingly important role in the retirement welfare of U.S. retirees. However, the private pension landscape is also evolving in ways that may result in lower private pension wealth for retirees. One recent such phenomenon involves the conversion of traditional defined benefit (DB) pension plans to cash balance plans, resulting in lower pension benefits for workers. In this study, I investigated how characteristics of the firm’s workforce influence whether the firm converted its traditional pension plan to a cash balance plan and how these characteristics related to the firm’s pension plan policy more generally. Using the Longitudinal Employer-Household Data and pension plan data from the Department of Labor/Internal Revenue Service and the Pension Benefit Guaranty Corporation, I found little evidence of workforce age distribution effects on the likelihood of DB plan conversion to a cash balance plan in the 1990s. More generally, I consistently found positive associations between firms with older and female workforces and having defined contribution plans during the same time.

The cash balance plan as a real option: Financial innovation and implicit contacts

This study examines, from the employer's perspective, the conversion from a defined benefit plan to a cash balance plan. The conversion to a cash balance plan presents a real option that is a financial innovation for the firm. The reasons to exercise this option (convert from a defined benefit plan to a cash balance plan) are discussed. The conversion can offer several benefits for the company. The firm may profit by taking the surplus assets of the pension plan without a tax penalty; the firm can increase risk sharing between the company and the employee (by reducing the company's pension liability risk and improving the predictability of the company's pension costs); the firm may choose to reduce future pension liabilities (by changing contribution and accrual patterns); and if the firm converts to a cash balance plan, the firm may improve recruitment and employee retention. The real option approach does not necessarily conflict with the implicit contract theory of pension plans. From the real option point of view, the fuzzy nature of defined benefit plans includes more than one possible real option. Most discussions of implicit contracts for pension plans focus on the concept of an implicit lifetime employment guarantee. The implied contract of the defined benefit plan could be included in the legal provisions of a cash balance pension contract. Even though a lifetime employment guarantee is not included in the current legal contract agreement, a cash balance plan can be structured to offer alternatives that provide the benefits that current employees would expect based on the implicit promises. The real option alternatives for converting to a cash balance plan can be used by the company to change provisions for the un-accrued pension benefits in ways that benefit the company and the employees. Owing to the difficulties in valuing these complex options, the model developed and analysed focuses on the potential value to the company of the option to change future pension plan contributions and the concomitant pension fund accruals for employees. A model is developed to find an optimal conversion time for employers based on the accrual patterns of the two types of plans.

Changes in Firm Pension Policy: Trends Away from Traditional Defined Benefit Plans

In light of the recent concerns regarding the solvency of Social Security’s Old-Age, Survivors and Disability Insurance (OASDI), private pensions may play an increasingly important role in retirement welfare of US retirees. However, the private pension landscape has evolved in ways that may result in lower private pension wealth for retirees. One recent such phenomenon involves the conversion of traditional defined benefit pension plans to cash balance plans, which resulted in lower pension benefits for many workers. In this study, I investigate how characteristics of the firm’s workforce influenced whether the firm converted their traditional pension plan to a cash balance plan and how these characteristics related to the firm’s pension plan policy more generally. Using the Longitudinal Employer-Household Data and pension plan data from the Department of Labor/Internal Revenue Service and the Pension Benefit Guaranty Corporation, I found little evidence of workforce age distribution effects on the likelihood of DB plan conversion to a cash balance plan in the 1990s. More generally, I consistently find positive associations between firms with older and more female workforces and defined contribution plans during the same time.

Securing pension benefits in DB private schemes with priority rules: an insight from contracting theory

AbstractThis contribution aims at enriching the debate on the priority of unfunded pension rights in the case of a sponsoring firm's bankruptcy. Starting from the idea that pension promises in DB schemes are part of a financial contract between a sponsor and participants to a sponsored pension plan, we argue that plan participants are not ordinary creditors and should be given the same priority as other claimants in the event of underfunding and a sponsoring firm's bankruptcy. We build up a model consistent with this view, which gives room for more participants' involvement in pension fund management. We assume that the sponsoring firm chooses the optimal share of a pension fund deficit that it commits to cover in case of underfunding, while participants choose the contribution rates that maximize their expected utility. We show that two regimes govern the pattern of the relationship between the optimal level of funding chosen by the sponsor and the optimal contribution rates chosen by the plan participants. Allowing plan participants to determine their desired contribution rates gives the entrepreneur the proper incentive for funding the pension plan. In a certain way, our pension contract resembles a cash-balance contract and our model suggests that more security can be given to plan participants in their pension savings by offering them a cash-balance plan which states a priority of unfunded pension rights in case of a firm's bankruptcy.

On the Determinants of Defined Benefit Pension Plan Conversions

This study utilizes pension plan level 5500 data from the Department of Labor and Internal Revenue Service to investigate the determinants of traditional defined benefit plan conversion to hybrid cash balance plans during the 1990s. Incorporating the possibility of plan termination instead of plan conversion, the author finds a negative effect of plan funding status, union status, the number of total defined benefit plans at the firm, and plan contributions on the likelihood of plan conversion. The number of active participants and total defined contribution plans at the firm positively affect the probability of conversion. Plans at firms with at least one union plan were less likely to terminate. Additionally, the number of defined benefit plans at the firm and plan contributions had a negative effect on the likelihood of plan termination. Industry fixed effects were significant in all specifications.