Cash balance pension plan conversions and the new economy

Abstract

Many firms that sponsor traditional defined benefit pensions have converted their plans to cash balance plans in the last ten years. Cash balance plans combine features of defined benefit (DB) and defined contribution (DC) plans, and yet their introduction has proven considerably more controversial than has the increasing popularity of DC plans. The goal of this study is to estimate a hierarchy of the influences on the decision of a firm to convert its traditional defined benefit pension plan to a cash balance plan. Our results indicate that cash balance conversions have been undertaken in competitive industries with tight labor markets and can be viewed largely as a response to better compensate a more mobile labor force. Indeed, many firms appear to increase their pension liabilities through such conversions. The results also shed light on the possible determinants of the broader shift from DB to DC pension coverage.

On the Determinants of Defined Benefit Pension Plan Conversions

“…Some have suggested that firms were converting to CB plans instead of incurring these costs, especially after the IRS increased the excise tax in 1990 (Clark et al 2001;Coronado and Copeland 2004;Niehaus and Yu 2005;D'Souza et al 2006 …”

“…Clark et al (2001) examine conversions in 1996 and find no difference in the funding levels of cash balance plans and traditional DB plans. Coronado and Copeland (2004) find that 16 of the 32 cash balance plans in their sample were over-funded prior to conversion, as measured by the projected benefit obligation (PBO) 4 . However, when they use a broader sample (316 S&P 500 firms that sponsor a DB plan), they find no effect of the funding ratio on the probability of conversion (Coronado and Copeland 2004).…”

“…Coronado and Copeland (2004) find that 16 of the 32 cash balance plans in their sample were over-funded prior to conversion, as measured by the projected benefit obligation (PBO) 4 . However, when they use a broader sample (316 S&P 500 firms that sponsor a DB plan), they find no effect of the funding ratio on the probability of conversion (Coronado and Copeland 2004). Using two separate matched samples: one with cash balance plans matched with traditional DB plans that terminated and a second with cash balance plans matched with terminating DB plans replaced by DC plans, D' Souza et al (2006) find weak support that plan funding affects the likelihood that a plan would convert.…”

“…The second hypothesis in the previous literature draws upon the implicit contract theory of deferred compensation (Lazear 1979;Ippolito 1985) by suggesting that converting firms were willing to retract the implicit promise of a certain amount of retirement benefits (Ippolito 2001;Coronado and Copeland 2004;Niehaus and Yu 2005;D'Souza et al 2006). According to the theory, the employee posts a bond by accepting lower initial wages and forfeits that bond (retirement benefits) if he quits or the firm reneges on the implicit contract.…”

The Labor Supply of Older Americans

“…Coronado and Copeland (2003) offer another perspective on the reasons for the shift to cash balance plans. They contend that these conversions occurred in competitive industries with tight labor markets, and were done largely to improve compensation for a more mobile workforce.…”