Treasury Allows Some Pension Freeze
By Ellen E. Schultz and Theo Francis
The Wall Street Journal
Saturday, February 2, 2008

Under intense pressure from employers, the Treasury issued a ruling that allows companies to freeze the pensions of older workers in certain cases without running afoul of laws meant to protect employees' nest eggs.

In addition to validating some pension rollbacks that could save companies billions of dollars, the Treasury's action also could tip the outcome of long-running lawsuits alleging age discrimination by pension plans at AT&T Corp., Cigna Corp., Dun & Bradstreet Corp., El Paso Corp., and other major companies.  The stakes are huge: In just the AT&T case, nearly 24,000 current and former workers had opted into a class action as of December, with potential claims exceeding $2 billion.

The companies declined to comment.

The crux of the issue is whether employers that change from traditional pensions to so-called cash-balance plans can freeze the growth of older workers' pensions for months or years following the change -- a phenomenon called "wearaway" -- even as younger workers' pensions continue to grow.  Many companies let employees remain in the old plan for a time, but that only delays the onset of wearaway.  The Treasury ruled that decades-old laws that effectively prohibit companies from temporarily freezing pension growth don't apply when the freeze is delayed.

The new rule covers certain plans through 2008, and the Treasury said it intends to issue a rule extending it beyond Jan. 1, 2009.

"The agency charged with enforcing a law to protect older workers has blown a hole in it," says Laurie McCann, a senior attorney at the elderly-advocacy group AARP.

The Treasury says it is just interpreting existing law.

Over the past decade, hundreds of employers shifted from traditional pensions to cash-balance plans.  This saves companies money because instead of calculating benefits by multiplying years of service and salary, which produces rapid pension growth in the later years, the company converts the pension to a cash-out value.  This becomes an account that then grows at a flat annual rate, commonly about 3% of pay.

Many companies low-balled older workers in establishing an opening account balance, setting it at, say, $80,000 even if the cash-out value was worth $100,000.  The older person's pension thus was effectively frozen, since it would take years to grow back to the amount the worker was entitled to at the time of the changeover.

Thousands of employees sued, arguing that this violated a law requiring that pension growth occur with a certain steadiness -- for example, it can't fall to zero, then jump.  The rules were intended to prevent abusive pension practices, such as having a "backloading" formula whereby a person could earn almost no pension for 19 years, and then have 90% of the pension benefit kick in at year 20.  The problem: employers could fire people in year 19 to avoid paying them a bigger pension.

Some courts sided with employees in wearaway cases;  wearaway was one of five claims in a suit that International Business Machines Corp. settled for $320 million in 2003.  (In 2006, IBM won its appeal on the age discrimination claim in that suit).

In response to a continuing outcry, Congress banned wearaway in the 2006 Pension Protection Act, explicitly saying that companies adopting cash-balance plans after June 2005 must give everyone the full present value of their pension.

Lawmakers didn't address companies that had already converted their pensions.  But they did open the door for the IRS to begin reviewing plans dating back to 1999, and in a review of more than 1,250 cash-balance plans last year the agency found widespread backloading violations.  The agency could have required companies to pay out billions of dollars more in pension benefits to current and future retirees.

Employers responded with a volley of lobbying, enlisting more than two-dozen lawmakers to ask the agency to back off.  Friday's action by the Treasury suggests the campaign was effective.  The Treasury and IRS are now agreeing that employers aren't violating backloading laws when they give employees a pension option that delays wearaway but doesn't eliminate it.

Treasury spokesman Andrew DeSouza says the backloading rules were enacted decades before cash-balance plans were designed, and that the ruling "provides clarity on how the backloading rules work in the context of cash-balance plan conversions."

Write to Ellen E. Schultz at ellen.schultz@wsj.com and Theo Francis at theo.francis@wsj.com

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