A Seventh Circuit Court of Appeals decision (August 7, 2006) found that IBM’s cash balance plan did not discriminate against older workers.
The latest chapter of the continuing saga of the conversion of the IBM pension plan from a traditional defined benefit plan to a “cash balance plan”, results in a federal appeals court determining that IBM's cash balance plan did not discriminate against older workers. Cooper v. IBM Personal Pension Plan, (7 th Cir., No 05-35888/7/06).

Background
In 1999, IBM converted their traditional defined benefit plan to a cash balance plan. This conversion applied only to those employees under age 50 and to those who did not have at least 25 years of service. All others remained in the old defined benefit plan. 140,000 older workers filed a lawsuit against IBM to recover money they claimed was lost due to the conversion. In 2003, a federal judge ruled that the plan had violated age discrimination rules because it unfairly penalized older employees. Because of the court battle, IBM ultimately terminated its Cash Balance Plan.

A cash balance plan is a defined benefit plan; however, because the benefits provided are based on a hypothetical account, the benefit provided mimics those provided under a defined contribution plan. Unlike a traditional defined benefit plan, this has the effect of frontloading rather than back-loading benefits, and therefore, does not favor older employees in benefit accrual. One of the basic precepts in the lawsuit was that cash balance plans discriminated against older workers because the older workers had a shorter time horizon for interest growth than younger workers. The trial court determined that not just this particular conversion was discriminatory, but rather that all cash balance plans are illegally discriminatory on their face because the older workers would always have less time for interest growth in a cash balance plan.

The Seventh Circuit Ruling

The three judge circuit court panel found that the terms of IBM’s plan were age-neutral, and thus, did not violate ERISA.

The trial ruling was based on the phrase “benefit accrual” which is not defined in ERISA. The District Court defined “benefit accrual” by looking at the definition of “accrued benefit”. The District Court found that the term “benefit accrual” should be measured not by what IBM put into the plan, but by what an employee takes out at retirement.

According to the Appellate Court “benefit accrual” reads most naturally as a reference to what the employer puts into the plan, while “accrued benefit” refers to outputs after compounding of interest.

Another quote from the case succinctly says a lot: “[T]his litigation went off the rails: when a phrase dealing with inputs was misunderstood to refer to outputs.”

The Court ruled that the plaintiffs failed to recognize the “time value of money”.

The fact that younger employees had more time to accrue interest did not mean that the plan discriminated against older workers. “Treating the time value of money as a form of discrimination is not sensible.”

The Court also rejected Plaintiffs contention that the plan discriminated against them because they received more favorable benefits under IBM’s traditional DB Plan. As the court said: “Removing a feature that gave extra benefits to the old differs from discriminating against them. Replacing a plan that discriminates against the young with one that is age-neutral does not discriminate against the old.”

Finally, the court made it clear when it wrote: “Litigation cannot compel an employer to make plans more attractive …It is possible, though, for litigation about pension plans to make everyone worse off… Whether that is good or bad (for employees or society as a whole) is not for us to say. What we can and do conclude, however, is that the decision [to offer a plan and what its terms are] may again be made freely, governed by private choice rather than legal constraint.”

Outcome
In an attempt to limit potential damages on the age discrimination issue if the appeals court were to rule against it, IBM had agreed in 2004 to settle the lawsuit for an amount not to exceed $1.7 billion. Because the circuit court ruled that IBM had not discriminated based on age, IBM does not have to pay the $1.4 billion settlement amount.

Current Status of Cash Balance Plan Conversions
The Pension Protection Act of 2006 passed by Congress on August 3, 2006 permits cash balance plan conversions from June 29, 2005 and forward. This date was selected because it was the date upon which Congress added this provision to the draft legislation. However, this results in a “black hole” for cash balance conversions that occurred before June 29, 2005. Although the IBM case set precedent for many of these cases, there are other federal circuit courts that do not agree with the holding in this case. Ultimately, a Supreme Court decision may be required to settle the law on conversions. The end result is that the initial IBM decision put the industry into a quandary as to how to handle conversions. Even now, while the IRS will issue Determination Letters for new Cash Balance Plans, conversion plans remain trapped in the “black hole.”