The rush by corporate America to convert their traditional defined benefit plans to "cash balance" plans may be over - at least for a while.

In July and August of this year, two federal courts issued decisions in favor of workers and against two of the largest employers in the country, IBM and Xerox, striking down cash balance plans which the companies had adopted in the 1990s. In doing so the courts effectively halted these pension plan conversions which had put hundreds of millions of dollars of additional profits in the pockets of corporations at the expense of the participants in the converted plans.

In 1999 The Wall Street Journal and other national media outlets exposed what was essentially a sham being pulled on workers when employers convert their traditional defined benefit plans to cash balance plans. The Wall Street Journal obtained recordings made at a national conference of actuaries who were advising corporations on how to convert to cash balance plans. One actuary on a panel of speakers said:

A second speaker on the panel replied:

To which the first panelist responded:

The Washington Post uncovered a letter written to a client by another pension consultant concerning a cash balance plan conversion:

If these cash balance plan conversions truly hoodwink employees into lower benefits without knowing it, why would consultants recommend them and employers adopt them. For the same old reason: greed. The consultants collect big fees for designing and implementing the conversions, and the corporations reap huge profits as a result. The two recent federal court opinions graphically describe the rewards to IBM and Xerox that flowed from their cash balance conversions.

In the first case, the IBM case, the court found that in 1998, the year prior to the conversion, the Company's pension plan had generated income of $395 million. In 1999 that income jumped to $638 million and by 2001 exceeded $1 billion. Under federal accounting rules IBM could reflect these gains as corporate income, which by 2001 accounted for 13% of the overall income of IBM.

Furthermore, IBM knew exactly what it was doing. The court found that at the time of its 1999 cash balance plan conversion, the plan's actuaries had projected that the conversion would produce savings of almost $500 million a year by 2009, and that these savings would result from reductions of up to 47% in future benefits that would have been earned by older IBM employees under the Company's traditional pension plan.

Unfortunately for IBM, many of the older workers who stood to lose almost half of their pensions happened to be mathematics and computer whizzes who, contrary to the views of the consultants quoted in the press reports, were able to quickly calculate exactly what the Company and its consultants were up to - and they went to court.

And, while the wheels of justice turned at their usual slow pace, when the Federal District Court's decision was issued on July 31, 2003, it was a complete and unequivocal victory for the workers. In essence, the court said that the design of the IBM plan, a design very typical of all cash balance plans, unlawfully discriminated against older workers.

A feature of cash balance plans, which distinguishes them from traditional defined benefit plans, is that the younger employees get exactly the same annual contribution added to their pension benefit as older employees. However, regardless of age those annual additions are compounded by interest every year until retirement. Because of this compounding the annual additions made at younger ages are much more valuable than those made at later ages when there is less time for the interest to compound. This inequality violates ERISA, and invalidates the plan. And in the IBM case, the court found that it was precisely this inequality between the benefits of younger and older workers that the Company knew would save it 47% of the cost of future benefits.

In the second case, the Xerox case, the U.S. Court of Appeals ruled that that Company must pay almost $300 million to former employees who were shortchanged by the Company's cash balance plan. One of the features advertised as a great advantage of cash balance plans - but which is actually harmful to retirement security - is that when employees leave the Company they can immediately get a lump sum payment equivalent to the present value of the pension benefit they would have received if they had waited until age 65 to retire. The reason these lump sum payments are dangerous is that every study done to date shows that the vast majority of participants that take these immediate lump sums spend them on other things before they reach retirement.

But the court found in the Xerox case that the lump sums paid were even less likely to make it to retirement because, when calculating the lump sums, the Company failed to give the employees credit for the amount of compounded interest that their account balances would have earned had they left the money in the account until age 65.

This compounding of interest is one of the basic features of all cash balance plans. By failing to give employees credit for this interest when they took lump sums, the Company kept almost $300 million for itself that should have gone to the participants.

What these cases prove is that the consultants who help companies set up cash balance plans are correct: it is very hard for workers to figure out how these plans work until it's too late. The lesson to be learned is that while these plans can be fair if properly set up, it is very easy for workers to be hoodwinked - especially workers who don't have a union like the International Union of Operating Engineers fighting to protect their retirement security from greedy corporations.