Retirement Heist

IN 1997, Cigna executives held a number of meetings to discuss their pension problem. At the time, the plan was overfunded, but executives weren’t satisfied and suggested cutting the pensions of 27,000 employees in an effort to boost the earnings they could report on their bottom line. The only hitch? How to cut people’s pensions—especially those for long-tenured employees over forty—by 30 percent or more, without anyone noticing?

Cigna was just the latest of hundreds of large companies, including Boeing, Xerox, Georgia-Pacific, and Polaroid, that had already gone through this charade in the 1990s. These companies had something in common: They all had large aging workforces—with tens of thousands of employees who had been on the job for twenty to thirty years. These workers were entering their peak earning years, and with traditional pensions that are calculated by multiplying years of service by one’s annual salary, their pensions were about to spike. With the leverage of traditional pension formulas, as much as half an employee’s pension could be earned in his final five years. In short, millions of workers were about to step onto the pension escalator.

Financially, that wasn’t a problem. Companies, including Cigna, had set aside plenty of money to pay their pensions, so having a large cohort of aging workers didn’t put the companies in peril. The companies had anticipated the growth rates of people’s pensions, and the estimated life spans of their workers, and had funded their pensions accordingly. So it didn’t matter that the pensions would quickly grow. The companies were prepared.

The problem, from the employers’ perspective, was that it would be a shame to pay out all that money in pensions when there were so many other useful ways it could be put to use for the benefit of the companies themselves.

Laying people off was one way to keep pension money in the plan. When people leave, their pensions stop growing, and if this happens just when employees’ pensions are poised to spike, all the better. In the 1990s, companies purged hundreds of thousands of middle-aged workers from the payrolls at telephone companies, aerospace and defense contractors, manufacturers, pharmaceutical companies, and other industries, reducing future pension outflows by billions of dollars.

Employers couldn’t lay off every middle-aged worker, of course, but there were other ways to slow the pension growth of those who remained. They could cut pensions, but there were certain constraints. Pension law prohibits employers from taking away pensions being paid out to retirees, and employers can’t rescind benefits its employees have locked in up to that point. But they can stop the growth, by freezing the plans, or slow it, by switching to a less generous formula.

That was the route Cigna took. The company estimated that the move would cut benefits of older workers by 40 percent or more, which meant that as much as $80 million that had been earmarked for their pensions would remain in the plan.

The challenge was how to cut pensions without provoking an employee uprising. Pushing people off the pension escalator just when they’re about to lock in the fruits of their long tenure would be like telling a traveler that his nearly one million frequent flier miles were being rescinded—they weren’t going to like it.

Cigna’s solution to this communications challenge? Don’t tell employees. In September 1997, consulting firm Mercer signed a $200,000 consulting contract to prepare the written communication to Cigna employees, describing the changes without disclosing the negative effects. One of these was a benefits newsletter Cigna sent employees in November 1997, entitled “Introducing Your New Retirement Program.” On the front, “Message from CEO Bill Taylor” declared: “I am pleased to announce that on January 1, 1998, CIGNA will significantly enhance its retirement program…. These enhancements will make our retirement program highly competitive.”

The newsletter told employees that “the new plan is designed to work well for both longer- and shorter-service employees,” provides “steadier benefit growth throughout [the employee’s] career,” and “build[s] benefits faster” than the old plan. “One advantage the company will not get from the retirement program changes is cost savings.” In formal pension documents it later distributed, Cigna reiterated that employees “will see growth in [their] total retirement benefits every year.”

The communications campaign was successful: Employees didn’t notice that their pensions were being frozen, and didn’t complain. “We’ve been able to avoid bad press,” noted Gerald Meyn, the vice president of employee benefits, in a memo three months after the pension change. “We have avoided any significant negative reaction from employees.” In the margins next to these statements, the head of Cigna’s human resources department, Donald M. Levinson, scribbled: “Neat!” and “Agree!” and “Better than expected outcome.”

When employees made individual inquiries, Cigna had an express policy of not providing information. “We continue to focus on NOT providing employees before and after samples of the pension plan changes,” an internal memo stressed. When employees called, the HR staff, working with scripts, deflected them with statements like “Exact comparisons are difficult.”

Cigna wasn’t the only company deceiving employees about their pension cuts, and actuaries who helped implement these changes were concerned, for good reason: Federal pension law requires employers to notify employees when their benefits are being cut. At an annual actuarial industry conference in New York later that year, the attendees discussed how to handle this dilemma. The recommendation: Pick your words carefully. The law “doesn’t require you to say, ‘We’re significantly lowering your benefit,’ ” noted Paul Strella, a lawyer with Mercer, which had advised Cigna when it implemented a cash-balance plan earlier that year. “All it says is, ‘Describe the amendment.’ So you describe the amendment.”

Kyle Brown, an actuary at Watson Wyatt, reiterated that point: “Since the [required notice] doesn’t have to include the words that ‘your rate of future-benefit accrual is being reduced,’ you don’t have to say those magic words. You just have to describe what is happening under the plan…. I wouldn’t put in those magic words.”[4]

Just to make sure this sunny message had sunk in, in December 1998, Cigna sent employees a fact sheet stating that the objectives for introducing the new pension plan were to:

• Deliver adequate retirement income to Cigna employees

• Improve the competitiveness of our benefits program and thus improve our ability to attract and retain top talent

• Meet the changing needs of a more mobile employee workforce, and

• Provide retirement benefits in a form that people can understand.

The letter went on to say that “Cigna has not reduced the overall amount it contributes for retirement benefits by introducing the new Plan, and the new Plan is not designed to save money.”

This was true, literally. Cigna had indeed not reduced the overall amounts it contributed for retirement benefits. It had lowered the benefits for older workers and increased benefits for younger workers (slightly) and for top executives (significantly). Looked at this way, the plan wasn’t designed to save money, just redistribute it.

The communications campaign was successful. Janice Amara, a lawyer in Cigna’s compliance department, didn’t learn that she had not actually been receiving any additional benefits until September 2000, when she ran into Cigna’s chief actuary, Mark Lynch, at a farewell party for two other Cigna employees. “Jan, you would be sick if you knew” how Cigna was calculating her pension, she recalled him telling her. “Frankly, I was sick when I heard this,” Amara said. Under Cigna’s new pension formula, Amara’s pension would effectively be frozen for ten years.

Cigna was a relative latecomer to the hide-the-ball approach to pension cuts. The cash-balance plan it implemented was initially developed by Kwasha Lipton, a boutique benefits-consulting firm in Fort Lee, New Jersey, as a way to cut pensions without making it obvious to employees.

Helping employers hang on to pension assets had been a Kwasha Lipton specialty for years. In the early 1980s, Kwasha Lipton helped companies like Great Atlantic & Pacific Tea Co. kill their pension plans to capture the surpluses. Pension raiding became more difficult as Congress began implementing excise taxes on the surplus assets taken from the plans, so Kwasha devised the cash-balance plan as a new way for employers to capture the surplus.

Changing to a cash-balance pension plan was a way to boost surplus because it reduced the growth rate of employees’ pensions, and thus their total pensions. Unlike a traditional pension plan that multiplies salary by years of service, producing rapid growth at the end of a career, a cash-balance plan grows as though it were a savings account. Every year, the pension grows at a flat rate, such as 4 percent of pay a year. At a benefits conference in 1984, a Kwasha Lipton partner stated that converting to this formula would “immediately reduce pension costs about 25 percent to 40 percent.”

Bank of America was the first company to test-drive the new pension plan, in 1985. The bank was cash-strapped because of soured Latin American loans and didn’t want to have to contribute to its pension plan. The pension change saved the company $75 million.

The bank’s employees didn’t complain when their pension growth slowed, because they didn’t notice. “One feature which might come in handy is that it is difficult for employees to compare prior pension benefit formulas to the account balance approach,” wrote Robert S. Byrne, a Kwasha Lipton partner, in a letter to a client in 1989.

The cuts were difficult for employees to detect because they didn’t understand how pensions are calculated, let alone these newfangled versions, which appeared deceptively simple.

In reality, cash-balance plans are complex. When companies convert their traditional pensions to cash-balance plans, they essentially freeze the old pension, ending its growth. They then convert the frozen pension to a lump sum, which they call the “opening account balance.” The lump-sum amount (i.e., the “balance”) doesn’t grow each year by multiplying years and pay, both of which would be growing, and thus generating the leveraged growth seen in a traditional pension. Instead, the pension “balance” grows by a flat percentage of an employee’s pay each year, say, 4 percent. Voilà: no more leveraged growth.

Ironically, employers were able to capitalize on the growing popularity of 401(k)s by presenting cash-balance plans as merely 401(k)-style pensions. Cigna told employees that the new cash-balance plan was like a 401(k), only better, because the company made all the contributions and departing employees could cash out their accounts or roll the money into IRAs. Employees didn’t realize that there was no actual “account” receiving actual employer “contributions” or “interest”—just a frozen pension, and a new pension that had a formula producing very low growth, with no leverage. The pension plan was still one big pool of assets, and the only thing that was changing was the formula used to determine how much each employee would get.

In other words, after a company changed to a cash-balance plan, most employees were no better off than if they had changed jobs or been laid off (which would have stopped their old pension from growing) and now had only a 401(k) at their new job, growing at only 4 percent a year.

But it was even worse than that at Cigna and other companies: Older workers weren’t even getting the annual increase. That’s because at many companies the “opening account balance” was worth less than the value of the lump sum. For example, if at the time of the pension change someone had earned the equivalent of a $300,000 payout, the opening account balance might be only $250,000. Consequently, it could take years for the pay credits to build the “balance” back up to where it had been when the pension change was made. As a result, following the change to a cash-balance plan, the pensions of older workers were frozen—in some cases for the rest of their careers. Employees didn’t notice because the amounts on their “account statements” always appeared to be growing.

In the pension world, this period of zero pension growth is called “wear-away,” because a person has to wear away his old benefit before his benefit begins growing again. Creating a wear-away is an employer’s way of saying, “We should have had this less generous pension all along, and if we had, your pension would be smaller. Bottom line: You’ve been overpaid and won’t get any pension until you’ve worked off the debt.”

It was little different from an employer cutting someone’s pay, then telling him he wouldn’t get a paycheck for five years, because he should have been paid less all along. Employees would notice if their pay was frozen, but they didn’t notice that their pensions weren’t growing because the opening account balance had been lowballed. Amara’s opening balance was $91,124, instead of the $184,000 she had earned. Under the new formula, she wouldn’t begin to build a new benefit until 2008. Essentially, wear-away is like a retroactive pension cut.

Under pension law, it’s illegal to retroactively cut someone’s pension (though employers can slow the pension growth or end it altogether by freezing the pension plan). Cash-balance plans provide a way around this prohibition against retroactive pension cuts because if employees leave before their accounts have caught up to their old pensions, they always receive at least the value of the benefit they had when the pension was changed. In this case, Amara would receive the lump sum of $184,000 if she left; but if she didn’t, she could work another ten years with no increase in her pension.

Gerald Smit, a longtime AT&T employee, was forty-seven when AT&T changed its pension plan in 1998. At the time, his pension would have been worth $1,985 a month when he reached age fifty-five. Though he continued to work at AT&T for eight more years, when he left, his pension was still worth just $1,985 a month. For other employees, the waiting period could be longer. Minutes of a 1997 meeting of AT&T’s pension consultants noted that “employees in their 40s could lose, [and] have to wait 10 years for benefits. By contrast, the benefit would build “immediately for younger employees.” (The benefits for younger employees and new hires would grow immediately, because they had accumulated little or nothing under the old pension.)

From the beginning, the cash-balance plan’s ability to disguise the pension cuts was one of its selling points with employers. In 1986, Eric Lofgren, an actuary and principal with Mercer-Meidinger (later called Mercer), discussed the newfangled cash-balance plans on a panel discussing new kinds of pension plans at an actuaries conference. The cash-balance plan, he explained, was a pension plan “masquerading as a defined contribution” savings plan, like a 401(k). It was, he commented, “a very worthy concept.”

Lofgren went on to provide two definitions of the cash-balance plan. “Both definitions are true, but they slant in different directions,” he said. “The first definition is the upbeat definition: ‘Dear employee: A cash-balance plan is an exciting, modern, flexible new plan designed with the advantages of both defined benefit and defined contribution. Easy to understand, each employee quickly vests in a portable lump sum account which is guaranteed to increase at the CPI [consumer price index] for inflation protection. There are many benefit options at retirement.’ ”

He continued: “The second definition goes like this: ‘Dear employee: We’ve got for you a cash-balance pension plan. It’s our way to disguise the cutbacks in your benefits. First we’re going to change it to career average [meaning that the benefit would be based on an average of one’s salary, not the highest amount, as in a traditional pension]. We’ll express the benefits as a lump sum so we can highlight the use of the CPI, a submarket interest rate. What money is left in the plan will be directed towards employees who leave after just a few years. Just to make sure, we’ll reduce early-retirement subsidies.’ ” These subsidies allow a person to retire at age fifty-five or sixty with roughly the same pension as if they’d stayed to age sixty-five. Taking away the subsidy could reduce a pension by 20 percent or more.

The desired effect of the pension change, from the employer’s point of view, was not just that it froze the pensions of older employees, but redirected some of the savings to younger workers. Publicly, employers emphasized that the new pension was better for “young, mobile workers” (a phrase that appeared in virtually every piece of marketing material issued by a company to help explain why it had changed the plan). In fact, two-thirds of young workers leave their jobs without vesting in their pensions, meaning that they got nothing. The forfeited amounts remained in the plan.

Initially, other consulting firms were skeptical of this radical design. But as Kwasha Lipton converted pension plans at Hershey, Dana, Cabot, and other companies, competing consulting firms saw a lucrative opportunity. Soon Mercer, Towers Perrin, and Watson Wyatt developed their own hybrid plans, and they too emphasized the ability of the plans to mask pension cuts.

WISE GUYS

Not everyone was fooled when their employers changed to a cash-balance plan. Jim Bruggeman was forty-nine when his employer, Central and South West, a Dallas-based electric utility, took this step in 1997. “The changes being made are good for both you and the company,” the brochure noted. Bruggeman, an engineer in Tulsa, was eager to find out how, and was uniquely qualified to do so. He also had a background in finance, his hobby was actuarial science, he had taken graduate-level courses in statistics and probability, and he knew CSW’s old pension plan inside and out. After considerable tinkering with spreadsheets, he was able to finally figure out that the supposedly “better” pension would reduce the pensions of many employees by 30 percent.

He wasn’t about to keep this finding to himself. At a question-andanswer session on the new plan, Bruggeman spoke up and told co-workers how their pensions were being reduced. He had a sheaf of spreadsheets to prove it. The next day, his supervisor went to his office with a message from CSW management in Dallas. They were concerned that his remarks would cause an “uprising” and warned him that if he continued to talk to other employees about the pension change, they’d think he wasn’t a team player and his job could be in jeopardy. In his next performance evaluation, his supervisor’s only criticism was that he “spends too much time thinking about the pension plan.” CSW saved $20 million in the first year it made the change. Bruggeman was fired in 2000.

Another engineer one thousand miles away was equally perplexed. Steven Langlie had spent three decades designing military engines, but he couldn’t figure out how the cash-balance plan his employer changed to in 1989 worked. The skeptical engineer relentlessly pestered his employer, Onan Corp., a unit of Cummins Engine in Minneapolis, for answers. When they refused to spill the beans, the increasingly apoplectic Langlie wrote to local lawmakers, complained to the Minnesota Department of Human Rights and the IRS, and traveled to Washington, D.C., to deliver a petition signed by 460 fellow workers to the Department of Labor.

As Langlie’s pension complaints escalated, he was transferred, denied training, and demoted, despite favorable job-performance reviews. The company also refused to upgrade his computer from a primitive IBM 286—the industry equivalent of an Etch A Sketch, which couldn’t run engineering software or communicate with the company’s servers. Finally, the human resources department told Langlie’s supervisor that it would “help retire him” and eliminated his job. After Langlie’s thirty-seven years with the company, his pension, which would have been $1,100 a month under the old pension plan, was just $424 a month.

Deloitte & Touche, the giant accounting firm, made a big miscalculation when it tried to switch to a cash-balance plan in 1998: The finance guys apparently forgot that a large number of the firm’s employees were older, experienced actuaries and accountants, who took a professional interest, as well as a personal one, in the plan’s novel design. They were horrified when they connected the dots and saw that their pensions would go over a cliff. They went ballistic, and the firm backtracked, allowing all who were already on the staff when the cash-balance plan was adopted to stick with the old benefit if they wished.[5]

IBM also underestimated the über-nerds on its staff, though it’s not hard to understand why the company was so complacent: It had cut pensions several times in the 1990s, and no one had noticed. Traditionally, it provided 1.5 percent of pay for each year of service, which resulted in a pension that replaced roughly one-third to almost one-half of a person’s salary in retirement. The calculation was simple: years of service times average pay in the final few years times .015. For example: If someone worked thirty years, and his average pay in the final years was $50,000, the pension would be worth $22,500 a year in retirement ($50,000 x 30 x .015).

Reducing any of these factors would produce a smaller pension. In the early 1990s, IBM reduced all three. In 1991, it capped the number of years of service that got taken into account when calculating pensions, limiting it to thirty years. This meant that if people worked longer than that, their pensions wouldn’t grow. Next, it lowered the multiplier from 1.5 percent to 1.35 percent, again reducing the pensions. Finally, it reduced the salary component; instead of basing the pension on the average salary an employee earned in the final five years of service, it began to use an average based on the entire time of service, including the early years when pay was low.

These early cuts were like gateway drugs: The first one produced a mild high; the next two were more potent; then IBM moved on to the equivalent of heroin: the “pension equity plan.” The very name was deceptive, like “low-fat” and “organic.” “Equity” suggested fairness. More than that, the pension equity plan looked as though it favored older workers.

At first glance, pension equity plans, which went by the zippy acronym PEP, looked similar to cash-balance plans. An employee received an “account” that would grow with an employer “contribution” based on the employee’s average pay over the prior five years or so. This pay figure would then be multiplied by a factor that increased the longer a person worked at the company. This sounded fair since, if the figure is rising, the pension must be increasing each year, too—right?

Well, here’s the beauty of the hat trick: If you multiply three items—all positive numbers—which keep growing each year (the years on the job, the salary, the multiplier), the result is an account with a rising balance. But if you then multiply the result by a declining number, the result can be a pension that isn’t growing—and might even be declining—in value.

That’s what happens in pension equity plans: The interest rate used to calculate the pensions—a rate that wasn’t disclosed—would get smaller as people got older. It was 5 percent for employees under age forty-five, 4 percent for those aged forty-five to fifty-five, and 0.5 percent less for each year above age fifty-five. So, even though the company “contributions” rose as a person got older, multiplying it by a declining (embedded) interest rate caused the pension’s rate of growth to shrink as a person aged. The “easy-to-understand” pension equity plan was a Rube Goldberg contraption of moving parts. “The plan took me months to understand,” Donald Sauvigne, head of retirement benefits at IBM—who had twenty-five years’ experience with pensions—told an audience at a 1995 actuaries conference in Vancouver.

After warming up with the series of modest pension trims, IBM was looking for something that would enable it to ditch its costly “early-retirement subsidy,” which allowed employees in their fifties to retire with nearly the pension they would have at sixty-five. This feature was once common at larger companies, and IBM had added it to its pension plan in the 1980s as an incentive to get workers to leave in their fifties rather than hang around until sixty-five to max out their pensions. It “encouraged departures,” so it “served us well,” Sauvigne told his colleagues at the conference. But IBM found that the subsidy also had the unwelcome effect of encouraging people to stick around until at least age fifty-five so they could lock in the subsidy.

IBM couldn’t just pull the plug on the subsidy, because pension law doesn’t allow a company to take away a benefit a person has already earned or take away a pension right or feature the company has granted. “So we had to design something different,” Sauvigne said. Enter Louis V. Gerstner Jr., IBM’s new president. He’d headed RJR Nabisco in 1993 when it faced a similar dilemma: how to reduce pensions and remove the retirement subsidy without obviously violating the law or provoking an employee backlash. Gerstner and IBM turned to Watson Wyatt, the same consulting firm that had helped Nabisco solve its pension problem.

Watson Wyatt had been marketing its “pension equity plan” design to large employers, with considerable success. Its brochure summed up the benefits: “Younger employees are happier because they see an account-based benefit; older employees are happy because benefits are still rich enough to achieve retirement security at long tenures; the CFO is happy because the PEP eliminates the expensive—and from a business sense counterproductive—early retirement subsidy.”

The brochure didn’t point out another benefit—deception—but it was no secret among the consulting community. “It is not until they are ready to retire that they understand how little they are actually getting,” said a Watson Wyatt actuary at a 1998 panel entitled “Introduction to Cash Balance/Pension Equity Plans.” That got a good laugh from the audience, as did the response by a fellow panelist, who was with Mercer: “Right, but they’re happy while they’re employed…. You switch to a cash-balance plan where the people are probably getting smaller benefits, at least the older, longer-service people; but they are really happy, and they think you are great for doing it.” More laughter.

Watson Wyatt epitomized the new breed of benefits consultants that was revolutionizing the compensation-and-benefits landscape. In prior decades, benefits specialists handled the garden-variety tasks of pension administration and human resources consulting. That began to change in the 1980s as consultants began more aggressively prospecting for business and developing niche specialties in cutting retiree benefits, boosting executive compensation, and managing mass layoffs and early-retirement windows.

Watson Wyatt was particularly innovative. It developed a suite of demographically inspired services specifically aimed at helping employers evaluate—and reduce—the cost of their older workers. One service was the firm’s “Aging Diagnostic,” which marketing material described as “a tool designed to measure how the cost of compensation and benefits is affected by an aging workforce, so organizations can detect this trend early… and begin managing it, before it manages them.”

With one baby boomer turning 50 every eight seconds for the next 10 years, the economic issues of an aging workforce could become a major issue for your company. For every 50-year-old employee in your company, you are likely to pay:

• Twice as much in health care as for a 30-year-old.

• More in base salary and vacation leave, because of longer job tenure.

• Up to twice the employer match on defined contribution deferrals than you would for a 20-year-old, due to higher participation and savings rates.

• More than twice the pension plan contribution rate that you would pay for a 25-year-old.

• Companies that manage this trend early—before it manages them—will create a significant competitive advantage…. That’s where Watson Wyatt’s Aging Diagnostic TM comes in. Our state-of-the-art modeling system uses your data and the latest demographic research to project the total impact of an aging workforce on your compensation and benefits costs…. Companies that want to combat the cost spiral of changing demographics should take a careful look at their current workforce demographics, hiring practices and benefits design, paying special attention to retirement packages.

With little fanfare, IBM rolled out the pension equity plan in 1995 and heard not a peep from the employees. Three years later, it was ready for yet another pension cut. This time it decided to convert the pension equity plan to a cash-balance plan. IBM’s consultants at Mercer Human Resource Consulting and Watson Wyatt calculated that when it switched to the cash-balance plan, approximately 28,300 older IBM employees would stop earning pension benefits for one to five years, while younger employees would begin to build benefits immediately. The net result, though, would be that the pension plan would pay out $200 million less, and most of the savings would come from older, long-service employees, like Dave Finlay.

Finlay was exactly the kind of employee the company was taking aim at: He was fifty-five and had been at the company twenty-six years. As a senior engineer, he had a comfortable, though not lavish, salary. He expected his pension to be the same, and it would have been if IBM hadn’t engineered its series of secret cuts. He began to figure this out in early 1999, after he got a brochure from IBM in the mail announcing that the company was modifying its pension plan to make it “more modern, easier-to-understand, and better suited for a mobile workforce.” Finlay was close to retirement, so he scrutinized the document, trying to figure out how the new pension compared with his old one. The description of the new pension was thin on details, noting only vaguely that employees “will see varying effects” and that those retiring early will “see lower value.” Not good enough.

Finlay went to the internal company Web site, where IBM had long offered a “Pension Estimator” that enabled employees to estimate how much their pension was—and would be—worth, depending on how long they’d worked, their estimated annual pay raises, and other factors. But IBM had taken the pension tool offline. When Finlay called administrators in IBM’s human resources department to complain, they told him the company had taken the estimator down because “it really does not seem appropriate to be modeling a plan that no longer exists.”

This response was common. The corporate finance departments that hatched these schemes typically kept most of the lower-level human resources managers and peons in the dark and fed them the same hooey they served up to the employees. For example, when IBM switched to a pension equity plan a few years earlier, it had sent a memo to managers stressing that the new pension equity plan was “the result of a recent study which concluded that the plan should be modified to meet the evolving needs of IBM and its increasingly diverse work force, and align more with industry practices and trends.” It didn’t tell the HR staff any more than it told the employees that it was cutting pensions (including theirs) and that it was doing so to keep more money in the plan to enrich the company.

After getting no help from the benefits administrators, Finlay began to suspect that IBM was hiding something. Though Finlay didn’t have the online pension estimator at his disposal, he had saved every benefits booklet, announcement, statement, and handout he’d ever received since he joined the company in 1972 and was able to reconstruct the estimator. It became a personal challenge. For weeks, he bicycled home from work to his subdivision on the outskirts of Boulder, Colorado, and stared at his computer until nearly midnight. He spent weekends developing spreadsheets and reverse-engineering the algorithms with the information he hauled up from his basement. Finlay eventually figured out that the earlier 1995 change, one that he hadn’t examined so thoroughly, had reduced his prospective pension from about $69,500 a year to about $57,700, a 17 percent drop. And the latest switch would cut his annual pension a further 20 percent, to about $45,800.

Finlay showed his spreadsheets to his manager and suggested sending them to the human resources department. Don’t bother, his manager said: The human resources people wouldn’t believe his figures and would tell the managers that he didn’t know what he was talking about. At that point, the self-described Republican and Vietnam vet was steamed enough, he said, that he would have joined a union if the company had had one.

BACKLASH AT BIG BLUE

To make up for the loss of the pension estimator, some IBMers launched a Web site on Yahoo! to compare notes and air gripes about the anticipated change. Finlay posted his spreadsheets and calculations, which gave his colleagues a way to measure how much their pensions would shrink. The site began getting fifteen thousand hits a day as many of IBM’s 260,000 employees around the world began picking apart virtually every actuarial assumption related to IBM’s calculation of benefits. “I’d like to think this group is too intelligent and motivated to let a bunch of corporate actuaries sell us down the river and think we’re too stupid to figure out their half-truths,” noted NiceGuys-Win-in-the-End.

The HR department was not popular. “The mathematically disadvantaged half-wits in HR can’t hold up a conversation on the topic of calculating anything,” remarked IBM-Ghost. “They are more like used-car salesmen trying to sell a car with a sawdust filled transmission (my apologies to any used-car salesmen as you probably have more integrity than HR),” wrote idontknowaboutyou.

CEO Louis Gerstner was unpopular, too. One employee suggested hiring an airplane to drag a banner over the IBM facilities in Silicon Valley during lunchtime, with the message HEY LOU, “THOU SHALT NOT STEAL.”

Meanwhile, IBM insisted that it was instituting the change to make the plan more “modern” and not to save money. This was a common, though disingenuous, claim. Sure, IBM wasn’t literally saving money, because it wasn’t spending any money. (The pension plan was overfunded.) Rather, the pension cuts were enabling the company to keep $200 million, which otherwise would have gone to pay benefits to long-term employees.

Another popular whopper used by Lucent, AT&T, and so many others, was that the change wouldn’t reduce a person’s retirement benefits. What they didn’t say was that in these calculations, they were also counting 401(k) savings as “pension benefits” and assuming that employees would be contributing a large percentage of pay that would receive double-digit returns. So, yes, the pension change wouldn’t, perhaps, collectively reduce the employees’ retirement benefits, as long as one included the fantasy portion. The pension change took place anyway, in July 1999, but employees didn’t drop their demands that the company change it back. The irony was that they wanted IBM to change the cash-balance plan back to the pension equity plan, which the employees didn’t realize—then or before—had already cut their pensions.

Employees formed the IBM Employee Benefits Action Coalition, which began to complain to the Equal Employment Opportunity Commission (EEOC), the IRS, Congress, and anyone else who would listen. August is usually a slow month that finds lawmakers at state fairs and pie-judging contests, but that year lawmakers in areas with large IBM populations were besieged in town hall meetings by angry IBM constituents. The largest was in Vermont, where eight hundred people jammed into an art center in Winooski for a meeting held by then Congressman Bernie Sanders. Sanders, a feisty independent, thought the IBM employees, who were asking IBM to let them remain in the old plan, had a point. “If converting to a new pension program doesn’t save a company any money, as some companies say, it should not be too expensive for companies to offer all of their employees the choice to remain in their original pension plan.”

A Senate committee decided to hold a hearing on whether employers were adequately disclosing pension cuts to employees. During the session, PricewaterhouseCoopers, a leading benefits consultant and accounting firm, circulated a briefing memo to lawmakers and the media stating that recent newspaper articles “leave readers with the unsubstantiated conclusion that corporate America uses cash-balance plans to mask significant reductions in pension benefits and costs.” The memo also noted, “It is unfair to imply that employers chose to switch to cash-balance plans in order to mask benefit reductions.”

But the impact of the consultants’ briefing material was extinguished when a witness at the hearing played an audiotape of William Torrie, a Pricewaterhouse actuary, telling a Society of Actuaries meeting the previous year that “converting to a cash-balance plan does have an advantage, as it masks a lot of the changes…. There is very little comparison that can be done between the two plans,” he said.

The witness played other audiotapes of discussions among actuaries made in the 1990s at other professional conferences. “If you decide your plan’s too rich, and you want to cut back, and you only want to do it for new hires, changing to a totally different type of plan will let you do that without being obvious about it,” said Norman Clausen, a principal at Kwasha Lipton, which had become a unit of PricewaterhouseCoopers. An article about the tapes’ contents had earlier appeared in The Wall Street Journal, and then NBC got hold of the tapes and played excerpts on the Nightly News.

Gerstner and other top managers were caught flat-footed by the backlash, and before long they were staging a partial retreat. The company agreed to allow 35,000 older employees to stay in the old pension, but it still saved plenty of money. The cash-balance plan boosted IBM’s pretax income in 1999 by $184 million, or 6 percent.

A MOVING STORY

Despite the negative attention its pension changes were getting, IBM continued to devise sly ways to cut benefits. One was to pay them out as lump sums. Companies championed the lump-sum feature as something that made cash balance and other hybrid pensions better for “a more mobile workforce.” Because employees change jobs more frequently than they did in the past, employers maintained, they need a portable pension, like a 401(k), that they can cash out when they leave and roll into an IRA (or blow on a bass boat or a Taco Bell franchise).

One flaw in this construct is that employers have always been free to provide lump sums from traditional pensions; lump sums aren’t intrinsic to cash-balance plans. And in any case, most employers automatically distribute pensions in lump sums when the pensions are worth $5,000 or less, to spare themselves the trouble of keeping track of them over many years.

Watson Wyatt, ever the innovator, offered employers the Single Payment Optimizer Tool (SPOT), a software program that enabled employers “to compare the cost of lump-sum cash outs to the costs of keeping employees on the retirement rolls.” “Often, lump sums are the most cost-effective form of pension payout because of lower administrative costs over time,” the accompanying marketing material says. It went on to note that sometimes employers are better off not offering lump sums if they can earn a higher rate of return on the assets than they will have to pay out to employees, adding that “SPOT can tell an employer when it is more cost effective to pay a lump sum and when an annuity is best…. With organizations scrutinizing every expense for bottom-line impact, every bit of savings helps.” So much for the concern about providing lump sums to help more-mobile workers build retirement benefits.

Another fallacy is that workers are more mobile. Younger workers are, indeed, more mobile—Bureau of Labor Statistics data show that they tend to change jobs seven times before they’re thirty-two. But pensions, including cash-balance plans, require five years on the job before one vests, so few younger, more-mobile workers remain in place long enough to collect a pension at all.

Older workers, by contrast, aren’t mobile at all (at least not voluntarily). As IBM and other employers were painfully aware, older workers tend to stay on the job until they lock in a bigger pension. That was the portion of the workforce IBM and other companies wanted to dislodge. Lump sums offered a twofold solution. For one thing, they were an enormous carrot to get people out the door. Companies knew that employees found lump sums irresistible. “Choosey Employees Choose Lump Sums!” was the title of one of Watson Wyatt’s surveys.

The carrot was especially effective when presented along with a stick: As part of their retirement “windows,” numerous companies told employees that if they agreed to leave now, they could take a pension as a lump sum. If not, they could take their chances and get laid off next year and have only the option of a monthly check in retirement. Another benefit of lump sums—from employers’ perspective—is that they shift longevity risk to retirees. Employers have been acutely aware that life spans are increasing, which explains why companies with a large percentage of women and white-collar professionals have been eager to provide lump sums.[6] If the pension is based on a life expectancy of seventy-eight, then an engineer who lives to age ninety will have drawn a pension for roughly twelve years longer than the amount the lump sum would have been based on.

By contrast, coal miners and factory workers tend to have shorter life spans than the national average, so it’s no surprise that they are less likely to have a lump-sum option. General Motors, for instance, doesn’t allow most of its factory workers to take a lump-sum payout. But it does allow its white-collar workers to take a lump sum if they leave before retirement age.[7]

Government data show a strong correlation between longevity and payout options: Bureau of Labor statistics show that about one-third of blue-collar workers have a lump-sum option in their pension plans, while 60 percent of white-collar workers do.

This concept is understood by noncorporate pension managers as well: The Marine Engineers’ Beneficial Association, which covers ship engineers and deck officers, requires workers to take a medical exam before being eligible for a lump sum. Retirees in good health can take a lump sum, but those in poor health may not be allowed to.

Thus, despite all the talk about the burden of longer life spans, employers that pay out pensions in lump sums actually face none at all: The longevity risk has been passed on to the retirees.

TAKING THEIR LUMPS

Lumps sums provided employers with yet another benefit. Companies used them to secretly cut pensions even as people walked out the door. The mechanism was simple: If someone’s pension, converted to a lump sum, was worth $400,000, the employer could offer a lump sum worth, say, $350,000. How can this be legal, given anti-cutback rules?

Simple: Companies didn’t tell employees that the lump sum was worth less, and employees couldn’t tell. But as long as the employee chooses the lump sum—unknowingly cutting his own pension—the anti-cutback law hasn’t been violated. (A key reason the lump sums are smaller is that they might not include the value of any early-retirement subsidy, which can be worth 20 percent or more of the total value.)

Few employees would knowingly give up tens of thousands of dollars’ worth of pension, but unless employers provided apples-to-apples comparisons of the actual values of the monthly pension and the lump sum, there was no way to compare. In 1999, Mary Fletcher, a marketing services trainer and fourteen-year veteran of IBM, had to decide between taking a lump sum and a monthly pension when IBM sold a unit with three thousand U.S. employees to AT&T. She hired an adviser who calculated that while the monthly pension would be worth $101,000 if cashed out, the lump sum IBM offered Fletcher was worth only $71,500. Still, she took the lump sum. Almost all employees do, figuring they can invest the money and eventually end up with more. She was forty-seven and figured she was better off having nothing more to do with the IBM pension plan.

Employee advocates, including the Pension Rights Center and AARP, demanded better disclosure rules, but employers fought back. Lobbyists for the American Society of Pension Actuaries, the ERISA Industry Committee, and the U.S. Chamber of Commerce told Senate staffers that employees would only become confused if they were presented with too much complex information, and that providing more disclosure would be a “daunting task.” Lawmakers didn’t completely buy this, so in 2004 the IRS began requiring employers to tell people more clearly if the value of the lump sum wasn’t equal to the monthly pension.

In 2006, the Pension Protection Act banned wear-away prospectively, meaning that if an employer set up a cash-balance plan after the 2006 law went into effect, it couldn’t include a wear-away period.

But the issue of pension deception is still playing out in the courts. Cigna employees, who hadn’t been told their pensions were essentially frozen when the company changed to a cash-balance plan, sued the company in 2001. In 2008, a federal court concluded that Cigna deliberately deceived its employees when it changed its pension plan in 1998, gave them “downright misleading” information about their pensions to negate the risk of an employee backlash. “CIGNA’s successful efforts to conceal the full effects of the transition to [the new pension] deprived [plaintiffs] of the opportunity to take timely action… whether that action was protesting at the time [the change] was implemented, leaving CIGNA for another employer with a more favorable pension plan, or filing a lawsuit like this one.”

The district court ordered Cigna to restore the pension benefits it had led employees to believe they would be receiving. Cigna appealed to the Second Circuit, and lost, but that wasn’t the end of it. Cigna didn’t try to appeal the court’s finding that it deceived its employees—the memos and documents that surfaced in the case were too damning.

But in a kind of hail Mary pass, Cigna appealed to the Supreme Court, arguing that in order to get the benefits, each individual employee must prove he’d acted on the misinformation–that is, didn’t change jobs or save more money, and thus suffered financial harm.

During oral arguments before the Supreme Court late in 2010, it became clear that the majority of justices were troubled by the fact that if they adopted the “detrimental reliance” standard Cigna was advocating, then employers would suffer no consequences even for the most egregious deception. “Doesn’t this give an incredible windfall to your client, Cigna, or to other companies that commit this kind of intentional misconduct?” Justice Elena Kagan asked Cigna’s attorney. In May 2011, the justices sent the case back to the lower court with instructions that it review its decisions, based on the portion of pension law that requires employers to tell employees, clearly and unambiguously, when it is cutting their pensions.

If the judge comes to the same decision to award the benefits to the employees—a total of $82 million—this would be the biggest award for employees whose employer hid pension cuts.

But Cigna has already taken steps to soften the blow: It froze the pension plan in 2009 and cut health, disability, and life insurance benefits for retirees, giving it a gain of $92 million.