WSJ: IBM Pension Plan Changes are Ruled Discriminatory

July 31, 2003

IBM Pension-Plan Changes Are Ruled Discriminatory
Finding Is Viewed as Boon To Older Workers in U.S.

By ELLEN E. SCHULTZ and WILLIAM M. BULKELEY
Staff Reporters of THE WALL STREET JOURNAL

International Business Machines Corp. discriminated against older
workers when it made changes to its pension plan in 1995 and 1999, a federal court ruled, in a decision that boosted IBM employees but
roiled corporations looking for ways to curb pension costs.

Potentially, IBM could have to recalculate benefits for 130,000
employees and retirees, paying most of them more.

But the decision, by U.S. District Court Judge G. Patrick Murphy in
the Southern District of Illinois in East St. Louis, will have
ramifications beyond IBM. Concerns about the health of pension plans and corporate maneuvers regarding pension funding have risen sharply during the past several months. The employee win also could have an impact on pending pension suits at AT&T Corp. and Cigna Corp. In addition, the ruling could influence regulators who are grappling with how to treat so-called cash-balance pension plans.

Though the potential increase in pension benefits for employees and
retirees could be in the hundreds of millions of dollars, the impact
to IBM's near-term operating cash flow would be negligible, because
the Armonk, N.Y., company would pay the benefits from its well-
funded pension plan. Indeed, the company filings say an adverse
ruling would be "immaterial."

IBM spokesman Bill Hughes said the company would appeal the ruling and "believes it will prevail." He said "under the court's
interpretation of the law, every cash-balance plan in the country is
illegal."

Janet Krueger, a former IBM software consultant in Rochester, Minn.,
who quit in 1999 after 23 years with Big Blue, said, "It's a red-
letter day. I know there will be a lot of partying in IBM homes
tonight." She said she understands it will be years before appeals
are exhausted, but she expects the ruling will mean her $1,024-a-
month pension check will be increased.

Employers had been quietly converting to cash-balance plans since
the 1980s. The conversions have been popular with employers because they typically reduce company liabilities and reduce annual pension cost. That is because instead of calculating a pension by
multiplying years of service and final average salary, the company
provides a hypothetical annual contribution, say 5% of pay, as in
IBM's case, which grows with interest. This leads to smaller pension
growth for longer-serving, older workers, who no longer benefit by a
rapid build-up in pension value in their later years.

IBM's conversion to a cash-balance plan in 1999 led to a fire storm
of protest from longtime employees, who estimated their pensions
would fall by 20% to 40% or more. In response, the company relented
and allowed people older than 40 with 10 years of service to remain
in the prior plan if they wished.

Employees nonetheless filed suit in 1999, saying the company's pension practices discriminate against older workers.

One complaint is that IBM violated a pension law that makes it
illegal to provide a rate of accrual that declines with age. IBM
doesn't dispute that the accrual rate declines in cash-balance
plans. (If cash-balance benefits are measured as a monthly pension
at retirement, the rate at which one builds a benefit declines with
age. That is because although everyone gets the same credit each
year, the older person has fewer years for the benefit to increase
with interest.)

But IBM contended cash-balance plans should be treated like 401(k)s or profit-sharing plans when it comes to the question of how the accrual rule should apply. Indeed, it isn't illegal to provide the
same company contribution to people of different ages in a 401(k)
plan.

IBM contended that plaintiffs ignored the fact younger workers would
get larger payments because they had longer to wait for retirement.
Mr. Hughes said, "To call such a plan age discriminatory makes no
sense and ignores the fundamental principle of the time value of
money."

In his opinion, Judge Murphy disagreed: "From an economist's
perspective, defendants have a good argument. A dollar today is
worth more than the promise of a dollar a year from now. This does
not mean, however, that the [cash-balance formula] is legal."

He said there was distinction between defined-contribution plans, in
which the risks and rewards of the investment are borne by the
employee. "The employer does not guarantee a particular result and
is off the hook." Pension plans, by contrast, provide advantages to
employers. "Here, the employer is literally on the hook but has the
opportunity to earn pension income and reduce the real costs of funding a pension for employees."

The suit also says that in 1995 IBM modified its traditional
formula, reducing the rate of growth for older workers, which they
say violated age-discrimination law, and the judge agreed with the
employees and granted their motion, without discussion.

There have been few resolved cases involving cash-balance plans. The first case involving age discrimination in cash-balance plans, Eaton v. Onan Corp., was settled after employees lost in the district
court of the Southern District of Indiana. AT&T and Cigna are
defending suits that say their cash-balance plans are age
discriminatory. AT&T declined to comment because of pending
litigation. A spokesman for Cigna said it hadn't had time to
evaluate the decision but added that its cash-balance plan differs
from IBM's.

There have been only a handful of other cases involving cash-balance
plans and none involved age discrimination. A district court agreed
with employees of Xerox Corp. that their employer had low-balled
their lump-sum payouts; a decision in the case, pending in the
Seventh Circuit Court of Appeals in Chicago, is expected soon. The judgment entered by the district court is the largest in pension
history, with damages of about $300 million. The company has taken a charge anticipating the outcome. A spokesman declined to comment because of the pending decision.

The ruling could make employers wary of converting to cash-balance
plans. In 1999, the Internal Revenue Service imposed a moratorium on conversions, because of concerns about age discrimination. The IRS is expected to release final regulations on cash-balance plans,
which will include a decision about whether the plans are
discriminatory.

Write to Ellen E. Schultz at ellen.schultz@w... and William M.
Bulkeley at bill.bulkeley@w...

Updated August 1, 2003