Checks and balances.

Employees at BOC, an international manufacturing firm, took their pension plan for granted. That was before the company installed a cash-balance plan to help drive home the save-for-retirement message.

Looking for some alternatives to pension-plan design? Consider a cash-balance program. This plan design, which combines features of a 401(k) and a defined-benefit plan, has been around since 1984, so it isn't a new kid on the block, but in today's pension environment, it can offer valuable solutions to many plan design, communications and funding dilemmas.

The BOC Group, an international company with operations in the industrial gases and medical products businesses, was one of the first companies to adopt this type of plan in 1986. The company employs about 35,000 employees worldwide, with 10,000 based in the United States. About 7,000 U.S. employees are eligible to participate in the company's cash-balance plan.

Cash-balance plans are defined-benefit pension plans that express participants' retirement benefits in the form of nominal "accounts" instead of as annuities, like more traditional pension plans. These account balances grow through dollar "deposits" (usually represented as a percentage of pay) that are credited to participants' accounts, and interest that is credited at a rate guaranteed by the plan.

Before 1986, BOC offered a traditional pension plan, with benefits based on employees' years of service and final average compensation. Unfortunately, as with many companies' pension plans, BOC's final-average-pay plan cost a great deal, and employees didn't appreciate the benefit. To most employees, the final-average-pay plan was invisible until later in their careers, when their thoughts turned to retirement. By contrast, employees showed more enthusiasm for the more "visible" 401(k) plan. Yet the company was spending approximately 2.5 percent of payroll on the 401(k) plan and 5 percent of payroll on the final-average-pay pension plan. It didn't take BOC long to conclude it wasn't getting much bang for the buck on the pension plan.

The company also wanted employees to assume more responsibility for their own postretirement financial security. Although the 401(k) plan had just been improved to provide a 50-percent match on the first 6 percent of pay, employees' participation and deferral rates were not what they should have been. BOC believed it would be easier to boost contribution rates by first clearly communicating the company's own financial commitment to employees' postretirement security.

The fact that the existing final-average-pay plan provided subsidized early retirement benefits also made cash balance an attractive and timely alternative. To provide cost-neutral or unsubsidized early retirement benefits at age 55, the company would have had to reduce those benefits by as much as 60 percent of the age-65 benefit. However, BOC's final-average-pay plan included early retirement reductions that were not as drastic. This subsidy is built into most final-average-pay plans to give employees enough financial security to retire early.

But BOC's work force was changing. The career employees, who typically received the most generous (and, in fact, the only) significant benefits under a final-average-pay plan, were becoming a rare breed. And with the ever-increasing cost of postretirement medical benefits, career employees who did remain couldn't afford to retire early if they were relying solely on their pension benefits.

So why continue to provide such a costly subsidy? BOC still had to fund and expense it, even though fewer people were taking advantage of it. After examining a few alternatives, senior management decided that the cash-balance plan - by virtue of its age-neutral approach to benefit delivery - proved to be a more equitable, cost-effective alternative. However, in order not to disadvantage those employees who were close to retirement in 1986 and who intended to take advantage of the existing early retirement subsidies, a grandfather provision was included to guarantee them a retirement benefit at least equal to what they would have received under the final-aver-age-pay plan.

Converting benefits from a traditional pension plan to a cash-balance plan was simple. BOC established participants' opening account balances as the lump-sum value of their benefits accrued under our traditional plan. Dollar deposits and interest were then prospectively credited to that balance.

BOC decided to adopt a plan design in which the dollar deposits to employees' cash-balance accounts are structured as a percentage of employees' pay. The percentage of pay credited to an employee's account increases in the later years of employment. The company also integrates these credits with Social Security using a step-up approach. The annual dollar deposit equals a percentage of employees' pay above the Social Security maximum taxable wage base for that year, and a higher percentage above that wage base.

Some companies' cash-balance plans use age-related credits. For example, they credit any employee under 30 with 3 percent of pay, those 30 years old to 40 years old with 4 percent of pay, and so on. But BOC wanted to remove age as a factor for benefit accruals, emphasize length of service and pay and redistribute the pension-plan assets along those lines.

The minimum interest credit rate guaranteed under the BOC plan is the Consumer Price Index. However, the company has the ability to occasionally amend the plan to provide higher interest credits when economic conditions warrant it. This ad-hoc flexibility gives a measure of control over benefit accruals to help stabilize the program's cost.

THE LIGHT BULB GOES ON

BOC's task of communicating employees' responsibility for their own retirement was far easier after adopting a cash-balance plan. While a cash-balance plan doesn't make retirement-income variables (like future cost-of-living or future pay increases) any easier to predict, it does make the retirement benefit more tangible. Instead of an esoteric formula, participants see a straight dollar amount, and they understand that better.

This allows participants to appreciate the value of the pension benefit that the company is providing to them and better understand the level of commitment that they need to make to their postretirement financial security. BOC cash-balance plan participants receive annual benefit statements, allowing them to track the growth of their account balances. Employees can also call an 800 number to ask for a current account balance.

For the company, another attractive feature is that the cash-balance plan is well-suited to the mobility of the modern work force, because it provides equal pay for equal service, regardless of the participant's age at hire. For instance, a 25-year-old new hire and a 45-year-old new hire who consistently earn the same compensation accumulate equal cash-balance pension benefits during the time they both work for BOC. This is a shift away from the final-average-pay plan's dollar distribution, which would provide higher benefits to the 45-year-old and cost the company more.

The plan also offers improved benefit portability for terminating participants. The normal form of benefit distribution under the cash-balance program is, by law, an annuity. This annuity amount is determined - as of the date the participant's benefits will begin to be paid - as the monthly benefit equal in value to the participant's account balance.

However, by also providing for a lump-sum distribution, the company's plan allows participants to take their retirement benefit with them to another employer. Even with this feature, though, BOC has seen 30 percent to 40 percent of employees who leave the company choose to retain their cash-balance accounts in the company's plan instead of rolling it over into their new employer's plan.

BOC management now has a smoother, more predictable pattern of annual costs and contributions, because of the age-neutral pattern of benefit accruals under the cash-balance plan, combined with the built-in interest-credit mechanism. Also, the financial impact of the early retirement subsidies payable under the old plan has continued to diminish as the grandfathered population retires.

From an investment perspective, the pension-plan trust fund's investment mix was about 60-percent equities and 40-percent fixed-income investments before implementing the cash-balance plan. Although the plan's lump-sum feature requires the portfolio managers to keep a closer eye on the level of liquid assets, the overall trust-fund investment strategy has been unaffected, since the company still retains the benefit liability for a large number of retired and terminated vested participants. However, the company keeps a watchful eye on the participant demographics and plan liability distribution to determine when and if it would be necessary to change the investment strategy.

In general, BOC's cash-balance program has proven to be both user-friendly and company-friendly. Users have more accessible and understandable pension benefits. The cash-balance plan is more a part of the company's benefits culture than the final-average-pay plan ever could be. And employees now understand the level of commitment that the company is making in helping them with a secure retirement.

RELATED ARTICLE: A Primer on Cash-Balance Plans

On the surface, cash-balance plans look a great deal like 401(k) and other savings plans, but there are some important differences. Like a 401(k), a cash-balance plan provides account balances (although these are nominal) that show the participants the dollar value of their retirement benefits. However, with a cash-balance plan, the company controls the trust-fund investments and assumes the investment risks and rewards for these funds which, of course, is not the case with a 401 (k).

Cash-balance benefits are largely guaranteed by the Pension Benefit Guaranty Corp. Therefore, the company must pay PBGC premiums on behalf of the plan. By contrast, savings plans aren't guaranteed by any government agency. The company also must conform to all of the same ERISA and IRS regulations that must be met by the sponsors of a "traditional" pension plan. - GJM and TJM 

Mr. Murray is director, employee benefits, at BOC in Murray Hill, N.J. Mr. Murphy is a consultant at The Kwasha Lipton Group of Coopers & Lybrand LLP in Fort Lee, N.J. You can reach them at [phone] and [phone], respectively.