Cash Balance Pension Plan Conversions: An Analysis of Motivations and Pension Costs

In recent years, many corporations have replaced their traditional defined benefit (DB) pension plans with “cash balance” (CB) plans, which share many of the characteristics of defined contribution plans. This study provides empirical evidence on the characteristics of CB converters and the behavior of pension costs and obligations pre- and post-conversion. We find that CB converters are larger than firms that retain traditional DB plans as well as those that terminate DB plans. They are less profitable than the former, but more profitable than the latter. CB conversions are not associated with proxies for greater labor mobility (e.g., firm-specific employee turnover rate). They are associated with a workforce that is closer to retirement, on average, lending credence to the breach of implicit contract rather than the labor market hypothesis as a motivator of CB conversions. Consistent with this intuition, we document that CB converters recognize a reduction of unrecognized prior service costs in the year of conversion, consistent with a negative plan amendment. Unlike pre-conversion, pension costs and obligations are significantly lower for CB firms post-conversion than for a matched sample of firms retaining traditional DB plans. CB conversions are more popular than DB plan terminations among firms with overfunded pension plan assets in periods when expected return on plan assets is likely to be high, with a consequent positive effect on reported income.