IBM is slowly, begrudgingly settling its pension and age discrimination lawsuit problems, most recently reaching a partial settlement with a small group of former pensioners. But IBM's problems are far from over. Some analysts report that the cost may ultimately be in the range of $6 billion. And though Lou Gerstner's reign at IBM brought many positive changes to IBM in the 1990s--by all accounts saving the company from imminent bankruptcy--IBM's decision to change the structure of its pension plans continues to haunt Gerstner's legacy and may ultimately cloud the future of the organization itself.

Casting Aside the Past

In 1995 and 1999, IBM switched its retirement pension plans for its cherished employees. First, it switched to a hybrid plan called a "pension equity plan," and then it converted to what is called a "cash-balance plan." The cash-balance plan combined some features of traditional pensions, but it melted many older workers' benefits (by as much as 50%, claim some employees, while revoking lifetime medical insurance). The net effect was to provide older workers with less time than their younger colleagues to build up equity in the retirement scheme.

IBM Found Guilty of Financial Age Discrimination

IBM pensioners filed suit, and last year, on July 31, 2003, Judge G. Patrick Murphy of the U.S. District Court in the Southern District of Illinois ruled that IBM's actions had discriminated against its older workers in several ways when it converted its pension plan. How? The changes in the pension left some employees with smaller benefits at retirement than younger workers would get when they eventually retired. But several questions remain: How did this happen? How many pensioners were impacted? How much is it going to cost IBM?

In February, the court ruled that IBM owed compensation to roughly 140,000 current and former employees. The sheer numbers of IBMers impacted is staggering. IBM said at the time that it was going to appeal the ruling, and it has begun the process, both in the courts and in the halls of the U.S. Congress, where it and other companies are claiming to be the real victims.

Treasury Department Rewrites Rules

Meanwhile, the U.S. Treasury Department under the Bush administration immediately began rewriting the pension regulations to address age discrimination concerns about the IBM pension plan and similar plans that other companies were using. This was to be the end run that IBM and other large corporations hoped would clear them of culpability.

However, a stalwart Independent U.S. Congressman from Vermont, Bernard Sanders, got the House of Representatives last year to vote 258 to 260 on a Treasury Department amendment to forbid the federal government from acting to overturn the federal district court's decision through regulation. That amendment prevented the federal government from spending money in the Treasury Department to assist in overturning the federal district court ruling that declared IBM's cash balance pension conversion to be in violation of the pension age discrimination laws that are on the books. As a result, the Treasury Department withdrew proposed new regulations in June of this year.

Partial Plan Termination Settlement

Several weeks ago, September 15, 2004, the parties in the lawsuit advised the U.S. District Court that they had resolved the partial plan termination claim, which affects a limited number of former employees who worked for the company for less than five years. At close of business last week, on September 30, 2004, IBM agreed to pay $320 million to that small group of employees, but analysts see this as the easiest part of the obstacles that IBM faces. IBM again said that it was continuing to appeal the original decision, making it clear that it was not going to give in easily.

Congress Supports Pensioners

In anticipation that IBM would recommence previous lobbying efforts with both the Treasury Department and the Congress, Congressman Sanders once again introduced an amendment to reinforce the House's insistence that the Treasury Department spend no money to rewrite regulations until the entire court case has been settled. On September 22, the House again passed this measure, this time with an increased majority vote of 237 to 162.

Sanders noted that hundreds of other companies still offered the same kind of cash-balance conversion pension plans. He thought lawmakers needed to go on record again in support of the court ruling. "Taxpayer money should not be used to support an age discriminatory cash-balance plan, and this amendment gives Congress the opportunity to make that very clear," he declared. "It is imperative that we keep fighting."

What's at Stake?

Though IBM's difficulties in this case have caught the media's attention, IBM is certainly not alone in being at odds with the age discrimination laws concerning pensions. These pension plans were once intended to induce loyalty and long service in workers. However, in the "new economy" of recent years, many corporations have often used those pension plans as a hidden asset from which they can launch expensive top-manager compensation initiatives or invest in new projects to increase stockholder loyalty.

Since the 1980s, many corporations have shifted from the once-traditional defined-benefit plans to "defined-contribution plans," such as the 401(k), that cap a company's liability and shift the risk to workers and retirees. Instead of a portfolio of promised future compensation and services, these defined-contribution plans simply match the funds that the individual employee puts toward retirement.

However, that shift is only a small part of the massive transformation that employee pensions have undergone. What the shift has allowed is for companies to treat pension plans as assets instead of liabilities.

How big is the problem? As of 2002, 42 million workers and retirees and $1.6 trillion dollars were still in traditional pension plans.

How Corporations Use Pension Plans to Benefit

There are many techniques by which corporations have transferred pensioner's funds from liabilities to corporate assets and then used those funds to further divest pensioners of their promised benefits. Two of the most innocuous are by inflating earnings expectations and then transforming the traditional pension plan to a cash-balance plan. This is how they do it:

Inflating Earnings Expectations--Corporations routinely project an unrealistically high rate of return for a pension as a justification that the plan is over-funded. These corporations then reduce their own contributions to the plan and divert the plan's assets to increase the corporation's bottom lines. During the 1990s, when the stock market was at an all-time high, this maneuver allowed corporations to inflate the reported earnings of their pension plans by as much as 10% to 15%. This strategy also contributed to the stock market bubble that supposedly justified the inflated rate of return. When the bubble burst in 2000, pension plans found themselves suddenly under-funded.

Cash-Balance Plans--Under U.S. laws, terminating a pension plan normally results in a large tax penalty to the corporation itself. However, financial consultants began inventing a hybrid plan, called a "cash-balance plan," that transformed the liability of the pension plan and "cashed out" the employee, providing new investment opportunities that act like a 401(k). This relieves the corporation of its growing long-term liability and transfers the future risk to the pensioner.

These are the solutions that IBM and many other companies used to cap their contributions to pension funds and at the same time claim those contributions as actual discretionary assets. Unfortunately, for pensioners, the result led to an under-valuation of the original pension, and--for older workers--reduced the amount of time in which they could recoup the value of the pension. These are the kinds of actions that the U.S. District Court has ruled are age discriminatory.

IBM's Reality-Based Pension Planning

IBM and others point out that workers today seldom stay with the same organization throughout their careers and that the value of a traditional pension plan has been supplanted by the more flexible 401(k) plans, which remain portable with the worker's career choices.

In addition, IBM retells its own experience during its devastating financial losses during the early 1990s. It claims that the liability of its once-touted "lifetime employment" policies were dragging the organization to its ruin. IBM says that when economic competition forces a company to turn over its employees--to bring new blood into the organization--the corporation should be allowed to also divest itself of obsolete compensation and pension models that weigh the organization down. IBM says that the trend toward cash-balance plans was initiated not by IBM but by the Bank of America in the late 1980s. IBM believed it was on firm legal ground when it initiated the plan shift in 1995, and it points to U.S. tax laws as supporting evidence.

Employees' Reality-Based Pension Planning

However, IBM pensioners have pointed to some of the financial chicanery that IBM pursued in revaluing those pension benefits. They claim that their benefits have ended up as increased bonuses and stock options for upper-echelon IBM execs, while they were left with retirement plans of diminishing value. This, these pensioners declare, is a breach of contract and a clear form of age-based financial discrimination. They filed a class action lawsuit in 1999 and sent an open letter to SEC Active Chairman Laura Simone Unger in February 2000, detailing how they believed IBM was using the pension fund savings to bolster IBM's annual report of financial earnings before shareholders. (For FAQs about the rationale for the lawsuit, visit the Alliance@IBM Web site, hosted by the Communications Workers of America. Note: MC Press does not endorse the CWA and is in no way affiliated.)

Changing Times in a Struggling Economy

In many ways, the conflict between IBM's corporate entity and its workers can be seen as a parable about how corporations must respond to the financial requirements of the stock market. Going into the 1980s, IBM's most valuable asset was its highly skilled, highly educated workforce. This workforce produced IBM's most profitable products and provided it with the personnel it needed to deliver those products into the business community. Its solution-based approach to the needs of business brought it loyal customers, attracted willing investors, and built an industry segment.

To build that organization, IBM needed the best and the brightest employees, and it invested heavily in identifying them at the best universities and winning them with career opportunities, extraordinary compensation, and unparalleled employee benefits.

However, as IBM became a successful publicly traded corporation, it was forced through a fateful transition from a customer-focused, solution-based enterprise to a stockholder-focused, capital-based behemoth. Management's wake-up call came when profits failed in 1989 and the company suffered a catastrophic fall from investor favor. Suddenly, its legacy of employee promises turned into one of its largest headaches. It was forced to recognize that its greatest asset of the past--its employee resource--had become the weight that investors were no longer willing to finance.

Lou Gerstner's success was based on awakening the corporate culture within IBM and recognizing the traumatic change that was being demanded. His team was forced to negotiate the transformation and to build a new service-based, stockholder-focused enterprise. His primary concern was to preserve the best parts of the organization while simultaneously increasing the stockholders' perception of value. He did this by bringing in new talent that could target and achieve realizable financial goals. In the process, his team's efforts successfully rescued the corporation from bankruptcy and drove it to short-term profitability, quarter by financial quarter.

IBM: Saved for Whom?

But the transition to this new environment has not come without a human cost--in the form of layoffs during the 1990s, accelerated retirements, decreased employee benefits, and diminished pension values for current and former employees. Gerstner played the game to win, and he played it well: He left a profitable company, and when he left that company, he took with him one of the most generous retirement packages in the history of the industry. He saved the company, but for whom?

IBM now estimates that it has over 250,000 workers on its current employment roles. The U.S. District Court in Illinois estimates that the company has an obligation to remedy past age discrimination claims of over 140,000 current and former employees. Estimates are that, if IBM loses its legal appeals, it may be liable for over $6 billion.

Gerstner's past life with IBM has taken on haunting proportions, but his legacy lives on.

Thomas M. Stockwell is Editor in Chief of MC Press Online, LP.