LOS g: Discuss hybrid pension plans (e.g.,cash balance plans) and employee stock ownership plans.

Q1. HAL Corporation is considering shifting their current defined-benefit pension plan to a cash balance plan. In an effort to educate HAL’s board of directors about cash balance plans, Mark Davidson, HAL’s Vice President of Human Resources puts together a memo that includes two statements regarding cash balance plans.

Statement 1:     The amount credited to a participant’s account in a cash balance plan is a function of salary, length of employment, and a benchmark interest rate.  

Statement 2:     Converting our defined-benefit pension plan to a cash balance plan would effective shift investment risk from us as the employer to the employee.

With regard to the statements in the memo, Davidson is:

A)   correct with respect to Statement 1 and Statement 2.

B)   incorrect with respect to Statement 1, but correct with respect to Statement 2.

C)   correct with respect to Statement 1, but incorrect with respect to Statement 2.

Q2. Which of the following is NOT a characteristic of employee stock ownership plans (ESOP)?

A)   ESOPs typically allow employees to purchase company stock at a discount from the current market price.

B)   An ESOP is typically funded by a company issuing new stock specifically to fund the ESOP.

C)   The regulation of ESOPs can vary widely across countries.

Q3. Jim Findlay is the Founder and CEO of Impact Products. Findlay takes great pride in having his firm be on the leading edge of providing benefits to employees. Every year, Findlay sits down with his two senior executives, Jeff Beery and Tom Harbal to discuss various employee benefit plans. This year’s focus is on employee stock ownership plans (ESOPs) and cash balance plans. With regard to ESOPs, Beery states, “In addition to the benefits to employees, an ESOP would be a useful way for you as owner of the company, Mr. Findlay, to liquidate a large block of your Impact Product holdings.” After further discussion, they move on to discussing cash balance plans. Harbal reports, “Unlike regular pension plans, cash balance plans can never be under funded because the cash balance reflects the actual amount put away for employees.” With regard to their statements about ESOPs and cash balance plans:

A)   Beery’s statement is correct; Harbal’s statement is incorrect.

B)   Beery’s statement is correct; Harbal’s statement is correct.

C)   Beery’s statement is incorrect; Harbal’s statement is incorrect.

LOS g: Discuss hybrid pension plans (e.g.,cash balance plans) and employee stock ownership plans. fficeffice" />

Q1. HAL Corporation is considering shifting their current defined-benefit pension plan to a cash balance plan. In an effort to educate HAL’s board of directors about cash balance plans, Mark Davidson, HAL’s Vice President of Human Resources puts together a memo that includes two statements regarding cash balance plans.

Statement 1:     The amount credited to a participant’s account in a cash balance plan is a function of salary, length of employment, and a benchmark interest rate.  

Statement 2:     Converting our defined-benefit pension plan to a cash balance plan would effective shift investment risk from us as the employer to the employee.

With regard to the statements in the memo, Davidson is:

A)   correct with respect to Statement 1 and Statement 2.

B)   incorrect with respect to Statement 1, but correct with respect to Statement 2.

C)   correct with respect to Statement 1, but incorrect with respect to Statement 2.

Correct answer is C)

Statement 1 is correct. In a typical cash balance plan, a participant’s account is credited each year with a pay credit and interest credit. The pay credit is typically based on the beneficiary’s salary, age, and/or length of employment, while the interest credit is based up on a benchmark such as U.S. Treasuries. Statement 2 is incorrect. The sponsor of a cash balance plan (employer) bears all investment risk since increases and decreases of a plan’s investments do not affect the benefit amounts promised to participants.

Q2. Which of the following is NOT a characteristic of employee stock ownership plans (ESOP)?

A)   ESOPs typically allow employees to purchase company stock at a discount from the current market price.

B)   An ESOP is typically funded by a company issuing new stock specifically to fund the ESOP.

C)   The regulation of ESOPs can vary widely across countries.

Correct answer is B)

ESOPs are typically funded with existing shares that are either repurchased by the company in the open market, or directly from a large shareholder. The other characteristics listed correctly describe features of ESOPs.

Q3. Jim Findlay is the Founder and CEO of Impact Products. ffice:smarttags" />Findlay takes great pride in having his firm be on the leading edge of providing benefits to employees. Every year, Findlay sits down with his two senior executives, Jeff Beery and Tom Harbal to discuss various employee benefit plans. This year’s focus is on employee stock ownership plans (ESOPs) and cash balance plans. With regard to ESOPs, Beery states, “In addition to the benefits to employees, an ESOP would be a useful way for you as owner of the company, Mr. Findlay, to liquidate a large block of your Impact Product holdings.” After further discussion, they move on to discussing cash balance plans. Harbal reports, “Unlike regular pension plans, cash balance plans can never be under funded because the cash balance reflects the actual amount put away for employees.” With regard to their statements about ESOPs and cash balance plans:

A)   Beery’s statement is correct; Harbal’s statement is incorrect.

B)   Beery’s statement is correct; Harbal’s statement is correct.

C)   Beery’s statement is incorrect; Harbal’s statement is incorrect.

Correct answer is A)

An ESOP is a type of defined-contribution plan that allows employees to purchase company stock, sometimes at a discount to the market price. Beery’s statement is correct. Occasionally, an ESOP will purchase a large block of the firm’s stock directly from a large stockholder (such as an owner who wants to liquidate a holding). The stock is then purchased at regular intervals by plan beneficiaries. Harbal’s statement is incorrect. The account balance shown on a cash balance plan’s statement to a beneficiary is calculated on paper only based on a participant’s credits. It is possible for a company not to fund its obligation, resulting in an underfunded cash balance plan.