Friday, October 6, 2017

Tax on CEO Pay Ratios That Are Too High

Back in 2010, stuck in Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act, corporate America was blessed with a new requirement -- disclose the ratio of the annual total compensation of the CEO to that of the median-paid employee in the company. It seemed simple enough except that it's not. Here are some reasons:

  • Annual total compensation isn't what you think. It's compensation as defined for proxy purposes (Form DEF 14A) and it includes things like increases in value and retirement benefits as well as the value of certain stock compensation.
  • The median-compensated employee is the one who is compensated such that half the people in the company are better paid and the other half are not paid as well. So, to determine the median-compensated employee, you have to determine that half the company is paid higher and half is paid lower. (Yes, we can make some simplifying assumptions, but it's still not as simple as just picking a person.)
  • Foreign-domiciled employees count and we have to convert currency.
  • Part-timers and seasonal employees count and we are not allowed to annualize their pay.
All of this is so that a company can disclose a single number in its definitive proxy statement -- the ratio of pay of the CEO to that of the median employee.

And, then the pain ends, right?


People will see this number. Shareholders will see it, unions whose members the companies employ will see it, institutional investors will see it, shareholder advisory services will see it, and cities and states will see it.

Cities and states you say? Why would these issuers of proxies care about that?

Frankly, for most companies, the financial effects imposed by cities and states will be more of a nuisance than anything else, but Portland, Oregon led the way by imposing a surtax on companies doing business there if there pay ratio is too high. The business tax in Portland, generally, is 2.2% of income derived from Portland business. But, the following surtaxes will apply:

  • If a company's pay ratio is at least 100 to 1, but less than 250 to 1, there will be a 10% additional surtax;
  • If a company's pay ratio is at least 250 to 1, there will be a 25% additional surtax.
Other cities and several states have proposed similar laws and while some may have passed, I personally am not aware.

As I said, these taxes are not a big deal in the scope of the companies involved, at least not for the most part. At the same time, however, I think we are going to see that companies with pay ratios exceeding 100 are going to be quite common.

To the best of my knowledge, taxes of this sort were first proposed by former Labor Secretary Robert Reich in 2014. Secretary Reich points out that pay ratios in the early 70s averaged about 28, but we should note that statistic as being based almost entirely on full-time American workers. The labor force has changed. And, so has the pay ratio. 

    Monday, August 21, 2017

    When Pensions Met Vintage TV

    Many of my readers are pretty familiar with pension plans. Those of you who have been around for a while may remember a time on the TV show 60 Minutes before the closing segment was occupied by Andy Rooney. Back in the late 70s, it was Shana Alexander on the left versus James J. Kilpatrick on the right on the Point-Counterpoint segment. In the early days of Saturday Night Live, this also led to the Jane Curtin-Dan Aykroyd segments famous among other things for their tag lines, "Jane, you ignorant slut," and "Dan, you pompous ass."

    What does all this have to do with pensions? Not a thing, but today I'm going to tie them together anyway.

    In any event, late last week, I read an article highlighting a Prudential study on the uptick in pension risk transfer (PRT). I thought that bringing back Shana and Jim (or Jane and Dan if you prefer) might be a good way to discuss it.

    Point: 31% of respondents to the survey said that desire to reduce their pension plan's asset volatility was a key reason to engage in PRT.

    Counterpoint: Jane, you ignorant slut, that means that 69% of plan sponsors didn't think that reducing asset volatility was a big deal. And, as I'll explain to you later, asset volatility can be dealt with.

    Point: Dan, you pompous ass, another 25% said they wanted to focus on their core business rather than deal with a pension plan.

    Counterpoint: But, Jane, you ignorant slut, a pension plan is part of their core business and 25% isn't very many anyway.

    Point: Dan, you pompous ass, 25% said that they were tired of having to deal with small benefit amounts.

    Counterpoint: Jane, you ignorant slut, if they didn't freeze their pensions, those companies wouldn't have to deal with small benefit amounts. Everyone would have wonderful pensions benefits.

    We'll return to Point-Counterpoint after a short commercial break, but while that's airing, let's consider what each of our erudite commentators is pointing toward. Shana/Jane (actually likely taking the more conservative Jim/Dan role) are taking the position that managing pensions has just gotten out of hand in the US. With rising PBGC premiums and wild asset fluctuations, they want out of the pension business, at least to the extent possible.

    At the same time, the other side is espousing that pensions can help with workforce engagement and management and that asset fluctuations need not cause angst for plan sponsors.

    After hearing "Plop plop, fizz fizz, oh what a relief it is" and "Mr. Whipple, please don't squeeze the Charmin," we return to our regular programming.

    Switching to our more traditional commentators ...

    Point: Jim, so you are trying to tell me that companies should still maintain these blasted pensions and that the problems that a group of CFOs are worried about just don't matter?

    Counterpoint: No, Shana, they matter. But, they are solvable. You've never had a creative mind, Shana.

    Point: Jim, you're getting curmudgeony now. If you don't watch it, they'll replace you with that Rooney guy with the bushy eyebrows.

    Counterpoint: Shana, I've heard you talk about LDI (liability driven investments), but how come you never talk about IDL.

    Point: Jim, now you've lost it. Are you telling me that Interactive Data Language should be part of a pension discussion. Or, are you telling me that I should die laughing at your ignorance of real financial issues.

    Counterpoint: Shana, IDL is investment driven liabilities. Since you clearly know nothing about this concept, you could choose to learn. Perhaps it doesn't resonate with you that if liabilities track to assets in a defined benefit plan, then all of these CFO issues would go away and companies would be able to keep their workers while keeping costs stable.

    And, returning to our other cast of characters ...

    Point: Dan, you pompous ass, that makes no sense at all. Everyone knows that assets don't drive liabilities.

    Counterpoint: Jane, you ignorant slut, suppose they did.

    Thursday, August 10, 2017

    HR Practices and Their Funding Similar Within Industries

    This shouldn't come as a revelation, but HR practices, particularly benefits and compensation tend to be similar within industries. It makes sense. They tend to be competing for the same talent and, therefore, they benchmark against each other.

    What may be a little bit less obvious is that allocations of capital to benefits and compensation also tend to follow patterns within industries. Reasons for this may not be quire as clear, but in a lot of cases, if what you are providing is the same, the way you pay for it and the amount that you pay for it may also be pretty similar.

    Again, it makes sense. If Company A pays me $50,000 per year or Company B pays me $50,000 per year, the cost of my cash compensation during that year will be $50,000 (ignoring taxes). If each company further offers me a 401(k) plan that matches 50 cents on the dollar up to 6% of pay and very similar health plans, their costs for the year for me remain pretty similar. There aren't a whole lot of choices there.

    So, now you may be asking why I am writing this. I haven't told you anything useful yet and you may be thinking I won't. But, wait, there's more!

    Certain rewards elements can be paid for differently. Primarily, those are incentive compensation (can be paid relatively immediately or deferred) and defined benefit (including cash balance) pension plans. There you as an employer have options.

    Let's consider briefly some of what those might be. You can fund the minimum required contribution (MRC) exactly on the statutory schedule. It's easy. You follow the rules. You do no more and you do no less. You can fund to the greater of the MRC or to 80% on whatever is the current funding basis. You can fund to the greater of the MRC or to 90% on that same current funding basis. Or 100%. Or, you can fund to the point at which you eliminate PBGC variable rate premiums.

    Sure, there are other levels to which you can fund, but that's enough to illustrate. The point here is that behaviors within industries tend to be pretty similar.

    Why does that matter?

    Let's consider the health care industry. Not insurers, but hospitals, clinics, and other similar organizations. Lots of them have pension plans of one flavor or another (many are frozen cash balance plans) and most of them fund those at the minimum on the statutory schedule. That is following the law, so from a compliance standpoint, it's fine.

    Where it's not as fine is from a financial sense standpoint.

    Suppose you looked at all of the companies that sponsor defined benefit plans and then among that group, you considered only those who are paying more in PBGC variable rate premiums than they need to (this is important because for a typical company like this, those variable rate premiums may represent a 1% or more "drag" on plan assets).

    What industry would predominate in that group?

    You guessed it -- health care.

    If you've made it this far and you are in the health care industry and you still have a pension plan, you probably want to see if you are facing that drag on assets. You probably are.

    I would encourage you to check and when you find out that you are experiencing that drag, there are strategies that can be employed that will save you on that drag without depleting valuable cash from other needs.

    Wednesday, July 5, 2017

    Perhaps Employees Just Don't Want HSAs

    I read an interesting article this morning whose focus is to tell the reader that health savings accounts (HSAs) would be more popular if people only understood them The article was based on research from Fidelity that shows that most eligible Americans (those enrolled in a high-deductible health plan (HDHP)) don't understand the benefits of HSAs. In fact, that part of that research is likely correct.

    But, despite that research, I think the answer goes deeper than that.

    Before digging in, let's review some of the key features of HSAs:

    • The money in your HSA can be used to pay qualified medical expenses.
    • Money in your HSA that is not used in a calendar year simply stays in the account, unlike in a Flexible Spending Account (FSA).
    • The account is yours. It goes with you if you change employers, are unemployed, retire, or just don't feel like deferring anymore.
    • You can generally defer to an HSA in a year that you participate in an HDHP.
    • There is a triple tax benefit from HSAs: money goes in tax-free, assets grow tax-free, money coming out for qualified medical expenses comes out tax-free.
    So, what's the problem then? Which of those bullets do people not understand?

    In my opinion, it;s more than that. I've done exhaustive -- well maybe not exhaustive -- research by just talking to people about HDHPs and HSAs. I don't ask them to rattle off the benefits of them, but I do ask them why they don't choose to use them. Here are some typical answers.
    • People don't like high-deductible health plans. When we consider that most Americans do not have enough in savings to get them through a 2-month work stoppage, they certainly don't want health insurance that may not cover them for the first one or two months of pay's worth of medical expenses.
    • When we consider that a typical employee's paycheck is already being "raided" by federal income taxes, state income taxes, FICA taxes, health benefit costs, 401(k) deferrals, and other benefit costs, there may not be enough left over for the day-to-day costs of living let alone HSA deferrals.
    HDHPs and HSAs were put into place as part of a move toward health consumerism. In other words, patients will be more conscious of how they spend their dollars if the money for other than catastrophic health expenses is coming out of their accounts.

    Let's think about what has happened because of this. An HDHP participant gets an annoying cold. He doesn't seek medical treatment because he is being a "smart consumer" of health services. Wait, it's not just a cold. It's bronchitis or influenza and suddenly, the costs are higher and his condition has spread as he has infected family members. That's not a good outcome.

    Here's another plausible scenario. Another HDHP participant watches his daughter limp off the field during a youth soccer game. Her keen home-grown injury detection skills don't think there is anything broken, so they just decide to ice down the injury because experience has told them that the cost of a medical examination of it might be several hundred to even a thousand dollars. Oops, the injury turns out to be more serious than anyone thought. Our heroine should have taken her daughter to the doctor because now there are complications.

    I'm not saying that the Fidelity research was flat out wrong. But, there's something more than people not understanding the benefits of HSAs. My conclusion is this:

    People don't want to understand the benefits of HSAs. If participation in an HDHP is an entrance requirement, your average participant just doesn't care about the possible benefits of a health savings account.
    The HSA experiment is now almost 15 years old. The concept of health consumerism is far older than that. Theoretically, it works. Theory and reality don't always agree.

    Thursday, June 29, 2017

    Using Retirement Benefits to Solve the Challenge of Hospital Sector Employment

    One of my colleagues sent me an interesting article last night. It reminded me that hospitals, perhaps more than any other classification of employer in the US have particularly interesting challenges when it comes to attracting and retaining their employees, mostly professionals. And, as hospital organizations have become a primary employer of physicians, the difficulties only increase.

    Let's consider the employee population of a hospital or hospital system. We can start with physicians. From a retirement compliance standpoint, they are probably all highly compensated employees (HCEs) meaning that their compensation, roughly speaking, exceeds $120,000 per year. But, not all physicians are paid the same. The general practitioners and internists, for the most part, are among the lowest paid of the group. At the other end, surgeons, cardiologists, anesthesiologists, and a group often referred to as critical care physicians are among the higher paid. Despite their pay, supply of these specialists may be less than demand. In order for a particular hospital system to meet their own demand, they need something that appeals to those physicians.

    Let's turn our focus to nurses. They're often thought of as the life-blood of the hospital. They are skilled professionals, not all that highly paid, and they have a high turnover rate due to burnout. Informal survey data shows that retention of nurses is often due to one of several factors including a great work environment and great benefits.

    Then there are the technicians. To someone just collecting data, they may look a lot like nurses. But digging deeper shows that they are not. They have different skill sets and different mindsets. Their pay may be similar to that of nurses, but their jobs would appear to have different stress levels. As a result, their turnover rates due to burnout seem to be lower.

    And, there are the true blue collar staff in the hospitals. While they may have learned specific skills and duties that make them more valuable to hospitals than they are in other industries, in many cases, they can find other employment outside of the hospital industry. These people are generally among the lower paid in the systems and probably value straight pay and their health benefits as much as anything.

    Finally, we'd be remiss in not mentioning all the other staff from the people who run the hospital systems -- the top executives -- to the administrative staff. All have usually developed specific skill sets that make them particularly valuable in a hospital system where they might not be in other industries. They tend to want to stay with a good organization, but they expect a lot before they would call that organization good.

    Moreso than many other industries, what we've pointed out here is that this is a really diverse population. As a group, they are intelligent and well-educated. As a group, they have high-stress jobs. That combination leads to a need for retirement benefits.

    But, how do we provide them? The top executives want to be treated as top executives. The physicians have large tax burdens and providing for their heirs that they worry about. The nurses may have relatively shorter careers and, according to data, do not always make saving for retirement a top priority early in their careers.

    The current method of choice is to use a deferral sort of arrangement perhaps with a match. So, that would be a 401(k) plan or a 403(b) for some tax-exempt hospitals. There are problems galore there. The physicians complain because they just can't defer that much (maybe even less if nondiscrimination testing is a problem). The nurses who don't focus on retirement suddenly see that between their high-stress, high-turnover jobs and their neglect of their retirement plans early in their careers that retirement may never be an option. Behaviors will likely vary among the other staff.

    We need other methods. Those other methods are there.

    Suppose we tell the doctors that they can defer more -- a lot more. Suppose we tell the nurses and the technicians that they will still have an opportunity to defer, but that we are going to give them something akin to their matching contribution even if they forget to pay attention to retirement. Suppose we tell the executives that all that nonqualified money that's not secure and not tax-effective can be.

    We might have people dying [yes, a very bad pun] to work for our system. When you become the employer of choice, work shortages are less of an issue for you, unwanted turnover is less of an issue for you, and yes, patient satisfaction and therefore profitability will improve.

    You need a solution that meets all of these criteria:

    • Costs are stable
    • Ability for very high-paid people to defer significantly is there
    • Nondiscrimination testing is easy to pass
    • Benefits are portable
    • Both lump sums and wholesale priced annuities (annuities from the plan as compared to from a mutual fund provider or insurer) are available
    The solution lies in designs like these. Costs can be controlled through proper design. Physicians wanting larger deferrals will happily pay for their own enhancements. Because these plans test so well, nonqualified money can often be qualified. Benefits will be portable for everyone and annuities will be available without lining the pockets of insurers for any participants who want them.

    it really should be the best of all worlds for hospital systems.

    Friday, June 23, 2017

    Fact or Fiction in the Retirement Wellness Media

    Sometimes you just have to wonder. Well, maybe you don't have to wonder, but I can speak for myself -- I certainly do have to wonder. The data that I read about simply cannot coexist. We cannot have record numbers of people deferring to 401(k) plans at record rates and yet still have almost universally low-five figure account balances, on average. At least we cannot unless we also have record amounts of leakage via plan loans, withdrawals, and both deferral and work stoppages.

    I'm not going to cite a bunch of data here because I don't have it at my fingertips. I'm on the road and it's 5:30 AM, so think of this as your favorite (or not favorite) blogger ranting. I'm allowed, or at least I'm pretty sure I'm allowed.

    Once upon a time (no, this is not the start of a fairy tale or one of Aesop's fables), American workers almost uniformly looked forward to the day when they could retire. They did that, in large part, on the backs of their corporate-sponsored defined benefit plans.

    As we knew back then, defined benefit plans had many things about them that worked well toward this goal including (but definitely not limited to):

    • Ability to generate lifetime income
    • Lifetime income that could be compared to retirement expenses to understand what other resources might be needed
    • Workforce management ability for plan sponsors using tools like retirement subsidies and early retirement windows
    Since then, we've seen changes ... many changes. Initially, they were design and structure changes. With the growth of 401(k) plans and Congress' constant tinkering with defined benefit plans in a supposed effort to save them, there was first a move toward what we now know as hybrid plans (largely cash balance) and then toward freezing and sometimes terminating those defined benefit plans. Thinking back, the most common complaint I heard from corporate finance executives was the financial accounting volatility. Later on, funding volatility became perhaps a bigger issue.

    I'll come back to this part of my rant later, but first it's time to return to my original topic.

    According to an article that I read yesterday, 74% of respondents to a question said that lifetime income is important, but only 25% thought they had a way to generate it. So, in a tribute to the recently departed Adam West (the "real" Batman), riddle me this fine readers: "How does this comport with all the other articles telling me how well the 401(k) system is working?" Clearly something must be rotten in the state of Gotham.

    We can do all of the modeling that we want and honestly, that modeling is in fact valid if, and that's a big if, participants can follow those models for their entire careers.If a person starts deferring at a reasonable level to their 401(k) when they are, say, 25 years old and continue to defer until some reasonable retirement age, all the while getting reasonable returns, that person will be able to retire and likely not outlive their resources.

    They can do that, however, if they can use those balances to generate a steady stream of lifetime income. 

    But, having reached the holy grail of retirement, these same people now want to do all the things they dreamed of while working. They wanted to retire to the beach or the mountains. They want to travel the world. They want to spoil their grandchildren. 

    There is a problem with all of that. Those expenses are pretty front-loaded. That is, they are going to be very expensive in the first years of retirement. That will in turn deplete account balances that can be used to generate lifetime income. In other words, lifetime income may not be what you thought it was going to be. Or, said differently, the retirement wellness data must have a lot of fiction in it.

    Once upon a time, that focus was on defined benefit plans. They focused on the employee who typically retired from a company in their 50s or 60s having worked for that company for 30 years or so. We all know that the current workforce doesn't tend to work 30 years for the same company, so that plan may be wrong.

    But a defined benefit plan can still be right. Let it take a different form. Defined benefit plans have evolved to the point where they can look and feel like defined contribution plans, but critically still operate as defined benefit plans.

    Why is this so critical? If the large majority of people think lifetime income is important, then we need plans that promote it. Yes, those people can get lifetime income from their 401(k), but if they are doing it through a commercial annuity, they have to purchase that annuity at "retail" rates. On the other hand, if they have a defined benefit plan, they can get better lifetime income from the same amount of money because they are getting the annuity at wholesale rates.

    Now, there's a way to generate retirement wellness.

    Holy Happiness, Batman.

    Monday, May 15, 2017

    Preparing for Pay Ratio

    Could the politically charged pay ratio calculation and disclosure of Dodd-Frank Section 953(b) go away with this year under this Republican Congress? Of course it could. Since companies generally will not be doing this disclosure until early 2018, does that mean they should hope that it goes away and not plan for it? No. The process will be long and data collection will be arduous for many companies. You don't want to get caught unprepared.

    For those of you not familiar, I have written on this extensively. And, despite the fact that I think it will be a huge expenditure of effort by issuers of proxies and that I think it will provide little value to shareholders and the public generally, it's still the law and it becomes a requirement in the upcoming proxy season.

    In a nutshell, determination of the pay ratio will follow this process:

    • Identify the CEO (that should be easy)
    • Identify the employee in the controlled group globally whose annual total compensation (a term of art including almost all forms of current and deferred compensation) when ranked sequentially among all employees falls right in the middle of that ranking
    • Determine the annual total compensation for the CEO (you're doing this for the proxy already)
    • Determine the annual total compensation for the median compensated employee
    • Determine the ratio of the two
    You may be wondering at this point where the complexities may lie; that is, in what situations are you more likely to want to consider outsourcing this determination than doing it yourself. Consider these as complicating factors:

    • You operate in multiple countries
    • You sponsor multiple pension plans perhaps in multiple countries
    • You provide equity compensation broadly
    • You provide other unusual forms of compensation
    • You are afraid for whatever reason that your pay ratio will be high enough to garner unwanted negative publicity and you'd like guidance on managing the message
    If you do have any of those situations, I'd suggest you consider seeking outside help. After all, this sort of data manipulation and these sorts of calculations are likely not in your core competencies. And, if they're not, I'd love to find a way to make your determination of the pay ratio less painful for you.