Tuesday, November 21, 2017

Cookie Cutter Doesn't Cut It

I was on the phone with a sophisticated client a few days ago. She remarked that the solution she was looking at was just pulled off the shelf and could equally apply to any [company]. She said that was bad consulting. I have to agree. Thankfully, that consulting was not ours.

When I started in the business, back in prehistoric times, the modus operandi that many of us were introduced to included answer the phone, do the work, record your time, and someone will bill the client for it. Complaints appeared to be limited.

Things got more complex. The booming economy in our business created by the Reagan-era bull markets and the Tax Reform Act of 1986 was a veritable full employment act for consulting actuaries. Employers of those actuaries needed all the quality staff they could find and clients needed all the support they could get.

Things changed. As processes got automated and later, as companies began to exit the business of sponsoring pension plans, this once highly valued actuarial service became more of a commodity. Whether it was true or not, consulting actuaries who could deliver actuarial valuations were viewed as being a dime a dozen.

How did the best differentiate themselves? They began to provide more and more customized solutions. They began to understand the client's business needs. There was a sudden shift in the order of necessary skills. The key ability of being able to do things was replaced in the pecking order by the ability to listen and then to thoughtfully react.

Somewhere around the same time, our society seemed to become far more litigious. The answer to many problems became finding some other party who could be found to be at fault and exacting a price from that party. Some made the observation that in response to this, there were a number of consulting firms that developed solutions that everyone should bring to each of their clients. In fact, I can recall professional friends of mine complaining that they needed to be able to "check the box' for each of their clients even if they felt as if that meant they were providing less than the optimal answer. In other words, they were being encouraged, or even required to pull the answer off the shelf or some might say, to deliver a cookie cutter solution.

Put yourself in the corporate shoes. Your adviser that you have worked with for years brings you a solution that they label best-in-class. A few days later, you find yourself at a gathering with your peers from other local companies. Alas, they have all been brought the same solution.

How is that possible? The companies aren't the same. Their plans aren't the same.

It's then that you remember that you had agreed, based on a referral, to a meeting the next day with some consultant you had never heard of. You wondered if she would try to sell you on the same best-in-class solution.

She didn't. After the initial niceties, she asked you a bunch of questions. And after each question, she listened to your answer and reacted accordingly by asking a follow-up, more probing question. She remarked that she was surprised that you weren't pursuing [pick your favorite strategy to fill in the blank] instead of the not best-in-class one that your longtime adviser had brought you.

You wanted to to business with her, didn't you?

Friday, November 3, 2017

Proposed Tax Bill Would Change the Face of Executive Compensation

Yesterday, Representative Kevin Brady (R-TX), Chair of the powerful House Ways and Means Committee, rolled out the Republican tax reform proposal. And, while no tax bill in my lifetime or likely anyone else's lifetime has made it through the legislative process unscathed, the draft bill fashioned as HR 1 certainly provides an indicator of where we may be headed.

Much seems completely as expected. We knew about the slimming to four tax brackets. We knew about the narrowing of deductions. We knew that some of the more heavily-taxed states would feel the pain of restructuring. What we didn't know and what frankly came as a surprise to me and to others that I know would completely change the face of executive compensation in the US. Honestly, on its surface, these proposed changes look to me as if they they had been constructed by Democrats. It wouldn't surprise me if these changes had been pre-negotiated, but that's entirely speculation on my part.

So, what's the big deal?

There are two extremely significant proposed changes according to my initial reading.


  1. The draft would amend Code Section 162(m) (the $1 million pay cap) to eliminate the exemption for performance-based compensation. In addition, that section would be amended to cover the Chief Financial Officer in addition to the Chief Executive Officer. 
  2. Code Section 409A would be repealed (you thought that was good news, didn't you?) and replaced with a new Code Section 409B. Essentially, 409B as drafted would apply the much more stringent taxation upon vesting rules that have previously applied generally only to 457(f) plans. 
162(m) Changes

Section 162(m) was added to the Internal Revenue Code by the 1993 tax bill. Widely praised at the time as a way to limit executive compensation, the exemption for performance-based compensation turned out to be a far bigger loophole than had been imagined. Many companies saw this as a license to offer base pay of $1 million to their CEO while offering incentive pay (some only very loosely incentive based) without limits while taking current deductions.

That would change. 

My suspicion is that companies would return to paying their top executives as they and their Boards see fit, but with the knowledge that particularly high compensation whether performance based or not would not be deductible. Additionally, so called mega-grants and mega-awards would likely become much rarer as the cost of providing them would no longer be offset by tax savings.

409B

The ability to defer compensation has long been a favorite of high earners. The requirement to defer compensation has also been considered a good governance technique by many large employers (for example, a number of large financial services institutions require that percentages of incentive compensation be paid in company stock and that receipt must be deferred),

Much of this would go away as very few people have the ability or desire to pay taxes on large sums of money before they actually receive that money.

What Might Happen If the Bill Passes

Nobody really knows what might happen. But since this is my blog, I get to guess. Here, readers need to understand that there is no hard evidence that what I say in this section will happen, but it seems as if it could.

The draft of HR 1 appears to keep tax-favored status for qualified retirement plans. That's important because qualified retirement plans are a form of deferred compensation with some special rules and requirements attached. What this means is that to the extent that an individual would like to defer compensation on a tax-favored basis, he would need to do it through a qualified plan.

However, qualified plans need to be nondiscriminatory; that is, they must (not an exhaustive list):
  • Provide benefits that are nondiscriminatory (in favor of highly compensated employees)
  • Provide other plan elements sometimes known as benefits, rights, and features that are nondiscriminatory
  • Cover a group of employees that is nondiscriminatory
There are techniques by which this can be accomplished in a currently legal manner, but they are not simple. It would not surprise me to see more interest in these techniques.

As I said at the beginning, I don't expect this bill to pass as is. But, these particular provisions written by Republicans should not draw ire from Democrats. We'll see where it goes.

Thursday, October 19, 2017

The Most Important Employee Benefit

I started writing this blog back in the fall of 2010 -- about 7 years ago. How? Why?

One day, I was feeling really unhappy and I thought that writing would be a good way to take my mind off of my unhappiness. It turned out that it was. And, while I've been at it, nearly 500 posts and 200,000 hits later, I think I can say that there have been at least a few times that I have imparted some wisdom and some knowledge to at least a few people.

Along the way, there have been some side benefits as well. I've made a few LinkedIn contacts, gotten some Twitter followers, and even developed some business from my blogging. But, the biggest benefit of all has come every day.

What's that? Since the day that I made my first post, not a single day has gone by without at least one person asking me what is the single most important benefit to provide to employees.

That's pretty cool, isn't it? Actually, it would be if it were true. But, the fact is that I don't think that anyone has ever asked me that question. However, because I write this blog, I get to address that question now.

As I said, back in the fall of 2010, I was pretty unhappy at work. Before then, I had worked for a firm that I thought was great. We were creative. We were thinkers. We were innovators. We worked together. And, then we were sold. But, in the new firm, a lot of that remained -- not all of it, but a lot of it to the extent that we could figure out how to fit that culture in. And, then we were sold again.

And, it all went away. Every last drop of it went away, at least for me it did and based on conversations and behaviors, I feel pretty certain that many of my long-time colleagues felt the same way.

We'd lost our best benefit. And, that benefit could have been provided to us at no cost. That's sad, isn't it?

In fact, not only could that benefit have been provided to us at no cost, it would have produced large amounts of additional revenue for our employer or for any employer that chose to provide it to us.

If my cryptic ways have confused you here, you could be wondering. What benefit has no cost, but provides revenue to the employer providing it? It's not your health plan. It's not a 401(k) or a pension. It's not even vacation time or flex hours. But, as the way we work has moved from a 1980s environment when I entered this profession to a 2017 environment, this benefit has become even more important.

It causes people who receive it to work harder, to work smarter, and to work longer hours. It causes them to collaborate more. It causes them to give that extra little bit. It causes them to embrace the company brand even if they can't identify exactly what that brand is. And, it's far more important in 2017 than it was in 1985.

I think back to my work world in 1985. I arrived early. I could get breakfast in the office. I ate lunch with my colleagues. My employer provided that lunch. After lunch, we would all walk around the campus. Yes, it was a ritual and we all looked forward to those 5 or 10 minutes. And, then we would all go back to work and work hard.

Today, in 2017, those opportunities are largely gone. Many people don't work in the company office. They often work from home. Nobody provides them breakfast or lunch. They don't eat with their colleagues and they certainly don't walk with their colleagues. In many cases, other than via email, maybe telephone, and perhaps instant messaging and social media, they don't even know their colleagues.

That all makes one benefit harder to provide, but more important than ever.

Okay, for all those of you (maybe there are two or three who have gotten this far, but haven't figured out where I am going), that most important employee benefit is engagement. Yes, it's free to provide and, in fact, it's quite costly to not provide. But especially in 2017, it's not so easy.

How do we engage our employees in 2017? We have to make sure that they have interesting work. We have to make sure that they have a future. We have to take an interest in them. We have to show them a path forward. In short, we have to talk to them. And, far more important, we have to listen to them.

Listening to them doesn't mean that we do everything that they ask, but it does mean that we should think about what they say. The best idea may come from the recent college graduate who (paraphrasing the late Robert F. Kennedy) may choose not to ask why, but to ask why not. The solution may come from the analyst who is not burdened by rules that she hasn't learned yet, but finds an answer that we discover fits within those rules.

So, why am I writing about this now? This morning, I had two reasons. One is that I am very pleased to be employed by a firm called October Three that does seem to do a good job of engaging its employees. I find that I am working harder and I am working pretty intelligently. And, our employees from bottom to top are finding solutions for our clients that are creative and unique.

The second one is that next week, I will have the honor of becoming President of the Conference of Consulting Actuaries. The pay will be low (zero) and the hours will be longer than you might imagine, but if we get it right, the rewards will be significant. As the head of a membership organization that is voluntary for likely every one of its members, I want to engage that membership. In a perfect world, I'd like for every one of those members to feel like this is their organization. I want them to be part of the organization and to seek more and more ways to be part of it because I want them to be fully engaged.

Hopefully, I'll remember to practice what I preach.


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?

Wrong!

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.