Tuesday, May 31, 2011

There is an Attorney Who is Willing to Admit the non-Attorney May Have Gotten it Right

Kudos to Steve Rosenberg, an attorney with the McCormack Firm in Boston. As many other attorneys were, Steve was quick to put pen to paper (or fingers to keyboard) immediately after the Supreme Court's verdict in Amara v Cigna. But, Steve's mind was open enough to read my somewhat more cynical and pithy write-up of the same case. And, what's more, he cited me for perhaps being one of the few who got it right. Because he is not another stuffy attorney, I have recommended Steve's blog in the past and I will continue to do so.

Friday, May 27, 2011

Consumer Driven Health Care - Who Are Its Users?

According to a report from the Employee Benefit Research Institute (EBRI), the times they are a-changin' (well, some guy named Bob Dylan said that first). Consumer-driven health plans (CDHPs) have been around for 10 years now. A recent EBRI study notes that in 2005, participants who enrolled in CDHP plans were more likely than those in non-CDHP plans to have income above $150,000. In 2010, more than half of those in CDHP had income between $50,000 and $100,000, but only about 1 in 7 had income over $100,000. Similarly, the study has found that participants who have more advanced education are more likely to be in CDHPs while those with only high school diplomas are more likely to be in non-CDHP plans.

What does this tell us? What should it tell us? Analyses that I have seen suggest that people who are more likely to know or understand what their choices are will enroll in CDHP plans. I disagree. Here is why. The study doesn't compare apples to apples. It doesn't say that each person in the study had a choice. It doesn't say that the choices were available on an equal basis.

Remember, companies often hire consultants to 'price' these plans for their participants. As the companies would often like to steer their employees to the CDHP plans, they instruct their consultants to price the options so that participants are more likely to choose the CDHP plans. Suppose a company offers only CDHP plans. In that case, even I can figure out that all employees who enroll in their company's health plan will be in a CDHP plan.

But, let's dig a bit deeper. Initially, when participants tended to have a choice, they looked at their options. One plan (the traditional) might have had a $500 deductible. The CDHP plan might have had a $3,000 deductible. Well, priced strategically, the $150,000 earner might say that all things considered (premiums plus medical expenses), the CDHP plan would likely cost them less. On the other hand, the $50,000 earner might say that they just can't afford the $3,000 deductible. 

Similar arguments can be made about education. Those with high levels of education are more likely to have higher income. 

The study also tells us that those in the CDHP plans generally have better health status and show better health behaviors than those in traditional plans. Again, is this the result of the CDHPs? Or, is it that those who are in excellent health are those less likely to have significant medical expenses and therefore more likely to opt for the lower premiums in the CDHP?

What the EBRI study doesn't look at are the medical care usage behaviors of those forced into CDHP plans. Anecdotal evidence suggests to me that many who are in CDHP plans against their will postpone medical coverage because they cannot afford it. Will the person who didn't go to the doctor in 2008 because they couldn't afford $2,500 out-of-pocket for the procedure they needed become a $100,000 patient in 2012? We don't know then answer to this, but people that I know tell me that either they or their friends have fallen into this category.

So, the people in the CDHP plans are who they are. Frankly, I don't think we really have a clue why.

Wednesday, May 25, 2011

IMHO -- Congress Got it Wrong With QDIAs ... Very Wrong

The Pension Protection Act of 2006 (PPA) was, in my opinion, a horrible piece of legislation. Frankly, it didn't protect many pensions and didn't do much else that, in retrospect, was very useful. One of the most well-regarded, at least initially, parts of PPA was the concept and requirement of Qualified Default Investment Alternatives, or QDIAs. In a nutshell, participants have their investments defaulted into a particular investment that is eligible to be a QDIA and unless they make an affirmative election to invest otherwise, there shall there assets reside.

The most popular QDIA has been Target Date Funds, or TDFs as they are usually referred to in the press. Most of the fund houses that offer them have one developed for each five-year age range. So, if you were born in 1970, for example, you will turn 65 in 2035, so you would get defaulted into the 2035 TDF. Some recordkeepers have gone so far as to say that if a plan's participants are not defaulted into their proprietary TDFs, then the sponsor needs to find a different recordkeeper.

This smells bad to me. And, it is.

I will probably explore this in more depth at some point, but let's consider some of what I view to be major flaws. First, as background, our 2035 Fund that we discussed is composed of assets in a broad, diversified group of asset classes. They are chosen to be appropriate for a person who is now 40 (or 41) years old who will retire in about 25 years at roughly age 65. Generally, its composition assumes that this pool of assets is their retirement income, perhaps in addition to Social Security. What is left out?

  • For a random participant, is their current level of savings more or less than the norm for 2035 participants?
  • Do they have outside savings? How are they invested?
  • Do they have a defined benefit either with this company or with a previous employer? An annuity from a defined benefit plan can be thought of as a fixed income investment lessening the need for other fixed income investments?
  • Does our participant have a working spouse? Does their spouse have a retirement plan? How is it invested?
There are many more, but bottom line, this Qualified DEFAULT Investment Alternative may be the correct default for only a small percentage of participants. Yet, all who don't make an affirmative election otherwise are defaulted into it. And, we haven't even talked about the fees and the specific funds that go into creating these funds of funds. The recordkeepers and fund houses will tell you that their TDFs are the greatest thing since sliced bread. I think otherwise.

Thursday, May 19, 2011

Kohl and Enzi Introduce Bill to Prevent 401(k) Leakage

In a rare bipartisan moment, Senators Herb Kohl (D-WI) and Mike Enzi (R-WY) have introduced the "Savings Enhancement by Alleviating Leakage in 401(k) Savings Act of 2011", also to be known according to the language in the bill as the "SEAL 401(k) Savings Act." Who thinks this stuff up? Hopefully, if it does become law, the SEAL Act will do a better job of sealing 401(k) leakage than the JOBS Act did of creating jobs. You can read the bill language here if you feel so inclined. If not, I'm going to summarize it for you below, adding commentary on the key provisions.

First, though, we need some context. When we look at 401(k) plan designs and retirement adequacy, the true champions of a DC-only world (only defined contribution retirement plans, no defined benefit plans) perform projections assuming that an individual enters the workforce at some age in their early 20s, participates in a 401(k) plan with a generous match for their whole career at one company never deferring less than the amount required to get the full match, never takes a loan or a hardship withdrawal, never has a work interruption, and gets a constant return on their investment of, say, 7% per year.

Thank you for your visit to Dreamland. Now, back to reality.

In reality, based on current trends, a person entering the workforce today and working relatively continuously until about age 65 will probably hold about 10 different jobs (don't ask me for a citation on this one because I admit that I just made it up and it is based on my powers of observation). At least some of those times, there will be discontinuities. Some of those jobs will provide 401(k) plans that are not so generous. Some will provide no retirement plan at all. Our hero(ine) will go through some times of economic hardship and not contribute enough to get the full match throughout their career. They will take plan loans from time to time and maybe even a hardship withdrawal or two. Like it or not, our new worker is going to have a lot of turmoil in their grand retirement plan. It is this combination of bad stuff that is sometimes referred to as leakage.

So, how is the SEAL Act going to stop this? Well, it's not a very long bill. It has five sections including the ridiculously silly Section 1 that seems to live in all bills and is called the Short Title (it seems to me that this could go in the bill header, but what do I know?). Each of the remaining sections has a purpose and we'll refer to them by number.

Section 2. This section would increase the rollover period for plan loans when a participant with an outstanding loan changes employment. It would allow the participant to wait until they file their federal income tax return for the year in question before having to repay the loan to their rollover account without suffering the penalties of a defaulted plan loan, and therefore, a deemed distribution. Senators Kohl and Enzi think that participants are not repaying these loans currently because they don't have enough time to make the decision. Do you know what? They are wrong. People are not repaying the loans because they don't have the money or even access to the money to do it. You can't repay a plan loan with hope or with a credit card, you need actual money.

Section 3. This would allow participants to take a hardship withdrawal, but still make deferrals to the plan during the six months immediately following the hardship withdrawal. Let's think about this. A participant jumps through all the hoops necessary to take a hardship withdrawal (including that they have no other sources of the money that they need) and Senators Kohl and Enzi expect them, or even want them, to continue deferring to the 401(k) plan. Either Kohl and Enzi don't get it or I don't get it, and at least in this case, my nod goes to them not getting it. According to his own Senate disclosures, Mr. Kohl's net worth has recently been in the vicinity of $250 million. Mr. Enzi's net worth, on the other hand, has only been in the range of $1 million to about $2.5 million. Even Mr. Enzi probably doesn't quite know the plight of someone dealing with a hardship withdrawal, and we can be sure that Mr. Kohl does not run in those circles.

By the way, if you want to check out the finances of a US Congressman, you can find their disclosures at opensecrets.org

Section 4. This would reduce the number of plan loans that a participant can have outstanding at any point in time to three. Perhaps I am missing something here, but a person who has three plan loans outstanding is probably not in a position to be making large deferrals.

Section 5. This would prohibit products like the 401(k) debit card that encourage participants to raid (self-leakage) their 401(k) accounts before retirement. In a press release, the bill's co-sponsors admit that such products are not prevalent.

So, there you have it, a summary of the bill named after either a strange looking mammal or Heidi Klum's husband. What do you think?

Wednesday, May 18, 2011

Supreme Court Rules in Amara v Cigna -- Who Gets the Final Rose?

Back in December, I wrote about a case fashioned as Amara v Cigna. The Supreme Court has ruled. Insomniacs among us may torture themselves with Justice Breyer's opinion and Justice Scalia's concurrence.

For a blogger, this case is interesting in a number of respects:

  • I have never seen so many ERISA attorneys rush to their computers to write about a case.
  • There are some very good reports out there, but my general impression is that what most of those attorneys have chosen to write is even less clear and more torturous than what the Supreme Court wrote.
  • In writings that I have seen, defendant's advocates think that Cigna has won and plaintiff's advocates think that Amara et al have won. Why can't this be more like The Bachelor where one unlucky lady gets a final rose (or some such nonsense) and gets to pretend that they actually love some highly eligible bachelor? On second thought, why is there anything called The Bachelor that I know about?
Those who writhe with pleasure over fine nuances in ERISA are seemingly ecstatic over the Supreme Court's discussions of whether relief might be available under Section 502(a)(1)(B) or Section 502(a)(3). You're excited at the mere thought, aren't you? Oh, you're not ...

To cut to the chase, here is what happened, or at least what this mind not formally trained in the law thinks happened.
  • The lower courts had found that Cigna's pension plan which had been changed from a final average pay plan to a cash balance plan had not been communicated properly through, among other things, the summary plan description (SPD).
  • The lower courts reformed the plan (the actual plan document) to say what they thought it should say based in part upon the language in the SPD.
  • The Supreme Court lambasted Cigna for its conversion and communications, but found that the lower courts had overstepped their bounds.
  • The Supreme Court remanded (people who speak regular English would say sent back) the case to the lower courts for a more appropriate remedy. In doing so, the Supreme Court severely limited the power of the SPD, but appears to have given the lower courts exceptionally broad leeway in their reformation.
  • Advocates for plan sponsors say that they have won because inadvertent miscommunications in SPDs cannot be used to provide unintended windfalls to participants.
  • Advocates for plan participants say that they have won because participants will now surely be entitled to the benefits that the SPD promised them.
And, in the final judgment, at least for now, neither bachelorette (Amara nor Cigna) has gotten the final rose.

Monday, May 16, 2011

Pay Ratio Disclosure Still Alive

I've written about it before, and not in the kindest terms. In fact, I called it the stupidest rule. It's the pay ratio disclosure rule under Section 953(b) of the Dodd-Frank law.

Scores of intelligent people have written to the SEC asking them to provide an easy means for companies to comply with this section of the law. Many of the same people have asked Congress to repeal it. So, what's all the hubbub?

For those who have not been following the issue, Dodd-Frank had as it primary goal cleaning up Wall Street. Largely, it was a reaction to TARP, "too big to fail", and the Wall Street "fat cats" getting fatter. Section 953(b) was pushed for and trumpeted upon passage by large labor. What does that mean? It means that the large labor unions like it.

Section 953(b) will require issuers of voting proxies who are SEC registrants (generally, companies with US public shares or public debt) to disclose the ratio of compensation of the median employee of a company to that of the CEO. I know, that doesn't sound so bad on the surface. But, here is what is really bad about it:

  • The ratio is backwards. If it has any value at all, then CEO compensation should be in the numerator and median employee compensation in the denominator so that the disclosed ratio is (or looks a lot like, just in case the SEC would require more significant digits) an integer. A ratio of 0.0083 is not going to be a number that shareholders can latch on to. A ratio of 120 (its reciprocal), on the other hand would have some meaning.
  • The definition of compensation is not what Joe Six-Pack thinks it is. It's not just cash compensation. It includes values of equity awards and grants, and changes in the value of certain nonqualified deferred compensation arrangements, among other things. That latter element is particularly troubling because CEOs of certain companies will be deemed to have earned more money simply because interest rates have fallen.
  • The law doesn't just apply to US employees. Suppose, for example, a company is in the rubber business. Well, there just aren't a whole lot of rubber plantations in the world's thriving economies. So, rubber plantation workers don't earn a whole lot of money; it's the nature of their local economies. Yet, this could make the pay ratio look really bad for that company.
  • Again, the law doesn't just apply to US employees. Foreign employees usually get paid in their local currency. So, this not very useful pay ratio may fluctuate do to foreign currency exchange rates. And, how will that happen? Well, we don't know. Suppose I worked in a country that uses the Euro (I'm not going to make this overly complicated and use an obscure currency). Further, assume that I get paid twice per month. Does my employer need to take each of my 24 paychecks and convert its value to dollars using the then current exchange rate, or do they get to use one exchange rate for the year? Either way, this process is unnecessarily cumbersome.
  • Determining the median employee is not easy. For the mathematically challenged, finding the median of a population entails ranking the entire population and picking the person in the middle. In this case, that means that the company will have to determine the compensation of every single employee worldwide. And, one other thing that we don't know is which employees this includes. Does it include temporary workers, seasonal workers, part-time workers, workers who were hired during the year, workers who terminated employment during the year? Would it be easier if it included those people or not? Would the answer be more useful if it included those people or not?
Finally, we will get a number for each company. And then what? Richard Trumka, President of the AFL-CIO thinks that a reasonable ratio (when the fraction is flipped) is 4. I don't know of a large company in the United States that would have a ratio of 4, unless there was a CEO who voluntarily chose to not be paid in that year. That's just not the nature of CEO compensation. And, with regard to CEOs that I am familiar with, frankly a ratio of 4 would be highly discriminatory against the CEO when compared with unions. In my experience, it's not unusual for a CEO to work 80 hours in a week. If that CEO were in a union, he would get time-and-a-half for overtime, plus shift differentials, double time (or more) on some weekends and holidays, and other bumps. If part-time workers, temporary workers, and workers who were employed for less than the full year were included, the CEO might have a lower effective hourly rate than the median employee.

So, here is where things stand now. On the negative side, the SEC says that the law is clear and that the SEC does not have the power or the flexibility to interpret the law in a way that would appease the commentators. Unless it gets repealed, SEC registrants will have to deal with it.

On the positive side, registrants will not be required to comply with this section until the SEC has regulated it. Looking at the SEC's regulatory calendar, this writer thinks that may not be in time for the 2012 proxy season. Maybe saner heads will prevail by then.

Wednesday, May 11, 2011

Writing and Speaking Properly

How is your English language usage? I'm not asking about when you are speaking with your kids, your spouse, or your significant other. I'm talking about when you are doing business. Would your 8th grade English teacher be proud of you? Or, in 2011, when people text things to each other like "2 kewl" and "h r u", does it just not matter?

I was an attendee at a training session at a conference for experienced consultants about 18 months ago where the both of the key presenters were heads of procurement for large, but not gigantic companies. Each was asked the question [paraphrasing], "When you receive a proposal, does the quality of the writing in that proposal matter?" One said that it did not; the other said that it does matter. The one that said that it does matter said that while she tried not to make it a big differentiator, she knows that she scores well-written easy-to-read proposals higher than ones with particularly cumbersome language usage. Further, she said that she has disqualified proposals that have been, in her judgment, poorly written.

When I spoke with her one-on-one after the session, she expounded a bit. She told me that she was somewhat offended when an e-mail to her from a prospective vendor started with the salutation "Hi Mary [not her real name]." In her mind, you say hi to your friends, you say hi to your family, you say hi to people you know, you don't say hi to a prospective client that you have never met. Further, she told me that although she really would prefer not to give higher scores to a very well written proposal than to just a well written one as it's generally not a proposal for writing services, she probably unconsciously does do exactly that. In other words, to her, the quality of writing matters, and bad writing doesn't have a chance.

I also spoke with her co-presenter, Mike [not his real name either] after the session. Mike was not as adamant about business writing and being addressed professionally. He insisted that he really doesn't care that much about the quality of writing in a proposal. I pressed him on that issue. He finally admitted that while it may not be as big of an issue for him as it is for Mary, the quality of writing does matter, even if it's just one of many factors, or sometimes just a tiebreaker.

How about use of the spoken word, does it matter? I think it does. Who would you rather use as your business consultant? Would you choose Arnold Jackson [yes, the one portrayed by Gary Coleman] who questioned. "What you talkin' about, Willis?" Or, would you prefer Alex P. Keaton [portrayed by Michael J. Fox] when he said, "Now that is a problem. Surely, we can find a solution."

I don't think that people in the business world are offended by less formal speech than we used to use. But, when things get too informal, I fear that what your audience remember is that you tried to sound too cool. They may have loved your demeanor, but they have no idea what you actually said. You may have won the personality battle, but you may have no credibility.

Perhaps, being somewhere in the middle is best. Maybe it is best to be a little bit less formal, but still proper. To me, that is in the eye of the beholder and has much to do with the comfort level of the speaker. However, if you are in the very informal group, give it a try. Consider adding a little bit of polish to your writing and  your speech.

You wouldn't show up for that sales final in dirty, torn jeans and tennis shoes, would you?

Monday, May 9, 2011

Private Equity Groups and Retirement Plan Compliance

They buy companies. They sell companies. That means, among other things, that at any given point in time, they own lots of companies.

What are they? They're private equity firms. And, in their normal mode of operation, many of them constitute a controlled group of corporations within the meaning of Internal Revenue Code Section 1563(a)(1).

So? Bully for them, right. Actually, if we look more closely, it may be far more complicated than that when it comes to retirement plans. In the most typical situation, each portfolio company will maintain one or more qualified retirement plans. So, the controlled group maintains lots of qualified retirement plans. And, because private equity firms usually allow each portfolio company to operate autonomously, the proverbial left hand may not know what the proverbial right hand is doing.

Usually, in my experience, they are mostly or entirely defined contribution (DC) plans. That's good, but let's think about the compliance issues. Each DC plan needs to satisfy the coverage rules of Code Section 410(b) on a controlled group basis. Each plan needs to satisfy the benefits, rights, and features rules of Treasury Regulation 1.401(a)(4)-4 on a controlled group basis. Each plan that is not a 401(k)/(m) plan (or 403(b)) needs to satisfy amounts testing under Treasury Regulation 1.401(a)(4)-2 (or -3 for a DB plan) on a controlled group basis. Each plan that is subject to 401(k)/(m) may wind up needing to be aggregated with another like plan in the controlled group for testing purposes.

I'm going to simplify this a little bit, but here is the way that we might look at the compliance situation for a group of DC plans in a controlled group.

  • Count up the number of nonexcludible (generally all that are at least age 21, have at least 1 year of service, are not covered by a collective bargaining agreement, and are not nonresident aliens) highly compensated employees (HCEs) in the controlled group. Let's call this number CGH.
  • Do the same thing for the nonhighly compensated employees (NHCEs) in the controlled group. Let's call this number CGNH.
  • For each plan, determine the number of HCEs and NHCEs, separately who are covered by that plan. For plan 1, we will call those numbers P1H and P1NH. For plan 2, let's call them, P2H and P2NH. You get the picture.
  • Now, take the ratio (P1NH/CGNH)/(P1H/CGH). Is it at least 70%? Are the similar ratios for all of the other plans also at least 70%? In my experience, the answer is often no. If the answer is yes, you are in good shape. If it's no, you may have problems.
  • At this point, you'll need to consider other issues such as plan aggregation, current year versus prior year testing methods, safe harbor designs, qualified separate lines of business (QSLOBs) and other equally wonderful concepts. You probably need an expert.
We could go on for pages and pages here. These situations often get ugly. The private equity company probably never thought about this stuff. Suddenly, the plans maintained by the companies that they own may have compliance problems.

In reality, when dealing with this type of organization, I've seen this issue more often than not. It's not part of the buying decision, it's not part of ongoing process, and frankly, the people completing (and signing) Forms 5500 for the various plans probably don't even realize the problem exists.

I've seen it. It's usually ugly. I can help.

Thursday, May 5, 2011

The Values of Shortfall and Surplus

You can look at it in lots of different contexts -- gambling, savings, personal finance, defined benefit plans. Which is bigger, the negative value of a 10% shortfall or the positive value of a 10% surplus? Of course, they are the same, 10% of something, but are they really?

From a personal finance standpoint, if you have a 10% surplus -- that is, 10% more money socked away than you need to meet your current obligations -- that is nice. But, if you have a 10% shortfall, that is really painful. The surplus gets you some comfort or some discretionary spending. The shortfall, on the other hand, increases your cost of money.

In defined benefit plans, it may be worse. And, the value of increasing surplus gets smaller and smaller (somewhat simplistically) as the surplus grows, but not so with the negative value of shortfall. Let's consider a fairly simple example. I'm going to assume that your defined benefit plan has a funding target of $100 million and assets of one of $80, 90, 100, 110, or 120 million. In other words, you have a Funding Target Attainment Percentage (funded status or FTAP) of one of 80%, 90%, 100%, 110%, or 120%. Let's ignore the Target Normal Cost and determine the one-year cost of paying down that unfunded liability (assume an effective interest rate of 5.00%).

At 80%, it's about $3.45 million. At 90%, it's about $1.73 million. At 100%, 110%, or 120%, it's $0. From a one-year funding standpoint, the negative value of shortfall is meaningful, but the positive value of surplus is not.

Suppose you are planning to terminate your plan. Absent the additional cost of annuities (insurance companies need to build in margin to manage their risks and to turn a profit), the surplus is generally worth about 15 cents on the dollar (less if you use it for a replacement plan), but the shortfall has a negative value of $1 on the dollar, unless you are going to get the PBGC to take over your plan.

Why do we care about all this? Until your plan gets into a restricted status (<80% funded) or an at-risk status (<60% funded), all oversimplified, each dollar of underfunding has the same negative value. But, overfunding has less positive value. So, when you are looking at your investment policy for your plan, when it is already fully funded, you should simply be looking to develop a strategy to keep the surplus there, but taking risks to grow the surplus is probably not prudent. It is only when a plan is underfunded that risk-taking may make sense. Again, absent the negatives that fall to a plan once it crosses below that 60% or 80% threshold, every dollar upside has the same value as every dollar downside. So, where a sponsor of an overfunded plan should be risk averse, the sponsor of an underfunded plan should be largely risk neutral. Frankly, the only scenario in which a sponsor should have a preference for risk is one where they are so poorly funded and the company's finances are so bad that they are making a bet with two possible outcomes: 1) the risk pays off and as a result the company is able to stay in business, or 2) the risk goes bad, and the PBGC takes over the plan.

Think about it. Then, think about your plan's investment policy. Does it make sense? Do you need help?

Wednesday, May 4, 2011

Survey Says Employer-Provided Benefits Declining, But Why?

Today's information is gleaned largely from "Prudential's Fifth Annual Study of Employee Benefits: Today & Beyond." For me, the key takeaway from an employee's standpoint is that 43% of employees said that the level of benefits that their company offers was down from a year earlier. This continues a trend that we have seen for the last few years. Pay increases, generally, are meager. What employees have to pay for equivalent benefits is increasing faster than pay. The end result is that an employee's income that is used to other than the necessities of life is shrinking.

Here I diverge from the theme of the survey. We've been down this road before. Employer-provided retirement benefits are decreasing. Defined benefit pensions, once nearly as prevalent as mom and apple pie, are now barely more common than the dinosaur. Cost-sharing in what are considered by most to be core benefits, such as health care, has increased on the employee side. And, all this has occurred while the level of benefits being provided is declining.

Once upon a time in a far-away land (oops, not so far away, but actually right here in the US), companies used to talk about the "deal" between an employer and an employee. The employee would work hard, but frankly, perhaps not as many hours as employees seemed to be working through the period from about 1985 to the early 2000s. In return, the employee would get fair pay with fair pay increases and certain core benefits (retirement and health care primary among them).

What ended this? From this lens, it appears that the beginning of the end was the bursting of the tech bubble. The recession of the early 2000s brought with it a rash of cuts in employee benefit programs. Companies looked for new ways to save money and such benefits were among the primary targets. Initially, we were told that such cuts would be temporary, but temporary is long since gone. That train has left the station.

Frequently, I rail on against those who choose to over-regulate things like executive compensation. But, if we look carefully, it is really only the executives whose total reward package has value that has kept up with or exceeded increases in the cost of living.

I think there is one reason for this that has not been discussed much. It's one of the OBRA brothers, in this case OBRA 93. It added Section 162(m), the foolish million dollar pay cap to the Internal Revenue Code. But, it exempted performance-based pay. And, while this was designed to rein in executive compensation, what it did is it allowed companies and their compensation consultants to design programs with obscene amounts of performance-based pay for top executives. So, executive pay went up, and it went up with the incentive attached to it that if the executives could increase corporate profitability by cutting employee benefits, part of that savings from cutting benefits would go right into the checkbooks of the executives.

So, for all the people in the early 90s who tried to rein in executive compensation, they really found a back door way to cut broad-based employee compensation and benefits. The Prudential survey doesn't say it, but I do.

And so it goes ...

Monday, May 2, 2011

Causing A SERP to Violate 409A By (lack of) Default

Code Section 409A has been one of the biggest disasters ever written into the Internal Revenue Code. It was supposed to raise lots of money for the government, but to my knowledge, it has not. It was supposed to make nonqualified deferred compensation no less favorable than its qualified brother, and it certainly has done that. But, some of the pitfalls that have come up are way beyond the scope of what Congress could possibly have considered. Let's consider a not uncommon situation.

XYZ Company decides to start a new (traditional) deferred compensation plan for certain executives. Eligible executives will be able to make deferral elections (amount, timing of payment, form of payment) during year X-1 with respect to compensation earned during year X. Earnings will be credited on those amounts based on the earnings of a funds selected by an executive from the group of funds also available under the qualified 401(k) plan. Deferrals will be matched by XYZ dollar for dollar on the first 10% of compensation deferred to the nonqualified plan (NQDC). As these executives previously participated in a nonqualified cash balance plan (that plan was frozen when the qualified plan was frozen), vesting is 100% after 10 years of service, with service counting back to date of hire.

Believe it or not, all, or at least most of these executives will be in violation of Code Section 409A the moment that they make their elections. Why? How can that be? Without reading down, do you know?

Here is the catch. Vesting service starts before the effective date of the plan. This is not the first plan of this type (account balance plans) in which the executives participate. For those who are immediately vested (10 years of vesting service), making an election in Year X-1 is making an election for services already performed. Yes, the mere fact that vesting service starts before the effective date of the plan causes the problem.

How do you fix this? The good news is that it is actually fairly simple. Make the initial deferral election a default. In other words, specify it in the plan with no choices. Given that no choices are available, the rules will be interpreted so that the executives have not made an election after the date on which some services have been performed.

Do you think this is ridiculous? So do I. Do you think that Congress intended it this way? Neither do I.

This, dear readers, is the level of stupidity to which 409A has sunken.