Thursday, August 29, 2013

Pay Ratio Rules are Coming

I've written about it many times. It lives in Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It's the pay ratio requirement. If this is new to you, you can get the background on it here. The New York Times wrote about it recently and finds no evidence as to how or why Senator Menendez (D-NJ) added that section into the Act. Perhaps this site maintained by AFL-CIO was a motivating factor.

I write about this again because of the rumor mill surrounding the SEC (I know, you can't find it in the supermarket tabloids).This rumor mill tells me that the SEC will provide its first guidance on this and other [Dodd-Frank] Title IX issues next month (September 2013).

Suppose you are an employer subject to Title IX (generally an SEC registrant), what should you do and what should you look out for?

If you are in the simplest of all situations-- that is, no employees outside of the US, no part-timers, no seasonal employees, no equity compensation, no defined benefit plans and no perquisites, your job is easy. CEO compensation and that of other employees is going to look a lot like W-2. You might even have a centralized payroll system on which you can run a report and easily determine who the median-paid employee in the company is. This could be a 30-minute exercise.

Oh, you're not in that simplest of all situations? It's going to be more complicated then. You will be faced with the exciting prospect of currency conversions, actuarial present value calculations, Black-Scholes calculations, gathering of data from multiple payroll feeds, and determination of the value of other benefits on which you usually don't place a price tag.

We think that one of the reasons that the SEC has taken three years to provide rules on much of Title IX is that they have not been able to figure out what makes sense. After having received thousands of comment letters, many suggesting simplifying procedures, apparently they are close. We will see soon what the rules look like.

In the meantime, if you fall into the group of companies that has one or more of the "problem areas", you will want to see what the rules say and see how they will affect your company. When the rules are published, you can read my analysis here. It may not cover every legal detail as the ones from law firms do, but I hope that it will give you practical advice.

And, now or then, if you'd like to get a head start on how to deal with this, e-mail me and we can discuss how to handle your situation.

It's not going to be pretty, I'm afraid.

Thursday, August 22, 2013

SAFE Retirement Plan -- A Paper from the Center for American Progress

The Center for American Progress (CAP) released a paper entitled American Retirement Savings Could be Much Better. For readers interested in the topic of retirement savings, I would highly recommend a read or at least a perusal of the paper. The authors are Rowland Davis, a well-known actuary who very clearly does have the training and experience necessary to undertake such a study and David Madland, a commentator on the economy, unions, retirement policy and public opinion. Not having the same background as Dr. Madland, I am not in a position to judge his background and experience, but as the paper is well-founded, I will presume that he too is highly qualified to opine on this topic.

Essentially, the authors propose what is often referred to as a collective savings or collective defined contribution plan. Under such a plan, in a nutshell, a worker would enroll in a SAFE (secure, accessible, flexible, and efficient) retirement plan. This plan would have all of these characteristics (not an exhaustive list):

  • Workers would opt into a SAFE Plan of their choosing
  • Employers could choose to contribute or not
  • Plan assets would be professionally invested at what would currently be considered very low levels of fees
  • Workers' accounts would get the returns on the professionally managed pools of assets subject to a floor and a ceiling (in combination, referred to as a collar)
  • At retirement, the account balance would be converted to an inflation-adjusted annuity
Let's consider what the authors have created here. Essentially, it's a contributory multiemployer cash balance pension plan with a set of features not currently permitted under the Internal Revenue Code for qualified plans. 

What a novel concept! The authors have chosen to separate retirement policy from tax policy. For this, they are to be applauded. Combined with the access that CAP has to legislators, this has far more value than when your poor little blogger (me) spews forth similar ideas ("public policy" ramblings in this blog). 

Frankly, this is a pretty cool idea. It has these attributes that are very positive:
  • The plan is portable
  • It provides for retirement income
  • It reduces "leakage" (the authors would have us believe, according to my reading, that it eliminates leakage and this might be the case if workers never experienced bouts of unemployment, but alas, they do)
  • The retirement income is somewhat protected against inflation
  • Employers can be employers of choice by contributing to their workers' SAFE Plans
What I like best about the proposed design, however, is that it violates the current Internal Revenue Code in oh so many ways. The retirement plan design is founded on retirement policy. Note the symmetry!

I would be remiss if I did not point out some of the issues that I take with the authors' work. In their paper, in at least one of their models, they appear to assume historical equity and fixed income returns going forward, but 2% inflation. In my opinion, this set of assumptions is not internally consistent. In my lifetime (it started in late 1957), there have been only 12 years out of the 55 from 1958 through 2012 in which inflation was less than 2% while in the other 43, the rate of inflation exceeded 2% annually (you can see the data here). 

Assuming that workers' salary deferrals to a SAFE Plan would be continuous from entry until retirement at age 67 is unrealistic (rates of unemployment are high). However, regardless of the assumption, SAFE Plans would be safer for workers (by a lot) than the current mostly 401(k) system that we have. Again, that is the point that the authors seek to make and they make it well.

Finally, in giving workers the option to reduce the automatic contribution to SAFE Plans, the authors tempt reality. To think that the typical worker will have the discipline to continue contributing at the appropriate level in times of hardship, need, or even desire to spend, is not, in my opinion, realistic. Once again, however, the results inherent in SAFE Plans far outpace those in the current retirement system.

The financial economists in the actuarial profession will scoff at the assumed equity risk premium. This is a debate on which both sides are fervent and will likely never agree. Regardless of who turns out to be correct, however, SAFE Plans will outperform any other equal cost plan currently permitted under the Internal Revenue Code.

Unlike most (in my experience) papers on retirement policy published by think tanks, CAP has engaged a highly qualified and experienced retirement actuary. Mr. Davis has made a set of actuarial assumptions and has disclosed the key assumptions. The paper has been reviewed by a group of individuals, two of whom are credentialed actuaries. I rue that several other of the reviewers are life-long Congressional staffers and or think tank workers, but I did not fund the work, so I have no say.

Ardent Republicans in my readership will have the inclination to look for flaws in the paper. Fervent Democrats will likely be in awe of the wondrous solution. I choose to read it with both a jaundiced eye and an open mind. It's a significant step in the right direction.

Wednesday, August 21, 2013

Rewardsball -- Where HR Meets Moneyball

I'm sure that many of you read Michael Lewis' excellent book Moneyball. Whether you have or not, it's the true story of the Oakland Athletics baseball team with a focus on their General Manager, Billy Beane and his focus on the value that players actually deliver. It's the story of how a smaller-market baseball team without a lot of money uses its money wisely to be competitive without a lineup full of superstars. It's a story that instructs that certain statistics are undervalued and that certain other statistics are overvalued. It's a story that tells us how to efficiently use our payroll budget to achieve the best results.

That seems like a really cool idea. It seems so simple, doesn't it? All we have to do is to develop a simple set of metrics and apply them to our company and we will use our payroll more efficiently than our competitors, generate more profits for our shareholders and pay all of our employees commensurate with their contributions to our profitability.

Wow, John, that is a fantastic idea. You should start a business, preach this to the masses, make millions of dollars implementing it, go on the banquet circuit and eat lots of really bad chicken.

Not so fast.

Baseball is a relatively ideal forum for the concept of Moneyball. There are 30 teams. Each team has the same rules. Each team's goal is to win as many games as possible of 162. Each team wins games by scoring more runs than its opponent. Each team scores a run when a player safely crosses home plate. So, a player who generates a lot of runs for one team is highly likely to generate a similarly large number of runs for another team (if he is traded).

Tell me two companies that play by the same set of rules. That's tougher, isn't it? In order to have the same set of rules, they need to have similar goals. Perhaps they need to offer similar products and services. We could argue that they need to have similar financial situations, but we know that the Oakland Athletics and New York Yankees do not have similar financial situations. Yet, the Athletics with a payroll often dwarfed by what the Yankees pay their starting infield currently sit five games ahead of the Yankees.

Even McDonald's and Burger King, though, have different jobs. They have different products. They have different locations. Presumably, they have different goals.

But, let's take a different approach that can be applied to any company. Suppose a company currently spends $1 million per year on its health care benefits for employees (and their families). Perhaps $800,000 is the minimum that they could spend. What is the value of that additional $200,000? Does the company get a good return on its investment for the additional $200,000? If not, should they cut benefits or enhance them.

This is actually what I am referring to as Rewardsball although I think I can come up with a better name. It's an interesting concept, isn't it?

Call me. Write me. +1 this post. Re-post it. Re-tweet it. Help me out please.

Thursday, August 15, 2013

Next on the Horizon -- Curing Ills or Creating Them

Congress and the President, and I'm not just talking about this Congress and this President, have a very consistent theme. They look for things that are wrong in the United States and they seek to fix them. This is good. In fact, I think it is indisputably good.

That doesn't sound like this author, does it? I almost never praise anyone in my blog. Consider Mark Antony's famous soliloquy from Julius Caesar, Act III, Scene 2 (Friends, Romans, and Countrymen ...).

So, what's the rub here?

Think back to late 1981. The typical American worker was covered by a strong retirement program. Without having statistics at hand, memory tells me that most were covered by defined benefit pension plans, a not insignificant number of which required employee contributions. Virtually none were yet participating in this new type of retirement plan called a "cash or deferred arrangement (CODA)", now known universally as a 401(k) plan (Section 401(k) was added to the Internal Revenue Code by the Revenue Act of 1978).

Well, that's all good, isn't it?

The 1980s saw an era where retirement benefit law was changed nearly every year, sometimes multiple times in a year. Each change was lauded as an improvement. Yet, 30 or so years later, look where we are. Workers who were nearing the retirement zone in the early to mid 80s generally retired early. Many, if not most, were able to live more comfortable lives in retirement than during their working lifetimes. Today, that does not seem to be the case. In fact, when I look at my cadre (those currently in their 50s), those who did not benefit significantly from the irrational stock market run-up during the mid to late 90s (and hold on to a good bit of that money) are talking about never being able to retire.

And, this is despite the 30+ laws passed by various Congresses and signed by various Presidents since the early 80s, each of which was designed to strengthen our private retirement system. Surely, I am not so lacking in command of the English language that the word strengthen is beyond my understanding.

In 2010, two of the more controversial laws in recent times were passed. I refer to the Patient Protection and Affordable Care Act (PPACA, ACA, or ObamaCare) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Each was voluminous and each was intended to cure an ill or multiple ills.

Each law has been viewed by many businesses as something that will cost them more money to operate those businesses. Curiously, businesses do not like to see their overhead increase. Perhaps that's not curious at all.

So, what do they do? Those businesses find ways to not increase their costs of doing business. For many, that has meant changing full-time jobs to part-time jobs, thus not requiring health care coverage of those employees under ObamaCare. The more socially-minded among us would consider this to be abhorrent. The more fiscally-minded would consider it a smart business practice. Robert Merton would consider it to be an unintended or unanticipated consequence (Merton wrote the seminal paper, "The Unanticipated Consequences of Purposive Social Action" in 1936).

Let's look at where we are today. Congress seems to get nothing done because the Democrats in the Senate and the Republicans in the House agree on essentially nothing. It's rare that even the Democrat-controlled Senate provides majority support for proposals from the Obama Administration. But, we certainly have ills. The economy has been largely stalled for seemingly (to me, anyway) a dozen years or more. Real wages, on average have declined. The rich get richer and the rest of us don't.

Congress will continue to make proposals. Some will be agreed to in compromise actions. Then, those bills will be scored by the Congressional Budget Office (CBO), a group which by the protocol it must follow will produce a cost or savings from the bill that has no footing in reality. Finally, we will have a new law which will hurt more than it will help and will produce more unanticipated consequences.

Congress has very few members who have run businesses. Neither the President nor the Vice President to my knowledge have ever run businesses. People who have never run businesses tend not to think as people who do run businesses would. As a result, we have unintended consequences.

This is my first rant in a while. I would be pleased if it spurred some discussion. If not, I'm sure I will find something more newsworthy to report on.

Friday, August 9, 2013

More On Private Equity and Retirement Plans

Just last week, I wrote about the ruling in Teamsters v Scott Brass. If you didn't read it, of course I think you should. The case, on its surface, focused on whether a private equity holding company (forgive me if I am not using the term exactly as an attorney would) and its funds were liable for multiemployer plan withdrawal liability when one of the fund companies that happened to participate in a multiemployer pension plan declared bankruptcy. The key to the First Circuit ruling was that the so-called Sun Funds were considered to be trades or business. In my previous post, I gave a bit of an explanation of the court's rationale for this. If you want a more detailed legal analysis, you can find one here.

I had an interesting conversation on this topic yesterday with an ERISA attorney who happens to no longer be practicing law. As the conversation progressed, we each realized (I think we already did, but to hear someone else agree with you makes it sink in a bit more) how complex this can be.

Think about the way a private equity company typically runs its portfolio. The holding company does make decisions about who will be in management at the portfolio companies. The holding company also usually makes some decisions about the way those business will be run. But, the holding company usually does not bother itself with the administrative details ("administrivia" if you need a cute little made-up word to describe this) of its portfolio companies' businesses. It leaves them to the individual companies.

Who cares?

The holding company should care. The portfolio companies should care. The employees of the portfolio companies should care. The officers and or directors of the holding company should care.

Consider a simple, but not irrational (purely hypothetical, however) private equity fund portfolio (we'll call it Fund 1):

  • Amazing Architects of Alaska
  • Brilliant Babysitters
  • Creative Candles 
  • Dreamy Doctors and Dentists of the Dakotas
  • Excellent Embroidery Experts
  • Fabulous Florists
  • Groovy Gambrelers (a gambreler is a person who prepares animal carcasses)
  • Happy Hypnotherapists of Hilo and Honolulu
Most of these companies have qualified retirement plans. The babysitters, all being young and also low-paid have never considered the day that they might retire, so they don't yet have one. All of the others have a 401(k) plan, but the embroiderers and florists don't have any matching contributions in theirs. At the same time, the doctors and dentists also have a profit sharing feature as well as a defined benefit plan to maximize their tax savings and their ultimate retirement benefits.

Still, who cares? For each company, these are the same benefits that they had before they were acquired by Fund 1.

In light of Scott Brass, all of the companies should care. They are part of a controlled group of corporations now. That means that unlike what they did when they were separate self-contained entities, they now must perform their nondiscrimination, coverage, and minimum participation testing on a controlled group basis. 

What does that mean in practice? Isn't this just administrivia? Let's consider some of the issues that we have here.
  • Company D has the highest-paid workers in the controlled group as well as the highest concentration of highly compensated employees (HCEs). Company D also has the richest benefits. And, Company D provides something known as benefits, rights, and features that no other portfolio company does. 
  • Company B is the lowest paid. It has only nonhighly compensated employees (NHCEs) who receive no retirement benefits.
  • Companies E and F have employees who are generally low-paid, but they get no matching contributions.
Do you get the picture yet? Fund 1 has a mess. Worse yet, by the magic of a fact pattern that I just created for this scenario, Fund 1 had a mess for the 2012 plan years (all calendar years). 

In a nutshell, the mess can be described this way. HCEs in total had benefits that were far more generous than NHCEs. Those HCEs also had benefits, rights, and features (BRFs) on a basis that was discriminatory in their favor for 2012. 

The good news is that there is a retroactive correction period to fix this problem (it ends on October 15, 2013). The complicating news is that the only way to fix the problem now is to provide additional benefits and BRFs to NHCEs. In other words, because of the extremely rich benefits at Company D, Companies B, E, and F are going to need to provide additional benefits.

The innocent onlooker says that's great. Surely, those poor babysitters, embroiderers and florists deserve something. But, benefits cost money. Who is going to pay for them? If we give benefits to babysitters, then that business goes from being profitable to one that is losing money. But, if we don't then, the plans for Company D risk disqualification.

Okay, you got me, this is just a bad dream, isn't it? Nope, this stuff happens and it happens frequently. To date, many private equity companies have chosen to ignore it, but post-Scott Brass, ignorance is probably not bliss.

These problems can be fixed, but not many people know how to do it. Such a person must have a good knowledge of the law, the suite of nondiscrimination regulations, and the mathematical/actuarial skills to perform the calculations.

There aren't very many of us. Call me ...

Thursday, August 8, 2013

Academic Study Inflames 401(k) Community

Ian Ayres, a Professor of Law at Yale University recently inflamed the 401(k) community by sending roughly 6,000 letters to plan sponsors telling them, in essence, that the fees associated with their investment lineups are too high. They appear to use as a benchmark a family of index funds provided by Vanguard and the fees at which those funds could be available. Additionally, Mr. Ayres is doing working with Quinn Curtis, Associate Professor of Law at the University of Virginia School of Law. Messrs Ayres and Curtis have posted a draft of the paper they intend to publish on the topic. If you were to do an internet search on Ayres/Curtis papers, you would probably find it, but since the authors ask that the paper not be specifically cited, I will leave that to the reader (more hints to come).

Three attorneys at Drinker, Biddle & Reath LLP (Fred Reish, Bruce Ashton, and Joshua Waldbeser) have written a critical analysis directed to the 401(k) community as well as an accompanying "cover memo." If you choose to read them carefully, you might find a way to access the draft paper (Ayres/Curtis).

Essentially, Ayres [and Curtis] has concluded that most participant "losses" in 401(k) plans (losses are cumulative investment returns that are less than optimal) are what they call "menu excess fee losses." While it's not 100% clear to me, I think that they are comparing the cost of a plan's investment menu to the cost of an arguably (or not) comparable Vanguard menu.

FULL DISCLOSURE: I personally have no strong bias for or against Vanguard as compared to their competitors. I have at various times had money invested in Vanguard funds. I know people who work for Vanguard as well as many of their competitors.

There are many factors that the Ayres/Curtis work fails to consider. Reish et al discuss what I would consider to be the large majority of them. I could opine on my own, but for the moment, I will take a different tact.

Suppose you were buying a car. All cars will, at least for a while, provide a capable driver with transportation from one place to another. Some cars are less expensive than others. Should you always purchase the least expensive car that meets your minimum standards? Most readers, I believe, would say no.

Let's return to the real topic at hand. Often times, for a plan sponsor to negotiate the best recordkeeping fee arrangement for plan participants (remember that those fees may be charged back to participants in an ERISA plan), the sponsor must agree to include some of the recordkeeper's proprietary funds in their investment menu. Done properly, the sponsor will have worked with experts internally or externally who have evaluated each of those funds to ensure to their satisfaction that the funds are appropriate for a participant-directed ERISA plan. Presumably, funds that either have poor track records, lack of manager stability, or other red flags that would cause them to be suspect will either not be chosen, or at least placed on a watch list.

As Reish et al point out, most plan committees do strive to fulfill their fiduciary duties. One could surmise this to be the case from the number of lawsuits that have been filed alleging that they are not fulfilling those duties as compared to the number that have not been thrown out by the courts.

Further, the study gathered much of its data from Forms 5500 for the 2009 plan years. Schedule C to Form 5500 is the place where plan sponsors disclose certain fees paid from plan assets. To what extent can a researcher gather this data to determine menu excess fee losses? Do the authors know what Vanguard would be charging the same plan sponsor? Do they know how much the sponsor was paying to the investment firms for each fund? What happens where a plan uses multiple funds from the same vendor and those fees are all listed together? Suppose some of those funds use asset classes not available through Vanguard.

In the limited cases where plan sponsors have been judged to not be fulfilling their fiduciary obligations, I have been critical of them. Personally, however, if I were to perform a study of this sort, I believe that many commentators would tell me that I was fishing for opportunities to serve as an expert for plaintiffs bar. Perhaps Ayres and Curtis are simply performing a service to the 401(k) community. My own feeling though is that they and other academics will always be well-served to seek out the opinions of people who actually work in the field rather than relying entirely on raw data. Perhaps they have, but I have not found evidence.

If Messrs Ayres and Curtis happen to read this, I would be more than happy to allow them to respond to this post. And, to the extent that any of my assertions are incorrect, I will correct them.

Friday, August 2, 2013

Attracting and Retaining -- The Role of Employer-Provided Health Care

I read the results of what I found to be an interesting survey this morning. The ADP Research Institute did a survey entitled "The Role of Employer Benefits in Building a Competitive Workforce." The good news about the survey summary is that it provides some excellent insights related to employer-provided health care benefits. The bad news is that either that's all the survey covered, or that's all the authors of the report found interesting.

In any case, according to the survey, nearly half of employers think that the health care benefits that their company provides to employees can be a differentiator when it comes to attracting and retaining employees. Fewer than 10% think that the health care benefits they provide are not particularly important in this regard (smaller employers are far more likely to say this).

Similarly, nearly half of employers think that the health care benefits that they provide to their employees are better than other companies in their industry. Only about 10% think they are worse.

Once upon a time, I was a student of high-level mathematics. I taught math at the college level. I passed actuarial exams on mathematical topics, generally with high scores, on my first attempt. The math here just doesn't work.

Perhaps when one becomes an HR leader (respondents were intended to be HR leaders), one is awarded with a pair of rose-colored glasses. If I were to take a similar survey, but ask employees rather than employers, I think that more than half of employees would say that their employer's health care plan is worse than average.

Why? Frankly, most plans have gotten worse for employees in recent years. Co-pays have increased. The employee's share of the premiums has increased.

I'm not saying that I can blame employers. Health care inflation has far outstripped general inflation and many companies, especially in a weak economy, cannot afford to pick up the inflationary increases in costs.

All that said, I am going to draw my own conclusions. I do this based on a single data point; that is, I draw it based on what I have learned in recent years by being in a health plan, talking to other people in health plans, talking to employers who sponsor health plans, and reading survey results like those from the ADP Research Institute.

In most job classifications, the primary differentiator in influencing a potential employee's decision to work for a company or not is compensation -- cash and cash-like (think equity compensation). Beyond that, it is the impression that the potential employee has gotten about what it's like to work for the company. If it's a great place to work, pay matters a little bit less. If it's a horrible place to work, you have to pay a lot. After that comes benefits. But, think about it. What do most potential employees ask about a benefits program before taking a job?

  • When do I get health care benefits?
  • Do you have a 401(k) plan that I can participate in?
  • How much vacation time do I get?
  • How much sick time do I get?
Most potential employees are not sophisticated enough to ask about the health care plan design. Even if they ask, they probably won't understand the answer. Many employees think all 401(k) plans are the same (I never believed this, but I started asking people and that is what I learned). 

Where I think that the difference in health care plans is large is in retention and in word-of-mouth recruitment. If a company has a great health care plan, its employees will talk to their friends about it. They will not be inclined to leave the company and give them up. On the other hand, if the health care plan is not good, water cooler talk will predominate. This may actually cut into productivity and those employees will certainly not recommend the company to their friends.

It's a tangled web, and clearly, HR leaders have not figured out how to untangle it. It's just my opinion, but in my blog, my opinion gets to be front and center. If your opinion is different, leave a comment, or write your own blog.