Friday, September 28, 2012

Connecting Executive Rewards

After all these years, I find it amazing. Consideration of executive rewards is still split up into pieces. And, those pieces are handled by different internal functions and by different consulting constituencies.

In a fairly typical case, cash, long-term incentives and equity are handled by the executive compensation function and by the executive compensation consultants. Executive retirement programs are typically handled by the retirement function and by the retirement consultants (frequently actuaries).

This is not a problem. The problem lies in the fact that the left hand and the right hand don't communicate with each other. And, they don't have compatible methodologies.

Let's look at retirement first. Traditionally, executive retirement packages have been designed to replace some targeted percentage of the executive's base plus bonus in their last few years before retirement. That methodology is not wrong. In the typical executive retirement study, consultants are asked to benchmark the plan design. Does it align with current trends and practices?

Consider executive compensation. Here, consultants look at such this as total cash compensation and total direct compensation. They benchmark this against the organization's peer group regressing (adjusting) for differences in size (and sometimes complexity). They develop medians and percentiles. That methodology is not wrong.

Suppose a Board chooses to pay its CEO at the 60th percentile. Perhaps they feel that their is complexity to their organization that belies its size. Suppose they also have an executive retirement program that their consultants say is pretty mainstream. I am going to tell you that almost to a degree of certainty, the retirement consultants have not considered the level of the CEO's pay in determining that the retirement program is mainstream. Isn't deferred compensation a part of compensation?

What would happen if we used the same approach for retirement benefits as we do for other forms of executive compensation? Suppose we calculate an annual value for such benefits and add it to other forms of compensation before doing that regression. Something tells me that the results might be surprising. In some cases, it might justify that rich SERP for which the proxy analysts have such disdain. In other cases, we might find that the company is perhaps inappropriately inflating TOTAL compensation -- the sum of the value of the entire rewards package.

In order to make this work, the executive compensation people need to talk to the retirement people and conversely. They need to speak each other's languages. Today, there are many gaps. There just aren't enough of us who are bilingual in this regard.

Perhaps we need to be.

Thursday, September 20, 2012

Why Companies Lose Their Best Young People

It's one of the biggest problems facing American companies these days -- the unwanted loss of lots of talented young workers. It's not exactly a new phenomenon, but it seems to be more rampant today. In my opinion, the reason often has to do with companies being penny wise and pound foolish, but I'll come back to that. In the meantime, I point you to an article that I found on LinkedIn.

If you choose to skip reading that article, I'll summarize the findings here. Talented young people leave because they are not learning. They're not learning the business they're in and they're not learning general business skills. Let's look at why this is happening.

I take you back to prehistoric times when I was a young up-and-comer in the consulting world. I had several means of learning:

  • The people that I worked for mentored me and taught me. They explained what they were doing and why. They viewed my development as an important part of their job. My success would contribute to their success.
  • I had the actuarial exam program. Yes, this still exists, but it has never and will never be the best learning opportunity for young actuarial wannabes. While it is improving, much of the examination process still appears to be about reading endless amounts of material to be able to regurgitate long lists of facts. This is not application, it's memorization.
  • I read. I read a lot. I read books -- those things with covers and words printed on paper. I sometimes highlighted those books so that I could find things when I needed them in the future. And, every firm that I worked for distributed hard copies of research memos. 
  • I was a participant in frequent training -- face-tot-face training -- where either an instructor from my office would address interested people from the office, or where designated people from many offices traveled to a centralized location for intensive multi-day training.
Much of this is gone in most companies. Supervisors (as a group) no longer spend much time teaching and mentoring those who support them. Why not? It's not in their goals. They don't get a tangible reward for developing staff. And, in fact, at most companies, if a star young person leaves and even attributes it to a lack of development, no senior person gets dinged for it. Since the senior people don't get money for it, they don't generally focus on developing others. Unwanted turnover costs. It's pound foolish.

Perhaps the exam program is better than it used to be. But, ask the students. For most, this is not the type of learning and development that they want.

Companies generally don't want to spend money on books anymore. Why? People can read snippets online. But, how do young people find the right materials to read online? For many of them, it's guesswork. They have no idea what to trust. They don't even know if what they are reading is factual. They don't develop and they leave. Penny wise and pound foolish.

Most training now is done via teleconference, webcast, or online. It's not as effective. People lose their focus. They don't pay attention. They don't learn and they leave. Penny wise and pound foolish.

Companies save money in terms of hard dollars, but they have lots of unwanted turnover and there they lose lots of soft dollars. In fact, my opinion is that the soft dollar cost of this exercise is far more than the hard dollar savings ... far more.

So, yes, I am suggesting that maybe a little bit less newfangled training and reading and a little bit more of the old-fashioned stuff might be an improvement. That means stop reading other people's blogs, but keep reading mine.

Wednesday, September 19, 2012

Building a 401(k) Plan that Prepares Employees for Retirement

It's one of the biggest concerns that I hear from people in 2012: "How will I ever be able to retire?" They tell me that their dad had a pension plan and Social Security, but they don't have a pension plan and they may not have Social Security. Whether these people will have Social Security benefits or not I can't tell you, but for most, their only employer-sponsored retirement plan will be a 401(k).

What does an employee whose only sources of retirement funds will be their 401(k) and Social Security need to do in order to ensure that he or she will someday have enough to retire? It's not rocket science, but it may not be easy either. Try this list on for size:

  • Start saving early in your career. Money that is saved at age 25, compounded at just 5% annually will have more than double by age 40. But, at age 25, most people have other things in mind for their paycheck than their 401(k).
  • Save continuously. Treat your 401(k) deferrals as if they will never be part of your paycheck. They are just money that is not there. In today's economy, that's not easy. When your expenses exceed your income, one way to cover that gap is to cut back on your 401(k). And, in these economy, more people than not seem to have an employment discontinuity. Just as employees don't have the loyalty to their employers that was once the norm, neither is the reverse true. Layoffs come frequently and re-employment is difficult.
  • Invest prudently. Especially with the communications that plan participants receive, most of them have no idea what it means to invest prudently. They receive more advice than they know what to do with while their personal filters are not good enough to know which advice they should follow. One rule of thumb that I see frequently is that the percentage of your account balance that should be in equities is 100 minus your age. But, equities are volatile, and that has an effect -- a dramatic effect.
  • Reduce volatility. Gee, John, didn't you just tell me to invest heavily in equities when I'm young, but that those investments are volatile? Actually, I didn't; I simply pointed out a common theme among the advice that plan participants receive. Consider this. Suppose I told you that in Investment A, the $1,000 that you deferred at age 25 would get an annual return of 5.00% every year until age 65, but in Investment B, your returns would alternate so that in the first year, you would get a return of -9.00%, in the second year, 20.00%, and that this would repeat itself until age 65. Simple math tells us that your average annual return would be 5.50%. So, which investment would you rather have (remember, these returns are guaranteed)? The answer is not even a close call. Despite the average return of 5.5% in Investment B, $1000 in Investment A after 40 years will accumulate to roughly $7,040 while $1000 in Investment B will accumulate to just $5,814. In fact, it would require the 20.00% return in the up years to increase to nearly 21.00% to make B as good an investment as A. Volatility is a killer.
So, the messages to the employees need to include 1) save early, 2) save continuously, 3) invest prudently, 4) reduce volatility. I would suggest that the first two items can be achieved for many people through auto-enrollment. But, most 401(k) plans that auto-enroll use a 3% deferral rate. 3% of pay is not enough. You'll never get there. Plans need to auto-enroll at rates closer to 10% of pay to ensure that employees will have enough to retire on. 10% is a lot. Many employees will opt out. It's going to be difficult.

The last two items relate to investments. The Pension Protection Act of 2006 (PPA) introduced a new concept to 401(k) plans, the Qualified Default Investment Alternative (QDIA). For employees who do not make an affirmative election otherwise, their investments are defaulted into the QDIA. Generally, QDIAs must be balanced funds or risk-based funds. Many plan sponsors use target date funds (TDFs) to satisfy the QDIA requirement. I went out to Morningstar's website to look at the performance of TDFs since the passage of PPA. All of them have had significant volatility. This is not surprising, of course, since equity markets have been extremely volatile over that period. But, we saw just a few lines up what volatility can do to you. Perhaps employees should be opting out, but into what? It's going to be difficult.

So, what are the characteristics of a 401(k) plan that guarantees employee preparedness for retirement? Many would argue that this 401(k) plan may not be a 401(k) plan at all. Perhaps what employees need is a plan that has some of the characteristics of a 401(k), but not all of them. Employees need to be able to save. Employees need portability as they move from one job to another. And, then, employees need protection against volatility and protection against outliving their wealth (longevity insurance). 

Consider that last term -- longevity insurance. The second word is insurance. Insurance generally is attained by a counterparty pooling risks. An individual cannot pool risks. An employer with enough employees can. An insurance company can.

Perhaps the law doesn't facilitate it yet, but a system in which employees can defer their own money to get a guaranteed rate of return (tied to low-risk or risk-free investments) and then have the amounts annuitized at retirement is the answer. Perhaps the law needs to facilitate it.

Thursday, September 13, 2012

Higher FICA Taxes on the Horizon

Health care reform in the guise of the Patient Protection and Affordable Care Act (PPACA) came to us with many new benefits. In order to pay for those benefits, the government had two options -- cut costs or raise revenue (spelled T-A-X). Here we talk about one of those new taxes.

Beginning January 1, 2013, high earners will be required to pay additional HI (Medicare) taxes under the FICA program. The additional tax is 0.9% of compensation in excess of $200,000 for individual filers or $250,000 for couples filing jointly. The employer portion of FICA will not increase.

First, this is going to need to be administered differently from traditional FICA taxes which generally are paid through payroll deduction. Here, your employer has no obligation to know how you file (in fact, you don't need to decide until you actually file), and your employer has neither the obligation nor the right to know your spouse's income. So, presumably, higher earners will simply have an additional tax tacked on to their Form 1040.

Think about this. What are FICA wages. Generally, they are compensation first vested and reasonably ascertainable in a year. For most deferred compensation plans, the amount of compensation that has been deferred is reasonably ascertainable. However, for plans such as defined benefit SERPs or for certain stock plans, this may not be the case. Regulations under Code Section 3121(v) allow taxpayers to early include such deferred compensation. In the case of individuals with significant SERP benefits in particular, they may want to discuss the possibility of early inclusion with their employers. While the tax hit for 2012 could be meaningful, it may lessen the long-term blow.

On the other hand, we don't yet know the outcome of the 2012 presidential election. Mitt Romney has pledged to repeal PPACA if elected. Its repeal would eliminate this tax.

Planning isn't as easy as it used to be.

Tuesday, September 11, 2012

Keeping Up With Inflation Isn't Easy

OK, I admit it, I've had paid jobs for a pretty long time. I've been in this career for more than 27 years now. And, it's not the first career I ever had. But, I'm not writing this to brag about my grey hair. I'm not writing to show you how boring I am for having been in the same profession for this long. What I am doing is trying to show how hard it is for workers to keep up.

Back in days gone by, I heard talk all the time about how each generation left the country better off than they found it. I heard talk about how standards of living had gone up. And, in many ways, standards of living continue to go up. But, they are going up these days primarily because of technology, but not because people have more buying power.

I think back to a position that I held in the early 1980s. I didn't make much money. But, I had health care benefits. I had a traditional indemnity plan with a $200 deductible and a $500 maximum family out-of-pocket limit. And, I didn't pay a penny for it. It was employer-provided.

Things have changed. I'm not here to lament what my employers have done. Instead, I'm looking at the workplace in general. Pay raises except for those due to promotions tend to be barely enough to cover inflation. Pension plans have disappeared for many workers, often replaced by 401(k) plans that may provide for an adequate retirement, but only if the worker contributes perhaps 8% to 12% of his or her pay annually. Health care benefits continually get cut back (higher deductibles, higher co-pays) while the employee pays a larger percentage of the total cost. How about other perqs that workers used to get? Company cars? Largely gone. Lots of employee get-togethers? Largely gone.

The fact is that the deal has changed. For many, if not most, there appears no way to keep up with inflation. The 90s that had stock options that made many wealthy are gone. For those that didn't have that experience, maybe you won't have your parents' retirement.

All I can tell you is to save early and save often. Maybe you'll get to retire someday.