Wake Up and See the Light, Congress!

Congress has a once-in-a-generation opportunity. Since its first major overhaul in 1922, Congress has seen fir to make earth-shaking changes to the Internal Revenue Code (Code) once every 32 years. 1922. 1954. 1986. And, while it seems that they may be one year early this time, they are pitching tax reform once again.

The concept of qualified retirement plans as we know them today comes from the Employee Retirement Income Security Act of 1974 (ERISA) signed into law that Labor Day in 1974. Since that time, there have been relatively few changes to the Code affecting retirement plan design. And, frankly, most of them have come on the 401(k) side. In fact, Section 401(k) was added to the Code after ERISA and since then, we have been blessed with safe harbor plans, auto-enrollment, auto-escalation,Roth, and qualified default investment alternatives (QDIAs). Over the same period, little has been codified or regulated to help in propagating the defined benefit plan -- you know, that plan design that has helped many born in the 40s and early 50s to retire comfortably.

Isn't this the time? Surely, it can be done with little, if any, effective revenue effects.

Since ERISA, there have been really significant changes in defined benefit (DB) plan design including the now popular traditional cash balance plan, the even better market return cash balance plan, pension equity plan, and less used other hybrid plans. And, DB plans have lots of features that should make them more popular than DC plans, especially 401(k) plans.

• Participants can get annuity payouts directly from the plan, thereby paying wholesale rather than the retail prices they would pay from insurers for a DC account balance.
• Participants who prefer a lump sum can take one and if they choose, roll that amount over to an IRA.
• Assets are professionally invested and since employers have more leverage than do individuals, the invested management fees are better negotiated.
• In the event of corporate insolvency, the benefits are secure up to limits.
• Plan assets are invested by the plan sponsor so that participants don't have to focus on investment decisions for which they are woefully under-prepared.
• Participants don't have to contribute in order to benefit.

But, they could be better. Isn't it time that we allowed benefits to be taken in a mixed format, e.g., 50% lump sum, 25% immediate annuity, 25% annuity deferred to age 85? Isn't it time that these benefits should be as portable as participants might like? Isn't it time to get rid of some of the absolutely foolish administrative burdens put on plan sponsors by Congress -- those burdens that Congress thought would make DB plans more understandable, but actually just create more paperwork, more plan freezes, and more plan terminations?

Thus far, however, Congress seems to be missing this golden opportunity. And, in doing so, Congress cites the praise of the 401(k) system by people whose modeling never considers that many who are eligible for 401(k) plans just don't have the means to defer enough to make those models relevant to their situations.

Sadly, Congress prefers to keep its collective blinders on rather than waking up and seeing the light. Shame on them ...

Focusing on the Pension Part of the Deal

Let's suppose you're on the finance side of a business. That business is buying a company and you learn that the company that you are acquiring has one or more defined benefit (including cash balance) pension plans. What do you do now?

Pension plans and the finances associated with them are among the most confusing and misunderstood elements of a deal like this.The rules are unnecessarily complex and are often misunderstood even by people that you might be inclined to engage as experts. Cash flow requirements do not align well with financial accounting charges and not knowing the right questions to ask could seriously impede your ability to get the answers that you need.

So, how can I help?

Among the really nice things about pension plans is the amount of information that is publicly available on each of them. You see, in its infinite wisdom, Congress and the agencies that Congress has entrusted to regulate pensions have deemed that a myriad of such information has to be disclosed every year for each plan. In unknowing hands, that information is just that -- information. In the right hands, however, it's a veritable goldmine.

As a senior finance person, what do you need to do?

1. Identify all of the plans that you might be (will be) acquiring.
2. Identify what measures are important to you (e.g., cash flow, financial accounting expense, government disclosures, volatility, loan covenants).
3. Identify your constraints (e.g., available cash to use for pensions, funded status triggers to loan covenants).
4. Identify your goals with regard to the plans.

Notice that I didn't mention plan documents, participant census data, plan asset statements, or anything else that you thought you needed to provide. This is where that goldmine comes in.

I call your attention to a recent situation where we had just the information in 1. through 4. above. The goals were fairly simple and included roughly these:

• Help us to understand the amount of cash necessary to pay for the plan(s),
• Tell us what is not being done optimally, and 
• Help us to find ways to optimize these plans on a path to termination.

Our client now has a 10-year forecast of cash flow requirements under multiple scenarios. They understand what has not been done optimally over the last 10 years or so. And, they now have a strategy all set to go so that when they do pull the trigger and finish their deal, they'll be putting their pension dollars to optimal use.

This is a place where off-the-shelf, cookie-cutter solutions don't work. Every plan is different. Every plan has different thresholds. Every company is different. Every company has different resources.

But what makes every company the same is that every company needs a solution that is customized to their situation.

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?

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.

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.

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. 

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.

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.

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.

Using Retirement Benefits to Solve the Challenge of Hospital Sector Employment

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

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

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

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

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

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

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

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

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

We need other methods. Those other methods are there.

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

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

You need a solution that meets all of these criteria:

• Costs are stable
• Ability for very high-paid people to defer significantly is there
• Nondiscrimination testing is easy to pass
• Benefits are portable
• Both lump sums and wholesale priced annuities (annuities from the plan as compared to from a mutual fund provider or insurer) are available

The solution lies in designs like these. Costs can be controlled through proper design. Physicians wanting larger deferrals will happily pay for their own enhancements. Because these plans test so well, nonqualified money can often be qualified. Benefits will be portable for everyone and annuities will be available without lining the pockets of insurers for any participants who want them.

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

Fact or Fiction in the Retirement Wellness Media

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

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

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

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

• Ability to generate lifetime income
• Lifetime income that could be compared to retirement expenses to understand what other resources might be needed
• Workforce management ability for plan sponsors using tools like retirement subsidies and early retirement windows

Since then, we've seen changes ... many changes. Initially, they were design and structure changes. With the growth of 401(k) plans and Congress' constant tinkering with defined benefit plans in a supposed effort to save them, there was first a move toward what we now know as hybrid plans (largely cash balance) and then toward freezing and sometimes terminating those defined benefit plans. Thinking back, the most common complaint I heard from corporate finance executives was the financial accounting volatility. Later on, funding volatility became perhaps a bigger issue.

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

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

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

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

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

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

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

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

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

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

Holy Happiness, Batman.

Preparing for Pay Ratio

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

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

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

• Identify the CEO (that should be easy)
• Identify the employee in the controlled group globally whose annual total compensation (a term of art including almost all forms of current and deferred compensation) when ranked sequentially among all employees falls right in the middle of that ranking
• Determine the annual total compensation for the CEO (you're doing this for the proxy already)
• Determine the annual total compensation for the median compensated employee
• Determine the ratio of the two

You may be wondering at this point where the complexities may lie; that is, in what situations are you more likely to want to consider outsourcing this determination than doing it yourself. Consider these as complicating factors:

• You operate in multiple countries
• You sponsor multiple pension plans perhaps in multiple countries
• You provide equity compensation broadly
• You provide other unusual forms of compensation
• You are afraid for whatever reason that your pay ratio will be high enough to garner unwanted negative publicity and you'd like guidance on managing the message

If you do have any of those situations, I'd suggest you consider seeking outside help. After all, this sort of data manipulation and these sorts of calculations are likely not in your core competencies. And, if they're not, I'd love to find a way to make your determination of the pay ratio less painful for you.

Overpaying PBGC Premiums -- Money You'll Never See Again

Earlier this week, October Three released what may have been the most comprehensive study ever on payment of PBGC premiums. The study analyzed premium payments of nearly every mid-sized or large defined benefit plan in the country over the period from plan years 2010 through 2015 (leaving out plans with fewer than 250 participants).

The key results were shocking:

• During that six-year period, companies overpaid variable rate premiums by more than $700 million in the aggregate. That is, using techniques designed to lessen variable rate premiums, they could have paid $700 million less.
• For the 2015 plan year, more than 65% of plans that paid variable rate premiums, and did not have their premiums limited by the so-called per participant cap, paid more than they needed to.

If we think about this particular pension expenditure, one could consider it among the worst of all sins. For example, if you contributed more than you needed to in 2015, then your future required contributions will be lower, your PBGC premiums may have been lower and your pension expense will have been lower. So, while you may have had other uses for the money, at least you got some benefit from those contributions.

On the other hand, suppose you paid a larger variable rate premium than you needed to. What benefit have you gotten or will you have gotten from that overpayment? Zero. Zilch. Nada. Nihil. Niets. Niente. Rien. They're all the same. You will have received absolutely no benefit from your overpayment and neither will your employees. In fact, the only beneficiary of your overpayment will have been the PBGC.

Don't get me wrong. There are some good people, some nice people at the PBGC. I have friends at the PBGC. But, that said, there is no reason to give them more money than you need to under the law.

If you've made it this far, I'm going to leave you with an analogy. PBGC premiums are a lot like taxes. You pay money to a quasi-governmental corporation (PBGC) as a condition of sponsoring a defined benefit plan. Similarly, you pay taxes to the federal government when your company turns a profit.

Here is where they diverge. Your company probably has a Tax Department. If it does, its primary function is to ensure that your company properly pays its taxes, but in as small amount as legally allowable. That is, their job is to reduce your tax burden.

Your Tax Department may be pretty big. How big is your PBGC Premium Department? Oh, you don't have a PBGC Premium Department? You know you could.

409A and the Reverse Haircut

No, you didn't read the title incorrectly. I used the term "reverse haircut." Don't go scouring google for it, though. I made it up, or at least I think I did.

What happened is that I was catching up on reading and in going through documents that I had received from a number of sources, my eyes fell on Chief Counsel Advice 201645012. I know -- it's not one of the biggies that caught your eyes. So, that's why I'm reporting it here.

Here are the salient facts from the Memorandum:

• On November 1, 2014, an employee entered into an agreement to defer $15,000 of the employee’s salary that would otherwise have been paid during 2015, with payment of the deferred amount to be made as a lump-sum payment on January 1, 2018, but only if the employee continues to provide substantial future services until December 31, 2017.
• Under the agreement the employee’s salary is reduced by $600 each biweekly pay period (so 26 x $600 or $15,600) and the employer credits matching amounts to the employee’s deferred compensation account of 25% of each salary reduction (so 26 x ($600 / 4) or $3,900) for a total amount deferred of $19,500.
• The matching amounts are credited each time a salary reduction amount is credited, which is the time the salary reduction amount would otherwise be paid as salary.

The issue here is whether the potential loss of the 25% matching contributions represented a substantial risk of forfeiture as compared to a risk of forfeiture. And, that is the reverse haircut approach. That is, the employee will receive those matching contributions only by providing future services.

People used to the qualified plan world may be a bit mind-boggled at this point. To them, this looks like a vesting condition, walks like a vesting condition, and quacks like a vesting condition, so it must be a vesting condition. And, the potential failure to vest must represent a substantial risk of forfeiture -- a term that doesn't exist in the qualified plan world.

Suppose, however, that the 25% was less, say 20%. Then what? Perhaps there would still be a substantial risk. Or, perhaps there would just be a risk. How about 15%? How about 10%? 

At what point would the potential diminution in compensation be so insufficient that its loss would not be material and therefore there would fail to exist a substantial risk of forfeiture? Or put differently, at what point would enough hair be returning to our hero's head that its loss would leave him wondering how he could go through the rest of his life so improperly coiffed?

What we know is that in this particular case, 25% was deemed by Treasury to be sufficient. In fact, the Chief Counsel Advice included the following language:

Yes, an amount that an employee could have elected to receive as salary may be treated as subject to a substantial risk of forfeiture under section 409A if the employer provides a matching contribution resulting in a 25% increase in the present value of the amount deferred.

How useful is that to you and me? Not very. CCA's cannot be relied upon for any precedential value. While Treasury is usually consistent in its administration of such issues, there exists no requirement that it be. We also don't know if, for example, 20% would have been sufficient. Or 15%. Or 10%. To any attorneys reading this, it must feel like a hypothetical in their law school contracts class.

We also don't know if the deferral period in question had anything to do with the decision of Chief Counsel.

What we do know is that roughly 6 months ago, based on all of the facts and circumstances of this particular situation, Chief Counsel deemed that the 25% reverse haircut was a material incentive and that such materiality did create a substantial risk of forfeiture.

 

Don't Make the Federal Government Your Company's Favorite Charity

You work at a decent sized company. That company has a Tax Department. The primary jobs of the Tax Department are to handle the company's taxes legally, and in doing so, to recommend and implement strategies that generally minimize those tax obligations.

Gee, everyone knows that, don't they?

Why do you want to minimize your tax obligations? Well, once you pay out money, you don't get it back. And, if for whatever reason, you happen to view the IRS as your favorite charity, you, the individual (or individual corporate) taxpayer don't get any more or better services for having given them extra money.

It doesn't work that way. In fact, the Internal Revenue Code is a ridiculously complex set of rules that, in total, generates revenue for the federal government. The federal government doesn't check to see who failed to take deductions that they could have and either call them out as being wonderful citizens or provide them with extra goods or services commensurate with the additional taxes that they paid. It doesn't work that way.

During the course of running a business, companies will find that they have large number of payments that they make to governmental or quasi-governmental agencies. For example, banks pay premiums to the Federal Deposit Insurance Corporation (FDIC). They do this so that their customers can feel secure in knowing that their deposits are backed by the United States government (to a point). Premium amounts differ by being in different risk categories. In other words, to some extent, a bank can control the amount of FDIC premiums that it pays.

Similarly, sponsors of defined benefit pension plans pay premiums to the Pension Benefit Guaranty Corporation (PBGC). Those premiums fall into two categories -- the fixed amount per person and the variable amount related to how well the plan is funded. Both of those amounts can be managed, and companies by and large either have been advised to or figured out on their own how to manage the fixed part. The variable rate premium is another story. While there has been a lot of press telling companies to borrow to fund their plans thereby reducing variable rate premiums, there are other techniques that exist.

It all comes down to paying the amount that the law requires you to or paying more. Paying more doesn't get you a trophy. Paying more doesn't get your employees trophies either -- not even participation trophies..

Suppose I told you that you had been overpaying your PBGC premiums by, let's call it, 15X per year. And, suppose I told you that by spending X one time, you could stop doing that. Would you do it?

What Does Your Plan Document Really Say?

What does your plan document really say?

That's right. You read my question correctly. You probably know the words that are there. And, you certainly know what they say. But, would everyone else agree with you? That may be the really key question.

Let's limit our discussion here to retirement plans, both qualified and non-qualified. Those are usually complex documents. They contain an awful lot of words that are intended to both inform the plan participants of their benefits and attendant rights and to tell the person or people administering the plan exactly how to do that. And, we all know that because the English language is so precise that no two people would ever disagree on the meanings of those words, would they? Of course, they would, and they often do.

Perhaps that's a key reason that there is so much litigation related to retirement plans. If a plan participant took his summary plan description (SPD) and calculated his own monthly benefit and determined that it was $2,000 and a few weeks later, he received a benefit determination that his monthly benefit would be $1,000, he's not going to be happy.

Perhaps his reading of the SPD was irrational. Perhaps the SPD specifically says everywhere that pensionable earnings shall be based on the participant's years with highest base pay and he read that to include bonuses and car allowances and equity grants as well.

On the other hand, perhaps his reading was different than yours, but rational. To quote Scooby Doo (I always wanted to quote Scooby Doo in a retirement benefits post), "Rut ro."

How do we avoid this problem?

There are presumably legal safeguards that are typically inserted into a plan document to get past this problem should it occur. Clearly, however, they don't always work. If they did, no plan sponsor would ever lose in litigation. We know that's not reality.

To help to ensure that you're not one of those litigation losers, wouldn't it make sense to have an independent review of those documents?

I'll leave it up to the attorneys to tell you how that should be structured. But, I am going to tell you that it's important to have attorneys and non-attorneys working together on this review.

Why? Attorneys certainly know how to read documents, especially the ones that they write. But, in practice, they won't be administering your plan. And, a person without legal training may read those legal words differently than an attorney will.

Additionally, since we are talking about retirement plans here, administration may include what I've heard a number of attorneys refer to as a dirty word -- math. While some are very good at it, I've heard many attorneys say that math was always their worst subject in school. They fought through it, but they never understood it.

And, sometimes, those plan documents serve to prove that. Suppose the attorney wrote the document to mean exactly what he thought it was supposed to. But, perhaps to a person with a little bit better understanding of the math involved, the calculation would work out differently. I'll say it again -- rut ro.

Use counsel as you should. Consider getting them to engage consultants on your behalf who can help them and you to understand when your plan may be interpreted differently than they had intended. By saving litigation costs down the road, it may be the cheapest money you've ever spent.

Thinking About the Year Ahead in Benefits and Compensation

I was talking to a member of the benefits press the other day and after the formal interview (for an article) was over, the reporter, looking for ideas for 2017 articles, asked for a favor. Paraphrasing, if I were running a Benefits or Compensation, or HR function at a good-sized company, what are some things that I would make sure that I did in 2017 including perhaps some things I had not done in the past?

I thought that was a pretty good topic. It's something I think about from time to time and frankly, I'm hoping that that reporter will think of me in the future when writing on some of those topics.

But, if you are reading this, you might be one of my faithful (or first-time) readers and you probably don't want to wait for those articles. So, I'll give you a little preview with a few of my thoughts.

Be a Better Partner

I know -- that sounds strange for Human Resources. People in HR virtually always think of themselves as good partners for the rest of their organization. But, perhaps surprisingly to our HR heroes, their colleagues might not agree.

To Finance, HR is a cost center. Face it, HR doesn't make money. HR doesn't have a product. HR doesn't sell goods and services. HR costs money. And, because of that, Finance may not think of HR as good partners. So, if you want to be better thought of by Finance, think in terms of dollars and cents. When you find a solution that saves money, make sure your Finance partners know about it and make sure you get some credit for it.

Somewhat similarly, Legal may think of you as a litigation risk. After all, there may be more laws on the books that deal with how an employer treats an employee than any other area. And to Legal, each one of those may represent a risk. Legal would like nothing better than to know that you have sound processes and procedures and probably more importantly that you are following them. It's amazing in reading through employment litigation how often a case falls apart for the employer because they had a set of procedures and they left a few steps out in, for example, terminating an employee.

Oops!

Implementing Those Partnerships

It's great to think about those partnerships, but thinking about them isn't very useful if we don't do something with those thoughts. Let's consider Finance first.

Most every element of your department has a cost associated with it. For 2017, I'm sure you have budgets. But, how about years after 2017? That's a little bit tougher, isn't it? Some of your costs are controllable. You can manage your payroll by the general cost-of-living type increases that you provide. How about your pension commitments? That's a tough one, huh?

First off, your actuary should be on top of that. You should never be getting a pension surprise from year to year or even quarter to quarter. You're not one of those who is getting surprises, are you? If you are, you don't need to be.

I've spoken with benefits people in the past who tell me that's a nice goal, but we just don't have much budget, we really don't have time and we don't have the staff to work with you so that you can get us what might be useful to us.

Suppose I told you that you don't need much budget. This is a very inexpensive project. In fact it's so inexpensive that more often than not, we'll save you more than you spend.

Suppose I told you that we don't need much of your time. In fact, I'm going to round up and say I need 15 minutes of it, but in reality 2 or 3 minutes will probably suffice. Although, to be fair, when I do have results for you, you'll probably want to save an hour or more to go through what we've found for you. After all, what good would discovered savings do you if you didn't actually know how to get them.

And, then there's that staff that you don't have to get us information and answer our questions. Don't worry -- I said that I don't need more than a few minutes of your time. It turns out that I don't need your staff's time either. It's true. All of what I said is true.

Turning now to partnering with Legal, you don't want your department to be thought of as a litigation risk, do you? Well, with respect to each of your plans and programs, you probably have a whole bunch of processes and procedures?

• Are they current? When was the last time they were updated? When was the last time anyone even looked at them?
• Are you following them? Every one of them?
• Do they still make sense? Would you make changes to them not because the law changed since that would necessitate changes, but because they're just not really appropriate in 2017?

I know, this all seems a bit pie in the sky. But, read through your favorite benefits digest tomorrow. There's probably something in there about litigation. What went wrong that caused a lawsuit to have a chance?

• A committee did not use a well-reasoned process in selecting plan investments.
• A committee actually had such a process, but didn't follow it.
• A plan document was vague enough that two reasonable people might interpret it differently. Counsel is telling you that you will win because of this notion sometimes known as "Firestone deference" (essentially, the administrator of a plan should have broad latitude in its administration), but even if you win, litigation may be costly and eat up a lot of your resources.
• You had a low performing individual in the company whose supervisor doesn't like documenting performance reviews, so when that individual was terminated, there was no written basis on which to do it.

I could go on, but you get the gist. But looking at all those things is tedious and you just don't have the staff to do it, but there is a solution.

Happy New Year. Have a great 2017.