CFO Priorities and Benefits and Compensation

CFO magazine did their annual survey of the priorities of chief financial officers recently. I read their article summarizing the findings from the survey and considered what this might mean for benefits and compensation.

Before I go on to my main topic, however, I need to bring up a few of the issues that I found near the bottom of the article. Three priorities that the article highlighted were written communication, networking with peers and presenting to large groups. Frankly, these are not just CFO priorities; they should be priorities for every professional in our 2015 world, and I was absolutely thrilled to see written communication in the list.

Returning to the main points of the article, I point out some of the top priorities that are more day-to-day for CFOs.

• Precision and efficiency in cash forecasting
• Budgeting
• Balanced scorecards
• Margins
• Risk management
• Performance management

Additionally, and in many cases perhaps more important, but less relevant for this blog is cybersecurity.

Let's also consider what some of the main elements of traditional benefits and compensation packages look like (with some grouping at my discretion).

• Health and wellness benefits
• Retirement benefits
• Other traditional welfare benefits
• Feelgood benefits
• Base pay
• Short-term incentives (bonus)
• Long-term incentives (often equity)

Health benefits are now essentially a requirement. Either you provide them or pay a fine under the Affordable Care Act (ACA). But, companies have lots of techniques that they can use to control costs. Popular today are high-deductible health plans (HDHP) where oftentimes, companies contribute fixed amounts to health savings accounts (HSAs) to help employees pay for costs up to those deductibles. Among the major advantages of these designs are that companies do a much better job of locking in their costs. In other words, more costs are known and far fewer costs are variable or unknown. 

On the subject of retirement benefits, I'm going to give you a shocker. In matching those CFO priorities, the single worst sort of retirement plan that a company can sponsor is a traditional 401(k) plan with a company match. That's right -- it's the worst! Why is that? In a 401(k) plan, the amount of money that a company spends is almost entirely dependent upon employee behavior. If you, as an employer, communicate the value of the plan, employees defer more and that costs you more. Most companies budget a number for their cash outlay for the 401(k) plan. Very few, in my experience, look at potential variability. One that does and that I worked with on this a number of years ago, estimates that between best case and worst case, that the difference in their cash outlay could be in the range of several hundred million dollars. That is a lot of money.

So, what is better?

Believe it or not, I can come up with lots of rationales (much beyond the scope of this post) for why having a defined benefit plan as a company's primary retirement vehicle is superior to using a 401(k) plan. Understand, I'm not talking about just any DB plan. But, the Pension Protection Act of 2006 (PPA) opened the door for new types of DB plans that either were not expressly permitted previously or, in other cases, that were generally not considered feasible. Think about a cash balance plan using a market return interest crediting rate with plan investments selected to properly hedge fluctuation. Cash flow becomes predictable. Volatility generally goes away. Budgeting is simple. The plan can be designed to not negatively affect margins.

I may write more in a future post, but for now, suffice it to say that this design that has not yet caught on in the corporate world needs some real consideration.

How about compensation? 

Base pay is the easiest to budget for. If you do have a budget and commit to not spending outside of that budget, base pay is pretty simple to keep within your goals. 

Incentive compensation is trickier. While many organizations have "bonus pools", they also tend to have formulaic incentive programs. So, what happens when the some of the formulaic incentives exceeds the amount in the bonus pool? Either you blow your budget or you make people particularly unhappy. There is little that will cause a top performer to leave your company faster than having her calculate that her bonus is to be some particular number of dollars only to learn that it got cut back to 70% of that number because the company didn't budget properly.

Perhaps it is better to assign an individual a number of bonus credits based on their performance and then compare their number of credits to the total number of credits allocated to determine a ratio of the total bonus pool awarded to that individual. After all, isn't the performance of the company roughly equal to the sum pf the performances of individuals and teams? And, if the company has a bad year, isn't it impossible that every individual and team exceeded expectations? Be honest, you know that has happened at lots of companies and the companies don't know what to do or how to explain it.

There is lots more to be said, but I want to keep it brief for now. If you have questions on some of the specifics, please post here or on Twitter or LinkedIn in reply to my post or tweet. And, if you have one of these areas on which you'd like to see me expand in a future post, let me know about that as well.

Pension Funding Relief On the Way?

While the Supreme Court was front and center making the big news of the day and the House of Representatives was busy finding Attorney General Eric Holder in contempt, the US Senate appears to have come to an agreement on a bill that would provide for more highway funding and for a better deal for students and prior students on student loans.

I know, what does this have to do with pension funding. Well, leave it to your Congress, because when they do stuff like this, I deny any linkage to them. Buried not so deep in this bill is so-called pension funding stabilization. You remember the pension reform law to end all pension reforms, the disastrous Pension Protection Act of 2006 (PPA), don't you? Well, it hasn't ended pension funding reforms yet and it doesn't look like it's close to doing so.

So, what is pension funding stabilization? Well, in a nutshell, PPA was supposed to do all of these things:

• Force companies to use current (or almost current) discount rates to value their liabilities
• Provide incentives for companies to get their plans better funded
• Get all plans essentially fully funded on a mark-to-market basis within 7 years

That was 2006. Things were rosy. The economy was booming. Interest rates were very low, but surely they were going to get at least a little bit higher.

Find the flux capacitor, Doc Brown. Where's the DeLorean? Let's go back to the future.

A few things have happened since 2006, including various types of pension funding reform. But, they haven't been enough. And, now, Congress in its infinite wisdom is working on legislation that, in my humble opinion, is very wrong.

Before I explain why it's wrong, let's look at the key provision of pension funding stabilization. Currently, companies (and their actuaries) in performing their pension funding calculations get to use an average of rates over the last 24 months. While this isn't quite a spot rate, rates have been in the same general range over the last 24 months, so it's far from abhorrent. And, putting in market-based funding was a cornerstone of PPA. 

Nearly six years after PPA's passage, however, we are in for a change. Should the bill become law, companies will get to average their rates over 25 years. That's a lot of years. 25 years ago was 1987. Rates on 30-year Treasuries, were, if memory serves me (because I am writing this remotely and am not in a position to look it up), in excess of 9% (for at least part of the year). What does 9% have to do with prevailing interest rates today? In fact, even if you believe that pension liabilities should be discounted at an expected long-term rate of return on plan assets, where can you get a consistent return of 9% these days?

If Congress wants to give pension funding relief, the way to do it is to still make companies pay for the cost of current year accruals, but let them pay off their unfunded liabilities on a basis slower than seven years. Instead, they are going to get to full funding on a basis that makes no sense.

Why is Congress doing this? Funding highway improvements and student loan writeoffs takes money. Pension contributions generally result in corporate tax deductions. So, the pension funding stabilization gets scored as a revenue raiser because the asinine rules of Congress look at only 10 years. As you and I know, the cost of a pension is the cost of a pension and no silly rules can change that. This means that those tax deductions are merely deferred. So, in reality, the government is once again spending money on stuff it has no way to pay for. 

Stupid bill!

Yes, stupid bill.

CBO, We Have A Problem

Sometime back, I wrote, not with admiration, about the Congressional Budget Office (CBO) and the 'scoring' rules that our Congress has burdened it with. Essentially, they don't adjust for inflation and they don't do dynamic scoring. Or, said differently, they are required to treat each bill as its own micro-economy, forecast for only 10 years, and  generally not reflect inflation. This approach allows the Congress to manipulate bills so as to score them as cost-neutral, or even as cost-savers, when in reality, everyone, including both Congress and the CBO, know that they are going to cost us a lot of money.

How much money? Does the number 15 trillion mean anything to you? The federal debt, according to the debt clock is now just above that number. It's a big number. It has 12 zeroes in it. It also has two other digits to the left of those zeroes.

I would posit that these rules and Congress' manipulation of these rules are responsible for a significant portion of that 15 trillion. In fact, and I'm just guessing (no calculator or spreadsheet in action here, not even any mental math), if I had to choose an over/under amount, more than half of that 15 trillion in debt has accumulated from flawed scoring.

I'm not saying that the CBO does poor math, in fact, they are very good at it. What I am saying is that the constraints that they are required to follow have caused the United States to underprice the costs of various bills by a really big number and I am guessing (that means that I don't know, but my brain now fully caffeinated for the day has estimated) that this number in the aggregate is more than half of 15 trillion dollars!

When I try to hide my political biases, I usually work in alphabetical order and I'm going to do that here. In this case, the Democrats are incredibly guilty of having gamed this system ... and they know it. In this case, the Republicans are incredibly guilty of having gamed this system ... and they know it. Most of the public doesn't know it. There has never been a public outcry. There should be.

So, what does this have to do with employee benefits? The good folks at the Employee Benefits Research Institute (EBRI) have a nice little chart (actually it's not so little) that they call Employee Benefit Tax Expenditures -- White House Fiscal Year 2011 Budget Estimates. It shows that the tax expenditure (that's a fancy name for the amount of deductions that people and corporations get on their taxes, either through deductions or through tax exemptions) for employer contributions for health care benefits in FY 2011 is in the neighborhood of $175 billion and  similarly, for employment based retirement plans, it's about $110 billion. That's $285 billion in total. The mortgage interest deduction for the same year is about $105 billion. So, employee benefits are a really big culprit.

I bet my readers know that those numbers go up every year. Of course, they do, inflation makes them go up, doesn't it? Suppose we adjust for inflation. Then, what happens? Well, EBRI can help us out with that as well. Here is the url for a spreadsheet (http://www.ebri.org/pdf/publications/books/databook/Table 5.2 Inflation Adjust.xls), and you'll have to copy and paste this one, that shows what happens when we adjust for inflation. Look at the spreadsheet. Find me a major element that decreases on an inflation-adjusted basis. You can't do it, can you? And, therein lies a problem of just enormous proportions.

The 10-year cost of many of these bills is understated because the CBO isn't allowed to use assumptions that faithfully project the cost. And, because cost increases tend to (read that as virtually always) significantly outstrip inflation, using virtually any 10-year cost projections for a bill that is expected to last for a long time (think Social Security or Medicare, for example) represents among the most significant frauds ever perpetuated on the American taxpayers.

Yes, I said it. It's a fraud.

It's time for the taxpayers to stand up to Congress.

I haven't used song lyrics in this blog for a while, but I'm going to go back to the Vietnam War era for this one. With thanks to Jefferson Airplane,

got a revolution got to revolution 
Who will take it from you 
We will and who are we 
We are volunteers of america

Change volunteers to taxpayers and ...

Public Enemy #1

Suppose I told you that I had a business idea for you that had profits (written as +) and costs (written as -) that went like this:

• 2010: + 100 billion
• 2011: + 200 billion
• 2012 : + 250 billion
• 2013: + 250 billion
• 2014: + 250 billion
• 2015: + 250 billion
• 2016: + 150 billion
• 2017: + 50 billion
• 2018: - 50 billion
• 2019: - 200 billion
• 2020 --> : - 200 billion or more every year

How would you "score" this business? Personally, I would say that if we went in to that business, it would be time to get out by 2017. The Congressional Budget Office (CBO), not because they are stupid (they are, in fact, a bunch of very smart people), but because they have a set of rules given to them by Congress that they must follow, would tell you that this business (or law) actually saves the country lots of money.

How can that be? Look at their rules. Time value of money is not part of the rules. So, one dollar in 2010 is the same as one dollar in 2012 is the same as one dollar in 2019. And, the scoring for a bill ends after 10 years. So (and my intent here is not to be political, but instead to make a point) construction of bills and therefore laws becomes a jury-rigged process. Every major bill that goes to the House Ways and Means Committee seems to save money early on and not start to cost money until close to Year 10. Hmmm? Does that make such a bill a budget-neutral, or even budget-positive bill? I don't think so. But the author of the bill will tell you how it will save the country money while neglecting to tell you that the same bill will saddle future generations with mountains of debt.

Where did the numbers above come from? I made them up. Where could they have come from? They could have come from the Affordable Care Act (PPACA), or Health Care Reform, if you prefer. There is a law where the savings are front-loaded, but once the program starts to cost the country money, it never is projected to stop costing money. Yet, the authors of the law say it saves the country money. And, they use the non-partisan CBO as ammunition to prove it. 

The CBO says PPACA will save us money. And, by their estimates, which I believe to be as valid as any others, it is expected to save us money ... over a 10-year time horizon. But, what happens after 10 years? Hmmm! It costs money every year after Year 10. So, if instead of scoring over 10 years, CBO rules asked them to score over 20 years, then proponents of the law could not say that PPACA saves the country money.

Does the public know this? Generally not. Does Congress know this? I think that some in Congress do, and some probably do not. Now you do.

To my mind, these rules are lunacy. We are in the computer age. If the CBO can do a 10-year projection, it can also do a projection for 25 years, 50 years, 100 years. It's not the CBO's fault, though. They have rules. But, to my mind, those CBO rules, foist upon them by Congress are Public Enemy #1.

What do you think?

Getting Ready for the Budget Debate

I can see it coming now. Its magnitude and its long-term effects could dwarf them all -- Lincoln-Douglas, Kennedy-Nixon, Reagan-Mondale, Bentsen-Quayle, Burr-Hamilton (well, that one was really more of a duel). I'm talking about the budget debate of 2011.

The war has started. I'm not sure just what the first shot was. Was it the failure of the 111th Congress to send a budget to the President? Was it the Tea Party forcing the more traditional Republicans to insist on cuts for the remainder of fiscal 2011? Was it Paul Ryan's (R-WI) proposal to cut roughly $6 trillion from the budget over 10 years, not leaving untouched the sacred cows known as Social Security and Medicare? Was it President Obama's proposal to similarly make some significant budget (and tax) changes, perhaps in response to the Ryan proposal?

For purposes of this post, I'm going to focus a bit on the Ryan proposal. As I read it, his proposed budget would make fairly sweeping changes to both Social Security and Medicare. With regard to Social Security, I think I'm safe. That "Fund", and I use the term loosely as it operates as nothing more than a bookkeeping entry is not in as bad shape as its younger sister, so the biggest changes appear to be set up to come in 25 year chunks. As I will be eligible for my unreduced Social Security benefit before 2025, I only need to worry about the program's ability to pay. But, for me, this will almost be found money, as I have assumed for years that I would never see a dime from Social Security (and I still may not, but that is for another day).

Medicare, on the other hand, that "Fund" is about as bankrupt as bankrupt can be. When President (Lyndon, not Andrew) Johnson signed it into law, nobody with a voice that could be heard figured that we would have the changes in health care that have occurred. Double-digit health care inflation wasn't even a nightmare, it just wasn't a possibility. Longevity improvement just wasn't a consideration. And, now look what's happened.

All of those employer-provided retiree medical plans - companies had to start accruing costs for them, and they all but disappeared. It's ok, Medicare is there. Well, for those of us not yet age 55, as I understand the Ryan budget proposal, Medicare may not be there, at least not in its current form. Yes, it needs changes, but like the rest of the people in my age cohort, I've paid a lot of money into that system, and I actually have expected, probably naively, that it would take care of a pretty good portion of my health care costs when I make it to age 65. I am beginning to feel betrayed.

It's not just me, though. For as long as I have been in this business, employer-sponsored retirement programs (including health care) have been designed with the presumption that both Social Security and Medicare will remain largely as they are. In these times of a down economy (yes, on the record, I think the economy is still down), global competition, and mark-to-market accounting fanaticism, companies are not feeling the need to provide better and more costly (to employers) health care benefits.

I'm a fan of what Congressman Ryan is trying to do. He is trying to cut runaway spending. I think it's common sense that if your goesoutas (expenditures) exceed your comeintas (revenues, generally from taxes) that you have to either cut your goesoutas or increase your comeintas or both.

Well, in round figures, the federal debt is about $14 trillion and the GDP is about $15 trillion. My very rough analysis of some graphs that I found online say that the economy is healthiest when debt as a percentage of GDP is in the range of 40% to 55%. Let's take a number in the middle, say 50%, because that makes my math easier. That would imply that we need to cut the debt by $6.5 trillion if the GDP doesn't grow. Frankly, growing at about 3% per year, it's change is not that significant to the equation.

So, let's do some math. The population of the United States is about 310 million. Cutting $6.5 trillion from the debt could be accomplished immediately if each American would be kind enough to contribute about $20,000 to Uncle Sam.

Ain't happening.

Among the people who want tax cuts, they surely don't want to see an increase. And among those who are calling for tax increases, very few are saying that those increases should start with their wallets.

So, Social Security and Medicare may truly need some huge changes. And, these changes will have a significant impact (for all the real grammarians and wordsmiths out there, I know that impact implies a physical collision, and because of that, I rarely use the word impact where affect or effect will suffice, but I feel a physical collision here) on benefit plan design and retirement income planning. And, after all, those are among the topics of this blog.

So, we'll try to keep you updated here, and occasionally attempt to both humor and educate the readership with some analysis, but in the meantime, to paraphrase President Reagan, I'm not sure that I am happy that Congressman Ryan wants to make my youth an issue in his campaign.