New Directions in Executive Benefits Design

Attracting and keeping top talent is increasingly difficult in today's operating environment. Stock offerings are suffering and there is great legislative and public scrutiny of executive compensation and benefit plans.

Yet maintaining a quality senior leadership team can decide, more than any other element, how effectively your company will perform. Companies with competitive, well-designed executive retirement plans can employ those plans as a recruitment tool to attract the top talent they need.

Ability to Attract and Retain Top Talent

Does your company have the right program in place to attract and retain top talent in today's operating environment?

Looking at the top Fortune 200 companies, total CEO compensation, including base salary, short and long-term incentives (bonuses), director's fees/retainers, stock option gains and restricted stock, increased on average from $3.1 million in 1990 to $11.5 million today. This story has been front page news across America.

But the real back story is that company after company is witnessing lower salary increases, reduced bonuses and decreased stock option values. Base salary has shrunk in the last decade from 29% down to 9% of earnings. Stock options have doubled from 25% to 50% but stock value has been cut in half. Long-term incentive and restricted stock has significantly increased, but the corporate pension has practically been eliminated in?just 1% of a CEO's total package.

Executive Benefits Menu

Corporate America's answer to the severity of today's operating environment is to provide the right mix of nonqualified deferred compensation (NQDC) plans. Long-term care, disability, executive life, financial planning, and other qualified benefits are also important components on creating the total compensation package for a corporate executive.

Through an NQDC plan, participants can defer a portion of their compensation into the future, typically until retirement or termination, to reduce current taxation. Companies usually require vesting on deferred amounts, company contributions, matching contributions or bonus interest, as a means of retaining key employees.

Unlike broad-based retirement plans, which qualify for tax advantages, non-qualified deferred compensation plans are not eligible for tax-favored treatment, but are exempt from most ERISA requirements. ERISA is the body of legislation that governs most retirement plans. The current $11,000 annual ceiling on 401K contributions has driven NQDC plan offerings from senior executives to mid-leadership personnel.

Design Options

Earnings rates from nonqualified deferred compensation plans are typically tied to a stock index interest rate, such as Standard & Poor's 500, the Prime rate, Moody's Corporate bond index rate or company stock. A premium rate over the base earnings rate, typically tied to company performance, is often added. Plans are funded primarily by corporate-owned life insurance (COLI), stocks and bonds.

The trends described earlier?our government's lack of support for company-sponsored pensions, employee versus corporate responsibility for funding retirement savings, and continued regulatory ceilings on the amount executives can contribute and receive from qualified benefit plans?support the growth in SERP vehicles.

A SERP is a type of nonqualified retirement plan under which the employer can provide additional retirement benefits to top employees. There are good reasons to put a SERP in place for employees earning $200,000 or more. SERPs help replace benefits lost by IRS salary caps, provide higher levels of retirement benefits than those under a qualified plan, provide targeted retirement compensation, and offer incentives for executive retention and recruitment.

As with deferred compensation plans (DCPs), SERPs are also funded primarily by variable and fixed Corporate-Owned Life Insurance. SERP payment benefits begin at normal retirement, early retirement, death, with disability or termination. Payment options may include a joint and survivor annuity, single life annuity, lump sum, or term certain over a specific number of years.

DCPs with in-service distributions may actually yield a higher after tax return and offer needed flexibility and short-term withdrawal window. With a DCP, take $20,000 in 2003 with a payout in 5 years to receive $32,000 in pretax earnings in 2007. Without a DCP in place, $12,000 in 2003, assuming a 10% crediting rate, yields just $18,004 in 2011.

In service distributed deferred compensation plans provide for 5-year, 10-year, 15-year and 20-year payout options, and offer an executive the flexibility to change their distribution options up to one year before retirement.

Protection Against Change

What happens if the company has a change of control, change of heart, change in financial condition or bankruptcy? Of all corporations who have protection mechanisms in place, Rabbi trusts are almost exclusively used to protect against these sudden change conditions and ensure benefit security. Rabbi trusts are taxable trusts, and trust assets must be available to corporate creditors in the event of a bankruptcy. These vehicles secure executives against the company's breach of its promise to pay and provide the company with enhanced funding flexibility.

But security devices come in all shapes and sizes; other mechanisms can include PRLs, secured trusts, ISOPs and SERP Swaps. Companies need to perform a "risk/rewards analysis" to determine which security device is best.

Review and Reassess

In charting the right direction for your executive benefits program, keep this in mind: Further governmental controls, such as accounting requirements, taxation and accelerated Securities & Exchange Commission reporting requirements are major issues that promise to definitively shape the future of executive compensation and benefit packages. For these reasons alone, it is essential that you undergo constant, vigilant benefits audits to ensure compliance with all regulatory requirements.

Finally, a sound internal review of the structure of your total executive compensation and retirement package is also important to ensure consistency and avoid unexpected cost increases. In these ways, you will keep your benefits program competitive and on course for the future.

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