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Putting the Pieces TogetherThe Process of Creating a Successful Deferred Compensation Plan
Overview Consultants are captivated by process. We create elaborate charts and graphs and checklists to bring order and clarity to a project. Unfortunately, this preoccupation with process often times can be a distraction that alters the focus from the real objective of creating a successful deferred compensation plan. What adds to this disconnect from the objective is how consultants are compensated, generally for process rather than for meeting objectives. At RCG, we too have a process. In fact, our process is elaborate and thoughtful and has its share of charts and graphs and checklists. The difference is that our entire focus is to use the process as a tool to achieve our client's objectives. Our process is not an end, but a means to an end. At RCG, the tail does not wag the dog. All this talk about process and objectives begs the question, what is a successful deferred compensation plan? In general, our clients answer that a successful deferred compensation plan is highly perceived as an attractive benefit by participants and is also a valuable tool for the company to use to attract, reward, and retain key employees. How do you know these objectives are being met? The short answer is high participation levels of 70% to 90% of the eligible employees. As with most things, when it comes to deferred compensation plans, executives "vote with their feet". What Makes a Successful Plan? In the 1980's, the term synergy was popular to describe how distinct activities, when properly coordinated, create a result superior to the individual activities. A saying which also describes synergy is "The whole is greater than the sum of its parts." A successful deferred compensation plan requires essential synergy and the thoughtful combination of a variety elements. Our experience at RCG indicates the deferred compensation puzzle has five key pieces. These five elements are for the most part consistent with every company. What varies between companies is how these elements are prioritized, weighed, and applied. That requires customization. What are the five elements?
Recently, RCG met with a number of frustrated companies. These companies spend a considerable amount of time, energy, and dollars on their deferred compensation plans and they don't believe the plans are working. After a few penetrating questions, it's clear the consultants who designed benefit plans for these companies did not define or focus on the companies' or the participants' objectives. What they don't realize is the tremendous opportunity cost, given that a properly designed and integrated deferred compensation plan should be a valuable strategic tool for management. Even though it sounds trite, the solution to a successful defined benefit plan is a thoughtful process that works not only in theory, but in practice. Not a process as an end in itself, but a process with a clear goal of creating a highly perceived, valuable benefit. RCG excels at putting the pieces of the puzzle together. |
1.
Flexibility and Access - Plan design
is the art of balancing participant desires with company constraints,
while at the same time walking the tight rope of constructive receipt.
This element becomes more challenging if the proposed legislation
regarding deferred compensation is eventually adopted. Notwithstanding,
best practices dictates the optimum combination of participant
flexibility and benefit access. In short, the more choices participants
have to determine the timing, form, and structure of various elections
and payouts, the better the plan design. 
2.
Competitive Investment Returns - Three economic
drivers make deferred compensation plans a home run for participants;
tax deferral, time (the law of compounding), and rate of return.
The best designed plan that doesn't provide competitive investment
returns is doomed to mediocrity. This is true whether the plan
is a fixed rate or variable rate plan. For fixed rate plans, the
return needs to reflect the duration and the risk of the benefit.
Generally this calls for an above-market rate of return. For variable
rate plans, the choices need to include top-performing funds with
low- expense ratios over a wide range of styles. Variable rate
plans require constant monitoring from capable third-party experts.
Flexibility and Access and Competitive Investment Returns may be
impacted by the proposed legislation. 
3. Benefit Security - Over the years, benefit
security has often been a theoretical discussion about the possibilities.
With the recent demise of Enron, WorldCom, Arthur Anderson, and
others, theory has given way to real concern over the security
of the plan participants' benefits. In today's environment, unless
benefit security is actively addressed, the plan will not be world
class. For a detailed overview of these issues, please refer to
a recent study by RCG entitled, "Securing Nonqualified Plan Benefits". 
4.
Financial Viability - What does the plan
cost? The right answer to this question is critical to a successful
plan from the company's perspective. However, it is a more complicated
question than you might think, partly because a number of ways
exist to define cost and partly because determining the financial
viability involves projections and assumptions. The basic options
for defining cost include both short- and long-term impact on the
income statement and cash flow and long-term economics (net present
value of cash flows). Each company weighs these criteria differently
and detailed modeling is required to make the evaluation. RCG's
experience has been that most companies focus on making sure the
impact of the plan on the short-term income statement is acceptable
and evaluating the long-term economics to determine whether the
plan is cost-neutral. Evaluating the informal funding alternatives
is an essential component of this process. These alternatives are
discussed in more detail as part of the study mentioned above "Securing
Nonqualified Plan Benefits". 
5.
State-of-the-Art Administration - Dramatic changes
have been made in deferred compensation plan administration in
recent years. In the past, this administration had been the exclusive
arena of a few bundled providers. Technology has allowed other
providers to enter the market and to advance the capabilities
and level of service. At a minimum, deferred compensation plan
administration should be user-friendly and should be on a web-based
platform. The trend has been for sophisticated buyers of this
service to begin questioning the efficiency and the effectiveness
of bundled providers. 
Conclusions 