Revised Additions shown by underscoring; deletions shown by strikethrough TO MEMBERS OF THE GOVERNANCE AND COMPENSATION COMMITTEE: ACTION ITEM

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Dina McDonald
5 years ago
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1 *Revised* Additions shown by underscoring; deletions shown by strikethrough G1 Office of the President TO MEMBERS OF THE GOVERNANCE AND COMPENSATION : Compensation Item/Type: Plan Amendment Funding: Non-State-Funded For Meeting of ACTION ITEM AMENDMENT OF THE ANNUAL INCENTIVE PLAN FOR PARTICIPANTS IN THE OFFICE OF THE CHIEF INVESTMENT OFFICER, OFFICE OF THE PRESIDENT EXECUTIVE SUMMARY The Office of the Chief Investment Officer (OCIO) manages the University of California s retirement, endowment, and cash assets totaling $97.6 billion as of June 30, 2016 under the policies, guidelines, and performance benchmarks established by the Regents. The Chief Investment Officer (CIO) implements those policies and guidelines by selecting, executing, and monitoring investment strategies designed to add value over and above the performance of benchmarks within a risk-controlled framework. The Office of the Chief Investment Officer Annual Incentive Plan (AIP) provides participants with market-based, at-risk incentive opportunities for meeting or exceeding investment benchmarks established by the Regents. The AIP is funded entirely through investment returns, using no State funds. For the past two years, the Chief Investment Officer has engaged in a thorough review of his organization s strategy and operations. Working closely with the President and the Chair of the Regents Committee on Investments (now the Investments Subcommittee), changes have been made to processes and organizational structure and composition, and most importantly, to the culture of the organization and how people operate within it. Emphasis has been placed on managing UC Investments as a total entity versus a conglomeration of investment asset classes. The organization s mission and vision has been clarified to provide long-term investment valueadd in the areas of pension and endowments. The orientation of the organization toward a longterm focus on behalf of the University has been made clear. In order to align with the new group s strategic direction and organizational focus, one of the key managerial tools, the Annual Incentive Plan (AIP), needs to be amended to reflect this new strategic direction. As a result, a number of critical changes are being proposed to the incentive plan. The changes being proposed will result in: Aligning the compensation strategy with the CIO s organizational and investment strategies. Strengthening teamwork and collaboration.

2 GOVERNANCE AND COMPENSATION -2- G1 RECOMMENDATION The President of the University recommends that the Governance and Compensation Committee recommend to the Regents approval of the proposed amendments to the Office of the Chief Investment Officer Annual Incentive Plan, as shown in Attachment 1, using investment proceeds and no State funds. The proposed changes will be effective July 1, Proposed Plan Changes BACKGROUND The Regents established Regents Policy 7712, Senior Management Group Incentive Awards, in July 2010, when they also approved revisions to the OCIO Annual Incentive Plan (AIP), including details of the approval authorities and administrative requirements for the Plan. These actions established a governance mechanism that delegated responsibilities to an Administrative Oversight Committee (AOC) comprised of the Executive Vice President Chief Financial Officer, the Executive Vice President Chief Operating Officer, the Vice President Human Resources, and the Executive Director Compensation Programs and Strategy. This Committee was empowered by the Regents to administer the Plan as approved by the Regents, including approving and implementing non-substantive changes or technical corrections to the Plan and approving the awards of participants below the level of the Chief Investment Officer. The changes proposed in this item have been reviewed by the AOC and are considered material or substantive, thereby requiring Regents approval, consistent with the policy and Plan document. The proposed changes have been reviewed by Regent Sherman as Chair of the Regents Investments Subcommittee, and are necessary to continue to drive organizational change and alignment with the longer-term strategy. The following summary provides an overview of the proposed changes for the AIP Plan that are substantive or material. Competitive Market Composite Systemwide Human Resources reviewed the comparators being used to evaluate the competitiveness of the compensation provided to OCIO employees. Currently, the Plan uses three market segments to construct the market composite: large public pension fund managers, large public endowments and public and private foundations, and private sector fund managers. The first part of this review focused on the endowment and foundation comparators. The University s endowment assets amounted to $9.1 billion as of June 30, Since 2010, the University has used 16 endowments and foundations with median assets under management of $14 billion as one component in establishing the UC s market composite to evaluate OCIO compensation. This peer group includes private foundations such as Ford and W.K. Kellogg, as well as university endowments such as those of University of Texas, Princeton, Harvard, and the University of Michigan. As a result of this review, the Office of the President proposes to narrow the comparator group to reflect higher education endowments only as those endowments more directly align with the University s endowment. The 20 endowments in the new peer group have median assets under management of $9.8 billion and include those institutions such as the University of Southern

3 GOVERNANCE AND COMPENSATION -3- G1 California, Harvard, the University of Virginia, the University of Texas, and others. The full list of institutions in the proposed higher education only peer group is included in Table 1 below. Table 1: The current and proposed competitive cohort for the endowment component is shown here with the pension component below that. Systemwide Human Resources also reviewed the current methodology used to establish the market composite against which base salaries and total cash compensation for OCIO employees are compared. Since 2010, the Regents authorized using market data from three categories of employers, weighting that data as follows: a 40 percent weighting to endowments compensation data, a 40 percent weighting to pension funds compensation data, and a 20 percent weighting to private sector compensation data. As a result of this review, the Office of the President proposes to eliminate the private sector data from consideration and give equal weighting of 50 percent each to the compensation data from higher education endowments and public pension funds. This results in a more conservative orientation in defining a market composite for setting and administering compensation for the OCIO. The CIO s Performance The Plan currently states that the evaluation of the CIO, for purposes of determining his AIP award, will be conducted by the Chair of the Regents Committee on Compensation with input from the President and the Chair of the Regents Committee on Investments. The proposed change would instead provide that the evaluation of the CIO will be conducted by the President, who will consult with the Chair of the Regents Investments Subcommittee. The proposed change would reflect a more appropriate process for evaluating the CIO s performance, since administrative oversight of this group falls to the President.

4 GOVERNANCE AND COMPENSATION -4- G1 Performance Metric Weighting The current Plan provides incentive opportunities for (a) individual or qualitative performance, (b) entity performance, and (c) for those who manage specific asset classes, a separate incentive component tied to the performance of those assets they manage. Currently, the weighting structure among these three areas places more emphasis on the performance of the asset classes, rather than the entity. This tends to drive more focused performance on the assets for which the participant is assigned and less on the overall teamwork and accomplishments. The CIO is proposing changes detailed in Table 2 below that would shift the weightings to place more emphasis on broader teamwork and collaboration. Table 2: The following chart displays the proposed changes in weighting for the Entity, Asset Class, and Individual/Qualitative performance components: Current Performance Weightings Proposed Performance Weightings Entity Asset Class Individual / Entity Asset Class Individual / Title / Sector Qualitative / Sector Qualitative Chief Investment Officer 80% -- 20% 75% -- 25% Sr Managing Director (Asset Class) 40% 50% 10% 50% 25% 25% COO/Senior Managing Director* 65% 15% 20% 75% -- 25% Managing Director (Asset Class) 40% 50% 10% 50% 25% 25% Director (Asset Class) 30% 60% 10% 50% 25% 25% Investment Operations Manager 20% -- 80% 75% -- 25% Investment Officer (Asset Class) 20% 70% 10% 50% 25% 25% Senior Investment Analyst 10% 70% 20% 75% -- 25% Managing Director - Risk 80% -- 20% 75% -- 25% Director - Risk % -- 25% Investment Officer - Risk 70% -- 30% 75% -- 25% *The Chief Operating Officer (COO) title is the current title. The previous title was Associate Chief Investment Officer which also functioned as the COO. The Associate CIO function and title has been eliminated. Transitional Weightings for the Awards for New Hires The AIP currently provides that new hires in the OCIO have a three-year transition period before they are fully accountable and receive incentives tied directly to their asset class and entity performance. Until then, individual/qualitative performance is the predominant measure for determining their incentive awards. The CIO proposes changing that to, again, focus attention on teamwork and collaboration by providing a 50/50 weighting on entity and individual/qualitative performance for the first partial year of service and then moving to the standard weighting for their role thereafter. Details are provided in Table 3 below.

GOVERNANCE AND COMPENSATION -5- G1 Table 3: The following chart summarizes the current and proposed transition plan for new hires and how the incentive component will be managed: Performance Measures

5 GOVERNANCE AND COMPENSATION -5- G1 Table 3: The following chart summarizes the current and proposed transition plan for new hires and how the incentive component will be managed: Performance Measures and Awards The current plan allows awards to be paid in years when negative returns are realized, as long as UC s performance was better than the benchmarks performance. The proposed changes would eliminate awards if the Entity, Asset Class, or Sector/Functional Group experience negative returns in any year, resulting in the three-year rolling average return (or other performance period, described in Table 3, above) being negative, regardless of relative performance against benchmarks. This means that that year s award for that component (Entity, Asset Class, or Sector/Functional Group) would be zero. In those years where a component has negative threeyear returns (or other performance periods as reflected in Table 3, above), a participant may nevertheless earn awards tied to the other components where performance over that performance period is positive, as well as for Individual/Qualitative performance. Negative performance in the current year will have no adverse impact on the deferred portions of prior-year awards. Award Approval The current Plan requires award approval by the AOC in consultation with the President and Chairs of the Regents Committees on Compensation and Investments. The proposed changes would still require the Regents approval for the Chief Investment Officer s award, but would replace the language to clarify that the approval of the President and the Regents be required in the unlikely event that the AOC proposes an award that is not consistent with the terms of this Plan document. Plan Approval Under the current Plan, if there are technical corrections or non-substantive changes to the Plan, the AOC may approve these changes after consultation with the President and Chairs of the Regents Committees on Governance and Compensation and Investments Subcommittee before implementation. The proposed amended language simplifies the approval process: Plan changes recommended by the AOC that are not material or substantive, or are deemed to be technical

6 GOVERNANCE AND COMPENSATION -6- G1 corrections, may be approved by the AOC after consultation with the President and will then be implemented by the AOC at an appropriate time. Similarly, if there are substantive changes to the Plan, the current language requires the AOC to obtain the approval of the President and the Regents Committees on Governance and Compensation and Investments Subcommittee before implementing such changes. The proposed change would clarify the approval process while maintaining transparency: If the AOC recommends any substantive or material changes to the Plan, including, but not limited to, changing the award opportunity levels, the AOC will obtain the approval of the President and the Regents Committee on Governance and Compensation and consult with the Chair of the Regents Investments Subcommittee before implementing such changes. In addition, the proposed language states, The Regents will receive reports of all substantive or material changes to the Plan. Termination Provisions The terms and conditions governing awards in the event of employee terminations have been clarified, as displayed in the table, below, for the Plan Year , as an example. The substantive changes pertain to how voluntary separations (other than retirements) will be handled. All other language represents clarification of current processes. Reason for Separation Voluntary Separation for any reason other than retirement Retirement Medical separation due to disability Death* Involuntary separation due to reorganization or restructuring Involuntary termination due to misconduct or inadequate performance Separation During Plan Year (i.e., on or before June 30, 2017) Forfeiture of award for Plan year. Forfeiture of deferred portions of awards from and Plan years. Partial award for Plan year. Payout of all deferred portions of awards from and Plan years. Forfeiture of award for Plan year. Forfeiture of deferred portions of awards from and Plan years. * In such cases, payments will be made to the estate of the participant. Separation on or after July 1, 2017 Payout of 50% of award for Plan year; forfeiture of remainder. Payout of half of deferred portion of award for Plan year; forfeiture of remainder. Payout of remaining portion of deferred award for Plan year. Award for Payout of all deferred portions of awards from and Plan years. Forfeiture of award for Plan year. Forfeiture of deferred portions of awards from and Plan years. Incentive Targets The current Plan uses annual objectives and a three-year rolling average performance against benchmarks to determine how much incentive award is earned by a participant in any given year. The current annual Target rates range from 20 percent of base salary for Senior Investment Analysts to 100 percent of base salary for the CIO. However, when the annual total cash compensation (base salary plus an incentive award at the target rate) is compared to that paid by the endowments and pension plan managers in the new peer group, the total cash compensation for some UC positions, particularly Managing Directors, is lower than UC s market comparators. This proposal requests approval to make minor adjustments to the incentive Targets of five

7 GOVERNANCE AND COMPENSATION -7- G1 percentage points for the Managing Directors, increasing their Targets from 45 to 50 percent of base, which would also increase their Threshold from 22.5 percent to 25 percent, and their maximums from 90 percent to 100 percent of base salary. Table 4: The following chart provides details showing the current and proposed changes to the University s incentive Targets for the Managing Directors. Title Current Target Proposed Target Chief Investment Officer 100% 100% Senior Managing Director 60% 60% Managing Director 45% 50% Director 45% 45% Investment Officer 35% 35% Senior Investment Analyst 20% 20% Managing Director - Risk 45% 50% Director - Risk 45% 45% Investment Officer - Risk 35% 35% Chief Operating Officer 60% 60% Investment Operations Manager/Director 320% 320% Award Reporting Consistent with changes proposed for recently made to Regents Policy 7712 (Senior Management Group Incentive Awards), the proposed changes provide that awards to Senior Management Group (SMG) participants and other participants whose total cash compensation falls within the applicable reporting criteria will be reported in the Annual Report on Executive Compensation. and apply to all SMG members and other participants whose total cash compensation exceeds the Indexed Compensation Level. This action eliminates a duplicative report to the Regents. Key to Acronyms AIP Annual Incentive Plan AOC Administrative Oversight Committee CIO Chief Investment Officer OCIO Office of the Chief Investment Officer Attachment: The University of California Office of the Chief Investment Officer Annual Incentive Plan for Plan Year July 1, 2017 through June 30, 2018

The University of California Office of the Chief Investment Officer Annual Incentive Plan (AIP) For Plan Year July 1, 2017 through June 30, 2018

The University of California Office of the Chief Investment Officer Annual Incentive Plan (AIP) For Plan Year July 1, 2017 through June 30, 2018 I. Plan Purpose Under the authority granted by The Board