2014 Retirement Webinar Series

Transcription

1 2014 Retirement Webinar Series

2 Funding Strategies for Nonqualified Plans Byron Beebe, Mark Merlotti, Aon Hewitt James Schokett, VF Corporation

3 Today s Agenda Section 1 Section 2 Section 3 Section 4 Why Companies Finance Nonqualified Plan Liabilities Typical Financing Options High Level Results Considerations 2

4 Why Companies Finance Nonqualified Plan Liabilities Reduce risk of volatile earnings Provide funds for benefit payments Improve participant perception of security when they are deferring income Manage cash flow Increase after-tax rates of return 3

5 Challenges to Developing a Strategy Service providers recommending product-driven solutions Commission or administration system-driven recommendations Existing assets: How to evaluate effectiveness 4

6 Focus of Session What are the typical financing options Do nothing (Unfunded) Taxable Investments / Mutual Funds Corporate Owned Life Insurance (COLI) Total Return Swaps (TRS) 5

7 Prevalence Data Financing Using a Rabbi Trust Source: Aon Hewitt 2012 U.S. Total 46% 75% Financing Using a Rabbi Trust Informal Financing Source: *Aon Hewitt 2012 U.S. Total Compensation Measurement (TCM ), The Newport Group A Survey of Current Trends in Executive Benefits

8 Unfunded Plans Concept Plan is offered but no funds are set aside to provide for future benefit payments Rationale Plan liability is immaterial/not projected to grow Requires no upfront commitment of cash or assets Cost is somewhat predictable with defined benefit or fixed rate plans 7

9 Unfunded Plans Pros No early cash commitment Appealing to high growth company with limited cash Cons Growing unfunded liability on balance sheet Pure benefit expense without hedge results in volatility of benefit expense Downstream program expenses to future management 8

10 Taxable Investments Concept Taxable investments typically mirror liability Rationale Simple concept; directly match liability allocations with the same asset 9

11 Taxable Investments Pros Large universe of investment options High degree of liquidity to satisfy benefit payments Precise pre-tax and after-tax earnings hedge Closest asset/liability match Cons Cash flow cost to Company for taxes on realized gains 10

12 Corporate-Owned Life Insurance (COLI) Concept Institutionally priced insurance products providing investment growth on a tax free basis Rationale Tax free asset growth most similar to profile of liability Generally, provides best long-term results for P&L and PV of cash flow if cost of capital is lower 11

13 COLI: How Does It Work? Cost of insurance is less than tax cost of taxable investments 12

14 Corporate-Owned Life Insurance Pros Investment choices available in all asset classes No taxes on gains from investment reallocations Unrealized gains recorded in P&L Tax free death proceeds and distributions Cons Must obtain written consent to issue policies Active management to maintain reasonable insurance charges Mismatch of benefit cash flow and death proceeds Fund offering more limited than mutual fund universe 13

15 Total Return Swaps (TRS) Concept Hedging strategy: Counterparty purchases asset to mirror liability Provides company with access to total returns for a fee Rationale Historically low LIBOR rates make TRS attractive for companies with high cost of capital Derivative accounting mirrors nonqualified liability accounting 14

16 TRS: How Does It Work? Employer Employer s cash outlays: Fees, market losses, taxes when hedge is closed Counterparty Synthetic ownership of notional portfolio to hedge NQDC Employer s cash receipts: Market gains Owns notional portfolio 15

17 Total Return Swaps Pros Pre-tax and after-tax hedge against P&L without committing assets Net positive deferrals are a source of cash flow to Company Deferred taxation until hedge is closed Cons No sinking fund for benefits Volatile cash flow from quarterly settlement of gains and losses Complexity of administration for tax recordkeeping Fixed cost may limit use to large transactions ($100 million+) Historically low LIBOR rates may underestimate the cost 16

18 High Level Comparison of Options Assumptions Funding for $50 million liability Earnings credited at 7.0% net Pre-tax present value rate of 7.0% (4.2% after-tax) Taxable Investment turnover: 100% annually COLI held until death TRS: All taxes deferred for first 7 years 17

19 High Level Comparison of Options Characteristics Unfunded Taxable Investments COLI Total Return Swap Sinking fund for liabilities Low administrative complexity Low out-of-pocket administrative cost Good Neutral/ Mixed Poor 18

20 High Level Comparison of Options Earnings Unfunded Taxable Investments COLI Total Return Swap Initial 10 Year 20 year Ability to minimize quarterly volatility Good Neutral/ Mixed Poor 19

21 High Level Comparison of Options Cash Flow Unfunded Taxable Investments COLI Total Return Swap Low initial cash flow Low ongoing tax/settlement cost Source for benefit payment Low life of plan PV cost (4.2% after-tax) Good Neutral/ Mixed Poor 20

22 After-Tax Earnings Analysis: Earnings at 7% net (numbers in thousands) 80,000 60,000 40,000 20,000 0 (20,000) (40,000) (60,000) (80,000) Unfunded DCP Liability DCP Financed with Taxable Investments DCP Financed with COLI Total Return Swap Hedging of DCP (LIBOR = 0.25%) Total Return Swap Hedging of DCP (LIBOR = 4.25%) 5 Years 10 Years 20 Years 21

23 NPV of Cash Flow at 7.0% Pre-Tax (4.2% After-Tax) Analysis: 7% pre-tax present value rate and varying investment returns and LIBOR rates (numbers in thousands) 250, ,000 50,000 (50,000) Unfunded DCP Liability DCP Financed with Taxable Investments DCP Financed with COLI Total Return Swap Hedging of DCP (LIBOR = 0.25%) Total Return Swap Hedging of DCP (LIBOR = 4.25%) 4% Earnings Rate 7% Earnings Rate 10% Earnings Rate Footnote: 3-month LIBOR range over last 7 years: 5.62 (9/07) to 0.24% (current) 22

24 Up Market/Down Market Analysis One year example: Investment losses change financial results (numbers in thousands) 6,000 Up Market (+10%) Down Market (-10%) 3,000 5,000 2,000 4,000 1,000 3, ,000-1,000 1,000-2, ,000-1,000-4,000-2,000-5,000-6,000 Unfunded Taxable Investements Pre-tax COLI After-tax TRS -3,000 Unfunded Taxable Investements Pre-tax COLI After-tax TRS 23

25 Considerations Optimal funding strategy is highly dependent upon key variables Corporate financial profile Funding objectives Assumed return/risk tolerance Executive demographics Combination of strategies likely to provide the best results Address efficiency issues with existing COLI portfolio to optimize yield 24

26 VF Corporation James Schockett Assistant Treasurer

27 Questions & Answers

28 Contact 27

29 About Aon Hewitt Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit Aon plc This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon Hewitt's preliminary analysis of publicly available information. The content of this document is made available on an as is basis, without warranty of any kind. Aon Hewitt disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Aon Hewitt reserves all rights to the content of this document. 28