Executive Retirement Benefits Practices

Transcription

1 2011 Report Executive Retirement Benefits Practices September 2011 Benefits Data Source U.S.

2 External pressures and the need for strong governance are driving U.S. organizations to review their executive compensation packages. Towers Watson s 2011 Report of Executive Retirement Benefits Practices shows that some employers have modified their executive retirement benefit offerings in recent years. This report provides an overview of the environment for executive rewards and the details of current executive program provisions.

3 Executive Retirement Benefits Practices Benefits Data Source U.S. Table of Contents Executive Summary 2 Key Findings 3 Glossary 4 About This Research 4 Program Prevalence 5 Retirement Income Replacement 6 Types of Supplemental Benefits Provided 7 Restoration Versus Supplemental Arrangements 7 Nonqualified Defined Benefit Plans 8 Nonqualified Defined Contribution Plans 8 Pay Components 9 Funding 9 Change in Control 10 Other Design Features 11 Vesting 11 Triggers for Payment in Defined Benefit SERPs 11 Payment Form 12 Investment Return Provided on Account-Based Benefits 13 Summary Report of Executive Retirement Benefits Practices 1

4 Executive Summary The spotlight on executive rewards salary, annual bonus, long-term incentives and benefits is more intense than ever before. Increasingly, shareholders, regulators and others focus on perceived disconnects between pay and performance. One result has been a provision of the Dodd-Frank Act that calls for a say on pay vote by shareholders. Although technically not binding on the company or its Board, this provision and enhanced disclosures enacted over the last few years have put pressure on compensation committees to justify each element of the executive rewards package. The still-struggling U.S. economy and employers efforts to control employee benefits and compensation have added another layer of pressure on executive compensation. Employers are combating increasing employee health care costs through a combination of aggressive program management, increased employee cost-sharing and other design changes. Organizations are also stepping up efforts to control retirement-related costs, particularly retiree medical and DB pension benefits. There is evidence that organizations are looking at whether and how these changes should be extended to executive retirement programs, and, more generally, whether to pare back supplemental executive benefits more significantly in the future. Securing the right mix of well-designed reward elements in today s challenging business climate is essential in attracting and retaining key talent. At the most senior levels, executive retirement benefits remain a key component of total rewards. Compensation committees must be able to demonstrate to shareholders and constituencies that these plans fulfill a valid business purpose, at reasonable cost and risk to the organization. Towers Watson s latest report on 371 U.S. organizations executive retirement practices sheds light on the current state (through year-end 2010) and compares it to our 2009 findings (as of mid-2008). This report provides data related to nonqualified retirement plans for newly hired executives including types of plans, the level of benefits provided to a typical executive and the prevalence of key benefit provisions. This report is based on data collected from publicly held companies that file with the Securities and Exchange Commission. Consequently, all commentary relates to those types of organizations. 2 towerswatson.com

5 Key Findings The majority of organizations analyzed (79%) continue to provide some version of nonqualified defined benefit (DB) or defined contribution (DC) plan along with a nonqualified deferred compensation arrangement (DCA). The number of employers that sponsor nonqualified DB plans has declined in the last two years from 47% to in conjunction with the closing and/or freezing of many broadbased DB plans. Organizations that continue to provide ongoing broad-based DB plans almost universally (96%) provide nonqualified benefits at a minimum level of benefits necessary to restore cutbacks from regulatory benefit and pay limitations. Organizations that provide DC plans are less likely to provide nonqualified retirement benefits. Only 7 of these types of organizations provide a nonqualified plan. 6 of organizations that sponsor employerpaid nonqualified plans offer only restoration plans. The number of organizations with supplemental plans that provide benefits in excess of pure restoration of regulatory limits has declined from 56% to in the last two years. Most nonqualified retirement plans cover broad groups of executives. However, about one-quarter of organizations surveyed provide supplemental individual retirement benefit agreements for the top five named executive officers (NEOs) identified in the proxy. Organizations provide an additional 6% to 7% of earnings, on average, in annual retirement income through nonqualified retirement plans for mid-level executives. More than 8 of nonqualified DB plans include base pay and annual bonus in determination of benefits, and 7 of nonqualified DC plans include them in the calculation of employer contributions. The majority of organizations do not pre-fund their nonqualified retirement plans. The key findings in this report are consistent with the results of an analysis Towers Watson performed for Fortune 100 companies that recently closed or froze their plans. The analysis found an overall decline in nonqualified DB programs, a decrease in the number of nonqualified DB and DC supplemental plans that provide benefits in excess of pure restoration of regulatory limits, and an increase in the number of nonqualified DC restoration plans. See Towers Watson s Insider article, What Happens to Executive Retirement Plans When Companies Close or Freeze Their Broad-Based Pension Plans? for more information Report of Executive Retirement Benefits Practices 3

6 Glossary Deferred compensation arrangements (DCA) are arrangements under which employees are provided an opportunity to defer a portion of compensation. If employer matches are provided on these deferred amounts, the plans are classified as DC plans. Restoration plans are designed to restore qualified plan benefits lost due to statutory limitations, including the Internal Revenue Code (IRC) Section 401(a)(17) pay limit, the IRC Section 415 limit and limits on IRC Section 401(k) deferrals. For purposes of this report, a restoration plan mirrors a qualified plan except for such limits. A plan that mirrors the qualified plan but also includes deferred compensation amounts in the pay on which benefits are based is also considered a restoration plan for purposes of this report. If a plan resembles the qualified plan but recognizes additional components of pay, provides more generous early retirement provisions, credited service or additional company contributions, it is considered a supplemental executive retirement plan, rather than a restoration plan. Supplemental executive retirement plans (SERPs) are designed to provide executives with more generous benefits than a qualified plan or a restoration plan. These plans typically follow a different benefit formula, include additional components of pay, contain more liberal early retirement provisions, provide for additional contributions and/or additional service credits. About This Research This report summarizes key statistics related to executive retirement benefits practices based on data from 371 organizations in over 30 industries. This data is derived from the Benefits Data Source U.S. Executive Retirement Benefits Database that includes information gathered from a review of plan documents filed with the Security and Exchange Commission and proxy disclosures. The data relate to provisions covering U.S. executives and plan information available as of year-end 2010, and encompasses nonqualified DB plans, nonqualified DC plans and nonqualified DCAs. The provisions summarized reflect plan provisions and benefits of nonqualified programs offered to newly hired executives. Individual arrangements or grandfathered provisions available to only a select group of executives are not included. This report updates a report published in July 2009 that summarized information on executive retirement programs for 322 organizations gathered as of mid Many of these organizations continue to be reflected in this year s report. All findings labeled as 2009 reflect the information published in the July 2009 report and all findings labeled as 2011 reflect the information in the current database (i.e., through year-end 2010). 4 towerswatson.com

7 Program Prevalence There are generally two types of nonqualified retirement arrangements plans that employers sponsor and pay for (DB or DC plans) and DCAs, which allow employees to defer a portion of earnings on a voluntary basis, without a company match. Of 371 organizations in the database, 9 sponsor a nonqualified retirement plan, and 79% include some level of employer-provided benefits. Since 2009, the percentage of database organizations offering nonqualified DB plans has declined from 47% to. However, sponsorship of nonqualified DC plans and DCAs has remained largely unchanged (Figure 1). Figure 1. Types of nonqualified retirement plans % of organizations Organizations that maintain broad-based DB plans almost universally supplement these benefits with a nonqualified DB plan for executives, while organizations that provide only DC plans are less likely to provide supplemental retirement benefits (Figure 2). If the current level of nonqualified plan sponsorship by DC-only sponsors continues into the future, the shift to broad-based DC-only plans could result in a decline in the level of executive retirement income from nonqualified retirement plan sources. The overall level of retirement income, however, will ultimately depend on the executive s total rewards package, including long-term incentives and other reward elements. In addition to formalized nonqualified programs, 24% of top-tier executives are reported to have supplemental individual retirement benefit agreements (Figure 3) None n = 2009: 322, 2011: 371 Nonqualified DB Figure 2. Organizations sponsoring employerprovided nonqualified retirement plans % of organizations Organizations whose broad-based retirement vehicle includes: DB and DC DC only n = 2009: 134 DB and DC, 144 DC only, 2011: 111 DB and DC, 222 DC only Nonqualified DC Nonqualified DCA Figure 3. Individual retirement benefit agreements % of organizations n = 352 CEO Other NEOs 2011 Report of Executive Retirement Benefits Practices 5

8 Retirement Income Replacement Figure 4. Projected retirement income The median level of retirement benefits (e.g., 50th percentile) provided for an average mid-level executive total 31% of total earnings for retirement at age 62 and 38% of total earnings for retirement at age 65. This replacement ratio includes employerprovided broad-based retirement plans, nonqualified retirement plans and Social Security. Additional results are shown at the 25th and 75th percentile of the total database (Figure 4). Amounts are indicated as replacement ratios with regard to annual cash compensation at retirement and assume the full employer match is received for all years of employment. The amounts are not adjusted for the impact of future inflation after the initial retirement date. The average retirement income replacement for our sample mid-level executive, from the same retirement sources as shown above, is similar to the median level. The breakout between broad-based plans, nonqualified retirement plans and Social Security is illustrated below: Average income replacement at retirement Income sources Retirement age 62 Retirement age 65 Broad-based DB 4.9% 5.7% Broad-based DC 15.6% 19. Nonqualified DB 2.8% 3.4% Nonqualified DC 3.1% 4. Social Security 5.8% 6.9% Total income all sources 32.2% 39. % of final total earnings Though income replacement levels vary based on executive position, pay and service levels, on average, nonqualified retirement plans add 5.9% of total earnings to a mid-level executive s annual retirement income at age 62 and 7.4% of total earnings for retirement at age 65. Retirement age 62 Retirement age 65 25th 50th 75th Sample mid-level executive current demographics Projection assumptions Age 50 Compensation increases 4. Base pay $250,000 Return on DC funds 7. Bonus $100,000 Inflation 2.5% Service 15 6 towerswatson.com

9 Types of Supplemental Benefits Provided Restoration Versus Supplemental Arrangements Sixty percent of organizations that provide nonqualified retirement plan benefits provide restoration benefits, or amounts needed to restore reductions due to pay and benefit limits. The remaining provide additional benefits in excess of the restoration level. The number of organizations providing Supplemental Executive Retirement Plans (SERPs) has declined from 56% in 2009 to in Organizations with DC programs are more likely to provide pure restoration plans (as opposed to SERPs) than those with DB programs. Fifty percent of organizations with nonqualified DB plans and 35% of organizations sponsoring nonqualified DC plans provide supplemental benefits, either in conjunction with restoration plans or as a separate plan. The prevalence of supplemental benefit plans has declined since 2009 for both types of programs (Figure 5). Figure 5. Types of supplemental arrangements 8 % of organizations All organizations Nonqualified DB Nonqualified DC Restoration SERP Restoration and SERP* * Restoration and SERP refers to organizations that provide both a restoration plan and a SERP. n = 2009: 263 all, 152 DB, 211 DC, 2011: 294 all, 149 DB, 244 DC 2011 Report of Executive Retirement Benefits Practices 7

10 Figure 6. Types of nonqualified DB plans 8 Nonqualified DB Plans Traditional final average pay plans continue to dominate in the design of nonqualified DB plans (Figure 6). Nonqualified DC Plans Designs employers are implementing for broadbased DC programs are being carried through to their nonqualified DC plans. Our analysis shows that 87% of organizations with nonqualified DC plans provide matching formulas. The matching formulas tend to mirror the matching formula under the broadbased 401(k) plan (Figure 7) The prevalence of nonelective contributions has increased since 2009, with 58% of organizations now providing this type of contribution. Forty-five percent of these organizations provide a matching contribution along with the nonelective contribution, almost double the number from 2009 (Figure 7). The majority of plans continue to determine contribution amounts based on a predefined formula (Figure 8). Traditional Cash balance Other account-based plans 6 6 n = 2009: 204, 2011: 201 Figure 7. Matching vs. nonelective contributions in nonqualified DC plans 8 Figure 8. Predefined vs. discretionary formulas in nonqualified DC plans % of organizations Predefined formula Discretionary/Profit-based formula 13 Match only Match and nonelective Nonelective only n = 2009: 233, 2011: 274 n = 2009: 209, 2011: towerswatson.com

11 Pay Components While annual bonus payments are typically included in earnings definitions for both nonqualified DB and nonqualified DC plans, their inclusion is more prevalent in nonqualified DB plans (81%) than in nonqualified DC plans (7). The number of nonqualified DC plans that cover bonuses has increased since 2009, while the percentages of plans covering all other elements of pay remain relatively stable. Almost all DCAs allow deferrals of all or a part of annual bonus amounts. Figure 9. Components of pay in nonqualified retirement plans Long-term incentives, such as additional pay for performance calculated over results from several years, are rarely covered by any programs other than DCAs (Figure 9) Base pay Annual bonus Long-term incentives Funding Nonqualified DB n = 201 DB, 274 DC, 296 DCA Nonqualified DC Nonqualified DCA Some organizations publicly disclose funding for their executive retirement programs. Among these organizations, pre-funding of nonqualified retirement plans is not a prevalent practice. About 15% of nonqualified DB plan sponsors and 25% nonqualified DC plan sponsors report setting up a funding vehicle to secure their nonqualified retirement plan arrangements. When funding is specified, the most popular funding vehicle is a rabbi (or grantor) trust (Figure 10). Figure 10. Funding arrangements in employer-provided nonqualified retirement plans Unfunded* Rabbi trust Other funding vehicles** 7 6 Nonqualified DB Nonqualified DC * Includes organizations that report having trusts that are set up to be funded upon change in control ** Includes corporate-owned and group universal life insurance, secular trusts and annuities n = 191 DB, 259 DC 2011 Report of Executive Retirement Benefits Practices 9

12 Change in Control Figure 11. CIC provisions in nonqualified plans Just over half of all nonqualified retirement plans include some form of change-in-control (CIC) provision that provides added benefit security via funding, vesting or immediate payout. While funding is specified upon CIC in only about 25 documentation, funding may occur more often than is disclosed in plan documents Tax gross-up provisions upon CIC were rarely provided within the formal plan arrangements we reviewed. Such provisions are more often found in individual agreements provided to executives (Figure 12). 12 Funded upon CIC Immediate vesting Benefit payable immediately Nonqualified DB Nonqualified DC Nonqualified DCA n = 104 DB, 142 DC, 150 DCA Figure 12. Tax gross-ups upon CIC /agreements 8 3 Plan provision Individual agreement Nonqualified DB Nonqualified DC n = 186 DB, 249 DC, 194 individual DB, 273 individual DC 10 towerswatson.com

13 Other Design Features Vesting Seventy percent of nonqualified DB plans provide vesting after three or five years of service, largely replicating the vesting provisions in broad-based DB plans. However, under a significant number of nonqualified DB plans (23%) vesting is not achieved until a participant becomes eligible for retirement. Nonqualified DC arrangements tend to provide faster vesting. Many DC plans vest contributions immediately (45%), and only 3% of DC plans delay vesting until retirement eligibility (Figure 13). Triggers for Payment in DB SERPs One hundred percent of nonqualified DB SERPs provide for payment of vested benefits upon separation from service. Nearly all plans also provide payments upon death. However, only onethird provide benefit distributions upon disability and just 25% pay benefits upon CIC (Figure 14). Regulations do impact plan design. The percentage of plans that provide distributions upon disability has declined from 5 in 2009 to 36% in This is likely due to plans complying with IRC Section 409A distribution regulations, which contain stringent rules regarding the definition of disability that qualifies for a distribution. Figure 13. Vesting provisions in nonqualified retirement plans n = 197 DB, 274 DC 45 Immediate Nonqualified DB Three years of service Five years of service Nonqualified DC Figure 14. Triggers for payment DB SERPs Retirementeligible Other Separation from service Death Disability CIC n = 2009: 147, 2011: 115 IRC Section 409A governs the timing of deferrals and the payment of benefits under nonqualified retirement plans. It was added in 2005, but as a result of the transition rules many plans were not formally amended to comply with the regulations until Report of Executive Retirement Benefits Practices 11

14 Payment Form Lump sum forms of payment are provided in about 75% of nonqualified DB plans (Figure 15). A key explanation for the popularity of lump sums is the benefit security they provide to executives, since terminating executives can take the entire value of their benefit with them. This form of payment has become even more popular with the advent of IRC Section 409A rules, which have made this the simplest way to administer payouts. Lump sum payments predominate within nonqualified DC and DCAs. Installment payments are also commonly provided (Figure 16). Figure 15. Availability of lump sum in nonqualified DB plans n = 2009: 204 DB, 2011: 201 DB 73 Figure 16. Optional forms of payment in nonqualified DC plans and nonqualified deferred compensation arrangements Lump sum Installments Annuities 2 1 Nonqualified DC Nonqualified DCA n = 263 DC, 285 DCA 12 towerswatson.com

15 Investment Return Provided on Account-Based Benefits Figure 17 shows the types of investment options offered by nonqualified DC plans and nonqualified DCAs. The most common approach is to offer the same array of investment options as the broadbased DC plan. The next most common offerings for these plans are company stock and investment/ mutual funds. A minority of plans link account values to fixed-income indexes or fixed rates. About 5% of nonqualified DCAs provide an accumulation rate that includes a spread over market rate indexes. Figure 17. Investment return options available under nonqualified DC plans and nonqualified DCAs Investment/ Mutual funds Company stock 5 7 Treasury bond yield 4 3 Fixed rate 4 6 Prime rate 8 7 Bond index Same as broad-based DC NQDC Nonqualified DCA n = 224 DC, 282 DCA Multiple options are available in many plans, so the same plan may be included in more than one category. Plans with accumulation rates based on spreads above market indexes are included in the applicable market index category (e.g., prime rate % is included in the prime rate category) Report of Executive Retirement Benefits Practices 13

16 Summary The size of total rewards and the need to link pay to executive performance, combined with a greater focus on risk and transparency, has increased pressure on organizations and their compensation committees to carefully assess ongoing trends in executive pay and benefits. For many organizations, design changes in broad-based retirement program benefits are translating to corresponding transformations in their executive retirement programs. It is likely that, based on the legislative environment, existing and perhaps even more disclosures will be required for the foreseeable future. This means, for program design and for individual agreements, organizations will be increasingly accountable for benefits offered. About the Executive Retirement Benefits Database The Towers Watson Executive Retirement Benefits Database provides robust analytical tools to monitor the competitiveness of your nonqualified retirement plans. Specifically, the Executive Retirement Benefits Database can assist with: The database analytical tools include: Detailed retirement program summaries for over 370 publicly held U.S. organizations Prevalence information covering a wide range of retirement benefit provisions (examples relating to some key benefit provisions have been documented in this report) Retirement income illustrations to enable comparisons across organizations and assessments of the adequacy of total retirement benefits Retirement benefit value analysis to determine and compare the benefits provided across a peer group of organizations values are based upon consistent actuarial methods and a fixed population, so that differences in value are exclusively a function of differences in plan provisions For information on how to access the Executive Retirement Benefits Database contact your local Towers Watson consultant. Evaluating design and financing practice prevalence Benchmarking benefit levels against peer groups Comparing benefit balance between program elements Providing competitive rationale for benefits provided Supporting program redesign 14 towerswatson.com

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18 About Towers Watson Towers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With 14,000 associates around the world, we offer solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Copyright 2011 Towers Watson. All rights reserved. TW-NA towerswatson.com