What Are the Latest Trends in Executive Retirement and Perquisites?

REWARD STRATEGY AND PRACTICE What Are the Latest Trends in Executive Retirement and Perquisites? Malinda Riley, Consultant, Hay Group * Executive compensation has been a hot topic over the past few years. Expanded proxy disclosures and say on pay have focused public attention on the size and mix of executive compensation packages. The struggling national and global economies along with declining share prices have also raised questions regarding what is fair and appropriate compensation in the C-suite. This environment is causing boards of both for pro t and not for pro t organizations to increasingly focus on the level and composition of executive bene- t programs. Boards not only want to structure their programs in a market-competitive manner that allows them to attract and retain executive talent but also serve shareholders' and public interests. Hay Group's recent survey of executive retirement bene ts and perquisites provides a window into the Boardrooms of organizations from a variety of industries, sizes and geographies. What do executive bene ts packages look like on the other side of our worst economic recession in decades? Have they changed dramatically? What do the results say about the future of executive bene ts? This article sets out to answer these questions through a review of the survey results as well as provide insights as to the latest trends. SURVEY DETAILS From July and August 2011, Hay Group conducted a survey of executive retirement bene ts and perquisites. An electronic survey questionnaire was made available to employees in a position to provide information on their companies' executive bene ts policies. The primary objective was to obtain current data on the prevalence of practice regarding executive retirement, deferred compensation and perquisites for employers of all sizes and across a broad group of industries. Hay Group tabulated and sorted the results from 317 responding employers with median revenue of nearly $1 billion. 16% of the respondents are tax exempt (not-for-pro t) organizations. * MALINDA RILEY is a Benefits Consultant with Hay Group, located in the firm's Chicago Office. She works with clients on the full spectrum of employee benefits challenges. Her expertise includes analysis of the market competitiveness of benefit programs, total remuneration analysis, retirement and health & welfare plan design, and executive benefit analysis and program design. 5

Journal of Compensation and Bene ts WHAT ARE THE ELEMENTS OF EXECUTIVE BENEFITS? There can be signi cant variation in the composition of executive bene t programs, but typically, these types of programs are comprised of the following components: E Retirement E Deferred Compensation E Perquisites When we refer to executive retirement, we are describing retirement programs provided to executives that are not quali- ed under the Internal Revenue Code. In other words, these non-quali ed plans are not subject to the non-discrimination, compensation and contribution limiting provisions of the Internal Revenue Code; and therefore, have much more exibility in the design and administration in order to provide additional retirement income to executives. Table A provides the de nitions for executive retirement programs. Table A Nonquali ed Retirement Plan Nonquali ed De ned Bene t Plan Nonquali ed De ned Contribution Plan Executive Retirement Plan De nitions Supplemental executive retirement plans (SERP), such as top-hat plans or excess plans, which provide certain employees with additional retirement bene ts. These plans may be free-standing plans that cover several executives or they may be part of individual executive employment contracts. Retirement plan that provides a xed bene t at retirement based on a formula or target income percentage. The plan is not quali ed under the Internal Revenue Code (IRC) and is usually in addition to a quali ed de ned bene t plan. This type of plan is designed to supplement de ned bene t pensions and/or restore bene ts in pension plans that are limited by ERISA. Retirement plan in which employers make xed contributions toward retirement. The plan is not quali ed under the IRC and is typically in addition to quali ed de ned contribution plans (401(k), 403(b), etc.) This type of plan is designed to supplement de ned contribution plans and/or restore bene ts that are limited by ERISA. Deferred compensation refers to programs whereby executives are permitted to defer their compensation until a date in the future provided they meet the legal requirements pertaining to the deferral period and payment election as outlined in section 409A of the Internal Revenue Code. Deferred compensation programs may be used by organizations as retention tools. In addition, these programs provide executives the ability to conduct more e ective tax planning. The nal component of executive bene ts is perquisites. Perquisites include such items as a car allowance, club membership, and use of company aircraft, as well as other health and welfare bene ts that provide enhanced bene ts or additional protection to the executive and the organization. EXECUTIVE RETIREMENT Based on Hay Group's survey results, executive retirement programs continue to be prevalent in the market. Nearly half the survey respondents provide some type of nonquali ed retirement plan, either de ned bene t or de ned contribution. Table B below shows not only the overall prevalence, but also the eligibility by executive group. As one might expect, eligibility for these types of programs decreases as the executive level does. TABLE B 6

Executive Retirement Reward Strategy and Practice O ered President & CEO Executive and Senior Division Heads Based on Compensation Nonquali ed Retirement Plan 49% 66% 57% 42% 17% 32% De ned Bene t 32% 74% 69% 49% 26% 35% De ned Contribution 31% 73% 72% 60% 37% 39% A decreasing number of organizations, only one third of the surveyed group, continue to provide both a de ned bene t and de ned contribution program. The vast majority, the remaining two thirds of the surveyed group, provide only one type of nonquali ed retirement plan. The market data suggest that de ned bene t plans are decreasing in prevalence, in both quali ed and nonquali ed arrangements; however, the data may also suggest that organizations with both de ned bene t and de ned contribution arrangements have grandfathered current executives into the DB program and o er a DC program to new executives. When we look at the prevalence of executive retirement plans by industry, we do see signi cant di erences, as the graph below illustrates. However, it should be noted that the prevalence is increasing in all industries in an e ort to attract and retain top talent. The survey data indicates that the primary reason organizations provide a nonquali ed executive retirement program is to make up for IRS limits. Organizations want to ensure that 7

Journal of Compensation and Bene ts executives receive the bene t provided by their quali ed retirement plan(s) based on their entire compensation, not just the amount up to the current $245,000 IRS limit. The table below shows the variety of reasons for providing a nonquali- ed retirement plan. Executive Retirement Plan Objective President & CEO Executive and Senior Division Heads Based on Compensation Make up for IRS Limits 74% 77% 71% 55% 32% 38% Bring retirement income to a target level 33% 87% 71% 44% 23% 15% Include deferred compensation 32% 90% 80% 72% 38% 30% Provide golden handcu s to retain executives 32% 82% 80% 45% 22% 16% Recruit mid-career execu- 26% 73% 78% 59% 32% 24% tives Improve early retirement bene ts 12% 79% 74% 47% 26% 26% Include bonuses not covered in quali ed plans 12% 79% 63% 42% 16% 21% Provide bene ts for executives with insu cient service 8% 75% 67% 42% 17% 17% Provide retirement bene ts to executives with no qualifed 8% 77% 85% 31% 8% 8% plan Maintain bene ts from executive's prior employer 6% 78% 67% 33% 22% 33% Keep whole executive transferring from subsidiaries or other countries 3% 75% 75% 50% 50% 25% Increasingly, organizations are using their nonquali ed retirement programs as a retention tool. E ective retention design features include a vesting schedule that only provides a full bene t at retirement or a bene t formula that increases with tenure. Although the market is moving away from de ned bene t plans, organizations are using a target retirement income level in setting their de ned contribution plan formulas. Rather than simply saying we will contribute X% each year to our SERP, organizations add a provision that states the contribution shall be a certain percentage provided it allows the executive to reach a target retirement income of 60% of 8 nal pay. For a later career executive hire, this might mean higher contributions throughout the course of their tenure to ensure the target income level is met, while a longer tenured executives may reach the target income through lower contributions. How organizations de ne compensation in their nonquali-

ed retirement plans is most typically base salary plus annual incentives. The rationale for an organization's de nition Reward Strategy and Practice Elements of Pay Included Base Salary 92% Annual Incentives 75% Long-term Incentives 18% Deferred Compensation 41% may depend on the mix of cash compensation. An organization that is highly leveraged is more likely to include bonus compensation, while the reverse is true for organizations that deliver most of their cash compensation in base salary. The market is split with regard to the funding of nonquali- ed retirement programs. As it is not required, organizations have the choice to fund all, some or none of their nonquali- ed plan contributions. The table below shows the breakdown of the 52% of organizations that have some type of funding in place for their nonquali ed retirement plans. Vehicle used to fund or secure plan Rabbi trust 72% Life insurance 23% Other 11% Paid out in cash each year without 7% gross-up for taxes Severance plan 4% Paid out in cash each year with 2% gross-up for taxes Secular trust 1% Not-for-pro t stock option plan 1% Rabbi Trust Secular Trust De nitions A trust created for the purpose of supporting the non-quali ed bene t obligations of employers to their employees. These trusts are sometimes referred to as grantor trusts. Called a Rabbi trust due to the rst initial ruling made by the IRS on behalf of a synagogue, these forms of trusts create security for employees because the assets within the trust are typically outside the control of the employers and are irrevocable. A variation of the irrevocable Rabbi trust arrangement used with a nonquali ed deferred compensation plan. Because the assets in a secular trust are not subject to the claims of creditors, it o ers an executive more security than a Rabbi trust. Although there is much variation in the design of nonquali- ed retirement plans, the one common element in all of these plans is the exibility these programs provide to organizations. Through the effective design of such features as the bene t formula, funding strategy, and the de nition of compensation, organizations can tailor their nonquali ed retirement programs to meet the needs of their business as well as their executives. 9

Journal of Compensation and Bene ts NONQUALIFIED DEFERRED COMPENSATION PROGRAMS This section details the ndings of voluntary deferred compensation programs, which may or may not have an employer contribution. Prevalence of deferred compensation programs is 53%, slightly higher than nonquali ed retirement plans. Prevalence of these types of programs is also higher at lower executive levels. Do you o er a nonquali ed deferred compensation plan to executives? Yes 53% No 39% Considering 5% Not Considering 3% Who is eligible for the plan? President & CEO 71% Executive and Sr. 71% 63% Division Heads 43% Based on compensation 43% Code Section 409A imposed strict requirements regarding deferral elections, timing of payments and acceleration of payments on nonquali ed deferred compensation (NQDC) arrangements. The impact of 409A may account for the relatively static prevalence of these types of arrangements. In addition, the restrictions placed on deferral elections and payment timing may have diminished the attractiveness of these types of programs. Participation in NQDC programs is on average 39% in the surveyed group. The elements of compensation that are eligible to be deferred under NQDC programs are as follows: What Type of Compensation is Eligible to be Deferred? Base 89% STI 79% LTI Cash 25% LTI Stock 9% Restricted Stock 7% The survey results suggest that organizations are not using their deferred compensation programs as a vehicle to provide additional employer contributions. However, organizations are more likely to make matching contributions in their deferred compensation arrangements in the absence of a nonquali ed retirement program. Just over one third of organizations are making company contributions to their deferred compensation programs. 10

Reward Strategy and Practice Do you match deferrals? Yes 36% No 64% Under deferred compensation arrangements, organizations typically de ne the events in which payment of bene ts is permitted. Separation from service, death and disability top the list of criteria for payment of bene ts. With regard to the method of payment lump sum payments are the most prevalent with annual instalments coming in second, as the table to the right below shows. What are the criteria for payment of bene ts under the NQDC plan? What are the payment options under the NQDC plan? Separation of Service 90% Lump Sum 94% Death 84% Fixed Annual Installments 62% Disability 70% Single or J&S Annuity 10% Change of Control 48% Monthly Installments 10% Speci ed Period of Time 45% Other 7% Hardship 43% Other 9% There is much variation with regard to the basis for crediting interest to participant accounts under deferred compensation arrangements. 47% of respondents credit interest based on a participant's investment elections in either the 401(k) plan funds or a separate line up of investment options. The fund line up in 401(k) plans typically covers the full investment risk spectrum, providing executives the exibility to invest their deferrals according to their own risk pro le. In addition, the rate of return for these fund line ups is published regularly and can easily be applied to participant accounts. What is the basis for interest crediting on NQDC deferrals? Participant Directed Investments 30% Stock Index 20% Mirror 401(k) Plan Investments 17% Bond Index 16% Fixed Rate 13% Treasury Note 11% Prime Rate 11% Company Stock 11% Other 8% The funding of deferred compensation arrangements is similar to the funding of nonquali- ed retirement plans. 54% of responding organizations have some type of funding arrange- 11

Journal of Compensation and Bene ts ment in place for their deferred compensation program. Also similar to nonquali ed retirement programs, rabbi trusts and life insurance are common vehicles used by organizations to fund their deferred compensation programs. Because nonquali ed plans are not required to be funded, any vehicle that protects assets set aside by the organization provides some security to participants. A rabbi trust provides such security. With regard to company owned life insurance, it is a funding vehicle that provides tax advantages to the employer, making it a more attractive funding tool. Is the NQDC plan funded? Informally funded 54% Unfunded 44% Considering 2% What vehicles are used to fund the NQDC? Rabbi trust 69% Life insurance 30% Other 13% Paid out in cash each year without 8% gross-up for taxes Secular trust 2% Not-for-pro t stock option plan 0% Severance plan 0% EXECUTIVE PERQUISITES The line up of executive perquisites continues to cover the full range of bene ts that provide added nancial and physical security to executives. The following perquisites are the most prevalent: Cell phones / Blackberry Company Car / Car Allowance Severance Pay Employment Contracts With regard to car allowances, the dollar amount provided to executives has remained fairly static over the past few years. Perquisites that show increased prevalence from prior surveys are Executive Physical Examinations and Executive Coaching. The physical health of all employees, not just executives, has been a focus of organizations over the past few years. Wellness programs that are designed to improve the health of employees through incentives or enhanced bene ts manifests itself at the executive level in the form of executive physicals. Organizations are invested greatly in their executives and want to ensure those executives are taking care of 12 themselves. Executive coaching is another way organizations are maximizing their investment in executives, ensuring they have the tools to e ectively lead. Perquisites that have decreased in prevalence include Executive Medical Reimbursement and Country Club Memberships. The passage of the Patient Protection and Affordability Care Act (PPACA) places greater scrutiny on medical bene ts provided to high income employees, which may account for the market's movement away from medical reimbursement arrangements. Club memberships fall into the

category of perquisites that typically gets the most public scrutiny. Does providing a membership enable the executive to perform their job duties better? Increasingly, the answer to this question for many organizations is no. The practice of grossing up perquisites for taxes was more common before enhanced proxy disclosure requirements, Reward Strategy and Practice but has declined signi cantly as evidenced by the survey responses. 82% of respondents do NOT gross up any perquisites for tax purposes. Within the 18% of organizations that do gross up perquisites, car allowance is the most commonly grossed up perquisite. When considered individually, an executive perquisite may not be costly for an organization to provide; however, when packaged into a suite of executive perquisites, the value of these bene ts can grow exponentially and the likelihood of public scrutiny increases. The table below provides an expansive list of perquisites and their prevalence based on executive level. Executive Perquisites O ered President &CEO Executive and Senior Division Heads Based on Compensation Cellular Phones 79% 94% 87% 83% 67% 9% Exec Severance Pay Practice 51% 87% 80% 58% 29% 8% Employment Contracts 48% 19% 55% 23% 13% 8% Exec Physical Exams 43% 96% 85% 55% 20% 4% Golden Parachutes 42% 92% 83% 31% 13% 7% Exec Parking 39% 95% 83% 56% 27% 1% Exec Group Life Insurance 37% 88% 80% 57% 22% 10% Exec LTD 37% 84% 80% 60% 26% 22% Car Allowance 36% 78% 71% 56% 34% 4% Average Car Allowance $11,988 $10,921 $10,376 $11,187 $7,667 Amount Personal Financial 31% 95% 82% 40% 19% 6% Counseling/Tax Prep Company Cars 30% 93% 57% 38% 24% 4% Home O ce Equipment 29% 93% 66% 57% 29% 2% Exec Vacation Policy 28% 92% 84% 75% 33% 6% Executive Coaching 26% 92% 80% 52% 29% 5% Country Club Membership 24% 94% 51% 27% 9% 8% Company Aircraft Personal 18% 95% 41% 10% 7% 2% Use Key Person Life Insurance 18% 93% 56% 36% 15% 11% Event Tickets or Boxes 16% 92% 71% 55% 35% 10% Post-Emp Consulting 15% 63% 67% 41% 28% 15% Agreement Airline Club Membership 15% 93% 67% 41% 20% 4% Athletic/Fitness Club Membership 14% 93% 75% 64% 34% 11% Exec Medical Reimbursements 13% 93% 79% 50% 24% 5% Paid Spouse Travel Expenses 13% 93% 56% 20% 7% 5% Luncheon Membership 13% 93% 65% 30% 13% 8% 13

Executive Perquisites Journal of Compensation and Bene ts O ered President &CEO Executive and Senior Division Heads Based on Compensation Excess Personal Liability 11% 89% 83% 60% 29% 6% Insurance Exec Retiree Medical 10% 91% 81% 59% 47% 6% Cha eur 10% 90% 27% 10% 3% 7% Home Security 9% 89% 41% 11% 7% 7% Apartments/Houses/Suites 8% 71% 50% 13% 4% 4% Split Dollar Insurance 5% 73% 80% 53% 33% 13% Exec Dining Room 4% 86% 64% 50% 36% 14% Personal Legal Services 4% 92% 83% 67% 42% 8% Sabbatical Leave 3% 88% 88% 88% 75% 13% Dependent College Tuition 3% 63% 63% 63% 50% 25% Executive Flex Plan 3% 88% 75% 75% 50% 25% Average Executive Flex Plan Amount $24,800 $13,500 $6,750 $3,250 $6,000 EXECUTIVE BENEFITS IN THE FUTURE Most surveyed organizations indicate they are not planning to change their current executive retirement or perquisite programs. Are you expecting to make changes to your executive bene ts program in the near future? Deferred Executive Retirement Compensation Perquisites Yes 9% 15% 9% No 91% 85% 91% Install 10% 17% 7% Improve 34% 41% 37% Cut Back 24% 7% 30% The following conclusions can be drawn from the survey ndings: In aggregate, executive bene ts have not changed signi cantly in the past several years; although the composition of executive bene t packages may have changed. Participation in voluntary executive programs, such as deferred compensation programs, may be lower due to uncertainty regarding the future tax environment as well as the economy in general. Perquisites may be the one area in which organizations are scrutinizing their o erings by eliminating perquisites that either do not enable their executives to perform their job duties better or provide adequate security to the executive as well as the organization in the event of unforeseen circumstances. 14