If I Had a Crystal Ball

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This article is reprinted with permission from the January 2015 issue of PSX: The Exchange for People Strategy, an eMagazine that brings you cutting edge views and perspectives on all things related to people strategy.

Wouldn’t it be enticing to be able to take a peek into the future and observe the coming trends in the world of Executive Benefits?  Robert Birdsell looks at what the future might hold of for Qualified Retirement Plans, Non-Qualified Retirement Plans, and Other Executive Benefit Plans.  He shares the major shifts in the way executive benefits will be delivered, financed and administered in the years to come. 

However, here in the real world our predictive tools – our crystal balls, if you will – are cloudy, leaving the future cloaked in uncertainty. And we would have to suspend belief to believe in any magical predictive “crystal ball-like” tools. But all is not lost. Rather than rely on science fiction or fantasy based instruments, we can rely on our own instincts and experiences to predict what the future holds. What follows are some forecasts I foretell on the subjects of:
• Qualified Retirement Plans
• Non-Qualified Retirement Plans
• Other Executive Benefit Plans

Qualified Retirement Plans

In the area of Qualified Retirement Plans, I predict that little will change in the qualified plan arena over the next decade, although traditional defined benefit pension plan will experience continuing erosion. The downfall of this once nearly universal retirement plan offering began well over a decade ago as more and more companies terminated or froze these plans with few, if any, companies offering new defined benefit plans. There were several reasons for the exodus from this once popular benefit program but, without doubt, the primary culprit was the cost associated with both P&L and cash flow reporting. Many of the plans were either not funded at all or grossly underfunded which resulted in a dilemma for senior executives and their boards. The issue was resolved in many companies by either terminating the plans completely or modifying them significantly to reduce their financial impact.

The most prevalent among qualified plans offered today is the 401(k) program which gained popularity soon after its introduction in 1981. The advent of the 401(k) plan created a fundamental shift in the employer’s approach to the way retirement plans were offered in the workplace. Prior to the introduction of the 401(k), the most prevalent retirement plan was the defined benefit pension plan. As we observed earlier, defined benefit plans have been losing favor with employers because of their exponentially growing future liabilities and the administrative burdens required. After the introduction of 401(k) plans, individuals became more involved in and, in fact, in charge of their own retirement plan accounts. The employer simply provides the opportunity for its employees to create their own retirement plans. And while most employers do provide a matching contribution to the 401(k) plan, this cost is controllable and the contribution can be linked to the profitability of the company. As we’re beginning to see, the transition from defined benefit pension plans to the now popular 401(k) is proving to be a useful model to follow in other areas, such as healthcare.

Some people think that the growing popularity of the 401(k) plan was accidental while others see the increase in attractiveness as a wave of the future, a trend that will put the employee in charge of his/her own welfare while relying on the company to provide only access and sponsorship. This trend can also be observed in the non-qualified benefit arena.

From the beginning, 401(k) plans benefited lower income employees because of the limits placed on plan contributions for higher income employees. This fact contributed to the growth of “Non-Qualified” plans which were designed to allow higher income employees to contribute literally as much as they desired to the “Non-Qualified” alternative.

Non-Qualified Retirement Plans

There are two primary types of “Non-Qualified” plans: Traditional and Nontraditional. For several decades, Traditional Non-Qualified Retirement plans have become part of the mainstream benefit offerings of most companies desiring to attract, retain and reward key executives. As suggested above, much of the growth occurred after companies realized that the 401(k) plan would not satisfy the retirement needs of their highly compensated employees. The most common Non-Qualified Deferred Compensation Plan operates similarly to a 401(k) plan as the participant elects to defer a certain amount of current income to some point into the future and not pay tax on either the deferrals or the earnings until distribution.As these plans grew in popularity, the designs also expanded to include the opportunity for pre-retirement scheduled distributions, expanded investment options, hair-cut distributions with little or no requirement for a personal hardship, and liberal contribution and distribution provisions.

Everything with respect to these plans was working just fine until Enron and few other nefarious companies began allowing their executives to drain the accounts prior to declaring bankruptcy. This resulted in Congress amending the tax code with §409A. This new law caused much anxiety for both the sponsoring company and its participating executives. For the company, it created complex new and restrictive rules which, if not strictly adhered to, would result in severe fines and possible plan disqualification. For the executive participant, §409A resulted in punitive restrictions on many aspects of deferred compensation, most notably on the timing of the deferrals and austere distribution rules. Rules regarding informally funding these plans also were subject to new restrictions and limitations. The final blow occurred when the participant could no longer elect to take any distribution from the plan prior to a specific, scheduled distribution date. As a result of this legislation, the popularity of Non-Qualified Deferred Compensation plans has declined.

Since the enactment of §409A, companies and executives have been searching for an alternative to the traditional deferred compensation plan, something that would be easier to implement, offer comparable benefits and be less costly to administer. Enter the new world of “Non-Traditional” plans.

Non-Traditional (Non-Qualified) Deferral and Other Executive Benefit Plans

Here is where we will take a leap into the future and make several predictions based on observations and comments we’ve gleaned from clients, associates and other subject matter experts.

Up until recently, companies were content to follow the herd with respect to offering their key executives supplemental benefit programs designed to attract, reward and retain their top talent. Excluding stock plans from consideration, most companies offered the traditional deferred compensation plans, SERPs (Supplemental Executive Retirement Plans), and a few provided supplemental disability income plans as well. Other programs often included supplemental life insurance plans; most common were split dollar plans. Each of these programs were funded and administered by the company and, therefore, much control over the design rested on the company’s Human Resources and Finance departments.

The trends we are beginning to observe involve a movement that allows the executive more control of his/her own financial future. Unlike the recent past where companies assumed a major role in deciding what is best for their executive population, a growing movement shifts the company’s role to that of a facilitator/sponsor. In this scenario the company does not assume the role of program designer where one design fits all. Rather the programs have built in flexibility that permits the executive to make individual decisions. After all, executives today are indeed capable of making their own decisions relating to retirement income needs, short and long term cash and family protection requirements, as well as disability income requirements, since the circumstances of each executive differs greatly.

This type of benefit, ‘Executive Personal Financial Planning’ has been around for several decades but, like so many other executive benefit plans, has lost its appeal and luster for a couple of reasons. First, the company sponsoring such a plan must make a long-term commitment to one financial planning firm. After that commitment is sealed, this organization is given confidential executive data such as income, the structure of the firm’s incentive and benefit plans, etc., after which the planning organization contacts each executive in an effort to meet with them one-on-one.

The difficulty with this approach is simple; it is enormously expensive ($10,000 to $50,000 per executive) and involves a tremendous time commitment from the executive with an end product that is little more than a complex written report with myriad of charts and schedules that require someone else to translate the message and, most frustrating, will be obsolete soon almost as soon as it is produced. It is time for us to examine a new paradigm for executive financial planning.

Most executives with whom we’ve met have engaged their own investment advisor and prefer not to use someone appointed by the company. Their advisor is someone with whom they have already developed a personal relationship and are conformable discussing issues relating to their financial and investment needs. Company sponsored financial planning programs may even seem intrusive and, therefore, unappealing to many eligible executives.

Perhaps the most important reasons not to offer a traditional, company-sponsored financial planning program is that new technology provides executives with complete, useful and understandable information about how to manage their financial affairs and interpret their benefit programs. Today’s technology allows executives to evaluate their benefit options and complete simple but accurate projections about what is right for them and how the company’s plans will fit into their personal financial plan.

Financial planning programs can be customized for each client company at a fraction of the cost of the outdated financial planning model described above. These financial planning programs can be constructed so that each executive benefit offering is easily accessed on-line and evaluated on an individual basis without the intrusion and time commitment required of the traditional financial planning model. And, most important, the system can be accessed at the executive’s leisure and in the comfort of his/her own home.

Now you might be wondering if all this is driven by technology, what role will the company play in its evolution? That’s an excellent question and worthy of a complete answer. In fact, the balance of this article will be devoted to providing a prediction on how executive benefits will be delivered in the future.

Executive Benefits of the Future

First, in order for the company to play a meaningful role in delivering this new type of executive benefit, two simple questions should be presented. First, what products and services is the company able to offer that the executive cannot secure on his/her own? Second, and equally important, are these products and services provided at lower cost to the company when compared to the traditional plans described above?

When a company endorses/sponsors and otherwise supports a benefit program, it is often able to provide the leverage necessary to secure products and services that are not available to the individuals and deliver these products on highly favorable terms. The products would be secured on-line and without direct company involvement other than possibly establishing a payroll deduction to fund the benefits. Program administration is conducted by a third party with little or no involvement on the part of the company.

The question then becomes, what exactly are these benefits/products? The answer to that question involves asking another question: “What do executives need that they may have difficulty securing on their own?” We maintain that, other than stock plans (which this article is not examining), executives need only 5 key benefits:
1. family income protection plan
2. individual disability protection plan
3. tax advantaged cash accumulation plan
4. supplemental retirement plan(s)
5. estate protection plan.

Products and services that are able to address these needs can best be satisfied through various life, disability and health insurance contracts. You might be wondering “what’s so new about that?”

Insurance companies today have developed very attractive contracts that can only be purchased through the sponsorship of a large company. The benefits provided are vastly superior to those that can be purchased on an individual basis. Probably the most significant benefit that can be achieved is guaranteed issue. All applications are approved regardless of the health of the individual. This is true for both life insurance and disability plans.

Why is that such a big deal? The reality is that 40% of all disability applications and 25% of all life applications are either declined, rated, or have provisions limiting the desired coverage. But the most compelling argument involves time. Busy executives today are not inclined to subject themselves to the inconvenience of going through traditional medical and financial underwriting which can take weeks or even months to complete and, in the end, result in the application being declined or highly rated. These facts alone provide a great incentive for the company to establish such a program.

In addition to the benefits described above, the products that can be secured are vastly superior to those that are available only on an individual or retail level. Both the pricing and the underlying benefits delivered are much more robust than can be purchased individually without the sponsorship of a company. In addition to the advantages of pricing and superior benefits, another truly outstanding advantage involves the underlying investment value. The return credited on this product using this approach is generally tied to an index, most commonly the S & P 500. In addition, most offer downside protection, meaning that the insurance company underwriting the policy will credit the cash value with a return tied to the S & P but guarantee that the owner will not lose money in a down market. However, there is a limit on the upside which is generally 12% to 14% (essentially this is the price paid for the guarantee.)

Aside from the simplicity of securing the contracts, other benefits may be even more significant. In a traditional environment where the company has established a Non-Qualified Deferred Compensation Plan, the executive has little opportunity to design a plan that best suits his/her needs. Participants are limited by the rules and procedures established under §409A, without regard for his/her individual financial requirements.

Under the new benefit program outlined above, each executive would have access to an on-line system designed specifically for his/her company. In addition to providing an overview of the new plan(s), each participant would have the tools available to design a program which is suitable to his/her personal financial requirements. This could focus on family protection needs, estate protection shortfalls, cash needs in the short term or long term, supplemental retirement income, or disability income shortfalls.

Coordinating these benefit offerings with the executive’s personal tax and investment advisor will provide additional advantages for each participant. Those executives requiring assistance with navigating the site will be offered the opportunity to schedule a time to speak with an executive benefit consultant from the organization sponsoring the program.

Although programs designed to meet the needs of the executive can be secured without financial involvement or commitment from the company, a modest company contribution can secure a much more hearty guaranteed issue program by further encouraging executive participation.

Summary

In summary, my prognostications suggest a major shift is already evolving in the way executive benefits will be delivered, financed and administered in the years to come. Companies will provide access to secure programs that are not available on an individual basis and perhaps provide a modest financial contribution to secure guaranteed issue insurance policies. Whatever contribution the company elects to make to the program would be a deductible item for the company and an income item for the participant.

We are confident the plan outlined in this article will deliver more valuable benefits for the executive and lower cost for the company. We feel this approach is long overdue!

Bob Birdsell can be reached at robert.birdsell@grahall.com

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