Effective Compensation Program Design

HR& BENEFITS March/April 2014

Retirement Income Solutions with Guaranteed Minimum Withdrawal Benefits

RETIREMENT

Retirement income solutions (RIS) are retirement plan investment options designed to generate a post-retirement income stream from participant-accumulated retirement savings, and include guarantees of minimum withdrawal amounts for life. These products, generically known as guaranteed minimum withdrawal benefit (GMWB) programs, intend to address the very real issue of retirees exhausting their savings during their lifetime. These products incorporate benefits of equity investing (i.e., target-date funds) with annuity income features and minimum withdrawal guarantees for an added fee (presently 50–100 basis points depending on guarantee provisions). RIS/GMWBs are currently experiencing dynamic product development and are attracting significant interest in the press and among plan sponsors. Effective Compensation As these products continue to evolve and become more accessible, this concept is Program Design also receiving support from Washington HUMAN RESOURCES regulators who are concerned about the issue of retirement readiness of the Compensation should always be an important term to use when employees are simply population in general. Phyllis Borzi, assistant consideration for organizations. After all, unhappy about their jobs in general. In other secretary of the Employee Benefits Security remaining competitively positioned in the cases, providing “compensation” as a stated Administration (the enforcement arm of the marketplace for talent plays a central role reason for resigning from the organization is Department of Labor [DOL]), is stimulating a in the retention of top performers. However, more politically acceptable than reporting “I national dialogue on the topic of participant it is a particularly compelling concern for can’t stand my supervisor.” retirement readiness and potential solutions organizations at this point in time, as the to the well-documented problem that few Therefore, while it is important to take seriously economy continues to improve and many participants are on track for successful employee complaints, concerns and turnover businesses resume their plans for growth that may be related to compensation issues, and/or expansion to new markets. Continued on Page 3 it is perhaps more important to ensure Recognizing that a compensation program that we analyze and properly examine the is potentially ineffective can be relatively organization’s compensation system and how straightforward. For example, current it compares to compensation offerings in the employees may voice dissatisfaction with their marketplace in which we compete for human base salary or bonus, sales staff may complain capital. The following are some key points to Need more information? that commissions do not adequately reward remember before we begin the development For information on any their results or resigning employees may and/or analysis of an organization’s report in exit surveys that they are leaving the compensation system: of the articles in this company for higher wages elsewhere. Consider the current culture and the culture newsletter, please contact However, we should remain mindful that not you aim to create. Is the organizational culture your benefits advisor. all employee complaints or reports about a performance-oriented or entitlement-oriented inadequate or inequitable compensation are, at one? How will we create a compensation their core, actual compensation problems. In program that attracts, motivates and many cases, “compensation” is a convenient retains top-flight performers? How will our

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“Effective Compensation Program Design” continued from Page 1 compensation system drive the achievement of Before establishing a compensation system, Perform a competitive analysis. Once the our business and financial objectives? the organization must define the appropriate organization has considered its unique culture, geographical area from which it recruits decided its market pay policy and determined All of these questions should be considered each individual position. the relevant marketplace for labor, then it should and resolved before developing a new benchmark compensation for every position compensation system or analyzing the and repeat the process in regular intervals every current one. Effectively designing a new one to two years. Decide where the organization wants or revised compensation This complex analysis requires the use to position itself in the marketplace. The of survey data (commercially available to organization must decide on a pay policy, system requires the HR/compensation practitioners) to compare which illustrates how it intends to react to base pay, bonus/incentive/commissions pay market changes and pressures. organization to first invest and total compensation of each position with In doing so, the organization establishes time in considering and that of the same or similar positions in other whether it will: analyzing important internal organizations in the relevant labor market. This process is undertaken to determine external • Lead the market by paying employees and external factors. (marketplace) equity. above‑market wages A separate analysis may also be completed • Match/follow the market by paying However, the result is a to determine internal equity for each position. employees comparable marketplace rates compensation strategy This process involves the hierarchical ranking • Lag the market by paying employees of all positions to determine their relative worth below‑marketplace wages for their and program that can in the organization. The ranking process is respective jobs be more effective in undertaken to ensure that each position is compensated according to the value of its Organizations that pay above-market rates recruiting, motivating contributions (both tangible and intangible) often do so to attain or retain marketplace to the organization. It can also be utilized dominance, or to secure and retain the “best” and retaining exceptional to determine if individual employees within talent available. talent, and increasing a particular position/job classification are Those that pay below-market rates may do compensated equitably as compared to one so because of an overly abundant supply of organizational performance, another, given each incumbent’s education, labor in the market. However, more often, productivity and profits. experience and work history. these organizations pay lower wages out At the completion of these efforts, the of necessity — they simply cannot afford organization has sufficient information to build a marketplace pay rates and/or the organization competitive and equitable base compensation itself is in a period of decline/demise. • Revenue and size: The organization’s revenue and number of employees grid, including pay grades and pay ranges, Most organizations choose to take neither a are important factors as well. Larger or salary bands, depending on its approach. leading nor lagging role with respect to wages, organizations with healthy revenues are It also presents a starting point for designing and instead pay comparably with that of other generally more willing and able to pay bonus/incentive and commissions plans for employers in the relevant labor market. employees competitive wages, while smaller some or all positions. Determine the relevant marketplace for organizations with fewer resources may Effectively designing a new or revised labor. Regardless of where the organization be less so. This is not always the situation, compensation system requires the organization positions itself in the labor market, it must however, as in the case of a large employer to first invest time in considering and determine the relevant marketplace in which that is in a period of decline/demise, or analyzing important internal and external it competes for labor. This is not necessarily a smaller employer that is in a period factors. However, the result is a compensation the same marketplace as the one in which of rapid growth. strategy and program that can be more the organization does business or competes For purposes of defining the relevant labor effective in recruiting, motivating and retaining for customers. market, though, we generally choose exceptional talent, and increasing organizational Several factors are involved in determining the to compare the organization to those of performance, productivity and profits. relevant labor market, such as: similar size with respect to revenues and To learn more, look for webinars offered by NFP HR number of employees. Services. These programs offer a comprehensive • Geographical location(s): Where does the • Industry type: The types of industry or look at HR topics and include best practices for organization operate? From where do we managers. As part of our total partnership offering, industries in which the organization operates recruit employees? From what area(s) do NFP HR Services extends a wide range of human candidates come to us for employment? and in which it competes for talent are also resources solutions to our clients, through our network significant factors in determining the relevant of highly capable, senior-level consultants. We offer One organization may recruit in the only labor market. Declining industries, such as customized, solution-oriented consulting for all of your metropolitan area in which it operates. manufacturing or railroads, generally pay less human capital challenges. Another may source candidates from several competitive wages while “sunrise” emerging areas in which it has multiple operations. or high-growth industries can often afford Others may seek qualified candidates to pay more generously. In addition, as we on a statewide, regional or even national define the relevant labor market, we must basis in order to remain competitive. Most include any related industries with which the organizations have a mixed approach, with organization competes for talent. many positions sourced locally, while some positions require a broader recruiting net. HR& BENEFITS 3

“Retirement Income Solutions ...” continued from Page 1 retirement. Interested parties are predicting that Second, evaluate factors unique to GMWBs of income, participant access to their account these products may receive similar support and RIS products: balance, annuity purchase rates, etc. as auto enrollment received from the Pension • Guarantees – The existence and viability of It is anticipated that RIS or similar products will Protection Act of 2006. guarantees make these products attractive. play a meaningful role in participant retirement Interest in GMWBs at the plan level does denote Considerations include: What are the planning in the near future. It is still early in certain fiduciary implications. Offering a GMWB guarantees? What is the financial strength the stage of product development, and there as a core plan investment option is a fiduciary of the provider supporting these guarantees is not yet any direct guidance or safe harbor decision and carries the responsibilities that any (evaluate capital/surplus/reserve adequacy)? provision from the DOL for fiduciaries. These fiduciary decision entails. What is the experience and expertise of products are likely to evolve considerably the insurer with this or similar products? over the next few years. The interest rate How Should a Fiduciary Prudently Is the cost/benefit analysis of the product environment may become more conducive to Consider These Products? “reasonable” per DOL standards? Would providing attractive annuity purchase rates. Based on regulator support, there soon may be First, utilize the same process in making all this product produce a significant benefit fiduciary safe harbor for fiduciaries. As these investment fiduciary decisions. Recent DOL for participants? products evolve and conditions change, some guidance on selecting and monitoring qualified • Hedging – A significant component in RIS of the above questions will be easier for a default investment alternatives (QDIAs) may be products, how is the hedging accomplished? fiduciary to answer. applicable to RIS and GMWBs. This process What is the history and strength of includes what the Internal Revenue Service their services? The development of products that can serve considers “procedural prudence,” and consists the participant in a meaningful way is to be • Administrative capabilities – What is of the following steps: applauded. Your plan consultant would be the provider’s experience administering happy to assist if you decide that RIS/GMWB is RIS? What is the history and strength • Identify and gather information to timely to consider for your plan. be considered. of their services? • Evaluate the information as a prudent expert • Portability – What accommodations are (hire an expert if necessary). available to participants in the event of fund or provider removal? Or upon eligibility for • Determine the most prudent course of action distribution? Are there alternative solutions to benefit participants. available? Might this issue be better • Take appropriate action. addressed with an “out of plan” solution, • Document activity. thereby avoiding the fiduciary issues? Every provider’s version of RIS/GMWB is • Periodically revisit the decision to ensure that different. Each has unique provisions that need it continues to be prudent. evaluation, such as the nature of guarantees

No. Many third-party administrators or an employer may not use a stand-alone HRA vendors are currently marketing products to reimburse the cost of an individual policy. To to employers claiming that the employer do so would violate the Patient Protection and may reimburse employees for individual Affordable Care Act’s (PPACA’s) prohibition on policy premiums on a pretax basis. These annual dollar limits for essential health benefits Compliance products may have a name such as Section and the requirement to cover preventive 105 plan, Health Reimbursement Plan or services. For plan years starting on or after Premium Reimbursement Arrangement. No Jan. 1, 2014, an HRA must be integrated with a matter what the product is called, effective group health plan. in 2014, an employer may not pay or provide In regard to cafeteria plans, the Internal reimbursement, on a pretax basis, for the cost Revenue Code excludes individual marketplace of an employee’s individual policy. coverage from the list of benefits that may be In order for an employer to provide offered through a Section 125 cafeteria plan. tax‑advantaged health benefits to employees, it Further, Notice 2013-54 provides that other must do so through a permissible arrangement, employer payment plans, which would include such as a Section 125 cafeteria plan, a a cafeteria plan, may not reimburse employees health reimbursement arrangement (HRA), for the purchase of an individual policy. Thus, Question: May an health flexible spending arrangement (FSA) an employee is not permitted to pay pretax or health savings account (HSA). Most of the premiums through an employer’s cafeteria plan employer pay or provide products being marketed to employers fit the for an individual policy purchased either inside reimbursement, on a pretax definition of an HRA. An HRA is a self‑funded or outside of the marketplace. arrangement under Section 105 that is 100 Per existing Treasury Regulations, insurance basis, for the cost of an percent employer funded and provides premiums are not a qualified medical expense employee’s individual policy? reimbursement for qualified medical expenses, from a health FSA. Finally, an HSA only permits which historically included premiums. However, tax-advantaged reimbursement of premiums on Sept. 13, 2013, the Internal Revenue Service in limited circumstances related to COBRA issued guidance (Notice 2013-54) clarifying that Continued on Page 4 HR& BENEFITS 4

“Compliance FAQ” continued from Page 3

or USERRA coverage, qualified long-term This article is a high-level overview of the care policies, an individual who is receiving legal requirements related to this issue. The unemployment compensation or an individual guidelines are discussed in greater detail in our who is aged 65 or older. white paper “The Future of HRAs and Employer Reimbursement for Outside Coverage.” To In summary, an employer may not reimburse request a copy of the white paper, please an employee on a tax-advantaged basis for contact your advisor. the cost of an individual policy or pay for such coverage directly. Failure to comply could put the employer at risk for a penalty under PPACA, which is $100 per day per affected individual.

This material was created by NFP (National Financial Partners Corp.), its subsidiaries or affiliates for distribution by their representatives and/or agents. This material was created to provide accurate and reliable information on the subjects covered, but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. Neither NFP nor its subsidiaries or affiliates offer tax or legal advice.

The services of an appropriate professional should be sought regarding your individual situation. Neither NFP nor its affiliates offer legal or tax services. Securities and Investment Advisory Services may be offered through NFP Securities, Inc. member FINRA/SIPC. NFP Securities, Inc. and the firm branded on this document are affiliated.