Supplemntary employee retirement plans are in the spotlight
A decade ago, supplementary employee retirement plans (SERPs) were a relatively obscure HR tool. Now they’re very much in the spotlight.
Employees are worried about the adequacy and security of their pension benefits. Employers are concerned about rising costs of funding and the inherent risks in sponsoring plans. Directors in turn are under pressure to ensure that senior management’s performance-based compensation really reflects the organization’s performance. And to top it off, investors and the media are demanding full disclosure.
SERPs restore pension adequacy for higher earners. This is to address the impact of federal government limits on the benefits that can be provided through a registered retirement plan — limits that have remained essentially unchanged since 1976. As salaries have risen, more people are affected by these limits so that it is no longer just senior executives whose pensions are affected.
A survey of 280 Canadian SERPs by Towers Perrin, confirmed SERP coverage for staff below the executive level has grown since 2000 (but may be starting to plateau). Meanwhile, there is greater differentiation between executive-only and broad-based SERPs. Both types are making greater use of defined contribution (DC) components.
Nearly three-quarters of survey respondents now sponsor SERPs. While larger organizations are more likely to offer this benefit, almost two-thirds of smaller organizations polled (those with less than 500 employees) have a SERP arrangement. Cost constraints and an insufficient number of employees affected by the registered pension plan limits were the main reasons cited for not having a SERP.
Consistent with the trend observed for registered pension plans, SERP arrangements are more likely today to have a defined contribution element in their design — in some cases as an adjunct to a defined benefit design element. This shift — together with the prospect of having multiple SERP arrangements, each covering a different employee group — is leading to SERP arrangements that are increasingly complicated to administer. The problem is much like the growing administration challenges that registered pension plan sponsors face.
About 53 per cent of SERP sponsors now cover employees below the executive level. That’s up slightly from 50 per cent in 2000. But among those organizations having only an executive SERP arrangement, relatively few organizations indicated that they might soon extend coverage to include other employees.
Increasing security
The security of SERP benefits is also being enhanced. Overall, 41 per cent of SERPs are now prefunded or secured in some manner. That’s up from 33 per cent in 2000. Part of the gain is attributable to the growth of DC, as these are more likely to be funded. But the prevalence of funding/security has also increased for defined benefit plans in isolation, perhaps reflecting increased concerns among plan members. This trend toward funding/security is likely to continue.
There are three main approaches that organizations use to provide security.
Some organizations simply pay a “pension bonus” each year in lieu of an accumulating defined contribution SERP entitlement. While limited in scope to defined contribution plans, this approach is “clean” as obligations are essentially settled as earned.
Benefits are secured from the perspective of participants — but participants also face earlier payment of taxes on these entitlements. Although this approach is being used by just four per cent of SERPs (or by 21 per cent of DC SERPs), it is likely that number will increase in the years ahead.
About 13 per cent of respondents now offer funded retirement compensation arrangements (RCAs), up marginally from 2000. Leaving aside many differences in detail, this approach is akin to the way registered pension plans are funded except that fund investment earnings are subject to tax — in effect, a 50 per cent tax. This high rate of tax often makes the approach more expensive than other security alternatives, especially so for an organization that is tax-exempt or taxable at a low rate.
Letters of credit are the most common security approach — used for 19 per cent of SERPs, compared to 17 per cent in 2000. In effect, this approach involves a trust that holds a letter of credit. If a “trigger event” arises, the letter of credit is called and the trust is available to meet subsequent SERP obligations even if the sponsoring organization is not. Under this approach, the letter of credit is regularly renewed and its size is assessed by actuarial valuation at each renewal.
Although the 2004 SERP survey reveals movement toward funding/security, most arrangements (59 per cent) remain on a “pay-as-you-go” approach.
However, there is a growing trend to earmark assets for these pay-as-you-go plans. The survey found that among SERPs that are not prefunded or secured, 19 per cent involve an internal earmarking of specific employer assets for SERP purposes. However, they stop short of setting these assets aside beyond the employer’s ownership. Earmarking does not protect benefits from corporate failure (as the assets could be attached by the employer’s creditors), but it demonstrates financial discipline. The trend suggests that many more organizations would likely prefund SERPs if the tax costs were less onerous.
More differentiation
SERP objectives for executives are often different from those for other employees. For example, the ability to attract and retain talent was cited as a SERP objective for both executive and other employees — but greater importance is placed on this objective for the executive group.
Similarly, competitiveness with industry practice and tax-effective delivery of compensation are relatively more important considerations for an organization’s executive team.
Not surprisingly then, the study revealed increased differentiation for executives. To illustrate, executive-only SERPs often have a higher benefit formula or differ in their treatment of bonus awards for pension purposes. Executive-only plans are also more likely to have special enhancements for individual participants, such as extra years of credited service.
This differentiation is not limited to the benefit formula, nor is the difference always an improvement. For example, vesting criteria frequently differ between executives and other employees — with the criteria being tougher for executives.
Better communication
Approximately 60 per cent of all SERPs provide periodic pension statements and are specified in a formal plan document. While this is an improvement from prior practice, it seems that a sizable portion of SERPs continue not to have these documentation elements. Without proper documentation, the employer may be found liable for unintended benefits, and may also be getting “less bang for its buck” in terms of employee understanding and appreciation. Benefit security may also be undermined, as funding/security necessitates that there be a clearly-articulated benefit entitlement.
The study shows that SERPs are now “on the radar screen” for most organizations. And greater use of the practice has in turn led to heightened interest in SERP practices, as many employers are benchmarking against competitors to identify any misalignment of the SERP program (or lack of SERP) with the organization’s workforce management strategies and related reward objectives.
Gerry Schnurr and Lyle Teichman are both principals with Towers Perrin. They can be reached at [email protected] and [email protected].
SERPs facing more scrutiny
Supplementary Employee Retirement Plans are under pressure from a number of quarters, Towers Perrin’s 2004 SERP Report notes. Here’s a look at the stakeholders and their areas of concern:
Plan sponsors
•Cost of funding.
•Risks and liabilities.
Boards
•Alignment with performance.
•Managing total compensation costs.
Plan members
•Competitiveness.
•Security.
•Sufficiency.
Investors, media, employees
•Better disclosure.
•Responsible pay.
•Equity.
Employees are worried about the adequacy and security of their pension benefits. Employers are concerned about rising costs of funding and the inherent risks in sponsoring plans. Directors in turn are under pressure to ensure that senior management’s performance-based compensation really reflects the organization’s performance. And to top it off, investors and the media are demanding full disclosure.
SERPs restore pension adequacy for higher earners. This is to address the impact of federal government limits on the benefits that can be provided through a registered retirement plan — limits that have remained essentially unchanged since 1976. As salaries have risen, more people are affected by these limits so that it is no longer just senior executives whose pensions are affected.
A survey of 280 Canadian SERPs by Towers Perrin, confirmed SERP coverage for staff below the executive level has grown since 2000 (but may be starting to plateau). Meanwhile, there is greater differentiation between executive-only and broad-based SERPs. Both types are making greater use of defined contribution (DC) components.
Nearly three-quarters of survey respondents now sponsor SERPs. While larger organizations are more likely to offer this benefit, almost two-thirds of smaller organizations polled (those with less than 500 employees) have a SERP arrangement. Cost constraints and an insufficient number of employees affected by the registered pension plan limits were the main reasons cited for not having a SERP.
Consistent with the trend observed for registered pension plans, SERP arrangements are more likely today to have a defined contribution element in their design — in some cases as an adjunct to a defined benefit design element. This shift — together with the prospect of having multiple SERP arrangements, each covering a different employee group — is leading to SERP arrangements that are increasingly complicated to administer. The problem is much like the growing administration challenges that registered pension plan sponsors face.
About 53 per cent of SERP sponsors now cover employees below the executive level. That’s up slightly from 50 per cent in 2000. But among those organizations having only an executive SERP arrangement, relatively few organizations indicated that they might soon extend coverage to include other employees.
Increasing security
The security of SERP benefits is also being enhanced. Overall, 41 per cent of SERPs are now prefunded or secured in some manner. That’s up from 33 per cent in 2000. Part of the gain is attributable to the growth of DC, as these are more likely to be funded. But the prevalence of funding/security has also increased for defined benefit plans in isolation, perhaps reflecting increased concerns among plan members. This trend toward funding/security is likely to continue.
There are three main approaches that organizations use to provide security.
Some organizations simply pay a “pension bonus” each year in lieu of an accumulating defined contribution SERP entitlement. While limited in scope to defined contribution plans, this approach is “clean” as obligations are essentially settled as earned.
Benefits are secured from the perspective of participants — but participants also face earlier payment of taxes on these entitlements. Although this approach is being used by just four per cent of SERPs (or by 21 per cent of DC SERPs), it is likely that number will increase in the years ahead.
About 13 per cent of respondents now offer funded retirement compensation arrangements (RCAs), up marginally from 2000. Leaving aside many differences in detail, this approach is akin to the way registered pension plans are funded except that fund investment earnings are subject to tax — in effect, a 50 per cent tax. This high rate of tax often makes the approach more expensive than other security alternatives, especially so for an organization that is tax-exempt or taxable at a low rate.
Letters of credit are the most common security approach — used for 19 per cent of SERPs, compared to 17 per cent in 2000. In effect, this approach involves a trust that holds a letter of credit. If a “trigger event” arises, the letter of credit is called and the trust is available to meet subsequent SERP obligations even if the sponsoring organization is not. Under this approach, the letter of credit is regularly renewed and its size is assessed by actuarial valuation at each renewal.
Although the 2004 SERP survey reveals movement toward funding/security, most arrangements (59 per cent) remain on a “pay-as-you-go” approach.
However, there is a growing trend to earmark assets for these pay-as-you-go plans. The survey found that among SERPs that are not prefunded or secured, 19 per cent involve an internal earmarking of specific employer assets for SERP purposes. However, they stop short of setting these assets aside beyond the employer’s ownership. Earmarking does not protect benefits from corporate failure (as the assets could be attached by the employer’s creditors), but it demonstrates financial discipline. The trend suggests that many more organizations would likely prefund SERPs if the tax costs were less onerous.
More differentiation
SERP objectives for executives are often different from those for other employees. For example, the ability to attract and retain talent was cited as a SERP objective for both executive and other employees — but greater importance is placed on this objective for the executive group.
Similarly, competitiveness with industry practice and tax-effective delivery of compensation are relatively more important considerations for an organization’s executive team.
Not surprisingly then, the study revealed increased differentiation for executives. To illustrate, executive-only SERPs often have a higher benefit formula or differ in their treatment of bonus awards for pension purposes. Executive-only plans are also more likely to have special enhancements for individual participants, such as extra years of credited service.
This differentiation is not limited to the benefit formula, nor is the difference always an improvement. For example, vesting criteria frequently differ between executives and other employees — with the criteria being tougher for executives.
Better communication
Approximately 60 per cent of all SERPs provide periodic pension statements and are specified in a formal plan document. While this is an improvement from prior practice, it seems that a sizable portion of SERPs continue not to have these documentation elements. Without proper documentation, the employer may be found liable for unintended benefits, and may also be getting “less bang for its buck” in terms of employee understanding and appreciation. Benefit security may also be undermined, as funding/security necessitates that there be a clearly-articulated benefit entitlement.
The study shows that SERPs are now “on the radar screen” for most organizations. And greater use of the practice has in turn led to heightened interest in SERP practices, as many employers are benchmarking against competitors to identify any misalignment of the SERP program (or lack of SERP) with the organization’s workforce management strategies and related reward objectives.
Gerry Schnurr and Lyle Teichman are both principals with Towers Perrin. They can be reached at [email protected] and [email protected].
SERPs facing more scrutiny
Supplementary Employee Retirement Plans are under pressure from a number of quarters, Towers Perrin’s 2004 SERP Report notes. Here’s a look at the stakeholders and their areas of concern:
Plan sponsors
•Cost of funding.
•Risks and liabilities.
Boards
•Alignment with performance.
•Managing total compensation costs.
Plan members
•Competitiveness.
•Security.
•Sufficiency.
Investors, media, employees
•Better disclosure.
•Responsible pay.
•Equity.
