For benefits packages, not exactly. Instead, financial executives will find themselves treading familiar ground in the year to come

WE WANTED TO START THIS ARTICLE WITH A REAL SHOCKER—a statistic or tidbit regarding how compensation and benefits packages will drastically change in the future. What we found, however, is that employee benefits is really more a case of evolution than revolution.

 

Rather than shocking the world with its twists and turns, employee benefits will continue to inch along a somewhat predictable path. And, for most of us, that’s probably a good thing.

That said, experts do point to three areas to watch, namely retirement, healthcare and executive compensation. While the trends are not revolutionary, they affect the bottom line for all American employers and the people who work for them.

 

1. RETIREMENT

 

Phased Retirement

 

Rick Pearson, Chicago office lead for human resources professional services firm Towers Perrin, remembers retirement as it was in his father’s day: “My father worked full time through his sixty-fifth birthday. And then, that’s it, cold turkey—he walked out the door and onto the golf course. That’s going to be history. Virtually no one will retire in that manner in the future.”

 

While retirement was once something welcomed by both employees (a long-awaited rest) and employers (a chance to bring in fresh talent at lower costs), it now carries different strategic and financial ramifications.

 

“We’re seeing definite employer concerns regarding talent management,” Pearson explains. “It’s pretty scary when you do the projection. Roughly 40 to 50 percent of some employers’ populations are eligible for retirement and could be leaving.”

 

This, in a nutshell, is the Baby Boomer effect. Boomers make up a significant percentage of the current workforce. Many are hitting retirement age now, with subsequent waves retiring over the next 10 to 15 years.

 

“Phased retirement is simply a demographic imperative,” states Mark Johnson, founder and president of ERISA Benefits Consulting Inc. and former managing director of benefits compliance and pensions for American Airlines. “You will see more people who have technically reached retirement age working part-time and drawing a pension without penalty.”

 

In addition to the demographically induced talent shortage, employee concerns regarding financial resources during retirement will fuel the push toward phased retirement.

“You’re starting to see academics and the press push back to the financial professionals who set monetary goals for retirement, stating certain dollar amounts will be necessary,” says John Ameriks, an economist at Vanguard. “They’re asking how you can know what enough is. Of course, we’ll only truly know that when the first generation of retirees who have had to provide mainly for themselves—with less generous Social Security and no company-sponsored pension plan—does it. In an era where you pretty much have to single-handedly fund your own retirement, there likely will be just a small subset of the population that will retire from a career and never work again. Most of us will continue to work in some form to help maintain financial stability and security—as well as some of the non-economic rewards of being active in the workforce.”

 

The DBP Demise

 

Defined benefit pension (DBP) plans have been dying a slow death for the past 20 or 30 years, according to Johnson. A Hewitt Associates 2006-2007 study of major US employers cites 55 percent as providing a defined benefit pension plan, as opposed to the 91 percent who offered one back in 1985. In those days, employers offered DBPs to employees who, traditionally, would have worked for them and them alone over the long haul. In return, the company “took care” of its employees, which included funding their retirement. Employers were the only parties putting money into DBPs, and they bore the risk of the market return.

 

In today’s volatile market, however, employers are no longer willing to take that risk. More importantly, very few retain any one employee for the number of years it would take to make that investment worthwhile.

 

“For a DBP to make financial sense for any employer,” says Johnson, “that employer must have a large number of employees who have long careers solely at that company. That old employment pattern is definitely gone. As a result, DBPs are now obsolete delivery vehicles.” Johnson explains that alternative retirement savings plans (usually defined contribution plans) will continue to take the place of DBPs, with matching 401(k)s topping the list.

 

Karen Friedman is director of the Conversation on Coverage, a Pension Rights Center initiative funded by the Ford Foundation as well as other foundations and organizations such as AARP, MetLife, Fidelity Investments, AFL-CIO, the Service Employees International Union and US Chamber of Commerce. She says that what’s needed is a range of new solutions, including new forms of defined benefit plan and savings approaches, to help increase retirement income, particularly for low- and moderate-income wage earners.

 

“The reality is that the old notions of retirement income need to be updated,“ says Friedman.” To increase the number of American workers that have some kind of retirement savings plan, we initiated the Conversation on Coverage and brought together more than 45 benefits experts to create innovative, common-ground proposals that have the necessary buy-in to be potentially implemented in the near future.”

 
 
 

On May 11 of this year, the group’s findings were formally released to the public. They included proposals for:

 

Two new types of hybrid and traditional pension plans. The Guaranteed Account Plan (GAP) is a new type of hybrid plan, combining some features of traditional pension plans with those of traditional 401(k)s. Under a GAP, employers contribute to employees’ pension accounts and guarantee a promised rate of return. Funding rules protect the employer from steep future funding increases. The Plain Old Pension Plan (POPP) is a new traditional defined benefit pension plan with simpler and more predictable funding rules than its predecessors.

 

A clearinghouse for individual retirement accounts. The Retirement Investment Account (RIA) establishes a new national clearinghouse to administer portable IRAs. The structure provides an easy and efficient way for individuals not covered by a plan to save for retirement.

 

A new type of small-business plan. The Model T is a simplified, low-cost, multiple-employer/payroll-deduction plan. If adopted, it will be offered, sold and marketed by financial institutions to small employers where coverage rates are the lowest.

 

“Beginning a public conversation by getting more ideas into the marketplace will help lead to increased coverage,” says Friedman. She adds that the plans developed by the Conversation on Coverage could lead to proposals on Capitol Hill, as well as the possibility of testing in demonstration projects in particular communities.

 

The Need for Financial Education

 

Many Americans fail to realize just how much they’ll need for retirement, largely because they’re still partially funded by resources such as Social Security and traditional pensions—resources that may provide less support in the future.

 

If the 2007 Retirement Confidence Survey, sponsored by the Employee Benefit Research Institute (EBRI), is any indication, Americans are fairly naïve about what retirement will require of them in terms of funding. Twenty-six percent of those surveyed said they would need less than $250,000 to retire. When broken down by income, 43 percent of those earning less than $35,000 a year subscribed to the $250,000 figure, along with 28 percent of those earning $35,000 to $74,000. According to EBRI estimates, the majority of male workers should have a nest egg 12 times their income by the time they retire. That translates to $600,000 for a man earning $50,000 a year, for example. Because of their higher life expectancy, EBRI estimates that a female worker should have accumulated 14 times her income.

 

Various financial education programs are underway to help fill the information gap. The US Department of Labor’s Employee Benefits Security Administration, for example, sponsors Saving Matters, a retirement savings education campaign for individuals, small businesses and other employers. It also offers materials specifically targeted towards women and the Hispanic population. The Illinois CPA Society, too, has initiated various financial literary programs to help educate the public in retirement issues and the need for a calculated approach to saving for the future.

The challenge going forward won’t be the information void, however, but rather finding ways to change spending and savings habits. “All these things that we ‘need’ that our parents couldn’t ever dream of having, just tell us that we will have to be a bit more disciplined regarding saving and spending decisions. All the information in the world won’t change a habit. It takes a person to do that,” says Ameriks.

 
2. HEALTHCARE
 

Value-based Design

 

The rising cost of healthcare is an ever-present concern. Hence the trend toward value-based design, which provides plan benefits commensurate with the proven value of services delivered. “For example, if evidence-based medicine supports a given test or medication, the plan could provide that benefit for very little cost to the participant. If, however, the approach is not supported by evidence, the plan would require greater cost-sharing by the individual," explains Jeff Munn, leader of healthcare design and development for human resources consulting firm Hewitt Associates.

 

Munn believes future employers will be divided into two main benefit approach categories: Super Highway and Stoplight-to-Stoplight. “As the Internet has come into our lives, we’re accepting mass production less and less,” he says. “That’s the theory behind Super Highway employers. They’re shifting away from mass-produced healthcare solutions and approaches and looking at select classes of individuals based on healthcare profiles and needs.”

 

Munn goes on to explain that in its first iteration, a Super Highway employer might look at certain types of medicines used for preventive purposes—such as beta-blockers—and give this medicine to employees for free or at an extremely low copay. In the second iteration, this employer will have its benefits firm determine who is using beta-blockers and for what preventive purposes. If it’s to prevent a heart attack, the employer will continue to provide the medicine at no or low cost. For employees who might be using beta-blockers to prevent something less catastrophic (a migraine, for example), the copay may not be discounted. In yet a third iteration, the employer will focus on select classes of employees—those at risk of diabetes or those already suffering from it—and then educate and coach them on an individual or small group basis.

 

“A Super Highway employer is looking to have the healthiest employees because it recognizes that as a business advantage,” says Munn. “So data warehousing your employees’ health risks and needs in a much more detailed way becomes part of an overall business strategy. And addressing those needs based on that information in a preventive way becomes part of that strategy also.”

 

Munn contrasts this approach with the Stoplight-to-Stoplight employer who says, “What do we need to do this year to get our healthcare costs down 8 percent?” Oversimplified, it’s line-item thinking versus building healthcare costs into your business strategy, and trying to contain them with a very individualized approach. The Super Highway approach will work better in the future for the same reasons it works in any area of your business—strategy trumps line-item thinking every time.

 

Consumer-driven Plans

 

“When you think about healthcare costs, the natural tendency is to think about the big health claim, such as a major surgery or procedure,” says Johnson. “But for any employer with 4,000 or more employees, healthcare is a volume business. It’s a few thousand dollars per head on flu shots, diabetes medication, etc. The plan doesn’t pay anything for most routine healthcare; it only has to pay up when a significant expense is incurred. So, high deductible plans will continue to be good business. Offering a really good healthcare plan for major health events is cost-effective. Combine that with wellness programs and employee-funded healthcare savings accounts (HSAs). Now you’ve got a consumer-driven healthcare plan that works for the bottom line.”

 

When healthcare savings accounts were first allowed in the fourth quarter of 2004, more than 3 million were set up in that quarter alone, says Johnson, which is proof that employers and financial advisors are educating Americans on the financial benefits of HSAs. The Health Savings Account Research Center lists a few of the potential benefits:

 

Control—You can use the HSA to pay for any qualified medical expense, as defined by the IRS. There's no need for service preauthorization, unless explicitly stated by the plan.

 

Flexibility—While healthcare dollars can pay for items identified by the health insurance plan, they also can pay for a broader list of items as defined by the IRS, including dental, vision, orthodontia, over-the-counter medicine and others (not all of these are applied to the deductible). These may be things routinely paid for with post-tax dollars.

 

Portability—If you leave your current employer, you can take your HSA with you.

 

Tax savings—Your contributions to the HSA are made with pre-tax dollars, so individuals lower their income taxes.

 

No use-it-or-lose-it policy—Balances rollover from year to year, so you don't need a crystal ball to forecast medical expenses in the next year. Unused HSA dollars remain in the HSA.

 

That said, only about 1 percent of the privately insured US population (ages 21-64 years) was enrolled in a plan with a health savings account or health reimbursement arrangement as of September, 2006, according to the EBRI-Commonwealth Fund Consumerism in Health Care Survey. While our experts can’t predict a specific percentage of HSA use in the future, most feel that the number will rise exponentially as Medicare benefits drop.

 
 
 
 
 
3. EXECUTIVE COMPENSATION
 

The Reign of Pay for Performance

 

“Pay for performance will only increase in prevalence going forward,” states Doug Friske, a managing principal with Towers Perrin. “The flip side of that equation is that severance benefits in executive employment agreements will be less generous as an offset to incentive compensation realized while employed. You’ll also see fewer and less generous SERPs (Supplemental Executive Retirement Plans) going forward as companies migrate toward stronger pay-for-performance packages.”

 

This is a direct response to the increased influence shareholders wield over executive pay, partly due to the efforts of labor organizations such as the AFL-CIO. General Electric, Home Depot and Wal-Mart are among those that have felt the pressure.

 

To help the average worker track CEO compensation, the AFL-CIO formed the Paywatch program, citing a tendency for such pay to rise even as a company’s stock falls. The program also tracks pension and retirement benefits for many top executives.

 

The AFL-CIO states its position on its website: “A reasonable and fair compensation system for executives and workers is fundamental to the creation of long-term corporate value. However, the past two decades have seen an unprecedented growth in compensation for top executives and a dramatic increase in the ratio between the compensation of executives and their employees. Boards of directors are responsible for setting CEO pay. Too often, directors award compensation packages that go well beyond what is required to attract and retain executives and reward even poorly performing CEOs. These executive pay excesses come at the expense of shareholders as well as the company and its employees. Excessive CEO pay takes dollars out of the pockets of shareholders—including the retirement savings of America’s working families. Moreover, a poorly designed executive compensation package can reward decisions that are not in the long-term interests of a company, its shareholders and employees.”

 

Such efforts are expected to increase as more American workers lose traditional pensions and hold top brass responsible for their continued financial health. While the responsibility has always existed, the culpability is now more intense.

 

Split on Top-level Hiring

 

The Baby Boomer effect comes into play again when recruiting for top executive positions. With fewer bodies to fill the same number of spots as Boomers retire, even the C-suite will become harder to populate with the right talent. As a result, “You’ll see an increased focus on leadership development and succession planning,” says Friske.

 
 
 
 
 

Paul Dorf, managing director of Compensation Resources, explains that, “In the past, I think it was more common for people to stay at one company for most or all of their careers. This is certainly not the case anymore. Will companies go back to their old ways because of pending labor shortages? I don't think so, except in those organizations that have made a conscious effort to establish a succession-planning program, including the identification of potential talent, managerial training, integrated pay arrangements that reward talent and motivate them to stay and grow, etc.

 

“The psychology of promotions and hiring has changed,” he continues. “We see companies paying more to hire an individual from a competitor, rather than promoting from within, or hiring someone on the beach. I believe this is a little of the ‘grass is greener’ syndrome. We have seen examples of heir apparents being lured away by a competitor either for more money or because the road to the top is too long in coming. When that happens, they are often left with no insiders that have the skill sets or broad experience necessary to satisfy the board or owners. In this case they have no choice but to go outside. In addition, we have seen many cases in which the company was grooming two or more to possibly succeed the ‘king.’ When one is promoted, the others become dissatisfied and leave. Succession planning isn't easy, and certainly not something that can be taken lightly.”

 

Only time will tell whether the labor shortage will translate into a talent shortage at upper levels. This will then help to determine where companies turn for the next generation of leaders.

No-frills Packages

 

Maybe "no frills" is a bit extreme, but executive packages will bear little resemblance to their current brethren. Perks such as the company car, complimentary financial planning and use of the corporate jet will decrease as scrutiny from shareholders makes them possible points of contention.

 

“Perks less than $50,000 were not under any required disclosure laws in the recent past,” explains Dorf. “But as of January 1, 2006, perks $10,000 and under must be declared. It’s really the tax and accounting rules that are changing the game of executive compensation. Over the next two to three years, it will continue to look like executive compensation is rising simply because these perks can no longer fly under the radar. But after that I think most companies will have found a way to do away with a lot of it to avoid being labeled as one of the companies fostering egregious executive compensation. It’s a hot issue and will continue to be one.”

 
Overarching all these trends is the need to not only better educate an American public that is still smarting from the withdrawal of corporate paternalism, but also encourage individuals to forego some current pleasures in favor of future financial security. The coming years are ones in which the role of a truly good financial advisor, whether on the corporate or investor side, will be crucial. While all else may evolve slowly, that’s one constant certain to remain.