When it’s easy to secure insurance coverage or hard to fathom a catastrophic loss, executives may have little interest in reassessing their company’s risk profile or exploring financing options. But complacent risk practices can leave companies at the mercy of changing market conditions and burgeoning exposures at a time when preserving every dime of capital is critical to business survival.
“Buying insurance may seem like a necessary evil, but funding an unanticipated loss is worse,” says Anne Petrides, senior consultant and actuary for Risk Advisory and Brokerage Services at Towers Watson. “Unless organizations have gone down the path of assessing how much risk they want to assume and developing a financing strategy, they could face an unwelcome surprise.”
“Many firms would be unable to exist in their same form following the extreme financial volatility imposed by a catastrophic event,” says Craig Nelson, senior consultant for Risk Advisory and Brokerage Services at Towers Watson. “The time to look at worst-case scenarios and explore mitigation strategies is before you enter the marketplace.”
Smart Business spoke with Petrides and Nelson about the need for disciplined risk fundamentals as part of a plan to preserve capital.
Why conduct an annual risk review?
Petrides: Risk tolerance is the cornerstone for all risk decisions and everyone from board members to shareholders must be comfortable with the company’s profile and appetite for risk. Executives should review each risk category on a periodic basis to decide how much exposure they wish to retain, from all categories of risk for a single event and in the aggregate. Realistically, companies will face trade-offs when they enter the marketplace but they need to anticipate their choices, calculate the impact and not let the marketplace dictate their risk tolerance.
Nelson: Although we don’t know if British Petroleum has enough (or any) insurance to cover claims in the Gulf of Mexico, the event is a reminder that all scenarios and stakeholders must be considered while constructing a profile and the possibility of a catastrophic event warrants executive attention. While most large companies might survive a catastrophic event like this, most would suffer severe damage to shareholder/stakeholder value. So, in many respects, it’s not so much survival versus nonsurvival, but what you are going to look like after the event and how long it will take to recover. By their very nature, a major earthquake, hurricane, or even a large, unanticipated liability claim can occur without warning.
What data should be included in the review?
Nelson: Companies should use sophisticated data modeling techniques and software to predict future claims by analyzing prior losses. The review may expose savings opportunities through the strategic acquisition of additional risk or reduction in the frequency or severity of claims through loss control or safety measures. In the world of property insurance, historical analysis has given way to predictive modeling that includes a real-time view of major events such as brush fires or windstorms and forecasts the probability of such events within a relative range of certainty. The model shows how these events have historically played out, which helps companies develop contingency and mitigation plans to avoid business interruption and sustained revenue losses.
Petrides: Sophisticated organizations have been collecting data for long periods of time and, based on the credibility of that information, can parameterize models using analyses of this data. Whatever metrics you use, it’s important to model the cost of capital and the equity costs associated with changing retention levels before you decide on a risk financing strategy. Insurance should be viewed as contingent capital rather than an expense. Additionally, the domino-like financial ramifications associated with a major event, like lower credit ratings, increased debt obligations and client defections should be considered in the modeling exercise. Overlay different variables to estimate the financial impact of each scenario before finalizing a risk statement and financing strategy.
How can companies optimize insurance purchases through data?
Nelson: Whether the insurance market is soft or hard, leverage your negotiating power by determining your risk tolerance up front, surveying the marketplace and dictating your retention levels before you enter the market. If you find a deal, it may make sense to purchase additional coverage and reduce your risk, but conversely, a company should never take on more risk than it can withstand.
Petrides: Companies can use predictive models or more sophisticated models to help negotiate higher coverage limits and pricing concessions when they enter the market. The data and analyses may establish your company as a premium risk, which will open the door to additional markets or justify higher retention levels.
Which alternate financing strategies are worth considering?
Petrides: Flexing your model or using a blended approach can be advantageous when dealing with a volatile market. There’s nothing wrong with purchasing additional insurance today, if it offers greater financial security, and returning to higher retentions when the market hardens.
Nelson: The tax benefits associated with captives, such as accelerated deductions for losses, have made them very attractive. But we’re also seeing some industries utilize captives to get into the risk management business and turn it into a profit-making venture. Offering buyers extended warranties is one example, another is offering renters of self-storage units property insurance. Not only does it allow the risk taker to make a profit, it may curtail claims, in the event customers search for a deep pocket to cover uninsured losses. The options and models are almost limitless, but a successful risk strategy always begins with a well-defined risk statement.
Craig Nelson is a senior consultant for Risk Advisory and Brokerage Services at Towers Watson. Reach him at (303) 628-4026 or firstname.lastname@example.org. Anne Petrides, FCAS, MAAA, is a senior consultant and actuary for Risk Advisory and Brokerage Services at Towers Watson. Reach her at (415) 836-1109 or email@example.com.
Just when companies need their most talented employees to capitalize on the recovering economy, new evidence suggests that many of these top people may not be up for the task. Since 2008, overall employee engagement dropped by 9 percent. But engagement levels for top-performing employees fell by 23 percent according to the 2009/2010 Strategic Rewards Report from Towers Watson.
“The survey numbers were surprising and significant,” says Bill Greene, senior consultant for the Talent, Rewards and Communications practice at Towers Watson. “When engagement declines, employees are less likely to recommend their companies to others. They’re less likely to devote extra energy to their jobs. Employees especially top performers become more likely to look for opportunities at other organizations. That means now is the time to take steps to re-engage top talent before the job market rebounds.”
Smart Business spoke with Greene about the best ways to re-engage top performers in the aftermath of the recession.
What factors contributed to the decline in employee engagement?
The past couple of years have been trying for all employees. Even people who avoided layoffs still experienced significant disruptions pay and benefit cuts, forced sabbaticals and diminished job opportunities. Well-publicized business failures, ethical scandals and regulatory challenges also had an impact. Employees are increasingly focused on the image of their employers and their success in managing risk both financial and reputational.
The cumulative effect is that the recession has further frayed the social, emotional and economic fabric that connects employees to a company. Many folks describe this fabric as the employee value proposition, or EVP. It’s the ‘deal’ an employer and employee strike when they work together. Top-performing employees are often most sensitive to shifts in the EVP. They have high expectations for themselves and for their employer. If the EVP isn’t what it used to be, top performers often feel it first, care about it most and are most likely to try to do something about it.
Do most companies have an EVP?
A recent study we conducted uncovered some really interesting results about EVPs. In this study, only 28 percent of employers responding indicated that their company had a formal employee value proposition in place. However, 74 percent of employees felt their company had an EVP. That’s a striking difference. It suggests many employees impute their own EVP which may or may not align with what the company wants it to be. In addition, 41 percent of high-performing employees felt that changes companies made during tough times had a negative impact on the EVP. Smart companies recognize these factors and are working to shape and manage their ‘deal’ rather than having it designed by default.
How are high-performing companies responding to the engagement challenge?
Companies are taking a variety of steps, but four of them stand out:
Defining (or redefining) critical competencies. Whether the challenge is retaining top performers or hiring for future growth, companies are looking again at which competencies and skills will drive business success. Then they’re retooling the roles, skill requirements, rewards, hiring, training and career development practices to support them.
Identifying pivotal employees and showing that they matter. Top and critical performers (for example, those who drive revenue or are instrumental in product development) want to know they have a future with the company. Job promotions send this message, but they’re not always possible in this economy. So top companies get creative with special assignments, attachment to high-visibility projects, skill-building opportunities, and formal or informal recognition.
Re-evaluating (and optimizing) ‘the deal.’ A number of companies are considering whether the employee value proposition they have still matches their business and talent. So they’re looking at redesigning their EVPs. Using marketing research techniques with employees, along with financial modeling, they’re able to develop reward program alternatives that maximize employee value (especially with pivotal employees) based on the total amount they want to invest for rewards (which may be lower than, higher than or the same as what they are investing now).
Communicating. When it comes to communications, high-performing companies distinguish themselves with courage, innovation and discipline. They have the courage to explain to employees the rationale behind difficult business decisions and actively address the impact. They’re innovative in creating brands and messages and using media (including social media) to show employees how their work affects the business especially as business conditions change (for worse or for better). They’re disciplined about having a plan, documenting it and measuring results.
Where do managers fit into the equation?
Most employees look to their managers to interpret vision and goals, clarify rules and make meaningful connections between the individual and the enterprise. Unfortunately, managers don’t appear to get a ringing endorsement from employees. In our 2010 Global Workforce Study, managers scored higher than senior leaders on a range of behaviors, including overall effectiveness. But employees felt managers still fell short, especially on the ‘human’ dimension of their role (for example, related to performance management). For many organizations in this economy, frequent manager transitions and shifting business priorities have hindered the focus on manager development. But building basic manager skills related to communication, performance management, and managing change warrant renewed attention and investment because of the strong, positive impact on employee engagement.
Bill Greene is a senior consultant for the Talent, Rewards and Communications practice at Towers Watson. Reach him at (415) 836-1286 or Bill.Greene@towerswatson.com.
Much has been written about the recession-induced struggles of employees, as they grapple with escalating workloads and diminishing promises from employers. But employees aren’t the only ones struggling to meet a host of increasing responsibilities and rising expectations in a new economy.
The recession raised the bar for business leaders, who must fend off attacks from tenacious competitors in a battle for market share and survival, while satisfying the burgeoning demands of shareholders and employees. Today’s leaders must foster innovation, take calculated risks, thrive in a 24-7 business climate and accomplish these goals with fewer resources as the stakes rise.
“If you look at the quick ascent of companies like Google and YouTube, it’s obvious that bigger companies have to be nimble just to keep up,” says Paul De Young, Ph.D., senior consultant for talent management and Western U.S. sales leader for Towers Watson. “This revolutionary economic environment requires new leadership skills and competencies. Executives must reinvent themselves if they want to stay on top.”
Smart Business spoke with De Young about the challenges facing today’s business leaders and the need for professional transformation.
How has the recession impacted workers’ expectations of business leaders?
Towers Watson surveyed 22,000 workers to get an in-depth look at their post-recession attitudes. In addition to altering their relationships and basic social contracts with their employers, the Great Recession dramatically changed the way employees view their leaders. They crave connections with emotionally intelligent leaders who are trustworthy and accessible and who demonstrate respect for the well-being of others. Fifty-six percent said they expect leaders to encourage their professional development, while 42 percent expect leaders to successfully manage the company’s financial performance. Unfortunately, the survey results were disturbingly low, with only 50 percent of employees stating that today’s leaders meet those expectations. The study exposes the gaps in leader performance and suggests that many could benefit from a professional makeover.
How can leaders meet these expectations?
Leaders need to step back and take stock of the skills that made them successful while consciously developing new competencies that will lead to future success. Inventory your strengths and development needs by observing the attributes of younger, emerging leaders and reviewing an atlas of the behaviors that demonstrate proficiency with critical leadership competencies. Not all leaders need to undergo radical change; some may fulfill employee expectations by tailoring their behaviors to fit the current business environment. Once you develop a list of the skills you wish to master, executive coaches and increased awareness can help you expand your repertoire of competencies. Remember, many leaders are in the midst of a professional transformation as they attempt to conquer growing responsibilities with fewer resources. The evolutionary process takes time, so don’t be afraid to discuss your journey with managers and employees, because it will increase transparency and encourage others to follow suit.
Are these expectations realistic?
In many ways, employees expect leaders to act like celebrities as well as business gurus. Think Bill Gates, Steve Jobs or Eric Schmidt. These leaders have reset the bar because they take the time to Tweet, blog and woo customers by delegating many of their day-to-day responsibilities. These fast-moving companies are also famous for cutting-edge technology and vaulting past the competition, because their leaders think outside the box and are willing to take risks.
Is it possible to thrive in a 24-7 business environment?
Forget about achieving work-life balance, because it is based on a world without the Internet. Leaders need to fully integrate their personal and professional lives in order to operate in today’s 24-7 business environment. Leadership essentials include blended skill sets such as multi-tasking and handling shifting priorities along with the capacity to nurture virtual relationships. One minute, an executive might be having dinner with his or her family, and the next she’s e-mailing, blogging or posting information on the company intranet to bolster employee engagement. The 24-7 phenomenon isn’t temporary, so leaders need to embrace the change and adapt their lifestyles. The best group of people to observe with this skill is working moms. They have mastered this better than anyone else.
What does it take to outhustle the competition?
Executive leaders must develop their direct reports and trust them to make decisions in order to thwart the advances of svelte competitors. Some leaders were still adjusting to the reduction in middle management and leaner organizational structures instituted during the prior recession when the Great Recession hit. Although the compressed configuration was supposed to eliminate bureaucracy and hasten the decision-making process, in reality managers have been wearing many hats, so many lacked the confidence and expertise to meet new customer mandates under extreme adversity. Now that the crisis is waning, executive leaders must loosen the controls so their direct reports can spread their wings. Assume the role of questioner and enabler, rather than restrictor. Courses in innovation and critical thinking can help engender innovation, but at the end of the day executives must be willing to take calculated risks and loosen the reigns if they want to develop their direct reports into future leaders.
Paul De Young, Ph.D., is a senior consultant for talent management and the sales leader for the Western U.S. for Towers Watson. Reach him at firstname.lastname@example.org or (562) 234-1669.
Employers took a giant leap of faith when they began investing in employee wellness programs to curtail the rising cost of health care. Little data existed to forecast the effectiveness of the new programs and employers could only speculate whether employees would be motivated to make lifestyle changes or follow proactive health regimens to manage chronic conditions.
Now new research by two Harvard professors affirms the hope-laden wellness hypothesis, revealing that companies saved an average of $3.27 in medical costs for every dollar invested in wellness programs while health-related absenteeism costs fell by about $2.73. The news couldn’t come at a better time for beleaguered employers who have theoretically exhausted their ability to shift rising health care costs onto employees, yet face another year of 7 percent increases, as the annual tab for employee medical benefits tops $10,000, according to Towers Perrin’s annual Health Care Cost Survey. Encouraged by early success, employers are turning up the heat on wellness through strategic medical plan designs.
“Employers can no longer cost shift or reduce plan benefits across the board and remain competitive,” says Vincent Antonelli, senior consultant for the health and group benefits practice at Towers Watson. “Savvy employers are offering substantial monetary incentives and value-based benefit designs to engage employees and their families in company-sponsored wellness programs.”
Smart Business spoke with Antonelli about the latest trends in medical plan designs and how employers are mitigating the rising cost of health care through innovative incentive programs.
What have we learned about employee wellness?
We’ve debunked the theory that if you simply build a great wellness program, employees will come. We’ve learned that employees need to be financially motivated to make wellness a priority so employers are offering substantial inducements to employees who actively participate in wellness programs and achieve specific health outcomes. At the same time, competitive health care benefits are now the second greatest attractor of new talent right after salaries, according to our latest survey. Additional data suggests that nearly 50 percent of employees are actively looking for new jobs or would entertain a new offer, making it difficult for employers to enact greater cost shifting without suffering potentially catastrophic consequences.
How are employers redesigning health plans and incentives to encourage wellness?
Many leading employers have migrated from offering encouragement or incidental rewards to employees who enroll in programs to refusing to subsidize employees who are unwilling to actively participate in health improvement programs or follow the specific recommendations from third-party wellness providers. Here are some examples.
- Reduced premiums and plan options. Employees who stop smoking, lose weight or lower their cholesterol may receive a credit toward their premiums or access to a more comprehensive health plan. Those who don’t must pay a greater share of their premiums or higher deductibles.
- Health savings account credits. Employers offering a high-deductible health plan contribute as much as $1,000 annually into the HSAs of healthy employees or those achieving specific outcomes. This is a high-impact option because premium reductions are apportioned over paychecks throughout the year, which dilutes the impact. Additionally, this incentive can be cost-neutral if employers offset the one-time payment through higher deductibles and co-pays essentially allowing employees to buy back the increased cost-sharing through incentive payments.
Are employers instituting other penalties or incentives?
Self-insured employers are instituting more draconian plan changes to encourage employees to become wiser consumers of health care services. Controlling the unit cost of medical services and paying more for procedures from quality providers are proven strategies for reducing total costs. Examples include reference-based pricing, where employers set a price ceiling for medical procedures or tests after surveying the market. While prices for an MRI may vary widely, for example, there’s often little variance in the quality of these diagnostic tests.
Some employers are refusing to pay for elective but recommended surgeries until employees undergo a series of evaluations that may include a second opinion. Back surgeries often fall into this category and employees often elect alternative therapies once they understand the risks and the success rates for these procedures.
Last, some employers are opting to pay a higher portion of the cost for a procedure when employees select providers and facilities with higher success rates. Although procedure costs may be similar, the outcomes are not. New access to quality data is helping employers educate employees to make wise choices while strategic plan designs provide the financial motivation.
How are employers engaging entire families in wellness?
Given the ROI on wellness programs, employers are reaching out to entire families in order to improve total population health. Some companies are offering premium credits for spouses or dependents when they participate in wellness programs and achieve specific outcomes like reductions in weight or blood pressure. The most influential health consumer in the family may not be the employee but a spouse or significant other, so don’t overlook their ability to encourage wellness, especially when there’s money on the line.
Vincent Antonelli is a senior consultant for the health and group benefits practice at Towers Watson. Reach him at (415) 836-1240 or email@example.com.
As we start a new year and begin to move into better economic times, it’s an important time for companies to re-engage employees in the employee value proposition (EVP). For some organizations, the EVP may have changed. Towers Watson’s recent Communication ROI Study clearly shows a distinct difference in financial performance when employees understand a company’s business goals, the steps that must be taken to reach those goals and rewards, and benefits they receive.
The Communication ROI Study also shows that companies who actively communicate the EVP, leadership changes or changes to benefits are more likely to see their employees engaged, focused and productive, even in uncertain times.
“The question becomes how to communicate effectively to a multicultural, multigenerational audience,” says Rosalind Watson, a communication consultant for Towers Watson. “And for many companies, it’s often a question of how to communicate more effectively with less resources.”
Smart Business spoke with Watson about the value of innovative communication and how executives can measure the return on investment of effective communication.
How does effective communication impact financial returns?
Companies that are highly effective communicators have the courage to discuss changes to their EVP and the discipline to communicate continuously with employees so that they understand the changes and can link them to the attainment of the company’s business goals. Companies that communicate effectively have posted a 47 percent higher total return to shareholders over the last five years than their less-effective counterparts.
In comparing the returns of 328 companies over five years, a $100 investment made in 2004 in a company with a highly effective communications program is now worth $130, whereas that same investment in a company with a less-effective communications program is valued at $83.
What’s the best way to communicate change?
Each company should tailor its media selection toward the specific message, the employee population and the culture. Top communicating companies often explain major changes through face-to-face meetings with trained managers, where employees can ask questions in an informal setting. Town-hall meetings give the CEO the opportunity to deliver a personal message, reinforcing the reasons behind the change. Personal involvement is crucial, because it allows the CEO to step down from the balcony and shorten the distance between himself and the employees at a critical time.
Electronic communication is starting to replace traditional paper communication, and highly effective communicators have embraced social media, often pre-testing their media selection and their message with an internal advisory group to see if the communication will be well-received.
What are some examples of innovative media?
Because media preferences vary by country or employee group, many employers use a variety of sources to deliver the same message.
- Wikis: A wiki page on the corporate intranet site provides a one-stop resource for information and is useful for explaining defined terms and knowledge management.
- Blogs and chats: Ghost bloggers can assist executives with daily posts and HR leaders can host online chat sessions about compensation and benefit changes.
- Town halls: Small group sessions allow executives to communicate directly with employees in an intimate setting and answer employees’ questions. Remote employees can attend via webcast and participate by e-mailing their questions during the session. The meeting can be recorded and uploaded onto the company’s intranet, so employees can view the session at their leisure.
- Webcasts: These can be used to deliver information about benefit changes, via a PowerPoint presentation delivered over the Web. Executives can host the meeting or provide the voiceover for the presentation.
- Interactive PDFs: Create an interactive PDF to help employees understand the changes, including links to videos, Web sites and important documents.
What is the investment rationale in social media?
Although many employers cite a lack of funding as a reason for not embracing social media, electronic communication is often more cost-effective than distributing printed materials and the duties can be handled by a few trained staff members. Communication is often viewed as a soft cost that is expendable during a downturn, but driving engagement and higher productivity levels is vital when there are fewer people to do the work. Helping employees to understand the rationale behind difficult decisions and provide feedback enables everyone to move forward together.
What’s the best way to measure the ROI from communication?
Employers can measure clicks and views to see which media sources are generating the greatest employee interest; surveys and focus groups can determine whether employees are embracing the message. Top-performing companies develop a documented communications strategy and assess its effectiveness by benchmarking key measurements, sometimes against other companies.
Although the ultimate litmus test of a company’s ability to engage its employees is its financial performance, many companies track return on sales or top-line growth during a specific campaign to measure ROI. Communication functions need to be held accountable for results just like other departments, because in business, what gets measured gets done, acknowledged and rewarded, and communicating effectively now helps companies to steer their way through to better times.
Relationships between employees and employers often morph with the changing economy. But the current conditions, including record productivity levels, a jobless recovery and the possibility of health insurance reform, are driving one of the most dramatic shifts since World War II. Savvy employers are seizing the opportunity to permanently lower labor costs by restructuring benefit and compensation plans and even shifting the burden of sourcing health care coverage onto employees.
“I believe we have seen the end of one-size-fits-all benefit plans,” says Rick Beal, managing consultant with Watson Wyatt Worldwide. “Executives may encounter some internal resistance to these nontraditional ideas, but employers will ultimately opt for a less paternalistic role by offering two-tier benefit programs or simply requiring employees to find their own health coverage.”
Smart Business spoke with Beal about the emerging changes to employment relationships and how employers can benefit from the “new normal” economy.
How have employment relationships evolved over time?
In a manufacturing economy, employers managed to maintain a stable work force by offering generous benefit packages that often included defined benefit pension plans and the promise of long-term employment. As the highly educated and less-structured baby boomers entered the labor market, relationships began to morph. Technology-driven productivity increases drove an emerging economy centered on global services and workers assumed greater responsibility for managing their own careers. During the 1990s, employees held the upper hand in the labor market and employers focused on winning the talent war by creating and branding distinct employment value propositions.
How is the ‘new normal’ economy impacting employment relationships?
As labor costs escalated, traditional management models dominant in industries such as auto manufacturing have all but disappeared. While employers will always need to compete for top performers and scarce knowledge workers, the balance of power has shifted toward employers as recessionary layoffs have cut deep. This has created an abundance of workers, especially among lesser-skilled populations, and this shift in supply and demand is redefining the relationship between employees and employers.
What changes are employers considering?
Employers will continue to offer competitive base salaries, but they’ll offer smaller annual raises while relying more on incentives like full value restricted stock units or stock grants. The stock will feature lengthy holding requirements, especially for senior executives.
Most surprisingly, some employers may limit access to company-sponsored health plans to critical knowledge workers. Other companies may establish steep healthy behavior requirement hurdles before employees can participate in company-sponsored benefit plans or limit health care coverage to consumer-driven health plans with health savings accounts.
Health care and retirement plans will be increasingly portable, like current 401(k) plans, as employers provide employees with the tools and technology to manage their own financial and physical health. In short, the days of uniform benefit offerings are likely over.
What upsides and downsides might result from these changes?
Employers generally stand to benefit from these changes, but each company has to consider its current and future work force and its employment value proposition before initiating wholesale modifications to compensation and benefit plans.
- Cost management. Employers will be able to reduce the cost of benefits administration and will benefit from predictable health care and retirement costs. Unless the next wave of technological change can increase productivity, cost control will play a dominant role in driving bottom line returns for the near future.
- Empowerment as an employment brand. Employers will compete for talent by branding themselves as enablers of employee empowerment. Independent workers attracted to increased freedom and self-determination will be highly engaged and more productive.
- Less control. Employers offering portable benefit plans will have less control over the timing of employee work force exits, which could negatively impact industries facing shortages of skilled workers.
How should executives proceed?
Employers need to set plans in motion before the recovery gains momentum.
- Conduct a strategic review of total rewards programs to see if they still make sense for your company’s future work force.
- Consider segments of the current work force where a new approach might be appropriate, such as part-time employees in the retail or service industries.
- Ask employees to weigh in during the review process so expenditures are targeted toward the benefit programs employees value most. Employees can make prudent choices if they are presented with the facts, and some groups might actually prefer making their own health plan arrangements, especially if it increases job security.
- Challenge the HR paradigms that impede progress. Owners may face resistance from benefits managers or company lawyers over revolutionary ideas like creating a two-tier benefits structure. Seek external opinions or hire a benefits manager from outside the HR field to stimulate nontraditional thinking.
Rick Beal is the managing consultant for Watson Wyatt Worldwide. Reach him at (415) 733-4310 or Rick.Beal@WatsonWyatt.com. At the time this article went to press, Towers Perrin and Watson Wyatt have announced their intent to merge and become Towers Watson. The merger is anticipated to close around the New Year.
As pension plan administrators wrestled with the new funding mandates and the mark-to-market requirements imposed by the Pension Protection Act (PPA), the bottom dropped out of the financial markets, pummeling asset returns. As a result, many employers froze existing plans and adjusted asset allocations on the fly.
Now that officials have granted employers a brief reprieve from PPA funding mandates and the financial markets have rebounded from their 2008 lows, embattled plan administrators have a brief window of opportunity to revisit the fundamentals and craft a comprehensive pension strategy that reduces volatility and risk and increases asset levels to meet future funding targets.
“Although the calamity has abated to some degree, the risk of market volatility persists, the government has not backed away from its original funding targets and current investment strategies may not be appropriate for a post-PPA world,” says Pete Neuwirth, senior consultant for the retirement practice at Watson Wyatt Worldwide. “Employers should use this time to prepare for future crises.”
Smart Business spoke to Neuwirth about the challenges facing employers offering defined benefit pension plans and the elements they should revisit during this brief respite.
How can employers mitigate escalating pension costs?
Many employers have opted to pay the least amount possible into their plans, without considering how those decisions might impact required contributions down the road. This strategy may ease short-term cash flow, but even companies with currently well funded or frozen plans need to manage their risks. If assets are currently sufficient, plan liabilities will still likely grow faster than assets as future benefits accrue, and even for frozen plans, the value of accrued benefits will continue to grow as employees near retirement. Since the ultimate cost of a pension plan is the cost of benefits paid minus investment income and contributions, the best ways to mitigate increasing costs are through plan redesign and improved asset performance. Employers should use this breathing space to reassess their liabilities and asset allocations to reduce income volatility and control costs.
How has PPA impacted funding policies?
PPA drives employers toward 100 percent funding for pension liabilities and most have been well below that target. This means that many employers will have to pay normal costs plus a seven-year amortization payment on any unfunded liability. Additionally, PPA curtails an employer’s ability to pay more in good years and draw against those credit balances in bad times. When reviewing existing funding policies, employers need to know their funding target date and be cognizant of credit balances, so they can make informed decisions on whether and when to use or give them up. On the positive side, PPA gives employers some limited flexibility to use spot market rates or 24 month average rates in their funding assumptions, but those decisions need to be calibrated with the company’s investment strategy, because each option has advantages and disadvantages and one solution will not fit all.
Should employers review plan design?
Roughly one-third of the Fortune 1,000 offering defined benefit pension plans have now frozen those plans. Others have changed to a hybrid model, and 55 percent of the Fortune 100 now put new hires into a defined contribution plan. Employers need to reassess these decisions to see if this is the right strategy going forward, especially now that assets have rebounded. A recent Watson Wyatt survey reveals that traditional pension plans are highly valued by employees, so employers must consider the impact of changes on other HR objectives as well as the financial risks associated with interest rates, asset returns, longevity and inflation. If an employer is committed to a defined plan, sharing the risk with employees through a lump sum option, cash balance or a hybrid plan or moving the benefit calculation from a final average to a career average can help to mitigate the risks.
How can employers manage the volatility in asset returns?
Many employers were caught off guard by the quick drop in the market and were then reluctant to sell devalued equities for fear of missing the rebound. Given the improvement in equities, now may be a good time to revisit your company’s risk position in light of future funding requirements. Traditionally, many administrators favored high-risk positions offering higher long-term returns. Those positions no longer make as much sense because under PPA the risk is asymmetrical, meaning that the possible downside from high-risk investments exceeds the possible upside. In a recent survey conducted among 80 financial executives, two-thirds have made or are planning to make policy changes in 2009 and 2010 to asset allocations, while more than half have already made changes or are planning to make changes to investment lineups.
How has PPA impacted the assumptions and methods for calculating pension expense?
Key assumptions such as the discount rate, salary scale and long-term rate of return can impact the pension expenses reflected on a company’s financial statements, so it’s important to forecast cash and expense using a range of assumptions. For example, simply changing asset allocations from equities to a more conservative mix of bonds may cause auditors to reduce the expected rate of return in the assumptions. Since this can have a broad impact on company finances, including the interest rate paid on borrowed funds, it’s important to consider how an investment strategy integrates with funding and accounting strategy. Despite an anticipated adjustment in the accounting rules, for now, a holistic management strategy remains the best way to avoid the impact of the next crisis.
Pete Neuwirth is a senior consultant for the retirement practice at Watson Wyatt Worldwide. Reach him at (415) 733-4139 or Peter.Neuwirth@watsonwyatt.com.
Many employers have undertaken dramatic cost reductions since the start of the recession. But in the process, they may have inadvertently created consequences that will linger well into the recovery period.
In the minds of many employees, reductions in staff and total rewards packages have breached the promises of their employers. The result has been a nearly 10 percent drop in employee engagement levels since last year and, among top performers, a precipitous decline of 23 percent, according to a recent survey by Watson Wyatt Worldwide. To prevent diminished productivity and high turnover, employers must take immediate steps to re-engage top performers by reinventing their employee value proposition (EVP).
“Employees place a great deal of emphasis on employer promises, whether those assurances are explicit or implied,” says Laurie Bienstock, U.S. practice director for strategic rewards at Watson Wyatt Worldwide. “Unfortunately, a diminished EVP is a blind spot for many employers, because they fail to recognize the gap between what’s promised and delivered and the EVP’s role in motivating employees.”
Smart Business spoke with Bienstock about the impact of cost reductions on employee engagement and the steps employers should take to eschew the fallout.
What is an EVP and why is it significant?
An EVP is the total value an employee receives for working for a company and it influences his or her decision to join or stay with an organization. It is composed of tangible remuneration like salary and benefits as well as intangible rewards like a positive work environment, job security, promotional opportunities, and training and development programs. Some employers strategically design their EVP, so it attracts the right candidates and delivers maximum return, while in other companies, the EVP may have evolved over time. Although employers often view an EVP as an informal agreement, 74 percent of employees consider it to be a formal pledge according to our survey, so when their deal changes, it alters an employee’s commitment.
What’s been the impact from cost reductions?
According to Watson Wyatt’s ‘2009/2010 Strategic Rewards Report,’ which surveyed 1,300 employees, there was a 26 percent decline in satisfaction with advancement opportunities and a 14 percent decline in likelihood that they would remain with their current employer, while the number who would recommend others take jobs at their company has declined by nearly 20 percent. Top performers are particularly frustrated by their inability to deliver quality work or adequate customer service due to staff reductions, and many say these conditions are impeding their company’s ability to recover from the recession. In fact, 36 percent say their employer’s situation has worsened in the past 12 months.
Another byproduct of widespread layoffs is a 15 percent increase in employee discrimination claims (based on claims data filed with the EEOC in 2008). And the recently passed Lilly Ledbetter Fair Pay Act places an additional burden on employers to ensure evidence/records of methodology for compensation administration and decisions (both in the past and future) as well as to review past compensation decisions.
Was the impact similar for all employers?
Financially high-performing organizations took the fewest actions in response to the downturn, mostly freezing programs as a preemptive measure and reducing fewer core components of total rewards such as salary, benefits or bonuses, and high-performing organizations averaged staff reductions of just 7 percent. Lower-performing organizations were forced to make deeper cuts in staff, averaging 9 percent, and total rewards, and they were less effective at using performance data to conduct layoffs. As a result, firms entering the recession in a stronger financial position are likely to emerge in better shape aided by a largely intact staff that is more highly engaged and productive.
How can employers reverse the trend?
Employers need to redefine their EVP and restore pay and benefits packages and rehire employees where appropriate as soon as business conditions allow. Bonus plans and performance metrics need to be aligned with current business goals to make sure they motivate employees. Permanent head count reductions or industry changes need to be considered, as they may render previous performance expectations unachievable. Closure of an on-site child day care center or elimination of telecommuting opportunities requires employers to reassess their tangible and intangible benefits in rebuilding their EVP so they aren’t making promises to employees they can’t keep. Focus expenditures on benefits that are most relevant to employees so your EVP delivers the maximum impact.
How does EVP redesign relate to changes employers may be making in response to the Lilly Ledbetter Act?
The actions needed to redesign your company’s EVP and set a foundation for compliance with the underlying laws affected by the Lilly Ledbetter Fair Pay Act (e.g. Civil Rights Act, ADA) are similar. Employers can respond to the legislation by using a systematic and documented approach to govern pay plans, assign job classifications and titles and to assess and document employee performance, especially for promotions. While a systematic approach to pay does not ensure pay discrimination will not occur, it provides a foundation for analysis, review and audit. Clearly outlining and governing an approach to defining jobs and setting and administering pay not only will assist managers in hiring and retaining employees but also engenders employee engagement through increased understanding of pay and career opportunities.
Laurie Bienstock is the U.S. practice director for strategic rewards at Watson Wyatt Worldwide. Reach her at (415) 733-4311 or Laurie.Bienstock@watsonwyatt.com.
Employers surveyed by Watson Wyatt Worldwide acknowledge that maintaining the status quo in the health care system isn’t a viable option. On the other hand, they express concerns that reform might create more problems than it solves. They fear new legislation may threaten existing group plans, increase an employer’s costs and counteract emerging gains in cost management.
To understand the proposed legislation and calculate its true impact, employers should get the facts and convey their concerns to legislators before a bill is finalized.
“Any plan to reform health care must address the issue of supply and demand and individual accountability to be viable and sustainable,” says Caty Furco, FSA, MAAA, office practice leader for group and health care at Watson Wyatt Worldwide. “The introduction of a play-or-pay system or the weakening of ERISA pre-emption may actually drive up costs by threatening existing employer programs.”
Smart Business spoke with Furco about the potential impact of health care reform on businesses.
Which reform elements are endorsed by employers?
In July, Watson Wyatt held round-table discussions with 95 large U.S. employers, which employ more than 400,000 workers and provide health care coverage to more than 970,000 individuals at an annual cost of $7.3 billion. Similar sessions were held in the Bay Area and local employers have echoed the sentiments of employers nationwide. In general, employers agree that we need health care reform, but how those changes are delivered and paid for is a major concern. The areas of consensus include the need for quality health care at a reasonable cost along with the need to reduce the ranks of the uninsured, the cost of which has been passed along to employers offering group plans. Improving efficiencies in our health care system, such as those achieved through the automation of health care records, and maintaining ERISA pre-emption were also endorsed by employers.
How might reform threaten employer-sponsored health plans?
Unless ERISA pre-emption is maintained, employers with multistate operations could be forced to comply with a multitude of local insurance laws, escalating the administrative burden for geographically dispersed employers. And the introduction of a play-or-pay mandate will specify a minimum benefit level. A ‘one-size fits all’ minimum benefit package could result in employers paying more, as currently many employers tailor their benefits to meet the specific needs of their own population.
What are the unintended consequences of reform?
Employers fear that reform will create a two-tiered insurance system, forcing them to offer a lower-cost government option to lower-paid workers, or perhaps leaving them with a high-cost population of insured workers if lower-paid workers are allowed to opt out of group coverage in favor of the government option. If the government option contains coverage limitations, competition could force employers to offer workers additional benefits to supplement the minimum mandates. Legislation needs to take into account today’s mobile work force — where an employee moves geographically but stays with the same employer. Reform could add layers of complexity and bureaucracy that drive up costs. And small business subsidies could yield an unfair advantage while shielding them from the true cost of health care.
Employers have been using claims and employee demographic data to customize employee wellness programs and create initiatives that encourage the proactive management of chronic conditions. When employee education programs are combined with high deductible plans, health savings accounts and other incentives, they are showing real results. Employers expressed apprehension about a government option undermining their progress in controlling costs if they end up without access to data or the autonomy to encourage personal responsibility and positive employee behaviors.
How can costs be controlled?
Three things must be included in any health care reform plan to control costs.
- Cost transparency. Patients are currently shielded from detailed cost estimates before consenting to a procedure. Consequently, no one really knows or understands why the cost of a knee replacement in the U.S. is $98,000. To create wise consumers, patients must know the costs and consider alternative treatments before making a decision. Greater cost transparency will not only invite scrutiny, it will encourage competition.
- Consumer education and responsibility. Consumers need to know the risks and outcome history for a particular treatment and provider to make prudent decisions. Complexity determines the price for a procedure, so consumers need to question whether a high-cost procedure is really necessary.
- Reduction in worker shortages. Unless reform addresses the supply side of health care by increasing the number of front-line, cost-effective health care professionals, such as physician assistants, nurses and primary care physicians, costs will continue to escalate.
How can executives help?
Legislators are currently seeking input, so executives must understand the details and the consequences of each proposal, then voice their concerns and recommendations. The bills are lengthy; executives may review a summary of the proposals at www.watsonwyatt.com/topics, under Controlling Health Care Costs, or by contacting their Congressional representative.
Caty Furco, FSA, MAAA, is the office practice leader for group and health care at Watson Wyatt Worldwide. Reach her at (415) 733-4309 or firstname.lastname@example.org.
It’s hard to hit a moving target. So when faced with the convergence of a volatile economy, new government legislation on executive pay and the growing momentum behind say-on-pay initiatives, many companies adopted a wait-and-see approach when constructing 2009 executive short-term incentive plans, opting for scaled-down or discretionary incentives until the dust settles.
Despite the complexities of developing realistic performance objectives and payout opportunities, as well as navigating a multitude of legislative changes under the watchful eye of investors, companies need to maintain the motivational and retentive qualities of their incentive plans. Compensation committees and executive management are being challenged to develop short-term incentive plans that are fundamentally sound, do not promote excessive risk-taking and can withstand increased scrutiny from the SEC and shareholders.
“Based on the fallout from the stock option backdating scandals, we learned that duck-and-cover is not a viable strategy for resolving executive compensation issues,” says Jason Taylor, senior compensation consultant for Watson Wyatt Worldwide. “Failure to act may result in the withholding of board member votes and negative press to financial settlements.”
Smart Business spoke with Taylor about the best ways to redesign and document executive short-term incentive plans in the current environment.
What’s influencing the trend in executive short-term incentive design?
Bonuses paid to executives in financial firms receiving government funds (TARP participants) exacerbated the already growing shareholder sentiment that executive pay is not appropriately calibrated to company results and needs greater oversight. So now the legislation originally created for TARP recipients may lead to broader intervention in all companies, including a stated review of the relationship between incentive pay and excessive risk taking and clawbacks of bonuses or incentives that were awarded to executives based upon materially inaccurate financial statements. This trend will likely influence pay actions in privately held companies as well, as stakeholders will want to ensure their short-term incentive plans meet corporate governance practices.
Additionally, as a result of enhanced disclosure requirements and the introduction of say-on-pay legislation, shareholders and investors have more access to compensation data, and are being more vocal with their opinions. Further, the SEC continues to review proxy statements to determine whether they contain sufficient rationale, background and information in describing the incentive plan design process, which requires the compensation committee’s validation and confirmation.
How can companies strengthen their incentive plan design process?
The overall theme is to apply more analytical rigor to the process. While citing the practices of industry peers is a good start, compensation committee members and executive management need to take their documentation and testing process to the next level by demonstrating why the plan mechanics and payout opportunities are appropriate for the company’s unique situation. We often find that, in many cases, there is historically little correlation between the metrics used to calculate executive short-term incentives and year-over-year shareholder return. Further, companies often fail to analyze the probability of performance achievement, which can result in sandbagging or windfall bonuses and no-confidence votes from shareholders.
The analytical process should include, at minimum, determining which metrics support the company’s short- and long-term strategic and financial objectives, analyzing the correlation between changes in shareholder value and various combinations of performance metrics, as well as reviewing incentive opportunities in relation to set performance levels. Additionally, incentive structure and mechanics should be analyzed to determine to what extent, if any, the plan promotes excessive risk taking. Last, document the process and findings in order to meet disclosure requirements and justify the appropriateness of the plan design.
What are the best incentive design work steps to follow?
- Continue to benchmark against peer companies and credible compensation survey data with comparable jobs. Avoid small sample sizes in both peer company and survey data, as well as any statistical summaries that have low confidence levels.
- Consider incentive opportunities within the context of executives’ total compensation package, not on an element-by-element basis.
- Evaluate incentive plan components independently to assure they incent appropriate behaviors and outcomes that have strong relation to improved shareholder returns.
- Use performance thresholds and bonus caps to avoid unintended consequences.
- Most importantly, calibrate incentive levels to appropriate performance. For example, 75th percentile pay opportunity should require 75th percentile, or above, performance.
What is the best way to set realistic year-over-year performance goals in a turbulent environment?
If projecting next year’s goals is too challenging, consider linking incentives to operational or qualitative improvements that historically have a strong relation to financial performance. Consider shorter-term incentives (e.g., quarterly, semi-annually) for hitting interim benchmarks, with overall year-end adjustments based on annual performance. Although discretionary plans are always an alternative, these plans may have a hard time passing muster with investors and the SEC in the current climate. Additionally, they can lead to management ‘gaming’ and/or entitlement issues, which makes conversion back to a true pay-for-performance incentive plan extremely painful for everyone.
Jason Taylor is a senior compensation consultant for Watson Wyatt Worldwide. Reach him at Jason.Taylor@watsonwyatt.com or (415) 733-4125.