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SERPs and Other Retirement Benefits

  1. Why You Need to Understand SERPs
  2. Pension Disclosure Odds and Ends
  3. Preparing the New Pension Benefits Table
  4. Practice Pointers
  5. Video Webcast Panel (2004 Compensation Conference)
  6. Video Webcast Panel (2005 Compensation Conference)
  7. Media Articles
  8. Firm Memos
  9. Good SERP Disclosure Examples
  1. Why You Need to Understand SERPs

    One area where there has been a woeful lack of understanding - and inadequate proxy disclosure – relates to SERPs (i.e. supplemental executive retirement plans). SERPs came into being to supplement the pension payouts of some higher paid executives beyond the IRS limits for qualified pension plans. Item 402 allows companies merely to include generic tables showing possible payouts based on years of service in their proxy statements.  From proxy disclosures, even the most sophisticated compensation consultants have been unable to figure out how much the Named Executive Officers will actually be receiving under a company’s SERP.

    A typical example of how SERPs can be manipulated to provide much higher payouts than the generic chart implies is the recently highlighted Delta Air Lines SERP. At Delta, the CEO was credited with an additional 22 years of service to inflate his pension payments so that he would receive $1million a year for the rest of his life, starting at age 65. Even after the CEO took a cut in his pay package in the face of the company’s downturn, his SERP was left intact and put in trust to protect the payments in the event of bankruptcy. At the same time, the company was reducing the pensions of its workers to conserve cash, without adequately disclosing the conflicting actions, calling into question the adequacy and accuracy of the company’s disclosures. At last month’s annual meeting, a precatory shareholder proposal seeking shareholder approval of SERPs received a majority vote and the new Delta CEO has agreed to implement this proposal and put future SERPs up for a vote.

    As widely reported, former Tyco CEO Dennis Kozlowski is trying to collect on a $4.5 million per year SERP, worth an estimated $50 million in current value. In addition to playing with years of service, the payout amounts have been inflated by including bonuses and other payments in the calculation.

    One respected compensation consultant says that compensation committees should view SERPs as the equivalent of restricted stock that is simply paid out in cash. As a result, they should be treated as a form of long-term compensation, and that those companies that have both SERPs and restricted stock (or other long-term compensation) are, in essence, double dipping. Again, a lack of understanding of SERPs has enabled many executives to receive additional compensation that has not been factored into the final tally. The bottom line is that you might think of SERPs as restricted stock paid out in cash annually upon retirement, with formulas that don’t reveal the true magnitude of the resulting huge payment obligations.

    Here is what the Council of Institutional Investors stated in its recently updated executive compensation policy:

    "Deferred compensation plans, supplemental executive retirement plans, retirement packages and other retirement arrangements for highly paid executives can result in hidden and excessive benefits.  The Council believes that special retirement arrangements, including ones structured to permit employees whose compensation exceeds IRS limits to fully participate in similar plans covering other employees, should be consistent with programs offered to the general workforce, and they should be reasonable. 

    Structure

    • Supplemental executive retirement plans (SERPs):  Supplemental plans should be an extension of the retirement program covering other employees.  They should not include special provisions, such as above-market interest rates and excess service credits, not offered under plans covering other employees.  Payments such as stock and stock options, annual/long-term bonuses and other compensation not awarded to other employees and/or not considered in the determination of retirement benefits payable to other employees should not be considered in calculating benefits payable under SERPS. 
    • Deferred compensation plans. Investment alternatives offered under deferred compensation plans for executives should mirror those offered to employees in broad-based deferral plans. 

    Limitations

    • Deferred compensation plans. Above-market returns should not be applied to executive deferrals, and executives should not receive "sweeteners" for deferring cash payments into company stock. 
    • Post-retirement exercise periods: Executives should be limited to three-year post-retirement exercise periods for stock option grants. 
    • Retirement benefits.  Executives should not be entitled to special perquisites—such as apartments, automobiles, use of corporate aircraft, security, financial planning—and other benefits upon retirement.  Executives are highly compensated employees who should be more than able to cover the costs of their retirements. 

    Proxy Statement Disclosure

    • Transparency: The terms of any deferred compensation, retirement, SERP or other similar plans covering the executive oversight group should be fully disclosed, in plain English, along with a description of any additional perquisites or benefits payable to executives after retirement. 
    • Tabular disclosure: A single table should be provided detailing the expected dollar value payable to each member of the executive oversight group under any deferred compensation, retirement, SERP or similar plan, along with a dollar value of any additional perquisites of benefits payable after retirement." 
       
  2. Pension Disclosure Odds and Ends - from Mark Borges' Blog (9/21/06)

    I participated in an ABA Videoconference today on the new disclosure rules with Paula Dubberly from the SEC's Division of Corporation Finance (as well as with Keith Higgins and Polly Plimpton). In addition to providing an overview of various aspects of the new rules, Paula also shared the following interpretive positions with us and the audience while we were discussing the Change in Pension Value column of the Summary Compensation Table:

    Pension Value Change is Negative

    Instruction 3 to Item 402(c)(2)(viii) states that where the amount of the annual change in the actuarial present value of a named executive officer's accumulated pension benefit is a negative number, it should be disclosed in a footnote to the Pension Value Change column, but not reflected in the column itself. Apparently, the staff has been asked how to apply this Instruction if an NEO participates in multiple defined benefit pension plans where the accumulated benefits value has increased in some plans and decreased in others.

    For example, assume that a company has a tax-qualified defined benefit pension plan, an additional non-qualified "excess" plan, and a supplemental executive retirement plan. For the fiscal year in question, the accumulated benefit value has increased by $4,000 in the tax-qualified plan and by $12,000 in the excess plan, but has decreased by $7,000 in the SERP. How would this be disclosed?

    Paula indicated that the three amounts should be added together. if the result is positive (as it is in my example, that amount would be included in the column (here, $9,000). However, where the net number is negative, then the company would follow Instruction 3. In either case, the company should explain the changes in value for each plan in the footnote to the column.

    Retirement Age Assumption in Benefit Calculation

    Instruction 2 to Item 402(h)(2) states that, for purposes of calculating the actuarial present value of an NEO's accumulated pension benefits, a company must use the same assumptions that it used for financial reporting purposes, except the retirement age assumption. Instead, the NEO's retirement age is to be based on the normal retirement age as defined in the plan, or, if not so defined, is to be based on the earliest time at which a participant may retire under the plan without any benefit reduction due to age.

    As was pointed out to me by some of Mercer's benefits experts, some pension plans provide for full retirement benefits at a specified "early retirement” age, as well as at "normal retirement” age. And, given the way these calculations are made, in many instances the present value of the "early retirement” benefit is different from (and can be larger than) the present value of the "normal retirement” benefit.

    Nonetheless, the Instruction seemed to require that the normal retirement age assumption be used. However, Paula told us that the staff has decided that the earlier age should be used, effectively changing the Instruction to provide that, where both a normal retirement age and an earlier unreduced benefit age are contained in the plan, a company should use the earlier age as its assumption.

    Effective Date FAQs Coming

    These are just the first of what I'm expecting will be numerous interpretive positions from the Staff over the next several months. Paula indicated that Corp Fin is working on a series of Questions and Answers concerning effective dates issues (including early compliance) and hopes to have them out soon.

    She also offered what I think will be some very helpful advice on preparing the disclosure tables. Acknowledging that, given the wide variety of executive compensation plans, not every grant or award is going to fit cleanly into the tables, she discouraged companies from being too rigid in how they apply the rules to complex or unusual awards. She also noted that companies may need to use supplemental narrative disclosure to explain to investors what is being presented in the tables.

    While some companies may not take a lot of comfort in this advice, it seems to me that it gives us latitude to use our judgment in deciding how to report specific awards as long as we stay within the spirit (or principles) of the rules. Take, for example, the performance share award I discussed yesterday. Based on what I heard, I have a lot more confidence today that, when the performance period ends and the number of shares earned is determined, this information should be reported in the Stock Awards columns of the Option Exercise and Stock Vested Table. To the extent that it's not clear to an investor what is going on, I can explain the transaction and any related details in a footnote to the table.

    Paula also made some additional significant comments on the reporting of new NEOs. Once I decipher my notes and make sure that they are accurate, I'll pass them along in a future post.
     

  3. Preparing the New Pension Benefits Table - from Mark Borges' Blog (8/17/06)

    My general impression is that the disclosure requirements for executive pension benefits are considerably simpler than originally proposed. Even so, in conversations with various retirement plan experts, I’m finding that the coming up with the required estimates is still going to be plenty challenging. Here are a few of the questions that have surfaced so far:

    • The new rules state that, in calculating the actuarial present value of a named executive officer’s accumulated pension benefits, you are to use the same assumptions that are used for financial reporting purposes, except that the assumed retirement age is to be the normal retirement age as defined in the plan, or, if not defined, the earliest time at which the NEO may retire without any benefit reduction. I’m told that while many plans have a specifically defined retirement age – usually, age 65 - it is common for them to also have a provision that allows participants to retire at an earlier age – for example, age 62 – without any benefit reduction.

      In this case, should the company use 65 or 62 in its calculation? Depending on the NEO’s age, the choice could have significant consequences. I’m told that using the earlier age could produce a disclosable amount that’s up to 30% larger than the result using age 65. A strict reading of the rule would suggest that age 65 is the correct assumption, but doing so would result in a significant increase in the benefit in the final year if the NEO retires early.
       
    • Another issue concerns the benefit calculation for a cash balance plan. I’m told that, while most of these plans allow participants to receive their account balance when they retire, they are also required to offer participants an opportunity to convert their account balance into an annuity. It’s not clear from the new rules whether the estimated benefit amount is to be based on the present value of the account balance or the present value of the projected annuity, which is likely to be higher.

      •  
    • Finally, I’m told that the accounting measurement date for most pension plans is September 30 (to give the actuaries sufficient time to make their necessary calculations by the end of the year for financial reporting purposes). Since the new rules use the plan measurement date as the focal point for the amounts to be reported in the Pension Benefits Table, in the case of calendar-year companies this amount won’t correspond with the company’s fiscal year. This means that the pension benefit information will be presented for a period that differs from the fiscal year period covered by the disclosure.

    While I’m sure that all of these issues will be resolved before the end of the year, they certainly underscore the complexity of these calculations. Companies should start looking at how the new rules will apply to their defined benefit pension plans now, so that they can identify any interpretive questions that will need to be answered before they make their required calculations this fall.
     

  4. Practice Pointers
  5. Video Webcast Panel: The Inside Scoop – Red Flags – Revealing Questions to Ask (2004 Compensation Conference)
    • What the compensation consultants have wanted to tell the compensation committee
    • How to understand the common – but often confusing – components of executive compensation
    • What you need to know (and haven’t been told) about Perks, Severance, Deferred Compensation, SERPs, 162(m), Surveys, and more
    • How to get a true handle on the CEO’s and NEO’s total compensation
    • How to factor in accumulated option and restricted stock gains when making current compensation decisions
    • Tally Sheets – what they are, how to use them – why every compensation committee needs to tally up all the components in one place

    Speakers: Mike Kesner, Deloitte & Touche; George Paulin, Frederic W. Cook & Co.; Dick Wagner, Strategic Compensation Research Associates; Diane Doubleday, Mercer Consulting; Tim Sparks, Compensia; Fred Cook, Frederic W. Cook & Co.
     

  6. Video Webcast Panel: "The Consultants Speak" on What You Need to Do Now (2005 Compensation Conference)
    • Where we have gone astray – and how to make the necessary fixes
    • Changes you can implement to restore integrity to the process
    • How to avoid liability for directors and their advisors.
       
    Speakers: Pearl Meyer, Steven Hall & Partners; Mike Halloran, Mercer Consulting; George Paulin, Frederic W. Cook & Co.; Douglas Friske, Towers Perrin
     
  7. Media Articles
  8. Firm Memos
  9. Good SERP Disclosure Examples

     
 

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