- from the "1st Annual Executive Compensation Conference" (10/04)

Talking Points - SERPs

 Mike Kesner is Head of the Executive Compensation Practice for Deloitte & Touche LLP

1. Plan Design
   1. The best way to manage SERP costs is through solid, responsible plan design.
   2. Targeted replacement ratios/accrual rates should be based on competitive data and in the context of total pay.
   3. The definition of compensation should be based on salary and bonus only
      1. No need to include long-term incentive payouts in the definition of final average earnings; LTI inclusion only serves to push replacement ratios to 90% (or higher) of salary and bonus.
      2.  Use of high 3 or 5 consecutive years in last 10 provides a representative level of pay.
         1. Avoid highest 3 or 5 nonconsecutive years’ bonuses.  This can significantly “average up” final average earnings used for pension purposes.
         2. Similarly, avoid highest salary earned (usually the final years’ salary).
   4. Avoid lump sum payouts
      1. But if you have to allow for lump sums, make sure you use a market rate of interest to calculate the lump sum, not a below market rate required by the qualified plan.
      2. Annuity payments also provide the company with some leverage to enforce post-retirement obligations such as non-solicitation, non-compete, non-interference with vendors, etc.
   5. Define normal and early retirement appropriately and apply reasonable early retirement discount factors in calculating pre-age 65 distributions.
   6. Use actuarial equivalent J&S benefits.
      1. Avoid paying single life benefits to the surviving spouse.
      2. Clearly specify mortality tables.
   7. Accrue benefits based on actual years of service and/or require a minimum number of years of service to be eligible for benefits.
      1. For example, 1.6% per year of service times final average earnings and at least ten years of service.
      2. Avoid defining the benefit as a percentage of pay.  For example, “60% replacement ratio at retirement” type plans could create a huge windfall for short service executives.
      3. Cap annual benefits at a specific dollar amount.  For example, “but in no event shall the single life annuity (or its actuarial equivalent) exceed $1,000,000 per year.”
   8. Be sure change in control (C-I-C) related provisions observe all of the above rules, and limit any increase in final average earnings to 110% of what the executives’ final average earnings were prior to the C-I-C.
2. Regular Monitoring and Reporting
   1. Each year, the Compensation Committee should be provided with an analysis of each senior executives’ benefit, including:
      1. Increase in present value.
      2. The single life annuity award at normal and early retirement based on current pay and years of service.
      3. The projected single life annuity value at normal and early retirement assuming a reasonable increase in future pay and the lump sum equivalent value of the projected payments.
   2.  The company should also provide the Committee with aggregate SERP costs including the accounting accrual for the year, and the current unfunded balance of the plan.