Executive benefit packages often contain errors

Enron's struggles, President Bush's tax cut and the tragedy played out with surviving families of those lost in the Sept. 11 attacks, have all brought about heightened interest in benefit packages for top executives.

Despite these concerns and an acute awareness of how these packages are developed, industry experts find that many companies continue to make a number of common errors when putting together benefits packages, and in particular, nonqualified benefit packages. The outcome, experts say, could harm the executives, the company, or both.

"Many executives think the primary reason for income deferral is to shift earnings from a currently high tax bracket into what will hopefully be a lower future tax bracket post-retirement," said Jim Clary, president of Mullin Consulting, a benefits consulting firm based in Los Angeles.

"In fact, compensation deferral plans continue their popularity because they remain the only solution for tax-effective savings in a world where government restrictions create reverse discrimination against executive savings. And while these compensation deferral plans continue their popularity, a host of errors are often made in designing these programs."

Mullin Consulting has comprised a list of common errors made by company executives in handling this executive benefit.

Overemphasis on industry peer group. Companies too often look to peer groups within their industry in designing competitive packages for top executives. This was fine a decade ago. In today's marketplace, however, top executives are making more lateral moves from companies outside of their industry. It's no longer good enough to just compete with companies inside your own industry for executive talent; executive benefit plans must be competitive with those offered all over the globe.

Over-reliance on stock options. Companies are still relying too heavily on stock options, which created significant executive wealth in the 1990s but have lost their luster in the last 18 months. Companies therefore need to balance their packages, educate themselves to other alternatives and create improved strategies to reduce risk.

Ceding plan control to a single executive. Once a plan design is in place, companies often allow executives to take control of plan provisions with management sometimes becoming slaves to whatever a top executive wants to do with the assets inside the plan. The resulting lack of central control can harm the overall company plan.

Treating the plan like a 401(k). Companies often use mutual funds to fund their nonqualified plans, but then defer to a vendor to run it much like a 401(k) plan. This allows plan participants to shift their individual holdings around, often triggering a taxation risk, could catch both company and participants unaware. In these instances, it is the participant who must pay the tax, not the company.

Lack of communication. Companies often experience value perception problems when they allot too little time and effort to communicate their executive benefit package to executives. This results in executives being unsure of its real value and makes the plan unsuccessful because of a lack of buy-in from all eligible executives.

Not being able to trust the rabbi trust. Many companies will design a nonqualified plan utilizing the security provisions of a rabbi trust. However, often notably missing is the provision that the trust be "callable." The rabbi trust is a grantor trust used to secure the company's promise against the company's refusal to pay benefits, but cannot secure the executive's benefit against company insolvency or bankruptcy. With a "callable" provision, the participant can have a right to "call" for his/her benefit at any time (subject to some forfeiture to prevent all plan participants from being in constructive receipt). This is a critical provision that should be included in a rabbi trust.

Failing to register the plan with the SEC. Many publicly held companies fail to register their plans with the Securities and Exchange Commission. By not doing this, the company is at risk of a lawsuit from the participant if his deferred compensation plan loses its value.

Under-communicating the risk. Many companies have not done a good job in explaining the risks of nonqualified benefit plans to their employees. The outcome of this is often an employee not handling the tax withholding correctly or not fully understanding the plan's provisions in the event of separation.

Creating a "Social Security syndrome plan." Often, when management sets down provisions for funding a plan, the plan gets designed to pay out handsomely for current top executives, but pushes down the plan's financial burdens to future employees and shareholders.

"Developing an executive compensation package that is highly perceived and financially sound requires a dramatic shift in thinking today," said Clary. "The good news for employers is that there are a variety of solutions for deploying benefits without falling into any of the common traps that can reduce value to the participant or increase its cost unnecessarily to the company."

Mullin Consulting has designed, implemented and administered executive benefit plans for 30 years.