Dylan Habeeb – Presentation and Case Design Specialist
The current problem facing Defined Benefit Plans (both Qualified and Nonqualified) in the corporate market:
It is estimated that 93% of Qualified Defined Benefit Plans are underfunded. Companies are getting rid of and amending Qualified Defined Benefit Plans due to the low interest rate environment and having to lock up large amounts of capital for long periods of time.
Companies that have existing Qualified Defined Benefit Plans have had to make very large contributions in order to sustain them due to these low earning rates. For example, Ford dropped $8.4 billion into its pension plan over the last two years and is instead offering more than 90,000 US salaried retirees and former executive employees an opportunity to take a cash lump-sum payment. This reduced the underfunded status from $18.7 billion (2012 EOY) to roughly $9 billion (2013 EOY).
Financing is an issue for both Nonqualified and Qualified Defined Benefit Plans; however, it is magnified for Qualified Plans. The issue is more on trying to find the best long-term asset to match the long-term liabilities that companies have by implementing Nonqualified Benefit Plans to incent and retain their top talent.
One last reason for the elimination or changes to Qualified and Nonqualified Defined Benefit Plans is that employers no longer want to give executive employees an “entitlement” benefit that isn’t tied to company and/or individual performance — Defined Contribution Plans are becoming more popular to tie performance with rewards.
What are the benefts of a Nonqualified Defined Benefit Plan (ie: SERP)?
- Employer promises to pay additional income to employee upon death, disability or retirement
- Employer can recruit and retain key employees by selectively choosing the participants of the plan
- Employee is not taxed on income earned until future payout
- Benefits can be designed as “golden handcuffs” to encourage key employees to continue to work for employer—ie: they are only paid out if still employed by the employer (vesting schedules are typical with these plans)
Why are Banks continuing to provide SERPs?
Banks have not been immune to the current low interest rate environment; however, Banks have the ability to own a unique asset to finance and hedge the cost of SERPs: Bank Owned Life Insurance (BOLI). “General Account” BOLI offers Banks a competitive and attractive tax free rate of return with no fluctuating yields, low variability and tax free death benefits to the Bank to help recover the cost of these plans.
The predictability of the BOLI earnings is unique and eliminates the funding volatility often found in Qualified Defined Benefit Plans.
What is the future of SERPs for Banks and corporations?
Although we are seeing an increase in more incentive based (or “pay for performance”) type plans (such as Defined Contribution Plans), Nonqualified Defined Benefit Plans still have a place for this compensation planning. This is especially true with Banks, primarily due to the hedging and financing option that BOLI provides.
In addition, although the perception is that SERPs are not as popular, they still are the largest type of plan out there for Banks. According to EBN’s compensation study of 111 banks in the Midwest, 45% of banks have a Nonqualified Benefit Plan and/or a Split Dollar Plan. Of those banks with a Nonqualified Benefit Plan, 77% consist of SERPs.
Executive Benefits Network’s Takeaway:
Although Executive Benefits Network is seeing an uptick in Nonqualified Defined Contribution Plans, SERPs are still relevant and worthy of discussion in designing Nonqualified Benefit Plans, especially for Banks. In addition, BOLI is an attractive asset for a Bank to hedge and finance the cost of implementing SERPs and provides a great long-term asset to match these types of long-term liabilities.
For more information on Nonqualified Benefit Plans and details from Executive Benefits Network’s Compensation Study, please CONTACT us.