Hr Innovation Spring 2013

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HR innovationSpring 2013

04

Rethinking incentive

plans: Improving cost/beneft and enhancing

strategy alignment

10

Considering anacquisition? Begin

total rewardsplanning now

16

Reaping the rewardsof organizational health

22

Taxing issues for 2013:Rising rates inuence

compensation choices


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Executives across industries share

the challenge of getting their employees

total rewards package right.


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Contents

Foreword 02

Scott Olsen, US Leader, Human Resource Services

Rethinking incentive plans: Improving cost/benet 04and enhancing strategy alignment

Scott Olsen

Considering an acquisition? Begin total rewards planning now 10

Aaron Sanandres and Andrew Skor

Reaping the rewards of organizational health 16

Don Weber

Taxing issues for 2013: Rising rates inuence compensation choices 22

Mike Xu


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02

Foreword

But its important to get it right.

Among participants in our 16th

Annual Global CEO Surveywho

view employees as important stake-

holders, 80% plan to strengthen their

employee engagement programs. The

key lies in the ability to look beyond

pure reward to the wider employee

value proposition, balancing thenancial and nonnancial rewards.

Incentives that are too complex or

ambiguous can create trust and value

gaps among employees. On the

other hand, nonmonetary incentives

can be just as effective as traditional

metrics-based bonuses or other

nancial rewards. For example, an

opportunity for development in anew and challenging area of the

business that a high-level executive

might consider a dream job could

be more effective in building long-

term loyalty and motivation.

Similarly, in todays global compe-

tition for talent, it may not be

enough to offer basic me too type

benets. Employers who want to

attract diverse, top-level talent

must design total rewards pack-

ages that contribute to the overall

mental and physical well-being of

their employees. Going beyond basic

health benets to include an incen-

tive-based wellness component,

for example, can help motivate

and engage employees, boost

productivity, and reduce illness

and absenteeism, all of which areessential to organizational health.

Employers who care about the

whole person also must take a

closer look at how global economic

austerity measures might affect

the nancial health of their talent

pool. Employees, especially higher

wage earners, are facing a greater

Executives across industries share the challenge of getting their

employees total rewards package right. From health benets

to incentive programs, executives struggle to measure the

effectiveness of total rewards in attracting, developing, and

retaining talent and contributing to organizational success.

Without a doubt, the total rewards challenge is chronic and

common, cutting across the industry spectrum and testing

leaderships strategic focusand sometimes patience.

US tax burden this year. Businessleaders who consider options such

as deferred compensation plans

can help their people manage their

personal nances more effectively.

In an era of continuing merger and

acquisition activity, it s crucial to

understand your own companys total

rewards structure and how a target

companys program might t into it.

The implications of an acquisition

for a target companys total rewards

structure can be profound, requiring

the buyer to tweak metrics, replace

certain awards, and often realign

the performance management

framework to support an integrated

post-acquisition rewards structure.

In this issue ofHR Innovation, we

delve into the complexities of totalrewards design. I hope youll enjoy

gaining the insights offered in

these articles:

Rethinking incentive plans:

Improving cost/benet and

enhancing strategy alignment

Incentive programs often fail. The

guiding principles of incentive


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03HR Innovation

plan design largely ignore theperceptions of executives and

employees. And sometimes

employers use incentives as a

substitute for effective manage-

ment and leadership. Learn how

to put incentive programs back

on track.

Considering an acquisition?

Begin total rewards planning

nowAcquisitions mean bigchanges, usually involving total

rewards. Learn how to mitigate

the risks.

Reaping the rewards of orga-

nizational healthA competitive

total rewards strategy requires the

development of a positive culture

that embraces organizational

wellness in addition to providing

health benets. Taxing issues for 2013:

Rising rates inuence deferral

choices Employees will feel the

pinch of rising income tax rates

this year. Look at whats behind

the trend and how employers can

respond to lessen the tax burden.

We hope youll take the opportu-nity to review the perspectives

offered inHR Innovation. We believe

employers may benet from reas-

sessing their total rewards programs,

looking at the balance of monetary

and nonmonetary incentives and

rewards and taking into consider-

ation the well-being of the employee

as a whole person whose physical,

mental, and nancial health is essen-

tial to the health of the organization.

Understanding employee perceptions

about current total reward offerings

can be an important rst step in such a

reassessment. Rening total rewards

programs to balance the objectives of

investors, the business, and employees

has the potential to benet both

employers and employees.

Scott Olsen

US Leader, Human Resource Services


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04

Rethinking incentive plans:Improving cost/benet andenhancing strategy alignment

By Scott Olsen

Incentive programs have

become a core component

of many companies total

rewards programs. Despite

widespread adoption of such

programs, we have found thatthe efcacy of traditional pay

for performance programs

is routinely considered to be

less than satisfactory. Namely,

they dont 1) provide a strong

bang for the buck, 2) create

strong incentives to maximize

performance, and 3) support the

execution of company strategy.

This is backed up by the view

among one-third of the CEOs

responding to PwCs 16th Annual

CEO Surveythat incentive plans

were not working as intended.

04


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05HR Innovation

Are these perceptions of incentiveplans well founded? We believe that

there are two primary reasons why

incentive programs may fail to deliver

on their promise. The rst is that many

of the principles that have guided

incentive plan design in recent years

have largely ignored the perceptions

of executives and employees. The

second is that incentives have often

been used as a substitute for effective

management and leadership rather

than as part of an overall management

and leadership model.

Executives undervalue

incentives relative to

their cost

Research conducted by PwC and

Dr. Alexander Pepper of the London

School of Economics and PoliticalScience provides important insights

into how executives value incen-

tives as part of their total rewards

program. The research points to

a fundamental trade-off in incen-

tive design. The very elements that

often dene pay for performance

multiple and complex metrics,

emphasis on relative performance

and stock based compensation, long-term deferrals and stock holding and

ownership guidelinesdecrease

the value of compensation to execu-

tives. We believe that the next phase

of incentive compensation strategy

is to develop programs that include

the best attributes of performance

alignment, while minimizing those

attributes that destroy value in the

eyes of participants.

The Research

Incentives are a by-product of

agency theory: that is, that conicts

between principals (e.g., inves-

tors) and agents (e.g., executives or

managers) can be addressed through

incentives. While this concept was

initially applied to executives as

a means of creating an owner-

ship mindset, it has been extendedto broader groups of employees

as a means of encouraging and

rewarding behaviors and outcomes

specied by the senior managers

who set company strategies.

Over time, as incentive plans have

evolved, the views of regulators and

shareholders have been fairly well

described and documented. Conversely,our research was designed to test

executives views about compensation

packages, specically how they value

various features of current compensa-

tion programs. We surveyed more than

1,100 executives from 43 countries. The

sample included male (81%) and female

(19%) executives in a variety of roles

and industries with total compensation

levels ranging from under $350,000 to

over $725,000.

Several consistent themes that arose

across all of the samples should help

inform the continuing evolution of

incentive compensation programs:

1. Executives are risk-averse: When

given a choice, a large majority of

executives chose a lower level of

xed pay over a higher expectedvalue of bonus.

Why it mattersVariable compensa-

tion effectively raises the overall cost

of rewarding executives. Put another

way, the cost/benet of incentive

plans is weaker than for xed elements

of pay, such as base salaries.

Our research was

designed to test

executives views

about compensation

packages.


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Conversely, continued staff reduc-tions, which place additional

demands on remaining executives,

will place upward pressure on pay

levels. Highly volatile compensation

plans (where realized compensation

may vary by more than 30% year

over year) will be highly discounted

by executives. (See nding 1.)

6. Recognition is an important motiva-

tion behind many incentive plans:

Even though executives may value

incentive awards (especially long-

term incentives) at a signicant

discount to their expected value or

cost (see ndings 1 through 4), they

value the opportunity to participate

in these plans.

Why it mattersIncentive plans

have intangible valueas a

recognition mechanism and as an

indication of status. Renements in

incentive design may better align the

economic value of these plans with

the intangible value they convey.

of rewarding executives. Further,a uniform policy toward deferrals

will have different consequences

for executives, depending on their

overall level of compensation and

demographics.

4. Fairness is fundamental:Its all

relative. Executives want to be paid

fairly against their peers (internal

and external), irrespective of their

level of compensation.

Why it mattersAnother down-

side of complex incentive plans

is a perceived unfairness of

outcomes. (See nding 2.)

5. People dont just work for money:

Executives are prepared to take a

fairly signicant reduction in pay

in order to work in their dream

job. But there is a oor on the

reduction they would be willing to

accept, regardless of their current

level of earnings.

Why it mattersInvestments in

job satisfaction may reduce the

upward pressure on compensation.

06

2. Complexity and ambiguity destroyvalue: Executives value incen-

tives more highly if they know and

understand the rules governing

the incentives.

Why it mattersIncentive

programs are more highly valued

when they are well understood.

You can increase the perceived

value of complex plans among

participants through consis-

tent management processes

and systems, including regular

communication of results, educa-

tion about the metrics, and the

use of metrics that are consistent

with strategy, corresponding key

performance indicators (KPIs),

and decision making.

3. The longer you have to wait, theless its worth: Executives value

deferred awards with a very high

discount rate; the average executive

applied a 50% discount to a bonus

with three-year pro rata vesting

(annual discount rate of over 30%,

compared with discount rates of

between 5%-10%, depending on

the form of compensation.) While

some of the differential in execu-

tive discount rates is attributable

to a lack of diversication for most

executives, it is clear that executives

have a strong aversion to deferred

compensation.

Why it mattersAs with variable

pay in general, the use of deferred

compensation raises the overall cost

Executives value incentives more highly

if they know and understand the rules

governing the incentives.


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07HR Innovation

Increasing the bang for the buckOne response to the research on exec-

utive perceptions would be to curtail

or limit incentive programs in favor

of xed compensation. However, to

do so would not only y in the face of

investor and regulator preferences, but

it would also eliminate a potentially

valuable management tool.

Rather, we believe that incentive plans

can be rened in ways that improve

the bang for the buck. If the cost/

benet gap related to incentive plans

represents an investment, what can

be done to increase the return on that

investment?

1. Evaluate the role of incentives in a

total rewards program

If incentives are over weighted

as a proportion of a total rewardsprogram, the cost/benet gap will

be exacerbated. Re-evaluating the

mix of pay may offer opportunities

to reduce the companys investment

in total rewards without reducing

the perceived value to executives.

2. Reduce the number and complexityof metrics used in incentive plans

Incentive plans that have too

many metrics, or metrics that are

not understood by participants,

have a greater chance of being

undervalued by participants. Plan

simplication and/or increased

communication and education

about the most important metrics

used in the plan can improve the

perceived value of the plan.

3. Invest in non-monetary rewards

Employees clearly value monetary

rewards. However, non-monetary

rewards such as recognition,

advancement, access to learning,

global opportunities, benets,

corporate responsibility, and culture

may reduce the pressure on direct

compensation. There may also beopportunities to tailor certain of

these non-monetary rewards to

different employee demographics

(e.g., by market/territory or

generational distinctions such as

millennials and boomers).

Incentives dont replace

leadership and management

Incentives are often cited as an impor-

tant tool for reinforcing the execution

of a companys business strategy. And

almost three-quarters of the CEOs wesurveyed in 2012 believed that their

organizations would be undergoing

transformational change during 2012

and 2013. Further, over 40% of US

CEOs surveyed believe that all staff

should be encouraged to participate

in strategic decision making. So one

would expect that incentives would

be instrumental in advancing the

anticipated transformation.

However, in a separate Performance

Alignment Survey, we found thatless than one-third of the responding

companies were satised with their

ability to execute strategic change.

This again points to the fact that

incentive programs are seen as

lacking among a large proportion of

companies.


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08

The leadership modelThe leadership model focuses on

several interim steps prior to dening

the operating model described in

the graphic:

Development and education of

strategic priorities and tradeoffs

How have the organizations

priorities changed as a result

of the new strategy?

How will day-to-day decision

making change as a result of

these revised priorities?

Do employees have the proper

tools to guide decision making?

Understanding strategic risks

Does the strategy have the

exibility to respond to risks that

may emerge during execution?

Do employees understand

how to recognize and react

to the risks that may occur?

And to report them back to

senior leaders?

One possible reason for this gapbetween the prevalence of incentive

plans and the perceived lack of effec-

tiveness of these plans in promoting

strategic change is a lack of align-

ment across company strategy,

incentive plans, and other manage-

ment processes and systems. In many

cases, an incentive plan is considered

to be a sufcient means of driving

strategic change. However, while

incentives may be a necessary compo-

nent of strategic change, they are

rarely sufcient for driving change by

themselves.

Our research in this area nds that

many companies move directly from

strategy development to an operating

model to support the strategy. While

an operating model, comprising

traditional PMO, implementationcommittee, organization structure

changes, and role development, is an

important aspect of strategy imple-

mentation, we believe that an interim

step to develop a leadership model

can both increase an organizations

ability to drive strategic change and

increase the effectiveness of incentive

plans in supporting strategic change.

The leadership model

Strategic priorities

& tradeoffs

Do those driving change truly

understand the priorities and

their inherent tradeos at

the level o detail that inorms

day-to-day decision making

and rontline execution roles?

Performance drivers

Are we managing business

and individual perormance

to the key success measures

that underpin the strategy?

Strategic risks

Are all risks associ ated

with the strategy adequately

understood, quantifed, and

prioritized?

Critical behaviors

Have we embedded the

specifc behaviors that

drive disproportionate

value in strategy delivery?

Embeds sufcient

understanding

of the strategy to

inform effective

decision making

Provides lead/lag

indication of

progress toward

embedding a new

operating model


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09HR Innovation

Regular reporting on the metricsand KPI scan address potential

perceptions ofunfairness

Calibrating incentive plans

(setting appropriate threshold,

target, and superior levels of

performance necessary to fund

incentives) in a way that recog-

nizes and reects risks in the

strategy can help address execu-

tives general risk aversion

Are your incentives getting

the right regard or sowing

seeds of regret?

Incentive plans will remain an

important component of executive

and employee reward structures.

Their ability to support a pay for

performance mentality for various

levels of employees and executives;

to introduce variability to aggregate

employee costs that is responsive

to business performance; and to

support, recognize, and reward stra-

tegic execution remains a compelling

objective of these plans.

Linking incentive plans withthe leadership model

Development of a leadership model

can have a powerful impact on incen-

tive plans. The incentive plans become

one component of a management

system around the strategy rather

than a singular driver of the strategy.

Elements of the leadership model can

be applied to incentive plans in some

important ways that also address

some of the problems with execu-

tive perceptions of incentives. A few

examples of ways to link the leader-

ship model with incentive design:

A clear understanding of the

companys strategy addresses the

complexity and ambiguitythat can

destroy executives valuation of

incentives

Linking metrics and KPIs to incen-tive plans will create a strong link

between the plan and strategy

Tailoring the appropriate metrics

and KPIs to incentive plans for a

broader group of employees can

improve the recognition value of

the incentive plans

Identifying supporting perfor-mance drivers

Have primary metrics and KPIs

for measuring the business been

updated to align with the strategy

and corresponding priorities?

Do systems provide interim

reporting on the primary metrics,

KPIs, and related objectives?

Do the metrics and KPIs highlightthe tradeoffs inherent in the

strategic priorities?

Developing role models for

behaviors necessary to support

the strategy

What changes in behaviors

are necessary to advance the

strategy?

Does leadership exhibit the

necessary and desired behaviors?

Are there consequences

throughout the organization for

failure to develop and demon-

strate the critical behaviors?

We believe that application of

research on executive (and employee)

perceptions to incentive plans can

improve the efcacy and cost/

benet relationship of incentives.

By adopting a leadership model, and

adapting incentive programs within

the context of a leadership model,

companies can support strategicchange, increase the likelihood

that plans meet their objectives,

and address some of the underlying

characteristics of incentive plans that

can otherwise cause executives and

employees to undervalue them.

Incentive plans will

remain an important

component of executive

and employee reward

structures.


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10

Considering an acquisition?Begin total rewards planning now

By Aaron Sanandres andAndrew Skor

Acquisitions mean big

changes for numerous

stakeholders. The implica-

tions for a target companys

total rewards structure can

be profound, requiring the

buyer to tweak metrics,

replace certain awards, and

often realign the performance

management framework to

support an integrated post-

acquisition rewards structure.


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11HR Innovation

This change management process canbe fraught with human capital risks that

can undermine the human resources

(HR) leaders ability to execute the post-

acquisition HR strategy successfully. To

mitigate these risks means that as soon

as practicable in the diligence process,

HR leaders should identify, plan, and

quantify them, where possible.

Its crucial to have a disciplined

methodology for addressing poten-

tial issues. A best practice used by HR

leaders to assess risks is by looking

at the organizations current state,

establishing a future state, and then

identifying what they should do to

close any gaps.

Understanding the targets

rewards structureIts not as easy as compiling a list of

plans, participants, and potential

payouts. The buyer should know

how the target makes compensation-

related decisions and understand the

companys performance management

process. Ask:

How does the target measure

individual performance?

How does the output of theperformance management

process (i.e., ratings) affect

compensation decisions?

What, if any, managing of the

performance rating distribution

exists?

Understanding the link between the

companys performance manage-

ment system and incentive structurescan provide valuable insight into the

targets culture, clues to potential

retention risks, and impediments to

rewards integration.

Specic considerations should include:

Annual incentives: Funding of

the annual bonus pool and indi-

vidual allocations should tie to

corporate-wide and individual goalsand objectives. The buyer should

understand how the target funds

its annual pool (i.e., ties funding to

company performance), the number

of participants, and criteria for

individual bonus determination.

Targets with signicant discretion

embedded into the annual incen-

tive process can present integration

challenges to an acquiring companythat relies on more formal bonus

allocation processes.

Long-term incentives: Long-term

incentives, generally delivered in

the form of equity compensation,

such as stock options and restricted

stock, can have material embedded

value. From a diligence perspective,

HR leaders will want to understand

the number of outstanding awards,concentration of holdings, compli-

ance with tax rules (e.g., 409A), and

the treatment of outstanding awards

in connection with the change

in control, which carries with it

certain tax benets and accounting

implications.

Equity plans commonly require auto-

matic vesting of all awards upon a

change in control, which can triggersignicant cash payments. This is

particularly true of private-equity-

owned companies, where long-term

incentive plans often pay signicant

sums to top executives upon a change

in ownership. However, the amount

of the windfall doesnt usually create

retention risk because management

Its crucial to

have a disciplined

methodology

for addressing

potential issues.


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12

(where retained) holds a key stake inthe transaction. Because the long-term

incentive (LTIP) cash-out removes the

employees largest tangible incentive

for staying until the prospective

incentive values take root, companies

can face retention risk.

More commonly, conditional accel-

erations can cause unvested equity

awards to fully vest unless the

acquiring company assumes them. But

the acquiring company has the oppor-

tunity to roll over unvested equity

award into unvested equity awards

over its own stock, thereby inher-

iting the awards embedded retention

value. Although an attractive option,

the decision to assume outstanding

equity award should be made in the

context of the broader post-combina-

tion total rewards strategy and dealeconomics (i.e., the use of rollover to

fund part of the transaction).

Buyers are sometimes hesitant about

exchanging target equity awards

because of dilution or concerns about

the associated expense. However,exibility under the tax rules for

setting the terms of the replacement

award beyond the more conventional

exchange ratio approach can reduce

the dilution and associated prot-

and-loss impact. For target LTIPs that

provide for board discretion on treat-

ment, any decision made by the buyer

will result in a compensation expense

related to the equity awards in the

post-combination period, regardless

of whether such awards are accel-

erated or cashed out at closing or

assumed as unvested awards over the

buyers equity.

Deferred compensation:

Mandatory deferral of compensa-

tion, which is increasingly common

across many industries, can take a

variety of forms. During diligence,

the buyers HR leaders should focuson the magnitude of the deferred

compensation obligation (and asso-

ciated funding, i f any), compliance

with tax rules (specically IRC

Section 409A), and whether such

balances are to be distributedupon the change in control (and

associated tax implications).

Benet plan liabilities:

Liabilities related to employee

welfare and retirement plans,

which are an important compo-

nent of the total rewards offering,

should not be ignored. The buyers

HR leaders should perform thor-

ough diligence to understand anytransferring liabilities, annual

expenses, and cash-funding

requirements associated with

employee dened-benet pension

plans or post-retiree welfare plans.

HR leaders should also understand

the potential effect that external

forces, such as market conditions

and healthcare reform, can have

on their operations. Given recent

market conditions, for example,dened-benet plans may be

signicantly underfunded, which

can result in large cash contribu-

tions post-transaction.

Buyers are some-

times hesitant about

exchanging target

equity awards

because of dilution

or concerns about the

associated expense.


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13HR Innovation

Dening the futureof total rewards &

understanding gaps

While integration risks can be

challenging to quantify, HR leaders

should assess the areas that present

the greatest risk and plan appro-

priately, mapping each component

of the targets total rewards to the

acquiring companys reciprocal

program to identify immediate gaps

and needs. The approach described

below considers corporate acquisi-

tions in which acquired employees

may be integrated into existing

structures. In practice, there are

many different approaches to estab-

lishing total rewards structures

post-transaction (many of which

may rely on the requirements or

leniency of the purchase agreement,

which may require certain provi-sions for compensation and benets

post-transaction).

HR leaders should also assess whether

the targets performance management

framework helps improve business

While integration risks can be challenging to

quantify, HR leaders should assess the areas that

present the greatest risk and plan appropriately,

mapping each component of the targets total

rewards to the acquiring companys reciprocalprogram to identify immediate gaps and needs.


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14

outcomes. For example, once thetargets employees are integrated

into the buyers incentive structures,

the performance review process

can help facilitate greater differentia-

tion of performance, if thats what

leadership desires.

We have outlined some common

post-acquisition structural changes

to targets HR programs:

Salaries: Salaries can consume

a signicant amount of planning

and analysis if the buyer chooses to

integrate target employees into its

salary structure. HR leaders should

understand comparative pay for

similar roles so they can identify

where positions and roles vary.

Many buyers go through a struc-

tured job mapping process to

align salaries across the combined

organization. A rudimentary

mapping matches job titles and

descriptions or links positionsbased on overlapping job codes.

(For example, if an accountant 3

at the acquired company is matched

to job 1234, a buyer may conclude

that this role is similar to its own

senior accountant, which is also

matched to job 1234.)

Annual incentives: A target

companys annual incentive plan

will likely need some modication

following a change in owner-

ship. At a minimum, the buyer

should assess whether perfor-mance targets and metrics support

underlying post-combination

business objectives. More material

changes can include those made

to the pay mix or the introduc-

tion of new performance metrics

into the determination of the

Many buyers go through a structured

job mapping process to align salaries

across the combined organization.

A rudimentary mapping matches job

titles and descriptions or links positions

based on overlapping job codes.

annual incentive (e.g., corporate-wide metrics or new, behavioral

metrics). The buyers HR leaders

should conrm that the targets

performance management frame-

work supports the changes and

that the changes are adequately

communicated.

Long-term incentives (e.g.,

stock-based compensation):

Integrating target employeesinto the acquiring companys

long-term incentive plan can

often prove problematic. Even for

similar companies, LTIP partici-

pation rates and relative grant

values can vary signicantly. Of

particular importance for an HR

leader is the task of identifying

those employees who had histori-

cally received meaningful levels of

equity awards under the targetsLTIP, but who are not expected

to participate in the buyers LTIP.

Another challenge occurs when

target employees will receive

lower grant values (absolute or

perceived) than they did histori-

cally. For these employees, it may


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15HR Innovation

be necessary or appropriate toprovide a replacement benet or

to consider modications to other

compensation structures.

Benets: Lastly, HR leaders

should consider differences in

employee benets programs

and their impact on employees

from a nancial and employee-

experience perspective. During

diligence, HR leaders shouldcompare benet plans (retirement,

medical insurance, vacation),

even if only at a high level. This

preparation can help them

anticipate integration challenges,

understand changes in annual

run-rate costs, and develop the

necessary employee messaging

and communications materials.

Pre-plan for

post-transaction poise

The launch of the diligence process

should be viewed as the time to start

building understanding of the targets

total rewards offering, a process that

should continue for the duration of

the deal. This can help the buyer to

structure a post-transaction total

rewards program that supports both

HR and business objectives.

In so doing, its important toconsider each element of the targets

compensation and benets package

separately, as well as to assess its

total overall value. This perspec-

tive can lend insight into where

take-aways in certain areas can

potentially be mitigated by more

generous provisions in other parts of

the rewards program.

Once leadership has a sense of the

changes the deal will entail and a

strategy for moving forward, theyshould also be prepared to come full

circle enterprise-wide with a solid,

proactive communication plan that

appropriately promotes the desired

changes, furthers business goals, and

nurtures the evolving culture.


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16

Reaping the rewardsof organizational health

By Don Weber

When health is absent,

wisdom cannot reveal itself,

art cannot become manifest,

strength cannot be exerted,

wealth is useless, and reason

is powerless.

Herophilus, A lexand rian, c . 335 bcc. 280

Smart HR leaders know how to

use health benets to contribute

to employees well-being and to

promote organizational success. A

balanced view of the importance

of workforce health and well-being

and the critical role of health

benets in a competitive and

effective total rewards program

can help employers reinforce the

motivating principles of partner-

ship, engagement, and alignment

for the employee population.


19/34

17HR Innovation

Employee and organizational healthshould be viewed not only as cost-

efciency and compliance issues, but

also as primary components of a total

rewards strategy, predicated on:

1. Recognizing the importance

of organizational health

and health benefts in a total

rewards structure.

2. Monitoring the impactof improving health on

organizational success and,

yes, even cost.

1. Recognize the importance of

organizational health and health

benets in total rewards.

A total rewards program can help

an employer attract, motivate,

and retain the people required to

build the organizations success.

Although each organization chooses

and denes the vital components

of its total rewards program in

a different manner, employers

generally develop these programs

based on commonly accepted HRwisdom about what monetary and

other motivators make sense for

employees and the business alike:

Employees value both monetary

and nonmonetary rewards.

Employees can be motivated by:

Extrinsic motivators (salary and

wages, performance recognition,

peer competition) Intrinsic motivators (feeling

valued and respected; having a

sense of achievement; trust in

the organization and its lead-

ership; enjoyment of work,

co-workers, and workplace; and

having a sense of security)

To retain talent, an employer

should adapt incentives to meet

the needs of an increasinglydiverse workforce.

Organizational mission, vision,

and culture should inform human

resource strategies and total

rewards programs.

The intrinsic value ofemployee health

A well-planned health benets

package, a mainstay of nonmon-

etary compensation, can function as

an intrinsic motivator and perfor-

mance enhancer while creating a

work environment and culture that

can positively inuence employees

health behavior choices. A culture

that encourages a healthy lifestyle

will potentially reduce employee

stress while boosting physical

tness, stamina, overall well-being,

and productivity.

The role of employee health

in recruitment and retention

Talent recruitment and retention

is another total rewards objec-

tive. Offering a health and wellnessprogram as part of a total rewards

strategy can help employers achieve

this objective. In addition to helping

employers recruit and retain talent,

health and wellness initiatives can

Talent recruitment and

retention is another

total rewards objective.


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18

curb illness and injuries, leading toless absenteeism, increased produc-

tivity, and fewer medical claims.

From the employee point of view,

wellness initiatives send a message

that the employer cares about

the well-being of its workforce, a

factor that can boost morale. For

example, PwCs recent Millenials

at work survey found that a good

We see this concept of the organiza-tion stressing its commitment to the

whole person outside the business

world as well. Look at the success of

various university athletic departments

recruiting programs. The ones that

routinely convince young recruits

that they care about their total well-

being usually have the top-ranked

recruiting programs.

In addition, many companies who

routinely place highly on Fortunes

100 Best Companies to Work For list

have robust wellness programs that

include incentives for participation and

on-site tness centers or subsidized

memberships to outside facilities.

A health program should

have common principlesacross demographic groups

A well organized employee health

program should address differences in

global market norms and cultures as

well as the changing lifestyles of workers

as they mature. Educational and preven-

tion programs can be consistent globally,

even as an employers role in providing

Wellness initiatives send a message that

the employer cares about the well-being of its

workforce, a factor that can boost morale.

benets package was one of the most

commonly cited factors that make

employers attractive, ahead of factors

such as exible working arrange-

ments or international assignments.


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19HR Innovation

healthcare may vary from market to

market. In addition, an overall health

program should be exible enough to

accommodate all workers as well as

changes in family status. Developing a

set of guiding principles for your

organizations health program glob-

ally, and maintaining its relevancy

throughout employees careers, will

positively impact its intrinsic value.

2. Monitor the impact of improving

health on organizational success and,

yes, even cost.

We recommend two core approaches

to monitoring organizational health:

Employee engagement and

achievement of corporate goals

Accurate calculation of a programs

return on investment (ROI)

Both of these monitoring functions,

with proper planning and analytics,

can assist in establishing the value of

employee health programs.

Employee engagement

We believe that a healthy and

vital workforce is likely to be more

engaged in meeting the organiza-

tions goals.

Employers can measure employeeengagement in a variety of ways,

with employee surveys being the

most common. Engagement surveys

measure levels and drivers of

employee engagement and how they

affect organizational performance

goals. The goals can be company-

wide or articulated and measured

at the department or operating-unit

level. By tying engagement to the

achievement of goals and measuring

variances among operating units and

locations, HR executives can develop

a concrete case for the continued

expansion of employee engagement

activities, including those related to

employee health.

To take monitoring further,

employers can track whether an

improvement in employee health

(e.g., reduced body mass index,

attainment of normal blood pres-

sure) correlates with an increase in

employee engagement and overall

productivity. This type of study

should be quantiable and tailored to

each employers setting and culture.

Improved employee

health and vitality

Increased employee

engagement

Successful achievement

of corporate goals

Linking a healthy and vital workforce to corporate goals


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20


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21HR Innovation

Calculating ROIEmployers should analyze the impact

of health on the organization. To

capture the complete picture, they

should consider not only employee

health benet costs, but also the

potential cost of disability, workers

compensation, and unplanned

absences. (The Winter 2012/2013 of

HR Innovation discusses this concept

in more detail.)

During the last decade, employers,

led by those with more than 5,000

employees, have been instituting

a variety of health management

programs designed to improve

employees (and their dependents)

health and productivity. These health

improvement programs range from

worksite wellness to on-site clinics,

health coaching and advocacy,disease management, and clinical

management. Even though their

value is not yet fully understood,

these programs have expanded

signicantly during the last three to

ve years.

Better understanding of the impactof health improvement programs

is within reach. Recent advances in

data and information availability and

data analytics can provide a solid

set of ROI measurements, provided

companies are willing to invest not

only in wellness programs but also in

measurement efforts that effectively

gauge their merit. These approaches

can be as simple as measuring

the reduction in negative medical

events, such as hospital admissions

or emergency room visits, for those

enrolled in a condition-specic disease

management program. Or they can

be more complex, population-wide

comparisons.

Choosing the right methodology for

your company depends on the type

of health improvement programs you

are evaluating, data and resources

available, and the degree of preci-

sion that management desires. (See

Determining the value of employer

sponsored Health Improvement

Programs in the Winter 2011 issue of

HR Innovation for a detailed descrip-

tion of measurement techniques.)

Building and sustaining ahealthy, competitive culture

A competitive total rewards strategy

requires the development of a positive

culture that embraces organizational

health and that provides appropriate

health benets. Proper planning and

monitoring with proven analytical

techniques can help HR executives to

quantify the merits of these programs

for upper management.

Employers who support broad

health improvement programs and

encourage a culture of health and

well-being will be well positioned

to reap intangible benets such as

higher employee morale, which in

turn can help establish ROI through

hard data on metrics such as produc-

tivity and employee engagement. The

likely result: happier employees whostay with you longer and contribute

more to company success.

A competitive total

rewards strategy requires

the development of a

positive culture that

embraces organizational

health and that provides

appropriate health benets.

To view past issues ofHR Innovation,

go to www.pwc.com/us/hrinnovation.
http://www.pwc.com/en_US/us/hr-management/assets/hr-innovation-winter-2012-2013.pdfhttp://www.pwc.com/en_US/us/hr-management/assets/hr-innovation-winter-2012-2013.pdfhttp://www.pwc.com/us/hrinnovationhttp://www.pwc.com/us/hrinnovationhttp://www.pwc.com/en_US/us/hr-management/assets/hr-innovation-winter-2012-2013.pdfhttp://www.pwc.com/en_US/us/hr-management/assets/hr-innovation-winter-2012-2013.pdf


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Taxing issues for 2013: Rising ratesinuence compensation choices

By Mike Xu

Income tax rates are on the

rise this yearand employees

will feel the pinch. Heres a look

at whats behind the trend and

how employers can respond.

Behind the tax rate increases

Federal tax rates for income, social

security, and Medicare have risen

with the January 2, 2013 enactment

of the American Taxpayer Relief Act

of 2012 (ATRA) and the 2010 Patient

Protection and Affordable Care

Act (ACA). Several states are also

increasing or proposing an increase

in their income tax rates.

Well share a high-level overview of

some of the stand-out facts and their

implications.


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23HR Innovation

Top individual income tax rateclimbs to 39.6%

The maximum marginal income tax

rate increases to 39.6% for single ler

taxpayers with incomes above $400,000

and for joint lers with incomes above

$450,000. For this same group of

taxpayers, the long-term capital gains

rate, which also applies to qualied

dividends, increases from 15% to 20%.

The tax base broadens

Itemized deductions equal to

3% of adjusted gross income (AGI)

in excess of $250,000/$300,000(single/married ling jointly) will

be disallowed, capped at 80% of

total itemized deductions. This

phaseout of itemized deduction does

not apply to deductions for medical

expenses, investment interest,

and casualty and theft losses. The

personal exemption of $3,800 will

phase out for taxpayers with AGI

in excess of $250,000/$300,000

(single/joint). The itemized phaseout

equates approximately to a tax

increase of 1.2%.

Medicare tax rises for someThe ACA raises Medicare tax rates.

Medicare tax on wages is now 2.35%

for wages received in excess of

$200,000 single or $250,000 married

(combined). Employers must with-

hold an additional 0.9% starting

at $200,000 of wages, whether the

employee is single or married.

The ACA also imposes a Medicare

contribution tax on unearned income

for taxpayers with adjusted gross

income (AGI) above $200,000/

$250,000 (single/joint). Generally,

income from dividends, interest, and

capital gains will be subject to this

3.8% tax. Individuals will pay this

tax on Form 1040; it does not apply to

qualied plan distributions.

Social security tax rises for employees

The employer portion of OASDI

(Social Security) tax is 6.2% on

wages up to $113,700, remaining the

same for 2013. The employee portion

of OASDI tax increases to 6.2% from

4.2% in 2012 on the same wage base.

This increase is an additional cost up

to $2,274 for each employee.

Employers must withhold

an additional 0.9% starting

at $200,000 of wages,

whether the employee is

single or married.

The impact of tax increases on different income brackets

All with wages

More than

200/250K in AGI

More than

250/300K in AGI

More than

400/450K in AGI

Additional 2% Social Security tax

Loss o Itemized Deductions

Medicare Tax on Investment Income

4.6% additional income tax and 5%additional tax on LTCG and dividends


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24

State and local taxes change

A number of states have made or

are considering big changes to their

state income taxes. Last November,California voters approved Proposition

30, which will add 1% to 3% to the

existing top tax rate through 2018,

sending the maximum tax rate up to

13.3%. And the tax hike was retroac-

tive, so lers will have to pay higher

income taxes on 2012 returns.

Implications for high-income

earners and compensation

decisions

High-income earners and theiremployers can blunt the impact of

rising tax rates by re-arranging their

compensation structures using quali-

ed plans and nonqualied plans.

Some qualied hybrid plans can

boost tax benet while incurring little

unfunded liability. By integrating

Wageincome

Interestincome

Qualieddividends

Capitalgains

2012 top rate 35.0% 35.0% 15.0% 15.0%

Medicare tax 1.45%

2001/2003 tax cut expiration +4.6% +4.6% +5.0% +5.0%

Medicare surtax +0.9% +3.8% +3.8% +3.8%

2013 top rate 41.95% 43.4% 23.8% 23.8%

Phaseout o itemized deductions +1.2% +1.2% +1.2% +1.2%

2013 eective top rate 43.15% 44.6% 25.0% 25.0%


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25HR Innovation

qualied and nonqualied plans,some employers can achieve

an even better result leveraging

benecial traits of both nonqualied

and qualied plans.

The tax increases may drive the

following decisions of compensation

arrangements:

1. Tax bracket arbitrage (39.6%

versus 35%): Executives maywant to manage their compen-

sation level above or below

$450,000 for a particular year. For

example, many executives are less

likely to have more than $450,000

of annual taxable income during

retirement. Accordingly, they can

defer current compensation when

their current compensation would

be more than $450,000 and the

deferrals will be taxed at the lower

tax rate during retirement when

their income is less than $450,000.

2. State tax arbitrage (high-

income-tax states versus

low- or no-income-tax states):

Federal law prohibits states from

imposing income tax on non-resi-dents for their retirement income

distributed from qualied plans and

certain nonqualied plans, notwith-

standing the fact that the income

was earned in that state. As such,

executives can cut state income tax

by deferring compensation while

working in a high-income-tax

state and later receiving the plan

distributions after moving to a

low- or no-income-tax state.

3. Corporate deduction arbitrage

(higher individual tax rate

versus lower corporate tax

rate): If individual rates exceed

the corporate tax rates, posi-

tive arbitrage exists between the

benets of deferral and the value

of a tax deduction.

4. Optimum tax benets under

qualied retirement plans:

Tax-qualied retirement plans

provide the most robust benets,

including current deduction,

deferred income recognition,

and exemption from OASDI and

Medicare tax.

Employees may defer compensationinto a nonqualied deferred compen-

sation plan (nonqualied deferrals) or

a qualied retirement plan (qualied

deferrals). In addition, employers can

shift their compensation strategy so

more pay is directed at tax advantaged

plans. For example, employers may

decrease direct pay or bonuses

for some groups, and may increase

contributions to qualied plans (quali-

ed contributions) for those groups.

While no rules impose a dollar limit on

the amount of nonqualied deferrals,

IRC 409A substantially restricts the

timing of distributions and the deferral

election. Moreover, nonqualied

deferrals are unsecured and subject to

claims of the employers creditors.

In contrast, qualied deferrals and

contributions are secured from the

claims of the employers creditors and

not subject to rigid timing rules under

IRC 409A. Qualied deferrals and

contributions are subject to certain

dollar limits and a complex set of

rules, such as the nondiscrimination

rule that prohibits favoring highly


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26

compensated employees and the

distribution rules. Most employers

already have qualied plans and are

dealing with the complex rules that

come with them.

Qualied deferrals and contributionsalso achieve signicant tax efciency:

Employer contributions, other

than employee deferrals, are not

subject to FICA taxes, which are

1.45% for the employer and 2.35%

for the employee (for the amount

above the $113,700 threshold).

The investment gains in the quali-

ed plan and the IRA after rollover

are not subject to the unearned

income Medicare contribution tax

of 3.8% under IRC 1411.

The employer is allowed a deduc-

tion at the time of the deferral and

contribution.

The tax deferral period may

extend after retirement by rollover

to an IRA or 401(k) plan (lending

the taxpayer the ability to time

taxation of distributions).

While plans must not discriminate in favor

of highly compensated employees, the

employers nonelective contribution may vary

by participant or group.

Different contribution levels can

be based on staff class, age, service,

or business unit.

Employers may want to evaluatethe compensation structure for

employees to potentially reduce

its cost and employees tax burden

by taking two steps to take full

advantage of the tax benets of

qualied plans as explained below.

Depending on an employers partic-

ular situation, the employer may

implement the rst step without

the second or vice versa. Neither

approach is wrong. The employerwill need to determine the best

approach for its particular situation.

Step One (DC enhancement):

Use the existing dened contribution

(DC) plan fully by providing contribu-

tions up to the annual limit for a group

of targeted employees identied by

the employer. Each of these employees

can defer salary up to $17,500 in 2013

($23,000 with age 50 catch-up). The

limit of combined annual contributions

to DC plans (employee deferrals and

employer contributions) is $51,000 in

2013 ($56,500 with age 50 catch-up).


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27HR Innovation

While plans must not discriminatein favor of highly compensated

employees, the employers nonelec-

tive contribution may vary by

participant or group. Different contri-

bution levels can be based on staff

class, age, service, or business unit.

Step Two (additional

DB benets):

Establish a cash-balance plan, also

known as a hybrid plan. A qualied

hybrid plan is a dened benet (DB)

plan under the regulations. It operates

like a DC plansignicantly reducing

the employers investment risk and the

likelihood of an unfunded liabilitythe two major drawbacks associated

with traditional DB plans.

On the other hand, because hybrid

plans are treated as DB plans under the

regulations, annual contributions can

be up to $220,000, depending on the

participants age and other factors. This

amount of contribution is above and

beyond the DC deferrals and contri-

butions implemented in Step One.

This table shows the maximum amount

of deferrals and contributions to

qualied plans that can be achieved by

implementing Step One and Step Two.

Age 45 Age 50 Age 55 Age 60

401(k) deerral $17,500 $17,500 $17,500 $17,500

Catch-up contribution $0 $5,500 $5,500 $5,500

Proft sharing and match $33,500 $33,500 $33,500 $33,500

Hybrid plan $100,000 $130,000 $170,000 $220,000

Total potential contribution $151,000 $186,500 $226,500 $276,5 00

Choosing a hybrid plan withmarket rate of return

In a hybrid plan, part icipants cannot

elect their individual contribution

amount. However, based on an

evaluation of the total benets and

compensation received by individuals

and groups, the amount of benets

and compensation provided can be

adjusted within regulatory limits.

This adjustment includes the amount

that can be provided to individuals

or groups in a hybrid plan. The

employer can, for example, establish

contribution tiers based on business

criteria, including job title, owner-

ship shares, location, age, and service


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28

at implementation. Required contri-butions for each individual follow

a predictable pattern, based on the

plan provisions.

Contributions are invested when

contributed, and each participants

benet value grows on a tax-deferred

basis with the investment return

of the asset pool. At termination of

employment, participants can take

the benet value and roll it over to anIRA or receive the funds in cash.

A hybrid plan will involve higher

administrative costs than a DC plan.

Although operated like a DC plan, a

hybrid plan is distinct from a DC plan

in two respects:

First, contributions are invested

in the aggregate, without self-

direction by individual partici-pants, although participants may

rebalance using 401(k) and other

discretionary assets to achieve an

overall target risk prole.

Second, a participant may not

elect to change participation or

contribution levels. The employer

For the rst time, the PPA permitsthe market rate of return of the plans

assets to be credited to participants

account balances directly. Using the

market rate of return, hybrid plans

further reduce the investment risk and

the likelihood of unfunded liability.

The PPA also introduced a preser-

vation of capital requirement. At

distribution, the plan must guarantee

payment of at least the sum of the paycredits (i.e., the accumulated contri-

butions). The possibility of a funding

shortfall because of this requirement

is very small.

can, however, amend the plan fromtime to time and design the plan

to adjust to changing business and

total compensation needs and, for

example, provide different benets

for different groups, depending on

the business needs and needs of

each group.

Before the Pension Protection Act

of 2006 (PPA), cash-balance plans

were able to use only at rates orcertain indices as the interest credit

on participants accounts. As such, the

employer still retained some degree

of investment risk and likelihood of

unfunded liability.

Traditional DB plansCash-balance(hybrid) plans

Cash-balance plans withmarket rate o return

Investment risks

Reduce investment risk

Reduce likihoodo ununded liability

Further reduce investment risk

Further reduce likihoodo ununded liability

As taxes rise, some willrise to the occasion

Making the right choices for your

employees and your company isnt

always easy, but employers who study

the options can help people manage

the tax burden. The results can go a

long way toward keeping employees

happy with their compensation

package and the organization that

provides it.


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Making the right choices for your employees

and your company isnt always easy, but

employers who study the options can help

people manage the tax burden.

29HR Innovation


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30

As a leading provider of HR consulting services, PwCs Human Resource Services global network of 6,000 HRpractitioners in over 150 countries brings together a broad range of professionals working in the human resource

arenaretirement, health & welfare, total compensation, HR strategy and operations, regulatory compliance,

workforce planning, talent management, and global mobilityaffording our clients a tremendous breadth and

depth of expertise, both locally and globally, to effectively address the issues they face.

PwC is differentiated from its competitors by its ability to combine top-tier HR consulting expertise with the tax,

accounting, and nancial analytics expertise that have become critical aspects of HR programs.

PwCs Human Resource Services practice can assist you in improving your performance across all aspects of the

HR and human capital spectrum through technical excellence, thought leadership, and innovation around ve

core critical HR issues: reward effectiveness and efciency; risk management, regulatory, and compliance; HRand workforce effectiveness; transaction effectiveness; and global mobility.

To discuss how we can help you address your critical HR issue s, please contact us.

About PwCs Human Resource Services (HRS)

Scott Olsen

Principal

US Leader,

Human Resource Services

(646) 471-0651

[email protected]

Ed Boswell

Principal

US Leader,

People and Change

(617) 530-7504

[email protected]

Peter Clarke

Principal

Global Leader,

International Assignment Services

(203) 539-3826

[email protected]

Please visit our website at

www.pwc.com/us/hrs or scan

this QR code:

HR Innovation Contributors

Scott Olsen

(646) 471-0651

[email protected]

Aaron Sanandres

(646) 471-4567

[email protected]

Andrew Skor

(646) [email protected]

Don Weber

(678) 419-1417

[email protected]

Mike Xu

(312) 298-3398

[email protected]
mailto:[email protected]:[email protected]:[email protected]://www.pwc.com/us/hrsmailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.pwc.com/us/hrsmailto:[email protected]:[email protected]:[email protected]


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2013 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC reers to the US member frm, and may sometimes reerto the PwC network. Each member frm is a separate legal entity. Please see www.pwc.com/structure or urther details.

This content is or general inormation purposes only, and should not be used as a substitute or consultation with proessional advisors. PwC US helpsorganizations and individuals create the value theyre looking or. Were a member o the PwC network o frms with 169,000 people in more than 158 countries.Were committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and fnd out more by visiting us at www.pwc.com/us.NY-13-0530

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