Bank-owned life insurance is a common tool that helps financial institutions offset the costs of employee benefits, and boards should review the BOLI program every year. Steve Marlow and Kelly Earls of Bank Compensation Consulting explain what boards should know about BOLI, including the impact of tax reform.
The roller coaster ride in banking over the last eight to 10 years took another unexpected turn in November with the election results. The financial sector gained new life, bank stocks soared and community banks began to see the prospect of regulatory relief becoming a reality. Interest in de novo banks has been picking up, and the likelihood of interest rate increases and decent loan demand appear to bode well for banks.
With that as a backdrop, the need to retain key members of a bank’s management team has re-emerged. Loan demand is good, profits are rising, optimism regarding regulatory relief is growing and the need to stabilize the management team of the bank is on the front burner as the talent grab has begun to heat up. Comprehensive compensation plans that serve to retain, reward and appropriately retire management teams are back in the spotlight.
During the financial crisis, many banks maintained salaries, as well as short and long-term incentive plans. Qualified benefit plans were continued, though often temporarily curtailed. But one key element of retention and reward, non-qualified plans, were either terminated, frozen or not introduced at all. Supplemental Executive Retirement Plans, or SERPs, are some of the most common non-qualified plans. Since the financial crisis, SERPs have lately seen a resurgence due to their multi-faceted benefit to both the bank and executive.
Objectives of a SERP
Retirement: Since inception, SERPs were designed to allow the company to provide supplemental benefits to executives whose contributions to traditional qualified plans such as 401ks and profit sharing plans were limited by the Internal Revenue Service or ERISA (The Employment Retirement Income Security Act). For example, the general employee base may be able to retire with 75 to 80 percent of final salary based on income from Social Security and qualified plans while the executive team was retiring at 35 to 45 percent from the same sources. In essence, those executives were discriminated against due to the ERISA and IRS caps. SERPs bridged the gap and allowed for the bank to provide commensurate benefits to key executives.
Retention: SERPs are non-qualified plans. They do not have the restrictions of qualified plans regarding vesting terms. As a result, the bank can structure the terms in the SERP however they desire from a vesting perspective. For example, assume an executive is to receive $60,000 per year for 15 years in a SERP. If in year five, the executive gets an offer from another bank, depending on the plan vesting, the executive may be walking away from all, or a large portion, of their SERP benefit. That’s $900,000 in post-retirement income at risk. This deterrent becomes a “golden handcuff.”
Reward: Banks can use SERPs whose value are determined based on performance measures. There may be a return on equity or return on assets threshold needed to get a minimum percentage of final salary from the SERP. That percentage would grow based on performance measures established in the plan.
Recruiting: SERPs provide the bank a plan that attracts talent. If the target executive is working at an institution that does not provide SERPs, the plan becomes an added attraction to joining your organization.
Other Items of Consideration
Unfunded, unsecured promise to pay: It is important to note that non-qualified plans such as SERPs are balance sheet obligations of the company and must be accrued for under generally accepted accounting principles (GAAP). The plan is an unfunded promise to pay by the bank. As a result, if the bank were to fail, the executive would lose his or her benefit. The SERP benefit is often matched up with bank-owned life insurance (BOLI) to provide income to offset the SERP accrual. This is not a formal funding of the plan, but a cost offset.
Top-hat guidelines: Executives participating in a non-qualified plan must qualify under top-hat guidelines as provided under the Department of Labor. These guidelines are murky, and consider position in the organization, compensation, negotiating ability (with the bank) and number of participants as a percentage of full-time equivalents. If there is any concern about who can participate, it is best to have legal counsel review prior to implementation.
In summary, SERPs are back in favor. The practical need for equitable retirement benefits, as well as the ability to retain, reward and recruit all have been catalysts in the resurgence of SERPs in the banking marketplace.
Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.
Many banks today struggle with two concerns related to loyalty, both among customers and employees. Attracting and retaining talented employees, particularly among the younger and tech savvy set, remains difficult for many banks. Commanding customer loyalty is another key issue. What’s known as “gamification,” properly used, can help financial companies address these problems.
In practice, gamification uses techniques learned from video games to reward specific behaviors. Microsoft Corp.’s Xbox console has long rewarded players for their achievements, whether it’s completing a level in the popular Halo series or constructing a sword on Minecraft. A 2007 study by Electronic Entertainment Design and Research, a video game research firm, found that game titles with a greater number of possible achievements sold more copies. It’s a tactic that can work for the banking industry, particularly those desperate to attract millennial employees and customers.
“‘Gamification’ is ultimately a very powerful methodology for increasing customer engagement and ‘stickiness’ to that institution,” says Michael Yeo, a Singapore-based senior market analyst with IDC Financial Insights.
San Antonio, Texas-based USAA is one financial services company that seems to have gone all-in. The bank’s Savings Coach app rewards members, who earn points and medals for completing challenges, like skipping trips to Starbucks, and transfers the money that would have been spent into a USAA savings account. The standalone app uses voice command technology, and features an animated eagle named Ace, which ties to the company’s logo and military membership. Ace provides bits of financial advice to users. “He’s sort of a stern-sounding dude who scans your transactions” to identify ways to save money, says Neff Hudson, vice president, emerging channels at USAA. Members have saved $400,000 so far through the app, which was introduced in July. In the near future, Hudson says members could earn rewards by using other USAA services, such as financial planning, that establish a more sound financial future for the customer.
Perhaps it’s no surprise that other examples from the world of video games abound in the fintech sector. New York City-based online investing platform Kapitall makes investing a game, where users can earn points by completing educational quests, participating in tournaments or playing investment-related games. These points can be redeemed for items in Kapitall’s online store. LendUp, an online lender based in San Francisco, rewards the good behavior of lessees that make payments on time or take education courses. Points earned by climbing “The LendUp Ladder” translate into a better rate for the borrower.
Similar to LendUp, mobile payment app PaySwag rewards good behavior among a consumer base that may lack good credit and has a greater need for financial education. PaySwag was developed by Reno, Nevada-based Customer Engagement Technologies. “What we’re trying to do is completely change the concept of collections, and build that around a combination of rewards, ‘gamification’ and…education, to help really minimize defaults and get rid of the negativity around collections,” says Max Haynes, the company’s CEO. Intended for high-risk borrowers who may struggle to make payments on time, the white label app partners with lenders and other entities involved in collecting debt. Users can earn points by watching educational videos or making payments on time. Those points translate into small rewards, like a $5 Amazon gift card. The program also allows some flexibility for the borrower to make changes to their payment plan. By using PaySwag, these organizations aim to establish good financial habits that help users avoid delinquencies—meaning PaySwag’s partners are paid on time. One auto lender saw serious delinquencies of more than 30 days drop by 50 percent over a one-year period, says Haynes.
USAA works with Badgeville, a Redwood City, California-based “gamification” solution provider. In addition to adding savings games for customers, USAA is in the early stages of using similar methods to better engage and motivate employees.
According to Karen Hsu, Badgeville’s vice president of marketing, the purpose is “to change behavior and motivate, really motivate people, and it’s to motivate to perform better year after year.” She says video game techniques can help speed up the onboarding process for new employees, and continue training and education efforts. Employees can provide each other with positive encouragement and real-time feedback, and earn points for answering a coworker’s question or sharing educational materials, like an article. “It’s hard to physically give everybody the time they need, and being able to give that instant feedback is really important,” says Hsu. Employees can also be encouraged to develop skills and expertise in certain areas, or to meet specific criteria that help the institution’s efforts to cross-sell products and services.
USAA has five projects in the works using video game methods, and more on the drawing board. “I really think we need to look at this as a set of tactics that can make the products that we offer our members and consumers better,” says Hudson. As expectations change to meet the demands of younger generations, “gamification” could provide a strategic advantage to banks creative enough to use it.
When it comes to executive compensation in banking, the importance of retaining great employees often gets short shrift to discussions of pay-for-performance and what the regulators want. However, retaining top performing executives can be critical to a bank’s success. Following are four important questions all compensation committees should be discussing.
Why is retention important? Developing a strong, high-performing executive team takes time. High-performing executives drive the development of the bank’s strategy and its execution. The unexpected departure of a key executive can create disruption and potentially lead to the departure of customers and other employees. Replacing those executives can often be a time-consuming and expensive proposition.
Compensation committees should also focus on succession planning, and retaining high-performers plays an important role. The next generation of leadership can be a target of competitors looking to strengthen executive talent. It is important for banks to identify top performers with the potential for greater leadership roles in the future, and ensure their compensation is structured to encourage them to remain and develop their skills within the bank.
How do you assess the level of retention in your programs? An assessment of the retention hooks within your executive compensation program should include the following:
Pay Opportunity: Do your high performing executives have market-competitive compensation opportunities and incentive programs that are viewed as challenging but reasonable? High performers want to be rewarded with an effective performance-based structure.
Value of Unvested Compensation: Do high performing executives have meaningful value in unvested compensation that would be forfeited if they left and difficult for another bank to replace? This can often be assessed by analyzing the following:
Value of unvested compensation (e.g. deferred cash incentives, equity awards): Committees should regularly evaluate the value of outstanding awards at the current stock price to see if it is meaningful enough to retain key executives. While there are no specific guidelines, executives often have outstanding awards greater than their annual salary, with top executives generally significantly higher.
Retirement benefits: While the use of enhanced retirement benefits such as SERPs (Supplemental Executive Retirement Plans) for executives has been declining, it remains important to understand the value provided through your retirement programs, vesting milestones and integration with other retention instruments (e.g. stock).
Development Opportunities: Do high-performers know they are viewed as critical to the organization’s future and are they given opportunities that allow them to further develop? Retention is about more than just compensation.
How can we enhance the retention value of our programs? There are several design features that can enhance retention:
Choice of Long-Term Incentive Vehicle: While there has been a significant shift towards the use of performance-based vesting, an over-emphasis on this vehicle can potentially create retention concerns–particularly if there is uncertainty in the potential payout (e.g. goals are set too high, and payouts are not seen as being likely). An overemphasis on stock options can create similar concerns since executives have less direct influence on stock price. Time-based restricted stock, when used in moderation, can be useful in ensuring some value will remain outstanding for executives while continuing to have the amount vary based on shareholder value.
Vesting of Equity: Irregular vesting schedules can result in uneven retention value from year-to-year, while annual grants with overlapping vesting schedules help ensure that executives always have meaningful value outstanding. Cliff vesting of large retention awards can also create concerns if the value of outstanding awards declines significantly after they vest.
Retirement Provisions: It is also important to understand the retirement provisions of your awards, as full vesting at an early retirement age will diminish the retention value of your program once executives meet retirement eligibility.
Retention is most effective when incorporated into the overall program, rather than as special one-time “make up” grants, which banks may need to give to executives when the existing program fails to provide adequate retention value.
How does retention fit into the rest of our program’s objectives? Balance is critical in executive compensation programs. Retention is just one of several important objectives of an effective total compensation program. In addition to ensuring that your programs encourage retention of high-performing executives, compensation committees also need to ensure compensation programs are aligned with the bank’s strategy, link pay outcomes with performance, align executives with shareholders and avoid encouraging excessive risk.
Every year Crowe conducts a compensation and benefits survey of financial institutions. The results of the 2013 Financial Institutions Compensation Survey are now in, and our analysis of the trends indicates some interesting patterns.
Pay is rising. Inflation expectations and market conditions appear to be strengthening as indicated by banks making larger upward adjustments to their salary structures.
2013 was not a banner year for CEO compensation growth. Slow compensation growth for CEOs in 2013 appears to indicate that bank financial performance has improved only modestly.
Hiring and retaining the right employees continue to be the highest-priority human resource concerns. While banks have several important priorities related to human resources, their most highly rated concerns appear to be finding and retaining the right employees.
Annual salary increases continue to average 2.70 percent. The market has settled into a stable range of annual salary increases.
Employee turnover is increasing. Employees appear to be more comfortable with their job prospects as turnover has returned to pre-recession levels.
Compensation growth varies widely by job position. Some job positions have experienced significant growth in compensation over the past four years while others have lagged. For example, compensation for chief credit officers is up 23 percent over the past four years, while branch manager II compensation is up only 9 percent.
Benefit costs continue to grow. Benefit costs as a percentage of salary continue to increase, with health benefits being the primary source of increased costs.
Benefit cost-containment efforts are a major focus. More than half of the banks surveyed are trying to contain costs by using a variety of techniques to shift a portion of benefit costs to employees.
This year, our analysis identified some differences between small banks (those with less than $1 billion in assets) and their larger brethren.
An above-market compensation strategy is more common at larger banks. A higher proportion of larger banks than smaller banks indicated they are consciously paying above-market compensation.
Smaller banks are doing a better job of differentiating pay for above-average performers. Smaller banks had a higher differential of pay increases between above-average performers and average performers.
Larger banks pay a higher proportion of incentives. Incentives as a percentage of salary are typically higher at larger banks, although the difference and amount vary from year to year.
Banks with more than $1 billion in assets are expecting more growth. A higher proportion of larger banks expect their number of employees to grow compared with their smaller counterparts.
View a full summary of the results of the survey for more detailed findings.