Addressing Gaps in Executive Disability Coverage


Risk continues to be an important issue for the banking industry. But what about the personal risk facing a bank’s valued executive? How should personal risks be addressed within a banker’s executive compensation plan and more specifically, what is the impact to the compensation plan if the executive becomes permanently disabled?

The Income Replacement Problem
Group long-term disability (LTD) plans provide excellent coverage for most workers, but leave gaps for highly compensated employees (HCEs). This is due to limitations on the amount of base salary covered, and the lack of coverage for bonuses, stock-based compensation and retirement plan contributions, including 401(k) plans and nonqualified plans such as supplemental executive retirement plans (SERPs). As a result, HCEs often end up with only 30 to 50 percent of their earnings protected, while most broad-based employees achieve more significant income protection. The following chart, which is an example, provides an illustration.

Title Base Salary Base Total Annual Compensation Total Monthly Compensation Monthly Group LTD* % Comp. Replaced
CEO $200,000 $150,000 $350,000 $29,167 $10,000 34%
SVP $175,000 $100,000 $275,000 $22,917 $8,750 38%
VP $100,000 $30,000 $130,000 $10,833 $5,000 46%
AVP $75,000 $15,000 $90,000 $7,500 $3,750 50%
Manager $50,000 $5,000 $55,000 $4,583 $2,500 55%

*60 percent of base salary to a maximum of $10,000 monthly benefit

Many HCEs are unaware of this potentially significant loss in earnings should they become disabled.

As another complication, retirement plans stop being funded when a disability occurs. For example, an HCE no longer contributes to the 401(k), and therefore no longer receives the matching company contribution. If the HCE has a nonqualified plan like a SERP, the plan normally provides for vesting in the accrued liability at the time of disability but does not provide additional credits to the account after the disability occurs. With a drastically reduced monthly income, it is difficult, if not impossible, to save for retirement.

While it can be an uncomfortable topic, and most people do not think it will happen to them, the fact is that disabilities do occur. But bankers are in the risk mitigation business: Once they understand this risk, they typically want to do something about it.

An Integrated Solution
Combining group LTD coverage with individual disability coverage provides the executive with a solid, well-thought out plan that can solve the gap in coverage, help attract and retain top talent, and keep the bank’s costs in check. By using company-sponsored individual policies rather than retail individual policies, the policies can be issued on a guaranteed issue basis and at a significant discount. Furthermore, the premiums are fixed, and the policies are portable and can’t be cancelled. Below is an example:

Title Total Monthly Compensation Monthly Group LTD* Individual Disability Income Total Disability Income % Comp. Replaced
CEO $29,167 $10,000 $11,875 $21,875 75%
Sr. VP $22,917 $8,750 $8,438 $17,188 75%
VP $10,833 $5,000 $3,125 $8,125 75%
AVP $7,500 $3,750 $1,875 $5,625 75%
Manager $4,583 $2,500 $938 $3,438 75%

The policies can be offered on a voluntary basis, and paid for by the employee or by the company. If company-paid, many banks invest in bank-owned life insurance (BOLI) as a way to offset and recover the cost, while others feel the expense is not that significant. In either case, it is well worth the expense as another tool to attract and retain top talent.

The shortfall in income replacement is a real problem for higher income earners should they become disabled. With the recent decrease in corporate tax rates, now would be a great time to explore solving this issue. Corporate-sponsored individual disability programs, when integrated with a group disability program, can protect HCEs from this risk in a cost-efficient manner for the employee and the company, while also providing one more important element in the ongoing desire of the bank to attract and retain key officers.

The Resurging Interest in Bank Supplemental Executive Retirement Plans


SERP-4-6-17.pngThe 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

  1. 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.
  2. 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.”
  3. 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.
  4. 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.

Compensation for Privately Owned Banks: What to Know


incentive-plan-11-9-15.pngPrivately held banks, including Subchapter S banks as well as mutuals, are no different than publicly traded banks in their efforts to provide meaningful compensation plans for their key officers. Privately held banks must compete with public banks when attracting and retaining key officers and producers.

Publicly held banks typically offer restricted stock or incentive stock options to key employees. This is much more difficult for privately held banks due to a lack of available shares or illiquidity of the stock. Therefore, privately owned banks competing for talent often require more creativity.

While some privately held banks offer stock options, restricted stock or restricted stock units (RSUs), these types of plans are uncommon. Rather, privately held banks that want to provide rights of ownership to executives often use synthetic equity such as Phantom Stock Plans (PSPs) and Stock Appreciation Rights (SAR) plans. While these plans have an earnings impact to the bank, they do not have a per-share dilution as no actual shares are issued.

Competition for top talent is strong. Assuming the bank offers a competitive salary and an annual incentive plan, the challenge is the ability to offer a long-term incentive/retirement plan. The following types of plans are often used to attract and retain key executives and include:

  • Supplemental executive retirement plans (SERP) can be designed to address an executive’s shortfall that would result if the executive only had social security and the bank’s qualified plan to provide retirement income. Generally, under the terms of a SERP, an institution will promise to pay a future retirement benefit to an executive separate from any company-sponsored qualified retirement plan. The benefit is typically expressed as a fixed annual dollar amount or as a percentage of final compensation.
  • Deferred compensation plans (DCP) allow the bank to make contributions to the executive’s account using a fixed dollar amount, fixed percentage of the executive’s compensation, or a variable amount using a performance-based methodology. The DCP can also allow the executive to defer his or her current compensation.
  • Split dollar plans allow the bank and the insured executive to share the benefits of a specific BOLI (Bank-Owned Life Insurance) policy or policies upon the death of the insured. The agreement may state that the benefit terminates at separation from service or it may allow the executive to retain the life insurance benefit after retirement if certain vesting requirements are met.
  • Survivor-income plans/death benefit-only plans specify that the bank will pay a benefit to the executive’s survivors (beneficiaries) upon his or her death. The benefit may be paid in a lump sum or in annual payments over a specified time period. Typically, the bank will purchase BOLI to provide death proceeds to the bank as a hedge against the obligation the bank has to the beneficiaries. The benefits are paid directly from the general assets of the bank.

Picking the right plan design is only part of the process. Striking the proper balance between making the plan attractive to executives but not excessively expensive to the company are also significant factors when designing the benefit plan. Nonqualified plans can be customized to each executive, avoiding a cookie cutter approach by allowing flexibility in the amount of the benefit, vesting schedule, non-compete provisions, timing of payments and duration of payments. For example, assume you provide a substantial retirement benefit to a 40-year-old executive, but provide no vesting until age 65. The executive will likely not see it as a valuable benefit since most 40-year-olds think they will retire long before age 65. Likewise, if the executive is fully vested at age 55, the executive may not be motivated to stay past that age.

The plan must also provide a fair benefit upon death, disability and change in control. The payment terms can be customized to fit the needs of the executive while remaining in compliance with IRC Section 409A of the tax code. A properly designed nonqualified plan can enhance the bank’s bottom line by attracting and retaining top talent, but doing so in a way that is cost-efficient to the bank.

With over 30 years of history, BOLI has proven to be an effective tool to help offset and recover benefit expenses. While many public banks purchase BOLI to recover the cost of general benefit liabilities only, many privately held banks purchase BOLI for the same reason, but also include recovering the cost of nonqualified plans. BOLI is a tax-advantaged asset whereby every $1 of premium equates to $1 of cash surrender value (CSV) on the bank’s balance sheet. The CSV is expected to grow every month and earnings are booked as non-interest income on a tax preferred basis. From a cash flow perspective, BOLI is a long-term accrual asset that will return cash flow to the bank upon the death of the respective insured(s). BOLI is an investment asset that currently generates a return in the range of 2.50 percent to 3.50 percent after all expenses are deducted, which translates into a tax equivalent yield of 4.03 percent to 5.65 percent (assuming a 38 percent tax bracket).

Summary
Privately held banks must compete with all types of organizations for talent. Their future is dependent on their level of success in attracting and retaining key executives. The use of nonqualified plans, when properly chosen and correctly designed, can make a major impact on enhancing long-term shareholder value.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Making Benefit Plans Work: It’s All in the Contract


5-2-14-equias.pngTo attract and retain key executives, banks have implemented nonqualified benefit plans as part of their overall compensation strategy. One of the challenges of bank board members is to understand what is or is not included in these agreements and how the agreement terms affect other agreements such as change-in-control, employment contracts, equity plans and others.

Prevalence of Nonqualified Plans
Such plans are common in the banking industry. According to the American Bankers Association 2013 Compensation and Benefits Survey, 64 percent of banks surveyed offer some kind of nonqualified deferred compensation plan for top management (CEO, C-Level, EVP), and 45 percent of respondents offer a Supplemental Executive Retirement Plan (SERP). Types include performance-driven benefit plans, director retirement plans, death benefit or survivor income plans, and phantom stock or stock appreciation rights (SARS) plans.

To avoid violating the U.S. Department of Labor rules concerning plan eligibility, participants in nonqualified plans should be limited to a “select group of management or highly compensated employees,” which taking a conservative approach, is typically no more than 10 percent of a company’s employees. In addition, the included employees should have the ability to affect or substantially influence the design and operation of their deferred compensation plan.

It is important for the board to understand the terms of their deferred compensation plans and the potential ramifications. Common questions that arise regarding some key agreement terms are:

  • What happens if the executive chooses to retire early or extend the time to retirement? Generally the benefits are payable at the time the executive separates from service. Depending on the plan design and the board’s intent, the benefit amount for delayed retirement may remain the same or may be increased.
  • What happens in the case of involuntary termination or termination-for-cause? Termination-for-cause provisions often include forfeiture of some or all of the benefit.
  • What happens if the executive becomes disabled? Some plans provide that payments commence upon separation from service due to disability while some commence at normal retirement age.
  • What type of vesting is common in plans? Since nonqualified plans are not governed by ERISA (Employee Retirement Income Security Act), they may use a number of different vesting options including: immediate, graded, cliff, rolling, or at-retirement. Vesting will vary depending on the objectives of the plan, tenure of the executive and annual expense accruals required.
  • What type of non-compete/non-solicitation terms are included? Some agreements include a definition of these terms, although many banks include them in separate agreements which should be consistent. The length of the non-compete/non-solicitation period as it relates to a nonqualified plan is typically 12 to 36 months, but may last as long as the benefit is being distributed.
  • Nonqualified benefit plan agreements should be reviewed together with other compensation related agreements, such as those mentioned above. So-called “golden parachute rules” are discussed in a previous article and are a perfect example of why a thorough review of all such agreements is critical.

Agreements generally include other terms such as pre- and post-retirement death, change-in-control, and form and timing of payment.

Key items to consider/evaluate when reviewing plans and agreements include:

  • Are key terms consistent with other implemented agreements such as employment agreements, change-in-control agreements, non-compete/non-solicitation, long term incentive plans and equity plans?
  • Has the total cost of a change-in-control based on the agreement provisions, including the accelerated vesting of benefits, been calculated and discussed with the board?
  • Are the plans properly documented in accordance with IRC Section §409A as appropriate, which governs deferred compensation plans?
  • Does the plan provide a meaningful benefit to the participant? Many plans were designed at a time when the benefit was meaningful, but the participant’s role and compensation may have significantly changed.

Summary
Nonqualified benefit plans will remain an important piece of the overall compensation strategy to attract and retain key officers, but it is critical to design meaningful and effective plans and ensure the plan documentation language is clear and avoids conflicts with all employment and benefit-related agreements. For deferred compensation plans subject to IRC 409A, there is limited ability to change the form and timing of payments after implementation; therefore, it is critical to work with experienced professionals who can help make sure you get it right the first time.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Designing the Pay-For-Performance SERP: Executive Retirement Plans Transformed


12-20-13-iZale.pngAttracting and retaining the most talented senior executives are key responsibilities of the bank board. But how do you do that, especially in an age where compensation programs are changing and there is more pressure on bank boards to design compensation programs that reward performance?

For key employees, one of the more popular ways to provide wealth accumulation opportunities is through a nonqualified deferred compensation plan, more specifically a Supplemental Executive Retirement Plan or SERP. Traditionally, SERPs have been defined benefit (DB) plans, where the bank promises to pay a fixed dollar amount (e.g., $50,000 per year) or a percentage of compensation (e.g., 25 percent of final average salary) during retirement. Defined benefit SERPs offer the highest attraction and reward value, and are often used to address the disparity between key and rank-and-file employees. (Typically, rank-and-file employees have a greater percentage of their income replaced in retirement than executives using traditional retirement plans.)

Accounting rules dictate how the bank should expense and accrue for the benefit. If the participant remains employed by the bank until retirement, the benefit will be paid. Defined benefit SERPs are not tied directly to bank performance, and this has led to some criticism and resistance to implementing them.

As a result, performance-based SERPs are increasingly being considered. With a performance-based SERP, an annual award is based on attainment of pre-defined goals. In other words, it’s a defined contribution or DC SERP. Since participants are usually senior executives, the DC SERP goals are typically bank-wide instead of individualized goals. They can be the same goals used for determining short-term incentives; in fact, there is administrative ease in such goal consistency. Unlike the annual incentive that is paid out now, however, each DC SERP award is deferred until retirement. Over the life of the plan, the awards accumulate and are distributed at retirement.

From an accounting perspective, DC SERP modeling is more complicated than DB SERP modeling but is built on the same principles. Under a DC SERP, if a 50-year old participant receives an award of $50,000 to be paid in installments beginning at age 65, GAAP (Generally Accepted Accounting Principles) requires the bank to expense the award at its net present value, and thereafter increase the balance sheet amount each year until retirement. Subsequent awards go through the same process—picture stacking Legos.

Boards should recognize that DC SERPs can result in greater benefits to the participants than a DB SERP. When properly designed, if a high-performing bank continuously achieves its goals, the cumulative DC SERP awards should be greater. It may also be desirable to have both a DB SERP and a DC SERP.

The normal expected retirement benefit is where most of the focus is, as that is what drives everyday accounting. However, proper SERP design requires consideration of other events that trigger distribution. The question for each trigger is what—if any—benefit should be paid.

  • Early voluntary termination. This is when the participant leaves employment before normal retirement age. Often there is no benefit, or there are several years of participation before any benefit begins to vest.
  • Early involuntary termination. Here, the participant is terminated by the bank without cause, or for defined “good reasons.” Often, there is some vesting immediately, whether in just the accrued benefit or some accelerated amount.
  • Disability. The participant suffers illness or injury that results in termination or meets the definition of Disability in IRC Section 409A. Typically, there is 100 percent immediate vesting in either the accrued benefit or some accelerated amount.
  • Change in control. When an acquisition takes place, the transaction is usually one trigger, and the participant’s termination of employment is a second trigger. Should one or both triggers be required for a payout to occur? Should the second trigger be voluntary or involuntary? Typically, there is some vesting immediately, but the amounts can vary significantly. Change in control benefits should be carefully considered, as there are Internal Revenue Code provisions that could tax these benefits heavily and impact a company’s ability to deduct them.
  • Death. Should the accrued benefit be paid, or some higher amount?

The board should understand the potential maximum payout and the impact on the bank’s income statement and balance sheet for each trigger, especially those that accelerate the amount compared to what has been accrued. Disability and death events can be insured; others cannot.

SERP design is both art and science. While the science is the same for all, working with an experienced vendor will make the art reflect your bank’s objectives.

How Mergers Can Impact Deferred Compensation Plans: Part I


9-20-13-Equias.pngMany bank boards during merger discussions find themselves confronting the question of severance benefits and how that will impact the merger. What if the bank being sold has a Supplemental Executive Retirement Plan (SERP)? Could that trigger a so-called golden parachute clause with tax consequences for the acquiring bank? The answer is yes. In some cases, this could impact the negotiations. In a series of articles, Equias Alliance explains how Internal Revenue Service rules are triggered and what to do about it. This first article describes when a change-of-control triggers a parachute payment and subsequent excise taxes.

If our bank has a Supplemental Executive Retirement Plan (SERP) or other non-qualified deferred compensation (NQDC) arrangement, what is the potential impact on a merger with another bank?

If the plan agreement provides for accelerated vesting of the benefit upon a change in control (CIC), two things happen:

  1. The increase in the vested benefit must be immediately accrued as a liability.
  2. The acceleration, referred to as a parachute payment, must be included in the calculation of total parachute payments under Section 280G of the Internal Revenue Code (§280G). (Note: §280G does not apply to Subchapter S banks.)

But if the buyer pays for it, why should we be concerned?

These provisions can impact the price the buyer pays for your bank. A general rule of thumb is that if the cost of all severance benefits is less than 5 percent of the purchase price, it should not impact the price paid for the bank. When the cost exceeds 5 percent, it may impact the price, depending on many other factors. The board should be knowledgeable of the total impact compensation costs might have in the event of a CIC.

If the executive(s) plan on continuing to work for the buyer, does that reduce the impact?

No, both generally accepted accounting principles (GAAP) and §280G require that the present value of the vested benefits be measured and recognized at the date the CIC occurs, even if payments are to be made at a later date.

How do we determine the impact?

First, §280G is very detailed and complex. The bank should seek advice from its accountants and legal counsel.

That said, the income and excise taxes become payable if the total parachute payments equal or exceed three times the executives average W-2 compensation for the past five years. Be careful here as parachute payments are comprised of all forms of compensation, including severance payments, as well as the incremental value of stock options, restricted stock, medical benefits, and incremental accelerated vesting of SERPs and other NQDC arrangements.

Example #1:
The executive’s five-year average W-2 compensation is $100,000 and his parachute payments total $250,000.Three times his compensation is $300,000, so he is under the §280G limit. No excise taxes are due and the payments are fully deductible by the bank, but the present value of the additional benefit obligations created by the CIC still must be accrued for GAAP purposes.

Example #2:
Assume the same facts as #1, except the executive’s parachute payments total $500,000. Since the executive’s payments exceed the allowable amount, payments in excess of one times his salary will be subject to excise taxes. The excise taxes would total $80,000 ($500,000-$100,000) x 20 percent. In addition, he would also pay regular income taxes on the $500,000. The bank would only be able to deduct $100,000 of the compensation paid.

Can we reduce what’s considered to be a parachute payment by deferring payment?

No, the measurement for purposes of §280G is what he is entitled to after the CIC. The present value of the incremental increase in his vested SERP benefit has to be included even if he is to receive the money at a later date. For example, assume the executive is vested in an annual SERP benefit of $25,000 for 15 years, but upon a CIC he becomes entitled to an annual benefit of $60,000 per year. If the CIC occurs, he receives an incremental vested benefit of $35,000 per year, a total payment increase of $525,000, but using present value calculations, the increased value for parachute payment purposes would be around $395,000.

The intricacies associated with the implications of §280G are complex and not easily covered in limited space. Stay tuned for Part II of our series, which will explore what to do if your bank is impacted by §280G.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc. IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, we advise you that any tax advice contained in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.

How to Retain Key Employees: The Benefits of a SERP


8-16-13-Meyer-Chatfield.pngAre you better off with or without them? That is a question advice columnist Ann Landers asked her readers. The answer is even more relevant when discussing key employees of community banks. As we emerge from the Great Recession, employee retention remains a primary focus. In a recent Bank Director survey, 40 percent of bank boards identified retaining key employees as a significant challenge. In fact, 44 percent of banks nationwide lost key executives or critical employees in the past three years.

What can banks do to retain key employees? Prior to the financial crisis, conventional wisdom accepted equity grants as the best method to retain executives and tie compensation to performance. Then came the economic downturn and those same equity grants looked like a reason for the lax credit policies whose aftermath continues to bedevil banks. Remember, many executives that received those rather large equity grants were approaching retirement age as the first wave of baby boomers. Their opportunity to benefit from equity grants had to be realized in a relatively short period of time, creating pressure for ever increasing earnings and price appreciation. History shows it did not turn out as expected.

Now, let’s reconsider a popular executive compensation benefit that fell out of favor in the wake of media and shareholder outrage. Prior to the economic downturn, many banking executives benefited from a supplemental retirement plan in addition to the company pension plan or 401(k) plan. These Supplemental Executive Retirement Plans (SERPs) were intended to provide benefits to replace the limitations imposed by Internal Revenue Service regulations. As a retention tool, SERPs are extremely effective. Typically SERPs require the executive to stay until retirement age to receive the benefit. For example, a SERP may provide an annual benefit for the executive of 40 percent to 60 percent of salary for up to fifteen years after retirement. In the event the executive leaves to work for a competitor, the SERP is forfeited. The primary objective of all compensation plans—to influence the decision making of the employee—is achieved with a SERP.

Is the expense worth it? Yes. For illustration purposes, let’s assume a bank has a SERP with a benefit of $100,000 per year for 15 years. The total cost to the bank is $1.5 million. Although spread over many years, it is still perceived as expensive. The cost on an after-tax basis is about $900,000 assuming a top tax rate of 40 percent. In an environment of detailed compensation disclosure, this seems excessive. But is it really?

Let’s look at the terms SERPs impose. First, executives must be employed with the bank until retirement. The bank is the guarantor of the benefit, not a third party as in the case of a 401(k) plan or a pension plan. For rank and file employees, if the bank fails, their retirement plan is guaranteed by a third party or the Pension Benefit Guaranty Association. With a SERP, the bank is the guarantor. If the bank fails, there is no one to make the payment and the executive loses the promised retirement benefit. Similarly, if the bank fails after the executive’s retirement, there is no one to make the payments.

One of the responsibilities of any manager is to develop talent to eventually succeed him or her. In this scenario, a 50-year old executive granted a SERP must focus on protecting shareholder value until retirement (age 65) and ensure the successor is capable—and motivated—to do the same. Thirty years is not a bad deal in exchange for a cost of $900,000.

When properly designed, the benefit to the bank and shareholders is greatly in excess of the cost of a SERP. Heidrick & Struggles, an executive search firm, says an incoming executive takes up to 18 months to achieve the level of productivity he or she provided prior to accepting a new position. This cost combined with what is known as the lost opportunity cost of not having a fully effective executive in a critical position makes the cost of a SERP appear minimal.

Top executives drive shareholder performance. If retaining these key employees is important to your bank’s future, then now is the time to make sure your bank doesn’t become one of the 44 percent who lost a key employee.