An effective tool or "dead dollars"?

Leveraging pension plans in the war for talent

Someone I know recently commented, “Quite honestly, I don’t see pensions as being strategic. I cannot see that they play a major role in attracting or retaining the type of people we need for the future.”

Pensions not strategic? Not an effective tool for attracting and retaining key talent? The question made me wonder whether the money spent on pension plans was just “dead dollars,” some leftover from a paternalistic past. Or is there a real role for these plans in supporting corporate business plans?

In today’s economy there’s a supply and demand problem when it comes to key employees. This situation is compounded when the talent pool is shrinking due to demographic factors such as decreasing birth rates, stagnant immigration levels of skilled workers, and an aging population.

Given this increasingly competitive environment, employers need to recognize the personal value that employees attribute to pension plans. Typically, these vary with age. Younger employees generally view pension plans as “nice-to-have but not required.” Older employees place a higher value on the company plan to ensure their retirement income and related quality of life.

Attraction: The right plan for the right demographic
Younger employees: The main concern for employers should be that this younger group might be put off by a poorly designed plan. Anecdotal evidence suggests that younger employees frequently attribute a general lack of management attention to the plan or a lack of autonomy within the plan as the source of their dissatisfaction with it. For example, they may complain the plan is too constraining because it significantly limits their ability to make personal RRSP contributions.

Or, consider a compulsory career-average plan, with required employee contributions of five per cent of earnings and a benefit formula of two per cent per year. A prospective younger employee might be put off by both the mandatory nature of the contributions, plus the fact that he will have no RRSP room. The fact that he will receive a significant Pension Adjustment Reversal (PAR) when he subsequently terminates employment is of no consolation to him.

A defined contribution plan or a savings plan will not create such a negative impression, but neither is it likely to sway an individual to join one company or another.

Mid-career staff: Mid-career individuals will likely take a different view of life. At a minimum, they will anticipate a package of pensions and benefits, even if they are unclear of the details. The absence of a plan might be enough to influence them to look elsewhere.

The key question is whether an employer could offer a plan that was so attractive that it could influence a potential employee to accept an offer of employment. Generally speaking, my reaction would be that money spent on providing a plan that is substantially above average for a particular industry, would be better spent on other types of human resource programs that provide a more obvious bang for the buck. However, the exception to this would be a plan that would cover service earned with the previous employer thus eliminating one of the major disadvantages of switching jobs.

The obvious route to achieving this is to have a reciprocal agreement with a number of other major employers that would allow past service to be recognized in return for a transfer of pension assets. This is being done in Ontario, where the major pension plans all participate in a common reciprocal agreement.

Executives: For mid-career executives this is further complicated by the desire for a supplemental employee retirement plan (SERP) that provides additional retirement income over and above the basic Registered Pension Plan (RPP). For an executive earning, say, $200,000, it is quite possible that more than half of her pension income would be provided through the SERP, hence the existence of such a plan would probably be critical in compensation negotiations. This would give rise to additional questions around the features of the SERP and the security of the benefits provided by it. Arrangements for the transfer of SERP liabilities are still at a fairly rudimentary stage. Any employer who has developed a seamless approach for bridging SERP benefits from a previous employer would enjoy a real attraction advantage.

Once again, it is unlikely that the retention of young employees will be materially affected by the presence of a pension plan. The greater risk is that a compulsory pension plan might be one of a series of dissatisfiers, leading to their resignation.

As employees age, considerations around pension arrangements will gain more importance. I was talking to a vice-president of human resources recently who was concerned that his organization was losing good people because they didn’t have any type of pension plan.

The retention issues for an employer with a plan will depend very much on the plan design. To be an effective retention tool, the plan must actually create a loss in potential benefits for the employees who terminate.

Traditional defined benefit plans contained milestones at which the value of the benefits earned increased dramatically. In most plans, the first milestone corresponded to vesting and the second corresponded to the earliest date for unreduced benefits upon retirement. Clearly, the period leading up to a milestone provided a powerful incentive for employees to stay put.

These days, vesting normally occurs after two years of plan membership. Many employers are also redesigning plans to reduce the “cliff” corresponding to early retirement enhancements. This can be illustrated by the trend to defined contribution plans that contain no powerful incentives for employees to remain with their current employers.

An interesting variation on the theme of retention is the notion of phased retirement. In this situation, employees who might otherwise retire are given the option to work a reduced number of hours per week. In its purest form, phased retirement allows an individual to both stay as an active member of a pension plan and to receive a partial benefit at the same time. Current legislation does not truly support this concept, but the flexibility to reduce the work week can be an attractive retention tool. I expect this approach to develop further as current demographic trends continue.

Finally, for an executive in a SERP, all things are possible. The employer can structure the SERP so as to permit vesting only after a certain combination of age and service has been satisfied. This is the real “golden handcuff.”

There is a fine line in all of this between creating an environment in which the employee feels well-compensated and one in which the employee feels trapped. Designing a plan that might influence unmotivated employees into staying is hardly supportive of corporate goals.

As we enter a new era, where retention will be increasingly critical, effective design features will be required to encourage individuals to remain in the workforce longer. Phased retirement will be just one of these design techniques.

Patrick Longhurst is a senior consultant in the Toronto office of Watson Wyatt Worldwide. He may be contacted at [email protected].

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