Employer-owned life insurance remains overwhelmingly the favored vehicle to fund non-qualified deferred compensation plans among Fortune 1000 companies. And recent federal legislation governing plan design and administration has not negatively impacted plan adoption rates.
These are among the key findings of the latest biannual survey of current trends affecting executive compensation from Clark Consulting, Chicago, Ill. Released earlier this month, the 13th annual survey probed approximately 18% of Fortune 1000 companies about data and trends respecting executive benefit plans, with an emphasis on deferred comp (voluntary deferral) and supplement executive retirement plans.
“It’s clear that there is still a great deal of opportunity in the non-qualified deferred compensation space,” says Tom Chisholm, a senior managing director at Clark Consulting. “That’s true not only at Fortune 1000 firms, but also among small and mid-size companies. There are great opportunities for funding these plans as well with corporate-owned life insurance.”
The prevalence of non-qualified deferred compensation plans is at the highest level since the survey’s inception in 1993. Ninety-five percent of responding companies reported having the plans, as compared to 91% in 2005.
Among financial institutions, the adoption rate remained at 92%. Corporation matching contributions to deferred comp plans were reported by 56% of respondents. Of these respondents, 51% use a 401(k) restoration match formula.
The choice of COLI as the informal funding vehicle for deferred comp plans continues to increase from the low Clark Consulting reported in 2003. And COLI’s use in supplemental executive retirement plans, or SERPs, remained steady from the 2005 survey results.
Of all respondents, 72% who informally fund non-qualified plans choose COLI as the funding vehicle, up from 70% in 2005. With respect to SERPs, 74% use COLI. Since 2004, the use of COLI has increased 11%; among SERP adopters, COLI’s penetration increased by 10%, up from 64%.
Yet, the prevalence of SERPs overall has followed a downward trend, according to the report. Of the respondents, 67% reported having a SERP, a decline from 2004′s reported high of 83%. Among financial institutions, 82% indicated they have adopted the plans.
“SERPs mirror old corporate pensions,” says Chisholm. “There is a declining need among companies for these plans for all but the highest level executives. Businesses are also increasingly wary of SERPs because of the disclosure requirements in company proxy statements and because of the bad P.R. involving highly compensated execs like [former New York Stock Exchange Chairman and CEO] Dick Grasso.”
To be sure, deferred comp plans also largely remain the province of upper management. Eligibility for such plans among presidents/CEOs, executive vice presidents and vice presidents was 89%, 90% and 83%, respectively in 2007. By comparison, the adoption rate among division/unit managers and highly compensated sales personnel was 39% and 33%, respectively.
How have recently enacted federal laws impacted adoption of non-qualified deferred comp plans? Chisholm says the effect of the IRS’s and U.S. Treasury Department’s now finalized 409A regulations, which govern the design of deferred comp plans, has not lessoned interest. The same is true of the Pension Protection Act of 2006, which includes best practice provisions respecting employer-owned life insurance. If anything, he claims, the impact of both has only been positive.
“The new IRS regulations have finally given clarity to these plans,” he says. “So companies now know exactly the parameters they’re dealing with. “Yes, 409A is seen as challenging, but once you understand the rules, they’re not terribly onerous to comply with.
“As to COLI,” he adds, “it’s still the best and most utilized tax-advantaged funding vehicle available to corporations.”
The report bears this out. Compared to the 72% of respondents who informally fund using corporate-/employer- and trust-owned life insurance, just 37% employ mutual funds. Still smaller percentages of respondents cited company stock (14%), “other” (10%), bonds or bond funds (7%) and managed portfolios (4%).
When asked about the times during which plan participants become eligible for distributions, 100% of respondents flagged “separation from service.” Fewer respondents identified death (89%), disability (74%), specified time (67%), change of control (59%), hardship (58%), and “other” (5%).
While not reducing plan adoption rates, IRC Section 409A is evidently impacting distribution elections. The report observes that of those surveyed, 33% of companies do not now allow changes to such elections. And of the 67% that do permit changes, 22% allow only one change. Twenty percent of respondents allow distributions in the form of company stock.
The increasing complexity of both deferred comp and SERP plans is also driving more companies to outsource plan administration. More than a third (35%) of respondents use a blend of in-house and outsourced administration for their deferred comp plans. Those using an in-house/outsourced combination for SERP plans also jumped to 40% from 31% in 2005.
“As these plans have evolved over time, they’ve become more 401(k)-like, which requires sophisticated administration,” says Chisholm. “It’s very difficult to administer plan funds internally. The added complexity due to 409A and 101(j) makes the case for outsourcing even stronger.”