HR innovation

Spring 2013
04 Rethinking incentive plans: Improving cost/ benefit and enhancing strategy alignment 10 Considering an acquisition? Begin total rewards planning now 16 Reaping the rewards of organizational health 22 Taxing issues for 2013: Rising rates influence compensation choices

Executives across industries share the challenge of getting their employees total rewards package right.

Contents

Foreword 02 Scott Olsen, US Leader, Human Resource Services Rethinking incentive plans: Improving cost/benefit and enhancing strategy alignment Scott Olsen Considering an acquisition? Begin total rewards planning now Aaron Sanandres and Andrew Skor Reaping the rewards of organizational health Don Weber Taxing issues for 2013: Rising rates influence compensation choices Mike Xu 22 16 10 04

Foreword

Executives across industries share the challenge of getting their employees total rewards package right. From health benefits 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.
But its important to get it right. Among participants in our 16th Annual Global CEO Survey who view employees as important stakeholders, 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 the financial and nonfinancial 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 financial rewards. For example, an

opportunity for development in a new and challenging area of the business that a high-level executive might consider a dream job could be more effective in building longterm loyalty and motivation. Similarly, in todays global competition for talent, it may not be enough to offer basic me too type benefits. Employers who want to attract diverse, top-level talent must design total rewards packages that contribute to the overall mental and physical well-being of their employees. Going beyond basic health benefits to include an incentive-based wellness component, for example, can help motivate and engage employees, boost productivity, and reduce illness and absenteeism, all of which are essential 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 financial health of their talent pool. Employees, especially higher wage earners, are facing a greater

US tax burden this year. Business leaders who consider options such as deferred compensation plans can help their people manage their personal finances more effectively. In an era of continuing merger and acquisition activity, its crucial to understand your own companys total rewards structure and how a target companys program might fit 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 of HR Innovation, we delve into the complexities of total rewards design. I hope youll enjoy gaining the insights offered in these articles: Rethinking incentive plans: Improving cost/benefit and enhancing strategy alignment Incentive programs often fail. The guiding principles of incentive

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plan design largely ignore the perceptions of executives and employees. And sometimes employers use incentives as a substitute for effective management and leadership. Learn how to put incentive programs back on track. Considering an acquisition? Begin total rewards planning now Acquisitions mean big changes, usually involving total rewards. Learn how to mitigate the risks. Reaping the rewards of organizational health A competitive total rewards strategy requires the development of a positive culture that embraces organizational wellness in addition to providing health benefits. Taxing issues for 2013: Rising rates influence 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 opportunity to review the perspectives offered in HR Innovation. We believe employers may benefit from reassessing their total rewards programs, looking at the balance of monetary and nonmonetary incentives and rewards and taking into consideration the well-being of the employee as a whole person whose physical, mental, and financial health is essential to the health of the organization. Understanding employee perceptions about current total reward offerings can be an important first step in such a reassessment. Refining total rewards programs to balance the objectives of investors, the business, and employees has the potential to benefit both employers and employees.

Scott Olsen US Leader, Human Resource Services

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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 that the efficacy 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

Rethinking incentive plans: Improving cost/benefit and enhancing strategy alignment

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 Survey that incentive plans were not working as intended.

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Are these perceptions of incentive plans well founded? We believe that there are two primary reasons why incentive programs may fail to deliver on their promise. The first 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.

and stock based compensation, longterm deferrals and stock holding and ownership guidelinesdecrease the value of compensation to executives. 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.

described and documented. Conversely, our research was designed to test executives views about compensation packages, specifically how they value various features of current compensation 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 fixed pay over a higher expected value of bonus. Why it mattersVariable compensation effectively raises the overall cost of rewarding executives. Put another way, the cost/benefit of incentive plans is weaker than for fixed elements of pay, such as base salaries.

Our research was designed to test executives views about compensation packages.

The Research
Incentives are a by-product of agency theory: that is, that conflicts between principals (e.g., investors) 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 ownership mindset, it has been extended to broader groups of employees as a means of encouraging and rewarding behaviors and outcomes specified 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

Executives undervalue incentives relative to their cost

Research conducted by PwC and Dr. Alexander Pepper of the London School of Economics and Political Science provides important insights into how executives value incentives as part of their total rewards program. The research points to a fundamental trade-off in incentive design. The very elements that often define pay for performance multiple and complex metrics, emphasis on relative performance

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2. Complexity and ambiguity destroy value: Executives value incentives 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 consistent management processes and systems, including regular communication of results, education 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, the less 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 executive discount rates is attributable to a lack of diversification 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

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 downside of complex incentive plans is a perceived unfairness of outcomes. (See finding 2.)

Conversely, continued staff reductions, 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 finding 1.) 6. Recognition is an important motivation behind many incentive plans: Even though executives may value incentive awards (especially longterm incentives) at a significant discount to their expected value or cost (see findings 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. Refinements in incentive design may better align the economic value of these plans with the intangible value they convey.

Executives value incentives more highly if they know and understand the rules governing the incentives.

5. People dont just work for money: Executives are prepared to take a fairly significant reduction in pay in order to work in their dream job. But there is a floor 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.

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Increasing the bang for the buck

One response to the research on executive perceptions would be to curtail or limit incentive programs in favor of fixed compensation. However, to do so would not only fly 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 refined in ways that improve the bang for the buck. If the cost/ benefit 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 rewards program, the cost/benefit 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 complexity of 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 simplification 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, benefits, corporate responsibility, and culture may reduce the pressure on direct compensation. There may also be opportunities 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 important tool for reinforcing the execution of a companys business strategy. And almost three-quarters of the CEOs we surveyed 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 that less than one-third of the responding companies were satisfied 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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One possible reason for this gap between the prevalence of incentive plans and the perceived lack of effectiveness of these plans in promoting strategic change is a lack of alignment across company strategy, incentive plans, and other management processes and systems. In many cases, an incentive plan is considered to be a sufficient means of driving strategic change. However, while incentives may be a necessary component of strategic change, they are rarely sufficient for driving change by themselves. Our research in this area finds that many companies move directly from strategy development to an operating model to support the strategy. While an operating model, comprising traditional PMO, implementation committee, organization structure changes, and role development, is an important aspect of strategy implementation, 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

The leadership model focuses on several interim steps prior to defining 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 flexibility 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?

The leadership model

Strategic priorities & tradeoffs

Do those driving change truly understand the priorities and their inherent tradeoffs at the level of detail that informs day-to-day decision making and frontline execution roles?

Strategic risks
Are all risks associated with the strategy adequately understood, quantified, and prioritized? Embeds sufficient understanding of the strategy to inform effective decision making

Performance drivers
Are we managing business and individual performance to the key success measures that underpin the strategy?

Critical behaviors
Have we embedded the specific behaviors that drive disproportionate value in strategy delivery? Provides lead/lag indication of progress toward embedding a new operating model

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 Identifying supporting performance 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 highlight the 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 demonstrate the critical behaviors?

Linking incentive plans with the leadership model

Development of a leadership model can have a powerful impact on incentive 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 executive perceptions of incentives. A few examples of ways to link the leadership model with incentive design: A clear understanding of the companys strategy addresses the complexity and ambiguity that can destroy executives valuation of incentives Linking metrics and KPIs to incentive 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

Regular reporting on the metrics and KPI scan address potential perceptions of unfairness Calibrating incentive plans (setting appropriate threshold, target, and superior levels of performance necessary to fund incentives) in a way that recognizes and reflects risks in the strategy can help address executives general risk aversion

Incentive plans will remain an important component of executive and employee reward structures.

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 strategic execution remains a compelling objective of these plans.

We believe that application of research on executive (and employee) perceptions to incentive plans can improve the efficacy and cost/ benefit relationship of incentives. By adopting a leadership model, and adapting incentive programs within the context of a leadership model, companies can support strategic change, 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.

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By Aaron Sanandres and Andrew Skor

Acquisitions mean big changes for numerous stakeholders. The implica-

tions for a target companys

Considering an acquisition? Begin total rewards planning now

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 postacquisition rewards structure.

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This change management process can be fraught with human capital risks that can undermine the human resources (HR) leaders ability to execute the postacquisition 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 potential 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.

How does the output of the performance 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 management system and incentive structures can provide valuable insight into the targets culture, clues to potential retention risks, and impediments to rewards integration. Specific considerations should include: Annual incentives: Funding of the annual bonus pool and individual allocations should tie to corporate-wide and individual goals and 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 significant discretion embedded into the annual incentive process can present integration

challenges to an acquiring company that 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, compliance 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 benefits and accounting implications. Equity plans commonly require automatic vesting of all awards upon a change in control, which can trigger significant cash payments. This is particularly true of private-equityowned companies, where long-term incentive plans often pay significant 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.

Understanding the targets rewards structure

Its not as easy as compiling a list of plans, participants, and potential payouts. The buyer should know how the target makes compensationrelated decisions and understand the companys performance management process. Ask: How does the target measure individual performance?

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Buyers are sometimes hesitant about exchanging target equity awards because of dilution or concerns about the associated expense.

(where retained) holds a key stake in the 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 accelerations can cause unvested equity awards to fully vest unless the acquiring company assumes them. But the acquiring company has the opportunity to roll over unvested equity award into unvested equity awards over its own stock, thereby inheriting 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-combination total rewards strategy and deal economics (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, flexibility 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 profitand-loss impact. For target LTIPs that provide for board discretion on treatment, 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 accelerated or cashed out at closing or assumed as unvested awards over the buyers equity. Deferred compensation: Mandatory deferral of compensation, which is increasingly common across many industries, can take a variety of forms. During diligence, the buyers HR leaders should focus on the magnitude of the deferred compensation obligation (and associated funding, if any), compliance with tax rules (specifically IRC Section 409A), and whether such

balances are to be distributed upon the change in control (and associated tax implications). Benefit plan liabilities: Liabilities related to employee welfare and retirement plans, which are an important component of the total rewards offering, should not be ignored. The buyers HR leaders should perform thorough diligence to understand any transferring liabilities, annual expenses, and cash-funding requirements associated with employee defined-benefit 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, defined-benefit plans may be significantly underfunded, which can result in large cash contributions post-transaction.

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Defining the future of 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 appropriately, 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 acquisitions in which acquired employees may be integrated into existing structures. In practice, there are many different approaches to establishing total rewards structures post-transaction (many of which may rely on the requirements or leniency of the purchase agreement, which may require certain provisions for compensation and benefits 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 reciprocal program to identify immediate gaps and needs.

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Many buyers go through a structured job mapping process to align salaries across the combined organization.
annual incentive (e.g., corporatewide metrics or new, behavioral metrics). The buyers HR leaders should confirm that the targets performance management framework supports the changes and that the changes are adequately communicated. Long-term incentives (e.g., stock-based compensation): Integrating target employees into the acquiring companys long-term incentive plan can often prove problematic. Even for similar companies, LTIP participation rates and relative grant values can vary significantly. Of particular importance for an HR leader is the task of identifying those employees who had historically received meaningful levels of equity awards under the targets LTIP, 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 historically. For these employees, it may

A rudimentary mapping matches job titles and descriptions or links positions

outcomes. For example, once the targets employees are integrated into the buyers incentive structures, the performance review process can help facilitate greater differentiation 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 significant 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.

based on overlapping job codes.

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. (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 modification following a change in ownership. At a minimum, the buyer should assess whether performance targets and metrics support underlying post-combination business objectives. More material changes can include those made to the pay mix or the introduction of new performance metrics into the determination of the

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be necessary or appropriate to provide a replacement benefit or to consider modifications to other compensation structures. Benefits: Lastly, HR leaders should consider differences in employee benefits programs and their impact on employees from a financial and employeeexperience perspective. During diligence, HR leaders should compare benefit 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.

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 to consider each element of the targets compensation and benefits package separately, as well as to assess its total overall value. This perspective 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, they should 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.

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

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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, Alexandrian, c. 335 bcc. 280

Smart HR leaders know how to use health benefits to contribute to employees well-being and to promote organizational success. A balanced view of the importance

Reaping the rewards of organizational health

of workforce health and well-being and the critical role of health benefits in a competitive and effective total rewards program can help employers reinforce the motivating principles of partnership, engagement, and alignment for the employee population.

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Employee and organizational health should be viewed not only as costefficiency and compliance issues, but also as primary components of a total rewards strategy, predicated on: 1. Recognizing the importance of organizational health and health benefits in a total rewards structure. 2. Monitoring the impact of improving health on organizational success and, yes, even cost. 1. Recognize the importance of organizational health and health benefits 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 defines the vital components of its total rewards program in a different manner, employers generally develop these programs

based on commonly accepted HR wisdom 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 leadership; 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 increasingly diverse workforce. Organizational mission, vision, and culture should inform human resource strategies and total rewards programs.

The intrinsic value of employee health

A well-planned health benefits package, a mainstay of nonmonetary compensation, can function as an intrinsic motivator and performance enhancer while creating a work environment and culture that can positively influence employees health behavior choices. A culture that encourages a healthy lifestyle will potentially reduce employee stress while boosting physical fitness, stamina, overall well-being, and productivity.

Talent recruitment and retention is another total rewards objective.

The role of employee health in recruitment and retention

Talent recruitment and retention is another total rewards objective. Offering a health and wellness program 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

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curb illness and injuries, leading to less absenteeism, increased productivity, 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 organization 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 wellbeing 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 fitness centers or subsidized memberships to outside facilities.

Wellness initiatives send a message that the employer cares about the well-being of its workforce, a factor that can boost morale.

A health program should have common principles across 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 prevention programs can be consistent globally, even as an employers role in providing

benefits package was one of the most commonly cited factors that make employers attractive, ahead of factors such as flexible working arrangements or international assignments.

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Linking a healthy and vital workforce to corporate goals

Improved employee health and vitality

Increased employee engagement

Successful achievement of corporate goals

healthcare may vary from market to market. In addition, an overall health program should be flexible enough to accommodate all workers as well as changes in family status. Developing a set of guiding principles for your organizations health program globally, 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 organizations goals. Employers can measure employee engagement 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 companywide 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 pressure) correlates with an increase in employee engagement and overall productivity. This type of study should be quantifiable and tailored to each employers setting and culture.

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Calculating ROI
Employers should analyze the impact of health on the organization. To capture the complete picture, they should consider not only employee health benefit 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 significantly during the last three to five years.

Better understanding of the impact of 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-specific 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 precision that management desires. (See Determining the value of employer sponsored Health Improvement Programs in the Winter 2011 issue of HR Innovation for a detailed description of measurement techniques.)

Building and sustaining a healthy, competitive culture

A competitive total rewards strategy requires the development of a positive culture that embraces organizational health and that provides appropriate health benefits. 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 benefits such as higher employee morale, which in turn can help establish ROI through hard data on metrics such as productivity and employee engagement. The likely result: happier employees who stay 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 benefits.

To view past issues of HR Innovation, go to www.pwc.com/us/hrinnovation.

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By Mike Xu
Income tax rates are on the rise this year and 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.

Taxing issues for 2013: Rising rates influence compensation choices

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Top individual income tax rate climbs to 39.6% The maximum marginal income tax rate increases to 39.6% for single filer taxpayers with incomes above $400,000 and for joint filers with incomes above $450,000. For this same group of taxpayers, the long-term capital gains rate, which also applies to qualified 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 filing 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 some The 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 withhold 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 qualified 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

Additional 2% Social Security tax

More than 200/250K in AGI More than 250/300K in AGI More than 400/450K in AGI

Medicare Tax on Investment Income

Loss of Itemized Deductions

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

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Wage income 2012 top rate Medicare tax 2001/2003 tax cut expiration Medicare surtax 2013 top rate Phaseout of itemized deductions 2013 effective top rate 35.0% 1.45% +4.6% +0.9% 41.95% +1.2% 43.15%

Interest income 35.0% +4.6% +3.8% 43.4% +1.2% 44.6%

Qualified dividends 15.0% +5.0% +3.8% 23.8% +1.2% 25.0%

Capital gains 15.0% +5.0% +3.8% 23.8% +1.2% 25.0%

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 retroactive, so filers will have to pay higher income taxes on 2012 returns.

Implications for high-income earners and compensation decisions

High-income earners and their employers can blunt the impact of rising tax rates by re-arranging their compensation structures using qualified plans and nonqualified plans. Some qualified hybrid plans can boost tax benefit while incurring little unfunded liability. By integrating

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qualified and nonqualified plans, some employers can achieve an even better result leveraging beneficial traits of both nonqualified and qualified plans. The tax increases may drive the following decisions of compensation arrangements: 1. Tax bracket arbitrage (39.6% versus 35%): Executives may want to manage their compensation 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 (highincome-tax states versus low- or no-income-tax states): Federal law prohibits states from

imposing income tax on non-residents for their retirement income distributed from qualified plans and certain nonqualified plans, notwithstanding 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, positive arbitrage exists between the benefits of deferral and the value of a tax deduction. 4. Optimum tax benefits under qualified retirement plans: Tax-qualified retirement plans provide the most robust benefits, including current deduction, deferred income recognition, and exemption from OASDI and Medicare tax.

Employees may defer compensation into a nonqualified deferred compensation plan (nonqualified deferrals) or a qualified retirement plan (qualified 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 qualified plans (qualified contributions) for those groups. While no rules impose a dollar limit on the amount of nonqualified deferrals, IRC 409A substantially restricts the timing of distributions and the deferral election. Moreover, nonqualified deferrals are unsecured and subject to claims of the employers creditors. In contrast, qualified deferrals and contributions are secured from the claims of the employers creditors and not subject to rigid timing rules under IRC 409A. Qualified 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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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 evaluate the compensation structure for employees to potentially reduce its cost and employees tax burden by taking two steps to take full advantage of the tax benefits of qualified plans as explained below. Depending on an employers particular situation, the employer may implement the first step without the second or vice versa. Neither approach is wrong. The employer will need to determine the best approach for its particular situation.

compensated employees and the distribution rules. Most employers already have qualified plans and are dealing with the complex rules that come with them. Qualified deferrals and contributions also achieve significant tax efficiency: 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 qualified 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 deduction 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).

Step One (DC enhancement):

Use the existing defined contribution (DC) plan fully by providing contributions up to the annual limit for a group of targeted employees identified 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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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.

likelihood of an unfunded liability the 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 contributions implemented in Step One. This table shows the maximum amount of deferrals and contributions to qualified plans that can be achieved by implementing Step One and Step Two.

Choosing a hybrid plan with market rate of return

In a hybrid plan, participants cannot elect their individual contribution amount. However, based on an evaluation of the total benefits and compensation received by individuals and groups, the amount of benefits 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, ownership shares, location, age, and service

Step Two (additional DB benefits):

Establish a cash-balance plan, also known as a hybrid plan. A qualified hybrid plan is a defined benefit (DB) plan under the regulations. It operates like a DC plansignificantly reducing the employers investment risk and the

Age 45 401(k) deferral Catch-up contribution Profit sharing and match Hybrid plan Total potential contribution $17,500 $0 $33,500 $100,000 $151,000

Age 50 $17,500 $5,500 $33,500 $130,000 $186,500

Age 55 $17,500 $5,500 $33,500 $170,000 $226,500

Age 60 $17,500 $5,500 $33,500 $220,000 $276,500

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at implementation. Required contributions for each individual follow a predictable pattern, based on the plan provisions. Contributions are invested when contributed, and each participants benefit value grows on a tax-deferred basis with the investment return of the asset pool. At termination of employment, participants can take the benefit value and roll it over to an IRA 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 selfdirection by individual participants, although participants may rebalance using 401(k) and other discretionary assets to achieve an overall target risk profile. Second, a participant may not elect to change participation or contribution levels. The employer

can, however, amend the plan from time to time and design the plan to adjust to changing business and total compensation needs and, for example, provide different benefits 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 flat rates or certain indices as the interest credit on participants accounts. As such, the employer still retained some degree of investment risk and likelihood of unfunded liability.

For the first time, the PPA permits the 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 preservation of capital requirement. At distribution, the plan must guarantee payment of at least the sum of the pay credits (i.e., the accumulated contributions). The possibility of a funding shortfall because of this requirement is very small.

As taxes rise, some will rise 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.

Investment risks

Reduce investment risk

Further reduce investment risk

Traditional DB plans

Cash-balance (hybrid) plans

Cash-balance plans with market rate of return

Reduce likihood of unfunded liability

Further reduce likihood of unfunded liability

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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.

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About PwCs Human Resource Services (HRS)

As a leading provider of HR consulting services, PwCs Human Resource Services global network of 6,000 HR practitioners 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 financial 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 five core critical HR issues: reward effectiveness and efficiency; risk management, regulatory, and compliance; HR and workforce effectiveness; transaction effectiveness; and global mobility. To discuss how we can help you address your critical HR issues, please contact us. Scott Olsen Principal US Leader, Human Resource Services (646) 471-0651 scott.n.olsen@us.pwc.com Ed Boswell Principal US Leader, People and Change (617) 530-7504 edwin.h.boswell@us.pwc.com Peter Clarke Principal Global Leader, International Assignment Services (203) 539-3826 peter.clarke@us.pwc.com

HR Innovation Contributors Scott Olsen (646) 471-0651 scott.n.olsen@us.pwc.com Aaron Sanandres (646) 471-4567 aaron.sanandres@us.pwc.com Andrew Skor (646) 471-2311 andrew.skor@us.pwc.com Don Weber (678) 419-1417 donald.p.weber@us.pwc.com Mike Xu (312) 298-3398 zhiyuan.xu@us.pwc.com

Please visit our website at www.pwc.com/us/hrs or scan this QR code:

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www.pwc.com/us/hrs

2013 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PwC US helps organizations and individuals create the value theyre looking for. Were a member of the PwC network of firms 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 find out more by visiting us at www.pwc.com/us. NY-13-0530