UK Treasury Recruitment: Part 2 - The Effect of Remuneration and the Ongoing Pension Crisis
Given the depressed level of employment and development opportunities, it has been unsurprising that there has been weak upward pressure on salaries for existing employees during 2003. Furthermore, many employers have been trying to cap the increases for those moving, such that more executives are changing employers for package increases nearer to 10 per cent than the 25 per cent that used to be more common. High calibre executives are still, however, achieving both respectable (5 per cent+) salary rises for staying, and larger premia for moving. Faced with this, some employers have dug their heels in, and have been left only able to afford executives of lower quality or seniority than desired. Most others are still, however grudgingly, paying what it takes to obtain and retain good executives, especially at senior levels. With the market improving, taxes rising and potential problems with employer pension contributions (see Remuneration III below) we forecast a return to more aggressive times over the next year or two.
A major shift is under way in the design of bonus and share option packages for senior corporate executives. Old style share option schemes – generally independent of cash bonuses – are being replaced by enhanced nominal bonus potentials. Within these new schemes however, a major percentage of the bonuses can either be, or must be, taken in the form of shares. The ‘purchase’ of these shares with the bonuses is deferred, usually for three years. Arguably, when compared to the old option packages, these schemes may offer less potential reward but considerably less downside risk. Inevitably, there will be major variations among employers on the cash/share bonus structures. The trend toward replacing the old style options appears, however, to be gathering momentum very rapidly.
A sea-change is also under way here. The old schemes, referred to as ‘defined benefit’ (of which the most common variety is ‘final salary’), are rapidly being replaced by ‘money purchase’ or ‘defined contribution’ plans. Indeed, the NAPF recently estimated that a quarter of major UK corporations have now closed their final salary schemes for new entrants. So why is this issue suddenly so important to corporate executives? The answer is that, at a time when investing in their own pensions appears to be growing less and less attractive (see below), executives face the prospect that future contributions from their employers may well be seriously reduced, even if executives do not actually change company. Bold statements? Well, maybe, but consider the following:
a) Very many defined benefit corporate schemes are now under-funded, some seriously so, and must be publicly accounted-for, and possibly topped up with cash, accordingly. This situation has evolved given the combination of a number of factors including: the £5bn+ a year lost after ACT credit removal; previous, more generous, accounting treatments being overhauled; and flawed actuarial assessments on issues such as stock market returns and expected life-spans. Adding unpredictable wage inflation to the equation, it is clear that final salary schemes are an open sore from a corporate planning perspective, with the risk almost entirely carried by the employers, not the employees. As a result, not only are the great majority of final salary schemes likely to be closed for new entrants, but, in the opinion of some experts, such will be the potential cash requirements that many corporations will simply have to freeze their schemes in years to come for existing employed members, substituting with money purchase schemes until retirement.
b) The Inland Revenue operates a £99k per annum salary cap, above which neither corporations nor individuals can make pension contributions tax efficiently. This threshold is already reached by 10 per cent of the corporate treasury profession and is most unlikely to be increased with wage inflation.
c) The government now wishes to impose a £1.4m executive fund cap, again unlikely to be raised in line with wage inflation. This may well only equate to an annual, pre-tax income of £60k in today’s money terms, above which resulting income would be taxed at a punitive rate of 60 per cent.
d) It is common for companies now only to contribute between 4 per cent and 8 per cent of salary (dependent upon age) into money purchase plans. Compare that with final salary schemes where, according to several experts canvassed, equivalent figures could well average out nearer 20 per cent over the remaining working lives of scheme members.
So, what can we conclude from this? Two points arise:
1) It is crystal clear that executives can rely neither on government nor employers to be generous with their retirement incomes from now on. It can be speculated that, for the majority of executives much below the age of 50, employer contributions may provide only a minority of their desired retirement income. They will thus have to maximise tax efficient AVCs (subject to the fund and salary caps) and make extra savings arrangements of their own.
2) From a recruitment perspective, an obvious result would be that many executives could now be seriously dis-incentivised from moving employer. Changing from a final salary to a money purchase scheme could confront a job-mover both with material reductions in employer contributions and increased risk to the purchasing value of his/her fund on retirement (the linking of final salary schemes to wage inflation reduces this risk, at the employer’s expense). Perhaps because most executives place more importance upon career development, or leaving unemployment, than on such issues, we have seen little evidence of this being a problem to date. It seems inevitable, however, that the issue will arise and hard decisions will have to be made.
To end on a positive note, a ramification of the present situation is that there is now considerably greater need, and opportunity, for UK treasury professionals to get directly involved in pension management. Trusteeships and/or investment duties have always been bestowed upon some senior UK treasurers. Recent events could, however, take us toward the US model, where such responsibility is commonplace. This is happening because under-funding is necessitating the far closer attention of senior corporate officers. Issues such as equity vs cash/bonds and the degree to which schemes need to be topped up in hard cash from central corporate funds, have become matters of real importance.
The point here is that, given normal head-office executive capabilities, it is reasonable to assert that the skill sets of treasurers make them well equipped to lead the necessary debates. It is thus unsurprising that the number of treasurers getting involved is on the increase and indeed, for some, pension restructuring is now taking up a significant percentage of their time. In years to come, corporate pension scheme management could become a core competency for treasurers if the opportunities are grasped.
There is, however, a caveat, resulting from the potential for conflict of interest. Executives whose remit is to act primarily in shareholders’ interests (i.e. employees), arguably should not be the same as those whose duty is to act primarily in pension-holders’ interests (i.e. trustees). In practice, in benign conditions, this might not really matter. Consider, however, some of the recent scenarios where a fund deficit is so large that it equates to a major percentage of a corporation’s market value or access to liquidity. Here the shareholders’ and pension-holders’ interests could become opposed and it is difficult to see how any senior corporate officer, treasurer or otherwise, could continue as a trustee. This would not necessarily preclude treasurers’ involvement, just reduce the remit to investment advice, rather than decision-making responsibility as such. It will be interesting to see how this particular debate proceeds.