Are SERPs On Their Way Out?

Increasingly, Compensation Committees are asking if Supplemental Executive Retirement Plans should be eliminated from executive pay packages along with Change in Control Parachute payments and country club dues.  SERPs are misunderstood as unnecessary expenditures of shareholders’ hard earned capital, but in a 2009 survey of executive benefits, conducted by Clark Consulting, Inc., 67% of responding companies reported having supplemental executive retirement plans (SERPs), similar to the prevalence in 2007.  Let’s look at the history of SERPs to see why they are so prevalent.

During the last quartile of the Twentieth Century, the capitalist world moved away from offering defined benefit retirement plans.  Shifting mortality rates and increasing volatility of investment markets rendered Plans that promise certain retirement benefits much riskier and companies found it increasingly difficult to forecast their future costs.  Most of those old defined benefit retirement plans provided for a retirement at roughly 75% of a career employee’s final five-year average base salary.  There were variations, but that was about the average Plan’s promised benefit.  Along came ERISA (Employee Retirement Income Security Act) which established by statute that highly compensated folks could not benefit at the same percentage as the average worker in these IRS qualified plans.  The limits that ERISA imposed on participation in qualified retirement plans, like defined benefit and defined contribution 401(k) Plans, meant that executives can only provide for about 40% of their final five-year average base salaries during their retirement years.  This is still true.

So, Companies realized that the folks who were having the greatest impact on the organization, were being discriminated against on their ability to participate in the retirement plans.  Supplemental Executive Retirement Plans were then created to plug the gap.  Over time, some have forgotten what SERPs were designed to do and some of the benefits got out of hand.  Those high benefit SERPs were criticized, and rightfully so, by stakeholders.  One old argument was that executives make so much on stock-based long-term incentive plans that they should not need to save supplements for retirement savings.  Recent trends in stock markets and other forces have pushed previously granted stock options “under water,” meaning the cost to the executive to exercise the option is now greater than the value of the underlying stock.  Who wants that?  Some would say, “well, to bad for the executives.  It is their fault that the stock price has declined.”  Maybe the executives should be replaced, but if a Board decides that they want to retain their executives, or recruit new executives, the SERP issue will need to be resolved.

Retirement funds are like “bread, butter and mortgage money.”  People do not want to risk it too much, especially now that traditional sources of savings, like Social Security, are shaky.  Congress, long ago, in all its wisdom, decided that highly compensated folks did not need help saving for retirement.  So, what happened?  SERPs were born…..and my guess is that they will be around for the foreseeable future.

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