Article by John Swabey, Talent & Reward consulting team for Central & Eastern Europe at Towers Watson.

Executive pay practices have hardly been out of the headlines in recent months. In the current economic maelstrom there is much disagreement over the future of the private sector and how it should be managed. An outraged public was shocked at the excesses of the banking system, but is the executive pay model in the West really completely bankrupt?

Assessing the system starts with an understanding of what executive remuneration currently looks like – which is not entirely straightforward. Because pay depends on how much is performance-related, and how an individual and organisation actually performed. The key is what is put into the executive’s wallet, not what is possible if they exceed their targets.

The typical executive package has five components: base pay, car and other perquisites, medical and other benefit plans, the annual bonus and, increasingly, long-term incentives. In most Central & Eastern European countries base pay rose above inflation fairly consistently between 1997 and 2007, with one or two hiccoughs, but between January and April 2009, when the recession was in full flood, base pay increases for executives did slow down. The median rise in chief executive pay, for example in Poland, was 2.8%. For executives reporting to the CEO it was 3%. Over the same period the median actual increase amongst all employees was 4%. And Poland is not an exception; for the first time in several years executives in Central & Eastern European countries are wearing more of a hair shirt than their employees. 

Reward is shrinking
Perquisites remain largely untouched, but the annual bonus is under pressure. Towers Watson research shows that the ‘variable’ element is having a real impact, and bonuses are paying out far less in the downturn. On average, in Central & Eastern Europe bonuses paid out were close to the target in 2008. In 2009, there were some zero bonuses and even at lower quartile of the market CEOs got as little as 50% of their incentive opportunity. Bonuses in payment are coming down for the first time in many years.

Similarly, long-term incentives (LTI) have lost some of their glamour. The value of grants may be multiples of annual salary but, as share prices drop, the value to executives drops as well. Of course, the whole purpose of having bonuses and long-term incentives is to allow pay to vary, and to decrease in bad times.

There are other signs that pay is being used appropriately to reward performance rather than to penalise failure. We have found that companies have been pretty tough on executives. When a recent UK survey asked what successful executive pay looks like, the most popular answer was that ‘executives had acted in the long-term interests of the company’. The next most popular was that ‘they achieved the performance the company wanted’.

Too harsh a squeeze will demotivate
But the third objective of successful executive pay was that reward ‘retained the executives that the company needed’. That is the other side of the equation. Many companies in the Central & Eastern Europe are in a recovery situation. The share price may have fallen to below 50% of what it was before the crisis; you need the executives who can turn that around and drive the share price up, and you need to pay at a good level to get that.

Clearly the system of executive reward is not perfect as it stands. However, there are elements that have proven successful. No one thinks it has been a roaring success, but very few think it has been a total failure, with the same result in Central & Eastern Europe.

This article was also published in HR Dergi Magazine.

An in-depth analysis by Luc de Wée, International Research Consultant at Towers Watson Data Services, specialised in employee benefits. 

Western Europe

In Western European countries there are different and separate layers that compose the retirement benefit of an individual, but it is often far from clear to which pension pillar each of these different layers actually belong. This is, however, important to know, as in each of these countries, different tax and social aspects apply for each of the existing pension pillars.

The multi-pillar pension system in Western Europe generally comprises the following three distinct pension pillars:

First Pillar
The first pillar pension system consists of the social security system, which is almost always a pay-as-you-go (PAYG) system, where the compulsory employer and employee social security contributions, together with the state subsidies granted, are financing the social security retirement benefits that are paid out to individuals.

Second Pillar
The whole of the second pillar pension system relates to what is called occupational pension plans, introduced on a voluntary basis by an employer. Throughout the whole of Western Europe, with the exception of Malta where to date no occupational pension plan legislation applies, the most common of these funding methods are group insurances and pension funds. In certain countries, allowed funding methods do actually comprise book reserves and sometimes also bank savings. The financing of such occupational pension plans is often by both employer and employee contributions.

Third Pillar
A third layer of an individual’s retirement replacement income consists of the whole range of an employee’s private individual retirement savings. In each country, the vehicles that can be chosen for the financing of this third layer are mainly driven by tax incentives.

Challenges

In certain of the Western European countries it is today not clearly stipulated for each of the existing pension systems to which pension pillar they actually belong. Many countries apply, on top of the existing social security system, an additional mandatory pension system for which it is not always clearly defined to which pension pillar it exactly belongs. Such additional system(s) exists for France, Greece, Switzerland and the United Kingdom, as well as for all Scandinavian countries. It is partially the case in Italy, where it actually depends on an employee’s category, the Netherlands with the existence of industry-wide pension plans and Belgium with the application of the so-called sector plans. For certain of these countries, however, it is not clearly defined as to whether these additional mandatory retirement provisions belong to the first or the second pillar pension in the country’s multi-pillar pension system.

Notwithstanding the above, in most of Western European countries there is a real need of a solid mandatory second pillar pension system. This results from the fact that the existing pay-as-you-go first pillar pension system will be facing considerable problems in the near future, due to a lowering birth rate and a higher life expectancy. Also, the drop in replacement income at retirement will be considerable for those individuals who are not covered under a mandatory second pillar pension system, and/or an occupational pension plan, and who have not been able to accrue sufficient personal retirement savings (as is the case for some in the UK for example).

Several countries are in the process of developing a mandatory second pillar pension system and it seems more and more that in the future a mandatory second pillar pension system on the one hand (as implemented by law) and a non-mandatory second pillar system (comprising the whole area of occupational plans) on the other hand will be applied.

Central and Eastern Europe 

As concerns Central and Eastern Europe, a more consistent and clearly defined multi-pillar pension system already applies for most of the countries, but the definition that is given to these different pillars is quite different from what applies in most of the Western European countries.

In their progress of developing new employee benefit scenes the Central and Eastern countries generally adopted the recommended World Bank Model of multi-pillar pensions. In a number of countries of this region this is still an ongoing process.

The World Bank Model comprises the following three distinct pillars:

• First pillar: the PAYG social security system
• Second pillar: a mandatory fully funded defined contribution type of system
• Third pillar: a voluntary fully funded defined contribution type of system (occupational pension plan) 

A typical feature under this three pillar pension concept is the transfer, for financing purposes of the mandatory second pillar pension system, of contributions from the first into the second pension pillar. 

Of the Central and Eastern European countries that implemented the three pillar pension concept, some are going beyond the model as recommended by the World Bank, whereas others do not exactly follow this World Bank Model of different pension pillars. 

Hungary, for instance, applies a five pillar pension system and this largely goes beyond what is recommended by the World Bank; whereas other countries introduced a multi-pillar pension concept which is totally different from the one that the World Bank recommends. In Lithuania, for example, affiliation to the existing second pillar system results of a voluntary employee decision, which once taken cannot be revoked. In Russia, a fairly complex and complicated employee benefit system is in place, which although it can be defined as a multi-pillar pension system, does not follow the World Bank Model. The system continues to comprise many features of the former Soviet system. In Slovenia, the applicable second pillar pension system is split up between one that is mandatory for employees subject to certain work conditions, such as difficult work or work that is harmful for their health, and one that is non-mandatory for all other employees. 

The existing mandatory second pillar pension systems are financed in different ways. Financing is by both employer and employees contributions, as is the case in Bulgaria, Estonia, Latvia, Lithuania and Slovakia. Financing is by employee contributions only, this applies for Croatia, Hungary, Poland and Romania. Or the second pillar is fully financed by employer contributions which is the case in Russia and Slovakia. 

Two groups of countries can be distinguished when it comes to the aspect of mandatory affiliation to the second pillar pension system. First, there is a group of countries where the criteria of mandatory affiliation relates to the fact of being born after a certain date. This is the case in Bulgaria, Croatia (in stages), Latvia and Romania. Second, in Hungary as well as in Slovakia, the criteria of mandatory affiliation relates to the fact of being affiliated to the social security system after a certain date. 

Challenges

Within the Central and Eastern European way of developing the pension pillar concept, there is the risk of a certain uncontrolled growth in the number of applicable pillars. Hungary, with its current five-pillar system, is a typical example of this. Second, a number of these countries are altering the initially implemented system which was based on the World Bank Model into one that differs from this model. Third, how will under this structure the application of occupational plans further develop? Fourth, the development in these countries of a fourth pillar of voluntary individual retirement savings is still open. 

Also see: 

Addressing Retirement Plan Risk: http://www.towerswatson.com/issues/Addressing-Retirement-Plan-Risk 

European Federation for Retirement Provision: http://www.efrp.eu/ 

Guidance Note on Pan-European Pensions: http://www.fedee.com/pensions.html

“If there is a future for pan-European pensions, then that future will be DC”, by Elizabeth Corley, CEO Allianz Global Investors Europe: http://www.ipe.com/magazine/if-there-is-a-future-for-pan-european-pensions-then-that-future-will-be-dc_33929.php?articlepage=1

More information on retirement pension benefits can also be found in Towers Watson Data Services Benefits Reports.

An in-depth analysis by Luc de Wée, International Research Consultant at Towers Watson Data Services, specialised in employee benefits. 

Western Europe

In Western European countries there are different and separate layers that compose the retirement benefit of an individual, but it is often far from clear to which pension pillar each of these different layers actually belong. This is, however, important to know, as in each of these countries, different tax and social aspects apply for each of the existing pension pillars.

The multi-pillar pension system in Western Europe generally comprises the following three distinct pension pillars:

First Pillar
The first pillar pension system consists of the social security system, which is almost always a pay-as-you-go (PAYG) system, where the compulsory employer and employee social security contributions, together with the state subsidies granted, are financing the social security retirement benefits that are paid out to individuals.

Second Pillar
The whole of the second pillar pension system relates to what is called occupational pension plans, introduced on a voluntary basis by an employer. Throughout the whole of Western Europe, with the exception of Malta where to date no occupational pension plan legislation applies, the most common of these funding methods are group insurances and pension funds. In certain countries, allowed funding methods do actually comprise book reserves and sometimes also bank savings. The financing of such occupational pension plans is often by both employer and employee contributions.

Third Pillar
A third layer of an individual’s retirement replacement income consists of the whole range of an employee’s private individual retirement savings. In each country, the vehicles that can be chosen for the financing of this third layer are mainly driven by tax incentives.

Challenges

In certain of the Western European countries it is today not clearly stipulated for each of the existing pension systems to which pension pillar they actually belong. Many countries apply, on top of the existing social security system, an additional mandatory pension system for which it is not always clearly defined to which pension pillar it exactly belongs. Such additional system(s) exists for France, Greece, Switzerland and the United Kingdom, as well as for all Scandinavian countries. It is partially the case in Italy, where it actually depends on an employee’s category, the Netherlands with the existence of industry-wide pension plans and Belgium with the application of the so-called sector plans. For certain of these countries, however, it is not clearly defined as to whether these additional mandatory retirement provisions belong to the first or the second pillar pension in the country’s multi-pillar pension system.

Notwithstanding the above, in most of Western European countries there is a real need of a solid mandatory second pillar pension system. This results from the fact that the existing pay-as-you-go first pillar pension system will be facing considerable problems in the near future, due to a lowering birth rate and a higher life expectancy. Also, the drop in replacement income at retirement will be considerable for those individuals who are not covered under a mandatory second pillar pension system, and/or an occupational pension plan, and who have not been able to accrue sufficient personal retirement savings (as is the case for some in the UK for example).

Several countries are in the process of developing a mandatory second pillar pension system and it seems more and more that in the future a mandatory second pillar pension system on the one hand (as implemented by law) and a non-mandatory second pillar system (comprising the whole area of occupational plans) on the other hand will be applied.

Central and Eastern Europe 

As concerns Central and Eastern Europe, a more consistent and clearly defined multi-pillar pension system already applies for most of the countries, but the definition that is given to these different pillars is quite different from what applies in most of the Western European countries.

In their progress of developing new employee benefit scenes the Central and Eastern countries generally adopted the recommended World Bank Model of multi-pillar pensions. In a number of countries of this region this is still an ongoing process.

The World Bank Model comprises the following three distinct pillars:

• First pillar: the PAYG social security system
• Second pillar: a mandatory fully funded defined contribution type of system
• Third pillar: a voluntary fully funded defined contribution type of system (occupational pension plan) 

A typical feature under this three pillar pension concept is the transfer, for financing purposes of the mandatory second pillar pension system, of contributions from the first into the second pension pillar. 

Of the Central and Eastern European countries that implemented the three pillar pension concept, some are going beyond the model as recommended by the World Bank, whereas others do not exactly follow this World Bank Model of different pension pillars. 

Hungary, for instance, applies a five pillar pension system and this largely goes beyond what is recommended by the World Bank; whereas other countries introduced a multi-pillar pension concept which is totally different from the one that the World Bank recommends. In Lithuania, for example, affiliation to the existing second pillar system results of a voluntary employee decision, which once taken cannot be revoked. In Russia, a fairly complex and complicated employee benefit system is in place, which although it can be defined as a multi-pillar pension system, does not follow the World Bank Model. The system continues to comprise many features of the former Soviet system. In Slovenia, the applicable second pillar pension system is split up between one that is mandatory for employees subject to certain work conditions, such as difficult work or work that is harmful for their health, and one that is non-mandatory for all other employees. 

The existing mandatory second pillar pension systems are financed in different ways. Financing is by both employer and employees contributions, as is the case in Bulgaria, Estonia, Latvia, Lithuania and Slovakia. Financing is by employee contributions only, this applies for Croatia, Hungary, Poland and Romania. Or the second pillar is fully financed by employer contributions which is the case in Russia and Slovakia. 

Two groups of countries can be distinguished when it comes to the aspect of mandatory affiliation to the second pillar pension system. First, there is a group of countries where the criteria of mandatory affiliation relates to the fact of being born after a certain date. This is the case in Bulgaria, Croatia (in stages), Latvia and Romania. Second, in Hungary as well as in Slovakia, the criteria of mandatory affiliation relates to the fact of being affiliated to the social security system after a certain date. 

Challenges

Within the Central and Eastern European way of developing the pension pillar concept, there is the risk of a certain uncontrolled growth in the number of applicable pillars. Hungary, with its current five-pillar system, is a typical example of this. Second, a number of these countries are altering the initially implemented system which was based on the World Bank Model into one that differs from this model. Third, how will under this structure the application of occupational plans further develop? Fourth, the development in these countries of a fourth pillar of voluntary individual retirement savings is still open. 

Also see: 

Addressing Retirement Plan Risk: http://www.towerswatson.com/issues/Addressing-Retirement-Plan-Risk 

European Federation for Retirement Provision: http://www.efrp.eu/ 

Guidance Note on Pan-European Pensions: http://www.fedee.com/pensions.html

“If there is a future for pan-European pensions, then that future will be DC”, by Elizabeth Corley, CEO Allianz Global Investors Europe: http://www.ipe.com/magazine/if-there-is-a-future-for-pan-european-pensions-then-that-future-will-be-dc_33929.php?articlepage=1

More information on retirement pension benefits can also be found in Towers Watson Data Services Benefits Reports.

Below follows some of the more important changes of the Code;

• Variable remuneration has to be linked to predetermined and measurable performance criteria aimed at promoting the company’s long term value creation;
• Variable remuneration paid in cash is to be subject to predetermined limits regarding the total outcome;
• Programmes that involve acquisition of shares should be designed for promoting personal holding of shares in the company, the vesting period for a share-based incentive scheme is to be no less than 3 years;
• Fixed salary during a period of notice and severance pay are together not to exceed an amount equivalent to two years fixed salary. 

The company needs to devote a section of it’s website to corporate governance matters including a description of the company’s system of variable remuneration to directors and of each outstanding share and share-price related incentive scheme. 

For further information, please contact: 

Tom Klackenberg
+46 8 555 517 74
tom.klackenberg@towerswatson.com

Moreover, while most companies are hiring, 49% still expect to make workforce reductions in 2010 – 5% say these will be broad-based and 44% say they will be targeted. This compares with 12% who have made broad-based reductions and 55% who have made targeted reductions since the start of the financial crisis.

The survey, conducted in early January and based on responses from 131 mostly large employers across Europe and 459 employers globally, found that while the picture is slowly improving, Europe lags North America. For example, 92% of US companies indicated they would be hiring in 2010 and only 37% expected workforce reductions.

Not surprisingly, given employment patterns both pre- and post-crisis, 40% of the survey respondents in Europe agree that it’s easier to retain talent now than it was before the financial crisis. However, 48% think that retention will be more difficult a year from now. Respondents also noted a rise in productivity over the past year, with over half (54%) agreeing that employee productivity had risen compared with pre-financial crisis levels, and more still (57%) expecting it will continue to rise by next year. Interestingly, the recession’s impact on employee engagement has also been mixed. While 23% report lower engagement today, 33% believe employee engagement has risen since before the financial crisis. For 2010, far more companies expect engagement to rise (41%) than decline (10%).

The survey confirmed the toll the past year has taken on employees in terms of pay and benefit cuts, and how employees have responded. For instance, 15% of respondents said the percentage of their employees working past their desired retirement age is higher than it was before the financial crisis, and 24% expect it will be even higher a year from now.

Employers are acknowledging their employees’ concerns. Some 34% expect that, in a year from now, they will put more emphasis on ensuring benefits provide a desired level of security for employees. Much larger numbers of respondents, however, expect to increase their focus on controlling and reducing benefit costs (45%) and managing the risk and volatility of those costs (45%). 

The Towers Watson analysis can be found at http://www.towerswatson.com/research/960.
For the full press release please click here .

Belgium - The new corporate governance code created in mid-2009 suggests that severance pay for senior executives be capped at one year’s basic and variable compensation. The code is intended to promote best practices, compliance is voluntary.

France - In late 2009, parliament passed legislation on top hat retirement schemes for senior executives and directors. Among other things, the law doubled the levy on employer contributions (from 8% to 16%) to plans where annuities exceed one third of the social security ceiling, raised the tax on internally funded plans from 6% to 12%, and prohibited the creation of new internally funded arrangements from 1 January 2010 (new plans must now be insured externally). 

Germany - The government passed the Act on the Appropriateness of Executive Remuneration to better align executive pay structures with sustainable business objectives in public companies and increase transparency for setting executive pay. Under the Act, variable pay plans should be related to a business’s multi-year performance and limits on pay should be established to guard against outsized payments in the event of extraordinary business results.
The Act also increased the minimum holding-period requirement for stock options from two to four years, expanded the supervisory board’s powers to realign executive pay with business results, including the possibility of reducing compensation in line with results and requires that the entire supervisory board be responsible for establishing executive pay compensation, rather than sub-groups such as remuneration committees.

Ireland - Due to the deep contraction in 2008-09 and its impact on State finances, the government enacted a special income levy of between 1-3% in early 2009 which was then doubled to 2-6% in May. It applies to gross income before deductions. In addition, the social security contribution ceiling increased from EUR 52,000 to EUR 75,036 and the health levy was doubled to 4% or 5%, the higher rate applying to income above EUR 75,036. In sum, the tax burden for all staff, particularly higher paid employees, sharply increased in 2009 with little prospect for near-term relief.

United Kingdom - Higher paid employees will see their take home pay reduced in 2010/11 with implementation of a third income tax bracket of 50% on annual income of GBP 150,000 or more. In addition, tax relief on pension contributions for individuals with gross annual income exceeding GBP 150,000 will be reduced from 40% to 20%.

More information on the latest developments in remuneration for top executives can be found in Towers Watson Data Services’ 2010 Top Management Compensation Report – EMEA .

As you are no doubt aware, Towers Perrin and Watson Wyatt announced plans to merge in the middle of 2009 and formally combined at the end of the year. While the merger affords us significant opportunities to meet all of our clients’ needs more effectively over time, we anticipate that you have one important question:

How will this merger affect me and the work my organisation is currently doing with either Towers Perrin or Watson Wyatt Data Services?

The short answer is: Not at all.

We will continue to operate our database businesses independently for a period of time. We have made this decision to ensure we maintain the quality and consistency of our products and services and our relationships with you and your organisation. This is our first priority and will guide all of our actions as we integrate the two legacy organisations across all of our business units and geographies.

Over the coming weeks and months, the only change you will see is in the look and feel of the materials you receive from us, and the web sites you routinely use, as we introduce our new brand identity. Watson Wyatt Data Services will now go to market as Towers Watson Data Services. And Towers Perrin’s Compensation Data BankTM and related data services will now go to market under the Towers Watson banner. However, our products, underlying methodologies and client service will not change, nor will your contractual agreements with our legacy organisations.

In closing, we want to reiterate our commitment to your organisation as you join the wider family of our new Global Data Services business at Towers Watson. We know that our success as a combined firm depends on the quality of work we do for you and the success you enjoy as a result. You can count on the same support and dedication you have in the past.

We encourage you to reach out to your current relationship manager to answer any additional questions you may have and discuss what you can anticipate over the next few months as our integration process continues.

Sincerely, 

Towers Watson Data Services EMEA

1) A continued trend towards closure of defined benefits schemes to future accrual.

Watson Wyatt predicted this trend would take off in 2009 and it did. “With a number of large schemes and household names making this change this year, many more are likely to follow in 2010,” according John Ball, head of defined benefits consulting. 

2) Increasing interest in enhanced transfer value (ETV) exercises.

“We are now seeing a number of major companies seriously investigating this, spurred on by the substantial fall in corporate bond yields over the year, which can make such exercises more attractive,” said John Ball. “As we have seen with closure to future accrual, there could be a domino effect once a few household name companies undertake such an exercise.” 

3) Higher contributions from scheme sponsors.

“The second half of this year will be the time when the bigger deficits caused by the financial crisis start making a dent in employers’ cash flows,” said John Ball. “This is a consequence of the time it takes for funding agreements relating to late 2008 and early 2009 valuations to be negotiated and implemented. The question is not whether contributions will rise but how much, how quickly and how uniformly.” 

4) A more interventionist Pensions Regulator.

“We can expect the Regulator to become more interventionist in 2010, not least in respect to sponsor/trustee negotiations around funding plans,” said John Ball. “But quite how much bite will the Regulator have?” 

5) Alternatives to pension savings.

Employers may start looking for alternative routes to help employees’ long-term savings ahead of the proposed restriction of higher-rate tax relief for pensions for those with income over £150,000 (and in some cases over £130,000) in 2011. “This may begin with higher-earners but employer-sponsored non-pensions savings vehicles may then become more widely available for other employees,” said John Ball.

After having been positive in the past, inflation will be negative for 2009, which could mean a decrease in salary as of January 2010, for those employees whose salary is adapted at the beginning of the year. In several sectors, the joint committee has an agreement in place in case of negative indexation. In the others, it is up to the employer to decide whether to apply it to salaries or not. According to SD Worx, around 30 sectors have a negative indexation, but only half will pass this on.

The negative inflation will have other impacts, such as the non-indexation of tax deductibles for pension purposes (3rd pillar), and therefore these amounts will remain unchanged.

Further details on pay, indexation and joint committees can be found in our Employment Terms & Conditions Report for Belgium.