Many business owners have had a difficult time over the past two years. Most have been challenged to keep revenues up and costs down. Many have had to reduce or freeze employee salaries and benefits. They may even have had to let some people go.
Experts predict business conditions will improve in the coming months. Hopefully, they will be right and businesses that survive will return to their previous profitability.
Experts predict business conditions will improve in the coming months. Hopefully, they will be right and businesses that survive will return to their previous profitability.
Until then, CEOs and business owners have a lot on their plate. Between making key decisions for their company, and preventing employees from taking off, there seem to be more problems than solutions for them. In such a situation, it could benefit the leaders if they had business peer groups to discuss important decisions, or even just to brainstorm with people who own and lead other companies. However, for a business owner flying solo, these problems can lead to ignorance of the problems their employees might be facing.
Moreover, since they’ve had to focus on their own problems, many business owners haven’t had the time or resources to focus on the toll the recession has taken on their employees. In many cases, employees and their families have borne the brunt of the cost-cutting strategies owners have implemented. Many employees have found their jobs less satisfying because they’ve had to work longer and harder with fewer resources. The pay and benefit reductions they’ve suffered have forced many to make sacrifices in their personal lives, scale back their activities, and revise their plans for retirement.
A Big Problem on the Horizon
When the economy rebounds and relatively good times return, business owners may have to face another big problem. Their unhappy employees may leave to join competitors or quit to start their own businesses. Most employees are like “free agents” on professional sports teams; most are “employees at will” who can resign and leave with relative ease to sell their services to competitors. Very few are “locked in” under written employment agreements.
Often business owners think this couldn’t possibly happen to them. Many think their employees should be grateful and stay loyal; especially after all that they have done to keep their people employed during the tough times.
In fact, many employees are probably grateful, but their primary loyalty is to their families. They may need to make up for the financial losses they’ve suffered during the recession or they may feel they need a change of scenery and a fresh start. If that means finding a different employer or going to work for themselves, there may be little an employer can do to stop them.
A number of recent studies show the risk of employee departure is very real. On March 24, 2010, Modern Survey published a report showing a precipitous decline in U.S. workers’ psychological investment in their organizations. While the economic recession may have temporarily motivated employees to put forth extra effort on the job, the data from this study suggests U.S. workers may have hit their breaking point.
Don McPherson, a founder of Modern Survey, said, “Some people have been asked to do too much for too long…What I’m predicting is that when opportunities happen, some of these experienced people will leave for other opportunities. Some of these companies will have to go through the expensive process of hiring and training new people.”1 Other studies/surveys reporting similar findings are listed in Chart 1.
Who Can Your Clients Afford to Lose?
This is a good time for you to suggest to your clients who are business owners to take a careful look at their employee rosters and estimate the value each employee adds to their business. Suggest that they might consider ranking their employees as A, B or C employees. “A”s are top performers who would be extremely difficult to replace. “B”s are solid, dependable workers who are good contributors but are replaceable. “C”s are the ordinary or under-achievers who can easily be replaced.
Once the ranking process has been completed, owners should consider strategies for “locking in” their A employees, because they bring the most value to the business.
How are employees weathering the recession? A study by The Center For Work–Life Policy concludes: “How is top talent dealing with this onslaught? In a word-badly. In focus groups conducted for this study, senior executives talked about being angry, anxious and deeply stressed. Troubled firms are finding that precisely the wrong people (top performers with other job options) are heading for the door.”2
Losing an A employee may trigger several problems. Owners should focus on at least two. First, replacing a key employee can be expensive. A recruiter may have to be hired and the replacement may command a higher salary and better benefits, or need extensive training because of the uniqueness of the business. It may take some time before he can perform at the same level as the old key employee.
Second, when a key employee leaves, he may take some valuable and important customers with him to the new business. This can be a business disaster, particularly when business is slow. Valuable revenues will be lost. New clients will have to be found to replace the lost revenues. Attracting new clients is often time-consuming and expensive.
After working so hard to stay afloat during the tough times, it could be devastating for a business to lose key employees and important clients just when the business climate is starting to improve.
Carrots and Sticks
A carrot and stick approach could potentially keep the A employees from looking for greener pastures. Carrots are strategies designed to motivate them, create loyalty and make them happy. Sticks are strategies designed to make leaving more difficult. A plan to retain A employees could include both.
Carrots. Carrot strategies include: (1) formal recognition of the contributions and sacrifices they’ve made to keep the business going, (2) a heartfelt “thank you” for their service to date, (3) a tangible reward for their efforts, and (4) new financial incentives to continue their high level of performance in the coming years.
A life insurance-funded executive benefit could potentially provide all four of these carrots. It could provide the recognition necessary to keep key employees on board and committed for the coming years. Executive benefits such as a 162 bonus plan, REBA (restricted executive bonus arrangement), split dollar loan, 401(k) look-alike plan, or a non-qualified deferred compensation plan/supplemental executive retirement plan (NQDC/SERP) could be customized for each key employee. As they remain productive and feel appreciated, their skills could produce the revenues needed to pay the costs of the benefit.
Why use life insurance? Life insurance policies have several unique features which may be quite useful in customizing executive benefits. For example:
•”‚When the plan includes a death benefit, life insurance offers the potential to have this obligation informally funded immediately when the plan is implemented by matching the policy’s death benefit to the benefit promised under the plan. Life insurance has the potential to make the plan self completing if the employee dies before the promised benefits are due to be paid and the policy is still in force.
•”‚When the plan promises to pay a key employee supplemental retirement income, life insurance cash values may provide the business a potential source of funds from which to make the promised payments; if the policy is not a modified endowment contract (MEC), the business may generally access policy cash values on an income tax-deferred basis.3
•”‚Life insurance policy death benefits are generally paid out income tax-free and, if properly structured, may allow the business to recover some or all of the costs it incurred to provide the benefit.4
Benefit Ladders
Life insurance-funded executive benefits may also be structured as a related series. The benefits can be designed to build on each other over time to provide greater incentives to participating key employees. Such arrangements are known as executive benefit ladders, and they may be attractive to businesses because the costs can start low and increase as business cash flow permits. Also, the benefit may potentially be changed over time and become more valuable the longer a key employee stays with the business. In fact, increases in the key employee’s productivity could possibly provide the revenues needed to pay for the benefits. Apart from providing life insurance for their employees, other rewards and recognition systems (such as gift cards) , too, could provide an incentive for them to stay. Employers might need to buy bulk gift cards if they are a large enough enterprise to provide substantial rewards to their staff. This would not only build a solid enough foundation for the employee benefits, but also let the employee know that the employer truly cares about their physical and mental well-being.
Sticks. Sticks are strategies that place a cost on a key employee’s departure from the business. One example is a restriction in a 162 bonus plan that prevents the key employee from accessing life insurance policy cash values without the written consent of the employer. This type of restriction converts the arrangement into a REBA. Another commonly used restriction is a provision in an employment agreement which requires the key employee to repay bonuses received if he leaves the business prior to a specified date or before retirement.
Another useful stick is a noncompete agreement. This is an agreement (or part of an employment agreement) in which the key employee agrees not to solicit the business’ clients for a specified period of time (usually not longer than one year) and within a specified geographic area. A noncompete agreement helps protect the business’ client base and puts employees on notice that they won’t be able to just walk out the door with the business’ client list. Noncompete agreements may also be effective in retaining A employees because their inability to take customers with them may decrease their value to competitors.
Noncompete agreements are not a do-it-yourself project. Because the rules for noncompete agreements vary from state to state, a knowledgeable attorney should be engaged to draft the agreement. Some states have laws that prevent the enforcement of noncompete agreements unless the employee receives something of value (consideration) in return for making the noncompete promise. A life insurance-funded executive benefit created as a carrot may provide the valuable consideration needed to satisfy these state law requirements.
Linking the executive benefit and the noncompete agreement could potentially provide the best of both worlds. The executive benefit can provide recognition for the employee’s efforts, incentive to continue topnotch performance, and the value needed to make the noncompete agreement enforceable (assuming the agreement is drafted to comply with all applicable state laws).
Attracting New Key Employees
Every year some professional athletes join new teams as free agents. Their contracts with their old teams have expired and teams that needs their unique skills hire them to increase their chances of winning a championship. Business owners have the same opportunity. There may be skill or knowledge gaps in their organizations which need to be filled, or they may know some talented people who could add extra value to the business. Attracting new key people with unique skills, experience or relationships may reduce costs or increase revenues and profits.
New key executives could come from several possible sources. Some businesses have been forced to terminate smart, experienced employees to reduce costs. Many of these people are looking for the right opportunity to restart their careers. In addition, there are likely some employed key people who aren’t happy in their current working environments and who may be open to making a change.
Customized executive benefits are often included in the compensation packages offered to new key executives. Split dollar loans, 162 bonus plans and NQDC/SERP plans are examples of customized executive benefits that use life insurance.
Conclusion
As the recession ends, business owners will find themselves with new opportunities and problems. A potential problem they can’t afford to overlook is the loss of valuable A employees who may be unhappy with their current situation. They may be looking to make up for the salary and benefits cuts they experienced over the last several years. Life insurance-funded executive benefits can be customized to give them incentives to stay and be even more productive. They may also be used to attract new key employees who could bring new skills, experience and customers to the business. As the economy rebounds, life insurance has the potential to help business owners lock in their key employees and grow their businesses. Ë›
Footnotes
1.”‚Minneapolis Star Tribune, “As Workloads Go Up, Worker Loyalty Falls, Survey Finds,” March 30, 2010.
2.”‚The Center for Work-Life Policy, “Sustaining High Performance In Difficult Times,” by Sylvia Ann Hewlet, Laura Sherbin, Peggy Shiller & Karen Sumberg, September 2009.
3.”‚Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans but only if the policy qualifies as life insurance, is not a modified endowment contract.
4.”‚For policies issued after August 17, 2006, IRC 101(j) provides that death benefits from an “employer-owned life insurance” policy are income taxable in excess of premiums paid, unless an exception applies and certain notice and consent requirements are met before the policy is issued. Additionally, life insurance owned by a C corporation may subject the corporation to the alternative minimum tax.
