Reducing payroll without involuntary terminations

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By Zorast Wadia | 15 August 2016

Challenge

A not-for-profit client had just lost a funding grant for one of its programs. Rather than undergo a reduction in force where some long-standing employees would have to be terminated, the client wanted to explore alternative ways to reduce its payroll. The retirement plan’s eligibility for early retirement was based on steep age and service requirements and not enough employees were retiring through attrition. Therefore, the client approached Milliman for a solution that would allow for reduction of payroll without having to go through a bunch of involuntary terminations. The client valued the retirement plan and has always taken a paternalistic approach to providing retirement benefits for employees.

Solution

Milliman actuaries discussed the situation with the client and asked questions to gain a better understanding. It was important to get an idea of the magnitude of the desired payroll reduction and also understand the work force dynamic. Like most organizations, there was a strong correlation between salaries and experience/tenure at the organization. The client was not willing to lose its top performers all at once as this would create another problem having to do with insufficient knowledge transfer.

Client payroll, plan membership, and age/service demographics were analyzed further. A group of employees was identified by the plan sponsor as replaceable based on the client’s future business objectives. Several solutions were suggested.

The first potential solution involved amending the retirement plan’s provisions that defined the criteria needed for early retirement. The retirement plan’s current early retirement requirement was attainment of age 60 with 20 years of service. Not many plan participants met both the age and service requirements. Participants who were hired at younger ages would generally meet the service requirement, but had to wait until at least age 60 to commence benefits. On the other hand, mid-career hires would generally not have at least 20 years before their earliest retirement eligibility of age 60. Thus, the plan’s current early retirement provisions were not a good fit for its current workforce.

A second potential solution was to offer a voluntary early retirement program (VERP). A VERP is a voluntary program often executed in a window format (typically 45 to 60 days but the timeframe can vary), where employees have a certain window of time to elect an enhanced benefits package in exchange for their termination or retirement. The goal for the VERP would be to entice the retirement of approximately 20 active employees ranging in age from 57 to 63. This group of participants was identified by the plan sponsor as providing less economic value relative to their current costs of employment. But it would not be easy to just have the desired participants accept early retirement without some enticement. Because active employees who retire or otherwise terminate employment are no longer provided ongoing healthcare coverage by the company, the incentives to retire are likely to be more palatable to the older employees closer to Medicare eligibility (age 65).

The client considered a VERP that offered numerous types of incentives, including:

  • Additional years of service and/or age credits
  • Cash payment(s)—for example, one or two weeks of pay for each year of service
  • Additional benefits, such as an extension of health coverage
  • “Bridge” payments, where employees are paid an annuity from their termination date to a fixed date (such as age 62 or 65)

For any window program, there is a tradeoff between an immediate additional cost in benefits versus a cost savings down the road. In addition, the client had to make sure that it was comfortable with the various outcomes of the early retirement window and the remaining staff’s ability to maintain an appropriate level of work without hurting long-term profitability. Milliman also advised the client to be prepared for fewer people taking the window offer than anticipated.

Outcome

Milliman actuaries confirmed that the 20 target members that the client wanted to include in a potential retirement window would not be classified as a discriminatory group and that any potential window offerings would be in compliance with the Internal Revenue Code’s nondiscrimination requirements for pension plans. Consequently, after considering the effects of several different window options for the 20 target members and reviewing the cash and accounting sensitivity scenarios prepared by Milliman, the client decided to execute an early retirement window, offering a combination of incentives. The window was offered to participants who were age 57 or older with early retirement benefits being calculated as if retiring participants were two years older with an additional two years of service. The additional years of service reward participants retiring early with higher benefits while the additional age criteria results in a lower reduction in benefit for most of the participants in the window group who would be retiring early. The client decided against offering an extension of health coverage because this option was deemed too costly.

The client also decided to amend the early retirement provisions in the retirement plan for future retirees. The early retirement eligibility was lowered from age 60 with 20 years of service to age 58 with 10 years of service going forward. The client felt that these changes would allow for a more orderly retirement of the work force and help facilitate work force transitions better in the future. Thus, not only was the client able to continue rewarding its employees with a strong retirement program, it was also able to redesign the retirement program to accomplish its human resource objectives.