Trends in Not-For-Profit Compensation and Benefits

Trends in Not-For-Profit Compensation and Benefits September 27, 2012 If you experience any technical difficulties, please contact 888.228.0988 or support@learnlive.com

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Today's presenters Presenter 1 Picture Presenter 2 Picture Ken Cameron Director, Compensation and Benefits Consulting Grant Thornton LLP 404.704.0136 ken.cameron@us.gt.com Eddie Adkins Partner, Compensation and Benefits Practice Tax Technical Leader Washington, DC 5

Agenda Current regulatory environment Competitive market approach Variable pay A look at deferred compensation programs Respond to your questions 6

The Executive Compensation Regulatory Environment Do these sound vaguely familiar? Compensation transparency is at an all time high New regulatory agency guidance on how to disclose granular elements of compensation Increased number of executives required to have their compensation disclosed in publicly filed documents New requirements to discuss the process for making decisions about executive compensation Moving away from perquisites and benefits that do not have an explicit business purpose Stakeholders, watchdog groups and regulators all commenting publicly on executive compensation programs that appear excessive Local law enforcement efforts directed at "reining in" excessive executive compensation through either litigation or potential criminal sanctions As a tax exempt organization in the United States today, can you relate to these issues? 7

The Executive Compensation Regulatory Environment (con't.) You are not alone These are the same issues, pressures and challenges felt by public companies all across the United States in light of new rules and regulations implemented under Sarbanes-Oxley, Dodd-Frank Act, The "TARP" Act and others Executive Compensation programs, whether due to level or design, are being scrutinized by more people with varying agendas and not always with a clear understanding of what an organization does or what it takes to lead a multi-dimensional tax exempt entity in today's economy and world While the "players" may be different (i.e., IRS not SEC) the pressure to implement effective, compliant, efficient and competitive executive compensation and benefit programs continues to increase on tax exempt organizations and for the near future this seems to be the trend 8

The Executive Compensation Regulatory Environment (con't.) As a tax exempt entity, the IRS provides guidance for establishing "reasonable" total compensation opportunities, and for some tax exempt entities failure to adhere to the rules may result in the imposition of excise taxes, and result in possible revocation of your tax exempt status 4958 of the Internal Revenue Code imposes an excise tax on excess benefit transactions between a disqualified person and an applicable tax exempt organization (i.e., 501(c)(3) or (4)). The disqualified person who benefits from an excess benefit transaction is liable for an excise tax. An organization manager may also be liable for an excise tax on the excess benefit transaction. In appropriate cases, the IRS may also propose revocation of tax exempt status, whether or not 4958 excise taxes are imposed. 9

The Executive Compensation Regulatory Environment (con't.) The rebuttable presumption test under IRC 4958 The burden to prove a disqualified person s compensation is unreasonable shifts to the IRS if a rebuttable presumption of reasonableness has been established by the organization with a threepronged approach Independent Committee Approves Compensation Before Paid Comprised of individuals: Unrelated to and not subject to the control of the disqualified person With no material financial interest in the transaction Who do not receive compensation subject to the disqualified person s approval Use of Comparable Organization Data Prior to Decision Amount paid for like services by like enterprises (including forprofits) under like circumstances For example, comparable in size, nature and operations Adequate and Contemporaneous Documentation Terms of the transaction and date it was approved Recording of the decision-making process and the actions of the Committee members, including those with a potential conflict of interest Basis for a decision, if outside range of data 10

Government Scrutiny In May of this year, New York Governor Andrew M. Cuomo announced that a number of state agencies have proposed regulations to take effect on Jan. 1, 2013, to limit compensation expenses at state-funded not-for-profit and for-profit service providers The regulations block providers from using State funds or State-authorized payments to pay a covered executive more than $199,000 for a year. If a provider chooses to pay more than $199,000 from sources other than State funds or State-authorized payments, compensation may not be paid in an amount greater than $199,000 per year unless the compensation: is no greater than the 75 th percentile of compensation provided to comparable executives at comparable providers, as determined by a compensation survey identified or recognized by the applicable State agency, and has been approved by the covered provider s board of directors or other equivalent governing body including at least two independent directors or voting members who have performed a review of comparability data 11

Other States Are Looking at NFP Executive Pay New Jersey issued regulations in 2010 to limit salaries for executives at social-service charities limited to no more than $141,000 if they are paid exclusively with state funds. Florida Senate committee approved a measure to cap executive salaries at slightly less than $130,000 a year if a charity received more than two-thirds of its budget from the state Massachusetts plans to reintroduce legislation that would limit executive pay to $500,000 The New Hampshire attorney general has criticized high salaries earned by hospital executives and has meetings on tap for later this year to encourage a new approach to compensation Illinois is planning to introduce a measure this fall that would make it easier to spot high salaries paid to leaders of charities who earn most of their income from for-profit subsidiaries 12

What is Generating Law Makers' Attention? NY Governor Cuomo read a New York Times article discussing high executive pay for a social service organization New Hampshire Attorney General was reviewing a proposed hospital merger A Massachusetts senator learned of the pay package (retirement and severance) paid to the CEO of Blue Cross/Blue Shield Illinois state legislators read a Chicago Tribune article which revealed how some social-service charities are earning most of their income through salaries paid by for-profit subsidiaries 13

Understanding the Total Compensation Package NY Museum Curator-in-Charge received a total compensation package in 2010 worth $988,523 The community had an extremely negative reaction $814,000 of this compensation was a lump-sum payout of a retirement plan that he had contributed to for nearly 40 years It's critical that the Board is fully aware of Schedule J Does the organization have a compensation philosophy? Has the organization conducted a competitive market analysis? 14

Comparing Salaries in the Marketplace When determining the competitive market level for executive salaries, there are few key things to keep in mind: Be thoughtful and strategic in choosing peer organizations Ensure you have competent staff (internal or external) who are familiar with not-for-profit compensation, including all of the individual elements, and understand how to conduct a valid competitive market analysis Use recent, valid and respected sources for your data (e.g., 990's, published surveys and custom analyses) Develop a peer group that is reflective of your organization and contains organizations/industry sectors with whom you compete for talent 15

Keys to Effectively Selecting Peer Groups Ensure your peer groups reflect your type of organization. Different subsectors can approach pay differently for jobs with similar skills: Healthcare Higher education Social service Trade associations Make sure you use some type of scope measure to approximate size Operating budget Revenues Number of employees 16

Keys to Effectively Selecting Peer Groups You can use multiple peer groups and blend the data All NFP's Industry or Sub Sector Targeted peer group (identify 7 to ten organizations) You can use general industry/for-profit data This should be for jobs with transferable skills Finance Legal HR Marketing In most cases, this information should be blended with NFP data Deciding how much to weight this data should be thought through carefully 17

Salary Trends Salary increases are remaining consistent Industry Sector Median 2012 Actual Salary Increases Median 2013 Projected Salary Increases All Executive All Executive General Industry 3.0% 3.0% 3.0% 3.0% Not-for-Profit (Religious, Grant making, Civic, etc.) 3.0% 3.0% 3.0% 3.0% Healthcare/SocialAssistance 2.8% 2.8% 3.0% 3.0% Educational Services 2.5% 2.6% 2.5% 2.5% Source: 2012-2013 WorldatWork Salary Budget Report 18

Variable Compensation Variable compensation in the not-for-profit (NFP) marketplace Discretionary bonuses are the most common type of variable pay Over 50% of NFP organizations are paying some type of variable pay Concern Need for greater rigor in calibration and design of incentive plans/metrics Director compensation Non-profit organizations generally reimburse Board members for meeting expenses Concern No cap on reasonable expenses associated with attending meetings However, no reimbursement for office, secretarial or spousal travel expenses Some state attorneys general (e.g., MA and CT) have questioned the "per se" reasonableness of providing NFP boards with "compensation" beyond "reimbursement" for expenses 19

Variable Compensation Grant Thornton Pulse Survey Grant Thornton conducted a pulse survey in June on the topic of variable pay. 75% of responding organizations indicated that they have some type of variable pay for their employees 20

Variable Compensation Grant Thornton Pulse Survey Variable pay programs are not just for executives with half of responding organizations providing this pay component to employees across the organization 21

Variable Compensation Best Practices An emerging trend is outcome oriented annual incentives, with objective criteria as follows: Financial performance No money, no mission Resource/expense/financial management: Efficiency management is critical in this day and era getting more out of less "Stakeholder" satisfaction (member, student, faculty, patient satisfaction) Efficiency and financial performance must coincide with tax-exempt mission Quality Outcome, experience (critical for health care providers in the era of health reform) Growth (specialty market share, program participation) Strategic growth, based on core services and/or emerging service lines 22

Trends in not-for-profit compensation Advantages of a well designed variable pay plan Better bang for the buck Focuses pay investment on those most responsible for results Reduces fixed costs by driving variable pay further in the organization Drives specific critical behaviors Creates a culture of individual and/or group accountability Significant rewards for top performers in high influence areas Increases motivation and job satisfaction through clear expectations and rewards Creates clear line of sight between performance and pay Performance-based pay (if designed properly) can have better optics to external constituents 23

Trends in not-for-profit compensation Variable pay levels in not-for-profits Median Annual Incentive/Bonus Payments by Role/Level PRM Not For Profit Survey Report 24

Variable Compensation Best Practices Incentive opportunities and leverage are getting more sophisticated, with pay for outcomes demonstrating achievement of tax-exempt mission Average award size is increasing Probably reflects better financial performance over past few years Leverage, or proportion of pay-at-risk, is increasing Opportunity levels increase with more conservative approach to base salaries, i.e., greater portion of pay-at-risk Sample annual incentives at some larger NFPs where incentives are offered: Position Target Award Maximum Award Exec Director/CEO 10% - 30% 15% - 45% Other Executives 7.5% - 25% 12.5 30% *There is considerable variation by industry 25

Variable Compensation Best Practices Awards are tied to a custom combination of organizational and individual metrics: Organizational/operating unit performance measures Functional performance measures Threshold level - probability of at least 80% Target level - probability of at least 50% to 60% Maximum level - probability of 10% to 20% 26

Variable Compensation Best Practices Summary Apply appropriate rigor/discipline in establishing metrics and performance ranges Only use metrics that can be effectively measured Avoid using more than three to five measures to ensure participants are focused on key organizational performance levers Ensure program details and results are communicated to participants throughout the performance cycle Ensure executive performance measures and results are formally approved by the Board 27

Variable Compensation Grant Thornton Pulse Survey From a governance perspective, NFP Boards are responsible for reviewing the compensation of CEOs/Executive Directors while 36% review the entire C Suite's compensation 28

How are not-for-profit organizations responding to the pressures of heightened regulatory concerns? "Common" features or elements of an executive benefit plan offering may include one or more of the following: Retention incentive (457(f)) Additional performance criteria being added Supplemental Executive Retirement Plan (457(f)) Trending down in the for-profit market Employer funded 457(b) Supplemental life or disability insurance Employment contracts with severance and CIC provisions 409A compliant Administration of effective and compliant supplemental executive programs is critical 29

Retirement Plan Trends in NFPs According to the most recent PRM Management Compensation Report for Not-For- Profit Organizations: Plans most commonly provided are 403(b) and 401(k) 15% of surveyed organizations offer a defined benefit plan Most employers with matching contributions provide a 100% and/or a 50% match On average, employers are contributing a total of 7.1% of base salaries to plans and approximately 91% of employees participate, overall 30

As the use of deferred compensation arrangements continues to evolve the different types available for not-for-profit entities continues to be an issue 457(b) 457(f) Eligible plans Ineligible plans 31

Contribution limits for a 457(b) plan Limit on total employer contributions plus employee salary reduction deferrals Lesser of 100% of compensation, or $17,000 in 2012 Amounts count toward limit in year of vesting Separate limits from 401(k) / 403(b) plans Age 50+ catch-up contributions $5,500 in 2012 Governmental entities only! Applies to deferrals under all 457(b) plans, even with different employers 32

Loan and funding rules for 457(b) plans Governmental Tax-exempt entities (non-governmental) Loans Permitted Loans are taxable Funding Must be funded in trust, custodial account or annuity contract Must be unfunded 33

Permissible distributions from a 457(b) plan Elective cash-out up to $5,000 One time only Available only if no contributions in last 2 years Severance from employment Unforeseeable emergency Attainment of age 70½ (even if still employed) Distributions must commence no later than April 1 of the year following the attainment of age 70-1/2 (unless still in service) 34

Moving on to 457(f) plans 457(f) is a catch-all category If a plan defers compensation, and It does not meet all the requirements for a 457(b) plan, and it is not a severance pay plan, then It's a 457(f) plan How does 457(f) define the term "deferred compensation" No definition But the Sec. 409A rules define it 35

Considering Sec. 409A's broad definition of deferred compensation When an employee has a legally binding right during a taxable year to compensation that is or may be payable to the employee in a later taxable year 36

Examples of deferred compensation arrangements under 457(f) Deferred compensation provisions in various types of agreements including: offer letters, employment agreements, noncompete agreements and consulting agreements Bonus plans Supplemental executive retirement plans 37

457(f) plans are a mixed bag The good news (i.e., better than 457(b)) No limit on amount of deferral No restrictions on when amounts may be distributed The bad news (i.e., worse than 457(b)) Amounts are subject to taxation as soon as they are no longer subject to a "substantial risk of forfeiture" 38

"Substantial risk of forfeiture" Sec. 457 says it means that the right to compensation is conditioned on "future performance of substantial services" More commonly referred to as vesting Usually, a very easy concept to apply Example: The individual vests after performing 3 years of service. Vesting can also occur upon death or disability without triggering current taxation Caution: It has nothing to do with the financial security of the plan 39

Primary differences between 457(b) and 457(f) plans Plan 457(b) Contribution Limit $17,000 in 2012 Included in Income When paid 457(f) Unlimited Upon vesting 40

Optimal plan design strategy First, implement the more attractive plan, which is a 457(b) plan Up to $17,000 can be contributed in 2012 (plus catch-up) Can be 100% vested Not included in income until paid Next, implement a 457(f) plan If there is a desire for additional deferred compensation No limit on the amount Subject to tax upon vesting 41

Caution: 457(f) plans can be subject to 409A Elective deferrals Rolling risk of forfeiture Non-compete provision 42

457(b) and 457(f) plans Form 990 / Schedule J reporting Reporting for contributions varies depending on whether vested or not vested at the time contributed to the plan Contributions not vested at the time credited (for cliff vesting, assume ratable crediting; don t include investment earnings) Contributions vested at the time credited (don t include investment earnings) Form 990, Part VII, Schedule A Schedule J, Part II Columns (D) and (E) Reportable compensation (W-2/1099-MISC) from the organization and from related organizations Column (B)(i) Base compensation Column (B)(ii) Bonus and incentive compensation Column (B)(iii) Other Reportable Compensation Column (F) Other compensation from the organization and related organizations Column Column (D) (C) Retirement and other deferred compensation Nontaxable benefits 43

457(b) and 457(f) plans Additional reporting when prior year nonvested contributions vest Include accumulated investment earnings in amount Form 990, Part VII, Schedule A Schedule J, Part II Columns (D) and (E) Reportable compensation (W-2/1099-MISC) from the organization and from related organizations Column (B)(i) Base compensation Column (B)(ii) Bonus and incentive compensation Column (B)(iii) Other reportable compensation Column (F) Other compensation from the organization and related organizations Column (C) Retirement and other deferred compensation Column (D) Nontaxable benefits 44

Additional reporting consideration for 457(b) and 457(f) plans Nonvested amounts reported in prior year Reported again in year of vesting, as indicated on prior slide Be sure to include in Schedule J, Column (F) 45

Even more reporting considerations for deferred compensation plans Applies to 457(f) plans, but not to 457(b) plans Schedule J, Part I, Line 4b, asks whether any individual reported on Form 990 participated in, or received payment from, a supplemental nonqualified retirement plan In Part III, must list the individual and amount paid, and describe the terms and conditions of the plan (even if no amount paid during year) 46

Some ideas for best practices Form 990 Disclosures Part VI, line 15, asks questions to indicate whether you established a rebuttable presumption regarding the compensation of your CEO, executive director or top management official and your other officers or key employees Schedule J asks which of six specifies approaches you used to establish the compensation of your CEO or executive director Schedule J disclosure include the following information: Actuarial increases in defined benefit pension values in "deferred compensation" column Supplemental nonqualified retirement benefits or deferred compensation arrangements as they accrue Identify compensation contingent upon revenues or net earnings Be prepared to have documentation regarding a "business purpose" for providing benefits such as first-class or charter travel, travel for companions (non-business purpose), tax indemnification and gross-up payments, discretionary spending accounts, housing allowance or personal residence, health or social club dues or initiation fees, personal services 47

Some ideas for best practices (con't.) Formal Compensation Committee -Consistent with the protocols currently in place for most Audit Committees, formal charters, guidelines and practices should be established for Compensation Committees of the Board and training should be provided to Committee members on the issues they need to consider Satisfy the Rebuttable Presumption of Reasonableness -The amounts and design of total compensation opportunities provided to a broad constituency of leadership individuals (e.g., disqualified persons, key employees, others, etc.) need to be reflected upon by appropriate decision-makers, with external comparable market data available and a formalized process for recording the final decisions Stakeholder Optics Considered -The potential implications for the disclosure of compensation elements to various stakeholders through sample or projected Form 990 disclosures should be reviewed at the time compensation decisions are made so that the Compensation Committee and Board can prepare potential responses if and when inquiries are made 48

Some ideas for best practices (con't.) Business Purpose Rule -Compensation Committees need to consider more than just the "how much" but also the link between total compensation and a business/mission purpose Leadership Collaboration -An effective partnership between Finance and H.R. will go a long way to deepening an organization's understanding of how compensation and benefits programs can change an organization, deliver on results and lead to overall operational success Pay-for-performance NOT "for pulse" Develop integrated pay-for-performance features through different elements of the compensation program with measurable goals consistent with the strategic objectives and mission of the organization Effective and compliant deferred compensation arrangements Implement the more attractive plan, which is a 457(b) plan Up to $17,000 can be contributed in 2012 Can be 100% vested Not included in income until paid Next, implement a 457(f) plan If there is a desire for additional deferred compensation No limit on the amount Subject to tax upon vesting 49

Questions/Comments 50

Contact Information Presenter 1 Picture Ken Cameron Director, Compensation and Benefits Consulting Grant Thornton LLP 404.704.0136 ken.cameron@us.gt.com Eddie Adkins Partner, Compensation and Benefits Practice Tax Technical Leader Washington, DC 202.521.1565 eddie.adkins@us.gt.com 51

Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered. For additional information on matters covered in this presentation, contact your Grant Thornton LLP adviser. 52

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