Board Due Diligence: Executive Pay and Benefits

2. Board Due Diligence:Executive Pay and Benefits NAFCU Volunteers Conference 2010 Presented by: Chris Burns-Fazzi (BFB) and Loretta Dodgen (HCSGroup)

3. Board Due Diligence “The board, CEO, CFO and senior human resources executive need to ensure alignment of organizational systems (work design and accountability, performance measurement, pay for performance, and talent management) to create the leadership selection and development plans that will drive sustainable growth… and capital-efficient business results in the long term. This organizational capability is the underlying driver of growth in (member) value and the board needs to ensure this capability is in place.” Mark Van Cliafe

4. Board Due Diligence • Three questions need to be addressed: • What should executives be held accountable for? • What dimensions of performance should be measured & reported? • Over what period should they be measured? • How will we compensate for that performance? • Establishes: • CEO’s accountability • How CEO and credit union performance will be measured • How performance will be tied into compensation

5. Board Due Diligence: Strategic Questions • 1. Do we have the right people in the right positions doingthe right things? • What skills will we expect our employees to have inthree years? • Do our job performance evaluations communicate expectations and promote accountability? • 4. Do our incentive plans address all key performance goals? • 5. Do we have an adequate succession plan in key areasof responsibility?

6. Board Due Diligence: Strategic Questions • Compensation philosophy • Framework • Decision criteria • Compensation strategy addressing current and future needs and aligning with corporate strategy • Focus for actions and decisions

7. Board Due Diligence: Compensation Policy • Board Oversight for Compensation policy • Procedures to set compensation for the organization’s chief executive, officers, and “key employees” • Review and approval by board of directors or compensation committee excluding those with conflicts of interest • Application of data for comparable compensation for similarly qualified persons in functionally comparable positions at similarly situated organizations • Documentation and recordkeeping of the deliberations and decisions regarding the compensation • Assurance that activities and operations of branches or affiliates are consistent

8. Board Due Diligence: Compensation Policy • Operational effectiveness • Legal and regulatory compliance • Risk avoidance

9. Measuring Performance • Set clear expectations • Connect compensation to performance • Use Human Capital metrics

10. Strategic View Human Capital Human Resources Personnel

11. Measuring Return Traditional HR Metrics • Turnover Rate • Average time to fill positions • Compensation Costs/employee • Benefits as % of Compensation Human Capital Metrics • Operating Income/employee • Comp and Market Ratios • Human Capital Efficiency Ratio • Human Capital ROI • Total Realized Value 11

12. Sample HC Metrics Study

13. HC Metrics Sample Comparisons

14. Challenges Today • 75% of executives listed executive succession as their primary concern • Gen X (1963-1981) “Me Generation “ – self reliant – buy them or challenge them – relationship oriented. • Gen Y (1982-1993) – Life, Balance & Environment important – globally oriented. Flexibility very important, challenge service concepts. Society of Human Resource Management (2007) • “ Strategic planning, succession planning and member growth are all intertwined… attracting the next generation to membership and employment must be a mandatory exercise for today’s credit union leaders. Welcoming and encouraging new faces and ideas is an important component in the evolution of the credit union industry.” Michael Fryzel, NCUA Board Member • SERPs are not just for CEOs anymore. Credit unions are using them to manage their succession planning process. By providing senior executives with a SERP, the board places “golden handcuffs” on them to encourage them to stay to help provide asmooth transition to the new leader. Credit Union Times (September 2009) 14

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16. A Competitive Compensation Program • Competitive Salary – compared to • • Peer Group – Other Credit Unions – Use Of Surveys And Other Market Data • Health And Life Employee Benefits • • Group Health, Life And Disability • • 125 Plans • Perquisites (Car, Club Dues, Etc.), Executive Disability, Additional Life Insurance, Education, Conventions • Qualified Retirement Plans • Incentive Compensation Plan • • Bonus – Annual Or Rolling • Nonqualified Benefit Plans • • SERPs– 457(b) And 457(f) • • Pay For Performance • • Post Retirement Medical • • Split-dollar 16

17. What Others are Doing

18. A Question of Fairness According to financial planners employees will need about 70-80 percent of pre-retirement income to enjoy a comfortable retirement. Typically retirement income sources include Social Security and qualified retirement plans. For employees with higher salaries a gap is created due to IRS limitations on qualified plans and annual exempt amounts with Social Security. The graph below shows the income replacement at retirement provided by Social Security and qualified plans for different income levels. Assumptions Years to Retirement 20 years Annual Salary Increase 5% Current 401k Balance 50% of Current Salary Employee 401k Contribution 10% of Salary 401K Interest Rate 6% Social Security Full Benefit in Future $ * Subject to qualified plan limits 18

19. Constructing An Executive Benefit Plan – A Roadmap • According to examiner’s guide compensation needs to be fair and reasonable • What is total compensation - a shortfall analysis • What are others doing - a compilation of surveys • Compensation philosophy + fair & reasonable = A Competitive Package • Roadmap to construct a plan identifying and avoiding risks Third Party Relationship Vendor Selection Risk Analysis Legal and Product Ongoing Board Due Diligence & Administration

20. Example of “GAP”

21. Vendor Selection Guidelines • Vendor Selection - Three Key Considerations: • Evaluate the vendor’s experience and expertise • History • Endorsements • Weigh the vendor’s industry reputation • Clients • Examine key operational issues • Online administration • Compliance reporting • SAS70 • Field personnel

22. Assessing Risk: Safety & Soundness • The Vendor should conduct a Pre-Purchase Analysis of allproducts used to ensure credit union understands risks, rewards and unique characteristics. • Risk Management Analysis of Permissible Product – understand and address potential informal funding risks, which include: • • Liquidity Risk – how does the product affect the Credit Union’s bottom line and balance sheet • • Market/Transactional Risk – full understanding of how the product works • • Interest Rate Risk – threat to earnings or capital when product fails to perform as expected • • Credit Worthiness – review of carrier ratings and financials • • Diversification – analysis and use of several carriers • • Compliance/Legal Risk – compliance with state and federal laws

23. Assessing Risk: Safety & Soundness (continued) • The credit union should understand contractual risks of a benefit plan • Risk Management Analysis of Legal Obligation which includes: Type Of Promise • Nonqualified • Welfare Benefit • Events That Trigger Payments (Cash Flows) • Payment Date/Retirement • Death • Disability • Change of Control • Termination – Voluntary, Involuntary

24. Ongoing Due Diligence & Administration • Implementation • Ongoing Administration System • Financial Reporting/Compliance • Annual Review • • Plan • • Product

25. Summary • Develop a compensation philosophy that is in alignment with the strategy of the Credit Union • Analyze and Review the metrics to determine if compensation and strategy are working properly • Perform Due Diligence on the following: • Benefits for Key People • Vendor Selection • Risk Management • Ongoing for Plan Performance

26. Board Due Diligence • Questions?