Executive Performance Based Compensation

1. Executive Performance Based Compensation Jerry Nelson, CEO HRN Management Group September 2003

2. Today’s Focus • Economic Review & Trends • Executive Base Compensation • Executive Performance Management • Executive Short-term Incentives (Bonus)

3. Current Economy • Gross Domestic Product grew at 3.1% annual rate in this year’s second quarter. • Consumer spending rose 3.8% from an earlier 3.3% estimate • Unemployment 6.2% in July • Some predict economic growth to jump to 5% in the third quarter.

4. Economic Review According to Mercer’s annual compensation survey & research… “What’s on executives’ minds? How can we: • Afford and sustain our current level of compensation spending? • Bolster growth & profitability through the use of our compensation strategy? • Reallocate our compensation dollars to achieve better control over spending? • Recognize and reward our highest performers? • Ensure pay reflects and encourages productivity and results?

5. Impact of Economic Downturn • 12% of organizations report salary freezes for at least one segment of employee population. • Executives, management, and technical/professional employee groups either had or were considering, as the top three cost saving measures: • salary freezes • extended review periods • lump sum payments.

6. Cost Saving Measures

7. Impact On Benefits • Overall decrease in number of organizations offering many benefits • Executive benefit programs have been reduced • Elimination of benefits that are “nice to have” but not affordable at this particular time

8. Base Pay Increases For Whom & For How Much?

9. Whose salaries have been frozen?

10. Inflation And Labor Markets Effect On Pay

11. Top Reward/Compensation Challenges Facing Companies

12. Rewarding The “Right” Talent

13. Increasing Role Of Short-term Incentives

14. Metrics Behind Short-term Incentive Plans

15. Executive Performance Based Compensation For Credit Unions Does it work? • Philosophy • Directional • Psychic Income • Competitive

16. Compensation Characteristics

17. Historical Perspective Common Notions of Pay • Legal foundation to eliminate pay discrimination/inequities. • To attract and retain competent employees. • To ensure compensation equity (internally/externally) • A means for budgeting and controlling salary expense.

18. Historical Perspective Progressive Notions of Pay • A means to hire the best • A means to retain the best • A means to elevate performance • Use pay strategically (align it with Credit Union success)

19. Then No formal pay plans or consistent base pay per position “Let’s pay John $6/hour and Sue $5/hour - okay!” Base Salary. Some Executive perks. Limited, if any, pay at risk. Defined Benefit Plans (Pension). Pay disparities based on gender. Now Formalized base salary administration programs based on internal equity (job evaluation) and market salary indexing and analysis. Base salary, but: Pay at risk Huge bonus and incentive amounts Participative retirement [401(k), etc.] The Differences - Compensation

20. Compensation Characteristics • Do people work for a credit union because of pay? • Do CEOs and Executives work for a credit union because of pay?

21. CEO and Executive Compensation

22. CEO and Executive Compensation Mix Circle of Elements Bonus Annual Merit Base Pay Recognition Retirement

23. However, first things first… The Foundation Does your BASE compensation program work? • Yes • No • Sometimes

24. CEO and Executive Base Pay Things to consider… • Is base pay important to the CEO/Executive? • YES! (It makes up over 80% of his/her total cash compensation.) • Is it competitve? • Yes • No • I hope!!

25. Base Pay Competitiveness What’s Important… • Credit Union Asset Size • Geographic Location

26. Base Pay Competitiveness How? • Market Surveys Valuable? • Yes, unfortunately, the only game in town. Are they accurate? • Yes • No • To a certain degree

27. CEO and Executive Base Salary Ranges

28. CEO and Executive Pay StructureDesign and Placement Maximum Midpoint Minimum Inexperienced. Highly experienced. Extremely high Performer. Meets or exceeds expectations. Very Experienced.

29. Years of Experience and Pay Grade Slotting Experience Only (in years) 0 - 2 3 - 5 7 - 10 12 - 15 17 + $100,000 $112,500 $125,000 $137,500 $150,000 min midpoint max 0 - 2 2 - 3 4 - 6 7 - 9 10 + High Performance Accelerators

30. Pick Your Poison Consequences:Ineffective Executive Base Pay Program CEO/Executive Turnover High Salary Expense $ Below Average Performance

31. CEO and Executive Recognition and Direction How? • Annual Performance Appraisal By Whom? • The Board Why? • To provide CEO/Executive with direction • To provide a means to adjust base pay • To set objectives • Board needs it • CEO needs it

32. A CEO/Executive Performance Appraisal Model (Standards)

33. A CEO/Executive Performance Appraisal Model (Results)

34. A CEO/Exec Performance Appraisal Model (Merit Matrix Guidelines)

35. CEO and Executive Bonus • Is it an entitlement Or • Is it a benefit?

36. Prevalence of CEO and Executive Bonus Plans A few statistics… 95% 90% 85% 65% Industrial Insurance Banks Credit Union

37. CEO Bonus as a Percentage of Salary A few more statistics..

38. Bonus DeterminationRisk vs. Opportunity? (How much) No Ceiling? INCENTIVE INCENTIVE INCENTIVE INCENTIVE BASE PAY BASE PAY BASE PAY BASE PAY Significant risk, but good opportunity Some risk, but added opportunity Significant risk, but greater opportunity No risk, but some opportunity.

39. Typical Mix of Compensation Perquisites Perquisites Perquisites Benefits Benefits Benefits Benefits Long-Term Incentive Long-Term Incentive ANNUAL BONUS Long-Term Incentive 100% ANNUAL BONUS ANNUAL BONUS ANNUAL BONUS BASE PAY BASE PAY BASE PAY BASE PAY Management group of large companies Officers of large companies Credit Union CEO/Execs CEO/Exec of large companies

40. Basic Types and Prevalence of Management Incentive Plans % of Companies Using Plan Type • Discretionary Plan 12% • Formula Plan 21% • Performance Target Plan 67%

41. Types of CEO and Executive Bonus Plans Discretionary Plans Pros • Flexible Cons • After the fact bonus • No pre-set rules • Subjective

42. Formula Plan • Key Features • Fixed formula determines pool, for example, 5% of profits in excess of 1.0% of return on assets • Advantages • Provides some direction • Defines threshold for bonus • Disadvantages • Formulas become obsolete • Pool not related to competitive compensation or goals • All or none - doesn’t recognize outstanding units

43. Types of CEO and Executive Bonus Plans Performance Bonus Plans Pros • Directional • Conditional • Flexible - can respond to changing conditions • Award opportunity tied to results Cons • Need to set targets each year • Sometimes administratively complex

44. Bonus Performance Factors Financial Factors (Absolute vs. Relative) • R.O.A. • Sustained R.O.A. (3 year average) • Asset Growth • Loan Delinquencies • Capitalization • Expense Ratios

45. Bonus Performance Factors Non-Financial Factors • Membership Growth • Improvements in Operations, D.P., Personnel, Other • Audit/Examiner Ratings • Member Survey Ratings • Services Per Member • Quality Service Measurements

46. Bonus Performance Factors Intangibles • Must take into consideration one time expenses (or other items) that might impact annual financial indicators.

47. Bonus Performance Factors Most Common Factors • Earnings (40%) • Board evaluation (38.6%) • Loan growth (19.4%) • IDC CAMEL Ranking (17.9%) • Membership satisfaction (11.6%) • Share growth (11.5%)

48. Typical Award Levels 30% Max 30% Maximum: Achieves highest level performance. Target: Meets designated objectives. Threshold: Minimum performance before any award given. 20% Target 20% Max 15% Threshold 10% 10% Target 10% Max 10% Target 7.5% Threshold 6% Threshold 5% 0% Executive Other Management CEO

49. Model Executive Compensation/Bonus Plan 2003