State Compensation Plan Audit

1. State Compensation Plan Audit Conducted for the Division of Financial Management September 2006

2. Contents • Introduction • Objectives • Methodology • Project Steps • Summary of Findings • Analysis • Conclusions and Recommendations • Appendix

3. Introduction • Two key pieces of legislation adopted in the 2006 legislative session had an impact on the State Compensation plan. These were HB 844 and SB1363. • As a result of this legislation, DHR was charged with making changes to the compensation plan to: • Revise the current salary and grade structure; • Increase the number of pay grades; • Have the pay grade for a position be based on a combination of “Hay points” and “market points;” • Geographic pay differentials; and • Develop compensation plan rules, guidelines and processes for implementation.

4. Introduction (cont’d) • Rules were developed by DHR and promulgated to Agencies for review. The amount of feedback from the Agencies indicated that there was a significant amount of concern about the new plan. • Accordingly, the Division of Financial Management (DFM) requested that Hay Group conduct an independent audit of the changes made to the compensation plan.

5. Objectives • Against that background, the objective of this project has been to conduct analysis of the changes made, and to provide commentary and recommendations, based on the principles of sound compensation management.

6. Methodology • The methodological basis of this review has been based on the six inter-related components of an effective classification and compensation plan. This model is set out on the following page.

7. Compensation Philosophy Classification The Description of Work Job Evaluation The Measurement of Work Pay Delivery The Recognition of Performance of Work Pricing (Pay Structure) The Value of Work Plan Administration Methodology (cont’d)

8. Project Steps • The following steps have been undertaken in conducting this project: • Meeting with the DHR Compensation Administrator to gain an understanding of the process used and changes made to the plan. • Reading of “background” papers that were relevant to supplement the information gained at the meeting with the Compensation Administrator. • Meeting with a focus group of HR leaders to gain an understanding from a “users” perspective of the changes to the plan. • Meeting with DFM leadership to gain an understanding of their issues with the changes to the plan.

9. Project Steps (cont’d) • Analysis of the methodology and processes used by the Compensation Administrator to develop the new recommended salary ranges for each position. • Preparation of this report.

10. Summary of Findings • The Idaho State Employee Compensation Report and Recommendations dated 12/1/05 set out a plan for changing the way in which the compensation plan would be designed and administered. SB844 and HB1363 took into consideration these recommendations and those of an Interim Committee. • These legislative initiatives directed DHR to “institutionalize” changes to the plan, such as: • Moving the salary ranges closer to market; • Having pay grade assignments based on Hay points and market points; • Having more grades; • Having pay movement delivered through a merit matrix; and • Allowing agencies flexibility in addressing pay issues.

11. Summary of Findings (cont’d) • We commend DHR and the Compensation Administrator for the quality and professionalism of the Idaho State Employee Compensation Report and Recommendations dated 12/1/05. This is a very well prepared and professional document and it is our understanding that this has been recognized by peer States through a recent communications award at the 2006 NASPE conference. • We are pleased to see that the content of the report not only addressed the coming Fiscal Year but also sets out a 5 and 10 year plan.

12. Summary of Findings (cont’d) • On an overall basis, what was designed by DHR is consistent with the legislation that gave it its direction. • The proposed salary structure accomplishes the goal of getting closer to the market, in aggregate. • However, it is the opinion of Hay that the specific methodology utilized is overly complex and difficult to understand, and there are specific issues highlighted in the Analysis Section of this report. • We are concerned that the methodology used could not be replicated by anyone other than the Compensation Administrator. In addition, there is a likelihood that following the same methodology next year may create a different result and grade allocation for a position which has not had any change in job classification or factoring.

13. Summary of Findings (cont’d) • The concept of utilizing external market data has been inappropriately combined with internal equity and job evaluations. This has created significant angst in Agencies where positions that have been factored at the same level for many years and are viewed by the Agency as being at the same level in terms of job content and accountabilities, are now at different pay grades. • The utilization of Hay points and market points puts an extraordinary emphasis on the need for current and accurate Hay points and accurate and credible market data. An overall review of the Hay points has not been conducted for 8 years and Agencies have questioned the validity of the definition of the market. Accordingly, it is the opinion of Hay that the two key components of the determination of what are now referred to as total points may not be accurate.

14. Summary of Findings (cont’d) • The methodology “undervalued” those positions for which there is a genuine market premium (such as Nurses). • There is a perception that while the legislation was intended to create flexibility in the administration of the pay plan, DHR has created tight rules and controls in their interpretation of the legislation. • While the concept of pay delivery through a merit matrix is sound in a pay-for-performance environment, it is the opinion of Hay that a merit matrix should not need to be used for all pay delivery changes. Other criteria can be used for changes such as salary upon promotion, reclassification, equity adjustments, etc.

15. Summary of Findings (cont’d) • In summary, the acceptance of the new plan was hamstrung right from the start due to: • The pay ranges for some jobs went down. When, for many years, the “message” has been “we are behind the market” and then the creation of the new plan causes pay ranges to decrease, that causes a significant perception issue and “noise barrier.” (A noise barrier is “I don’t hear the features that are sound because I cannot get by this one big issue.”) • The faulty assumption that the previous plan did not take into consideration market. Internal equity as measured by Hay points and external competitiveness as measured by the market have not and are not mutually exclusive. The adopted approach, with its use of the term “total points” will mean that the perceived value of job content may change from year to year, even though the job content has not changed.

16. Analysis • In this section, Hay looked at the various steps/components that were part of the development of the plan and analyzed these components. We have then set out the findings of our analysis, together with issues which these findings raise and commentary on these issues.

17. Analysis (cont’d) Definition of the Market

18. Analysis (cont’d) Market Matches

19. Analysis (cont’d) Current Policy to Market Ratio (60/40)

20. Analysis (cont’d) Using “Market Points”

21. Analysis (cont’d) New Grade Structure and Ranges

22. Analysis (cont’d) Merit Matrix / Pay Delivery

23. Analysis The Rules

24. Conclusions and Recommendations • As stated in the Summary of Findings, the new pay plan has achieved its objective of increasing the pay ranges for the majority of positions closer to market. • However, in the opinion of Hay, this has been done in a very complicated way which: • Will be difficult to replicate; • Is not understood by the “user” community; • Has produced results where the pay ranges of positions have gone down when the message has been “we are behind market;” • Has altered the value of what has become known as a “Hay point;” and • Has changed what has been seen as appropriate internal alignments.

25. Conclusions and Recommendations (cont’d) • In addition, while the intent of the legislation was to create flexibility in compensation administration, the users view that: • There are tighter controls than existed before. “Rules have become rules, not tools;” • Due to the fact that they don’t understand how the plan was designed, they have to rely on DHR more than they believe they should; and • Ability to administer the plan to meet their specific needs within their agencies is inhibited through the perceived “control” of the merit matrix.

26. Conclusions and Recommendations (cont’d) • Put simply, in the past: • “We knew what a Hay point was and how it was arrived at.” • “We knew how a position was assigned to a pay grade.” • “We knew our pay grades were behind market.” • “We knew how pay increases were given.” • Now: • “We are not sure of the value of a Hay point.” • “It appears that the assignment to a pay grade may change from year to year even if the job does not change.” • “We are not sure of the credibility of the market data if jobs go down when we know we are behind the market.” • “Why do all pay increases have to go through a centrally approved matrix?”

27. Conclusions and Recommendations (cont’d) • The summary on the previous page indicates, in the opinion of Hay, that the plan now has become complex, is not understood and hence, regardless as to whether it is sound in design or not, lacks credibility in the eyes of the users. • In addition, Hay has a significant concern as to whether the same methodology, if followed next year, will produce a different result. • Common practice is to adjust a salary structure each year and then look at “market premium” positions to address their level of competition. It is not common practice to re-price every job, particularly in an organization the size and complexity of the State of Idaho.

28. Conclusions and Recommendations (cont’d) • In the opinion of Hay, any recommendations must be considered in light of legislative intent as it was legislation that provided the framework within which changes to the compensation plan have been made. Accordingly, we recommend the following: • Meet with the relevant legislators to provide them with a summary of this report and get their feedback as to the extent of the connect or disconnect between their legislative intent and what has occurred (we recommend a concurrent meeting with relevant Executive branch leadership to provide them with a similar summary). It is the opinion of Hay that this will provide a basis for consideration as to whether revised legislation may be needed or changes that may need to be made can be made through rule.

29. Conclusions and Recommendations (cont’d) • Within the context of that feedback, we recommend that the following be reconsidered: • The definition of the external market (to include large in-State public sector employers); • A job factoring quality assurance review of a revised benchmark sample of classifications; • Discontinuation of the mixing of Hay points and market points to create “total points;” • Move the salary structure by an aggregated amount and then consider genuine “market premium” positions, rather than re-price each job each year. • Continue the concept of a merit matrix for pay-for-performance delivery but develop other guidelines for the delivery of pay for actions such as promotion, reclassification, etc.

30. Appendix

31. Appendix (cont’d) • Set out in this Appendix is a summary of the process that was used to develop new policy midpoints. This has been prepared by Hay based on information provided by the DHR Compensation Administrator. • Example 1 shows how the new process of combining Hay points and market points does not recognize the true “market premium” for a position. • Example 2 shows how for positions for which the average market movement was applied, the end result varied by position. • Example 3 shows how the process resulted in positions having a decreased midpoint.

32. DHR Methodology for Creating New Policy Midpoints Steps 1. For each job classification, the following calculations were completed and added together based on the indicated weighting. Structure Adjusted to Market Current Policy Midpoint * 103.6% = 60% weight 95% of Market Market Rate * 95% = 40% weight 2. For each job, the resulting value in step 1 was plotted against Hay points. A smoothed curve was created via the Power function (similar to linear regression). Based on the equation of this curve, a new value was determined for each job. New $ Value = 3. A “market ratio” was calculated in order to determine “market points.” Market Ratio % 95% of Market New $ Value / = Market Points Market Ratio % Hay Points = * 4. Total Points are a weighted average of Hay Points and Market Points. Market Points * 40% Total Points Hay Points * 60% = + 5. Total Points are assigned into a grade structure and the New Policy Midpoint for each job is determined based on the curve formula created in Step 2. = New Policy Midpoint

33. Example 1 Market rate is significantly higher than the previous policy, but the new policy is still not reflective of the market premium.

34. Example 2 For each of the following jobs, the market rate was an average 7.8% higher than the previous policy, however the new policy varies in comparison – it is lower for some and yet higher for others.

35. Example 3 Market rates were lower than the previous policy causing both the new policy value and total points to decrease.