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It’s high time to rethink incentive plan designs

Future of Work|Talent|Total Rewards
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By Susie Al-Ibrahim and Thomas J. Kelly | November 5, 2021

Leverage your plans to effectively reward and retain strong individual performers.

The past two years have seen significant shifts in how employers reward talent, yet little has been done to modify annual incentive plan designs to support retention priorities and reward organizations’ strongest performers. Findings from our 2021 Willis Towers Watson Annual Incentive Plan (AIP) Design Survey reveal why organizations have made the design decisions they have, and what they need to think about moving forward.

Emerging interest in non-financial metrics

While financial metrics will always be at the core of most incentive plans, the instability brought by the pandemic pushed many organizations to reconsider their approach in measuring performance (Figure 1).

A bar graph showing profit measures at 80%, sales/revenue measures at 40%, - Description below

ESG measures at 33%, individual performance (line of sight) at 30%, cash flow measures at 29%, cost measures at 15%, ratio measures at 15%, operational measures at 13%, accounting return measures at 10%, team/department performance (line of sight) at 10%.

Figure 1: Most prevalent performance metrics in annual incentive plans

The 2021 AIP Design Survey reveals that three out of ten participants use Environment, Social and Governance (ESG) metrics, making these the third most prevalent performance metric. Specific ESG measures vary for each industry. For example, Oil and Gas, and Manufacturing industries focus on environmental measures, while customer-oriented industries rely on social measures.

The social aspect of ESG sees the most activity this year, particularly organizational actions to support Diversity, Equity and Inclusion (DEI). Organizations are increasingly looking to leaders to strengthen DEI in workplaces, especially around hiring and promotion.

Paying for individual performance

The pandemic increased the unpredictability of performance outcomes, causing organizations to struggle to effectively pay for individual performance. Despite these challenges, organizations want to use compensation plans to recognize and reward top performers. Most do not have unique bonus programs or design features to do so effectively.

68% of organizations have the same plan, no distinction. - Description below

22% have one similar to executive bonus program, with some differences. 9% have separate and distinct bonus plans for executives and non-executives. 1% of organizations do not have an annual incentive program for employees below the executive level

Figure 2: Most organizations do not have unique bonus plans for executives and non-executives.

This year’s survey included questions around bonus plans for participants below the executive level. The results revealed that 68% of organizations have the same bonus plans for executive and non-executives, 22% have bonus plans for non-executives that are mostly similar to executive plans, 9% have separate and unique bonus plans and 1% have no bonus plans at all for non-executives.

Among organizations that differentiate between executive and non-executive incentive design plans, payout for the non-executive population is largely based on organizational performance. Forty percent of organizations base the payouts primarily on organizational performance results, 27% balance the basis equally between organizational and individual performance and 21% base payouts solely on organizational performance results. Only 10% of organizations use individual performance results as a primary basis and a mere 1% use individual performance only.

40% are primarily based o organizational performance results. - Description below

27% are equally balanced between organizational and individual performance results. 21% are solely based on organizational performance results. 10% are primarily based on individual performance results. Approximately 2% are solely based on individual performance results. Approximately 2% are other.

Figure 3: Companies that differentiate executive and non-executive bonus plans largely base their payouts on organizational performance results.

Bonus programs need to change to address current challenges

Establishing and managing appropriate annual incentive plans can be challenging at any time, but is especially so in today’s pandemic-affected economy. Organizations should consider changing their incentive plan design to address new challenges brought by the pandemic.

When paying for performance, organizations should redefine what performance means to them amidst the type and level of unpredictability that they experience – whether they need to focus on cost containment or cost management, or whether they are experiencing an unplanned growth.

A competitive design could enhance the overall value proposition to support employee attraction and retention. Our 2021 Talent Attraction and Retention Survey found that compared with last year, almost three times as many organizations struggle with employee attraction and retention, and most of them expect this to continue to 2022. In response, many employers are considering using some types of variable pay, including recognition, referral rewards and sign-on bonuses. Companies may also want to consider modifying their annual incentive plans to place more emphasis on individual performance measures that will help them reward and retain their strongest performing employees.

Preparing for the 2022 annual incentive plan design

Our 2021 Annual Incentive Plan Design Survey provides access to essential data such as plan funding, award payout calculations, performance expectations criteria and historical payout levels, international plan adjustments and more. As businesses prepare for economic uncertainties that may persist into 2022, they need relevant and reliable information to help evaluate the effectiveness and relevance of their incentive program for next year’s plan.

Authors

Associate Director - Data Services

Senior Director, Executive Compensation

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