WTW has observed growing interest among insurance industry clients in using some element of discretion to adjust the funding scores of short-term incentives (STI) and long-term incentive (LTI) plans. Accordingly, we conducted a pulse survey of our industry clients, reflecting both Life & Annuity (L&A) and Property & Casualty (P&C) insurers, addressing practices over the past 5 years. This survey, with input from 46 insurers across North America, provides multiple lenses on the use of discretionary adjustments in scoring these incentive plans, including prevalence, the methods, impact on scoring and structure, if any. The survey also collected the specific issues insurers sought to address through these adjustments.
Findings: Prevalence
- STI: Over 60% of participants used discretion at least once in the past 5 years, and roughly half of those applied discretion in multiple years.
- Slightly higher observed for L&A vs P&C, and for public vs. non-public
- LTI: Over a third of participants (38%) used discretion at least once in the past 5 years, and several applied discretion in multiple years; slightly more prevalence for P&C vs. L&A.
- Slightly higher observed for P&C vs. L&A, and for non-public vs. public
Observations
- This seems to represent a shift toward use of discretion, particularly in LTI, reflective of difficulty in the goal-setting process, and the unique nature of the industry where future cost is uncertain at the time of sale.
- It appears for both STI and LTI, process that allows for use of discretion is a meaningful design feature for most companies.
- The increased use might be related to increased volatility of the past few years, which has included the pandemic and other disruptions.
- This might account for the surprising finding of more prevalence for use of discretion on STI by public insurers, whose actions on incentives of course have public disclosure and say on pay implications (less prevalence for public insurers discretion in scoring LTI was not surprising).
- We also found that aside from applying discretion, about half of participants report qualitative elements built into the STI metrics; there is much less prevalence (13%) for qualitative elements in LTI metric selection.
Findings: Impact on scoring
We collected aggregate information on magnitude of upward and downward discretionary adjustments across both STI and LTI – the median upward adjustment was 25%, and the median downward adjustment was 10%.
Observations
- The timeframe surveyed from 2019-2023 reflects challenging external environments, so it is not surprising that greater impact was made in upward adjustments.
- The findings also indicate some balance of upward and downward adjustments; in practice, even in a difficult environment, adjustments were not all used to move scores higher.
Findings: Not just pandemic-driven
- More than half of respondents who made discretionary adjustments indicated factors considered were not just pandemic-related.
- P&C slightly more driven by pandemic-related factors than L&A
- Non-public companies were much more likely to indicate adjustments were made because of pandemic-related factors than public companies.
Observations
- The prevalence of discretionary adjustments is not limited to the pandemic and the practice can be expected to continue post-pandemic.
- Disclosure requirements might drive public companies to a broader set of factors to be considered for adjustments.
Findings: Wide range of factors and processes
- A broad variety of factors driving adjustments were cited by participants, with none predominating – “quality of results” was most prevalent, noted by 21% of responses.
- Most factors cited overlapped between L&A and P&C, with some notable exceptions; e.g., tax changes were mostly noted by L&A participants, and catastrophic (CAT) losses only by P&C responses.
- There were few clear principles and formal process steps noted for deliberating the application of discretionary adjustments for companies to exercise discretion.
- Board-level oversight of the application of discretion is most common.
Observations
- Discretion is a common feature of most programs given the frequency of adjustments in practice, but most companies appear to take an ad hoc approach to the process and framework.
- Discretionary incentive funding adjustments are considered significant enough to have board-level oversight, and companies will need to take the opportunity to better formalize and govern the process, if it is likely to be repeated at some point.
Findings: P&C insurers adjustments for CAT losses
For the P&C segment, which had 23 participants, we addressed how CAT losses are treated for annual incentive plan metric and scoring purposes.
- A minority – 43% - reported fully including CAT losses; the majority take some action to normalize, including collaring or fully excluding, case by case, and other approaches.
- Even within the minority 43%, more than one also has qualitative metrics included in the plan that could allow for adjustments in a year when CAT losses significantly suppress incentive scores.
Observations
- Most P&C insurers have some mechanism to normalize outcomes for CAT losses that have an outsized impact on scoring.
- The rationale is often that annual incentive plans include a broad segment of employees, who often make their greatest impact e.g., customer service or fraud prevention, when CAT losses are high.
- While not the focus of this survey, in our experience, normalization of CAT losses in LTI, where participation is more selective, is much less prevalent, consistent with a rationale that the most senior executives should have alignment with ownership or policyholders, including CAT loss impact.
Opportunity to better structure the use of discretion
The application of discretion to incentive scoring for the insurance industry has significant prevalence and appears to be mostly performed on an ad-hoc basis. These actions also typically require board-level discussion and approval. Accordingly, we would expect to see more focus on a repeatable, balanced process and framework for these assessments. We are seeing some emerging practices that can be considered in achieving the objective of fair and appropriate scoring and oversight of incentive programs, which can include defining process and factors to be considered in advance.
