Current ABI Guidelines
In recent years the ABI has updated its guidelines on executive remuneration each year in December. This year the ABI has decided not to make any changes to the Guidelines published in December 2007. Instead Peter Montagnon has sent a letter to the Chairmen of Remuneration Committees setting out how the ABI and its members are applying the Guidelines in these volatile times.
The key message is a request to give shareholders adequate notice of proposed changes to remuneration packages and share incentive arrangements, and to undertake the consultation process with a willingness to listen to and respond to the views of shareholders.
An extract from the ABI letter of 19 September 2008 is set out below:
EXTRACT FROM LETTER FROM ABI – Association of British Insurers, 51 Gresham Street, London, EC2V 7HQ. Tel: 020 7600 3333 Fax: 020 7696 8999
Direct Tel. 020 7216 7670
E-mail peter.montagnon@abi.org.uk
Direct Fax. 020 7696 8979
Chairman of the Remuneration Committee
19 September 2008
Dear Remuneration Committee Chairman
Executive Remuneration – ABI Guidelines on Policies and Practices
I am writing to advise you in good time that the ABI has decided not to make any changes this year to the Guidelines published in December 2007. This reflects our view that the Guidelines remain relevant at this time. We would encourage Remuneration Committees to satisfy themselves that the Principles of the Guidelines are fully reflected in the remuneration policies and practices of companies.
In addition, we would like to use this opportunity to draw attention to the following points, which we consider to be pertinent in the current economic climate.
- The remuneration policy should be fully explained and justified, particularly when changes are proposed. Members will carefully scrutinise remuneration uplifts, particularly increases in salaries or annual bonus levels.
- Where a company has underperformed and seen a significant fall in its share price, this should be taken into account when determining the level of awards under share incentive schemes. In such circumstances, it is not appropriate for executives to receive awards of such a size that they are perceived as rewards for failure.
- Shareholders are generally not in favour of additional remuneration being paid in relation to succession or retention, particularly where no performance conditions are attached.
- In the context of the consultation process for share incentive schemes, Remuneration Committees should ensure that shareholders have adequate time to consider the proposal and that their views are carefully considered. Relevant information related to the consultation should be clearly and fully disclosed.
The ABI and its members are always available to discuss issues relating to executive remuneration and the Guidelines since we strongly believe that good communication between companies and their shareholders is an essential part of the corporate governance process.
For your reference enclosed is a copy of the Guidelines, they are also available on our IVIS website (www.ivis.co.uk) together with the ABI/NAPF Joint Statement on Executive Contracts and Severance.
Yours sincerely
Peter Montagnon
Director of Investment Affairs
This year's launch of the ABI guidelines is earlier than in previous years - but there have only been a few minor amendments. The main changes in each of the three sections of the guidelines are set out below.
Section I REMUNERATION COMMITTEES AND THEIR RESPONSIBILITIES
Consideration of the ABI guidelines on responsible investment disclosure published on 1 February 2007 is now added to the second main provision. A copy of this is available at http://www.abi.org.uk/Members/circulars/viewAttachment.asp?EID=15636&DID=14121.
The fourth main provision has had its wording altered somewhat. There is no longer a reference to legal redress -- the full wording is as follows: "Where performance achievements are subsequently found to be significantly mis-stated so that bonuses and other incentives should not have been paid, effective avenues of redress should be considered."
Section II GUIDANCE FOR BASE PAY, BONUSES, PENSIONS AND CONTRACTS AND SEVERANCE
There is a new provision 2.2 dealing with payments in lieu of pension scheme participation. The wording is sensible and is as follows "Payments in lieu of pension scheme participation should be clearly disclosed and treated as a separate non-salary benefit. Accordingly, they should be excluded from the calculation of bonus entitlements and share scheme grants.”
In addition there are minor changes so that only where changes to pension benefit entitlements or transfers are of a discretionary nature is it necessary to provide justification.
Section III GUIDANCE FOR SHARE-BASED INCENTIVE SCHEMES
There is a new guidance paragraph 4.9 which reads as follows: "The calculation of starting and finishing values for TSR should be made by reference to average share prices over a short period of time at the beginning and end of the performance period. Lengthy averaging periods should be avoided." We expect that a one-month to three-month period will be acceptable.
The Guidelines were sent by the ABI to the Chairs of the Remuneration Committees of the FTSE 350 companies. The text of the letter enclosing the guidelines was as follows:
Copy of Letter dated 3 December 2007 sent to Remuneration Committee Chairmen of FTSE 350 companies
Dear Remuneration Committee Chairman
I am writing to enclose a copy of our newly revised Guidelines on Executive Remuneration which are intended to provide useful guidance for all companies on market best practice.
We have been grateful for the attention you have paid to our Guidelines in the past, and would like to take this opportunity to highlight some specific points of current interest.
As in previous years, quantum remains a key issue and Remuneration Committees should provide a clear explanation and justification of year-on-year changes. Our members acknowledge the need to set remuneration at levels that retain and motivate executives. However, they expect companies to follow the principle established in the Combined Code “of not paying more than is necessary”. It is therefore important for Remuneration Committees to consider each element of pay in light of the total package and to explain to shareholders any changes and their consequences for the total package.
There have been a number of other issues arising from this year’s reporting round that have concerned members, including one-off or exceptional grants. Although these issues have not caused any specific changes to the Guidelines, members wanted me to draw your attention to these where they relate to share incentive schemes.
- Performance conditions. Members expect performance to be measured either as a single primary measure or as a combination of measures which contribute to the creation of shareholder value. Where two or more performance measures are used, consideration should be given to making them inter-dependent i.e. integrated in a matrix rather than evaluating them independently. This will strengthen the alignment of vesting with improvements in the overall financial performance of the company.
- Vesting schedules for long-term incentive schemes. Remuneration Committees should:
- take account of the proportion of remuneration that is fixed when setting the vesting schedule;
- ensure that the performance threshold equates to a level of attainment that exceeds, or at least matches, the market’s expectations;
- consider using wider performance targets such as upper decile in the case of TSR performance;
- recognise the value of performance shares at initial vesting should not be significant in relation to base salary.
Finally, it is helpful for shareholders if there is disclosure in the Remuneration Report of the overall share usage for remuneration purposes, actual and potential, with an indication whether this is dilutive or has been sourced from market purchase shares.
We trust your Committee will find our Guidelines and this letter helpful and informative.
Yours sincerely
Keith Skeoch
Chairman, Investment Committee
The text of the Guidelines is as follows:
EXECUTIVE REMUNERATION – ABI GUIDELINES ON POLICIES AND PRACTICES
______________________________________________________________
3 December 2007
Foreword
There have only been a few minor amendments to the Guidelines, following this year’s review.
The Guidelines are designed in a format with over-arching Principles, Main Provisions and more detailed Guidance. They are predominantly for companies with a main market listing but are useful for companies on other public markets and for other entities too. All companies are encouraged to observe the Guidelines in the spirit of best practice.
The ABI and its members are always available to discuss any cases relating to executive remuneration and also where there may be doubt as to how these Guidelines should be applied.
The Guidelines together with the ABI/NAPF Joint Statement on Executive Contracts and Severance can be found on the IVIS website: www.ivis.co.uk.
Keith Skeoch
Chairman, Investment Committee
Contents
Section I – Remuneration Committees and their responsibilities Page 5
Section II – Guidance for Base Pay, Bonuses, Pensions and
Contracts and Severance Page 6
Section III – Guidance for Share-Based Incentive Schemes Page 10
PRINCIPLES
Boards are responsible for adopting remuneration policies and practices that promote the success of companies in creating value for shareholders over the longer term. The policies and practices should be demonstrably aligned with the corporate objectives and business strategy and reviewed regularly.
Remuneration Committees should be established in accordance with the provisions of the Combined Code. They should comprise independent directors who bring thought and scrutiny to all aspects of remuneration. It is important to maintain a constructive and timely dialogue between boards and shareholders regarding remuneration policies and practices.
Executive remuneration should be set at levels that retain and motivate, based on selection and interpretation of appropriate benchmarks which should be used with caution, in view of the risk of an upward ratchet of remuneration levels with no corresponding improvement in performance.
Executive remuneration should be linked to individual and corporate performance through graduated targets, that align the interests of executives with those of shareholders. The resulting arrangements should be clear and readily understandable.
Shareholders will not support arrangements which entitle executives to reward when this is not justified by performance. Remuneration Committees should ensure that service contracts contain provisions that are consistent with this principle.
REMUNERATION COMMITTEES AND THEIR RESPONSIBILITIES
Main Provisions
Remuneration Committees are responsible for ensuring that the mix of incentives reflects the company’s needs, establishes an appropriate balance between fixed and variable remuneration, and is based on targets that are stretching, verifiable and relevant. They should satisfy themselves as to the accuracy of recorded performance measures that govern vesting of variable and share-based remuneration.
They should establish effective procedures for disclosure and communication of strategic objectives, which enable shareholders to take an informed and considered view of remuneration policy and its implementation. Where appropriate, account should be taken of the ABI Guidelines on Responsible Investment Disclosure.
They should ensure that remuneration levels properly reflect the contribution of executives and be rigorous in selecting an appropriate comparator group. They should guard against unjustified windfalls and inappropriate gains arising from the operation of share incentive schemes and other associated incentives.
Where performance achievements are subsequently found to have been significantly mis-stated so that bonuses and other incentives should not have been paid, effective avenues of redress should be considered.
Remuneration Committees should also pay particular attention to arrangements for senior executives who are not board members but have a significant influence over the company’s ability to meet its strategic objectives.
Section II
GUIDANCE FOR BASE PAY, BONUSES, PENSIONS AND CONTRACTS AND SEVERANCE
1. BASE PAY AND BONUSES
Main Provisions
Remuneration Committees should ensure that base pay reflects the contribution of the executives concerned and be robust in setting and monitoring targets for bonuses. They should ensure that bonuses reflect actual achievements against these targets.
Any material payments that may be viewed as being ex-gratia in nature should be fully explained, justified and subject to shareholder approval prior to payment. Shareholders are not supportive of transaction bonuses that reward directors and other executives for effecting transactions irrespective of their future financial consequences.
Remuneration Committees should scrutinise all other benefits, including benefits in kind and other financial arrangements to ensure they are justified, appropriately valued and suitably disclosed.
Guidance
Base Pay
1.1 Remuneration Committees should ensure their policy on base pay is fully communicated to shareholders. Where a company seeks to pay salaries at median or above, justification is required.
Bonuses
1.2 Annual bonuses should be demonstrably related to performance. Both individual and corporate performance targets are relevant and should be tailored to the requirements of the business and reviewed regularly to ensure they remain appropriate.
1.3 Any share matching arrangements should be treated in accordance with relevant provisions under the Guidance for Share-Based Incentive Schemes. (see Paragraph 4.6)
1.4 Where consideration of commercial confidentiality may prevent a fuller disclosure of specific short-term targets at the start of the performance period, shareholders expect to be informed of the main performance parameters, both corporate and personal, for the financial year being reported on.
1.5 Following payment of the bonus, shareholders will expect to see a full analysis in the Remuneration Report of the extent to which the relevant targets were actually met.
1.6 Maximum participation levels should be disclosed and any increases in the maximum from one year to the next should be explicitly justified. Shareholders will expect increases to be subject to correspondingly more stretching performance.
1.7 Annual bonuses should not be pensionable.
1.8 Remuneration Committees should retain discretion to reduce or reclaim payments if the performance achievements are subsequently found to have been significantly mis-stated. Where there is doubt Remuneration Committees should work with the Audit Committee to ensure the basis of their decision is correct.
2. PENSIONS
Main Provisions
Remuneration Committees should recognise the impact that pension arrangements can have on the mix between fixed and variable pay. In setting an appropriate balance, they should bear in mind that pension entitlements may represent a significant and potentially costly item of remuneration that is not directly linked to performance.
Guidance
2.1 Shareholders expect there to be full disclosure of the extent to which actual and potential liabilities, such as pension promises or early retirements, are funded together with any aggregate outstanding unfunded liabilities.
2.2 Payments in lieu of pension scheme participation should be clearly disclosed and treated as a separate non-salary benefit. Accordingly, they should be excluded from the calculation of bonus entitlements and share scheme grants.
2.3 There should be informative disclosure identifying incremental value accruing to pension scheme participation and any other superannuation arrangements. Pensions paid on early retirement should be subject to abatement.
2.4 Changes in pension benefit entitlements or to transfer values reflecting significant changes in actuarial and other relevant assumptions should be fully identified and explained. Where changes to pension benefit entitlements or transfers are of a discretionary nature, these should be made clear and justification provided.
2.5 Companies should recognise the risks of changes to future mortality rates and investment returns and consider how to limit the potential liability created by pension commitments.
2.6 Companies should not compensate individuals for changes in personal tax liabilities arising from changes to pensions taxation. Companies may wish to consider whether there may be ways of delivering remuneration that are more cost-effective than a pension fund and more aligned with shareholder value creation.
3. CONTRACTS AND SEVERANCE
Main Provisions
Remuneration Committees should ensure that contracts protect the company from being exposed to the risk of payment in the event of failure.
The treatment of bonuses should be clear and a contractual link established between variable pay and performance. In the event of early termination there should be no automatic entitlement to bonuses or share-based payments.
Guidance
3.1 Remuneration Committees should ensure that the policy and objectives on directors’ contracts are clearly stated in the Remuneration Report.
3.2 When drawing up contracts, Remuneration Committees should calculate the likely cost of any severance and determine whether this is acceptable. All payments made should be based upon performance in relation to objectives and take account of the overall financial circumstances of the company.
3.3 Companies should justify their policies on contractual protection. Contracts should commit companies not to pay for failure.
3.4 Phased payments are generally appropriate for fulfilling compensation on early termination.
3.5 Shareholders are less supportive of the liquidated damages approach which involves agreement at the outset on the amount that will be paid in the event of severance.
3.6 Remuneration Committees should ensure that full benefit of mitigation is obtained. This includes the legal obligation on the part of the outgoing director to mitigate the loss incurred through severance by seeking other employment and reducing the need for compensation.
3.7 Contracts should make clear that if a director is dismissed as a result of a disciplinary procedure, a shorter notice period than that given in the contract would apply.
3.8 Contracts should not provide additional protection in the form of compensation for severance as a result of change of control.
3.9 Pension entitlement on severance can represent a large element of cost to shareholders. Remuneration Committees should identify, review and disclose in their report any arrangements that guarantee pensions with limited or no abatement on severance or early retirement. These would not be regarded as acceptable if included in new contracts. Remuneration Committees should demonstrate that the route taken on severance represents the lowest overall cost to the company.
Section III
GUIDANCE FOR SHARE-BASED INCENTIVE SCHEMES
Main Provisions
Share-based incentives should align the interests of executive directors with that of shareholders and link reward to performance over the longer term. Vesting should therefore be based on performance conditions measured over a period appropriate to the strategic objectives of the company. This will not be less than, and may exceed, three years.
All new share-based incentives or any substantive changes to existing schemes should be subject to prior approval by shareholders by means of a separate and binding resolution. Their operation, rationale and cost should be fully explained so that shareholders can make an informed judgment.
The operation of share incentive schemes should not lead to dilution in excess of the limits acceptable to shareholders.
Executive share options should not be granted at a discount to the prevailing market price.
It is desirable to align the interests of chairmen and independent directors with those of shareholders, for example through payment in shares bought at market prices. However, shareholders consider it inappropriate for chairmen and independent directors to receive incentive awards geared to the share price or corporate performance that would impair their ability to provide impartial oversight and advice.
Shareholders encourage companies to require executive directors and senior executives to build up meaningful shareholdings in the companies for which they work.
Guidance
1. SCOPE
1.1 This Guidance applies to all share-based schemes whether option-based or involving conditional awards of shares, and including any arrangements whereby the value of an option gain will be paid either in the form of cash or shares (cash or share-settled share appreciation rights respectively).
2. REVIEW AND DISCLOSURE
2.1 Remuneration Committees should:
§ regularly review share incentive schemes to ensure their continued effectiveness, compliance with the current Guidance and contribution to shareholder value;
§ provide a statement in the Remuneration Report as to whether a review of the current share incentive schemes has been undertaken both as regards their operation, including how discretion has been exercised, and whether grant levels, performance criteria and vesting schedules which have been previously approved by shareholders remain appropriate to the company’s current circumstances and prospects; and
§ obtain prior shareholder authorisation for any substantive or exceptional amendments to scheme rules and practice, including changes to limits and changes which make it easier to achieve performance targets, and where significant exercise of discretion is proposed by the Remuneration Committee.
2.2 Scheme and individual participation limits must be fully disclosed in share incentive schemes. Disclosure should, inter alia, cover performance conditions and related costs and dilution limits as set out in the relevant sections below. The reasons for selecting the performance conditions and target levels, together with the overall policy for granting conditional share or option awards, should be fully explained to shareholders.
3. GRANT POLICY
Phasing of Awards and Grants
3.1 The regular phasing of share incentive awards and option grants, generally on an annual basis, is strongly encouraged because:
§ it reduces the risk of unanticipated outcomes that arise out of share price volatility and cyclical factors;
§ it eliminates the perceived problem that a limit on subsisting options encourages early exercise;
§ it allows the adoption of a single performance measurement period; and
§ it lessens the possible incidence of ‘underwater’ options, where the share price falls below the exercise price.
The phased vesting of awards in specific tranches following the minimum three year performance measurement period is not an alternative to phased grants. However, it can help to enhance the linking of vesting of awards to sustained performance and maintain incentivisation.
4. PERFORMANCE
4.1 The desired alignment of interests is best achieved through the vesting of awards under share incentive schemes being conditional on satisfaction of performance conditions. Performance measures should be fully explained and be clearly linked to the achievement of challenging and stretching financial performance which will lead to enhancement of shareholder value.
Remuneration Committees should satisfy themselves that vesting of awards accord with these objectives.
4.2 Challenging performance conditions should:
§ relate to overall corporate performance;
§ demonstrate the achievement of a level of financial performance which is demanding and stretching in the context of the prospects for the company and the prevailing economic environment in which it operates;
§ be measured relative to an appropriate defined peer group or other relevant benchmark; and
§ be disclosed and transparent.
4.3 Threshold vesting amounts should not be significant by comparison to annual base salary. Furthermore, award structures with a marked ‘cliff-edge’ vesting profile are considered inappropriate, particularly where there may be clustering of performance outcomes around the average.
4.4 The vesting of awards with high potential value should be linked to commensurately higher levels of performance. Full vesting should be dependent upon achievement of significantly greater value creation than that applicable to threshold vesting. Companies should explain clearly how this is achieved, especially when annual grants of options in excess of one times salary, or equivalent long term share incentive awards, are made.
4.5 Sliding scales are a useful way of ensuring that performance conditions are genuinely stretching. They generally provide a better motivator for improving corporate performance than a ‘single hurdle’.
4.6 Awards of matching shares arising from annual bonuses payable in the form of shares where these are held for a qualifying period, should be subject to the satisfaction of performance criteria prior to the vesting of the matching element. (see Paragraph 1.3 – Guidance for Base Pay, Bonuses, Pensions and Contracts and Severance)
4.7 Comparator groups used for performance purposes should be both relevant and representative. Where only a small number of companies are used for a comparator group, Remuneration Committees should satisfy themselves that the comparative performance will not result in arbitrary outcomes which are inconsistent with this Guidance. Awards should not vest for less than median performance.
Performance Criteria
4.8 Total Shareholder Return (TSR) relative to a relevant index or peer group is one of a number of generally acceptable performance criteria. However, Remuneration Committees should satisfy themselves prior to vesting that the recorded TSR or other criterion is a genuine reflection of the company’s underlying financial performance, and explain their reasoning.
4.9 The calculation of starting and finishing values for TSR should be made by reference to average share prices over a short period of time at the beginning and end of the performance period. Lengthy averaging periods should be avoided.
4.10 Where TSR is used as a performance criterion and the chosen comparator group includes companies listed in overseas markets, it is essential that TSR be measured on a consistent basis. The standard approach should be for a common currency to be used. Where there are compelling grounds for the calculation to be based on local currency TSR of comparator group companies, then the reasons for choosing this approach should be fully explained.
4.11 The definition of Earnings Per Share (EPS) or any other financial measure should fully reflect the performance of the business on a consistent basis in respect of the measurement period.
4.12 Shareholders need to have sufficient data to judge the appropriate size of the award for any given performance level. They also expect a maximum level of grant to be disclosed.
4.13 The setting of a premium exercise price is not of itself a substitute for the adoption of relative performance conditions in accordance with this Guidance.
Retesting
4.14 It is recognised that any retesting of performance conditions for all share-based incentive schemes is unnecessary and unjustified.
5. COST AND BASIS OF PARTICIPATION
Cost
5.1 The primary information that should be disclosed includes:
§ The potential value of awards (see Appendix) due to individual scheme participants on full vesting. This should be expressed by reference to the face value of shares or shares under option at point of grant, and expressed as a multiple of base salary.
§ The maximum dilution which may arise through the issue of shares to satisfy entitlements.
5.2 Shareholders also wish to understand the Expected Value (see Appendix) of incentive awards at the outset, bearing in mind the probability of achieving the stipulated performance criteria. Where changes to award levels or structures are being proposed, shareholders wish to have disclosed what changes in Expected Value will result and the reasons why the Remuneration Committee considers this justified.
5.3 There should be prudent and appropriate arrangements that are fully disclosed, governing the acquisition of shares, and financing thereof, to meet contingent obligations under share-based incentive schemes.
5.4 The use of phased grants of share options and restricted shares, and utilisation of both new and purchased shares to satisfy the vesting of awards, requires a comprehensive approach to valuation. Assessment should focus on expected value, which should be disclosed, and it should take account of the performance vesting schedule which is adopted as well as the existence of any ‘retesting’ and ‘replacement option’ facilities such as have been prevalent under traditional schemes. Shareholders are helped in this task by disclosure of face value of any share award or option grant as well as of expected value.
Vesting of Awards
5.5 Remuneration Committees should consider the use of performance measurement periods of more than 3 years and deferred vesting schedules, in order to motivate the achievement of sustained improvements in financial performance.
5.6 Where LTIP awards are made over whole shares, a better alignment of interest with shareholders will be achieved if, in respect of those shares that do vest, equivalent value to that which has accrued to shareholders by way of dividends during the period from date of grant also vests in the hands of LTIP recipients. To the extent that the shares conditionally awarded do not vest then nor should any scrip or cash amounts representing the rolled-up dividends.
5.7 Remuneration Committees should ensure that the size of grants made on this basis takes into account reasonable expectations as to the value of the dividend stream on the company’s shares over the period to vesting. Where the facility for rolled-up dividends is introduced a smaller initial grant size is required in order to target a similar level of value in the conditional share award.
Performance on Grant
5.8 Shareholders expect that future performance should govern the vesting of options or share awards. Performancing at point of grant is generally not considered a suitable alternative.
Change of Control Provisions
5.9 Scheme rules should state that there will be no automatic waiving of performance conditions either in the event of a change of control or where subsisting options and awards are ‘rolled over’ in the event of a capital reconstruction, and/or the early termination of the participant’s employment. Remuneration Committees should use best endeavours to provide meaningful disclosure that quantifies the aggregate payments arising on a change of control.
5.10 In the event of a change of control, the key determinant of the level of awards vesting should be underlying financial performance. Also, any such early vesting as a consequence of a change of control should be on a time pro-rata basis i.e. taking into account the vesting period that has elapsed at the time of change of control. Remuneration Committees should satisfy themselves that the measured performance provides genuine evidence of underlying financial achievement over any shorter time period. They should explain their reasoning in the Remuneration Report or other relevant documentation sent to shareholders.
Participation
5.11 Participation in share incentive schemes should be restricted to bona-fide employees and executive directors, and be subject to appropriate limits for individual participation which should be disclosed.
5.12 There should be no absolute right of participation in share incentive schemes. Grant policy should be disclosed and consistently applied and, within the limits approved by shareholders, reflect changing commercial and competitive conditions. In the event of declining share price levels it is particularly important to avoid unjustified increases in the actual number of shares or options awarded.
5.13 Participation in more than one share incentive scheme must form part of a well-considered remuneration policy, and should not be part of a multiple arrangement designed to raise the prospects of payout.
6. PRICING AND TIMING
Pricing of Options and Shares
6.1 The price at which shares are issued under a scheme should not be less than the mid-market price (or similar formula) immediately preceding grant of the shares under the scheme.
6.2 Options granted under executive (discretionary) schemes should not be granted at a discount to the prevailing mid-market price. | 
