Challenges, Issues and Operational Impact

In October, 2007, when the first of the baby boomers walked into a Social Security office and applied for those benefits, one era passed and another began. In keeping with what they’ve been doing since birth, this generation is becoming the catalyst for yet another series of profound changes in the marketplace, the workplace, and arguably the world in general.

Over the past two years, Ernst & Young has surveyed a number of Fortune 1000 companies and talked with many C-suite and Human Resource (HR) executives to track what changes may be occurring as the baby boom generation nears retirement. With 43% of the workplace eligible to retire between 2004 and 2012, we wanted to see whether planning activities were being anticipated or implemented. How were companies preparing for the upcoming wisdom withdrawal? What changes were they making in their compensation packages or benefits? Where did they think they would lose the most talent and what were they doing about replacements? Did they have strategic plans or were they reacting to one-off occurrences? Had the fact and scope of potential “wholesale retirement” registered with them at all?

We’ve continued to track the impact of the baby boomers—from a high-level perspective in our 2006 survey to a more focused look at the operational impact in 2007—sharing our knowledge via a series of whitepapers, articles and a recent web cast, held October 24, 2007. While we haven’t seen a groundswell of actions and programs, we have seen a significant increased awareness of this impending business risk and its impact on the organization. In 2006, just under 40% of our survey respondents said that retaining key employees and maintaining intellectual capital was their number one concern. By 2007, nearly 70% had such human capital issues at the top of their lists. Whether they called it the talent gap, brain drain or wisdom withdrawal, just over three in ten said that was their concern in 2006; seven out of ten did in 2007.

Despite being more focused on what’s happening with their aging workforce, however, companies still seem to be operating from a more reactive point of view. We’ve found very little affirmative strategic planning to address the mounting issues and meet the challenges that are arising with growing frequency.

That said, the impact of the aging workforce is beginning to be recognized as a critical business risk, not just an HR concern, with strategic, financial, compliance, and operational ramifications. It’s a complex set of issues requiring long-term solutions and a broad level of accountability from boards of directors, C-suite leaders, and HR executives. Each company will want to look at its own “retirement population profile” in a holistic manner—understanding employee demographics, their interests and needs, the overall HR strategy and how it aligns with the business strategy—and factoring them all in to determine their implications for the organization’s financial statements. No quick fix. Not a passing trend.

The Ernst & Young 2007 survey and its comparison to the 2006 survey responses resulted in key findings that provide insight into the corporate landscape and how the aging workforce is changing it. These findings fall into the general categories of talent and succession planning, retirement, health care, executive compensation, and HR risk and compliance.

This is the issue that may be considered the most strategic, as it deals with how organizations today recruit, retain and develop talent for the future. More than 40% of the survey respondents said they have a high turnover in key positions. Middle level retention was the concern for 41% of respondents, while 75% of those with succession plans said they focus on the senior management level. Since 52% said they go outside their organizations to hire for key positions, it’s clear that companies will feel the impact of increasing costs in training and development, as well as in health care and retirement. With retention such a critical issue, it’s important for companies to start focusing on programs for retaining and developing middle management to promote strategic growth.

Organizations that do a good job of succession planning and talent development will be ahead of the graying curve and on the way to higher retention rates, higher productivity and higher employee satisfaction, creating significant future financial and non-financial returns.

As employers are paying more attention to the literal transfer of business wisdom from their baby boomers to the next generation, one of the practices having significant success is mentoring. In the past, the role of the mentor has been a relatively informal one. With this newly defined need, however, companies are formalizing the practice. Older workers are formally assigned to younger workers who have potential in a specific area of expertise, with the goal of developing these individuals along career paths that make sense and leveraging the mentoring relationship to transfer business wisdom, which goes beyond know-how to know-why.

Indeed, some employers are tasking their older employees with such specific mentoring and wisdom transfer goals that these are becoming part of their performance review criteria. Others are implementing job sharing,where a junior person shares a job with someone senior and more experienced and knowledge transfer becomes a measurable part of this arrangement. Yet another approach is actually to bring retirees back to the organization in a consultancy role. This allows an individual to retire when he or she chooses, yet extends the time for transferring knowledge and wisdom to other staff. Whether a company takes a more or less aggressive approach, de facto informal arrangements are no longer enough and some formal knowledge management/knowledge transfer plans may represent the only way a company can capture wisdom and keep it in the organization.

Retirement today is often a protracted process rather than a single momentous event. What’s more, people are working longer. Some employees retire, take their pension and then return to work elsewhere. Some are looking for a bridge from fulltime employment to something less than fulltime.

Employers are shifting more retirement responsibility (from financial planning to health care programs) onto their employees; they do not appear to have developed an accurate assessment of employee interests or to have implemented programs for win-win transitions. Phased retirement is one example of an available, yet underused, option for retaining talent and managing the wisdom withdrawal, from both cost and resource perspectives. Nearly 90% of organizations do not allow phased retirement and fewer than 30% are considering it.

Our survey also looked at issues relating to regulatory and legislative changes, but it wasn’t clear if employers have assessed how these changes could affect an aging workforce. More than half (60%) of those surveyed said their C-suite executives and boards of directors were concerned with the Pension Protection Act of 2006 or with FAS 158, the Financial Accounting Standards Board statement on employers’ accounting for defined benefit pension and other postretirement plans. About 20% were not concerned at all.

Wherever their focus lies now, employers need to assess what their employee population may need to look like in the future. Only then will they be able to determine what their needs and issues are when it comes to retirement programs. Although programs like phased retirement may be challenging to implement, they do provide options and flexibility that allow employers to hold on to their key talent. In addition, more dialogue between C-suite and HR executives is necessary so that organizations can better address these issues.

Survey respondents ranked health care as the top program influencing a person’s decision to stay or retire. Even so, less than half said they had changed their benefits programs to respond to the financial needs of an aging workforce. Most of those said the action they’d taken was to increase employee and/or retiree cost-sharing in the medical plans. These responses are another indication that the majority of employers have little or no clear strategy. Although they have a strong idea of what influences employee’s to stay, they haven’t leveraged this information to drive decisions about their health care programs.

Employers without a retiree medical program may find that employees are staying longer than they normally would—a dilemma we call “health care handcuffs.” Ironically, this may be a welcome result if the employer doesn’t want to lose key talent to retirement, even if the decision to eliminate or not offer retiree medical benefits was most likely a cost-based one rather than a tactic for talent retention. This raises the question whether the lack of a retiree medical plan is keeping the right talent; those with the financial means to afford their own medical benefits after retirement may leave regardless of whether there’s an employee-responsive medical plan for retirees. Bluntly put, employers may find themselves in a situation where, rather than retaining the talent necessary to survive the brain drain, they’re simply keeping retirees on the active payroll. Alternatively, employees with an extensive retirement medical plan may find that they’re no longer handcuffed and retire at will.

Therefore, whether or not they have a retiree medical program, extensive or not, it’s imperative for employers to develop a long-term strategy to address the issue that 68% of respondents called top of mind—retaining key talent and intellectual capital.

All of this suggests that the demographic make-up of the workforce will significantly change over the next few years, prompting variances in health care costs. This may stem from the geographical dispersion of employees and retirees covered under a medical plan (active employees moving from cold weather climates to warmer geographies when they retire) or general changes in the demographic make-up of those currently covered under the health plans. Variances in health care costs can be directly influenced by geographical and demographical changes.

Health care costs are rising—at a fairly consistent rate of 7-10% and across the spectrum of employers. As suggested, though, the results of Dartmouth’s renowned studies over the years have shown significant variances based on where one lives. For example, lumbar fusions are performed 4.6 times more often for residents of Idaho Falls than for those of Bangor, Maine. In other words, claims change based on where a workforce resides.

There are also differences in cost of utilization when we look at other demographics of particular employee populations. For example, the health care costs for a 64-year old can be two to three times that of a 40-year old, and the cost for a retired individual can be more than that for a person of similar age who is active. Whether this disparity is due to the individual’s decision to retire because of health reasons or because the retired person has more time to address health care issues is really irrelevant. In either case, employers need to understand what drives the costs of health care plans for their employees, as well as their retirees. The absence of a strategic plan or a detailed analysis of health care programs and claims information can have a considerable impact on long-term costs, even causing an organization to miss opportunities for realizing economies of scale.

Although loss of key talent certainly isn’t limited to senior management and executives, the Ernst & Young survey did indicate that 75% of employers responding are most concerned with individuals at this level, where retention has long been a key driver for compensation packages. Our findings also indicate that many companies want certain senior management to stay beyond normal retirement, yet 60% said their compensation programs were neutral in terms of encouraging or discouraging retirement. That begs the question, “Can a company better use its pay programs to help address the wisdom withdrawal/knowledge retention issue?”

Only 17% of survey respondents indicated that long-term incentive programs were the top consideration influencing an employee’s decision to retire. Even fewer respondents (11%) said they believe that variable compensation will be a key retention factor, but 20% plan to increase compensation to address these concerns. Indeed, compensation is one area that lends itself to customization, because it can be determined on a selective basis, making it a more attractive vehicle for addressing aging workforce issues than broad-based retirement or health and welfare plans whose changes have to be more universal.

But if long-term incentives aren’t enough on their own to assuage the aging workforce issues, what other programs and features are likely candidates for consideration? Those deserving of a look include supplemental retirement plans, non-qualified deferred compensation plans, restricted stock and restricted stock units, even deferred bonuses with premiums driven by employment after normal retirement age. Any of these might contribute additional incentive for talent retention, yet none of them should be implemented in a vacuum. Also important are the broader business implications for the organizations’ pay philosophy and compensation strategy, cash flow, financial statement impact, tax impact, and more. While these considerations may not outweigh the prospect of losing talent, they must be assessed.

Our survey also revealed a paradox: some key employee pay programs work almost at odds with the mounting concern about retiree brain drain. For example, some programs reward individuals when they reach retirement age with automatic vesting or more liberal stock option exercise provisions. These are well-established compensation features, to be sure, and would have been particularly appealing to baby boomers when they were young, up-and-coming executives. But as more employees draw closer to the end of their careers, companies will need to address this possible reverse, adverse effect.

Though compensation program designs in and of themselves will not be the ultimate solution for avoiding the brain drain and loss of key talent, this is one category that can be a positive factor in a strong strategic solution.

Members of the aging workforce are increasingly opting for continued flexible employment, and Ernst & Young’s survey shows that 25% of respondents are trying to adjust benefits accordingly. While adopting policies and plan changes designed to benefit and retain experienced workforce members may seem the right move, such changes may not be compliant with pension and benefits requirements. What started with an employer’s good intentions may result in a negative impact on the tax-qualified status of a retirement plan or exposure to plan fiduciaries.

As Congress and regulatory agencies react to the graying trend as well, the playbook for retirement will be an iterative document, with the terms of compliance shifting with new legislation. An overwhelming majority of survey respondents (77%) say that responsibility for keeping up with these changes and their accompanying financial risks, then modifying the company’s plans accordingly, falls squarely on the HR executive. With 70% of respondents saying that compliance issues are top of mind in the C-suite, HR’s role will become both more demanding and more visible. Statistics notwithstanding, the optimal approach to ownership of these issues will be a collective effort—HR is the sponsor, with an understanding of, and input from, the organization overall with respect to issues, interests, needs and demographics.

In light of the newest requirements of the Pension Protection Act and FAS 158, companies are even more focused on being technically compliant. The ingredient that may be missing is an understanding of what that means through the lens of an aging workforce. The result is an apparent disconnect between what’s being done to address compliance, on one hand, and what management and stakeholders want, on the other. In contrast to this strategy gap, however, compliance with labor and discrimination laws has received more attention, with 69% of respondents having analyzed their plans to make sure they’re compliant.

Change in social policy relative to the aging workforce began to occur in about 2002. An employer now has the option to allow participants who are 50 or older to make 401(k) plan catch-up contributions, currently up to $5,000 and likely to increase. Additionally, defined benefit plans are allowed to pay retirement benefits as either a pension or a lump sum prior to the date a participant would reach the plan’s normal retirement age. As much momentum as there is behind the reality of social change driven by an aging workforce, pension and benefit laws have some catching up to do. When laws are passed that introduce change, it will be important to make sure that eligible employees understand such changes and know how to use them.

Complex and multi-dimensional though any discussion on the aging workforce must be, there are a few key themes that emerge from the statistics.

Employers are grappling with internal issues, particularly roles and responsibilities for solutions to the challenges posed by an aging workforce. Leading practices suggest that the best approach puts HR as the sponsor, with C-suite, boards of directors, and HR executives working together to develop a comprehensive strategic plan that dovetails with overall business strategy.

  • Solutions are as unique as the businesses themselves and should be developed based upon an in-depth understanding of employee demographics, business issues, competitive pressures, program cost drivers, and financial and business risks.
  • For retirement plans, issues will become more obvious as the workforce ages. A reactive posture won’t be sufficient; projecting change and continually monitoring the workforce will be key to identifying and recognizing the issues and meeting the needs in a timely and responsive manner.
  • In the push to retain key talent, companies should reassess the components of their compensation strategy, along with workforce demographics and particular areas of vulnerability, then use compensation adjustments as part of a comprehensive solution.
  • Succession planning and knowledge transfer require a specific strategy, with executive by-in and a collective effort enterprise-wide.
  • Solutions to the challenges will come from the “four R’s”: recruitment, retention, retirement and redeployment.

    The Ernst & Young 2007 Aging US Workforce Survey: Challenges and Responses an Ongoing Review was written by the following authors:

    William J. Arnone, Principal, Employee Financial Services, Ernst & Young LLP. He can be reached at

    William B. Leisy, Americas Markets and Services Leader, Performance & Rewards Practice, Ernst & Young LLP. William authored the white paper on Talent and Succession Planning and can be reached at

    Arthur L. Conat, Executive Director, Resource Actuary, Performance & Rewards Practice, Ernst & Young LLP. Arthur authored the white paper on Retirement Plans and can be reached at

    David G. Johnson, National Service Line Leader – Executive Compensation Strategy & Design, Performance & Rewards Practice, Ernst & Young LLP. David authored the white paper on Executive Compensation and can be reached at

    Edward Pudlowski, ASA, MAAA, Principal, Performance & Rewards Practice, Ernst & Young LLP. Edward authored the white paper on Health Care and can be reached at

    Christopher Lipski, Principal, HR Risk Service Line Leader, Performance & Rewards Practice, Ernst & Young LLP. Christopher authored the white paper on HR Risk and Compliance and can be reached at

    The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP.