Early-Retirement Offers That Work Too Well

When telecommunications giant Verizon Communications wanted to reduce its workforce in 2003, it turned to the time-honored method of offering employees incentives to take early retirement. Verizon’s package, which included a 5 percent increase in pension benefits, a one-year extension of medical coverage, two weeks’ pay for each year of service and a one-time severance benefit of up to $30,000 for managers, was generous. In fact, it may have been a bit too generous.

    Instead of the 12,000 workers that Verizon had hoped to convince to leave, more than 21,000–about a tenth of the company’s total workforce–jumped at the offer. As the company scrambled to hire new people and promote rank-and-file employees to replace the 16,000 managers who’d abruptly vanished, it assured customers that service and reliability wouldn’t be negatively affected. But not everyone was convinced. “It’s a mystery how they’re even running this company today,” said Don Trementozzi, president of Local 1400 of the Communications Workers of America, which represents 1,550 Verizon call-center workers in New England, in an interview with the Boston Globe. “We’re down to bare-bones staffing.”

    Although Verizon had hoped to shave $1 billion a year from its personnel costs, the massive expense of the buyout–upwards of $3 billion–meant that it would be at least several years before the benefit showed up on the bottom line.

    The company’s massive early-retirement miscalculation, say human resources consultants and experts on retirement strategy, illustrates the potential pitfalls of the device, which was once widely viewed as a painless, affordable way to reduce staff, cut expenses and make Wall Street investors happy. In the 1980s and 1990s, early-retirement plans were so common that some companies actually had successive waves of buyouts, says Rich Koski, retirement products leader for Mellon’s Human Resources and Investor Solutions in New York. “It got to the point that employees were starting to wait them out, knowing that the pot would get sweeter the next time around.” Companies didn’t worry that much about the cost of buyouts because they could keep them off the books by dipping into their existing retirement plans, which often were flush with extra funds from stock market investments.

    But the economic downturn of the past few years, which made early-retirement programs more difficult to finance, has greatly diminished the advantages of early retirement as a workforce-reduction and cost-saving device, experts say.

    The increasingly few companies that are still utilizing buyouts–about 17 percent of firms, according to a recent survey by Watson Wyatt Worldwide–often find early-retirement offers to be unexpectedly costly and fraught with unpleasant side effects, such as the loss of crucial staff members. As a result, more companies are now opting for involuntary layoffs with severance packages, or periodic pruning of the lowest-ranking performers from their workforces.

    Even so, the early-retirement plan hasn’t yet become obsolete. For certain types of companies, such as those with unionized workforces or a high proportion of older workers, early-retirement plans may still be the best way to go. But making early retirement work effectively requires more preliminary research, calculations and careful planning than companies generally did in the past.

    Some experts have always taken a dim view of early-retirement programs precisely because they offered a seemingly pleasant, cheap way to solve the unpleasant, expensive problem of bloated workforces and pump up sagging corporate balance sheets. “Early-retirement plans enabled managers to avoid having to make tough decisions,” says John Sullivan, professor of management at San Francisco State University, who also has a consulting firm that bears his name. “They didn’t have to go up to Joe and say, ‘Sorry, but you’re just not productive enough, and the company needs to let you go,’ and risk Joe getting mad at them or filing a lawsuit. Instead, they could just periodically pay a bunch of people to retire voluntarily. And it seemed as if it didn’t cost anything because the money didn’t come out of operating income. Because it was painless, nobody ever wanted to look at whether it really worked in the long-term interests of the company.”

    Often it didn’t, Sullivan says. Because companies making buyout offers to broad segments of their workforces are unable to control who accepts them, they have watched helplessly as low performers stay on the job and high-performing workers with difficult-to-replace skills stick the money in their pockets and take jobs with the competition. “Imagine if the Yankees offered to buy out everyone on their roster,” Sullivan says. “They’d end up losing star players who can easily go out and get a great deal from another team, not the third-string catcher.” Other companies have been forced to hire back those critical workers as freelancers or consultants–at higher wages that negate the purpose of the buyout. “It’s staggering how many of them seem to find themselves in that bind,” Sullivan says.

    Despite these problems, early-retirement programs are still a good choice for some companies, say Dan Ishac, office practice leader for retirement, and Alex Dike, a senior retirement consultant, both with the Chicago office of Watson Wyatt International. A company with a unionized workforce may find it difficult under a collective-bargaining agreement to lay off its lowest-performing workers. Similarly, a company with a high proportion of older workers, women or minorities may find itself facing discrimination claims in the wake of involuntary downsizing. “Any time you have a performance-related conversation with a protected class under the law, there’s a litigation risk,” Dike says. “With a voluntary program, you avoid that problem.”

    But companies that want to use early retirement have to do more research and move more deftly than they once did. Dike and Ishac recommend that, instead of offering a buyout to most or all of their workforce, companies target their offers at specific business units or job classifications. “You want to be sure that you’re getting at the areas where you have redundancy or pockets of poor performance, rather than just spreading money all over the place,” Ishac says. In addition to studying today’s workforce snapshot, companies should try to project their staff needs 5 to 10 years ahead, so that this year’s retirements don’t leave the company with a shortage of, say, experienced senior managers down the road.

   Once a company identifies whom it wants to lure into early retirement, the next step is to come up with a package that will attract that group. Studying the age demographics of the targeted segment is crucial. “Employees who are 5 to 10 years from [normal] retirement require the most incentives to leave,” Ishac says. “They’re going to want six months to a year of severance, plus medical coverage. People who are two to five years away, in contrast, may be satisfied with a temporary cash enhancement to their pension, until Social Security kicks in.” Similarly, medical benefits aren’t quite as alluring to those older workers because they’re closer to age 65, when they become eligible for Medicare coverage. (About one-third of the firms in the Watson Wyatt study included enhanced health benefits in their offer.)

   Another new tactic is to offer incentives to retire. For example, a company might promise retirees that they will receive full health coverage if they leave the company before April 1.

    But a company doesn’t want a package to be too compelling, lest it end up in a Verizon-like situation. John Challenger, chief executive officer of the Chicago-based consulting firm Challenger Gray & Christmas, recommends the use of surveys to predict how employees will react to the offer. “You also should study other companies in your field or in the area, and benchmark what they’ve done.” Additionally, he says, smart companies identify critical employees who are eligible for buyouts and essentially re-recruit them, promising them desirable assignments and affirming their importance to the company’s future. “They’re going to those people and saying, ‘You’re entitled to take the buyout, too, but here are all the reasons why we hope you won’t,’ ” Challenger says. “You don’t want to leave that to chance.”

Workforce Management, January 2004, pp. 66-68 — Subscribe