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Does Your Severance Plan Make the Cut

August 1, 1995
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Downsizing. Rightsizing. Restructuring. Reengineering. These seem to be defining words for business in the '90s. Yet these terms are inherently vague; their interpretation depends on whom you query. Ask many employees today, and they'll give you their gut reaction: Hearing these words announced by the company means that they may soon be out of work. Scores of job functions have been cut over the past few years. That doesn't mean companies are just cutting back on people—companies are eliminating entire occupations.

Enter the severance package—a phrase that, surprisingly, has come up very little, despite all the changes and cutbacks. Yet it is very much alive and well. In a benchmark study of 2,893 HR professionals across the United States, 82% reported that their companies have a severance policy or practice. Yet the study (conducted by New York City-based Lee Hecht Harrison in conjunction with Personnel Journal and New York City-based law firm Jackson, Lewis, Schnitzler and Krupman) showed wide variances of policy particulars.

Apparently, the definition of an effective severance policy also depends on whom you ask. For some, a severance package is an extension of goodwill, and so should be sweeping in its inclusion of employees—no matter their reason for separation or their length of service. For others, it's a reward for a job well done, provided on a case-by-case basis for those deemed worthy. Still others view it as a way of warding off lawsuits, and so packages are carefully doled out by the book in exchange for releases.

Which approach is right? All of them. An effective severance package is one that meets its goals—and these goals can be as varied as the companies that choose them. As long as they are carefully thought out and executed, any type of severance package can be a success—but you must ask yourself some questions first.

What should our severance package look like?
You can check out your neighbors' policies all you want, but in the long run each individual company must decide what its policy should reflect. Two basic issues must be addressed before a policy can begin to take shape:

  • You must know why your company is providing a severance package in the first place.
  • You must decide whether your policy should be formal or informal.

Why spend company money on a severance package? It's not required by law. In fact, for many companies, it's one of the first benefits to be trimmed away in a belt-tightening strategy. So why is your company choosing to offer a severance package?

For many organizations, the reason is primarily altruistic. "We feel that to provide a package that can assist employees financially during the period of transition following termination from the company is just the right thing to do," says Marilyn Wilfong, manager of employee benefits for Tacoma, Washington-based Weyerhaeuser Co. "I really can't imagine why we would ever do away with it. We feel it's the right thing to do when our employees are losing their jobs." The sentiment is certainly echoed by other companies. In the survey by Lee Hecht Harrison, participating companies reported that the No. 1 reason for offering severance was "to provide an adequate bridge to new employment" (stated by 80% of companies). This was followed by "to maintain a positive reputation as an employer" (68%) and "it's the right thing to do" (62%).

Golden, Colorado-based Coors Brewing Co., in the midst of a substantial restructuring, has several reasons for providing a severance package—some grounded in altruism, and some anchored in business strategy. "First of all, we want to make sure our employees are treated fairly," says Jennifer Thomas, director of HR. "Because the transition between employment and re-employment is often difficult and emotional, we want to reduce the financial concerns so they can focus 100% on their job search." But Coors also wants to protect itself, so its new severance guidelines, now in the final stages, will also include a mandatory release of claims.

Such use of a release is not uncommon; only 20% of companies in the survey reported that they never require a release in exchange for severance payments. That doesn't mean, however, that most companies feel they need releases. Fifty-five percent of respondents felt that simply offering a severance package reduced the likelihood of lawsuits.

"Because the transition between employment and re-employment is often difficult, we want to ensure employees can focus 100% on their job search."

Reduced complaints are one benefit that Merrill Wall, first vice president and director of HR for Irwindale, California-based Home Savings of America, sees in severance. The company publishes the policy in the employee handbook so everyone knows ahead of time what to expect. Wall believes this clear delineation of benefits helps cut down on disappointment when a severance package is issued; and that by cutting down on disappointment, the company has fewer disgruntled employees leaving the fold. "Employees have a sense of just what the severance is. I think they also have a sense that the company is being both fair with them, and reasonable as it relates to severance," he says.

Massachusetts-based Cambridge Savings Bank takes a similar stance. Mary Livingston, first vice president of HR, uses a generous severance package as a final form of wishing a terminated employee well—and as a means of making the exit as uneventful as possible. "We get a lot more mileage out of being generous in these situations," she says. "As long as we can afford financially to do that, we feel it's in our best interest. We don't want disgruntled employees talking badly about the bank. And we certainly don't want an angry employee filing a lawsuit, which they'd be more likely to do if we were tight on our severance package."

Whether it be to avoid lawsuits or help an employee transition, once a company has ascertained that it does indeed have specific reasons for offering a severance package, HR must decide whether to make the package formal or informal. For many companies, this can be quite a dilemma: An informal package will give HR much more room to maneuver, with the ability to act on a case-by-case basis. But if a package is ever challenged, the formal, corporatewide severance policy has a much better chance of standing up.

Those companies that choose to maintain informal packages generally are smaller organizations. In the Lee Hecht Harrison survey, only 68% of companies with fewer than 5,000 employees had policies in writing. Compare this to 91% of companies with more than 5,000 employees who had written policies, and the difference becomes fairly profound.

Northlake, Illinois-based The Custom Companies is a small organization with no formal package. Tom Boyle, assistant vice president of administration, says that the 240-employee transportation company always decides severance packages on a case-by-case basis. "We're a very young company—only nine years old—so a lot of our policies are being developed as we move along. [An informal package] gives us more flexibility. It has worked quite well up to this point."

Cambridge Savings' Livingston echoes the desire for flexibility. Similar in size to The Custom Companies, with 250 employees, the bank also opted to go the informal route. Livingston says HR tries to be as consistent as possible in issuing packages, but isn't interested in formalizing a procedure. "We just don't want to be locked into anything," she says. For Cambridge Savings, the flexibility of an informal plan outweighs the risk of potential lawsuits—and Livingston isn't too worried that one will come her way. "In each situation, we've been able to justify or defend our approach. Whether that would hold up in a court of law I don't know. But we feel more comfortable with that risk to keep the flexibility."

With 100 active employees, Enfield, Connecticut-based Bloom's Inc. also has an informal severance package—for much the same reason. Says Robert Clark, personnel manager: "We feel that an informal policy like this allows us the advantage to tailor the severance package to suit each situation. We've never been sued; we don't give our employees any reason to initiate action against us."

Larger companies, however, tend to need more formal policies. Penny Shaw, executive vice president with Lee Hecht Harrison, says that the sheer number of employees these large companies deal with necessitates an objective policy. "These big organizations could literally have hundreds of people being terminated from the organization in the course of a year. It could even be thousands if they're going through lots of downsizing. So at that point it becomes incumbent to have something that is fair and consistent—a policy that can be relied on because of the volume of people being handled."

Home Savings of America is one such company. With 10,000 employees, the organization simply requires an objective policy. "Part of the reason for having a formal policy is so that you don't have to administer it on an individual basis," says Wall. "Also, I think from the standpoint of fairness, if different employees with the same years of service, perhaps the same performance level, receive different packages, you have to justify why. Favoritism could get involved." With 6,300 and 15,000 (salaried) employees respectively, Coors and Weyerhaeuser also have strict formal policies in writing.

But small companies be warned. Neal Schelberg, a partner at New York City-based Proskauer Rose Goetz and Mendelsohn LLP, recommends that any severance policy be set down in writing in a separate legal document—no matter what size the organization. This could provide a legal advantage if the company is ever challenged on its package. "If you have an informal policy that is not set forth in any kind of clear, concise statement, you have not reserved the right to interpret your plan. Then, should you have to defend a denial of severance benefits in court, you're going to have a much tougher case." Schelberg advises companies to be as explicit as they can in the document, identifying exactly what the triggering event is for severance as well as exactly who is eligible. But to set this information down, you must first decide the scope of your severance package.

Who, how much, and under what circumstances?
A well-defined severance package details which employees qualify (part-timers? non-exempt?), how much they qualify for (a week for every year of service? is there a cap?) and under what circumstances they receive severance (termination for performance? only for downsizing?).

"The first question you need to ask is who among your employees do you wish to provide with severance," says Schelberg, whose specialty is employee benefits law. "Are all employees eligible, or is it perhaps only some particular group or job classification? Is it for hourly employees, or just for salaried employees? Clearly reflect the company's intentions when you say 'employee severance.'"

Sometimes union issues prevent companies from issuing an all-encompassing severance policy. For instance, Weyerhaeuser's corporate-wide severance package affects only the salaried work force. The package for the hourly work force is handled locally. "We're trying to blend the line between the salaried and hourly work force, but it's hard because a lot of the hourly work force is union, so they negotiate their benefits," says Wilfong. The company does, however, make it very clear that a single plan governs the severance of their salaried work force. "Regardless of whether you work in Columbus, Mississippi, or Tacoma, Washington, if you're a salaried employee, you're part of one plan."

As Coors revamps its severance guidelines, it's focusing on which workers it wants to cover with severance. The new plan may, for instance, cover certain part-time employees. This addition reflects Coors' change in work structure—many former full-time employees have accepted part-time positions, and Coors wants to recognize them. "As we go forward with the plan, we look at what makes sense," says Thomas. "We look at how we can meet the needs of our long-service, part-time employees, because we don't think it's fair to just let them go."

As far as determining how much a terminated employee qualifies for, length of service and salary level play two very important roles. In the Lee Hecht Harrison survey, companies were asked to name all the factors they used in deciding the severance amount. Years of service was the biggest factor: 89% of organizations based severance for their exempt employees on their length of time with the company (83% for non-exempt). Salary or grade level was another important determiner: 32% of companies used this as a deciding factor for exempt employees (25% for non-exempt).

Weyerhaeuser's package is a fairly typical one, reflecting an employee's years of service at the company. It kicks in at one year, and employees with up to five years of service at the time of termination receive one week for each year of service. For those with six to 15 years with the company, an additional two weeks' pay plus one week for each year of service is granted. The scale graduates to 26 or more years of service: These employees receive eight weeks' pay plus one week per year of service.

Home Savings of America also bases payment amount on length of service: An employee at the company two years at the time of termination receives two weeks' pay; three years earns three weeks' pay and so on, capped off at 12 weeks' for a non-officer employee. The plan works a bit differently for officer-level employees, with the minimum amount of severance being four weeks'—on up to a maximum of 26 weeks' pay.

Companies with informal packages, such as Bloom's, obviously have no set pay system. Yet they generally look at similar issues when gauging severance. "There are no minimum or maximum package amounts, but they are within a range we feel comfortable with," says Clark. "Generally we give a number of weeks of salary based on issues such as tenure, the contributions that the employee has given the company, and any other mitigating circumstances that caused the termination."

The circumstances surrounding the termination do exert a major influence on most severance packages. Some companies, for instance, provide packages for any kind of involuntary termination, while others assist only those who were separated from the company due to downsizing.

"If you have an informal policy that's not really set forth in a clear, concise statement, you haven't reserved the right to interpret your plan."

One major dividing line is whether to provide severance for an employee terminated for poor performance. Home Savings of America, for instance, firmly believes that termination for performance prohibits an employee from receiving severance. "In the case of performance, the individual employee always has the opportunity to improve," explains Wall. "With the counseling process we have, employees are always given a time frame in which to improve performance. So if an employee has 30 days to improve, that in essence is a notification to the employee that something is wrong. But in the case of layoffs or downsizing, these may come as a surprise to the employee. So we felt that we needed to give them some security or notification, and that's what the severance plan really provides them."

Conversely, Weyerhaeuser does provide severance for employees separated due to performance issues. Part of the reason, explains Wilfong, is Weyerhaeuser's corporate culture. The company remains fairly paternalistic, and so assumes a fair share of the blame when an employee doesn't work out. "Unless it's for some gross negligence or a really out-and-out violation, we offer severance. The bottom line is we hired them. For some reason they aren't performing satisfactorily. Maybe they just weren't a good hiring selection. So we're not going to penalize them because we hired them."

Cambridge Savings Bank takes a similar approach to employees terminated for performance. However, Livingston reports that the company—which determines severance on a case- by-case basis—would be more likely to give the low-performing employee a smaller payment than the severance awarded a downsized employee. "We might give them less than [usual] if it was strictly a job-performance situation, but maybe for longevity reasons or political reasons we don't want to not do anything."

Weyerhaeuser and Cambridge Savings Bank are actually in the minority in offering severance for poor performance; only 33% of respondents said their company recognized low performance as a triggering event for severance. The most common qualifying conditions companies gave for severance were downsizing (95%) and job elimination (94%).

Will our severance package be good forever?
Probably not, is the short answer. Like any other benefits package, a good severance policy must be continually revisited to ensure it reflects the changing times—both internally and externally.

Coors' extensive organizational re-alignment, for example, is an internal change that forced the company to review its severance package. "The old guidelines we had in place were designed to take care of people who didn't have a lot of service with the company," says Thomas. "Now we're getting into situations where we potentially will be outplacing people who do have a lot of service with the company." Thomas didn't feel the former guidelines would adequately cover the long-term employees. "The new guidelines are going to address situations of reorganization and restructuring or an actual change in job function or job requirements. For instance, you may occupy a particular job, and now we're saying that we need this job to perform different functions. Our old guidelines didn't cover [employees displaced this way]. Our new guidelines will."

The new guidelines will also focus on providing more equitable severance for senior-level people. For instance, the basic industry formula is that for every $10,000 in salary an employee earns, it will take one month to find a new position. So an employee who makes $100,000 will likely be out of work for 10 months. The old guidelines didn't really address that issue: At one year of service an employee received one month severance, with one weeks' pay for each additional year of service after that. The package didn't have a cap, but for the $100,000-employee, 20 years of service would still only cover that person for half his or her expected period of unemployment. A recently hired employee—one with only a few years' service—would likely run out of severance months before finding new work. "One month's salary isn't going to do it for them," explains Thomas. "Not that we're necessarily going to give them 10 months', but we do need to have special considerations."

In addition to caring for its downsized employees financially, Coors also added a mandate to its new guidelines to ensure that more personal issues are addressed. The company now requires mandatory outplacement assistance in order to receive severance. "Every employee being outplaced goes through at least career counseling and resume writing," says Thomas. "For professional employees, there will also be additional one-on-one counseling or group sessions. We're no longer allowing them to cash in the dollars instead of taking the services."

Like Coors, Weyerhaeuser has also recently revisited its policy—but did so in light of external rather than internal changes. "Based on some competitive data we received, we felt our severance plan was too rich on the low end and not rich enough on the high end—that is, for long-term service employees," says Wilfong. "So we made some changes this year." To maintain its competitiveness, Weyerhaeuser has a planning and consulting group within the company that is responsible for reviewing all benefits packages annually. "We're always looking at competitive data," says Wilfong. "We take a look at how we stack up. When we look at benefits comparisons, we want to be sure that we're right in the middle of the pack. That's where we want to be competitively."

Home Savings of America keeps an eye on external and internal conditions, and reshapes its package accordingly. "We're constantly trying to assess our needs and our employees' needs as well as how competitive we are in the marketplace," says Wall. For instance, when downsizing in harsh times, the company has initiated an enhanced severance plan to help employees weather the tough job market. "We were going through a time when we were downsizing a significant number of people, and we knew that it was going to be especially difficult, because of the economic conditions, for them to find other employment." So the company enhanced the package by adding an additional week for each year of service, graduated by seniority. "We just wanted to give people a greater sense of security during that window period. Of course, that window opens and closes depending on the economic circumstances. We've only offered enhanced severance once or twice during the last seven or eight years."

So, what do employees generally think of their severance packages? Those companies that have appeals systems report that very few employees bring forth complaints. Weyerhaeuser says its only appeals on severance have been when an employee lost a job due to a sale. But because the company has made it clear that employees picked up in a sale receive no severance, the issue was quickly resolved. "In our policy decisions we've always tried to bend over backward in favor of the employee," says Wilfong. "We get very few appeals on severance. I don't think you could even calculate the percent."

Bloom's and Cambridge Savings Bank, which both offer informal appeals procedures, each report that they have never had an employee present a complaint. "When it comes right down to it, employees may be unhappy concerning being terminated. But once things settle down [the employees I've talked to] were very appreciative and very happy they were given severance," says Livingston. Most employees do indeed appreciate their severance. In a Lee Hecht Harrison client survey of 577 respondents, 66% reported that they felt they'd been treated fairly.

Satisfaction with severance pay is possible—for those on both sides of the termination. When a company asks itself the right questions and creates a package that works for the business and its employees, it seems that severance need no longer be a taboo word.

Personnel Journal, August 1995, Vol. 74, No. 8, pp. 32-40.

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