A Glimpse Into the Rising Popularity — and Shifting Nature of — Variable Pay Plans

November 12, 2018 Ken Abosch

Variable pay plans continue to be a critical component of many organizations’ total rewards package as traditional merit increase budgets remain at record low levels. In 2018, a median 98% of total U.S. employees who were eligible for at least one type of variable pay award actually received an award, according to Aon’s Variable Compensation Measurement (VCM) Report.

The Evolution of Variable Pay

Back when we first started tracking this type of data in the early-1990s, the prevalence of broad-based variable pay was not a mainstream practice. According to Aon’s Salary Increase Survey in 1995, 59% of organizations in the U.S. indicated they had at least one broad-based variable pay plan in place. By 2018, 89% of U.S. organizations had implemented a broad-based variable pay plan.

In addition, funding for variable pay continues to remain consistent. Even with the changing economic environment, variable pay budgets remain significantly higher than salary increase budgets. While salary increases have hovered at or around 3% for the past six years, variable pay budgets (as a percentage of payroll) have consistently been in the double digits, though we have observed a decline in recent years – most recently 12.8% in 2016, 12.7% in 2017, 12.5% in 2018 and projected 12.1% for 2019.

Not only have more U.S. organizations in our database introduced broad-based variable compensation in

recent years, but they have also changed the look and feel of their variable pay plans. In many cases, one-size-fits-all plans that cover all employees in all locations and/or departments are being replaced by more customized variable compensation plans.

Today, organizations tend to design plans with multiple measures for different employee groups. A typical mix of variable pay plans may include a business incentive plan with combined financial and operational performance criteria for staff functions. Individual performance plan measures or modifiers give managers the power to reward and retain their top performers.

Most Popular Types of Variable Compensation

Aon’s VCM database has been tracking the prevalence of the different types of variable pay for more than a decade. Figure 2 offers a glimpse into the types of variable compensation plans that are used by organizations in our database over the last five years.

Notice how business incentive plans have remained popular across this time period with 82% of organizations reporting at least one business incentive plan. Around half of organizations (52%) use special recognition plans and 20% of companies utilize individual performance plans.

Figure 2

Percentage of Organizations with Each Plan Type

Business incentive plans are the most flexible type of variable pay plan because they allow the combination of financial and operational performance measures that can be assessed at different levels of the organization. Business incentive plans can be seen as hybrids of more traditional types of variable compensation plans by linking different performance measures and aligning employees from different areas of the business with the same goals.

As the second most popular plan type, special recognition awards are mostly smaller in size than payouts under other variable pay plans, and most often take the form of merchandise or cash. Despite the lower value, special recognition programs can be very effective in recognizing and rewarding short-term, above-and-beyond contributions from employees.

Effectiveness of Variable Pay Plans

Organizations feel positive about the overall effectiveness of their variable pay plans. The majority of organizations (86%) still believe that variable pay plans helped or somewhat helped their business results in this year’s survey, while 92% of organizations felt their plan benefits equaled or outweighed the costs.

And even though economic conditions play a role in determining feedback, it’s interesting to note that 94% of organizations in this year’s survey said their plans were likely to meet some or all of their target plan objectives.

Next Steps

Variable compensation has become increasingly important in helping organizations achieve their required business results, particularly since merit budgets aren’t rising anytime soon. At the same time, there is a heightened focus on pay for performance both by employers, investors and outside advisers.

Aon’s Variable Pay Index (VPI) Study is a diagnostic tool capable of assessing a variable pay plan’s strengths and weaknesses. If you want to learn more about this tool, or if you have specific questions for our compensation experts, please contact us now.

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