HR Magazine, April 2001: The Kindest Cut

By Carolyn Hirschman Apr 1, 2001

HR Magazine, April 2001Vol. 46, No. 4

With some sectors softening, make sure your organization has a policy for addressing the needs of laid-off workers before any announcements have to be made.

Have you looked at your severance policy lately? Chances are you haven’t. But taking a fresh look at this important benefit may be a good idea, even if your organization does not anticipate any layoffs.

Most employers provide cash, medical benefits and outplacement services to employees who lose their jobs as a result of downsizing, mergers, acquisitions or other events. The idea is to help tide workers over until they find new jobs and to keep benefits competitive with those of other organizations.

"Even in this era of low unemployment, separation benefits continue to be an important concern for U.S. businesses," says outplacement firm Lee Hecht Harrison of Woodcliff Lake, N.J., in its 1998 triennial survey. Eighty-three percent of nearly 2,000 employers queried had severance policies. The company’s next such survey is due out later this year.

Even if your company isn’t at risk of laying off workers, revisiting your severance pay policy will help you keep up with changes in your workforce, industry and corporate culture, compensation experts say.

"Companies need to understand the job market isn’t hot for everybody. It doesn’t take into account your tenure and your family’s goals. You have to look at the big picture," says Bernadette Kenny, executive vice president of Lee Hecht Harrison.

Downsizing is on the Upswing

As the days of tight labor fade, an increasing number of employers are letting people go. The pace of downsizing is picking up, with 142,208 job cuts announced during January, a 181 percent increase from January 2000, reports Challenger, Gray & Christmas, a Chicago-based outplacement firm. February saw 101,731 layoffs, almost triple that of the same period last year.

The dot-com sector in particular has taken a pounding at the hands of economic forces and Wall Street. Internet employers cut nearly 66,000 jobs during the past 15 months, according to Challenger, Gray & Christmas.

The continuing pace of mergers and acquisitions also is a factor. "With companies being bought and sold, severance is a frequent issue," notes Michael C. Lynch, an attorney in the Washington, D.C., office of the Pittsburgh law firm Reed, Smith, Shaw & McClay. One of the first questions merging companies face is whether and how to pay severance benefits to employees of the acquired firm, he says.

Although imminent layoffs are an obvious reason to re-examine severance policies, the best time to review or change your policy is when times are good. Kenny advises firms not to cut back on severance during bad times "unless you want to create an employee relations nightmare."

A better practice is to look at severance, as well as other benefits, periodically—perhaps every few years—to ensure that they match your workforce in such areas as age and seniority. You also want to make sure your severance is competitive with what’s offered by peer companies and otherwise enhances your employer’s public image.

However, Challenger cautions against changing severance policies to meet short-term ups and downs of the economy. "I don’t think companies should alter their severance policies because of unemployment rates. It’s going to be very difficult to manage if it swings up and down." And Kenny warns that, "Whatever you do, severance must be consistent with corporate culture."

A Boost to Recruiting?

It’s logical to think that a beefed-up severance package could help attract workers. But compensation experts agree that, other than a few exceptions, severance benefits alone won’t help recruiting efforts much.

CEOs, whose tenures have become shorter and shakier than in past decades, could be lured by a generous severance, says Craig N. Clive, SPHR, a principal at Baylights Compensation Consulting LLC in Ellicott City, Md. "More and more executives are negotiating their severance package as part of their compensation package. They want to know what happens when the balloon bursts."

Similarly, because of the severe volatility and turnover at Internet firms, some applicants might be tempted by a guarantee of severance pay if they are laid off, experts say. But "the person who takes that kind of job is willing to take a risk," notes Bill Coleman, vice president of compensation for, a web site based in Wellesley, Mass.

Even so, Alec Levenson, a labor economist at the Milken Institute, a Santa Monica, Calif., think tank, says that severance would have to be "fairly expensive" to influence recruitment. He doesn’t see it as "something that will attract people in high demand." For the rest of the workforce, severance won’t be as important as salary and benefits, Levenson adds, so HR managers must think carefully about how they spend their compensation budgets.

Based on the latest available data, severance is generally a tiny part of the HR budget. Civilian employers spent $5.80 per hour worked on all benefits, according to a March 2000 Bureau of Labor Statistics report, which notes that only 3 cents of that amount went for "other benefits," including severance.

Formal vs. Informal Policies

Severance policies and practices vary widely by employer size and industry, consultants say. Large established companies tend to have formal written policies with relatively generous payments. Small and new firms are less formal, often negotiating severance on a case-by-case basis.

There are pros and cons to both approaches. A formal policy establishes what employees can expect if their jobs are eliminated. It also helps avoid claims of disparate treatment that can arise when severance is negotiated individually. "We strongly recommend that the company have a stated severance policy," says Kenny. "You open yourself up to a lot of different kinds of liability if you negotiate differently with Jane or Jack."

Another strategy, says Andrea Eisenberg, managing principal of the New York office of Right Management Consultants, a Philadelphia-based outplacement firm, is for employers to adopt temporary "event-driven" plans that typically last three to six months.

These plans typically offer terms not found in standard plans, including minimum payouts and early retirement, Eisenberg says, lasting only as long as it takes to arrange layoffs prompted by mergers or other short-term situations. "Usually, the company develops a policy or practice based on a philosophy of how they want to treat employees or [based on] what’s going on in the market."

A standard severance plan doesn’t mean that everyone must be treated exactly the same. Employers generally have a lot of discretion to set eligibility criteria. Certain employees can be excluded, and different formulas can apply to different job levels as long as employees in protected classes are not discriminated against, employment lawyers say.

KeyCorp, a Cleveland-based and financial services company of 23,000 workers, is using a severance policy established in 1994 as it eliminates 2,300 jobs through the end of 2002, says Katie Ladd, vice president of corporate employee relations and HR compliance. "We’re very committed to making sure all employees are treated equitably."

Severance pay for laid-off KeyCorp workers ranges from two weeks’ salary to one year, based on years of service, and the employee’s job level in the company’s hierarchy. Employees also receive continued health insurance and outplacement help, including the services of "transition centers" in Albany, N.Y.; Cleveland, Ohio; and Takoma, Wash., where KeyCorp has a large presence.

Severance payments end when employees find new jobs at KeyCorp, as have about 30 percent of those laid off so far, or if they refuse transfers to comparable jobs within the company, Ladd says. However, those who take jobs elsewhere continue to receive their full severance anyway.

Employers who prefer to negotiate severance packages individually retain the flexibility to change or eliminate severance, since no expectations have been established. However, there needs to be some degree of fairness, even if that means different terms based on the same general principles, experts say.

For example, an employer could create a general severance formula, decide whether or not to include medical benefits and set eligibility criteria, says Antoinette Pilzner, an attorney at the Detroit law firm Butzel Long PC. Workers who are laid off could receive more benefits on a negotiated basis.

Although case-by-case negotiations would seem to invite discrimination claims, they actually are rare, says Michael Richman, an attorney in the Washington, D.C., office of Reed, Smith, Shaw & McClay. "As long as a company has a rational business reason for distinguishing between two situations, there’s a pretty good chance of being OK legally."

This individualized approach works well with top executives, small firms and companies with infrequent departures, Eisenberg says, adding that it doesn’t make sense for companies with mass layoffs because it would be impractical to individually negotiate the severance terms of each employee.

The Dot-Coms Are Different

The issue of severance has become especially acute among dot-com firms, many of which have had to jettison employees in the storm of shake-ups and shake-outs that has hit the industry, and which are often too new or too small to think about it.

"The companies that are laying off don’t have a ton of money," says Lori Zelman, vice president of HR at a New York-area Internet company, noting that severance plans aren’t usually developed until layoffs occur.

"It’s hard to figure out what the criteria should be because most employees have been around only one or two years," Zelman adds. Policies based on seniority don’t make sense, so any severance tends to be based on job level, with two weeks to three months the going amount—"significantly less" than at traditional employers, she says.

One Internet company based in the Southeast, which did not want to be further identified, had no formal severance policy but paid at least two weeks’ salary to 17 employees laid off last fall, says its HR manager. Although many workers got new jobs and job offers quickly, "We wanted to compensate them for the loss of their jobs," the manager says. The 150-person firm, begun in 1996, also brought in a recruiter and contacted potential employers.

This Internet company is more generous than most, HR experts say. The norm in this hard-driving, high-turnover industry is no severance pay—and no HR policies or managers at all.

Many HR experts believe it’s wrong for dot-com companies to terminate without severance workers who often have labored 60- and 70-hour weeks. "In a tight job market, people think they can get away with stuff that they shouldn’t," Eisenberg says.

E. Lynne Pou of Human Resources Consulting in New York advises to offer at least some severance to employees in exchange for coming to a job with a potentially shaky future. According to Zelman, Internet companies make up in part for small or no severance payments with other types of outplacement help, such as contacting potential employers and holding resume-writing workshops.

Questions to Ask

Before adopting or changing a severance policy, a few key questions need to be answered. The answers will change, depending on your organization’s corporate culture, workforce and employment needs, but the questions—whom to pay, how much and in what manner, and how to communicate changes in severance policy to the workforce—won’t. Here are some options to consider:

Who should get severance. The best policies state clearly who is eligible. The "vast majority" of companies it surveyed in 1998 gave severance to all full-time employees who were laid off, says Lee Hecht Harrison. Forty-eight percent offered severance to part-time employees, while 7 percent offered it to temporary and contract staff.

A related issue is which conditions trigger severance. HR experts agree that workers who lose their jobs due to downsizing or other events beyond their control should receive severance, but they’re split about someone who is fired for cause or forced to resign. While Lee Hecht Harrison found that only 13 percent of employers gave severance to workers terminated for cause in 1998, that was more than double the 5 percent figure in the 1995 survey.

How much to pay. Most employers use a formula based on years of service and some factor in the job level—one week’s salary (base pay only) per year of service is typical. The higher the employee is in the organization, the less likely severance will be based only on tenure. Other factors can include employment agreements and the reason for the separation.

Severance covered an average of 21.8 weeks in 1999, compared with a record low of 12.8 weeks in 1996, according to Challenger, Gray & Christmas. Many employers set floors and some set ceilings on total payouts.

Today’s norms are one to four weeks’ severance per year of service for executives, with a minimum of six months to one year, Challenger says. For middle managers, the rate is one to two weeks per year of service, with a minimum of three to four months. For other workers, it’s one week per year of service, with a minimum of one to two months (see charts, left).

While an employer has the option of stopping severance when a laid-off employee finds a new job, in most cases employers don’t. Some firms even provide extra payments for workers who have trouble finding new jobs. The company’s stock-option plan governs whether employees can get additional vesting as part of severance. Some employers speed it up to allow laid-off employees to exercise options within a certain time frame, says Clive of Baylight Corporation.

How severance is paid. There are three approaches: lump sum payments, continuation of salary and giving workers a choice between the two. Most employers select one method or the other. Fewer than 10 percent give workers a choice, according to the Lee Hecht Harrison survey.

Many employers prefer a lump sum payment because they don’t have to continue medical benefits after workers leave. Conversely, many employees prefer regular payments because they continue to receive health insurance as long as the payments last.

Communicating changes in severance policy. Be straightforward but low-key, experts advise—the last thing you want is an anxious staff wondering when the ax will fall. HR should announce and explain—in memos, newsletters or meetings with managers—any changes in severance policy. Even better, announce changes in severance along with changes in other benefits. If the change is for the better, employees may be reassured. If there will be layoffs, announce who is affected and when.

Carolyn Hirschman is a business writer based in Rockville, Md. She has written for a variety of business publications and has covered workplace issues since 1991.

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