Trying to demystify Manulife’s executive bonus calculus

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Manulife Financial Corp. uses a very specific measure of profit – net income – as part of the annual bonus plan for its executives. Why? The company says, in its proxy circular to shareholders, that net income focuses its executives on "building value for our shareholders." Hard to argue!

Manulife set a target of more than $3.4-billion in net income for 2015, but, sadly, instead posted just under $2.2-billion, a miss of 35 per cent. And, as a result, the company's "performance score" was, curiously, 89 per cent, which then led to three top executives, including chief executive officer Donald Guloien, getting more than 100 per cent of their target bonuses.

If this doesn't make sense to you, then you don't know executive compensation these days – or the alternative method of profit-counting that Manulife has embraced.

First, let's say something nice about what's going on at Manulife: The company actually measures seven different things when calculating that "company performance score" that goes into the bonuses. Seven is a little high, in my view, but it's better than measuring just one thing – executive-pay types will tell you that bonus plans based on just one metric can create undue pressure for executives to focus on one narrow matter. So, that's good.

Earnings, labelled "financial success," make up 50 per cent of the score. But it's not just the aforementioned net income, as calculated per International Financial Reporting Standards or IFRS. It is joined, in equal weighting, by "core earnings," which is not a term you will find in the accounting literature.

It is a phrase, however, that is all over Manulife's earnings reports in recent years. Core earnings, the company explained in its year-end 2015 earnings release, "consist of items we believe reflect the underlying earnings capacity of the business." More explicitly, core earnings exclude "the direct impact of equity markets and interest rates," except that Manulife keeps up to $400-million a year of investment gains in core earnings.

Core earnings also excludes changes in actuarial methods and assumptions in its insurance business, and a bunch of other stuff related to variable annuity guarantees. I apologize for being brief and lacking specificity, but Manulife's explanation of core earnings is nearly as long as this column.

As it happens, Manulife posted core earnings of $3.428-billion, versus a target of $3.565-billion, which is a lot closer to the target. A miss as well, yes, but a smaller one. One big difference: Because IFRS, but not "core earnings," require Manulife to "mark to market" its energy portfolio, Manulife had to subtract $876-million from net income.

Now: How did Manulife miss both targets in the "performance type" labelled "financial success" and still award full bonuses? Well, to start, there's every student's favourite, partial credit. It's not an all-or-nothing affair, and Manulife gives itself some part of the score even in the case of an earnings miss. And there's the other half of the performance scorecard, which includes, for example, "building for the future," weighted at 10 per cent.

Just as there's partial credit, though, there's also extra credit. Manulife's board compensation committee gave the company a 155-per-cent score on "building for the future," which helped offset some of the points lost from the earnings misses.

All of the weightings and scorings ultimately yielded a "company performance score" of 89 per cent, which suggests the executives should fall short of their target bonuses. But wait! "Awards are also based on each executive's individual performance against goals that are tied to major initiatives for the year, and on the executive's contribution to Manulife as a whole." So three of the five executives ended up with bonuses that topped 100 per cent of their target. And since Mr. Guloien's target is 150 per cent of his $1.72-million salary, the result was a $2.88-million bonus.

Which is pretty nice, to return to our original point, for a company that missed its net income target by more than a billion dollars.

Manulife chairman Richard DeWolfe, in his letter to shareholders, says the board "continues to express great confidence in Manulife's senior leadership team," including Mr. Guloien. And, he adds: "As I reflect on 2015, I am disappointed that the impact of weak oil and gas prices and the resulting shortfall in net income has diminished so many positive outcomes and individual accomplishments."

Net income is known colloquially as "the bottom line" because it's typically the final line of the income statement. But as Manulife has shown, it's often far from the final word in determining the size of executive bonuses.