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2014 Compensation &
Benefits Conference Connecticut Business & Industry Association
Incentive Pay: Making it a Lasting
and True Motivator
Prepared by Consulting Performance, Reward & Talent
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc
(NYSE: AON).
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). 2
Bottom Line on Top
Variable pay has become the primary mechanism to pay for performance
today
There are sub-optimal practices that are inhibiting the effectiveness of variable
pay plans
Now is the time to Get it Right!
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). 3
Road Map for Today’s Discussion
Prevalence and trends
Is incentive pay inherently effective?
Ensuring effective incentive pay
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). 4
Sources of Information
Variable Compensation Measurement™
(VCM ™) Report 2013
Created in 1996
740 U.S. Companies and over 1,000
globally
Broad-based plans
– More than 380 cash variable pay
plans
– Plan information covering over 2
million employees
Plan characteristic driven database
– Prevalence
– Effectiveness
Aon Hewitt U.S. Salary Increase Survey
2014/2015
Created in 1976
Fortune 1000 companies
1,064 companies in 2014
Merit/overall salary increases
Salary structure movement
Variable compensation
Pay practices
Data effective as of June/July 2014
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). 5
Variable
Pay
Fluctuating component of compensation that is delivered contingent upon results
Performance award, usually covering 12 months
Must be re-earned
Does not increase base salary
May or may not be considered in benefits calculation
Defining Variable Pay
Base Pay
Variable
Pay
Total Cash
Compensation
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
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Prevalence of Broad-Based Variable Pay
Broad-based variable pay is a key component of companies’ total
compensation programs
Use of broad-based variable pay is widespread and continuing to expand
47%
51%
61%
68%
60% 59% 61%
67%
72% 70%
78% 81% 80%
77% 78% 78% 80%
90% 90% 88% 88%
92% 90% 90% 91%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Percent Organizations With at Least One Broad-Based Variable Pay Program
Source: Aon Hewitt U.S. Salary Increase Survey 1990–2014
Consulting | Broad-Based Compensation
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Variable Pay is a Global Phenomenon
0 10 20 30 40 50 60 70 80 90 100
United States
Canada
Venezuela
Puerto Rico
Mexico
Chile
Brazil
Argentina
United Kingdom
Switzerland
Sweden
Spain
Netherlands
Italy
Hungary
Germany
Belgium
Austria
Thailand
Taiwan
Singapore
Philippines
Malaysia
Korea
Japan
India
Hong Kong
China
Australia
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
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Eligibility for Variable Pay Across Employee Groups
Percentage of Employees Eligible for Variable Pay Plans
92%
66%
45%
6%
Exempt >$60,000 Exempt <$60,000 Nonexempt Union
Source: VCM Report 2013
Consulting | Broad-Based Compensation
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Aon Hewitt U.S. 2014/2015 Salary Increase Survey—
Variable Pay Budgets by Employee Group
11.3%
6.0%
5.3% 4.6%
11.6%
6.3%
5.2% 5.0%
12.0%
6.2% 6.0%
4.9%
12.0%
6.0% 5.4%
4.8%
12.7%
6.7%
6.1% 5.6%
12.7%
6.8%
5.9%
5.0%
Salaried Exempt Salaried Nonexempt Nonunion Hourly Union
2010 Actual
2011 Actual
2012 Actual
2013 Actual
2014 Actual
2015 Projected
Variable Pay
Pe
rce
nta
ge
of P
ayro
ll
Source: Aon Hewitt Survey—U.S. Salary Increases 2014/2015
Consulting | Broad-Based Compensation
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Industry Variable Pay Outlook for 2015 Salaried-Exempt Employees
20
0
15
12
5
Pe
rce
nta
ge
of P
ayro
ll
Energy Industrial
Machinery/
Equipment Chemicals
18.0 15.3
14.3
Aerospace
8.6 Business/
Computer Services
10.0
Industry
Not for
Profits
9.4
Health Care/
Medical Services
7.9
Construction/
Engineering
15.0
Source: Aon Hewitt Survey—U.S. Salary Increases 2014/2015
Perennial
Winners and
Losers
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Shift in Pay Mix
8.2%
10.0%
5.5%
4.3%
1.8%
3.0%
4.2%
9.7%
12.0% 12.7%
1977 1981 1990 2000 2009 2015 Projected
Salary increase
Variable pay spend
Source: Aon Hewitt Survey—U.S. Salary Increases 1977-2014
Pe
rce
nta
ge
of P
ayro
ll
Change in the Total Compensation Budgets and Spending for Salaried-
Exempt Employees (1977–2015)
Why?
Fixed vs. variable costs
Need to focus and drive
behaviors
Need to create alignment
Perceived control
Shareholder/
analysts value it
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Putting Our 2015 Plan Into Perspective: Salary Increases
5.5
5
4.6 4.3 4.3 4.3
3.6 3.4
3.7
1.8
2.4 2.7
2.9 2.9 2.9 3.0
1990 1991 1992 1993 2000 2001 2002 2003 2008 2009 2010 2011 2012 2013 2014 2015 Projected
Most Recent Recession Had the Most Dramatic Impact
1991 Recession 2002 Recession 2009 Recession
Pe
rce
nta
ge
of P
ayro
ll
Source: Aon Hewitt Survey—U.S. Salary Increases 2014/2015
Consulting | Broad-Based Compensation
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Putting Our 2015 Plan Into Perspective: Variable Pay
4.2 3.8
5.7 5.9
9.7
10.8 10.5
8.8
10.8
12.0 11.3 11.6
12.0 12.0 12.7 12.7
1990 1991 1992 1993 2000 2001 2002 2003 2008 2009 2010 2011 2012 2013 2014 2015 Projected
Upward Trend in Spending
1991 Recession 2002 Recession 2009 Recession
Pe
rce
nta
ge
of P
ayro
ll
Source: Aon Hewitt Survey—U.S. Salary Increases 2014/2015
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
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Funding
The majority of plans are funded as an add-on expense, without specifically
tying it to a formula based on financial/business results
Source: 2013 Aon Hewitt Variable Compensation Measurement (VCM) Report
Consulting | Broad-Based Compensation
Proprietary & Confidential | 2014 Compensation Planning Briefing
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Conclusions
Cost containment on fixed expenses (salaries) will continue for several years
Alternatively, funding for variable expenses (variable pay) is at record
high levels
Spending will continue to rise
– Organizations are placing their pay for performance bets on variable
pay programs
Organizations must be more bold in channeling their limited
dollars to their top performers— even at the risk of
alienating their average performers
Consulting | Broad-Based Compensation
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Incentive Effect
Effect on what current workforce does
Meta-analysis findings on pay for performance (Gerhart & Rynes,
Compensation, Sage, 2003)
– 30% improvement in productivity due to introduction of incentive plans
(Locke et al., 1980)
– 49% improvement in productivity due to introduction of incentive plans
(Judiesch, 1994)
– r = .32 (d = .68) between incentive use and performance
quantity/productivity (Jenkins, Mitra, Gupta, & Shaw, 1998, k = 41 studies)
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Sorting Effect
Effect on who current and future workforce is
High performers are attracted to organizations that pay for performance and
recognize their contributions
High performers will leave organizations that do not reward performance
Low performers will self select out of organizations that emphasize high
performance in rewards
Low performers are more likely to stay with an employer when pay for
performance relationships are weaker
Source: Compensation 11th Edition, Milkovich, Newman & Gerhart
Consulting | Broad-Based Compensation
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Pay differentiation is strongly associated with successful Pay-for-Performance
Effects of Successful Pay-for-Performance Programs on:
…High Performers …Mid-Range Performers …Low Performers
Up Down No Change Up Down No Change Up Down No Change
Engagement 78% 0% 22% 63% 2% 34% 21% 26% 54%
Innovation 80% 3% 18% 45% 5% 51% 11% 21% 68%
Productivity 88% 0% 13% 65% 0% 35% 31% 18% 51%
Quality of work 80% 0% 20% 60% 3% 38% 28% 21% 51%
Teamwork 65% 3% 33% 67% 3% 31% 23% 21% 56%
Turnover 20% 50% 30% 20% 34% 46% 54% 15% 32%
Source: Hewitt—WorldatWork, Joint Research on Pay-for-Performance, 2004
Underperformers start looking
elsewhere
Making the best better!
…and more of them stay
These employees get stronger too…
Keeping more of the right
people
Pay-for-Performance Can Have a Dramatic Impact on the Overall Workforce
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Proprietary & Confidential | 2014 Compensation Planning Briefing
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Incentive and Sorting Effect Combined
Pay for performance (an incentive plan) was introduced at an automobile parts
manufacturing plant that did not have pay for performance previously; the
following effects on productivity were observed
44% increase in productivity
22% (or half) of the increase in productivity was due to those employed before
and after the change being more productive under the incentive plan
The remaining increase in productivity was due to attrition of poor performers
and the addition of new employees with higher performance
Source: E. Lazear
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Point/Counterpoint
Incentive plans are based on faulty underlying psychological assumptions and
are doomed to fail (Kohn, Deming, et al)
Rewards succeed at securing one thing only: temporary compliance
Extrinsic motivators do not alter the attitudes that underlie our behaviors
People who expect to receive an award do not perform as well as those who
do not
Rewards have a punitive effect because they are manipulative
Incentive programs reduce cooperation
When employees compete for a limited number of incentives, they view each
other as obstacles
Employees may be tempted to conceal problems rather than ask for help
Incentives are perceived as bribes, and by association these must be tasks I
wouldn’t want to do
Incentive plans may promote unethical behavior
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Point/Counterpoint
Intrinsic motivation only goes so far (Lawler, et al)
Temporary compliance can be extremely important to an organization
Underlying attitudes may be less relevant than achieving objectives
Not all tasks are intrinsically fun and interesting
Business needs change; incentives are an effective megaphone for
communicating these changes and combatting inertia
Incentive programs can be structured to enhance cooperation
Competition can be a healthy thing
Incentive plans allow organizations to pay people fairly for their performance
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From Our Database
29%
58%
12%
1% 0%
Helped Somewhat helped
Had no effect Somewhat hindered
Hindered
Impact on Business Results
Source: Variable Compensation Measurement™ (VCM™) Report 2013
Consulting | Broad-Based Compensation
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Factors Contributing to the Success
of the Plan
Source: VCM Report 2013
Percent of plans1 n=
Support of executives/management 56% 78
Employee ability to impact results 38% 53
Employee understanding of plan objectives 37% 52
Effective communication of plan 24% 34
Realistic goals/Targets 24% 34
High employee commitment/Participation 19% 27
Appropriate Award Size 16% 22
Continued employee participation in plan design or ongoing goal setting 10% 14
High-level champion 8% 11
Eligibility limited to key contributors 1% 1
Other 5% 7
n=139
1Percentages will total more than 100% since more than one response was provided by some participants
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Factors Hindering the Effectiveness
of the Plan
Percent of Plan1 n=
Poor communication of plan expectations/Objectives 37% 42
Payouts viewed as entitlements by employees 35% 40
Plan design too complex 23% 26
Employees had little ability to impact results 22% 25
Unobtainable targets or goals 17% 19
Lack of employee participation in plan design or ongoing goal setting 15% 17
Award size 12% 14
Lack of executive/management support 5% 6
Lack of employee commitment 4% 5
Inappropriate measures 3% 3
Lack of high-level champion 2% 2
Plan improved results of one measure while reducing another 0% 0
Other 3% 3
The effectiveness of the plan was not hindered 19% 22
n=115 1Percentages will total more than 100% since more than one response was provided by some participants
Source: VCM Report 2013
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Types of Variable Pay Plans
Types of Incentive Plans
Incentive Plan Type
% of companies surveyed
2013 All Industries
Business incentives—Combines financial and/or operating measures for the
company, business unit, department, plan and/or individual performance
58%
Cash profit sharing plans—Designed to award employees a percentage of the
company’s profits. Typically make equal payment (as a flat-dollar amount or percent of
salary) to all or most employees based on organizational profitability.
14%
Individual performance plans—Payouts are based solely on individual performance
criteria and the amount typically varies from one employee to another.
44%
Gainsharing/Productivity plans—Designed to share a percent of cost savings of a
group, unit or organization. Gains are typically shared uniformly among all participants.
5%
Team awards—Designed to reward employees for the result/improvement in team
results. Provide incentives to individuals on a project work team.
17%
Special recognition plans—Plans that are designed to recognize special individual or
group achievements with small cash awards or merchandise.
52%
Source: Aon Hewitt U.S. Salary Increase Survey 2013–2014
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Strategic Impact By Plan Type
Plan type
Incentive
effect
Sorting
effect Bonus Incentive Behaviors Results Individual Group
Business
incentives
Cash profit
sharing
Individual
performance
Gainsharing
Team awards
= Primary impact
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Create focus
on required
results
Share in
successes
and failures
Facilitate
ideas and
improvements
Motivate
desirable
behaviors
Improve
performance
Role of Variable Pay
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Design With Strategic Intent
Bonus
Behaviors
Individual
Incentive
Results
Group
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Bonus Incentive
“Bonus” Versus “Incentive”
Rewards performance after
it occurs
Subjective
Eligibility uncertain
Award uncertain
Payouts discretionary
Share successes/failures
with employees
Goals established up-front
Objective
Eligibility known
Award must be earned
Payouts based on
goal achievement
Intended to change behavior
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Objective
Less reliance on
managerial discretion
More directly aligned with ability
to pay
Behaviors Results
“Behaviors” Versus “Results”
Subjective
Allows for managerial discretion
Can factor in variables
out of employee’s control
Assesses how the
results were achieved
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Individual Group
“Individual” Versus “Group”
Employees want to be judged
on their own contributions
May result in higher
individual productivity
Strong line of sight
All employees measured
and rewarded collectively
and share similar rewards
Less likely to create competition
among employees
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Critical Plan Design Components
Measures
Eligibility
Funding
Alignment
Line of Sight
Plan Mechanics
Targets & Stretch
Participation
Requirements
Communication
Plan
Administration
Measuring P
lan E
ffectiveness
Identifies factors (financial, nonfinancial and individual) to determine performance
Must be controllable and relevant to business
Considers eligibility for both exempt and nonexempt employees
Be as inclusive as possible
Means of funding and spend on variable pay as percent of key financial parameters
Should be accrued, reflective of actual business results and sufficient
Determines the degree of inclusiveness across all-employee groups
Checks for common goals and clear linkages
Analyzes ability of the individual to impact the performance measures
As much direct influence on outcomes as possible
Evaluates levers on which the plan operates
Reflective of pay philosophy and culture, balanced between realistic and challenging
Assesses payout targets and degree of stretch built into target level of performance
Competitive with appropriate pay at risk given line of sight and role
Explores clauses associated with a variable pay plan
Causes under which participation and payouts can be denied
Considers frequency, methods and details of plan features that are communicated
Understandable and communicated goals, timing and updates
Time required to evaluate performance, payouts and frequency of review
Should include assessment of continuous improvement
Source: Variable Pay Index™ (VPI™) 2013
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Aon Hewitt’s Variable Pay Index™ (VPI™)
Source: VCM Report 2013
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Changes in Plan Effectiveness
Actual Score as Percent of Maximum
52%
36%
49% 48% 41%
38%
57%
71%
78%
49% 53%
59%
44%
63%
40%
30%
56%
71%
59%
92%
Measures Eligibility Funding Alignment Line of sight
Plan mechanics
Targets Participation requirements
Commun- -ication
Plan administration
2010
2013
Source: VCM Report 2013
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Comparative Variable Pay Plan Characteristics
Highest Performing
Greater incentive opportunity
Greater emphasis on communication
– Communication vehicles
– Performance targets and updates
on projected results
More accurate goal setting
Realistic goals and targets
Formal recognition of individual
performance when determining
incentive awards
Lowest Performing
More moderate incentive opportunity
Less leveraged incentive
opportunities
Fewer communication methods—
less likely to communicate
Less frequent communication of
performance targets
Broad measures—low line of sight
Entitlement-based payouts for poor
results (payout ratios)
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Line of Sight by Plan Type
Strong
Individual performance
Business incentive
Team awards
Profit sharing
Weak
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Limited Line of Sight: Entitlement or Futility?
Corporate Results
X X X X X
Business Unit Results
Department Results
Individual Results
X
Nonexempts Entry Exempts
Managers Directors Executives
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Relevant Weightings for Line of Sight
Executives
Sr. Leaders
Directors
Managers
Individual Contributors
Clerical/Technical
Organizational
Performance
Weighting
Individual
Performance
Weighting
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Dilutive Impact of Too Many Measures in the Plan
Plan Weights
Employee With $50,000 Salary (5% Bonus Target)
Corporate 50%
■ Net Income 25% $625
■ Revenue 25% $625
Business Unit 20%
■ Cash Flow 10% $250
■ Revenue 5% $125
■ Quality 2.5% $62.50
■ On-Time Delivery 2.5% $62.50
Department 20%
■ Safety 10% $125
■ Attendance 10% $125
Individual 10%
■ Attendance 2% $50
■ Project Completion 3% $75
■ Idea Creation 5% $125
100% $2,500
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Miscalibration of Funding Requirements
$1.0M $1.5M $3.0M $6.5M
Maximum
Target
Threshold
Funding
Funding Gap
Funding Required by Plan
Actual Available Funding
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Bonus Pay Back Design
Grade
Midpoint
Employee
Salary
Salary to Midpoint Comparison
$5,000
Less
Salary
Over
Midpoint
Calculated
Bonus
Payment
Bonus Payout Calculation
$10,000
$5,000 $5,000
Actual
Bonus
Paid
– =
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Why Incentive Pay Has Limited Impact As a Pay Differentiator
For incentive pay to reach its potential as a pay differentiation tool…
An organization has to have a broad-based incentive pay plan
– 10% do not
Employees have to be eligible to participate in the plan
– 34% of exempt employees earning less than $60,000 are not
– 55% of nonexempt employees are not
There has to be an individual performance component
– Only 42% of plans incorporate an individual performance component
There has to be sufficient weighting on the individual component
– The average weighting is 22% of total opportunity
• E.g., of a 10% total target opportunity, the individual performance component is
2.2%
The plan has to allow for sufficient leverage (i.e., upside/downside)
– Typically, it is 50% to 150%
• Continuing the previous example, outstanding individual performance might be
worth 3.3%
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Individual Performance Determination
The most common form of determining employee performance is through a
performance rating
Source: 2013 Aon Hewitt Variable Compensation Measurement (VCM) Report
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How We Can Do Better
Line-of-sight measures
No more than 3 to 5 metrics
Adequate funding modeled for expected performance outcomes
Performance delimited
More weight on individual component
Assess how the plan is working and make changes to the design frequently
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For Further Information
Preston Handler
Norwalk, Connecticut
To learn more about any of our surveys, please visit
www.aon.com/salaryresults
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About Aon Hewitt
Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent,
retirement and health solutions. We advise, design and execute a wide range of solutions that enable
clients to cultivate talent to drive organizational and personal performance and growth, navigate
retirement risk while providing new levels of financial security, and redefine health solutions for greater
choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over
30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information
on Aon Hewitt, please visit www.aonhewitt.com.
© 2014 Aon plc
This document is intended for general information purposes only and should not be construed as advice
or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon
Hewitt's preliminary analysis of publicly available information. The content of this document is made
available on an “as is” basis, without warranty of any kind. Aon Hewitt disclaims any legal liability to any
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