MODULE 13

EMPLOYEE
BENEFITS
 Introduction
Benefits seem to influence whether potential employees come to work for a
company, whether they stay, when they retire—perhaps even how they perform.
Although employers continue to be focused on cost control, as the chapter-opening
story indicates, different employees look for different types of benefits. Benefits can be
used to differentiate an employer from competitors, allowing it to tap into what in some
cases may be a valuable, but underutilized, part of the pool of human capital.

Benefits have unique aspects. First, there is the question of legal compliance. A
second unique aspect of benefits is that organizations so typically offer them that they
have come to be institutionalized. A third unique aspect of benefits, compared with
other forms of compensation, is their complexity.
Economic theory tells us that people prefer a
dollar in cash over a dollar’s worth of any
specific commodity because the cash can be
used to purchase the commodity or
something else. Cash is less restrictive.
Several factors, however, have contributed to
less emphasis on cash and more on benefits
in compensation.

To understand these factors, it is useful

to examine the growth in benefits over
time and the underlying reasons for
that growth.
 Factors that contributed to this tremendous growth:
1. During the 1930s several laws were passed as part of Franklin Roosevelt’s New
Deal, a legislative program aimed at buffering people from the devastating
effects of the Great Depression.
2. Wage and price controls instituted during World War II, combined with labor
market shortages, forced employers to think of new ways to attract and retain Marginal tax
employees. rate is the
3. The tax treatment of benefits programs is often more favorable for employees percentage of
than the tax treatment of wages and salaries, meaning that a dollar spent on additional
benefits has the potential to generate more value for the employees than the earnings that
same dollar spent on wages and salaries. goes to taxes.
4. The cost advantage that groups typically realize over individuals.
5. The growth of organized labor from the 1930s through the 1950s. This growth
was partly a result of another piece of New Deal legislation, the National Labor
Relations Act, which greatly enhanced trade unions’ ability to organize workers
and negotiate contracts with employers.
 Most benefits fall into the one of the
following categories:

•Social Insurance
•Private Group Insurance
•Retirement
•Pay for Time Not Worked
•Family-friendly Policies
 Social Insurance (Legally Required)
Social Security
Among the most important provisions of the Social Security Act of 1935 was the
establishment of old-age insurance and unemployment insurance. The act was later amended
to add survivor’s insurance (1939), disability insurance (1956), hospital insurance (Medicare
Part A, 1965), and supplementary medical insurance (Medicare Part B, 1965) for the elderly.
Together these provisions constitute the federal Old Age, Survivors, Disability, and Health
Insurance (OASDHI) program. More than 90% of U.S. employees are covered by the program,
the main exceptions being railroad and federal, state, and local government employees, who
often have their own plans.

An important attribute of the Social Security retirement benefit is that for those at full
retirement age, it is free from state tax in about half of the states and free from federal tax if
no other income is received or if that other income falls below a certain level (recently, $25,000
for single tax return filers, $32,000 for married/joint filers. Additionally the federal tax code has
an earnings test for those who are still earning wages.
 Percentage of Full-
Time Workers in U.S.
Private Industry with
Access to Selected
Benefits Programs by
Establishment Size

Total Hourly
Compensation and
Benefit Costs, U.S.
Civilian Workers, by
Establishment Size
 Social Insurance (Legally Required)
Unemployment Insurance

Established by the 1935 Social Security Act, this program has four major objectives:
(1) to offset lost income during involuntary unemployment,
(2) to help unemployed workers find new jobs,
(3) to provide an incentive for employers to stabilize employment, and
(4) to preserve investments in worker skills by providing income during short-term layoffs
(which allows workers to return to their employer rather than start over with another
employer).

The unemployment insurance program is financed largely through federal and state
taxes on employers. And a very important feature of the unemployment insurance program
is that no state imposes the same tax on every employer. Instead, the size of the tax
depends on the employer’s experience rating.
Social Insurance (Legally Required)
Workers’ Compensation

Workers’ compensation laws cover job-related injuries and death. Prior to enactment of
these laws, workers suffering work-related injuries or diseases could receive
compensation only by suing for damages. Workers’ compensation benefits fall into four
major categories:

1. disability income,
2. medical care,
3. death benefits, and
4. rehabilitative services
 Private Group Insurance
Group insurance rates are typically lower than individual rates because of economies of
scale, the ability to pool risks, and the greater bargaining power of a group. This cost advantage,
together with tax considerations and a concern for employee security, helps explain the prevalence
of employer-sponsored insurance plans.

TWO MAJOR TYPES OF PRIVATE GROUP INSURANCE

Medical Insurance

Not surprisingly, public opinion surveys indicate that medical benefits are by far the most
important benefit to the average person. The most important issue in benefits management is
the challenge of providing quality medical benefits while controlling costs.
Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985 is act that requires
employers to permit employees to extend their health insurance coverage at group rates for up
to 36 months following a qualifying event, such as a layoff.
 Disability Insurance
Two basic types of disability coverage exist, the short-term and long-term disability insurance.
Short-term plans typically provide benefits for six months or less, at which point long-term plans take
over, potentially covering the person for life.
Federal income taxation of disability benefits depends on the funding method. Where employee
contributions completely fund the plan, there is no federal tax. Benefits based on employer
contributions are taxed. Finally, disability benefits, especially long-term ones, need to be coordinated
with other programs, such as Social Security disability benefits.

Retirement
We discussed the old-age insurance part of Social Security, a legally required source of
retirement income. This remains the largest single component of the elderly’s overall retirement
income (35%). Other sources of income are pensions (17%), earnings from assets (savings and
other investments like stocks and bonds, 11%), earnings (34%) and other sources (3%).
 Retirement
Defined Benefit
A defined benefit plan guarantees (“defines”) a specified retirement benefit level to
employees based typically on a combination of years of service and age as well as on the employee’s
earnings level (e.g., the three to five highest earnings years). Defined benefit plans insulate
employees from investment risk, which is borne by the company. In the event of severe financial
difficulties that force the company to terminate or reduce employee pension benefits, the Pension
Benefit Guaranty Corporation (PBGC) provides some protection of benefits.

Pension Benefit Guaranty Corporation (PBGC) -the agency that guarantees to pay
employees a basic retirement benefit in the event that financial difficulties force a
company to terminate or reduce employee pension benefits.

Employee Retirement Income Security Act (ERISA)- the 1974 act that increased the
fiduciary responsibilities of pension plan trustees, established vesting rights and
portability provisions, and established the Pension Benefit Guaranty Corporation (PBGC).
 Retirement
Defined Contribution
It does not promise a specific benefit level for employees upon retirement. Rather, an
individual account is set up for each employee with a guaranteed size of contribution.

The Pension Protection Act (PPA) of 2006 requires defined contribution plans holding publicly traded
securities to provide employees with (1) the opportunity to divest employer securities and (2) at
least three investment options other than employer securities.

Cash Balance Plans

It is a type of retirement plan in which the employer sets up an individual account for
each employee and contributes a percentage of the employee’s salary; the account earns interest at
a predefined rate.
 Retirement
Funding, Communication, and Vesting Requirements

ERISA does not require organizations to have pension plans, but those that are set up must
meet certain requirements. In addition to the termination provisions discussed earlier, plans
must meet certain guidelines on management and funding.

Summary Plan Description (SPD) - a reporting requirement of the Employee Retirement

Income Security Act (ERISA) that obligates employers to describe the plan’s funding,
eligibility requirements, risks, and so forth within 90 days after an employee has entered the
plan.

ERISA guarantees employees that when they become participants in a pension plan and
work a specified minimum number of years, they earn a right to a pension upon retirement.
These are referred to as vesting rights. Vested employees have the right to their pension at
retirement age, regardless of whether they remain with the employer until that time.
Employee contributions to their own plans are always completely vested.
Pay For Time Not Worked
At first blush, paid vacation, holidays, sick leave, and so forth may not seem
to make economic sense. The employer pays the employee for time not spent
working, receiving no tangible production value in return. Therefore, some
employers may see little direct advantage. Perhaps for this reason, a minimum
number of vacation days (20) is mandated by law in the European Community.
Sick leave programs in the United States, among employers that provide them,
often provide full salary replacement for a limited period of time, usually not
exceeding 26 weeks.
 Family-friendly Policies
To ease employees’ conflicts between work and nonwork, organizations may use family-friendly
policies such as family leave policies and child care.

Family and Medical Leave Act - the 1993 act that requires employers with 50 or more employees to
provide up to 12 weeks of unpaid leave after childbirth or adoption; to care for a seriously ill
child, spouse, or parent; or for an employee’s own serious illness.

Child Care

U.S. companies increasingly provide some form of child care support to their employees. This
support comes in several forms that vary in their degree of organizational involvement.
 There is much room for progress in the
evaluation of benefits decisions. Despite
some of the obvious reasons for benefits—
group discounts, regulation, and minimizing
compensation related taxes—organizations
do not do as well as they could in spelling
out what they want their benefits package to
achieve and evaluating how well they are
succeeding.
Survey and Benchmarking
As with cash compensation, an important element of benefits management is
knowing what the competition is doing.

Cost Control
In thinking about cost control strategies, it is useful to consider several factors. First,
the larger the cost of a benefit category, the greater the opportunity for savings.
Second, the growth trajectory of the benefit category is also important: even if costs are
currently acceptable, the rate of growth may result in serious costs in the future. Third,
cost containment efforts can only work to the extent that the employer has significant
discretion in choosing how much to spend in a benefit category.
 Cost Control
Health Care: Controlling Costs and Improving Quality
Health Maintenance Organization (HMO) - a health care plan that provides benefits on a prepaid basis
for employees who are required to use only HMO medical service providers.
Preferred Provider Organization (PPO) - a group of health care providers who contract with employers,
insurance companies, and so forth to provide health care at a reduced fee.
Employee Wellness Programs (EWPs) focus on changing behaviors both on and off work time that could
eventually lead to future health problems.

Two important phenomena are often encountered in cost control efforts. First, piecemeal
programs may not work well because steps to control one aspect (such as medical cost shifting)
may lead employees to “migrate” to other programs that provide medical treatment at no cost to
them (like workers’ compensation). Second, there is often a so called Pareto group, which refers
to a small percentage (perhaps 20%) of employees being responsible for generating the majority
(often 80%) of health care costs.

Staffing Responses to Control Benefits Cost Growth

Employers may change staffing practices to control benefits costs.
 Nature of the Workforce
Employers must also consider the specific demographic composition and preferences of their
current workforces in designing their benefits packages. At a broad level, basic demographic
factors such as age and sex can have important consequences for the types of benefits
employees want.

COMMUNICATING WITH EMPLOYEES AND MAXIMIZING BENEFITS VALUE

Employees Typically Underestimate the Value of their Benefits

Effective communication of benefits information to employees is critical if employers

are to realize sufficient returns on their benefits investments. Research makes it
clear that current employees and job applicants often have a very poor idea of what
benefits provisions are already in place and the cost or market value of those
benefits. Organizations can help remedy the problem of applicants’ and employees’
lack of knowledge about benefits.
COMMUNICATING WITH EMPLOYEES AND MAXIMIZING BENEFITS VALUE
Flexible Benefits Plans
Rather than a single standard benefits package for all employees, flexible benefit plans (flex-
plans or cafeteria-style plans) permit employees to choose the types and amounts of benefits
they want for themselves.

Potential advantages of such plans:

- Employees can gain a greater awareness and appreciation of what the employer provides
them, particularly with plans that give employees a lump sum to allocate to benefits.
- By permitting employee choice, there should be a better match between the benefits
package and the employees’ preferences.
- Employers may achieve overall cost reductions in their benefits programs.

Flexible Spending Accounts

A flexible spending account permits pretax contributions to an employee account that can be drawn on
to pay for uncovered health care expenses (like deductibles or copayments).
 Benefits
Communication
Methods Used by
Organization

Percentage of
Employees Preferring
Various Benefits
Communication
Methods
 Affordable Care Act
The Affordable Care Act, signed into law in 2010, has several provisions that will have a major impact on
employers as they are implemented through the year 2018.

Nondiscrimination Rules, Qualified Plans and Tax Treatment

As a general rule, all benefits packages must meet certain rules to be classified as qualified plans. The
advantage of qualified plans is basically, it receives more favorable tax treatment than a nonqualified plan.
In the case of a qualified retirement plan, for example, these tax advantages include :
(1) an immediate tax deduction for employers for their contributions to retirement funds,
(2) no tax liability for the employee at the time of the employer deduction, and
(3) tax-free investment returns (from stocks, bonds, money markets, or the like) on the retirement funds.

Each benefit area has different rules. It would be impossible to describe the various rules here, but some general
observations are possible. Taking pensions as an example again, vesting requirements must be met. More
generally, qualified plans must meet so-called nondiscrimination rules. Basically, this means that a benefit cannot
discriminate in favor of “highly compensated employees.”
 The Affordable
Care Act: Impact
on Employers
Sex, Age, and Disability
Sex
A second area of concern for employers in ensuring legal treatment of men and women in
the benefits area has to do with pension benefits. Women tend to live longer than men, meaning
that pension benefits for women are more costly, all else being equal.

Age
Two major age-related issues have received attention under the Age Discrimination in
Employment Act (ADEA) and later amendments such as the Older Workers Benefit Protection
Act (OWBPA):

1. Employers must take care not to discriminate against workers over age 40
in the provision of pay or benefits. As one example, employers cannot generally cease accrual
(stop the growth) of retirement benefits at some age (like 65) as a way of pressuring older
employees to retire.
2. Early retirement incentive programs need to meet the following standards to avoid legal liability:
• the employee is not coerced to accept the incentive and retire,
• accurate information is provided regarding options, and
• the employee is given adequate time (is not pressured) to make a decision.

Disability

Employers also have to comply with the Americans with Disabilities Act (ADA), which went
into effect in 1992. The ADA specifies that employees with disabilities must have “equal access
to whatever health insurance coverage the employer provides other employees.” However, the
act also notes that the terms and conditions of health insurance can be based on risk factors as
long as this is not a subterfuge for denying the benefit to those with disabilities.
Monitoring Future Benefits Obligations

Financial Accounting Statement (FAS) 106, issued by the Financial Accounting Standards
Board, became effective in 1993. This rule requires that any benefits (excluding pensions)
provided after retirement (the major one being health care) can no longer be funded on a pay-
as-you-go basis. Rather, they must be paid on an accrual basis, and companies must enter
these future cost obligations on their financial statements. The effect on financial statements
can be substantial. Increasing retiree health care costs (and the change in accounting
standards) have also led some companies to require white-collar employees and retirees to
pay insurance premiums for the first time in history and to increase copayments and
deductibles.
“You cannot mandate
productivity: you must
provide tools to let people
become their best.”
- Steve Jobs