• Definition of “Employee Benefits”

• Benefits included in the definition

• Federal laws covering employee benefits

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• Retain, motivate, and attract employees
• Employer costs are deductible
• No tax payable on interest accumulations, which can reduce
ultimate cost

• Tax deferral
• Forced savings for retirement
• Professional money management
• Lower cost of insurance
• Available when individual insurance unavailable

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• Nondiscrimination rules
• Generally, cannot favor HCEs
• Group insurance differs from individual insurance in several
ways:
• Many people are covered under
one contract
• Coverage costs less than comparable insurance purchased individually
• Individual evidence of insurability is usually not required
• Experience rating is used

• Group insurers observe certain underwriting principles:

• The group should not be formed for the sole purpose of obtaining
insurance
• There should be a flow of persons through the group
• Benefits should be automatically determined by a formula
• A minimum percentage of employees must participate
• Individual members should not pay the entire cost
• The plan should be easy to administer

• Eligibility for group status depends on company policy

and state law
• Usually a minimum size is required
• Employees must meet certain participation
requirements:
• Be a full time employee
• Satisfy a probationary period
• Apply for coverage during the eligibility period
• During the eligibility period, the employee can sign up for
coverage without furnishing evidence of insurability
• Be actively at work when the coverage begins

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• No savings - annual term coverage
• Amount of insurance - various schemes, but not
individually selectable
Typically ,1-5 times annual salary
• Employee designates beneficiary
• Conversion if employee leaves group
• First $50,000 tax free for employee, excess
charged.

• Short-term sick leave plans

• Long-term plans
• Permanent disability
• Integrated plans

• Definition of disability
• Unable to perform all of the duties of your own occupation
• Unable to work in any occupation for which you are reasonably fitted by
education, training, and experience
• Unable to do any substantial gainful activity
• Social Security

• Types of Group Medical Expense Insurance

• Traditional Indemnity
• Managed Care
• HMO
• PPO
• POS
• CDHP

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• Under a traditional indemnity plan:
• Physicians are paid a fee for each covered service
• Insureds have freedom in selecting their own physician
• Plans pay indemnity benefits for covered services up to certain
limits
• Cost-containment has not been heavily stressed
• These plans have declined in importance over time
• Some plans have implemented cost-containment provisions
• Common types include basic medical expense insurance and
major medical insurance

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• Basic medical expense insurance is a generic name for

group plans that provide only basic benefits
• Covers routine medical expenses
• Not designed to cover a catastrophic loss
• Coverage includes:
• Hospital expense insurance
• Plans pay room and board or service benefits
• Surgical expense insurance
• Newer plans typically pay reasonable and customary charges
• Physicians’ visits other than for surgery
• Miscellaneous benefits, such as diagnostic x-rays

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• Major medical insurance is designed to pay a high

proportion of the covered expenses of a catastrophic
illness or injury
• Can be written as a supplement to a basic medical expense plan,
or combined with a basic plan to form comprehensive coverage
• Supplemental major medical insurance is designed to supplement
the benefits provided by a basic plan and typically has:
• High lifetime limits
• A coinsurance provision, with a stop-loss limit
• A corridor deductible, which applies only to eligible medical
expenses not covered by the basic plan

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 • Comprehensive major medical insurance is a combination of
basic benefits and major medical insurance in one policy,
and typically has:
• High lifetime limits
• A coinsurance provision
• A calendar-year deductible
• A plan may contain a family deductible provision

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• Managed care is a generic name for medical expense plans that

provide covered services to the members in a cost-effective manner
• An employee’s choice of physicians and hospitals may be limited
• Cost control and cost reduction are heavily emphasized
• Utilization review is done at all levels
• The quality of care provided by physicians is monitored
• Health care providers share in the financial results through risk-sharing
techniques
• Preventive care and healthy lifestyles are emphasized

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 A health maintenance organization (HMO) is an organized system of

health care that provides comprehensive services to its members for a
fixed, prepaid fee
Basic characteristics include:
 The HMO enters into agreements with hospitals and physicians to provide
medical services
 The HMO has general managerial control over the various services
provided
 Most services are covered in full, with few maximum limits
 Choice of providers is limited
 A gatekeeper physician controls access to specialty care
 Providers may receive a capitation fee, which is a fixed annual payment
for each plan member regardless of the frequency or type of service
provided
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• A preferred provider organization (PPO) is a plan that
contracts with health care providers to provide medical
services to members at reduced fees
• PPO providers typically do not provide care on a prepaid basis,
but are paid on a fee-for-service basis
• Patients are not required to use a preferred provider, but the
deductible and co-payments are lower if they do
• Most PPOs do not use a gatekeeper physician, and employees do
not have to get permission from a primary care physician to see a
specialist

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• A point-of-service plan (POS) is typically structured as an HMO, but

members are allowed to go outside the network for medical care
• If patients see providers who are in the network, they pay little
or nothing out of pocket
• Deductibles and co-payments are higher if patients see
providers outside the network
• Managed care plans generally have lower hospital and surgical
utilization rates than traditional indemnity plans
• Emphasis on cost control has reduced the rate of increase in
health benefit costs for employers

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• A consumer-driven health plan (CDHP) is a generic term for

an arrangement that gives employees a choice of health care
plans
• Designed to make employees more sensitive to health care costs
• In a defined contribution health plan, the employer contributes a
fixed amount, and the employee has a choice of plans, such as an
HMO, PPO, or POS
• In a high-deductible health plan (HDHP), the employee is covered
under a major medical plan with a high deductible and a health
savings account (HAS)

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 • Managed care plans are criticized for:
• Reducing the quality of care, because there is heavy
emphasis on cost control
• Delaying care, because gatekeepers do not promptly
refer patients to specialists
• Restricting physicians’ freedom to treat patients, thus
compromising the doctor-patient relationship
• Current developments include:
• Declining enrollments in HMOs, while enrollments in
PPOs continue to increase
• Increased cost sharing, through higher premiums,
deductibles, coinsurance, and co-payments

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• Other recent developments include:

• Three-tier pricing for prescription drugs, which sets different co-
payment charges for drugs in different categories
• Tiered networks of health care providers, allowing employees to
choose from a narrower network of providers to reduce co-
payment charges
• Disease management programs aimed at chronic diseases, such as
asthma
• Health risk assessments to identify special health needs
• Declining coverage for retired workers

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• The Consolidated Omnibus Budget Reconciliation Act of
1985 (COBRA)
• Employees are allowed to continue health benefits for up to 36
months after a qualified separation from employment
• Also, coverage can be continued after divorce, death of covered
spouse, and other reasons
• Insured must pay up to 102% of (group) premium

• The Health Insurance Portability and Accountability Act (HIPAA)

of 1996
• Attempts to promote labor mobility
• Limits the use of the pre-existing conditions exclusions if the employee
presents evidence of prior health insurance coverage
• Maximum 12 months
• Reduced for previous qualified coverage

• The Family and Medical Leave Act (FMLA)

• Allows employees to leave the job for a variety of medical and family
reasons without pay while guaranteeing an equal or equivalent position
upon return

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• A benefit formula is used to determine contributions or benefits
• In a defined-benefit plan, the retirement benefit is known, but the
contributions will vary depending on the amount needed to fund
the desired benefit
• In a defined-contribution formula, the contribution rate is fixed, but
the retirement benefit is variable

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• Defined-benefit plans:
• The amount can be based on career-average earnings or on a final average
pay, which generally is an average of the last 3-5 years earnings
• Under a unit-benefit formula, both earnings and years of service are
considered
• Some plans pay a flat percentage of annual earnings, while some pay a flat
amount for each year of service
• Some plans pay a flat amount for each employee, regardless of earnings or
years of service

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• Vesting refers to the employee’s right to the employer’s

contributions or benefits attributable to the contributions if
employment terminates prior to retirement
• A qualified defined-benefit plan must meet a minimum vesting
standard:
• Under cliff vesting, the worker must be 100% vested after 5 years of service
• Under graded vesting, the worker must be 20% vested by the 3rd year of
service, and the minimum vesting increases another 20% for each year until
the worker is 100% vested at year 7

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• Faster vesting is required for qualified defined-contribution plans
to encourage greater employee participation
• Employer contributions must be 100% vested after 3 years
• The worker must be 20% vested by the 2rd year of service, and the minimum
vesting increases another 20% for each year until the worker is 100% vested
at year 6

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• Contributions to defined benefit plans are limited:

• For 2013:
• The maximum annual benefit is limited to 100% of the worker’s
average compensation for the three highest consecutive years or
$205,000, whichever is lower
• The maximum annual compensation that can be counted in the
contribution of benefits formula for all plans is $255,000

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• The Pension Benefit Guaranty Corporation (PBGC) is a federal

corporation that guarantees the payment of vested benefits to certain
limits if a private pension plan is terminated
• Benefit depends on year plan terminates and employee’s age
when plan terminates
• For plan terminated in 2013
• Age 45 max = $1,197
• Age 55 max = $2,155
• Age 65 max = $4,790
• Age 75 max = $14,561

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• Funds withdrawn from a qualified plan before age 59½ are
subject to a 10% tax penalty, except under certain circumstances,
e.g., for certain medical expenses
• Pension contributions cannot remain in the plan indefinitely
• Distributions must start no later than April 1st of the calendar year following
the year in which the individual attains age 70½
• If the participant is still working, the distributions can be delayed
• Qualified plans use advance funding to finance the benefits
• The employer systematically and periodically sets aside funds prior to the
employee’s retirement

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• A Section 401(k) plan is a qualified cash or deferred

arrangement (CODA)
• Typically, both the employer and the employees contribute, and the employer
matches part or all of the employee’s contributions
• Most plans allow employees to determine how the funds are invested
• Some plans allow the contributions to be invested in company stock
• Employees can voluntarily elect to have part of their salaries invested in the
Section 401(k) plan through an elective deferral
• Contributions accumulate tax-free, and funds are taxed as ordinary
income when withdrawals are made
• For 2006, the maximum limit on elective deferrals is $15,000 for workers
under age 50

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• A Section 401(k) plan is a qualified cash or deferred

arrangement (CODA)
• For 2009, the maximum annual contribution to a defined-contribution plan is
100% of earnings or $49,000, whichever is lower
• Workers age 50 or older can make an additional catch-up contribution
of $5000 per year

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 • If funds are withdrawn before age 59½, a 10% tax penalty applies, with
some exceptions
• The plan may permit the withdrawal of funds for a hardship
• IRS recognizes four reasons for hardship:
• To pay certain unreimbursable medical expense
• To purchase a primary residence
• To pay post-secondary education expenses
• To make payments to prevent eviction or foreclosure on your home
• The 10% tax penalty applies, but plans typically have a loan provision
that allows funds to be borrowed without a tax penalty
• In the new Roth 401(k) plan, you make contributions with after-tax dollars,
and qualified distributions at retirement are received income-tax free

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• A funding agency is a financial institution that provides for

the accumulation or administration of the funds that will be
used to pay pension benefits
• The plan is called a trust-fund plan if it is administered by a
commercial bank or individual trustee
• If the funding agency is a life insurer, the plan is called an insured
plan
• If both funding agencies are used, the plan is called a split-funded
plan
• A funding instrument is a trust agreement or insurance
contract that states the terms under which the funding
agency will accumulate, administer, and disburse the pension
funds

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• Under a trust-fund plan, all contributions are deposited with

a trustee, who invests the funds according to the trust
agreement
• The trustee does not guarantee the adequacy of the fund, the
principal itself, or interest rates
• A separate investment account is a group pension product
with a life insurance company
• The plan administrator can invest in one or more of the separate
accounts offered by the insurer
• These accounts are popular because pension contributions can be
invested in a wide variety of investments, including stock funds, bond
funds, or similar investments

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• The Employee Retirement Income Security Act of 1974 (ERISA)
• The Age Discrimination in Employment Act of 1967 as amended
(ADEA)
• Civil Rights Act of 1964
• The Retirement Equity Act of 1984 (REA)

• Allocated versus unallocated funding

• Insurance - group deposit administration contracts and
immediate participation guarantee contracts
• Insurance funding

• The decline of defined benefit plans

• The underfunding of pension plans
• The insolvency of the PBGC

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• Profit Sharing - defined contribution plan
• 401(k) - limited pre-tax funding by employee
• 403(b) - for employees of nonprofit employers
• Keogh plans - for the self-employed
• Cafeteria plans - employees choose benefits given a fixed
amount to spend

• Single people not covered by an employer sponsored plan

• Married couples where neither spouse is covered under an
employer sponsored plan
• Single or married couples covered by an employer sponsored
plan, but because they are in lower or middle income levels
they may make deductible contributions as a function of total
income

• The portion attributable to deductible amount is taxed, all

investment income taxed
• Age 59 ½ is earliest age to withdraw without a penalty –
early withdrawal causes regular tax on amount and 10% tax
penalty
• Must begin withdrawal by age 70 ½

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• Newer version of the traditional IRA
• Contributions are not tax deductible but contributions are tax
free when withdrawn after 59 ½ and 5 years
• Investment income tax free if IRS rules followed

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