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chapter concepts.
1.1.1 Chapter Summary
Effective management of benefits is crucial for organizations to be competitive, since benefits
are a substantial portion of labor costs. In addition, another concern is the rapid increase in the
cost of health care. Benefits are used to attract and retain employees, and communication
regarding the value of benefits is important. Many organizations are allowing employees to
tailor their own benefits packages in flexible-benefits plans. Since organizations are typically the
major source of economic security for employees, any changes made to benefits plans can have a
significant impact on employees and retirees. In the future it is likely that employees must
become more educated and better consumers relative to such issues as health care and planning
for retirement.
Learning Objectives
After studying this chapter, the student should be able to:
1. Discuss the growth in benefits costs and the underlying reasons for that growth.
2. Explain the major provisions of employee benefits programs.
3. Discuss how employee benefits in the United States compare with those in other
countries.
4. Describe the effects of benefits management on cost and workforce quality.
5. Explain the importance of effectively communicating the nature and value of benefits to
employees.
6. Describe the regulatory constraints that affect the way employee benefits are designed
and administered.
2 Extended Chapter Outline
Note: Key terms appear in boldface and are listed in the “Chapter Vocabulary” section.
2.1.1 Opening Vignette:
Controlling Health Care Costs: Employers Turn to ‘Carrots and Sticks’
Employers are beginning to look at differential cost contributions for employees who do not live
a healthy lifestyle. Michelin North America is one such company – who has employees paying
as much as an extra $1,000 per year if their blood pressure, blood sugar, or waist size exceeds
targets. With the average cost to employers of healthcare premiums being $11,000 per worker,
polling data indicating that overweight workers miss 450 million more days per year than other
workers, and data that suggests that lost productivity costs $153 million per year, employers are
taking notice. Michelin is using wellness plans and adding monetary consequences in attempts
to get employees to be healthy. Questions concerning whether or not these practices might be a
form of “legal discrimination” are beginning to arise. Current law allows a penalty of up to 20%
of the cost of the employee’s healthcare coverage (employees with conditions making it
impossible for them to meet the employer’s goals are exempt from these penalties).
Discussion Question
1. What are some of the reasons that companies are requiring employees to contribute more
and more to the cost of their own healthcare coverage and using penalties for not being
healthy?
The fundamental reason that companies are requiring employees to contribute more and
more to the cost of their own health coverage is to keep costs contained. Companies are
I. Introduction
A. The cost of benefits adds an average of 44.5% to every dollar of payroll, thus
accounting for about 30.8% percent of the total compensation package.
Controlling benefits is crucial for competitiveness.
B. Although it makes sense to think of benefits as part of total compensation,
benefits have unique aspects.
1. There is a question of legal compliance. Although direct compensation is
subject to government regulation, the scope and impact of regulation on
benefits is far greater.
2. Organizations so typically offer them that they have come to be
institutionalized. Providing medical and retirement benefits of some sort
has become almost obligatory for many employers.
3. Compared with other forms of compensation, it is complex. It is relatively
easy to understand the value of a dollar as part of a salary, but not as part
of a benefits package.
II. Reasons for Benefits Growth—Figure 13.1 gives an indication of overall growth in
benefits. Although cash is preferred by most people, since it is less restrictive, the
following factors have contributed to less emphasis on cash and more on benefits:
A. Several laws were passed during and after the Great Depression that mandated
benefits (such as Social Security and unemployment insurance).
B. Wage and price controls instituted during World War II and labor shortages forced
employers to add benefits to attract workers.
C. The tax treatment of benefits is often more favorable for employees than that of
wages and salaries; therefore, benefits are perceived as being of value. The
marginal tax rate is the percentage of an additional dollar of earnings that goes
to taxes (Table 13.1 shows the impact of a $1,000 increase on a worker).
Employers realize tax advantages from certain benefits. For example, Social
Security and Medicare taxes are paid on wages and salaries, but most benefits are
tax-free. Also, for employees, pension plans accrue investment returns tax-free
until retirement.
D. There is a cost advantage in buying insurance in a group rather than as an
individual.
E. Organized labor, which grew from the 1930s to the 1950s, often had benefits as a
key objective (in 1990’s, it is estimated that one-half of striking employees were
striking because of health-care issues). Acquiring benefits represented a tangible
success for unions and was often seen as more important than a small wage
increase.
F. Employers may differentiate themselves to become unique in the eyes of current
or prospective employees (Table 13.2 shows some examples). This way,
employees can set themselves apart from the rest of the pack.
III. Benefits programs usually fall into the following categories: social insurance, private
group insurance, retirement, pay for time not worked, and family-friendly policies. Table
13.3 provides a listing of the prevalence of benefits based on Bureau of Labor Statistics
data.
Social Insurance (Legally Required)
1. Social Security includes provision for old-age insurance, unemployment
insurance, survivors’ insurance, disability insurance, hospital insurance,
and supplementary medical insurance. Having begun with the Social
Security Act of 1935, which only implemented the first two listed, the
combined list is now the federal Old Age, Survivors, Disability, and
Health Insurance (OASDHI) program. Over 90% of American workers
are covered; exceptions are railroad and federal, state, and local
government employees who often have their own plans.
a. Social Security retirement benefits are free from federal tax and
free from state tax in about one-half of the states. Currently, full
benefits begin at age 65 years and 6 months or a reduced benefit
can begin at age 62.
b. Both employers and employees are assessed a payroll tax of 7.65%
(a total of 15.3%) on the first $106,800 of an employee’s earnings.
The 1.45% Medicare tax is assessed on all earnings.
c. The eligibility age for benefits and any tax penalty for earnings
influence retirement decisions. The elimination of the tax penalty
on earnings for those at full retirement age should mean a larger
pool of older workers in the labor force for employers to tap into.
2. Unemployment insurance (established by the Social Security Act of 1935)
has the following objectives: to offset lost income during involuntary
unemployment, to help unemployed workers find new jobs, to provide an
incentive for employers to stabilize employment, and 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).
a. The program is financed through federal and state taxes on
employers.
– The size of the state tax for employers depends on an
experience rating, which is set by the organization’s history
with layoffs. Those who have laid off more workers in the
past pay higher taxes. Management must try to keep this
rating low.
b. Unemployed workers are eligible for benefits if they have worked
steadily in the past (often 52 weeks or four quarters of a work at a
minimum level of pay), are available for and are seeking work,
were not discharged for cause, were not discharged for cause, did
not quit voluntarily, and are not out of work because of a labor
dispute.
– Benefits vary by state, but are usually about 50% of a
person’s earnings in his or her last 26 weeks—some states
with high employment rates may fund longer, and some–
times Congress passes emergency legislation to extend
benefits. Unemployment benefits are taxed as ordinary
income.
3. Workers’ compensation laws protect employees who are involved in
job-related injuries and death. The system is based on no-fault liability,
which means that an employee does not have to establish gross negligence
of the employer, and the employer is protected from lawsuits, unless the
employer contributed to a dangerous workplace. About 90% of U.S.
workers are covered.
a. Workers’ compensation benefits are related to disability income,
medical care, death benefits, and rehabilitative services.
b. Benefits vary by state, but are usually about two-thirds of
predictability earnings and are tax-free. Funding is either through
a state fund, private insurance companies, or self-funding by the
organization. Rates are based on the nature and risk of
occupations, state law, and the organizations experience rating.
c. Many actions can be taken to reduce claims—making the
workplace safer, work redesign, training, and to speed the return to
health, and thus to work.
Private group insurance is offered at the discretion of employers, and plans are not legally
required. Group rates are lower because of economies of scale, the ability to pool
risks, and the greater bargaining power of a group.
1. Medical Insurance
a. Medical insurance tends to be the most important benefit for people.
Most organizations offer this benefit (Text Table 13.3). Types of
medical expenses typically covered are hospital expenses, surgical
expenses, and physicians’ visits. Other plans may include dental and
vision care, birthing centers, and prescription drug programs.
b. The Consolidated Omnibus Budget Reconciliation Act
(COBRA) of 1985 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 termination (except
for gross misconduct), death, and other events.
Competing Through Technology
Controlling Health Care Costs by Fighting Painkiller Abuse: Prescribing a Dose of
High-Tech Algorithms
The cost of painkiller abuse is in the rise, and an analysis of data provided by insurers and
medical-bill review consultants might aid in the creation of guidelines for physicians to use in
deciding when and if they plan to prescribe painkillers and to whom. Rising Medical Solutions,
Inc. is a data analytics company that is working on developing algorithms to assess
whether an individual is low, medium or high risk for prescription painkiller abuse. Employers
can also use this data to benchmark worker’s compensation cases. Doctors have expressed
concern that using algorithms could result in for some people in legitimate need of painkillers.
Discussion Question
1. Would you recommend that other companies follow a similar approach?
2. Do you feel that the rights and needs of workers are adequately addressed?
2. Disability insurance includes short-term plans that provide coverage for
six months or less, at which point long-term plans take over (often for
life). Salary replacement is most often between 50 and 70%. Benefits
based on employer contributions are taxed.
Retirement—Employers have no obligation to provide retirement plans, although most
do. If provided, the plan must meet the standards of Employee Retirement
Income Security Act (ERISA). Social Security generally composes
approximately 39% of retirees’ income, the combination of private pensions
(18%), earning from assets (16%), elderly’s income comes from earnings (24%),
and other sources (3%).
1. Defined Benefit Plan—Guarantees a specified retirement benefit level to
employees, usually based on a combination of age and service as well the
employee’s earnings (usually the five highest earning years).
a. Defined benefit plans insulate employees from investment risk,
which is borne by the company. The Pension Benefit Guaranty
Corporation (PBGC) guarantees to pay employees a basic
retirement benefit in the event that financial difficulties force a
company to terminate or reduce employee pension benefits. This
agency was established by the Employee Retirement Income
Security Act (ERISA) of 1974, which increased the fiduciary
responsibilities of pension plan trustees, and established vesting
rights and portability provisions. PBGC guarantees a basic benefit,
not full replacement.
2. Defined Contribution Plan—Do not promise employees a specific benefit
level upon retirement. Rather, an individual account is set up for each
employee with a guaranteed size of contribution. Employers therefore
shift investment risk to the employee. They do not have to calculate
payments based on age and service, and there is no need to make
payments to PBGC. In small companies, this plan is more prevalent (Text
Table 13.3). A few types of defined contribution plans are:
a. A Money Purchase Plan—An employer specifies a level of annual
contribution, and at retirement the employee receives the
contribution and investment returns. Employees typically purchase
an annuity rather than taking the money as a lump sum.
b. Profit sharing plans and employee stock ownership plans are often
used as a retirement vehicle.
c. Section 401(k) plans (the term comes from the tax code section)
permit employees to defer compensation on a pretax basis. Annual
contributions in 2004 are limited to $13,000 and are adjusted each
year according to the Consumer Price Index.
3. Cash balance plans – An 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.
4. Funding, Communication, and Vesting Requirements—Besides specifying
termination procedures as mentioned, ERISA requires certain guidelines to
be met on management and funding. Employers are required to fund
future obligations sufficiently. There are a number of reporting and
disclosure requirements to the IRS, to the Department of Labor, and to
employees. For example, employees must receive within 90 days after
entering a plan a summary plan description (SPD) which obligates
employers to describe the plan’s funding, eligibility requirements, risks,
and so on.
a. ERISA also guarantees that employees, after working a certain
number of years, earn the right to a pension at retirement. These
are referred to as vesting rights. Even if an employee leaves the
organization before retirement, the contributions are vested.
Employee contributions are always vested. These requirements
were designed to prevent organizations from terminating
employees right before retirement or before they vest in the plan.
Vesting schedules that may be used are as follows:
(1) Employees are vested after five years of service.
(2) Employers may vest employees over a three– to seven-year
period, with at least 20 percent vesting in the third year and
each year thereafter.
b. In recent, many companies have sought to reduce their work forces
through early retirement programs is also consistent with the
notion that pensions are used to retain certain employees while
encouraging others to leave.
c. Greater mobility from employer to employer may tend to
encourage defined contribution plans, since they tend to be more
portable (transfer of funds) across employers.
3 Pay for Time Not Worked
1. Some employers may see little advantage to paid vacation, holidays, sick
leave, and so on, since employers pays the employee for time not spent
working, receiving no tangible production value in return. In the United
States, there is no legal minimum, although 10 days is common. Workers
may have to have 20 to 25 years of tenure before receiving as much paid
vacation as their western European friends. A comparison of hours worked
by employees in several other countries relative to the US can be seen in
Figure 13.3.
2. Sick leave programs often provide full salary replacement for a limited
period of time, usually not exceeding 26 weeks. The amount of sick leave
is often based on length of service, accumulating with service. If
employees still have designated “sick leave” days at the end of each year,
they may develop a “use it or lose it” mentality. Organizations try to avoid
this by encouraging employees to accumulate sick days or pay employees
(often a portion) for unused sick days.
Family-friendly Policies-Organizations are more frequently taking steps beyond work
schedules to ease the family-work conflicts. These include child care and family
leave policies.
1. Family Leave – The Family and Medical Leave Act requires organiza-
tions with 50 or more employees within a 75-mile radius to provide as
much as 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. Employees are guaranteed the same or comparable job when they
return to work. Employers have to continue providing medical benefits
while the employee is on FMLA leave. Employees with less than a year of
service or those who work less than 25 hours a week or who are the 10
percent highest paid are not covered.
2. Child Care—Employers may provide some type of child care support to
employees: child-care information, vouchers or discounts for existing
child care services, or child care at or near their worksites. Matching the
work force needs to the program should choose the appropriate alternative.
IV. Managing Benefits: Employer Objectives and Strategies – although some constraints are
imposed legally, organizations have a great deal of latitude and need to evaluate the
payoff of benefits. If organizations do not meet the expectations of employees, however,
they violate an “implicit contract” between employer and employees. If employees do
not feel that employers are committed to their welfare, they will not commit themselves
to the company’s success. Many organizations do not have written objectives (see Table
13.5 for an example of one company’s objectives).
A. Surveys and Benchmarking—The company should know what the competition is
doing. Surveys are available from private consultants, U.S. Chamber of
Commerce, and the Bureau of Labor Statistics (BLS). Costs data are available
from the BLS (Table 13.3).
B. Cost Control—The larger the cost of a benefit, the greater the possibility for
savings. The rate growth must also be monitored since there may be future
problems. Cost containment is possible only if the employer has discretion in
revising benefits. Some legally required benefits can be controlled by experience
ratings (see the example under workers’ compensation).
Health Care: Controlling Costs and Improving Quality – in the United
States, health-care expenditures have gone from 5.3% of the GNP ($27
billion) in 1960 to 18% (approximately $2.7 trillion) recently. Table 13.6
indicates that the United States spends more on health care than any other
country in the world, yet there is widespread dissatisfaction.
1. Attempts at cost control have come through employers, since most health
care is provided through organizations rather than through national health
care as in Western Europe and Canada. These efforts, called managed care,
involve plan design, use of alternative providers, use of alternative funding
methods, claims review, education and prevention, and external cost
control systems.
2. Another trend is to shift costs to employees through the use of deductibles,
coinsurance, exclusions and limitations, and maximum benefits. Also,
cost reduction is attempted through preadmission testing and second
opinions on the need for surgery.
3. The use of alternative providers has increased. Health maintenance
organizations (HMO) focus on preventive care and outpatient treatment,
requiring employees to use only HMO services and providing benefits on
a prepaid basis. HMOs pay physicians and other health-care workers on a
flat salary basis to reduce incentives to increase patient visits or tests.
Preferred provider organizations (PPOs) are groups of health care
providers who contract with employers, insurance companies, and so on,
to provide health care at reduced fees. They do not provide benefits on a
prepaid basis, and employees often are not required to use just the PPOs.
Employers will provide incentives to use PPOs. PPOs tend to be less
expensive than traditional health care but more expensive than HMOs.
Employers may also vary employee contributions based on the
employee’s health and risk factors.
4. Employee wellness programs (EWPs) focus on changing behaviors both
on and off work time that could eventually lead to future health problems.
a. There are two broad classes of EWP’s, passive and active. Passive
programs use little or no outreach to individuals and provide no
ongoing motivational support. Active wellness centers assume that
behavior change requires not only awareness and opportunity, but
also support and reinforcement.
b. Examples of passive programs include health education programs
and fitness facilities. Active programs may be similar to the
passive programs but include counselors who handle one-on-one
outreach, tailored programs, and reinforcement.
5. Health care costs and quality: Ongoing challenges—Two important
phenomena are often encountered in cost-control efforts: (1) piecemeal
programs may not work well, and steps to control one aspect of costs may
lead employees to try and use other programs; and (2) there is often a so
called Pareto group, which refers to a small percentage of employees
being responsible for generating the majority of health care costs.