CHAPTER TWELVE
THE BENEFIT DETERMINATION PROCESS
Overview
Part Five of the text discusses the key issues associated with employee benefits. Given the
rapid escalation in the cost of employee benefits, organizations are advised to evaluate the
effectiveness of their benefit adoption, retention, and termination procedures. Since employee
benefits cost more than $10 trillion per year, companies are increasingly paying attention to
this reward component. Unfortunately, the contribution employee benefits can make to an
organization is unclear. The degree to which benefits impact an organization’s ability to
attract, retain, and motivate employees is not known. Compounding this issue is the
ever-present entitlement problem. Employees perceive benefits as a right, independent of how
well they or the company performs. Efforts to reduce benefit levels or eliminate parts of the
package altogether would meet with employee resistance and dissatisfaction.
Assuming that organizations must find ways to control the costs of benefits wherever possible,
this section of the text focuses on identifying ways to maximize the returns from benefit
expenditures. Chapter 12 identifies issues organizations should face in developing and
maintaining a benefit program. A model of the benefit determination process is also
presented, to proved a structure for thinking about employee benefits. Chapter 13 provides a
summary of the state of employee benefits today. Hopefully this will provide the groundwork
for the innovative and effective benefit packages of tomorrow.
This chapter outlines the reasons for the growth in employee benefits, and studies on the value
of employee benefits as perceived by employees. Next, details related to the key issues in
benefit planning, design, and administration are presented. The chapter concludes with the
presentation of a model of the key factors influencing benefit choices, from both an
employer’s and employee’s perspective.
Learning Objectives
Analyze the reasons for the growth of employee benefits and understand the value of
employee benefits.
Identify the key issues in benefit planning, design, and administration.
Understand both employer factors and employee factors as they relate to the
components of a benefit plan.
Discuss aspects of administering the benefit program including employee benefit
communication, claims process, and cost containment.
Lecture Outline: Overview of Major Topics
I. Why the Growth in Employee Benefits?
II. The Value of Employee Benefits
III. Key Issues in Benefit Planning, Design, and Administration
IV. Components of a Benefit Plan
V. Administering the Benefit Program
VI. Your Turn: World Measurement
Lecture Outline: Summary of Key Chapter Points
In comparison to the “benefits” from the past, today’s reality seems staggering. Companies
that made the Fortune magazine list of “100 Best Companies to Work For in America.”
recognize the importance of taking care of employees’ needs as a key factor in attracting and
retaining the best employees. A first-class benefit plan includes a mix of the following
benefits:
Education reimbursement
On-site child care services
Car cleaning
Financial counseling
Concierge services
Retirement benefits
Now consider some of the extra benefits at Google, the number 1 rated company to work at:
12 weeks of fully paid leave for new parents of either gender.
$500 in “Baby Bonding Bucks”
Liberal policies for volunteering.
On-site fitness centers and medical care.
Lavish paid lunches daily.
College reimbursement for tuition.
Google would argue that these extra services are important benefits of employment, making
attraction, retention, and motivation of employees much easier. But the truth is, companies
don’t know if even ordinary benefits have positive payoffs. Companies do know that
employees consistently rate benefits a key factor in job satisfaction even though less than
one-half of employees are actually satisfied with their benefits. Unfortunately, though, there is
a mismatch between cost to employer and perceived value to employee: the cost is much
higher than employee estimate.
Until companies can clearly identify the advantages of employee benefits, they need to find
ways to control their costs or at least slow their growth. Exhibit 12.1 illustrates the rapid rise
in employee benefit costs, moving from about 25 percent of payroll costs in 1959 to over 40
percent by some calculations. As the exhibit illustrates, employee benefits can no longer
realistically be called “fringe benefits”.
Definition: Employee benefits are that part of the total compensation package, other than pay
for time worked, provided to employees in whole or in part by employer payments (e.g., life
insurance, pension, workers’ compensation, vacation).
Over one 20-year period (1955-1975), employee benefit costs rose at a rate almost four
times greater than employee wages or the consumer price index.
A similar comparison for the period 1963–1987 showed that the rate of growth had
slowed (benefit costs rose twice as fast as wage costs).
And a still later comparison, for the period 1993–1999, the cost of benefits actually
stabilized at about $14,700 per full-time employee.
Recently, though, benefit costs have begun to heat up again—with survey results from
2014 showing the average cost ranging from $9.60–$15.78 per hour worked for
civilian and government workers.
oFor a standard 35-hour workweek, this translates into an average annual benefit
cost of roughly $16,800 to $27,695. That translates into health care costs that have
more than doubled since 1990.
oPension costs also are an area of concern. There are companies that face huge
unfunded pension liabilities. Problems may even be worse in the public sector,
where state governments have regularly underfunded pension plans.
I. Why the Growth in Employee Benefits?
A. Wage and Price Controls
During both World War II and the Korean War, the federal government instituted
strict wage and price controls.
With strict limitations on the size of wage increases, both unions and employers
sought new and improved benefits to satisfy worker demands.
This was the catalyst for growth in pensions, health care coverage, time off, and
the broad spectrum of benefits virtually unthinkable before 1950.
B. Unions
The climate fostered by the wage and price controls created a perfect opportunity
for unions to exercise these rights they had acquired under the Wagner Act of
1935. Several National Labor Relations Board rulings during the 1940s freed
unions to negotiate over employee benefits.
With little freedom to raise wages during the war, unions fought for the
introduction of new benefits and improvement of existing benefits.
Largely through the efforts of unions, most notably the autoworkers and
steelworkers, several benefits common today were given their initial impetus:
pattern pension plans, supplementary unemployment compensation, extended
vacation plans, and guaranteed annual wage plans.
C. Employer Impetus
Many of the benefits in existence today were provided at employer initiative.
Much of this initiative can be traced to pragmatic concerns about employee
satisfaction and productivity.
oRest breaks often were implemented in the belief that fatigue increased
accidents and lowered productivity.
oSavings and profit-sharing plans were implemented to improve
performance and provide increased security for worker retirement.
Indeed, many employer-initiated benefits were designed to create a climate in
which employees perceived that the management was genuinely concerned for
their welfare.
However, without hard data about payoffs, benefits slowly became a costly
entitlement of the American work force.
D. Cost Effectiveness of Benefits
Another important and sound impetus for the growth of employee benefits is
their cost effectiveness in two situations:
oThe first cost advantage is that most employee benefits are not taxable.
Provision of a benefit rather than an equivalent increase in wages avoids
payment of federal and state personal income tax.
oA second cost-effectiveness component of benefits arises because many
group-based benefits (e.g., life, health, and legal insurance) can be obtained at
a lower rate than could be obtained by employees acting on their own. Group
insurance also has relatively easy qualification standards, giving security to a
set of employees who might not otherwise qualify.
E. Government Impetus
The government has played an important role in the growth of employee benefits.
Three employee benefits are mandated by either the state or federal government.
oWorkers’ compensation (state)
oUnemployment insurance (federal)
oSocial security (federal)
In addition, most other employee benefits are affected by such laws as the
Employee Retirement Income Security Act (ERISA), which affects pension
administration, and various sections of the Internal Revenue Code.
Most recently, the highly controversial Patient Protection and Affordable Care
Act signed into law is currently impacting corporate practices dramatically, as
we’ll see in the next chapter.
II. The Value of Employee Benefits
Exhibit 12.2 shows the relative importance employees attached to different
types of benefits across five different studies. In general, the five studies reported in
Exhibit 12.2 show remarkably consistent results over the past two decades.
oFor example, medical benefits continue to be ranked tops in importance for most
employee groups. These rankings have added significance when we note that
today an employer pays on average $6,025 for health coverage of a single
employee. That figure jumps to $16,834 for a family.
The trillions of dollars employers spend on benefits each year would not seem
nearly so outrageous if there was evidence that employees place high value on the
benefits they receive.
oIn one study employees were asked to recall the benefits they received. The
typical employee could recall less than 15 percent of them.
For the past 20 years, it has been argued that benefits are taken for granted.
Now, though, with companies cutting back benefits, or shifting costs to employees
(or retirees), the air of entitlement is fast disappearing.
oA study by the Society of Human Resource Management indicates both
employees and HR professionals see benefits as the top factor driving job
satisfaction.
One possible direction out of the money pit comes from recent reports of
employees looking not necessarily for more benefits, but rather for greater choice in
the benefits they receive.
oThe perceived value of benefits rises when employers introduce choice through a
flexible benefit package.
oMaybe better benefit planning, design, and administration offer an opportunity to
improve benefit effectiveness. Indeed, preliminary evidence indicates employers
are making serious efforts to educate employees about benefits, with an outcome
of increased awareness.
oSome experts speculate that a key element in reward attractiveness (and benefits)
may be their visibility. Not only do employers have to plan and design an
effective benefit program, they also need to communicate their value to
employees.
III. Key Issues in Benefit Planning, Design, and Administration
A. Benefits Planning and Design Issues
Employers need to decide the role of benefits in their overall compensation
package.
In addition to integrating benefits with other compensation components, the
planning process also should include strategies for ensuring external
competitiveness and adequacy of benefits.
oCompetitiveness requires an understanding of what other firms in your
product and labor markets offer as benefits. Firms conduct benefit surveys
much as they conduct salary surveys.
oEnsuring that benefits are adequate is a somewhat more difficult task.
Most organizations evaluating adequacy consider the financial liability of
employees with and without a particular benefit.
There is no magic formula for defining benefit adequacy. In part, the
answer may lie in the relationship between benefit adequacy and the third
plan objective: cost of effectiveness.
More organizations need to consider whether employee benefits are
cost justified.
More frequently than ever before, companies are saying no to
absorbing the cost increases of benefits. One survey shows that 59
percent of employers are shifting increased benefit costs to employees
through higher deductibles and co-pays, for example.
B. Benefit Administration Issues
Four major administration issues arise in setting up a benefit package:
oWho should be protected or benefited?
oHow much choice should employees have among an array of benefits?
oHow should benefits be financed?
oAre the benefits legally defensible?
The first issue—who should be covered—ought to be an easy question. The
answer is employees, of course. But every organization has a variety of
employees with different employment statuses.
oShould these individuals be treated equally with respect to benefits
coverage?
oA whole series of questions need to be answered:
What probationary periods (for eligibility of benefits) should be used for
various types of benefits? Does the employer want to cover employees
and their dependents immediately upon employment or provide such
coverage only for employees who have established more or less
permanent employment with the employer? Is there a rationale for
different probationary periods with different benefits?
Which dependents of active employees should be covered?
Should retirees (as well as their spouses and perhaps other dependents) be
covered, and for which benefits?
Should survivors of deceased employees (and/or retirees) be covered? If
so, for which benefits? Are benefits for surviving spouses appropriate?
What coverage, if any, should be extended to employees who are
suffering from disabilities?
What coverage, if any, should be extended to employees during layoffs,
leaves of absence, strikes, and so forth?
Should coverage be limited to full-time employees?
oThe answers to these questions depend on the policy decisions
regarding adequacy, competition, and cost effectiveness.
The second administrative issue concerns choice (flexibility) in plan coverage.
oIn the standard benefit package, employees typically have not been
offered a choice among employee benefits. Rather, a package is designed
with the average employee in mind, and any deviations in needs simply go
unsatisfied.
oThe other extreme is represented by “cafeteria-style,” or flexible,
benefit plans. Under this concept employees are permitted great flexibility in
choosing the benefit options of greatest value to them.
oExhibit 12.3 illustrates a typical choice among packages offered to
employees under a flexible benefit system. An employee with retirement in
mind might select option B with its contributions to a 401(k) pension plan
oExhibit 12.4 summarizes some of the major advantages and
disadvantages of flexible benefits.
oEven companies that are not considering a flexible benefits plan are
offering greater flexibility and choice. For example, such plans might
provide:
Optional levels of group term life insurance
The availability of death or disability benefits under pension or
profit-sharing plans
Choices of covering dependents under group medical expense coverage
A variety of participation, cash distribution, and investment options under
profit-sharing, thrift, and capital accumulation plans
oThe level at which an organization finally chooses to operate on this
choice/flexibility dimension really depends on its evaluation of the relative
advantages and disadvantages of flexible plans, noted in Exhibit 12.4.
oIt is argued that flexible benefit plans increase employee awareness of
the true costs of benefits, and, therefore, increase employee recognition of
benefit value.
oAnother way to increase employee awareness, and probably the biggest
trend today in health care, is to offer market-based, or customer-driven,
health care. Although there are many variants on consumer-driven health
care, here are the basic issues:
In a consumer-driven or high deductible plan an employee pays all health
care costs up to some pre-determined rate. As high as $3,000 – $6,000.
After that, the employee pays a rate of 10-35 percent of any additional
medical services (called coinsurance).
The obvious inducement to an employee is to shop around for the lowest
rate. Before these high deductible plans, the employee had no motivation
to choose a low cost provider.
For the employer, this yields a huge savings and monthly premiums can
dip as low as $100.
Of course, this can cause a health care crisis for the employee who
foregoes the procedure due to cost.
The third administrative issue involves the question of how to finance benefit
plans. Alternatives include:
oNoncontributory (employer pays total costs).
oContributory (costs are shared between employer and employee).
oEmployee financed (employee pays total costs for some benefits—by
law the organization must bear the cost for certain benefits)
oIn general, organizations prefer to make benefit options contributory,
reasoning that a “free good,” no matter how valuable, is less valuable to an
employee.
oFurthermore, employees have no personal interest in controlling the
cost of a free good.
Finally, benefits have to comply with hundreds of arcane sections of the tax code
and other “devils.”
oBecause there are so many rules and regulations, benefit administrators
should develop a compliance checklist and regularly conduct audits to ensure
that they are complying with the avalanche of new and existing requirements.