978-1259532726 Chapter 13 Lecture Note Part 1

Unlock access to all the studying documents.

View Full Document

CHAPTER THIRTEEN

BENEFIT OPTIONS

Overview

Since the 1940s, employee benefits have been the most volatile area in the compensation field.

From 1940 to 1980, dramatic changes came in the form of more and better types of employee

benefits. The result should not have been unexpected. Employee benefits are now a major, and

according to some, a prohibitive component of doing business. The spiraling costs of benefits,

combined with insufficient evidence of the role they play in helping an organization achieve a

competitive advantage, are key challenges facing employers. Thus, it is predicted that a key

objective for the majority of employers will be the pursuit of cost-saving efforts to improve

their competitive position. A portion of these cost savings are likely to result from tighter

administrative controls on existing benefit packages. Another part may come from a reduction

in existing benefit packages. If this does evolve as a trend, benefit administrators will need to

develop a mechanism for identifying employee preferences and use them as a guideline to meet

agreed-upon savings targets

This chapter provides a summary of employee benefits—the goal is to provide a clearer

appreciation of employee benefits. The chapter begins by presenting a widely accepted

categorization of employee benefits based on an annual report issued by the U.S. Chamber of

Commerce. This report is based on a nationwide survey of employee benefits and identifies

seven categories of benefits in a breakdown highly familiar to benefit plan administrators.

These seven categories are used to organize the benefits presented in the chapter. Virtually

every employee benefit is somehow affected by statutory or common law. The benefits

required by statutory law—workers’ compensation, social security, unemployment

compensation—are discussed first. Next, benefits most commonly provided by employers are

described; they include retirement plans, life insurance, medical and medical-related benefit

payments, paid time off during work hours, payment for time not worked, and miscellaneous

benefits. Important principles affecting the strategic and administrative concerns for each

benefit type are also presented.

Learning Objectives

Identify employee benefits required by law including worker’s compensation, social

security, unemployment insurance, FMLA, COBRA, and HIPAA.

Discuss retirement and savings plan payments including defined benefit plans and

defined contribution plans, IRAs, ERISA, and life insurance.

Define medical and medically related payments including general health care, cost

control strategies, short- and long-term disability, dental and vision insurance.

Understand issues related to miscellaneous benefits such as paid time off, child or elder

care, domestic partner benefits, legal insurance, and benefits for contingent workers.

Lecture Outline: Overview of Major Topics

I. Legally Required Benefits

II. Retirement and Savings Plan Payments

III. Life Insurance

IV. Medical and Medically Related Payments

V. Miscellaneous Benefits

VI. Benefits for Contingent Workers

VII. Your Turn: Adapting Benefits to a Changing Strategy

Lecture Outline: Summary of Key Chapter Points

Usually, at least in the past, employee benefits lagged behind such rewards as pay,

advancement opportunity, job security, and recognition. Recently, though, a dramatic shift in

this admittedly unscientific poll has been noticed. As benefits costs, especially health care,

have skyrocketed, so has their popularity. A recent survey listed the top four rewards

contributing to employee satisfaction. In order, they are compensation, benefits, job security,

and work/life balance.

With this increased popularity comes a need for HR professionals to understand what benefits

are important to employees.

Exhibit 13.1 provides the data for costs of benefits per hour and % of total employee benefit

costs for government and in private sectors. Both wages and benefits tend to be higher in a

government job.

Exhibit 13.2 lists the widely accepted categorization of employee benefits. The U.S. Chamber

of Commerce issues an annual update of benefit expenditures. This report identifies seven

categories of benefits in a breakdown that is highly familiar to benefit plan administrators.

Exhibit 13.3 shows employee participation in selected benefit programs. In virtually every

category, the percentages are higher in large- and medium-size companies.

I. Legally Required Benefits

Virtually every employee benefit is affected by statutory or common law (many

of the limitations are imposed by tax laws). In this section, the primary focus is on

benefits required by statutory law: workers’ compensation, Social Security, and

Unemployment Compensation. At the end of this section, the text briefly discusses

the Family and Medical Leave Act (FMLA), Consolidated Omnibus Budget

Reconciliation Act (COBRA), and the Health Insurance Portability and

Accountability Act (HIPAA).

A. Workers’ Compensation

As a form of no-fault insurance (employees are eligible even if their

actions caused the accident), workers’ compensation covers injuries and

diseases that arise out of, and while in the course of, employment. Benefits are

provided for:

oMedical care for work-related injuries, beginning right after the accident

oTemporary disability benefits after a 3–7 day waiting period

oPermanent partial and permanent total disability benefits for lasting

consequences of disabilities on the job

oSurvivor benefits

oRehabilitation and training in most states, for those unable to return to

their prior career

Workers’ compensation costs vary over time. During the early years of

this century, the costs rose. But as recently as 2005, the dollar costs began to

decline. Costs in recent years have been the lowest since 1980.

oExperts believe part of this stabilization relates to employer safety

programs, with far few fatal accidents occurring and somewhat higher

incidents of minor, less costly accidents.

States vary in the size of the payout for claims.

oFor example, New York State has a payout formula for totally or partially

disabled that is based on his/her average weekly wage from the previous

year. It is calculated as follows:

2/3 × average weekly wage × % of disability = weekly benefit

Some states provide “second-injury funds.”

oThese funds relieve an employer’s liability when a pre-employment injury

combines with a work-related injury to produce a disability greater than

that caused by the latter alone.

Workers’ compensation is covered by state, not federal, laws.

oAs, exhibit 13.4 shows, in general the states have fairly similar coverage,

with differences occurring primarily in benefit levels and costs.

oIn recent years states have made significant changes in Workers’

Compensation (WC) designed to reduce costs.

oFor example Montana and five other states passed major reforms

attempting to control medical costs and rein in WC as a result.

B. Social Security

When Social Security was introduced in 1937, only about 60 percent of

all workers were eligible. Today, nearly every American worker (96%) is

covered.

oWhether a worker retires, becomes disabled, or dies, Social Security

benefits are paid to replace part of the lost family earnings.

oEver since its passage, the Social Security Act has been designed and

amended to provide a foundation of basic security for American workers

and their families.

oExhibit 13.5 outlines the initial provisions of the law and its subsequent

broadening over the years.

The money to pay these benefits comes from the Social Security

contributions made by employees, their employers, and self-employed people

during working years.

As contributions are paid in each year, they are immediately used to pay

for the benefits to current beneficiaries. Herein, lies a major problem with

Social Security.

oWhile the number of retired workers continues to rise, no corresponding

increase in the number of contributors to Social Security has offset the

costs.

oCombine the increase in beneficiaries with other cost stimulants and the

outcome is not surprising.

oTo maintain solvency, there has been a dramatic increase in both the

maximum earnings base and the rate at which that base is taxed.

Exhibit 13.6 illustrates the trends in tax rate, maximum earnings base,

and maximum tax for Social Security.

oWith the rapid rise in taxable earnings, one should get used to paying

some amount of Social Security tax on every dollar one earns. Now the

maximum is over $110,000 and for one part of Social Security (Medicare),

there is no earnings maximum.

oFor every dollar deducted as an employees’ share of Social Security, there

is a matching amount paid by employers. Because Social Security is

retirement income to employees, employers should decrease private

pension payouts by a corresponding amount.

oCurrent funding levels produced a massive surplus during the 1990s.

oBaby boomers have reached their peak earnings potential, and their Social

Security payments subsidize a much smaller generation born during the

1930s. The first of these boomers are now retiring, and the impact of the

social security taxes lost and new benefits being paid spells big problems

for the system.

oThere are now almost 3.5 workers paying into the system for each person

collecting benefits. Within the next 40 years this ratio will drop to about 2

to 1.

Benefits under social security

oThe majority of benefits under Social Security fall into four categories.

Old age or disability benefits

Benefits for dependents of retired or disabled workers

Benefits for surviving family members of a deceased worker

Lump-sum death payments

oTo qualify for these benefits, a worker must work in covered employment

and earn a specified amount of money (about $1250 today) for each

quarter-year of coverage.

Forty quarters of coverage will insure any worker for life.

The amount received under the four benefit categories varies, but

in general it is tied to the amount contributed during eligibility

quarters.

C. Unemployment Insurance

The earliest union efforts to cushion the effects of unemployment for

their members (c. 1830s) were part of benevolent programs of self-help.

Working members made contributions to their unemployed brethren.

With passage of the unemployment insurance law (as part of the Social

Security Act of 1935), this floor of security for unemployed workers became

less dependent upon the philanthropy of co-workers (147 million workers are

covered today).

Unemployment insurance laws vary by state.

Financing

oIn the majority of states, unemployment compensation paid out to eligible

workers is financed exclusively by employers that pay federal and state

unemployment insurance tax.

oThe federal tax amounts to 6.2 percent of the first $7,000 earned by each

worker. In addition, states impose a tax above the $7,000 figure.

oThe extra amount a company pays depends on its experience rating—

lower percentages are charged to employers who have terminated fewer

employees.

Coverage

oAll workers except a few agricultural and domestic workers are currently

covered by unemployment insurance (UI) laws. These covered workers

(97 percent of workforce), though, must still meet eligibility requirements

to receive benefits.

One must meet the state requirements for wages earned or time

worked during an established (one year) period of time referred to as a

‘base period.’

One must be determined to be unemployed through no fault of

his/her own (determined under state law), and meet other eligibility

requirements of state law.

Duration

oUntil 1958, the maximum number of weeks any claimant could collect UI

was 26 weeks.

oHowever, the 1958 and 1960-61 recessions yielded large number of

claimants who exhausted their benefits, leading many states temporarily to

revise upward the maximum benefit duration.

oIn 2008 Congress enacted the Emergency Unemployment Compensation

program (EUC08). The program provided additional weeks of benefits to

long term unemployed, extending benefits to as long as 53 weeks.

This program expired in 2013 and maximum benefits duration

returned to 26 weeks.

Weekly Benefit Amount

oIn general, benefits are based on a percentage of an individual’s earnings

over a recent 52-week period—up to the state maximum amount.

For example, in many states, the compensation will be half the

earnings, up to a maximum amount.

Controlling Unemployment Taxes

oEvery unemployed worker’s unemployment benefits are “charged

against” the firm or firms most recently employing that currently

unemployed worker.

oThe more money paid out on behalf of a firm, the higher is the UI rate for

that firm.

oEfforts to control these costs quite logically should begin with a

well-designed human resource planning system. Realistic estimates of

human resource needs will reduce the pattern of hasty hiring followed by

morale-breaking terminations.

oA benefit administrator should attempt to audit pre-layoff behavior and

compliance with UI requirements after termination.

oThe government can also play an important part in reducing

unemployment expenses by decreasing the number of weeks that people

are unemployed.

oResearch shows that unemployment duration decreases by three weeks

simply by stepping up enforcement of sanctions against fraudulent claims.

D. Family and Medical Leave Act (FMLA)

The 1993 Family and Medical Leave Act applies to all employers

having 50 or more employees and entitles eligible employees to receive

unpaid leave up to 12 weeks per year for specified family or medical reasons.

Common reasons for leave under FMLA include caring for a newborn or

seriously ill family member.

More state legislatures are now moving toward some form of paid

family and medical leave for workers.

E. Consolidated Omnibus Budget Reconciliation Act (COBRA)

In 1985 Congress enacted this law to provide current and former

employees and their spouses and dependents with a temporary extension of

group health insurance when coverage is lost due to qualifying events (e.g.,

layoffs).

All employers with 20 or more employees must comply with COBRA.

An employer may charge individuals up to 102 percent of the premium

for coverage (100 percent premium plus 2 percent administration fee), which

can extend up to 36 months (standard 18 months), depending on the category

of the qualifying event.

The biggest concern for individuals getting health insurance under

COBRA is the relatively brief qualifying period, after 18 months you are not

eligible. With passage of the Affordable Care Act, COBRA participants can

opt into the Health Insurance Marketplace.

F. Health Insurance Portability and Accountability Act (HIPAA)

The 1996 HIPAA is designed to:

oLessen an employer’s ability to deny coverage for a preexisting condition

oProhibit discrimination on the basis of health-related status

Perhaps the most significant element of HIPPA began in 2002, when

stringent new privacy provisions added considerable compliance problems for

both the HR people charged with enforcement and information technology

people delegated the task of building secure health information systems.

II. Retirement and Savings Plan Payments

Pensions have been around for a long, long time. The first plan was established

in 1759 to protect widows and children of Presbyterian ministers.

After decades of steady growth in private pension plan coverage, today only 64

percent of workers have access to pension coverage, and only 49 percent actually

participate.

Blame competitive pressures from globalization, the recession, and paltry

growth in productivity, but the reality is that more than half of the population will

depend on Social Security for retirement income. That tends to be a problem because

employees tend to rank pensions as one of the more important benefits.

The importance of employer-provided retirement plans is evidenced by a study

showing that employees with employer-provided retirement plans are more likely to

have sufficient savings for a comfortable retirement than those who did not have these

plans.

Two generic types of pension plans are:

oDefined benefit plans (may be a dying breed)

oDefined contribution plans

Many companies are shifting to 401 (k) plans (a popular type of defined

contribution plan) where the dollar contribution is known and controllable.

A. Defined Benefit Plans

In a defined benefit plan an employer provides a specific level of retirement

pension, which is expressed as either a fixed dollar or a percentage-of-earnings

amount that may vary (increase) with years of seniority in the company.

The firm finances this obligation by following an actuarially determined benefit

formula and making current payments that will yield the future pension benefit for

a retiring employee.

The majority of defined plans calculate average earnings over the last 3 to 5 years

of service for a prospective retiree and offer a pension that is about one-half this

amount (varying from 30 to 80 percent) adjusted for years of seniority.

The major complaint against defined benefit plans by chief financial officers

(CFOs) center on funding.

B. Defined Contribution Plans

In a defined contribution (DC) plan the employer makes provisions for

contributions to an account set up for each participating employees. Years later

when employees retire, the pension is based on their contributions, employer

contributions, and any gains (or losses) in stock investments.

There are three popular forms of these plans.

o401 (k) plan

oEmployee stock ownership plan (ESOP)

oProfit sharing plan

A 401(k) plan, so named for the section of the Internal Revenue Code describing

the requirements, is a savings plan in which employees are allowed to defer pretax

income.

oEmployers typically match employee savings at a rate of 50 cents on the

dollar.

oDC plans are more popular than defined benefit plans in both small and

large companies. The number of traditional plans continues to drop at a rapid

rate.

oHistorically DC plans are faster to vest (the companies matched share of

the contribution permanently shifts over to employee ownership, and they are

more portable—job hopping employees can take their pension accruals along

to the next job).

oOn the negative side, the recession of 2008–2010 destroyed many 401(k)

portfolios. Poor investment decisions, either by employees or by a chosen

financial advisor, reduced many retirement funds by half or more.

oFurther, these plans have been plagued by low contribution rates. About

40 percent of all employees don’t contribute enough to get the full employer

match.

In a basic employee stock ownership (ESOP) plan, a company makes a

tax-deductible contribution of stock shares or cash to a trust.

oThe trust then allocates company stock (or sock bought with cash

contributions) to participating employee accounts. The amount allocated is

based on employee earnings.

oWhen an ESOP is used as a pension vehicle (as opposed to an incentive

program), the employees receive cash at retirement based upon the stock value

at that time.

oESOPs have one major disadvantage, which limits their utility for

pension accumulations. Many employees are reluctant to “bet” most of their

future retirement income on just one investment source. If the company’s

stock takes a downturn, the result can be catastrophic for employees reaching

retirement age.

A profit sharing plan can be considered a defined contribution pension plan if

the distribution of profits is delayed until retirement.

Both defined benefit and defined contribution plans are subject to stringent tax

laws.

For deferred compensation to be exempt from current taxation, specific

requirements must be met. To qualify, an employer cannot freely choose who will

participate in the plan (hence, it is labeled “qualified” deferred compensation

plan).

oThis requirement eliminated the common practice of building

tax-friendly, extravagant pension packages for executives and other highly

compensated employees.

oThe major advantage of a qualified plan is that the employer receives an

income tax deduction for contributions made to the plan even though

employees may not yet have received any benefits.

oThe disadvantage arises in recruitment of high-talent executives. A plan

will not qualify for tax exemptions if an employer pays high levels of deferred

compensation to entice executives to the firm, unless proportionate

contributions also are made to lower-level employees.

A hybrid of defined benefit and defined contribution plans has emerged in recent

years. Cash balance plans are defined benefit plans that look like defined

contribution plans.

oEmployees have a hypothetical account (like a 401[k]) into which is

deposited what is typically a percentage of annual compensation.

oThe dollar amount grows, both from contributions by the employer and

from some predetermined interest rate.

In 2009, 401(k) contributions were suspended by many companies in the wake of

the suffering U.S. economy.

oGeneral Motors, FedEx, Sears Holdings, and Eastman Kodak are among

companies who suspended contributions.