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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.
