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C. Individual Retirement Accounts (IRAs)
An individual retirement account (IRA) is a tax-favored retirement savings plan
that individuals can establish themselves.
Unlike the other pension options, IRAs don’t require an employer to set them up.
Even people not in the workforce can establish an IRA.
Currently, IRAs are used mostly to store wealth accumulated in other retirement
vehicles, rather than as a way to build new wealth.
D. Employee Retirement Income Security Act (ERISA)
The early 1970s were a public relations and economic disaster for private pension
plans. Many people who thought they were the victims of complicated rules,
insufficient funding, irresponsible financial management, and employer
bankruptcies.
Some pension funds, including both employer-managed and union-managed funds
were mismanaged; other pension plans required long vesting periods.
The result was a pension system that left far too many lifelong workers poverty
stricken. The Employee Retirement Income Security Act was passed in 1974 as a
response to these problems.
ERISA does not require that the employers offer a pension plan. But if a company
decides to have one, it is rigidly controlled by ERISA provisions.
The provisions were designed to achieve two goals:
oTo protect the interest of approximately 100 million active participants
oTo stimulate the growth of such plans
The actual success of ERISA in achieving these goals has been mixed at best. In
the first two full years of operation (1975 and 1976) more than 13,000 pension
plans were terminated.
The major requirements of ERISA are:
oGeneral Requirements
oVesting and Portability
oPension Benefit Guaranty Corporation
oThe Pension Protection Act of 2006 (PPA)
General Requirements
oERISA requires that employees be eligible for pension plans beginning
at age 21.
oEmployers may require twelve months of service as a precondition for
participation.
oThe service requirement may be extended to three years if the plan offers
full and immediate vesting.
Vesting and Portability
oVesting refers to the length of time an employee must work for an
employer before he or she is entitled to employer payments made into the
pension plan. The vesting concept has two components:
Any contributions made by the employee to a pension fund are
immediately and irrevocably vested.
The vesting right becomes questionable only with respect to the
employer’s contributions. The Economic Growth and Tax Relief
Reconciliation Act of 2001 states that the employer’s contribution must
vest at least as quickly as one of the following two formulas:
Full vesting after three years (down from five years)
20 percent after two years (down from three years) and 20 percent
each year thereafter, resulting in full vesting after six years (down
from seven years)
The vesting schedule that an employer uses is often a function of the
demographic makeup of the workforce. An employer who experiences
high turnover may wish to use the three-year service schedule.
By doing so, any employee with less than three years’ service at time of
termination receives no vested benefits.
Or the employer may use the second schedule in the hopes that earlier
benefit accrual will reduce undesired turnover.
oPortability of pension benefits becomes an issue for employees moving
to new organizations.
ERISA does not require mandatory portability of private pensions.
On a voluntary basis, though, the employer may agree to let an employee’s
pension benefits transfer to the new employer.
For an employer to permit portability, the pension rights must be vested.
Pension Benefit Guaranty Corporation
oDespite the wealth of constraints imposed by ERISA, the potential still
exists for an organization to go bankrupt or in some way fail to meet its vested
pension obligations.
oTo protect individuals confronted by this problem, employers are
required to pay insurance premiums to the Pension Benefit Guaranty
Corporation (PBGC) established by ERISA.
oIn turn, the PGBC guarantees payment of vested benefits to employees
formerly covered by terminated pension plans.
The Pension Protection Act of 2006 (PPA)
oThe PPA was passed by Congress in the wake of Enron and WorldCom.
Its purpose was to protect employees’ retirement income as well as transfer
some responsibility for retirement savings from the employer to the employee.
oA key provision of the law allows employees in publicly traded
companies the freedom to sell off any employer stock purchased through
deferrals or after-tax contributions.
It is expected that this provision will motivate employees toward investing
in defined contribution plans and reduce some of the burden on employers.
oThe law also aims at employers who fail to set aside enough reserves to
cover current and future pension obligations by defining plans less than 70%
funded as ‘at risk’ plans.
E. How Much Retirement Income to Provide?
The level of pension a company chooses to offer depends on the answers to five
questions:
oFirst, what level of retirement compensation would a company like to set
as a target, expressed in relation to pre-retirement earnings?
oSecond, should Social Security payments be factored in when
considering the level of income an employee should have during retirement?
One integration approach reduces normal benefits by a percentage (usually
50 percent) of Social Security benefits.
Another feature employs a more liberal benefit formula on earnings that
exceed the maximum income taxed by social security.
Regardless of the formula used, about one-half of U.S. companies do not
employ the cost-cutting strategy.
oThird, should other postretirement income sources be integrated with the
pension payments?
oFourth, how to factor seniority into the payout formula?
Most companies believe that the maximum pension payout for a particular
level of earnings should be achieved only by employees who have spent
an entire career with the company (e.g., 30 to 35 years).
As exhibit 13.7 vividly illustrates, job hoppers are hurt financially by this
type of strategy.
oFinally, companies must decide what they can afford.
III. Life Insurance
Roughly three-fourths of all employees have access to paid life insurance and
this figure is about the same for both public and private sectors.
Typical coverage would be a group term insurance policy with a value of one to
two times the employee’s annual salary.
oMost plan premiums are paid completely by the employer.
oSlightly over 30 percent include retiree coverage. To discourage turnover, almost
all companies make this benefit forfeitable at the time of departure from the
company.
oFlexibility is introduced by providing a core of basic life coverage (e.g., $25,000).
The option then exists to choose greater coverage (usually in increments of
$10,000 to $25,000) as part of the optional package.
IV. Medical and Medically Related Payments
A. General Health-care
Health-care costs continue to increase.
Exhibit 13.8 shows the dollar increase over time.
oMore costly technology, the increased number of elderly people, and a
system that does not encourage cost savings have all contributed to the rapidly
rising costs of medical insurance.
Before 1930 health care coverage did not exist.
In the 1960s national health insurance emerged to cover the elderly (Medicare)
and the poor (Medicaid).
In 2012 the Affordable Care Act (ACA aka Obamacare) targeted the uninsured
with a goal of providing health care coverage to everyone.
oExhibit 13.9 outlines the ACA .
The basic underlying structure of health care delivery:
oCommercial insurance plan – through companies like Prudential or
Aetna.
oHealth maintenance organization (HMO) – pulls together a group of
providers willing to provide services at an agreed upon rate in exchange for
the employer limiting employees to these providers for health care.
oPreferred provider organization (PPO) – employers select providers who
agree to price discounts and submit to strict utilization controls and charges
high fees if employees make selections outside the provider network.
oPoint-of-service plan (POS) – is a hybrid plan combining HMO and
PPO benefits. The plan permits individuals to choose which plan to seek
treatment from at the time services are needed, providing the economic benefit
of the HMO with the freedom of the PPO.
Costs and participation rates of each type of plan are noted in Exhibit
13.10.
B. Health-care: Cost Control Strategies
There are three general strategies available to benefit managers for controlling the
rapidly escalating costs of health-care.
oFirst, organizations can motivate employees to change their demand for
health care, through changes in either the design or the administration of
health insurance policies. Included in this category of control strategies are:
Deductibles, or the first x dollars of health-care cost are paid by the
employee
Coinsurance rates (premium payments are shared by the company and
employee)
Maximum benefits (defining a maximum payout schedule for specific
health problems)
Coordination of benefits (ensure no double payment when coverage exists
under the employee’s plan and a spouse’s plan)
Auditing of hospital charges for accuracy
Requiring preauthorization for selected visits to health-care facilities
Mandatory second opinion whenever surgery is recommended
Using intranet technology to allow employees access to online benefit
information, saving some cost of benefit specialists.
Providing incentives to employees for using providers who meet certain
high performance criteria.
oThe second general cost control strategy involves changing the structure
of healthcare delivery systems and participating in business coalitions (for
data collection and dissemination).
At the extreme are companies that simply decline to provide any
health-care coverage at all.
Less extreme are choices like HMOs, PPOs, POSs, and consumer-directed
health-care plans. Also called Consumer Driven Health Plans and High
Deductible Plans, this popular option for companies cuts costs by shifting
much of the burden of purchasing health care over to employees.
Employees choose from any of the traditional providers but the
employer sets its contribution equal to the lower cost of the choices,
usually an HMO cost.
These plans usually are accompanied by high deductibles.
oAn employer helps lessen the cost of the deductible by setting up
Health Savings (HAS) or Health Reimbursement (HRA) accounts.
oFunds in these accounts are either contributed by employees with
pre-tax dollars (HAS) or by the employer up to a fixed dollar
amount (HRA)
A final category of cost control strategies links incentives to healthy behaviors.
oPreventable illnesses account for 70 percent of all health-care costs.
C. Short- and Long-Term Disability
A number of benefit options provide some form of protection for disability. For
example, workers’ compensation covers disabilities that are work-related. Even
Social Security has provisions for disability income to those who qualify.
Beyond these two legally required sources, there are two private sources of
disability income:
oSalary continuation plans
oLong-term disability plans
Many companies have some form of salary continuation plan that pays out
varying levels of income depending on duration of illness (Exhibit 13.11).
oAt one extreme is short-term illness covered by sick leave policy and
typically reimbursed at a level equal to 100 percent of salary. The most
prevalent practice these days is to give paid time off (PTO) rather than sick
days.
oAfter such benefits run out, disability benefits become operative.
oShort-term disability (STD) pays a percentage of an employee’s salary
(about 60 percent on average) for temporary disability because of sickness or
injury (on-the-job injuries are covered by worker’s compensation).
oLong-term disability (LTD) plans, if available, typically kick in after
the short-term plan expires.
LTD is usually underwritten by insurance firms and provides 60 to 70
percent of pre-disability pay for a period varying between two years and
life.
Estimates indicate that only about 34 percent of all U.S. businesses
provide long-term disability insurance.
D. Dental Insurance
A rarity 30 years ago, dental insurance is now much more prevalent, with about
60 percent of all employers with more than 500 employees providing some level
of coverage.
At the start of the century, the typical cost for employee dental coverage was
$219. Annual cost increases now, though, are beginning to heat up.
oThe relatively modest increase in dental care costs can be traced to
stringent cost control strategies and an excess supply of dentists. As the excess
turns into a predicted shortage in the coming years, it is expected that dental
benefit costs will grow at a faster rate.
E. Vision Care
Vision care dates back only to the 1976 contract between the United States Auto
Workers and the Big Three automakers. Since then, this benefit has spread to
other auto-related industries and parts of the public sector.
Seventy-eight percent of large employers offer a vision plan.
Most plans are noncontributory and usually cover partial costs of eye
examinations, lenses, and frames.
V. Miscellaneous Benefits
A. Paid Time Off During Working Hours
This benefit includes payment for rest periods, wash-up time, travel time, lunch,
clothes-change time, and get-ready time benefits.
B. Payment for Time Not Worked
Included within this category are:
oPaid vacations and payments in lieu of vacation
oPayments for holidays not worked
oPaid sick leave.
oOther (payments for National Guard, Army, or other reserve duty; jury
duty and voting pay allowances; payments for time lost due to death in the
family or other personal reasons).
Twenty years ago it was relatively rare to grant time off for anything but
vacations, holidays, and sick leave. Now many organizations have a policy of
ensuring payments for civic responsibilities and other obligations.
Any outside pay for such civic duties (e.g., jury duty) is usually nominal, so
companies often supplement this pay, frequently to the level of 100 percent of
wages lost.
There is also increasing coverage for parental leaves. Maternity and, to a lesser
extent, paternity leaves are much more common than they were 25 years ago.
oPassage of the Family and Medical Leave Act in 1993 provides up to 12
weeks of unpaid leave (with guaranteed job protection) for the birth or
adoption of a child or for the care of a family member with a serious illness.
Many companies are switching from traditional time-off plans (TTO) to
paid-time-off (PTO) plans. These lump all time off together into one total
allotment and deduct any day missed from this bank.
oNot only is this administratively easier for companies to track, but it also
eliminates the need for employees to lie and say they’re sick when the reality
is, for example, a scheduled dentist appointment.
C. Child Care
It is becoming quite common for employers (96 percent) to offer flexible
spending accounts with child care expenditure as a legitimate expense.
The employee, the employer, or both pay into an account with pre-tax monies and
individuals can then use these funds to pay local child care providers.
D. Elder Care
With longer life expectancy than ever before and the aging of the baby-boom
generation, one benefit that will become increasingly important is elder care
assistance.
Almost one-half of the companies offering child care assistance to employees also
offer elder care assistance.
E. Domestic Partner Benefits
These benefits are voluntarily offered by employers to an employee’s unmarried
partner, whether of the same or opposite sex.
The major reasons motivating U.S. corporations to provide domestic partner
benefits include fairness to all employees regardless of their sexual orientation or
marital status.
F. Legal Insurance
Prior to the 1970s, prepaid legal insurance was practically nonexistent. Even
though such coverage was offered only by approximately 7 percent of all
employers in 1997, that percentage has more than tripled in the past decade (24
percent).
A majority of plans provide routine legal services (e.g., divorce, real estate
matters, wills, traffic violations) but exclude provisions covering felony crimes,
largely because of the expense and potential for bad publicity.
Most legal insurance premiums are paid by the employee, not the employer.
Technically, then, this does not qualify as a traditional employee benefit.
VII. Benefits for Contingent Workers
Depending on the definition used, contingent workers represent between 5 and
35 percent of the workforce. Ninety percent of all employers use some contingent
workers.
Contingent work relationships include:
oWorking through temporary help agency
oWorking for a contract company
oWorking on call
oWorking as an independent contractor
Both to reduce costs (because fewer benefits are offered) and to permit easier
expansion and contraction of production/services, contracting offers a viable way to
meet rapidly changing environmental conditions.
