12 – 1 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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.
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.
Chapter Twelve: The Benefit Determination Process 12 – 2
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
A. Benefit Planning and Design Issues
B. Benefit Administration Issues
IV. Components of a Benefit Plan
A. Employer Factors
B. Employee Factors
V. Administering the Benefit Program
12 – 3 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
Lecture Outline: Summary of Key Chapter Points
• In comparison to the “benefits” from the past, today’s reality seems staggering.
o 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.
o A first-class benefit plan includes a mix of the following benefits:
▪ Education reimbursement
o 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.
• Google would argue that these extra services are important benefits of employment,
making attraction, retention, and motivation of employees much easier.
o But the truth is, companies don’t know if even ordinary benefits have positive payoffs.
• As Exhibit 12.1 illustrates, employee benefits can no longer realistically be called “fringe
benefits.”
o Among private sector employers, the average costs of benefits is $10.25 per hour,
accounting for 30% of total compensation and adding 44 cents on top of every dollar
Chapter Twelve: The Benefit Determination Process 12 – 4
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Education.
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).
I. Why the Growth in Employee Benefits?
31.7% of total compensation.
• There are several factors that have contributed to the growth in benefits costs.
A. Wage and Price Controls
• During both World War II and the Korean War, the federal government instituted
strict wage and price controls.
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.
o Several National Labor Relations Board rulings during the 1940s freed
unions to negotiate over employee benefits.
C. Employer Impetus
• Many of the benefits in existence today were provided at employer initiative.
o Much of this initiative can be traced to pragmatic concerns about employee
satisfaction and productivity.
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and provide increased security for worker retirement.
• Indeed, many employer-initiated benefits were designed to create a climate in
D. Cost (including tax) Effectiveness of Benefits
• Another important and sound impetus for the growth of employee benefits is
their cost effectiveness in two situations.
o The first cost advantage is that most employee benefits are not taxable.
▪ Provision of a benefit rather than an equivalent increase in wages avoids
o A second cost-effectiveness component of benefits arises because many
group-based benefits (e.g., life, health, and legal insurance) can be obtained at
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.
• In addition, most other employee benefits are affected by such laws as the
II. The Value of Employee Benefits
• Exhibit 12.4 shows the relative importance employees attached to different types of
benefits across five different studies.
o In general, the five studies reported in Exhibit 12.4 show remarkably consistent
Chapter Twelve: The Benefit Determination Process 12 – 6
pays on average $5,477 for health coverage of a single employee and $13,049 for
family coverage.
• A major concern is evidence that employees frequently undervalue the benefits
provided by their organization, or even unaware of them.
• One possible way to improve employer return on investment in benefits is to provide
employees with greater choice in the benefits they receive.
o The perceived value of benefits rises when employers introduce choice through a
o Some experts speculate that a key element in reward attractiveness (and benefits)
may be their visibility.
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.
o Will adding a business-sponsored day care center help achieve the
compensation objective of attracting more young female applicants to my
low-wage entry-level positions?
o Will designing a benefit package that improves progressively with seniority
help reduce turnover?
• In addition to integrating benefits with other compensation components, the
planning process also should include strategies for ensuring external
competitiveness and adequacy of benefits.
• Ensuring that benefits are adequate is a somewhat more difficult task.
o Most organizations evaluating adequacy consider the financial liability of
12 – 7 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
o 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
B. Benefit Administration Issues
• Four major administration issues arise in setting up a benefit package:
• The first issue—who should be covered—ought to be an easy question.
o The answer is employees, of course.
o But every organization has a variety of employees with different employment
statuses.
o In fact, a whole series of questions need to be answered.
▪ What probationary periods (for eligibility of benefits) should be used for
various types of 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?
Chapter Twelve: The Benefit Determination Process 12 – 8
▪ What coverage, if any, should be extended to employees during layoffs,
• The second administrative issue concerns choice (flexibility) in plan coverage.
o In the standard benefit package, employees typically have not been offered a
choice among employee benefits.
o The other extreme is represented by “cafeteria–style,” or flexible, benefit
o Exhibit 12.5 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
o Exhibit 12.6 summarizes some of the major advantages and disadvantages of
flexible benefits.
o Even 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
o The 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 12.6.
o It is argued that flexible benefit plans increase employee awareness of the
true costs of benefits, and, therefore, increase employee recognition of benefit
value.
▪ Another way to increase employee awareness, and probably the biggest
trend today in health care, is to offer market-based, or customer-driven,
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health care costs up to some pre-determined rate.
• The obvious inducement to an employee is to shop around for the
lowest rate.
o Before these high deductible plans, the employee had no
• The third administrative issue involves the question of how to finance benefit
plans. Alternatives include:
▪ Noncontributory (employer pays total costs).
o In general, organizations prefer to make benefit options contributory,
reasoning that a “free good,” no matter how valuable, is less valuable to an
employee.
• Finally, benefits have to comply with hundreds of arcane sections of the tax code
and other “devils.”
IV. Components of a Benefit Plan
• Exhibit 12.7 outlines a model of the factors influencing benefit choice, from both the
employer’s and the employee’s perspective.
A. Employer Factors
• As Exhibit 12.7 indicates, a number of factors affect employer preference in
determining desirable components of a benefit package.
Relationship to Total Compensation Costs
• A good compensation manager considers employee benefit costs as part of a
total package of compensation costs.
Chapter Twelve: The Benefit Determination Process 12 – 10
• A good compensation manager thinks whether there is a better use for the
Costs Relative to Benefits
• Too frequently the costs/advantages of a particular benefit inclusion are
viewed in isolation, without reference to total package costs or forecasts of
rising costs in future years.
• To control spiraling benefit costs, administrators should adopt a broader,
cost-centered approach.
o As a first step, this approach would require policy decisions on the level
of benefit expenditures acceptable both in the short and the long runs.
• A cost-centered approach would require that benefit administrators, in
cooperation with insurance carriers and armed with published forecasts of
anticipated costs for particular benefits, determine the cost commitments for
the existing benefit package.
o Budget dollars not already earmarked may then be allocated to new
benefits that best satisfy organizational goals.
• If a benefit forecast suggests future cost containment may be difficult, the
benefit should be offered to employees only on a cost-sharing basis.
Competitor Offerings
• Benefits must be externally equitable, too.
o A policy decision must be made about the position (market lead, market
• One of the best strategies for determining external equity is to conduct a
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benefit survey.
Role of Benefits in Attraction, Retention, and Motivation
• Given the rapid growth in benefits and the staggering cost implications, it
seems only logical that employers would expect to derive a fair return on this
investment.
• First, employee benefits are widely claimed to help in the retention of
workers.
o Benefit schedules are specifically designed to favor longer-term
employees.
▪ For example, retirement benefits increase with years of service, and
o There is some research to support the common assumption that benefits
increase retention.
o It has been assumed that turnover is bad and stability is good.
▪ In fact, there are times when turnover may be good—something
employers may not want to discourage.
• Employee benefits also might be valued if it could be proved that they
increase employee satisfaction.
o Benefits also would be valuable if we could show a link to increased
productivity.
Chapter Twelve: The Benefit Determination Process 12 – 12
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Education.
▪ Perhaps as a result, companies are cutting benefits, especially medical
insurance, as a cost reduction strategy.
o If we want to argue that benefits matter, first we need to show that
benefits are well-designed—in part this means they must meet employee
needs.
▪ Critics argue that benefits administrators haven’t responded to long
o One response to these workforce changes is increased interest in so-called
work/life balance benefits.
▪ Things like day care, elder care, on-site fitness centers, and weight-
Legal Requirements
• Employers want a benefit package that complies with all aspects of the law.
o Exhibit 12.8 shows part of the increasingly complex web of legislation in
the benefit area.
Absolute and Relative Compensation Costs
• Any evaluation of employee benefits must be placed in the context of total
compensation costs.
o Cost competitiveness means the total package must be competitive—not
B. Employee Factors
• Employee preferences for various benefit options are determined by
individual needs.