13 – 13 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
poverty stricken.
o The Employee Retirement Income Security Act was passed in 1974 as a
response to these problems.
• ERISA does not require an employer to 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:
• The actual success of ERISA in achieving these goals has been mixed at best.
o In the first two full years of operation (1975 and 1976) more than 13,000
• The major requirements of ERISA are:
o General Requirements
General Requirements
o ERISA requires that employees be eligible for pension plans beginning at age
21.
Vesting and Portability
o Vesting 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.
o The vesting concept has two components:
o 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:
Chapter Thirteen: Benefit Options 13 – 14
o The vesting schedule 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-
o Portability of pension benefits becomes an issue for employees moving to
new organizations.
▪ ERISA does not require mandatory portability of private pensions.
Pension Benefit Guaranty Corporation
o Despite 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
The Pension Protection Act of 2006 (PPA)
o The PPA was passed by Congress in the wake of Enron and WorldCom.
▪ Its purpose was to protect employees’ retirement income as well as
o A 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.
o The 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.
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employees with at least three investment options other than employer
securities.
E. How Much Retirement Income to Provide?
• The level of pension a company chooses to offer depends on the answers to five
questions.
o First, what level of retirement compensation would a company like to set as a
target, expressed in relation to pre-retirement earnings?
o Second, 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
o Third, should other postretirement income sources be integrated with the
pension payments?
o Fourth, how to factor seniority into the payout formula.
▪ Most companies believe that the maximum pension payout for a particular
III. Life Insurance
• 56% of private sector employees have access to paid life insurance.
• Typical coverage would be a group term insurance policy with a value of one to two
times the employee’s annual salary.
o Most plan premiums are paid completely by the employer.
• Flexibility is introduced by providing a core of basic life coverage (e.g., $25,000).
o The option then exists to choose greater coverage (usually in increments of
Chapter Thirteen: Benefit Options 13 – 16
IV. Medical and Medically Related Payments
A. General Health Care
• Health-care costs continue to increase.
• Exhibit 13.10 shows the percentage increase over time.
o More costly technology, the explosion of lawsuits, the increased number of
• Before 1930, health care coverage did not exist.
• Blue Cross and Blue Shield was the first institutional health care.
• In the 1960s, national health insurance emerged to cover the elderly (Medicare)
and the poor (Medicaid).
• In 2010 the Affordable Care Act was signed into law and its provisions as they
affect employers came into full effect in 2018.
• The basic underlying structure of health care delivery:
o Commercial insurance plan – through companies like Prudential or Aetna.
o Health 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.
B. Health-care: Cost Control Strategies
• There are three general strategies available to benefit managers for controlling the
rapidly escalating costs of health care.
o First, organizations can motivate employees to change their demand for health
13 – 17 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
▪ 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)
o The 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
• A final category of cost control strategies links incentives to healthy behaviors.
o Preventable illnesses account for 70% of all health-care costs.
C. Short- and Long-Term Disability
Chapter Thirteen: Benefit Options 13 – 18
• A number of benefit options provide some form of protection for disability.
• Beyond these two legally required sources, there are two private sources of
disability income:
• Many companies have some form of salary continuation plan that pays out
varying levels of income depending on duration of illness.
o At one extreme is short-term illness covered by sick leave policy and typically
reimbursed at a level equal to 100% of salary.
o After such benefits run out, disability benefits become operative.
▪ Short-term disability (STD) pays a percentage of an employee’s salary
(about 60 % on average) for temporary disability because of sickness or
D. Dental Insurance
• A rarity 30 years ago, dental insurance is now much more prevalent.
o The dental equivalent of HMOs and PPOs is the standard delivery system.
• At the start of the century, the typical cost for employee dental coverage was
$219.
E. Vision Care
• Vision care dates back only to the 1976 contract between the United States Auto
Workers and the Big Three automakers.
13 – 19 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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Education.
examinations, lenses, and frames.
V. Miscellaneous Benefits
A. Paid Time Off During Working Hours
B. Payment for Time Not Worked
• Included within this category are:
o Paid vacations and payments in lieu of vacation
o Payments for holidays not worked
• There is also increasing coverage for parental leaves.
o Maternity and, to a lesser extent, paternity leaves are much more common
than they were 25 years ago.
o Passage 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
C. Child Care
• It is becoming quite common for employers to offer flexible spending accounts
with child care expenditure as a legitimate expense.
o The employee, the employer, or both pay into an account with pre-tax monies
Chapter Thirteen: Benefit Options 13 – 20
and individuals can then use these funds to pay local child care providers.
• A flexible spending account permits pretax contributions of up to $2,600 to an
employee account that can be drawn on to pay for uncovered health care
expenses.
D. Elder Care
• With longer life expectancy than ever before and the aging of the baby-boom
E. Domestic Partner Benefits
• These benefits are voluntarily offered by employers to an employee’s unmarried
F. Legal Insurance
• Prior to the 1970s, prepaid legal insurance was practically nonexistent.
o Even though such coverage was offered only by approximately 7% of all
G. Addressing Financial Precarity
• “Financial precarity” can adversely affect employee performance at the
workplace.
13 – 21 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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Education.
o In addition to higher wages, employers can take steps to encourage or
incentivize employees to save enough money for an emergency, through
programs that help with balancing work and family, and by programs
encouraging wellness.
VII. Benefits for Contingent Workers
• Depending on the definition used, contingent workers represent between 5 and 35%
of the workforce.
o 90% of all employers use some contingent workers.
• Contingent work relationships include:
• Both to reduce costs (because fewer benefits are offered) and to permit easier
VIII. Your Turn: Adapting Benefits to a Changing Strategy
Summary of Case
McDonald’s is scrambling trying to meet the changing needs of consumers. These include
millennials who prefer healthier products, customers who complain about long wait times in
Learning Objective
Analyze corporate strategy and wage/benefit decisions.
Teaching Guideline
Discussion of Case Questions
1. Given the facts from the case, what can you glean from news reports about
Chapter Thirteen: Benefit Options 13 – 22
McDonald’s, what do you think is going on? Specifically, how do corporate strategy
and wage/benefit decisions either support or conflict with each other?
McDonald’s faces several pressures. They need faster drive times. They have fewer menu
items but the ones they do have respond to specific customer requests, requiring a different
skill set for employees and faster times for making product. They have older workers who
Answers to Review Questions
1. James A. Klingon has a mandate from his boss to cut employee benefit costs. In a
company expanding by 10 percent in employees every year, Jim decides to control
costs through his selection strategy. Is he crazy? Or crazy like a fox? Explain.
James’ plan to control costs through a selection strategy is definitely a smart option.
Considering health benefits form the highest percentage of employee benefits, it could
2. Explain the concept of experience rating using examples from unemployment
insurance. Would the same concept apply to workers’ compensation? Using the
Internet, find out if experience rating plays a role in insurance coverage.
In the majority of states, unemployment compensation paid out to eligible workers is
financed exclusively by employers that pay federal and state unemployment insurance tax.
13 – 23 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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Education.
Insurance companies use the technique of experience rating to determine the correct price
of a policy premium, by analyzing the past losses of others in the insured group to project
future losses. The insurer sets a high premium to cover the potential claims of these high-
risk activities and still earn profits.
Experience rating applies to workers’ compensation as well. For example, a company can
be rated in terms of the number of accidents or injuries occurred and ratings can be
provided. This will help insurers set high premiums for companies where injuries and
accidents occur frequently. Experience rating takes into account the frequency of
occurrence, the cost of injuries, and the severity of losses. This approach motivates the
employer to promote loss reduction, ensures quick recovery of the injured, and provides
financial incentives to promote occupational health and safety.
Experience rating plays a similar role in insurance coverage to identify the potential
companies or individuals who bear high risk and hence need to be charged high premiums.
For example, life insurance companies charge higher premiums to smokers than for non-
smokers.
3. The CEO of Krinkle Forms Inc. says there is a serious problem with turnover, with
data for her observation provided below.
Seniority
Turnover Rate
0–2 yrs
61%
2–5 yrs
21%
5 + yrs
9%
The CEO wants to use employee benefits to lessen this problem. Before agreeing to
look at this as the solution, what should run through your mind as a trained
professional? What might you do, specifically, in the areas of pension vesting,
vacation and holiday allocation, and life insurance coverage in the effort to reduce
turnover?
An organization could specifically tie each of these benefits to seniority. It could increase
life insurance amounts and tie the number of vacation days and holidays to seniority. A
company has two options regarding its contributions to a pension plan:
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Education.
4. Why are defined contribution pension plans gaining in popularity in the United
States and defined benefit plans losing popularity?
The two major benefits to employers of a defined contribution pension plan are:
• The employee assumes the risks associated with changes in inflation and interest rates
5. Some experts argue that consumer-directed health care is, amongst other things, a
great communications tool for employee benefits. Defend this position.
Consumer-directed health services are one way of cost control for companies offering
employee benefits. These services involve negotiation of rates with hospitals and other