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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
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.
Learning Objectives
• Identify and discuss employee benefits required by law.
• Know the facets of retirement and savings plans payments.
• Recognize and define medical and medically related payments.
• Understand and differentiate between issues related to miscellaneous employee
benefits.
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Lecture Outline: Overview of Major Topics
I. Legally Required Benefits
A. Workers’ Compensation
B. Social Security
II. Retirement and Savings Plan Payments
A. Defined Benefit Plans
B. Defined Contribution Plans
C. Individual Retirement Accounts (IRAs)
D. Employee Retirement Income Security Act (ERISA)
E. How Much Retirement Income to Provide?
III. Life Insurance
IV. Medical and Medically Related Payments
A. General Health Care
V. Miscellaneous Benefits
A. Paid Time Off During Working Hours
B. Payment for Time Not Worked
VI. Benefits for Contingent Workers
VII. Your Turn: Adapting Benefits to a Changing Strategy
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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.
With this increased popularity comes a need for HR professionals to understand what benefits
are important to employees.
• The population is aging which changes the pattern of preferences.
• Yet, not all companies are attuned to changing preferences.
o A McKinsey Survey reports 89% of CEOs think benefits are extremely or very
important to attracting and retaining employees.
This chapter provides a clearer appreciation of employee benefits, including their cost.
• Exhibit 13.1 provides the data for costs of wages and salaries, benefits, and specific
benefits categories.
o In private industry, total compensation equals $33.72, of which $23.47 is wages and
salaries and $10.25 is benefits.
Exhibit 13.2 shows employee access to selected benefit programs, by establishment size.
• Larger establishments are much more likely than smaller establishments to offer many
types of benefits.
The rest of the chapter is organized to show a more detailed categorization of employee
benefits, as in Exhibit 13.3.
I. Legally Required Benefits
• Virtually every employee benefit is affected by statutory or common law (many of
the limitations are imposed by tax laws).
Chapter Thirteen: Benefit Options 13 – 4
• In this section, the primary focus is on benefits required by statutory law: workers’
compensation, Social Security, and Unemployment Compensation.
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:
o Medical care to treat the job injury or illness
• Workers’ compensation costs vary over time.
o During the early years of this century, the costs rose.
o But as recently as 2005, the dollar costs began to decline and leveled off
• States vary in the size of the payout for claims.
o For example, New York State has a payout formula for totally or partially
disabled that is based on average weekly wage from the previous year.
o It is calculated as follows:
• Some states provide “second–injury funds.”
o These 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.
o As, exhibit 13.4 shows, in general the states have fairly similar coverage,
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o For 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% of all workers
were eligible. Today, nearly every American worker (96%) is covered.
• 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 come in, they are immediately used to pay for the benefits to
current beneficiaries. This is a major problem with Social Security.
o While the number of retired workers continues to rise, no corresponding
increase in the number of contributors to Social Security has offset the
costs.
• Exhibit 13.6 illustrates the trends in tax rate, maximum earnings base, and
maximum tax for Social Security.
o As of 2018, the total Social Security Tax on earnings is 7.65% paid by
both employees and employers for a total of 15.3%. Self-employed pay
o Several points jump out from Exhibit 13.6.
▪ In 1980 the maximum taxable earnings were $25,900.
▪ There is now no earnings maximum for the second portion of the
Social Security tax, Medicare.
Chapter Thirteen: Benefit Options 13 – 6
▪ For every dollar deducted as an employees’ share of Social Security,
there is a matching amount paid by employers.
• Current funding levels produced a massive surplus during the 1990s.
o The government continually used the funds to finance spending.
o Baby boomers have reached their peak earnings potential, and their Social
Security payments subsidize a much smaller generation born during the
1930s.
o 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.
▪ In 1940, the ratio of social security covered workers (those paying
Benefits under social security
o The majority of benefits under Social Security fall into four categories.
▪ Old age or disability benefits
o To qualify for these benefits, a worker must work in covered employment
and earn a specified amount of money (about $1320) for each quarter-year
of coverage.
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.
• The unemployment insurance program has four major objectives.
o To offset lost income during involuntary unemployment
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o To help unemployed workers find new jobs.
• Since unemployment insurance laws vary by state, the following will cover
some of the major characteristics of different state programs.
Financing
o 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.
Coverage
o All workers except a few agricultural and domestic workers are currently
covered by unemployment insurance (UI) laws.
o These covered workers must meet eligibility requirements to receive
benefits.
▪ Must meet the state requirements for wages earned or time worked
Duration
o Until 1958, the maximum number of weeks any claimant could collect UI
was 26 weeks.
o However, 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.
o In 2008, Congress enacted the Emergency Unemployment Compensation
program (EUC08).
Chapter Thirteen: Benefit Options 13 – 8
Weekly Benefit Amount
o In general, benefits are based on a percentage of an individual’s earnings
Controlling Unemployment Taxes
o Every unemployed worker’s unemployment benefits are “charged
against” the firm or firms most recently employing that currently
unemployed worker.
▪ The more money paid out on behalf of a firm, the higher is the UI rate
for that firm.
o Efforts to control these costs quite logically should begin with a well-
designed human resource planning system.
o The government can also play an important part in reducing
unemployment expenses by decreasing the number of weeks that people
are unemployed.
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.
o Common reasons for leave under FMLA include caring for a newborn or
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).
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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
F. Health Insurance Portability and Accountability Act (HIPAA)
• The 1996 HIPAA is designed to:
o Lessen an employer’s ability to deny coverage for a preexisting condition
o Prohibit discrimination on the basis of health-related status
• Perhaps the most significant element of HIPPA began in 2002, when stringent
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.
o After decades of steady growth in private pension plan coverage, today only 68%
of workers have access to pension coverage, and only 53% actually participate.
• Blame competitive pressures from globalization, the recession, and paltry growth in
productivity, but the reality is that fewer are paying into Social Security and more are
drawing benefits.
• Two generic types of pension plans are:
• Exhibit 14.7 provides a comparison of the two types of plans.
o Keep in mind that defined benefit plans have become less common and those that
remain are often not open to new enrollees.
o Prominent companies such as IBM and Verizon have frozen their traditional
defined benefit pension payouts.
o Many companies are shifting to 401(k) plans (a popular type of defined
contribution plan) where the dollar contribution is known and controllable.
▪ Only 18% of private sector employees are covered by defined benefit plans,
Chapter Thirteen: Benefit Options 13 – 10
A. Defined Benefit Plans
• In a defined benefit (DB) plan an employer provides a specific level of retirement
pension (“defined benefit”), 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 majority of defined benefit 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%) adjusted for years of seniority.
• The major complaint against defined benefit plans by chief financial officers
(CFOs) center on funding.
o How much needs to be invested to have the money to pay the retirement
benefits?
B. Defined Contribution Plans
• In a defined contribution (DC) plan, the employer makes provisions for
contributions to an account set up for each participating employee.
o Years later when employees retire, the pension is based on their contributions,
• 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.
• The growing use of DC plans and drop in use of DB plans, has some advantages
for younger employees.
o Historically DC plans are faster to vest (the companies matched share of the
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to the next job.
o On the negative side, the recession of 2008–2010 destroyed many 401(k)
portfolios.
• Several factors affect the amount of income available upon retirement.
o The earlier the age at which investments are made, the longer returns can
accumulate.
o Different investments have different historical rates of return.
▪ Exhibit 13.8 shows, if historical rates of return were to continue, an
o A third consideration is the need to counteract investment risk by
diversification because stock and bond prices can be volatile in the short run.
• The second type of DC plan is an employee stock ownership plan (ESOP).
o A company makes a tax-deductible contribution of stock shares or cash to a
trust.
▪ The trust then allocates company stock (or sock bought with cash
o When 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.
o ESOPs have one major disadvantage, which limits their utility for pension
accumulations.
▪ Many employees are reluctant to “bet” most of their future retirement
o Recently, 401(k) contributions have shifted away from company stock.
• Finally, a profit sharing plan can be considered a defined contribution plan if the
distribution of profits is delayed until retirement.
• Both defined benefit and defined contribution plans are subject to stringent tax
laws.
Chapter Thirteen: Benefit Options 13 – 12
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(hence, it is labeled “qualified” deferred compensation plan).
o This requirement eliminated the common practice of building tax-friendly,
extravagant pension packages for executives and other highly compensated
employees.
o The 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.
o The disadvantage arises in recruitment of high-talent executives.
• A hybrid of defined benefit and defined contribution plans has emerged in recent
years.
o Cash balance plans are defined benefit plans that look like defined
contribution plans.
• In 2009, 401(k) contributions were suspended by many companies in the wake of
the suffering U.S. economy.
C. Individual Retirement Accounts (IRAs)
• An individual retirement account (IRA) is a tax-favored retirement savings plan
that individuals can establish themselves.
D. Employee Retirement Income Security Act (ERISA)
• The early 1970s were a public relations and economic disaster for private pension
plans.
o Many people who thought they were the victims of complicated rules,
insufficient funding, irresponsible financial management, and employer