chapter 13

LIFE INSURANCE

As we saw earlier, 56 percent of private sector employees have access to paid life insurance.50 Typical coverage would be a group term insurance policy with a face value of one to two times the employee's annual salary.51 Most plan premiums are paid completely by the employer.52 The cost is about ten cents per hour per employee.53 Slightly over 30 percent include retiree coverage. To discourage turnover, almost all companies make this benefit forfeitable at the time of departure from the company. Life insurance is one of the benefits heavily affected by movement to a flexible benefit program. Flexibility 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.

BENEFITS FOR CONTINGENT WORKERS

Contingent workers, defined as workers who do not expect their jobs to last or who report their jobs are temporary, represent between 1.3 and 3.8 percent of the workforce.75 Additionally, alternative work arrangements, which include independent contractors (6.9 percent), on-call workers (1.7 percent), temporary help agency workers (0.9 percent), and workers provided by contract firms (0.6%) represent another 10.1 percent of total employment. Because it reduces direct workforce costs (because there are no legally required benefits for non-employees and other benefits may not be offered), and permits easier expansion and contraction of the workforce in response to expansion and contraction of production/services (sales), use of alternative work arrangements offers a way to meet rapidly changing economic conditions.76 We say more about this subject in Chapter 14.

MEDICAL AND MEDICALLY RELATED PAYMENTS

General Health Care - Health care costs continue to increase. As we saw previously, annual premiums to provide family coverage now average $18,764, with $13,049 paid by the employer and $5,714 paid by the employee. By comparison, in 2000, the average annual premium for family coverage was $6,438. Exhibit 13.10 shows the percentage increase in annual premium costs over time, which have substantially outstripped increases in inflation and worker earnings. More costly technology, the explosion of lawsuits, 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. Not surprisingly, employers continue to seek ways to cut health care costs or eliminate them completely from their benefits package. After a discussion of the types of health care systems, these cost-cutting strategies will be discussed. Before 1930, health care coverage essentially didn't exist. Health issues were the responsibility of the family. After the Great Depression, though, Blue Cross (BC) and Blue Shield (BS) appeared as the first institutional health care. Envious of the profits made by BC/BS, insurance companies began to offer plans for hospitalization along with doctor and surgical coverage. Then, of course, the government got involved. In the 1960s national health insurance emerged to cover the elderly (Medicare) and the poor (Medicaid). The Affordable Care Act was signed into law in 2010 and its provisions as they affect employers came into full effect in 2018. The Act isn't intended to change the way health care is delivered, but rather is aimed at expanding health care coverage through both an individual mandate to purchase health insurance and an employer mandate (for those with 50 or more employees) to provide qualifying health insurance coverage or face financial penalties. "Under the law, the number of uninsured nonelderly Americans decreased from 44 million in 2013 (the year before the major coverage provisions went into effect) to less than 28 million as of the end of 2016."54 Although the individual mandate was eliminated in 2018, the employer mandate remains in place. Exhibit 13.11 summarizes provisions of the Act that pertain to employers. - As noted, the Affordable Care Act hasn't changed the basic underlying structure of health care delivery. The first method is through commercial insurance companies like Prudential, Aetna and Humana. Plans through these companies are called indemnity plans or so-called pay-for-service plans. Under these plans an employee can choose any health care provider. The second method of delivery is through a Health Maintenance Organization (HMO). An HMO pulls together a group of providers (e.g., hospitals and doctors) willing to provide services at an agreed upon rate in exchange for the employer limiting employees to these providers for health services. Employees make prepayments in exchange for guaranteed health care services on demand. Third, to provide employees with more options in selecting doctors and hospitals, Preferred Provider Organizations (PPOs) arose. Employers select certain providers who agree to provide price discounts and submit to strict utilization controls (e.g., strict standards on number of diagnostic tests that can be ordered). In turn, the employer influences employees to use these providers by charging higher fees if employees make selections outside the provider network. Finally, a point-of-service plan (POS) is a hybrid plan combining HMO and PPO benefits. The POS plan permits an individual to choose which plan to seek treatment from at the time that services are needed. POS plans, therefore, provide the economic benefits of the HMO with the freedom of the PPO. The HMO component of the POS plan requires office visits to an assigned primary care physician, with the alternative of receiving treatment through the PPO component. The PPO component does not require the individual to first contact the primary care physician but does require that in-network physicians be used. When POS plan participants receive all of their care from physicians in the network, they are fully covered, as they would be under a traditional HMO. Point-of-service plans also allow individuals to see a doctor outside the network, for which payment of an annual deductible ranging between $100 and $5,000 is required.55 Health Care: Cost Control Strategies - There are three general strategies available to benefit managers for controlling the rapidly escalating costs of health care.56 First, 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 (1) deductibles, or the first x dollars of health care cost are paid by the employee (at the extreme the state of Georgia recently told employees that certain name brand drugs will require a $100 copay, clearly signaling that enough is enough);57 (2) coinsurance rates (premium payments are shared by the company and employee); (3) maximum benefits (defining a maximum payout schedule for specific health problems); (4) coordination of benefits (ensure no double payment when coverage exists under the employee's plan and a spouse's plan); (5) auditing of hospital charges for accuracy; (6) requiring preauthorization for selected visits to health care facilities; (7) mandatory second opinion whenever surgery is recommended; (8) using intranet technology to allow employees access to online benefit information, saving some of the cost of benefit specialists;58 (9) providing incentives to employees for using providers who meet certain high performance criteria.59 The more questions answered online, the fewer specialists needed. The second general cost control strategy involves changing the structure of health care 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 whatsoever. 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 increasingly 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 (HMO, PPO, Indemnity Plans), but the employer sets its contribution equal to the lower cost of these three (usually HMO). If the employee wants a more expensive option, the extra cost is out-of-pocket. These plans usually are accompanied by high deductibles, sometimes reaching several thousand dollars.60 Typically an employer helps lessen the cost of the deductible by setting up Health Savings (HSA) or Health Reimbursement (HRA) accounts. Funds in these accounts are either contributed by employees with pretax dollars (HSA) or by the employer up to some fixed dollar amount (HRA). All of this complexity is introduced simply to force employees to make choices in the most economical way while hopefully not neglecting important health issues. A final category of cost control strategies links incentives to healthy behaviors. We know that preventable illnesses account for 70 percent of all health care costs.61 Obesity, for example, is preventable. Dieting, however, is not a favorite pastime. How, then, do we get people to lose weight? The answer may be health incentives. For example, Caesar's Casinos give a $40 award to employees who get screened to measure cholesterol level and then make efforts (e.g., by losing weight) to lower their levels. More than two-thirds of medium and large employers with wellness programs have incentives to get employees involved in wellness.62 JetBlue provides a maximum of $400 in Health Reimbursement Accounts to be used by employees in roughly 45 activities (e.g., smoking cessation). On the negative incentive side, CVS drugstores charge employees $600 more in health premiums for not completing wellness assessment activities like annual checkups. In general, incentives are becoming much more popular. In 2009 only 57 percent of companies had any of these incentives. Now 75 percent use these motivational tools.63 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: employee salary continuation plans and long-term disability plans.64 Many companies have some form of salary continuation plan we include here vacation days that might be used for sick leave as a last resort that pays out varying levels of income depending on duration of illness. At one extreme is short-term illness covered by sick leave policy and typically reimbursed at a level equal to 100 percent of salary.65 The most prevalent practice these days is to give paid time off (PTO) rather than sick days. This reduces the need for companies to "police" whether employees are indeed sick, and allows employees more flexibility in life planning. After such benefits run out, disability benefits become operative. Short-term disability (STD) pays a percentage of your salary (about 60% on average) for temporary disability because of sickness or injury (on-the-job injuries are covered by workers' compensation). Long-term disability plans (LTD), if available, typically kick in after the short-term plan expires. Long-term disability 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.66 Dental Insurance - A rarity decades ago, dental insurance is now much more prevalent, with most larger employers offering coverage. In many respects dental care coverage follows the model originated in health care plans. The dental equivalent of HMOs and PPOs is the standard delivery system. For example, a dental HMO enlists a group of dentists who agree to treat company employees in return for a fixed monthly fee per employee. At the start of the century, the typical cost for employee dental coverage was $219.67 Since then, of course, cost increases have been an issue and employers now typically require employee contributions.68 The relatively modest increase in dental care costs can be traced to stringent cost control strategies (e.g., plan maximum payouts are typically $1,000 or less per year) and an excess supply of dentists. 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. Most large employers offer a vision plan. Most plans are noncontributory and usually cover partial costs of eye examination, lenses, and frames.

For years we've asked our students and HR professionals to rate different kinds of rewards in terms of importance. Usually, at least in the past, employee benefits lagged behind such rewards as pay, advancement opportunity, job security, and recognition. Recently, though, we've noticed a dramatic shift in this admittedly unscientific poll. As benefits costs, especially health care, have skyrocketed, so has their popularity. With this increased popularity comes a need for HR professionals to understand what benefits are important to employees. Just ask Rich Floersch, the executive vice president for human resources at McDonald's Corporation.6 As we noted in Chapter 12, several years ago McDonald's unveiled a new benefits program for crew members. When we asked Rich why McDonald's was modifying its health care package as part of a total benefits upgrade, he cited the rising value of benefits to workers and the strategic importance of its hundreds of thousands of employees (and close to two million, including its franchises). Look at it from another perspective: The population (and your three favorite authors) are aging. This alone changes the pattern of preferences. We're not sure all companies are as attuned to changing preferences as McDonald's. For example, a McKinsey Survey reports 89 percent of CEOs think benefits are extremely or very important to attracting and retaining employees. However, less than one-half of these executives thought they understood what benefits employees wanted. Moreover, almost 60 percent of these executives admitted they never assessed whether benefits were helping the company achieve its strategic goals.7 Is it any wonder that daily news reports bring frequent alarms about the rising cost of benefits?

Our goal in this chapter is to give you a clearer appreciation of employee benefits, including their cost. Exhibit 13.1 reports employer costs of wages and salaries, benefits, and specific benefits categories. In private industry, total compensation equals $33.72, of which $23.47 is wages and salaries and $10.25 is benefits. Legally required benefits are the single most costly category. Overall, benefits account for just over 32 percent of total compensation (and add almost 46 cents on top of every dollar of wages and salaries). Employer costs are higher in state and local government, where benefits are a higher share (just over 37 percent) of total compensation. It seems to pay to work for the government! There are caveats, however. First, government employees earn more partly because they have higher average education.8 Second, government workers having a graduate degree actually earn less total compensation (wages/salaries plus benefits) than private industry workers with a graduate degree. Third, stock option/grant payouts, received only by private sector employees, are not included in these figures. Exhibit 13.2 shows employee access to selected benefit programs, by establishment size. We can see that larger establishments are much more likely than smaller establishments to offer many types of benefits. Many students tell us they are struck by how low the retirement and health insurance figures are. The follow-up question we get is, "Doesn't everyone get a retirement package?" The answer is no! Many Americans work in jobs with no paid retirement. Many also receive no health coverage. To organize the rest of this chapter, we will use a somewhat more detailed categorization of employee benefits (Exhibit 13.3). We will use these seven categories to illustrate important principles affecting strategic and administrative concerns for each benefit type.

MISCELLANEOUS BENEFITS

Paid Time off during Working Hours - Paid rest periods, lunch periods, wash-up time, travel time, clothes-change time, and get-ready time benefits are self-explanatory. Payment for Time Not Worked - Included within this category are several self-explanatory benefits: 1. Paid vacations and payments in lieu of vacation 2. Payments for holidays not worked 3. Paid sick leave 4. Other (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. Indeed, 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 adoption of a child or for the care of a family member with a serious illness. The following sick policy, taken from Motley Fool's employee manual, shows just how far such policies have come: "Unlike other companies, The Motley Fool doesn't make you wait for six months before accruing vacation or sick time. Heck, if you're infected with some disgusting virus—stay home! We like you, but don't really want to share in your personal anguish. In other words, if you're bleeding out your eyes and coughing up a lung—don't be a hero! Stay home. Out of simple Foolish courtesy, we expect you to call your supervisor and let him or her know you won't be in. And yes, you will get paid. So, pop quiz: You're feeling like you're going to snap any moment if you don't take some personal time off, you've made a small deposit on an M-16 rifle and are scoping out local clock towers, BUT you've only been a paid Fool for a short time . . . what do you do, what do you do?69 " Many companies are switching from traditional time-off plans (TTO), as described above, to paid-time-off (PTO) plans. These lump all time off together into one total allotment and deduct any day missed from this bank. Not 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.70 Child Care - Relatively few companies directly provide child care. However, it's becoming quite common for employers to offer flexible spending accounts with child care expenditures as a legitimate expense. The employee, employer, or both pay into an account with pretax monies, and individuals can then use these funds to pay local child care providers. Here again, the tax-advantaged nature of benefits is important to consider. 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 (like deductibles or co-payments). A separate account of up to $5,000 per year is permitted for pretax contributions to cover dependent care expenses. The federal tax code requires that funds in the health care and dependent care accounts be earmarked in advance and spent during the plan year. Remaining funds revert to the employer. Therefore, the accounts work best to the extent that employees have predictable expenses. The major advantage of such plans is the increase in take-home pay that results from pretax payment of health and dependent care expenses. Consider again the hypothetical employee with an effective total marginal tax rate of 40.33 percent we discussed earlier. Now, examine Exhibit 13.12, which shows that the take-home pay from an additional $10,000 in salary with and without a flexible dependent care account is: $4,415 - $3,367 = $1,048 per year. Even more money can be saved using a dependent care account, which allows a maximum contribution of $5,000. 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. The majority of companies report that they provide employees paid or unpaid time off to provide elder care.71 Domestic Partner Benefits - Domestic partner benefits are benefits that 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. 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 (to 24 percent).72 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. Keep in mind, though, that most legal insurance premiums are paid by the employee, not the employer. Technically, then, this doesn't qualify as a traditional employee benefit. Addressing Financial Precarity - In the United States, it has been reported that "money-related concerns are a more prevalent source of distress than those related to health, work, or family" and that "most people ... do not have $400 in savings to cover an emergency," and there is some evidence that such "financial precarity" can adversely affect employee performance at the workplace.73 In addition to higher wages, of course, employers can also take steps to encourage/incentivize employees to save enough money for an emergency (e.g., by cooperating with banks), through programs that help with balancing work and family, and by programs that encourage wellness.74

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 68 percent of workers have access to pension coverage, and only 53 percent actually participate.33 Blame competitive pressures from globalization, the recession, and paltry growth in productivity, but the reality is, as we saw above, that fewer people are paying into Social Security and more are drawing benefits. Employer-provided retirement plans are thus more important than ever if people are going to be able to retire and hopefully do so with confidence. In this vein, employees with employer-provided retirement plans are more likely to have sufficient savings for a comfortable retirement than those who do not have these plans.34 Two generic types of retirement plans are discussed below: defined benefit plans (the term "pension plan" most often refers to these) and defined contribution plans. Exhibit 13.7 provides a comparison of the two types of plans. As you read their descriptions, keep in mind that defined benefit plans have become less common and those that remain are often not open to new enrollees. Prominent companies such as IBM and Verizon have frozen their traditional defined benefit pension payouts. Workers still get their pensions, but there isn't any growth in the amount as a function of additional time on the job. Rather, many companies are shifting to 401(k) plans (a popular type of defined contribution plan) where the dollar contribution is known and controllable.35 As we saw earlier, only 18 percent of private sector employers are covered by defined benefit plans, whereas 62 percent are covered by defined contribution plans, such as a 401(k). A few decades ago, these percentages would have been reversed. To understand why this major change occurred, we next explain the different cost and impacts of the two types of plans. Defined Benefit Plans - In a defined benefit (DB) plan an employer agrees (promises) to provide a specific level of retirement pension ("defined benefit"), which is expressed as either a fixed dollar amount or a percentage-of-earnings amount, which typically varies (increases) 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.36 - 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% percent) adjusted for years of seniority, at least for employees who have been with the firm for a sufficiently long period of time. - So what is it about defined benefit plans that make them prime targets for cost cutting? The major complaints by chief financial officers (CFOs) center on funding: If I've got to pay Jim $40,000 a year at retirement, I have to start investing now to have that cash available. How much should I invest, though? Given how volatile the stock market is, it's hard to predict how much is needed. CFOs report that this is a drag on corporate financial health and a distraction from running the core business. As an example, General Motors (GM) recently eliminated its defined benefit plan for salaried employees. New hires already were covered by a defined contribution (DC) plan. Now all salaried employees are enrolled in DC pension plans. Why? GM had a $12 billion shortfall in funding its pension. As one step to eliminate their pension burden, GM paid Prudential $2.5 billon to take over 25 percent of GM's pension burden.37 What companies do is purchase annuities with insurance companies. GM had a total of $25 billion in annuities with Prudential. Verizon had a $7.5 billion annuity, also with Prudential. Motorola and Bristol Meyers Squibb paid a combined $4.5 billion to Prudential to take over all pension payments. These companies buy the annuity at a premium (often 10%). When interest rates fluctuate in the future, now these companies won't have to worry about significantly higher pension costs. The annuity stabilized the cost of their pension obligation.38 Defined Contribution Plans - In a defined contribution (DC) plan the employer makes provisions for contributions to an account set up for each participating employee. 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 defined contribution plans. 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. Employers typically match employee savings at a rate of 50 cents on the dollar.39 The growing use of defined contribution plans (and drop in use of defined benefit plans) has some advantages for younger employees (like many of you). Historically these plans are faster to vest (the company's matched share of the contribution permanently shifts over to employee ownership) and they are also more portable—job hopping employees can take their retirement fund accruals along to the next job. On the negative side, whereas employers bear the investment risk under a defined benefit plan, investment risk is borne by employees under defined contribution plans, a point unfortunately driven home to many during the recession of 2008-2010, when many employees saw their 401(k) portfolios decimated. Another problem with such plans is that many employees do not invest enough (i.e., contribution rates are low). About 40 percent of all employees don't contribute enough to get the full employer match.40 To sum up, under a defined contribution plan, whether an employee will be able to afford to retire depends on decisions made by the employee. As such, employers must consider how to help employees learn the basics of investing (including the importance of diversification). Several factors affect the amount of income that will be available to an employee upon retirement. First, the earlier the age at which investments are made, the longer returns can accumulate. As Exhibit 13.8 shows, an annual investment of $3,000 made between ages 21 and 29 will be worth much more at age 65 than a similar investment made between ages 31 and 39. Second, different investments have different historical rates of return. Between 1928 and 2016 the average annual return was 9.53% for stocks, 5.18% for bonds, and 3.46% for cash (e.g., short-term Treasury bills or bank savings accounts). As Exhibit 13.8 shows, if historical rates of return were to continue, an investment in a mix of 60% stock, 30% bonds, and 10% cash between the ages of 21 and 29 would be worth about four times as much at age 65 as would the same amount kept in the form of cash. A third consideration is the need to counteract investment risk by diversification because stock and bond prices can be volatile in the short run. Although stocks have the greatest historical rate of return, that is no guarantee of future performance, particularly over shorter time periods. (This fact becomes painfully obvious during the dramatic drops in stock market values that are experienced every so often, most recently a drop of 38% in the S&P 500 in 2008.) Thus, some investment advisers recommend a mix of stock, bonds, and cash, as shown in Exhibit 13.8, to reduce investment risk. Younger investors may wish to have more stock, while those closer to retirement age typically have less stock in their portfolios. The second type of DC plan is an employee stock ownership plan (ESOP). In a basic ESOP, a company makes a tax-deductible contribution of stock shares or cash to a trust. The trust then allocates company stock (or stock bought with cash contributions) to participating employee accounts. The amount allocated is based on employee earnings. 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. ESOPs 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 approaching retirement age. A classic example of this comes from Enron . . . yes, the same Enron linked to all the ethics problems. Under Enron's 401(k), employees could elect to defer a portion of their salaries. The employees were given 19 different investment choices, one of which was Enron common stock. Enron matched contributions, up to 6 percent of an employee's compensation. Enron's contributions were made in Enron stock and had to be held until the employee was at least age 50. This feature resulted in 60 percent of the total plan value being in Enron stock in 2001. Guess what? When Enron's shares went through the floor in 2001-2002, thousands of employees saw their retirement nest eggs destroyed. Recently 401(k) contributions have shifted away from company stock. The majority (53%) of companies allow less than 10 percent of assets in company stock.41 Corey Rosen, founder of the National Center for Employee Ownership, advises, "Employees need to think very carefully about investing their own money beyond 10% in company stock." That implies that 47% of companies still have too much of retirement assets in company stock.42 Consider what has happened at General Electric (GE). The drop in its stock price in late 2017 and early 2018 resulted in an estimated $140 billion in wealth disappearing, more than was lost at Enron (and at Lehman and Bear Stearns). Compared to its 2000 peak, GE's market value dropped more than $460 billion. That, of course, had consequences for GE employees and retirees who for years took advantage of GE's stock purchase plan, under which GE would match up to 50 percent of worker stock purchases. When Gary Zabroski retired in 2016 from being a punch press operator at GE, he did so with an annual pension of $85,000 and GE stock valued at $280,000. A few years later, however, the value of his GE stock had fallen to $110,000. He decided he needed to find a job even though he hadn't planned on "having to go back to work." His monthly mortgage payment and the cost of supporting his partially disabled wife made his financial situation "kind of scary" after the drop in the value of his GE stock.43 Finally, a profit-sharing plan can be considered a defined contribution plan if the distribution of profits is delayed until retirement. Chapter 10 explains the basics of profit sharing. Not surprisingly, both DB and DC compensation plans are subject to stringent tax laws. For deferred compensation to be exempt from current taxation (i.e., to be a qualified deferred compensation plan), specific requirements must be met. To qualify, an employer cannot freely choose who will participate in the plan. Instead, they must meet nondiscrimination tests that are intended to encourage companies to spread benefits coverage to all employees. This requirement eliminated the common practice of building tax-friendly, extravagant pension packages (only) for executives and other highly compensated employees (a term precisely defined by the Internal Revenue Service in performing equally precise nondiscrimination tests).44 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. The 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 a defined contribution plan. Employees have a hypothetical account (like a 401[k]) into which is deposited what is typically a percentage of annual compensation. The dollar amount grows both from contributions by the employer and from some predetermined interest rate (e.g., often set equal to the rate given on 30-year treasury certificates). In 2009, 401(k) contributions were suspended by many companies in the wake of the Great Financial Crisis in the United States. General Motors, FedEx, Sears Holdings, and Eastman Kodak are among companies who suspended contributions. Such flexibility (in terms of what if any contributions are made when times are hard) can be viewed as another advantage (from the employer's point of view) of a defined contribution plan. Individual Retirement Accounts (IRAs) - An individual retirement account (IRA) is a tax-favored retirement savings plan that individuals can establish themselves. That's right, 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.45 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 covered 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. Enter the Employee Retirement Income Security Act (ERISA) in 1974 as a response to these problems. ERISA does not require that employers offer a pension plan. But if a company decides to have one, it is rigidly controlled by ERISA provisions.46 These provisions were designed to achieve two goals: (1) to protect the interest of approximately 100 million active participants,47 and (2) to 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. A major factor in these terminations, along with the recession, was ERISA. Employers complained about the excessive costs and paperwork of living under ERISA. Some disgruntled employers even claimed ERISA was an acronym for "Every Ridiculous Idea Since Adam." To examine the merits of these claims, let us take a closer look at the major requirements of ERISA. = General Requirements= ERISA requires that employees be eligible for pension plans beginning at age 21. Employers may require 12 months of service as a precondition for participation. The service requirement may be extended to three years if the pension plan offers full and immediate vesting. - Vesting and Portability= These two concepts are sometimes confused but have very different meanings in practice. 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. The vesting concept has two components. First, 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: (1) full vesting after three years (down from five years previously) or (2) 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 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 so doing, 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. The strategy adopted is, therefore, dependent on organizational goals and workforce characteristics. Portability of pension benefits becomes an issue for employees moving to new organizations. Should pension assets accompany the transferring employee in some fashion?48 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, of course, the pension rights must be vested. - Pension Benefit Guaranty Corporation= 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 pension obligations. In the event of severe financial difficulties that force the company to terminate or reduce employee pension benefits, the Pension Benefit Guaranty Corporation (PBGC) provides some protection of benefits. Established by the Employee Retirement Income Security Act (ERISA) of 1974, the PBGC guarantees a basic benefit, not necessarily complete pension benefit replacement, for employees who were eligible for pensions at the time of termination. We guarantee you, there are many Eastman Kodak employees who lose sleep over this issue! The PBGC is funded by employer premiums paid annually and these premiums are larger for underfunded plans. (Note that the PBGC does not guarantee retiree health care benefits.) - Pension Protection Act of 2006 (PPA)= Remember Enron? Maybe you didn't know that many Enron employees lost more than their jobs. As we noted earlier, many employees had their retirement funds allocated to Enron stock. When the stock went through the floor, so did many retirement dreams. The 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. 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. We expect this provision will motivate employees toward investing in defined contribution plans and reduce some of the burden on employers. 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 percent funded as 'at risk' plans. There are at least two other important provisions of the PPA. One is that defined contribution plans holding publicly traded securities must provide employees with at least three investment options other than employer securities. The other provision is to allow employers to enroll workers in their 401(k) plan automatically and to increase a worker's 401(k) contribution automatically to coincide with a raise or a work anniversary. Workers can decline, but the onus is on them to do so. How Much Retirement Income to Provide? - The level of pension a company chooses to offer depends on the answers to five questions. First, what level of retirement compensation would a company like to set as a target, expressed in relation to pre-retirement earnings? 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 50%) of Social Security benefits.49 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. Once a company has targeted the level of income it wants to provide employees in retirement, it makes sense to design a system that integrates private pension and social security to achieve that goal. Any other strategy is not cost-effective. Third, should other post-retirement income sources (e.g., savings plans that are partially funded by employer contributions) be integrated with the pension payment? Fourth, a company must decide how to factor seniority into the payout formula. The larger the role played by seniority, the more important pensions will be in retaining employees. 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 13.9 vividly illustrates, job hoppers are hurt financially by this type of strategy. In our example—a very plausible scenario—job hopping cuts final pension amounts in half. (Would a job hopper perhaps prefer to be covered by a defined contribution plan such as a 401k instead?) Finally, companies must decide what they can afford. As noted earlier, defined benefit plans at both companies and governments are often chronically underfunded. Of course, the decline in the use of defined benefit programs (especially in private industry) and a concurrent shift toward greater use of defined contribution plans can be explained in large part by a desire to get away from these funding challenges/financial obligations in the future, instead shifting them to employees.

LEGALLY REQUIRED BENEFITS

Virtually every employee benefit is somehow affected by statutory or common law (many of the limitations are imposed by tax laws). In this section the primary focus is on benefits that are required by statutory law: Workers' Compensation, Social Security, and Unemployment Compensation. Workers' Compensation - What costs employers about $95 billion a year and is a major cost of doing business? Answer: workers' compensation. Of this total cost, $62 billion was in the form of benefits paid to workers, with $31 billion of that for medical care and the remaining $31 billion paid in cash.9 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 given for:10 1. Medical care needed to treat the job injury or illness. 2. Temporary disability benefits to the employee to help replace lost wages. 3. Permanent disability payments to the employee to compensate for permanent effects of the injury. 4. Survivor death benefits. 5. Rehabilitation 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 and then began to level off and increase somewhat starting in 2010.11 Experts believe part of this stabilization relates to employer safety programs, with far fewer fatal accidents occurring and somewhat higher incidents of minor, less costly accidents. States vary in the size of the payout for claims. New York State, for example, has a payout formula for totally or partially disabled that is based on his/her average weekly wage for the previous year. The following formula is used to calculate benefits: 2/3 × average weekly wage × percent of disability = weekly benefit Therefore, a claimant who was earning $400 per week and is totally (100 percent) disabled would receive $266.67 per week. A partially disabled claimant (50 percent) would receive $133.34 per week.12 Some states provide "second-injury funds." 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. For example, if a person with a known heart condition is hired and then breaks an arm in a fall triggered by a heart attack, medical treatments for the heart condition would not be paid from workers' compensation insurance; treatment for the broken arm would be compensated. Workers' compensation is covered by state, not federal, laws. For details on each state's laws, go to the e-Compensation website below: As Exhibit 13.4 shows, in general the states have fairly similar coverage, with differences occurring primarily in benefit levels and costs. In recent years states have made significant changes in Workers' Compensation (WC) designed to reduce costs. For example, Montana paid $3.22 per $100 of payroll cost, a figure much higher than most states. They and five other states passed major reforms attempting to control medical costs and rein in WC as a result.13 In Montana, the cost per $100 of covered wages decreased more than in any state over a seven-year period, from $3.22 to $2.17.14 Social Security: Old Age, Survivors, Disability & Health (OASDI) + Medicare - When Social Security was introduced in 1937 (under the Social Security Act of 1935), only about 60 percent of all workers were eligible.15 Today, nearly all American workers (96 percent) are covered.16 Whether a worker retires, becomes disabled, or dies, Social Security benefits are paid to replace part of the lost family earnings. Ever 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. Exhibit 13.5 outlines the initial provisions of the law and its subsequent broadening over the years.17 In combination this law and its updates provide coverage in the form of: retirement insurance; survivors insurance; disability insurance; hospital and medical insurance for the aged, the disabled, and those with end-stage renal disease; prescription drug benefit Extra Help with Medicare Prescription Drug Costs supplemental security income; and special veterans benefits.18 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. While the number of retired workers continues to rise (because of earlier retirement and longer life spans), no corresponding increase in the number of contributors to Social Security has offset the costs. Combine the increase in beneficiaries with other cost stimulants (e.g., liberal cost-of-living adjustments) and the outcome is not surprising. To maintain solvency, there has been a major increase over time 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. As of 2018, the total Social Security Tax on earnings is 7.65 percent (6.2 percent OASDHI + 1.45 percent Medicare), which is paid by both employees and employers (for a total of 15.3 percent). Although not shown in Exhibit 13.6, the federal government did not forget about the self-employed, who, in the absence of a separate employer, pay a tax rate of 15.3 percent (12.4 percent OASDHI tax plus a 2.9 percent Medicare tax). Also not shown is a tax added as of 2013 by the Affordable Care Act, referred to by the Social Security Administration as the High Income Tax and by the Internal Revenue Service as the Additional Medicare Tax, which is 0.9 percent on adjusted gross income above $200,000 for single filers and $250,000 for married filers. This tax is paid only by individuals. Employers do not pay this tax. Several points immediately jump out from Exhibit 13.6. First, with the rapid rise in taxable earnings, you should get used to paying some amount of Social Security tax on every dollar you earn. This wasn't always true. Notice that in 1980 the maximum taxable earnings were $25,900. Every dollar earned over that amount was free of OASDHI portion of the Social Security tax. Now the maximum is $128,400. Another major change in taxes is that when it comes to the second portion (Medicare) of the Social Security tax, there is no earnings maximum any more. If Jordan Spieth makes $30 million this year, he will pay 7.65 percent social security tax on the first $117,000 and 1.45 percent (the health/Medicare portion) on all the rest of his income. For the super rich (even with royalties, textbook authors need not apply), this elimination of the cap may leave a mark. Second, remember that, as noted, for every dollar deducted as an employees' share of social security, there is a matching amount paid by employers. For an employee with income in the $70,000 range, this means an employer contribution of just under $6,000. Current funding levels produced a massive surplus throughout the 1990s. There is still, at least in accounting terms, a huge surplus today. Unfortunately the surplus is something of a myth. The federal government doesn't put your contributions in a savings bank in anticipation of your retirement. Instead, they've continually used the fund to finance government spending. Baby 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 retired, and the impact of 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 into the fund) to beneficiaries was 159.4 to 1 and 5.1 to 1 in 1960. In 1990, the ratio was 3.4 to 1, and more recently it has dropped below 3.0 to 1.19 Without action, the ratio is expected to continue to decline and the funding of future benefits will become more uncertain. - Benefits under Social Security= The majority of benefits under Social Security fall into four categories: (1) old-age or disability benefits, (2) benefits for dependents of retired or disabled workers, (3) benefits for surviving family members of a deceased worker, and (4) lump-sum death payments. To qualify for these benefits, a worker must work in covered employment and earn a specified amount of money ($1,320 this year) for each quarter-year of coverage.20 Forty quarters of coverage will insure any worker for life. The amount received under the four benefit categories noted above varies, but in general it is tied to the amount contributed during eligibility quarters. For example, a person who had maximum taxable earnings in each year since age 22, and who retired this year at "full retirement age" (age 66) will earn $2,788 per month in benefits. What is sometimes missed, however, is that if that person waited until age 70, the maximum retirement benefit would be $3,698 per month. There is no further benefit to retiring after age 70. There is also a spousal benefit of up to 50 percent of the primary recipient's benefit (if larger than the spouse's own benefit) with a minimum time married. Unemployment Insurance - The earliest union efforts to cushion the effects of unemployment for their members (ca. 1830s) were part of benevolent programs of self-help. Working members made contributions to their unemployed brethren. Wisconsin, in 1932, was the first state to introduce unemployment insurance. 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. The Great Depression started in 1929, and as we have noted, the unemployment rate eventually went as high as 25 percent. Think of that and the fact that no unemployment insurance existed until several years into the Great Depression. The unemployment insurance program has four major objectives: (1) to offset lost income during involuntary unemployment, (2) to help unemployed workers find new jobs, (3) to provide an incentive for employers to stabilize employment, and (4) to preserve investments in worker skills by providing income during short-term layoffs (which allows workers to return to their employer rather than start over with another employer). Unemployment insurance laws vary by state. The following discussion will cover some of the major characteristics of different state programs. - Financing= 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. The federal tax amounts to 0.6 percent of the first $7,000 earned by each worker.21 In addition, states impose a tax above the $7,000 figure. The extra amount a company pays depends on its experience rating—lower percentages are charged to employers who have terminated fewer employees. The tax rate may fall to almost 0 percent in some states for employers that have had no recent experience (hence the term "experience rating") with downsizing and may rise to 10 percent for organizations with large numbers of layoffs. - Coverage= All workers except a few agricultural and domestic workers are currently covered by unemployment insurance (UI) laws. These covered workers though, must still meet eligibility requirements to receive benefits: 1. You 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." [In most states, this is usually the first four out of the last five completed calendar quarters prior to the time that your claim is filed.] 2. You must be determined to be unemployed through no fault of your own [determined under state law], and meet other eligibility requirements of state law.22 - Duration= Until 1958, the maximum number of weeks any claimant could collect UI was 26 weeks. However, the recessions of 1958 and 1960-1961 yielded large numbers of claimants who exhausted their benefits, leading many states temporarily to revise upward the maximum benefit duration. In 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.23 This program expired in 2013 and maximum benefits duration returned to 26 weeks. Because unemployment has fallen to under 6 percent in many states, there has been some state legislation to reduce duration to as low as 20 weeks.24 - Weekly Benefit Amount= In general, benefits are based on a percentage of an individual's earnings over a recent 52-week period—up to the state maximum amount.25 For example, in many states, the compensation will be half your earnings, up to a maximum amount. For example, New York State recently increased its minimum benefit rate to $100 and the maximum to $420 with provisions for annual increases in these figures.26 - Controlling Unemployment Taxes= 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 unemployment insurance tax rate for that firm (i.e., the tax is based on the experience rating defined above). Efforts 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. Additionally, a benefit administrator should attempt to audit pre-layoff behavior (e.g., lateness, gross misconduct, absenteeism, illness, leaves of absence) and compliance with UI requirements after termination (e.g., refusing a job can disqualify an unemployed worker). The government can also play an important part in reducing unemployment expenses by decreasing the number of weeks that people are unemployed. Research shows that unemployment duration decreases by three weeks simply by stepping up enforcement of sanctions against fraudulent claims.27 Family and Medical Leave Act (FMLA) - The 1993 Family and Medical Leave Act applies to all employers having 50 or more employees and entitles all eligible employees to receive unpaid leave up to 12 weeks per year for specified family or medical reasons.28 Common reasons for leave under FMLA include caring for a newborn or seriously ill spouse, child, or parent.29 More state legislatures are now moving toward some form of paid family and medical leave for workers. 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% premium plus 2% administration fee), which can extend up to 36 months (standard 18 months), depending on the category of the qualifying event.30 The biggest concern for individuals getting health insurance under COBRA is the relatively brief qualifying period. After 18 months you're not eligible. With passage of the Affordable Care Act COBRA participants can opt into the Health Insurance Marketplace.31 Health Insurance Portability and Accountability Act (HIPAA) - The 1996 HIPAA is designed to (1) lessen an employer's ability to deny coverage for a preexisting condition and (2) prohibit discrimination on the basis of health-related status.32 Perhaps the most significant element of HIPAA began in 2002, when stringent new privacy provisions added considerable compliance problems for both the HR people charged with enforcement and the information technology people delegated the task of building secure health information systems. Just watch next time you visit a new doctor. You will have to sign a HIPAA document that, should you choose to read it, will make your eyes glaze over.