Managing Human Resources, Cascio, 7th Edition

Chapter 12
Indirect Compensation: Employee Benefit Plans

CHAPTER LEARNING OBJECTIVES

Questions this chapter will help managers answer:
1. Whatstrategicconsiderationsshouldguidethedesignofbenefitsprograms?
2. Whatoptionsareavailabletohelpabusinesscontroltherapidescalationofhealthcare
costs?
3. Shouldcompaniesofferauniformpackageofbenefits,orshouldtheymovetoa
flexibleplanthatallowsemployeestochoosethebenefitsthataremostmeaningfulto
them,uptoacertaindollaramount?
4. Whatcosteffectivebenefitsoptionsareavailabletoasmallbusiness?
5. Inviewoftheconsiderablesumsofmoneythatarespenteachyearonemployeebenefits,
whatisthebestwaytocommunicatethisinformationtoemployees?

KEY TERMS
Doctrine of constructive receipt

Managed care

Antidiscrimination rule

Gatekeeper

Contributory plans

Health maintenance organization (HMO)

Noncontributory plans

Point-of-service plan

Protected health information

Pension

Yearly renewable term insurance

Defined-benefit plan

Flexible benefits

Defined-contribution plan

Workers compensation programs

Cash-balance plan

Long-term disability

Grandfather clause

Disability management

Cost shifting

Managed health

Cafeteria benefits
1

Managing Human Resources, Cascio, 7th Edition

Flexible spending accounts

CHAPTER 12 OUTLINE
THE NEW WORLD OF EMPLOYEE BENEFITS

Intheearly1990s,expertspredictedthatbenefitspackageswouldbecomeevermore
generousascompaniescompetedforashrinkingpoolofworkers.

Struggling to deal with benefits costs that seem to rise relentlessly, many firms are
eliminating benefits or asking employees to pay more for them.

Plans that allow employees to choose among alternative benefits choices, so-called
flexible benefits, force employees to make trade-offsand profoundly affect how
they think about security, company loyalty, and employment itself.

Most employers are not only changing the range of benefit choices they offer, but also
changing the basic structure of their benefits.
Economics and demographics are driving these changes.

Benefits are no longer the fringe of compensation. Today they often compose 40
percent or more of wages.

Increasing life expectancy has made pensions more costly as well.

Firms are required to report the cost of future retiree health care benefits on their
balance sheetsthereby reducing profits.

A more diverse workforce means that the one-size-fits-all approach to employee

benefits doesnt work.
Single parents and childless couples place very different priorities on child
care benefits.

Many employers determine a sum theyll spend on each employee, establish a menu
of benefits, and then let each employee choose the benefits he or she wants or needs.

Such life-cycle benefits plans represent the next generation of full-blown flexible
benefits.

Yesterdaysfringeshavebecometodays(expected)benefitsandservices.Hereare
somereasonswhybenefitshavegrown:
Wage ceilings during World War II forced organizations to offer more benefits
in place of wage increases to attract, retain, and motivate employees.
The interest by unions in bargaining over benefits has grown, particularly
since employers are pushing for more cost-sharing by employees.
The tax treatment of benefits makes them preferable to wages because taxes
are deferred.
Granting benefits confers an aura of social responsibility on employers; they
are taking care of their employees.

Challenges
1.

Do you think that companies should provide a broader menu of "exotic" benefits
(e.g., veterinary care, dietary counseling) or improve the menu of "core" benefits
(e.g., health care, insurance, pensions)? Why?
Student answers will vary, depending on their viewpoint. Sample answer:
The word "should" in the question implies that employers have a choice. To a large
extent, they do not. Employers must respond to the requirements of their legal, social,
economic, and competitive environment. Many benefits are essentially "forced" upon
employers in order to attract and retain the types of employees they need to have to be
successful. To the extent that employers have any leeway in the determination of
benefits, they should focus on those that support their competitive strategy and are
most highly valued by employees.

2.

How might employees preference for various benefits change as they grow older,
or as their family situations change?
Obviously a person's life situation changes over time, and these changes affect
preferences for benefits. Changes in marital status, home ownership, number of
children, working or nonworking spouse, elder care needs, retirement planning, and
so forth are examples of life situations that will fundamentally affect benefit
preferences. The need for elder care in dual-career families typifies a new growth area
in benefits brought on by the changing demographics of the workforce as a whole.

3.

Shouldemployeesshareatleastsomeofthecostsandrisksofbenefitswiththeir
employers?Whyorwhynot?
Student answers will vary, depending on their viewpoint. Sample answer:
Personally, I believe that employees should shoulder some of the costs and risks of
benefits. When benefits are provided at no charge, employees tend to under-rate their
value and use them indiscriminately. For example, when my company offered soft
drinks for free, it was not uncommon to see multiple half-empty cans sitting on
employee desks. When the drink started to get warm, theyd just get another one.
When the company started charging 25 cents for each drink, waste was reduced
dramatically. I believe that the same principle applies to health care.
On the other hand, if companies shift too many costs to employees, or are just doing it
to increase profit margins, the resentment it breeds is likely to backfire and cause
morale and employee retention problems.

STRATEGIC CONSIDERATIONS IN THE DESIGN OF BENEFITS PROGRAMS

Managers need to think carefully about what they wish to accomplish by means of
their benefits programs.

On average, firms spend over $15,000 in benefits for each worker on the payroll.

To leverage the impact of these expenditures, managers should be prepared to answer

questions such as:
Are the type and level of our benefits coverage consistent with our long-term
strategic business plans?
Given the characteristics of our workforce, are we meeting the needs of our
employees?
What legal requirements must we satisfy in the benefits we offer?
Are our benefits competitive in cost, structure, and value to employees and
their dependents?
Is our benefits package consistent with the key objectives of our total
compensation strategy, namely, adequacy, equity, cost control, and balance?

Long-Term Strategic Business Plans

Such plans outline the basic directions in which an organization wishes to move in the
next 3 to 5 years.

One strategic issue that should influence the design of benefits is an organizations
stage of development.
A start-up venture probably will offer low base pay and benefits but high
incentives; a mature firm will probably offer more generous pay and benefits
combined with moderate incentives.

Other strategic considerations include:

The projected rate of employment growth or downsizing
Geographic redeployment
Acquisitions
Expected changes in profitability

Diversity in the Workforce Means Diversity in Benefits Preferences

The benefits that appeal to a worker depend on their individual circumstances.

Young employees who are just starting out are likely to be more concerned
with direct pay (e.g., for a house purchase) than with a generous pension program.
Older workers may desire the reverse.
Unionized workers may prefer a uniform benefits package.
Single parents, older workers, or workers with disabilities may place heavy
emphasis on flexible work schedules.

Employers that hire large numbers of temporary or part-time workers may offer
entirely different benefits to these groups.

The perceived value of benefits rises when employers introduce choice through a
flexible benefits package.

Legal Requirements

The government plays a central role in the design of any benefits package.

Income-maintenance laws were enacted to provide employees and their families with
income security in case of death, disability, unemployment, or retirement.

Two principles have had the greatest impact on benefits:

The doctrine of constructive receipt holds that an individual must pay taxes
on benefits that have monetary value when the individual receives them.
The antidiscrimination rule holds that employers can obtain tax advantages
only for those benefits that do not discriminate in favor of highly compensated
employees.

Together they hold that if benefits discriminate in favor of highly paid or key
employees, both the employer and the employee receiving those benefits may have to
pay taxes on the benefits when they are transferred.

Social Security, which accounts for $1 of every $5 spent by the federal government,
has an effect on the growth, development, and design of employee benefits.
The government is increasingly shifting costs to the private sector and
emphasizing cost containment; such pressures will intensify.

National policy on unfair discrimination, particularly through the civil rights laws,
has caused firms to reexamine their benefits policies.

Competitiveness of the Benefits Offered

The issue of benefits-program competitiveness is much more complicated than that of

salary competitiveness.
In the case of salary, both employees and management focus on the same
item: direct pay (fixed plus variable).
In determining the competitiveness of benefits, senior management tends to
focus mainly on cost, while employees are more interested in value.

Offering employees a benefits plan that they consider competitive may lead to
excessive costs. On the other hand, achieving competitiveness provides no assurance
that employees will perceive the benefits program as valuable to them.

Four Major Income-Maintenance Laws

Social Security Act (1935)

Federal Unemployment Tax Act (1935)

Workers compensation (state laws)

Employee Retirement Income Security Act (ERISA)

Total Compensation Strategy

The broad objective of the design of compensation programs is to integrate salary and
benefits into a package that will encourage the achievement of an organizations
goals.

In all cases, considerations of adequacy, equity, cost control, and balance should
guide decision making in the context of a total compensation strategy.

Components of the Benefits Package

According to the U.S. Chamber of Commerce, benefits fall into three categories:
Security and health
Payments for time not worked
Employee services
Cost

In its 2004 benefits survey, the Society for Human Resource Management found that
the average percentage of salary reflecting the cost of mandatory benefits was 20
percent.

Voluntary benefits averaged 22 percent.

Companies with more than 500 employees offered the largest percentage of both
mandatory and voluntary benefits, while companies with 2,501 to 5,000 employees
offered the largest percentage of benefits

Assuming that a company pays an average salary of $45,000 per year, its average cost
of benefits per employee is $13,500.

Security and Health Benefits

These include:
Life insurance
Workers compensation
Disability insurance
Hospitalization, surgical, and maternity coverage
Health maintenance organizations (HMOs)
Other medical coverage
Sick leave
Pension plans
Social Security
Unemployment insurance
Supplemental unemployment insurance
Severance pay

Insurance is the basic building block of almost all benefits package, for it protects
employees against income loss caused by death, accident, or ill-health.

The plans may be contributory (employees share in the cost of the premiums) or
noncontributory (the employer pays the full cost of the premiums).

Under the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1986:

Companies with at least 20 employees must make medical coverage available
at group insurance rates for as long as 18 months after the employee leaves
whether the worker left voluntarily, retired, or was dismissed.
Following a workers death or divorce, the employees family has the right to
buy group-rate health insurance for as long as 3 years.
Employers who do not comply can be sued and denied corporate tax
deductions related to health benefits.

However, only one in every four workers who get laid off can afford continued health
coverage through COBRA.

Because some corporate medical plans do not cover preexisting conditions, some
employees found that when they changed jobs (and health plans), their benefits were
reduced sharply.

To alleviate that problem, Congress passed the Health Insurance Portability and
Accountability Act (HIPAA) in 1997:
New employees can use evidence of previous health care coverage through
their prior employer to reduce or eliminate preexisting health condition
requirements.
Employees who are leaving a company must be given a certificate of prior
creditable health care coverage to use for this purpose.
Since 2002, and individual or group health plan that provides or pays the cost
of medical care may not use or disclose protected health information without the
consent or authorization of the person in question.
Group Life Insurance

This type of insurance is usually yearly renewable term insurance; that is, each
employee is insured 1 year at a time.

Typical coverage is one to two times the employees annual salary.

The more expenses and dependents you have, the more life insurance you will need.

About 95 percent of all companies offer this benefit.

To discourage turnover, most companies cancel this benefit if an employee

terminates.

Flexible benefits programs typically provide a core of basic life coverage and then
permit employees to choose greater coverage as part of their optional package.

Workers Compensation

Workers compensation programs provide payments to workers who are injured on

the job, or who contract a work-related illness.

The payments cover three areas:

Payments to replace lost wages
Medical treatment and rehabilitation costs
Retraining to perform a different type of work (if necessary)

These payments vary by state.

Disability benefits, which have been extended to cover stress (in four states) and
occupational disease, tend to be highest in states where organized labor is strong.

Workers compensation is second in size only to the sum of Social Security disability
insurance and Medicare.

A states industrial structure also plays a big part in setting disability insurance rate;
loggers are more prone to injury than are electronics assemblers.

Sometimes the cost of workers compensation can get out of hand, especially for
small businesses.
Los Angeles fish wholesaler City Sea Foods saw premiums jump 68 percent,
to nearly $7,000 per worker. As a result, the company had to lay off 7 of their 57
employees.

Trends such as these have prompted high-cost states, such as California, Florida,
Michigan, and Maine, to lower workers compensation premiums so that they can
continue to attract and retain businesses in their states.

At present, all 50 states have workers compensation laws. While specific terms and
levels of coverage vary by state, all state laws share these features:
All job-related injuries and illnesses are covered.
Coverage is provided regardless of who caused the injury or illness
Payments are usually made through an insurance program financed by
employer-paid premiums.
A workers loss is usually not covered fully by the insurance program. Most
cash payments are at least two-thirds of the workers weekly wage, but, together
with disability benefits from Social Security, the payments may not exceed 80
percent of the workers weekly wage.
Workers compensation programs protect employees, dependents, and
survivors against income loss resulting from total disability, partial disability, or
death; medical expenses; and rehabilitation expenses.

Disability Insurance

Disability insurance provides a supplemental, one-time payment when death is

accidental, and it provides a range of benefits when employees are disabled.

Long-term disability (LTD) plans cover employees who are disabled 6 months or
longer, usually at no more than 60 percent of their base pay, until they begin receiving
pension benefits.

Disability leaves for those in their 20s to 50s rose throughout the 1980s and 1990s,
coinciding with significant rises in obesity, diabetes, and asthma.

Disability leaves cost companies between 8 and 20 percent of payroll annually.

Although disability benefits traditionally were divided into salary continuation, shortterm disability, and long-term disability, combined disability management programs
now merge all three.

Doing so allows for a single claim application process and uniform case management.

Another developing trend is toward integrating disability coverage with workers

compensation and group health care.
Under this scenario, patients would be treated under the same health care
system, regardless of whether they became ill or were injured at work or on their
own time.
This concept, called managed health, holds great potential.
Hospitalization, Surgical, and Maternity Coverage

These are essential benefits for most working Americans.

Self-insurance is out of the question since the costs incurred by one serious,
prolonged illness could easily wipe out a lifetime of savings and assets and place
a family in debt for years to come.

The U.S. health insurance system is based primarily on group coverage provided by
employers. The system is characterized by statistics such as:
MostAmericanshavehealthinsuranceandreceiveexcellentcare.Exceptfor
thepoor,especiallyininner cities, Americans are healthier than ever.
Those over age 65 are covered by Medicare, but fewer than half of those
living below the poverty line are covered by Medicaid.
About 45 million Americans have no health insurance. Most of the uninsured
are part-timers and per-day workersthe working poor. Nearly one-third of
workers in companies with 25 or fewer employees are uninsured.
Insurance rates have climbed faster for small businesses than for large ones.
Whether employed or not, younger people, as well as African-American and
Hispanic people, are most likely to lack health insurance.

 Americans with chronic diseases or a history of serious illness have trouble

obtaining affordable insurance.
Figures on the number of uninsured people understate the extent of
vulnerability. Over a recent 28-month period, one in four Americans spent at least
a month without health insurance.
Polls indicate that most Americans are pleased with their doctors and
hospitals. Yet there is widespread anxiety about the reliability of the system.
>From 1999 to 2004, the average increase in health insurance premiums was
32 percent. This exceeded the levels of inflation in those years as well as the
average increase in workers earnings.

Because employers pay most of the nations health care premiums, over time such
increases may make them less competitive in global markets.

Rising medical costs automatically translate into lower wages and they are a big
reason offshoring has become so attractive.

Competitiveness issues arising from health-care costs are particularly acute at

companies with the following three characteristics:
Their workforces are composed largely of people in their 40s and 50s, who
require more health care than younger workers do.
Their health plans cover a much larger number of retired workers than do
those of newer companies.
They make products that must compete on world markets.

Whats driving these increases in the cost of health care?

Population changes
General inflation
Excess medical inflation
Costly new drugs
Rising prescription volumes
The cost of new technology

Drugs are the fastest-growing part of health-care spending, but increased usage of
drugs causes much of that increase.
The switch to generics may help; the average cost of a brand-name drug is
$76.29, the average cost of a generic drug is $22.79.

When it comes to health-care technology, the United States relies far more heavily on
it than do other advanced nations.
The United States has four times as many diagnostic imaging machines as
Germany and eight times as many as Canada.
U.S. doctors perform open-heart surgery 2.6 times as often as Canadian
doctors and 4.4 times as often as German doctors.
When it comes to the use of smart machines to perform medical tests, one
expert noted: Theres no way to shut it off. The doctors crave it, its reassuring,
and patients crave it.
Hospitals often push to buy the latest machines in order to retain their
competitive status as full-service, modern health care centers.
Cost-Containment Strategies

Strategies that firms have taken to gain tighter management control over the cost of
health care:
Bandingtogetherwithothercompaniestoformapurchasingcoalitionto
negotiatebetterrates with insurers.
Dealing with hospitals and insurers as with any other suppliers.
Introducing a three-tier plan to encourage the use of generic drugs.
Offering incentives to nudge working spouses off company health plans.
Adopting a consumer-driven health plan (CDHP).

Managed care relies on a gatekeeper system of cost controls.

Fully 85 percent of Americans with health insurance belong to some

kind of managed-care plan.

The consumer-directed part of CDHPs allows you to use your account to pay for
prescription drugs and medical services from the providers in the network you have
selected.

Once your HRA is exhausted, you face a deductible.

When the deductible has been satisfied, coverage continues at the usual co-insurance
rate; employees and insurers sharing the cost of health care.

Fully 35 percent of midsize and large employers may soon add a CDHP to their
benefits package.

Health Maintenance Organizations

An HMO is an organized system of health care that assures the delivery of services to
employees who enroll voluntarily under a prepayment plan.

The emphasis is on preventive medicine, that is, maintaining the health of each
employee.

Legally, HMOs are authorized under the HMO Act of 1973.

The objective of HMOs is to control health-care costs by keeping people out of the
hospital.

HMOs were quite successful in the early 1990s in doing so, but the gains have not
lasted. Here are five reasons why:
Much of the progress came from eliminating unnecessary procedures and
hospitalizationsa one-time savings.
An explosion of new medical technologies and drug treatments has jacked up
prices again.
The population has aged, further spiking expenses.
Hospitals and doctors have refused to accept reduced reimbursement rates.
Employees have rebelled against managed-care limits on doctors and
procedures.

These factors have led to a growing realization that the managed-care revolution
seems to have run its course.

To overcome some employees complaints about the lack of freedom to choose their
doctors in an HMO, some firms offer point-of-service (POS) plans.

Such a plan offers patients a choice every time they seek medical care. They can use
the plans network of doctors and hospitals and pay no deductibles and only a
copayment for office visits (like an HMO), or they can see a physician outside the
network and pay 3040 percent of the total cost (like traditional health coverage).

Employees who are provided a choice are moving away from HMO and POS plans
toward preferred-provider organizations (PPOs), even though PPOs are more
expensive on a monthly basis, in order to have freedom of choice.

A few companies are giving workers the money they would have contributed to their
health-insurance premiums and letting them make their own decisions about
coverage.

Forces driving the trend include:

The backlash against managed care
The popularity of company-sponsored savings plans that let employees decide
how to invest their money

 The rise of websites that help consumers make decisions.

Experts see only a gradual transition to greater consumer control, as policy makers,
the market, and employees themselves get used to the idea.
Other Medical Coverage

Medical coverage in areas such as employee assistance programs and mental illness is
offered by about 70 percent of companies.

Dental HMOs, PPOs, and indemnity (traditional fee-for-service plans) are growing
fast.

Dental coverage is a standard inclusion for 95 percent of U.S. employers.

Fully 71 percent offer employees some form of vision-care insurance as well.

Sick-Leave Programs

These programs provide short-term insurance to workers against loss of wages due to
short-term illness.

In 2004, 57 percent of U.S. firms offered paid sick leave benefits.

In many firms, such well-intentioned programs have often added to labor costs
because:
Employees have abused the program
There is a widespread belief that sick leave is a right
Employees believe that if sick leave is not used, it will be lost (use it or lose
it)

To control these costs, 29 percent of firms are turning to paid time-off plans that
combine sick leave, vacation, and personal days into one plan.

Other companies have reduced the number of discretionary sick-leave days offered
and then at the end of the year pay employees at their current wage rate for unused
days.
Pensions

A pension is a sum of money paid at regular intervals to an employee (or to his or her
dependents) who has retired from a company and is eligible to receive such benefits.

Two developments in the late 1940s stimulated the growth of pension plans:
Clarification of the tax treatment of employer contributions
The 1948 Inland Steel case, in which the National Labor Relations Board
ruled that pensions were subject to compulsory collective bargaining.

For a time there were no standards and little regulation, which led to abuses in
funding many pension plans and to the denial of pension benefits to employees who
had worked many years.

This led to the passage of the Employee Retirement Income Security Act (ERISA) in
1974.

ERISA does not require employers to offer a pension plan. But if they do, the plan is
rigidly controlled in order to achieve two goals:
To protect the interests of plan participants
To promote the growth of such plans

Money set aside by employers to cover pension obligations has become the nations
largest source of capital.
Pension-fund managers tend to invest for the long term and invest few assets
in leveraged buyouts or high-risk, high-yield junk bonds.

Falling stock prices and low interest rates, together with practices such as using
pension assets to pay for the costs of laying off workers and retiree health benefits,
caused many pension plans to become underfunded.

To assure that covered workers will receive their accrued benefits even if their
companies fail, ERISA created the Pension Benefit Guaranty Corporation (PBGC).
This agency acts as an insurance company, collecting annual premiums from
companies with defined-benefit plans that offer specific payments upon
retirement.
A company can still walk away from its obligation to pay pension benefits to
employees entitled to receive them, but it must then hand over up to 30 percent of
its net worth to the PBGC for distribution to the affected employees.
Currently, the PBGC is running a deficit in excess of $11 billion.
If a company terminates its pension plan, the PBGC guarantees the payment
of vested benefit to employees, up to $44,386 (the current maximum set by law).

Despite these protections, the consequences of pension-plan termination can still be

devastating to some pensioners.
Executives whose accrued benefits are bigger than the PBGCs guaranteed
limits can see their monthly checks shrivel.
Employees who havent worked at a company long enough to be vested arent
entitled to any benefits.

As a matter of social policy, it is important that workers end up getting nearly all that
is promised to themand most of them do.

How Pension Plans Work

Contributions to pension funds are typically managed by trustees or outside financial

institutions, frequently insurance companies.

As an incentive for employers to begin and maintain such plans, the government
defers taxes on the pension contributions and their earnings.
Retirees pay taxes on the money as they receive it.

Under a defined-benefit plan, an employer promises to pay a retiree a stated pension,

often expressed as a percentage of preretirement pay.
In 2004, 44 percent of companies offered such plans.
Defined-benefit plans favor older, long-service workers.

A second type of pension plan, popular either as a support to an existing definedbenefit plan or as a stand-alone retirement-savings vehicle, is called a definedcontribution plan.
Fully 77 percent of U.S. employers offered some form of such a plan in 2004.
Examples include stock bonuses, savings plans, profit sharing, and various
kinds of employee stock-ownership plans.
Future benefits depend on how fast the fund grows.
Such plans therefore favor young employees who are just beginning their
careers (because they contribute for many years).
Defined-contribution plans have great appeal for employers because a
company will never owe more than what was contributed. However, employees
cannot be sure of the size of their retirement checks.

Regardless of whether a plan is a defined-benefit or a defined-contribution plan,

employees will not know what the purchasing power of their pension checks will be,
because the inflation rate is variable.

A third type of pension plan is known as a cash-balance plan.

This type of plan is offered by 36 percent of large employers.
Under it, everyone gets the same, steady annual credit toward an eventual
pension, adding to his or her pension account cash balance.
Employers contribute a percentage of an employees pay, typically 4 percent.
The balance earns an interest credit, usually around 5 percent.
It is portable when the employee leaves.
Cash-balance plans do not vest any sooner than traditional pension plans, so if
an employee leaves before vesting, he or she gets nothing.

 An older employee who is switched into a cash-balance system can find his or
her eventual pension reduced by 20 to 50 percent, and in rare cases, even more.

To soften the blow, some employers are providing a grandfather clause that allows
older employees to remain in the old plan. However, only 9 percent of companies
converting to cash-balance plans do this.

Research shows that employees differ in their preferences for various features of
defined benefit, defined contribution, and cash-balance plans.
Allowing employees choices to choose plans that are consistent with their
personal characteristics and needs leads to greater satisfaction with the plans and
serves as an effective tool in attracting and retaining employees.

Just as awarding large bonuses to executives as their companies were laying off
workers aroused a deep sense of injustice among members of the public, similar
sentiments now apply to the pension plans of many large employers.
Many companies are cutting back on pension payouts in many subtle ways,
while at the same time boosting payouts for senior executives.
Pension Reforms That Benefit Women

According to the Retirement Equity Act of 1984, corporate pension plans must now
include younger workers and permit longer breaks in service.
Women typically start work at a younger age than do men, and they are more
likely to stop working for several years in order to have and care for children.
Because the new rules apply to both sexes, so men will accrue larger benefits.

There are five major changes under the act:

As of January 1, 1985, pension plans must include all employees 21 or older
(down from 25).
Employers must use 18 rather than 22 as the starting age for counting years of
service.
Employees may have breaks in service of as long as 5 years before losing
credit for prior years of work. In addition, a year of maternity or paternity leave
cannot be considered a break in service.
Pension benefits may now be considered a joint asset in divorce settlements.
Employers must provide survivor benefits to spouses of fully vested
employees who die before reaching the minimum retirement age.

Social Security

Social Security is an income-maintenance program, not a pension program.

Without it, the poverty rate among the elderly would have jumped from about 15 to
50 percent.

Social Security is a pay-as-you-go system.

Payroll taxes earned by current workers are distributed to pay benefits for
those who are already retired.
Right now there are more than 3 workers for every retiree in our society, but
by 2015 there will only be 2.7, and by 2030 there will only be about 2 workers per
retiree.
People are also living substantially longerby 2020 the life expectancy for
65-year-old men and women will be 81.5 and 85 years, respectively.

The system will be solvent through the year 2030. At that time, Social Security taxes
will cover only 75 percent of promised benefits.

To meet such long-term funding needs, the system will have to be reformedby
raising payroll taxes or retirement ages, cutting benefits, or by investing a portion of
the current surplus in the stock market.

This last alternative raises several vexing policy arguments:

Should workers retirement be built on government guarantees or the
economys health?
Should the government own one-sixth of the stock market?
Should Washington expose workers retirement funds to market fluctuations?

Social Security was never intended to cover 100 percent of retirement expenses.
For a worker earning $60,000 a year, experts estimate that he or she will need
about 75 percent of that in retirement. Social Security will replace about 40
percent of preretirement income; pensions and personal savings will have to make
up the rest.

Unemployment Insurance

Although 97 percent of the workforce is covered by federal and state unemploymentinsurance laws, each worker must meet eligibility requirements in order to receive
benefits.

An unemployed worker must:

Be able and available to work and be actively seeking work;
Not have refused suitable employment;
Not be unemployed because of a labor dispute (except in Rhode Island and
New York);
Not have left a job voluntarily;
Not have been terminated for gross misconduct; and
Have been employed previously in a covered industry or occupation, earning a
designated minimum amount for a specific minimum amount of time.

Many claims are disallowed for failure to satisfy one or more of these requirements.

As of 2000, states have the option of using state unemployment compensation

resources to make partial wage replacement available to parents who leave
employment after the birth or adoption of a child.

Every unemployed workers benefits are charged against one or more companies.
The more money paid out on behalf of a firm, the higher the unemployment
insurance rate for that firm.
The tax in most states amounts to 6.2 percent of the first $7,000 earned by
each worker.

Benefits can be paid for a maximum of 26 weeks in most states. (An additional 13
weeks of benefits may be available during times of high unemployment.)

Massachusetts has the highest weekly benefit ($278.86); Puerto Rico has the lowest
($102.82).

Severance Pay

Severance pay is not legally required, and because of unemployment compensation,

many firms do not offer it.

However, severance pay has been used extensively by firms that are downsizing.

While length of service, organization level, and the cause of the termination are key
factors that affect the amount of severance pay, those amounts have been declining.
The typical manager now gets just 10 weeks of severance pay, down from 22
weeks in 1999.
Only 35 percent of employers now offer guaranteed severance to new
executives, down from 38.5 percent in 2001.

Chief executive officers with management contracts may receive two to three years
salary in the event of a takeover.
Payments for Time Not Worked

Included in this category are such benefits as:

Vacations
Personal excused absences
Holidays
Grievances and negotiations
Reporting time
Sabbatical leaves

The reality in the Infotech Age is that, for huge numbers of workers, the concept of a
vacationas an entitlement or an imposed restrictionis not realistic.
Employee Services

Employees qualify for employee services purely by virtue of their membership in the
organization, and not because of merit.

Some examples are:

Tuition aidthrift and short-term savings planscredit unionsstock-purchase
plansauto insurancefitness and wellness programsfood servicemoving and
transfer allowancescompany cartransportation and parkingcareer clothing
merchandise purchasinglegal servicesChristmas bonusescounselingservice
and seniority awardschild adoptionumbrella liability coveragechild care
social activitieselder carereferral awardsgift matchingpurchase of used
equipmentcharter flightsfamily leavesdomestic partner benefitsflexible
work arrangements.

People are more attached and more committed to organizations that offer familyfriendly policies, than to those that do not, regardless of the extent to which they
benefit personally from the policies.

Once viewed as an expense with little return, such policies are now endorsed by a
growing number of executives as an investment that pays dividends in morale,
productivity, and ability to attract and retain top-notch talent.

Domestic partner benefits are voluntarily offered by employers to an employees

unmarried partner, whether of the same or opposite sex.
They do so to be fair to all employees, regardless of their sexual orientation
and marital status, and because of the competition and diversity that characterize
todays labor markets.

BENEFITS ADMINISTRATION
Benefits and Equal Employment Opportunity

Equal employment opportunity requirements affect the administration of benefits.

The Age Discrimination in Employment Act has eliminated mandatory
retirement at any age.
It also requires employers to provide for employees over the age of 70 the
same group health insurance coverage that they offer to younger employees.

The Older Workers Benefit Protection Act of 1990 restored age-discrimination

protection to employee benefits.
Early retirement offers are now legal if they are offered at least 45 days prior
to the decision, and employees are given 7 days to revoke them after acceptance.
Employers are entitled to deny severance pay if an employee is eligible for
retiree health benefits.

With regard to pensions, the IRS considers a plan discriminatory unless the
employers contribution for the benefit of lower-paid employees covered by the plan
is comparable to contributions for the benefit of higher-paid employees.
The catch: The plan has to be available to everyone in any company that
implements it.
Maximum employee contributions each year are based on average company
participation. Thus poor participation by lower-paid employees curbs the ability
of the higher paid to make full use of the 401(k).

Costing Benefits

Despite the high cost of benefits, many employees take them for granted.

Employers have failed to do in-depth cost analyses of their benefit programs and thus
have not communicated the value of their benefits programs to employees.

Four approaches are used widely to express the costs of employee benefits and
services:
Annual cost of benefits for all employees
Cost per employee per year
Percentage of payroll
Cents per hour

Cafeteria, or Flexible, Benefits

The theory underlying cafeteria benefits is simple: Instead of all workers at a

company getting the same benefits, each worker can pick and choose among
alternative options, cafeteria style.

The typical plan works like this: Workers are offered a package of benefits that
includes basic and optional items. Employees can then use flexible credits to
choose among such additional benefits as full medical coverage, dental and eye care,
more vacation time, additional disability income, and higher company payments to
the retirement fund.

About 42 percent of large firms offer flexible-benefit plans (24 percent of small
ones).

They were devised largely in response to the rise in the number of two-income
families.

Two studies found substantial improvements in satisfaction and understanding after

the plan was implemented.

Flexible plans allow employers to pass cost increases on to workers more easily.

Flexible spending accounts (offered at about 70 percent of all large firms) allow
employees to save for expenses such as additional health insurance or day care with
pretax dollars, up to a specified amount.

Major communications efforts are needed to help employees understand their benefits
fully.
Because employees have more choices, they often experience anxiety about
making the right choices.
Careful attention to communication can enhance recruitment efforts, help cut
turnover, and make employees more aware of their total package of benefits.
Communicating the Benefits

Generally speaking, there are four broad objectives in communicating benefits:

To make employees aware of them.
To help employees understand the benefits information they receive in order
to take full advantage of the plans.
To make employees trust the information they receive.
To convince present and future employees of the worth or value of the
benefits package.

A multi-media approach is often the most effective way to educate employees about
their benefits.
Some employees prefer direct-mail information that comes to their homes so
they can discuss benefit options with significant others away from the context of
work.

Company-based Intranets, with ready access by all employees to personalized

benefits information, make HR on the desktop a reality for a cost that is up to
99 percent cheaper than conventional means of presentation.

Instead of just sending employees enrollment forms, employers are encouraging

employees to learn whats right for them.

At IBM, up to 80 percent of employees now enroll via the Intranet system, saving
$1 million per year in costs associated with the delivery of benefits information.

THE NEW WORLD OF EMPLOYEE BENEFITS

Health Insurance:
No more blank checks. Both employers and insurers are taking an aggressive
role in managing chronic diseases, which account for 75 percent of the nations
health care bill.

Keeping Employees Healthier:

One of the most important themes in employee benefits is now prevention.
The Travelers Insurance Companies found that the funds it spent on health
promotion helped it save $7.8 million in employee benefits costs, a savings of
$3.40 for every dollar spent.

Retirement ProgramsSharing the Risk:

The number of defined-contribution pension plans, in which the employee
shares the investment risk, is growing by 10 percent per year.
In return for risk, employees have a larger voice in choosing how the funds
will be invested.
Employees also have greater portability.
Nine out of 10 companies that offer 401(k)s provide a partial matching of
employees savings.
Retirement plans are easily funded through payroll deductions.

Expanding the 401(k) Concept:

Companies want plans that give employees choices to suit their needs,
incentives to conserve funds, and risks to share with the company.
It is important to address key flaws in 401(k) plans: high fees, poor investment
decisions, under-participation, and over-reliance on company stock.

During the next decade, the number of choices available to employees is likely to
expand and become more complicated. Therefore, advice on how to make informed
choices will itself become an increasingly popular employee benefit.

SUMMARY

Managers need to think carefully about what they wish to accomplish by means of
their benefits programs.

At a cost of about 40 percent of base pay for every employee on the payroll, benefits
represent substantial annual expenditures.

Important strategic considerations in the design of benefits programs:

The long-term plans of a business
Its stage of development
Its projected rate of growth or downsizing
Characteristics of its workforce
Legal requirements
The competitiveness of its overall benefits package
The total compensation strategy.

The three major components of the benefits package:

Security and health
Payments for time not worked
Employee services

Despite the high cost of benefits, many employees take them for granted.

Employers have not done in-depth cost analyses or communicated the value of their
benefits programs.

Counseling must accompany the implementation of a flexible-benefits program,

coupled with the use of computer-based expert systems and decision-support systems.

ANSWERS TO DISCUSSION QUESTIONS

12-1. What should a company do over the short and long term to maximize the use
and value of its benefits choices to employees?
It is not immediately clear why an employer would want to maximize the use of its
benefits (health insurance? life insurance? family leave?). However, an employer
would clearly want to maximize their value, especially from a cost-benefit
perspective. In the short run, better communication of the breadth, value, and cost of
benefits to employees will help. In the long run, organizations should carefully
monitor the benefits needs of their employees (possibly borrowing techniques of
consumer research from the field of marketing), and adapt quickly to those needs.
12-2. The new world of employee benefits is best described as sharing costs, sharing
risks. Discuss the impact of that philosophy on the broad areas of health care
and pensions.
In a broad sense, sharing costs, sharing risks means that companies are shifting
more costs onto the backs of employees. In return, employees are given a greater say
in how their money is spent or invested. There are four major areas that this type of
change has profoundly impacted: health insurance, programs to promote healthy
lifestyles, retirement plans, and employee savings programs.
As far as health insurance is concerned, employers and insurers are taking an
aggressive role in managing chronic diseases, which account for 75 percent of the
nations health care bill. They are also focusing on prevention, which can result in a
savings of over $3.00 for every dollar spent.
When it comes to retirement plans, companies are giving employees more choices to
suit their needs, incentives to conserve funds, and more control over investment
strategies. At the same time, companies are working to address retirement plan flaws,
such as high fees, poor investment decisions, under-participation, and over-reliance
on company stock.
12-3. In terms of the attract-retain-motivate philosophy, how do benefits affect
employee behavior?
Benefits generally are not contingent on performance so we would not expect them to
be a motivator. However, they are significant factors in motivating employees to
join and stay (attract-retain) with organizations, behaviors that employers value
highly. And there is also the likelihood that employees will perform better in order to
keep their jobs, in order to hold on to important benefits or to achieve vesting.

12-4. What can large firms do to control health-care costs? What about small firms?
Regardless of the size of the company, you should consider one or more of the
following steps:
a) Raise deductibles and co-payments by employees,
b) Remove the incentives in plans that favor hospitalization over outpatient care,
c) Induce employees to voluntarily choose reduced medical benefits through
cafeteria-style benefit options,
d) Require a second opinion for elective surgery, and e) set some rules for hospital
visits (e.g., don't enter on the weekend when the treatment starts Monday, audit large
hospital bills, require preadmission certificate).
Smaller companies, which often dont offer health insurance, can control costs by
turning to paid time-off plans that combine sick leave, vacation, and personal days
into one plan. Alternatively, they can reduced the number of sick-leave days offered
and then at the end of the year pay employees for unused days.
12-5. Your company has just developed a new, company-sponsored savings plan for
employees. Develop a strategy to publicize the program and to encourage
employees to participate in it.
One can follow the steps for effectively communicating benefits. The first goal is to
raise awareness and the second is to increase understanding. These can be done
through both formal and informal communication channels (memos, newsletters,
meetings, grapevine, etc.). Then, trust must be built in the message and the value of
the new benefit communicated. Here, top managers and other opinion leaders in the
firm can be helpful if they explain the benefits and model the desired behavior by
investing themselves in the savings plan. Lastly, firms might develop computerized
decision support systems to assist employees in planning for their own long-term
retirement needs.

CASE 12-1: REDUCING HEALTH CARE COSTS

Polson Corporation (pseudonym for a real firm) is a large high technology automotive and
electronics products company employing 70,000 workers. It has recently developed a
nationwide, managed health-care network in order to reduce its skyrocketing benefits costs.
The case describes how the system works, and, in particular, the role of Polsons health care
partner, insurance carrier Whitefish Corporation.
Case Questions
1.

How should Polson communicate its new health benefits plan to employees?
Communication of the new plan is critical if employees are to accept and
commitment to a managed care network. Employees must understand the strong
financial incentives that are present for staying in the network rather than using the
traditional indemnity side of the plan. At the same time, details of the new plan must
be communicated in such a way that it is clear to employees that Polson is committed
to a strong health care program and cares about them as individuals.
The approach used by "Polson" began with a series of regional meetings held between
sector benefits personnel, the task force, and Whitefish representatives. A
communication package was developed which included data, videotapes, scripts,
slides, and overhead materials, which was presented to employees at each of Polson's
individual locations. During the next three years, the implementation of the managed
care program was accomplished through three phases. Phase One focused primarily
on the west coast where Whitefish had a large number of existing networks already in
place. In Phase Two, the plan was implemented in the Midwest and the east in major
cities where Whitefish had some network contacts, but in other cases networks had to
be developed. In such cases, Whitefish had to engage in extensive scouting efforts to
locate significant numbers of quality physicians willing to participate in the program.
Phase Three, which is on-going, consists of extending the network to outlying
locations in smaller towns where Polson has small groups of employees but Whitefish
has no network.
As noted in the text, it is important that benefits be communicated to employees so
that they are aware of them and understand them, but in such a way that employees
trust the information they receive and are convinced of the value of the benefits
package. This may be achieved by focusing on providing employees with benefits
information they need, when they need it (e.g., through interactive computer
programs). Such systems use computers (decision support systems), telephone
hotlines, and/or interactive videos to provide the information that employees need in
the timeliest manner.

2.

What results in terms of cost reduction do you anticipate Polson will achieve
through the implementation of its new health care program?
Of course, students will have to speculate a bit to answer this question, but they do
know from the case information that for all employees who choose to stay within the
network of managed care, the company is guaranteed by Whitefish a maximum
increase in health care premiums of 10% per year over the first three years of the
program. So the real issue becomes estimating what percentage of employees are
likely to stay within the network rather than using the traditional indemnity program.
Polson's experience in this regard is that 44,000 employees out of its 50,000
employees located in cities where networks have been established have enrolled in
the Whitefish program. According to utilization studies conducted during the first
three years of the program, more than 75% of all eligible employees stayed in the
managed care network between 95% and 100% of the time. As a result, the savings
achieved by Polson included: a) annual premium increases were indeed held to less
than 10%, b) the average cost per employee was reduced from $3,200 under the old
indemnity plan to $2,700 under the managed care plan, saving the company a total of
$200 million in reduced premiums, and c) the total health care premium paid by the
company and its employees was $360 million, an increase of only $5 million from
1995 (significantly below the estimate of $613 million that Ron McGee provided to
executives).

3.

What additional follow-up should the benefits administration people at Polson

take now that the program has been in effect for several years?
It would be a good idea to check in with employees after a few years of experience
with the program to find out what they like and dislike about the new managed health
care system. In fact, Polson intends to do that sometime in the future. In such a
survey, it would be important to check the level of understanding that employees have
of the new system and the degree to which they are committed to staying within the
network and using the managed care portion, as opposed to moving to the indemnity
side of the program. It will also be important determine if employees believe that the
features and benefits of the new plan have been communicated effectively, if they feel
that they are valued as members of the organization, and if they feel that Polson is
committed to a strong health care maintenance program.

4.

To what extent do you believe managed health-care plans such as those at Polson
are the wave of the future for health benefits plans in major American
corporations?
Polson was a pioneer in terms of having a national managed care network in place,
but many other organizations, such as IBM, AT&T, General Motors, and Sears, have
moved rapidly in that direction. As of 1991, membership in the Managed Health Care
Association included 150 of the Fortune 500 companies. Many firms have moved
away from traditional fee-for-service plans and into managed care programs. Unions
seem to be supportive of this movement because they are interested in helping
management find alternative high quality medical delivery systems that will have the
effect of holding down their members' increasing annual contributions which skyrocketed under traditional fee-for-service plans.