CH12.pdf

Chapter Twelve TheBe nefit Determination Process ChapterOut line Why the Growth in Employee Benefits? Wage and Price Controls Unions Employer Impetus Cost Ef fectiveness of Benefits Go vernment Impetus The Value of Employee Benefits Components of a Benefit Plan Employer Preferences Employee Pr eferences Administering the Benefit Program Employee Benefit Communication Claims Pr ocessing Cost Containment Your Turn: World Measurement Key Issues in Benefit Planning, Design, and Administration Benefit Planning and Design Issues Benef it Administration Issues What can you do with four trillion dollars?1 Help balance the budget? Buy four new copies of this book? Well, the answer is, you can cover the cost of all employee benefits in the United States today. It’s hard to believe that employee benefits cost this much. This is particularly hard to believe when we take a look at what used to pass as benefits in the not-too-distant past: • A carriage shop published a set of rules for employees in 1880 that stated, in part: “Working hours shall be from 7 a.m. to 9 p.m. every day except the Sabbath. . . . After an employee has been with this firm for five years he shall receive an added payment of five cents per day, provided the firm has prospered in a manner to make it possible. . . . It is the bounden duty of each employee to put away at least 10 percent of his monthly wages for his declining years so he will not become a burden upon his betters.” • In 1915, employees in the iron and steel industry worked a standard 60 to 64 hours per week. By 1930 that schedule had been reduced to 54 hours. • It was not until 1929 that the Blue Cross concept of prepaid medical costs was introduced. • Prior to 1935, only one state (Wisconsin) had a program of unemployment compensation benefits for workers who lost their jobs through no fault of their own. • Before World War II, very few companies paid hourly employees for holidays. In most companies, employees were told not to report for work on holidays and to enjoy the time off, but their paychecks were smaller the following week.2 414 Chapter 12 The Beneﬁt Determination Process EXHIBIT12.1 Changesin Benefit Costs Over Time Source: U.S. Chamber ofC ommerce, Annual BenefitSu rveys, www. uschamber.com, June 22,2008. PercentageofPay roll 415 1959 1969 1990 1998 2008 24.7 31.1 38.4 37.2 42.7 In comparison to these “benefits” from the past, today’s reality seems staggering. Consider the kinds of things that are common in companies that made the Fortune magazine list of “100 Best Companies to Work For in America.” These companies recognize the importance of taking care of employees’ needs as a key factor in attracting and retaining the best employees. A first-class benefit plan includes some mix of the following benefits: education reimbursement and employee training; on-site child care services, financial counseling, and concierge services; and retirement benefits. 3 Just consider some of the extra benefits beyond the norm at this year’s number-1 rated company to work at: NetApp, a data storage, management, and protection company. Want to help Habitat for Humanity build homes in a hurricane ravaged coastal area? No problem. At NetApp you get five paid days for volunteer work. Want to adopt a child? NetApp gives you $11,390 adoption aid. NetApp is so family centered that it even has coverage for autistic children. Since 2006, 43 employees have tapped into this benefit at a cost of $242,452.4 Clearly NetApp would argue that these extra services are important benefits of employment, perhaps making attraction, retention, and motivation of employees just that much easier. But the truth is, we don’t know if even ordinary benefits have positive payoffs. We do know that employees consistently rate benefits a key factor in job satisfaction.5 Unfortunately, though, there is a mismatch between cost to employer and perceived value to employee: the cost is much higher than employees estimate.6 Until we can clearly identify the advantages of employee benefits, we need to find ways to control their costs or at least slow their growth. Exhibit 12.1 illustrates the rapid rise in employee benefit costs, moving from about 25 percent of payroll costs in 1959 to more than 40 percent by some calculations today.7 As Exhibit 12.1 illustrates, employee benefits can no longer realistically be called “fringe benefits.” As an example, visualize a $20,000 car rolling down the assembly line at General Motors. A cost accountant would tell you that $1,200 of this cost is due to worker health insurance alone. Compare it to the cost of all the steel for the same car—$500—and the impact is evident. Now compare it to health insurance costs as low as $100 for foreign automakers in their U.S. factories (with their younger, healthier workers and hardly any retirees), and the global implications of benefit costs are all too frightening.8 Over one 20-year period (1955–1975), employee benefit costs rose at a rate almost four times greater than employee wages or the consumer price index. 9 A similar Employee benefits are that part of the total compensation package, other than pay for time worked, provided to employees in whole or in part by employer payments (e.g., life insurance, pension, workers’ compensation, vacation). 416 Part Five Employee Beneﬁts comparison for the period 1963–1987 showed that the rate of growth had slowed (benefit costs rose twice as fast as wage costs). And a still later comparison, for the period 1993–1999, the cost of benefits actually stabilized at about $14,700 per full-time employee. Recently, though, benefit costs have begun to heat up again—with survey results from 2008 showing the average cost at $18,496.10 Health care costs alone increased an average of 5.0 percent last year, only slightly less than the 5.9 percentage trend for the past 15 years.11 That translates into health care costs that have more than doubled since 1990 (an increase of 123 percent), and that are expected to hit 4.3 trillion dollars by 2017. Pension costs also are an area of concern. Just ask Delta Airlines or Sara Lee. Both companies face huge unfunded pension liabilities. When you are behind hundreds of millions in pension funding, it’s difficult to interest anyone in buying your stock.12 And problems may even be worse in the public sector, where state governments have regularly underfunded pension plans. With looming retirements of baby boomers, this could spell catastrophe for already burdened state budgets.13 WHY THE GROWTH IN EMPLOYEE BENEFITS? Wage and Price Controls During both World War II and the Korean War, the federal government instituted strict wage and price controls. The compliance agency charged with enforcing these controls was relatively lenient in permitting reasonable increases in benefits. With strict limitations on the size of wage increases, both unions and employers sought new and improved benefits to satisfy worker demands. This was the catalyst for growth in pensions, health care coverage, time off, and the broad spectrum of benefits virtually unthinkablebe fore1950. Unions The climate fostered by wage and price controls created a perfect opportunity for unions to flex the muscles they had acquired under the Wagner Act of 1935. Several National Labor Relations Board rulings during the 1940s freed unions to negotiate over employee benefits. With little freedom to raise wages during the war, unions fought for the introduction of new benefits and the improvement of existing benefits. Success on this front during the war years led to further postwar demands. Largely through the efforts of unions, most notably the autoworkers and steelworkers, several benefits common today were given their initial impetus: pattern pension plans, supplementary unemployment compensation, extended vacation plans, and guaranteed annual wage plans.14 EmployerIm petus Many of the benefits in existence today were provided at employer initiative. Much of this initiative can be traced to pragmatic concerns about employee satisfaction and productivity. Rest breaks often were implemented in the belief that fatigue increased accidents and lowered productivity. Savings and profit sharing plans were implemented (e.g., Procter & Gamble’s profit sharing plan was initiated in 1885) to improve performance and provide increased security for worker retirement years. Indeed, many Chapter 12 The Beneﬁt Determination Process 417 employer-initiated benefits were designed to create a climate in which employees perceived that management was genuinely concerned for their welfare. Notice, though, these supposed benefits were taken on faith. But their costs were quite real: Without hard data about payoffs, employee benefits slowly became a costly entitlement of the Americanw orkforce. Cost Effectiveness of Benefits Another important and sound impetus for the growth of employee benefits is their cost effectiveness in two situations. The first cost advantage is that most employee benefits are not taxable. Provision of a benefit rather than an equivalent increase in wages avoids payment of federal and state personal income tax. Remember, though, recurrent tax reform proposals continue to threaten the favorable tax status granted to many benefits. A second cost-effectiveness component of benefits arises because many groupbased benefits (e.g., life, health, and legal insurance) can be obtained at a lower rate than could be obtained by employees acting on their own. Group insurance also has relatively easy qualification standards, giving security to a set of employees who might notothe rwisequa lify. GovernmentIm petus Obviously the government has played an important role in the growth of employee benefits. Three employee benefits are mandated by either the state or federal government: workers’ compensation (state), unemployment insurance (federal), and social security (federal). In addition, most other employee benefits are affected by such laws as the Employee Retirement Income Security Act (ERISA affects pension administration) and various sections of the Internal Revenue Code. THE VALUE OF EMPLOYEE BENEFITS Exhibit 12.2 shows the relative importance employees attached to different types of benefits across five different studies.15 In general, the five studies reported in Exhibit 12.2 show remarkably consistent results over the past two decades. For example, medical payments regularly are listed as one of the most important benefits employees receive. These rankings have added significance when we note that over the past two decades health care costs are the most rapidly growing and the most difficult to control of all the benefit options offered by employers.16 In 2008, health care costs alone were $4,256 for the typical employer.17 The four trillion dollars employers spend on benefits each year would not seem nearly so outrageous if we had evidence that employees place high value on the benefits they receive. Unfortunately, there is evidence that employees frequently are not even aware of, or undervalue, the benefits provided by their organization. For example, in one study employees were asked to recall the benefits they received. The typical employee could recall less than 15 percent of them. In another study, MBA students were asked to rank the importance attached to various factors influencing job selection.18 418 Part Five Employee Beneﬁts EXHIBIT12.2 Rankingof Employee Benefits Note: 3 5 indicates a benefit that was not rated in this study. Study 1 2 3 4 5 Medical 1 1 3 1 1 Pension 2 3 8 3 2 Paid vacations and holidays 3 2 3 2 3 Sickness 4 3 5 8 3 Dental 5 3 6 6 3 Long-term disability 7 3 7 9 6 Life insurance 8 3 4 3 5 Presumably the large percentage of labor costs allocated to payment of employee benefits would be easier to justify if benefits turned out to be an important factor in attracting good MBA candidates. Of the six factors ranked, employee benefits received the lowest ranking. Opportunity for advancement (#1), salary (#2), and geographic location (#3) all ranked considerably higher than benefits as factors influencing job selection. Compounding this problem, these students also were asked to estimate the percentage of payroll spent on employee benefits. Slightly less than one-half (46 percent) of the students thought that benefits comprised 15 percent or less of payroll, and 9 out of 10 students (89 percent) thought benefits accounted for less than 30 percent of payroll. Only 1 in 10 students had a reasonably accurate (39 percent of payroll) or inflated perception of the magnitude of employee benefits.19 For the past 20 years, we’ve argued here that benefits are taken for granted. Given their cost, that’s not a good thing. Now, though, with companies cutting back benefits, or shifting costs to employees (or retirees!), the air of entitlement may be disappearing. A recent study by the Society of Human Resource Management indicates both employees and HR professionals see benefits as the top factor driving job satisfaction.20 One possible direction out of this money pit comes from recent reports of employees looking not necessarily for more benefits, but rather for greater choice in the benefits they receive.21 In fact, up to 70 percent of employees in one study indicated they would be willing to pay more out of pocket for benefits if they were granted greater choice in designing their own benefit package. We do know, in support of this, that the perceived value of benefits rises when employers introduce choice through a flexible benefit package.22 Maybe better benefit planning, design, and administration offer an opportunity to improve benefit effectiveness. Indeed, preliminary evidence indicates employers are making serious efforts to educate employees about benefits, with an outcome of increased employee awareness.23 For example, the simple act of stating in an employment ad that benefits are generous leads to applicants’ focusing on this characteristic and relying more heavily on it in job choice. Some experts speculate that a key element in reward attractiveness (and benefits in this example) may be their visibility. Not only do we have to plan and design effective benefit programs; we also need to communicate their value to employees. Chapter 12 The Beneﬁt Determination Process 419 KEY ISSUES IN BENEFIT PLANNING, DESIGN, AND ADMINISTRATION Benefits Planning and Design Issues What do you want—or expect—the role of benefits to be in your overall compensation package?24 For example, if a major compensation objective is to attract good employees, we need to ask, “What is the best way to achieve this?” The answer is not always, or even frequently, “Let’s add another benefit.” Put yourself in the following situation as the benefits manager. Recently, a casino opened up in the Niagara Falls area. The Seneca Indians own this casino, and they needed to fill thousands of entry-level jobs. The wages for a blackjack dealer were $4 per hour plus tips. The combination of the two exceeds minimum wage, but not by much. How do we attract more dealers, and other applicants, given these low wages? One temptation might be to set up a day care center to attract more mothers of preschool children. Certainly this is a popular response today, judging from all the press business-sponsored day care centers are receiving. A more prudent compensation policy would ask the question: “Is day care the most effective way to achieve my compensation objective?” Sure, day care may be popular with working mothers, but can the necessary workers be attracted to the casino using some other compensation tool that better meets needs? If we went to compensation experts in the gaming industry, they might say (and we would be impressed if you said this along with them): “We target recruitment of young females for our entry-level jobs. Surveys of this group indicate day care is an extremely important factor in the decision to accept a job.” If you used this kind of logic in your arguments as benefits manager, we think you’re well on the way to a successful career. As a second example, how do we deal with undesirable turnover? Rich Floersch, Sr. Vice President of HR at McDonald’s, faced this very question. After looking at other alternatives to reduce turnover, Rich decided that the best strategy was to design a benefit package that improved progressively with seniority, thus providing a reward for continuing service. Keep in mind, though, Rich only made this decision after evaluating the effectiveness of other compensation tools (e.g., increasing wages, introducing incentive compensation). In addition to integrating benefits with other compensation components, the planning process also should include strategies for ensuring external competitiveness and adequacy of benefits.25 Competitiveness requires an understanding of what other firms in your product and labor markets offer as benefits. Firms conduct benefit surveys much as they conduct salary surveys. Either our firm must have a package comparable to that of survey participants or there should be a sound justification of why deviation makes sense for the firm. In contrast, ensuring that benefits are adequate is a somewhat more difficult task. Most organizations evaluating adequacy consider the financial liability of employees with and without a particular benefit (e.g., employee medical expenses with and without medical expense benefits). There is no magic formula for defining benefit adequacy.26 In part, the answer may lie in the relationship between benefit adequacy and the third plan objective: cost of effectiveness. More organizations need to consider whether employee benefits are cost justified. All sorts of ethical questions arise 420 Part Five Employee Beneﬁts when we start asking this question. How far should we go with elder care? Can we justify paying for a $250,000 surgical procedure that will likely buy only a few more months of life? Companies face these impossible questions when designing a benefit system. And more frequently than ever before, companies are saying no to absorbing the cost increases of benefits. A recent survey shows that 59 percent of employers are shifting increased benefit costs to employees through higher deductibles and copays, for example.27 Cybercomp Benefitslink,at www.benefitslink.com/index.shtml, provides a wealth of information about types of benefits, a message board for interacting in discussions with others interested in benefits, and an “Ask the Expert” question-and-answer column. BenefitA dministrationIs sues Four major administration issues arise in setting up a benefit package: (1) Who should be protected or benefited?; (2) How much choice should employees have among an array of benefits?; (3) How should benefits be financed?28; and (4) Are your benefits legally defensible?29 The first issue—who should be covered—ought to be an easy question. The answer is employees, of course. But every organization has a variety of employees with different employment statuses. Should these individuals be treated equally with respect to benefits coverage? Exhibit 12.3 illustrates that companies do indeed differentiate treatment based on employment status. Across the board, far fewer part-time workers are eligible for the benefits regularly given to full-time employees. As a second example, should retired automoble executives be permitted to continue purchasing cars at a discount price, a benefit that could be reserved solely for current employees or—given the state of the auto industry—perhaps eliminated entirely? In fact, a whole series of questions need to be answered: 1. What probationary periods (for eligibility of benefits) should be used for various types of benefits? Does the employer want to cover employees and their dependents immediately upon employment or provide such coverage only for employees who EXHIBIT12.3 ContingentWorker Benefits Compared to Full-Time Workers Source:“ National Compensation Survey 2005,” Bureau of Labor Statistics, www .bls.gov, June 27, 2006. Holidays Vacations Short-TermD isability Long-TermD isability LifeI nsurance Retirement Medical Dental Vision Full Time Part Time 89% 90 48 38 64 69 85 56 35 37% 36 14 5 12 27 22 14 9 Chapter 12 The Beneﬁt Determination Process 2. 3. 4. 5. 6. 7. 421 have established more or less permanent employment with the employer? Is there a rationale for different probationary periods with different benefits? Which dependents of active employees should be covered? Should retirees (as well as their spouses and perhaps other dependents) be covered, and for which benefits? Should survivors of deceased employees (and/or retirees) be covered? If so, for which benefits? Are benefits for surviving spouses appropriate? What coverage, if any, should be extended to employees who are suffering from disabilities? What coverage, if any, should be extended to employees during layoffs, leaves of absence, strikes, and so forth? Should coverage be limited to full-time employees?30 The answers to these questions depend on the policy decisions regarding adequacy, competition, and cost effectiveness discussed in the last section. The second administrative issue concerns choice (flexibility) in plan coverage. In the standard benefit package, employees typically have not been offered a choice among employee benefits. Rather, a package is designed with the average employee in mind, and any deviations in needs simply go unsatisfied. The other extreme (discussed in greater detail later) is represented by “cafeteria-style,” or flexible, benefit plans. Under this concept employees are permitted great flexibility in choosing the benefit options of greatest value to them. Picture an individual allotted x dollars walking down a cafeteria line and choosing menu items (benefits) according to their attractiveness and cost. The flexibility in this type of plan is apparent. Exhibit 12.4 illustrates a typical choice among packages offered to employees under a flexible benefit system. Imagine an employee whose spouse works and already has family coverage for health, dental, and vision. The temptation might be to select package A. An employee with retirement in mind might select option B with its contributions to a 401(k) pension plan. Exhibit 12.5 summarizes some of the major advantages and disadvantages of flexible benefits. Even companies that are not considering a flexible benefit program are offering greater flexibility and choice. Such plans might provide, for example, (1) optional levels of group term life insurance; (2) the availability of death or disability benefits under pension or profit-sharing plans; (3) choices of covering dependents under group Package EXHIBIT 12.4 Possible Options in a Flexible Benefit Package * AE 5 average earnings. Health Dental Vision Lifei nsurance Dependentc are 401(k)s avings Cashbac k A B C D No No No 1 3 AE* Yes No Yes No No Yes 2 3 AE No Yes No Yes No Yes 2 3 AE No No No Yes Yes Yes 3 3 AE No No No 422 Part Five EXHIBIT12.5 Advantages and Disadvantages of Flexible Benefit Programs Employee Beneﬁts Advantages 1. Employees choose packages that best satisfy their unique needs. 2. Flexible benefits help firms meet the changing needs of a changing workforce. 3. Increased involvement of employees and families improves understanding of benefits. 4. Flexible plans make introduction of new benefits less costly. Any new option is added merely as one among a wide variety of elements from which to choose. 5. Cost containment: Organization sets dollar maximum; employee chooses within thatc onstraint. Disadvantages 1. Employees make bad choices and find themselves not covered for predictable emergencies. 2. Administrative burdens and expenses increase. 3. Adverse selection: Employees pick only benefits they will use; the subsequent highbenefit utilization increases its cost. 4. Flexible benefit plans are subject to nondiscrimination requirements in Section 125 oftheI nternalRev enue Code. medical expense coverage; and (4) a variety of participation, cash distribution, and investment options under profit-sharing, thrift, and capital accumulation plans.31 The level at which an organization finally chooses to operate on this choice/flexibility dimension really depends on its evaluation of the relative advantages and disadvantages of flexible plans, noted in Exhibit 12.5.32 Many companies cite the cost savings from flexible benefits as a primary motivation. Companies also offer flexible plans in response to cost pressures related to the increasing diversity of the workforce. Flexible benefit plans, it is argued, increase employee awareness of the true costs of benefits and, therefore, increase employee recognition of benefit value.33 Another way to increase employee awareness, and probably the biggest trend today in health care, is to offer market-based, or customer-driven, health care. Although there are many variants on consumer-driven health care, here are the basic choices:34 • Full-Defined Contribution—The employee is responsible for finding and purchasing individual medical coverage. The employer provides funding through either direct compensation or a voucher. • Tiered Networks—The employer offers employees a choice of medical plans, which include medical systems of varying costs. • Menu-Driven—Employers provide online information to help employees customize their own benefit plan by selecting co-pays, deductibles, and so forth. • Managed Competition—The employer provides a subsidized basic medical plan with buy-up options. Plans can be from the same or multiple insurers. • Health Savings Accounts—A fund is created by the employer, employee, or jointly that is used to pay the first x dollars of health care expenses. Chapter 12 The Beneﬁt Determination Process 423 Each of the alternatives creates a motivation for employees to think about what option fits their budget and particular health characteristics. The third administrative issue involves the question of how to finance benefit plans. Alternatives include: 1. Noncontributory( Employerpa yst otalc osts.) 2. Contributory (Costs are shared between employer and employee.) 3. Employee financed (Employee pays total costs for some benefits—by law the organization must bear the cost for certain benefits.) In general, organizations prefer to make benefit options contributory, reasoning that a “free good,” no matter how valuable, is less valuable to an employee. Furthermore, employees have no personal interest in controlling the cost of a free good. And with the cost of benefits rising considerably more than other goods and services, employers are increasingly turning to ways for cutting their costs.35 Finally, benefits have to comply with hundreds of arcane sections of the tax code and other “devils” designed to turn any benefit administrator’s hair gray. Because there are so many rules and regulations, benefit administrators should develop a compliance checklist and regularly conduct audits to ensure that they are complying with the avalanche of new and existing requirements.36 COMPONENTS OF A BENEFIT PLAN Exhibit 12.6 outlines a model of the factors influencing benefit choice, from both the employer’s and the employee’s perspective. The remainder of this chapter briefly examines each of these factors. EmployerPr eferences As Exhibit 12.6 indicates, a number of factors affect employer preference in determining desirable components of a benefit package. Relationship to Total Compensation Costs A good compensation manager considers employee benefit costs as part of a total package of compensation costs. Frequently employees think that just because an employee benefit is attractive, the company should provide it. A good compensation manager thinks somewhat differently: “Is there a better use for this money? Could we put the money into some other compensation component and achieve better results?” Benefit costs are only one part of a total compensation package. Decisions about outlays have to be considered from this perspective. Costs Relative to Benefits A major reason for the proliferating cost of benefit programs is the narrow focus of benefit administrators. Too frequently the costs/advantages of a particular benefit inclusion are viewed in isolation, without reference to total package costs or forecasts of rising costs in future years. To control spiraling benefit costs, administrators should adopt a broader, cost-centered approach. As a first step, this approach would require 424 Part Five EXHIBIT12.6 Factors Influencing Choice of Benefit Package Employee Beneﬁts Employer Factors 1. Relationship to total compensation costs 2. Costs relative to benefits 3. Competitor offerings 4. Role of benefits in: Attraction Retention Motivation 5. Legal requirements Benefits Package Employee Factors 1. Equity: fairness historically and in relationship to what others receive 2. Personal needs as linked to: Age Sex Marital status Number of dependents policy decisions on the level of benefit expenditures acceptable both in the short and the long runs. Historically, benefit managers negotiated or provided benefits on a package basis rather than a cost basis. The current cost of a benefit would be identified, and if the cost seemed reasonable, the benefit would be provided for or negotiated with employees. This failed to recognize that rising costs of this benefit were expected to be born by the employer. The classic example of this phenomenon is health care coverage. An employer considering a community-based medical plan like Blue Cross during the early 1960s no doubt agreed to pay all or most of the costs of one of the Blue Cross options. As costs of this plan skyrocketed between the 1960s and the 1990s, the employer was expected to continue coverage at the historical level. In effect, the employer became locked into a level of coverage rather than negotiating a level of cost. In subsequent years, then, the spiraling costs were essentially out of the control of the benefit manager. A cost-centered approach would require that benefit administrators, in cooperation with insurance carriers and armed with published forecasts of anticipated costs for particular benefits, determine the cost commitments for the existing benefit package. Budget dollars not already earmarked may then be allocated to new benefits that best satisfy organizational goals. Factors affecting this decision include an evaluation of benefits offered by other firms and the competitiveness of the existing package. Also important is compliance with various legal requirements as they change over time (Chapter 13). Finally, the actual benefit of a new option must be explored Chapter 12 The Beneﬁt Determination Process 425 in relation to employee preferences. The benefits that top the list of employee preferences should be evaluated in relation to current and future costs. Because future cost estimates may be difficult to project, it is imperative that benefit administrators reduce uncertainty. If a benefit forecast suggests future cost containment may be difficult, the benefit should be offered to employees only on a cost-sharing basis. Management determines what percentage of cost it can afford to bear within budget projections, and the option is offered to employees on a cost-sharing basis, with projected increases in both employer and employee costs communicated openly. In the negotiation process, then, employees or union representatives can evaluate their preference for the option against the forecasted cost burden. In effect, this approach defines in advance the contribution an employer is willing to make. And it avoids the constraints of a defined-benefit strategy that burdens the employer with continued provision of that defined-benefit level despite rapidly spiraling costs. Competitor Offerings Benefits must be externally equitable, too. This begs the question, what is the absolute level of benefit payments relative to important product and labor market competitors? A policy decision must be made about the position (market lead, market lag, or competitive) the organization wants to maintain in its absolute level of benefits relative to the competition. One of the best strategies for determining external equity is to conduct a benefit survey. Alternatively, many consulting organizations, professional associations, and interest groups collect benefit data that can be purchased. Perhaps the most widely used of these surveys is the annual benefit survey conducted by the U.S. Chamber of Commerce.37 Role of Benefits in Attraction, Retention, and Motivation Given the rapid growth in benefits and the staggering cost implications, it seems only logical that employers would expect to derive a fair return on this investment. In fact, there is at best only anecdotal evidence that employee benefits are cost-justified.38 This evidence falls into three categories.39 First, employee benefits are widely claimed to help in the retention of workers. Benefit schedules are specifically designed to favor longer-term employees. For example, retirement benefits increase with years of service, and most plans do not provide for full employee eligibility until a specified number of years of service have been reached. Equally, the amount of vacation time increases with years of service, and employees’ savings plans, profit-sharing plans, and stock purchase plans frequently provide for increased participation or benefits as seniority increases. By tying these benefits to seniority, it is assumed that workers are more reluctant to change jobs. There is also some research to support this common assumption that benefits increase retention. Two studies found that higher benefits reduced mobility.40 More detailed follow-up studies, though, found that only two specific benefits curtailed employee turnover: pensions and medical coverage.41 Virtually no other employee benefit had a significant impact on turnover. 426 Part Five Employee Beneﬁts We’ve been assuming here that turnover is bad and stability is good. In fact, there are times when turnover may be good—something we may not want to discourage. For example, at one time or another 3 Americans in 10 have stayed in a job they wanted to leave simply because they could not give up their health care coverage. 42 This “job lock” probably is not a desirable outcome for employers. Employee benefits also might be valued if we could prove they increase employee satisfaction. Unfortunately, today only 32 percent of workers are satisfied with their benefits.43 This is down from 83 percent in the early 1980s.44 Why have satisfaction ratings fallen? One view holds that benefit satisfaction falls as costcutting companies attempt to reduce coverage and also shift more of the costs to employees.45 A second view is more pessimistic, arguing that benefit plans fail to meet either employer or employee needs. In this view, simply pumping more money into benefits is inappropriate. Rather, employers must make fundamental changes in the way they approach the benefit planning process. Companies must realize that declining satisfaction with benefits is a result of long-term changes in the workforce. Ever-increasing numbers of women in the labor force, coupled with increasing numbers of dual-career families and higher educational attainments, suggest changing values of employees.46 Changing values, in turn, necessitate a reevaluation of benefit packages. Finally, employee benefits also are valued because they may have an impact on the bottom line. Although supporting evidence is slim, there are some glimmers of potential. For example, employee stock ownership plans used for pensions (Chapter 10), according to some reports, improve company productivity.47 Presumably, owning stock motivates employees to be more productive. After all, part of the reward returns to them in the form of dividends and increased stock value. Similar productivity improvements are reported for employee assistance programs (e.g., alcohol and drug treatment programs for employees), with reports of up to 25 percent jumps in productivity after their implementation.48 This finding suggests there may be some payoff to so-called work/life benefits, those that increase employee perceptions of a company’s caring attitude. Things like day care, elder care, on-site fitness centers, and weight-loss programs foster a perception that the company cares about its employees. And in one well-constructed research study, this caring attitude led to greater worker involvement in suggesting ways to improve productivity and in helping others with their work.49 Maybe benefits can pay off; we just need to document this better. Legal Requirements Employers obviously want a benefit package that complies with all aspects of the law. Exhibit 12.7 shows part of the increasingly complex web of legislation in the benefit area. Greater details on the three legally mandated benefits (workers’ compensation, social security, and unemployment insurance) are provided in Chapter 13. Absolute and Relative Compensation Costs Any evaluation of employee benefits must be placed in the context of total compensation costs. Cost competitiveness means the total package must be competitive—not just Chapter 12 The Beneﬁt Determination Process EXHIBIT12.7 427 Impact of Legislation on Selected Benefits Legislation Impact on Employee Benefits FairL aborStandar dsA ct1938 Created time-and-a-half overtime pay. Benefits linked to pay (e.g., social security) increase correspondingly with those overtime hours. EmployeeReti rementI ncome Security Act 1974 If an employer decides to provide a pension (it is not mandated), specific rules must be followed. Plan must vest (employee has right to both personal and company contributions into pension) after five years’ employment. Pension Benefit Guaranty Corporation, as set up by this law, provides worker some financial coverage when a company and its pension plan go bankrupt. Taxr eforms—1982,1986 Permit individual retirement accounts (IRAs) for eligible employees. Established 401(k) programs, a matched-contribution saving plan (employer matches part or all of employee contribution) that frequently serves as part of a retirement package. Health Maintenance Act 1973 Required employers to offer alternative health coverage (e.g., health maintenance organizations) options to employees. Discrimination legislation (Age Discrimination in Employment Act, Civil Rights Act, Pregnancy Disability Act, various state laws) Benefits must be administered in a manner that does not discriminate against protected groups (on basis of race, color, religion, sex, national origin, age, pregnancy). ConsolidatedO mnibus Budget Reconciliation Act (COBRA) 1984 Employees who resign or are laid off through no fault of their own are eligible to continue receiving health coverage under employer’s plan at a cost borne by the employee. Family Medical Leave Act (1993) Mandates 12 weeks of leave for all workers at companies that employ 50 or more people. specific segments. Consequently, decisions on whether to adopt certain options must be considered in light of the impact on total costs and in relationship to expenditures of competitors (as determined in benefit surveys such as the Chamber of Commerce survey mentioned earlier in this chapter). EmployeePr eferences Employee preferences for various benefit options are determined by individual needs. The benefits perceived to best satisfy individual needs are the most highly desired. In part, these needs arise out of feelings of perceived equity or inequity. Equity To illustrate the impact of equity, consider the example of government employees working in the same neighborhood as autoworkers. Imagine the dissatisfaction with government holidays that arises when government employees leave for work every 428 Part Five Employee Beneﬁts morning, knowing that the autoworkers are home in bed for the whole week between Christmas and New Year’s Day. The perceived unfairness of this difference need not be rational. But it is, nevertheless, a factor that must be considered in determining employee needs. Occasionally this comparison process leads to a “bandwagon” effect, in which new benefits offered by a competitor are adopted without careful consideration, simply because the employer wants to avoid hard feelings. This phenomenon is particularly apparent for employers with strong commitments to maintaining a totally or partially nonunion work force. Benefits obtained by a unionized competitor or a unionized segment of the firm’s workforce are frequently passed along to nonunion employees. While the effectiveness of this strategy in thwarting unionization efforts has not been demonstrated, many nonunion firms would prefer to provide the benefit as a safety measure. Personal Needs of Employees One way to gauge employee preferences is to look at demographic differences. The demographic approach assumes that demographic groups (e.g., young versus old, married versus unmarried) can be identified for which benefit preferences are fairly consistent across members of the group. Furthermore, it assumes that meaningful differences exist between groups in terms of benefit preferences. There is some evidence that these assumptions are only partially correct. In an extensive review of employee preference literature, Glueck traced patterns of group preferences for particular benefits.50 As one might expect, older workers showed stronger preferences than younger workers for pension plans.51 Also, families with dependents had stronger preferences for health/medical coverage than families with no dependents.52 The big surprise in all these studies, though, is that many of the other demographic group breakdowns fail to result in differential benefit preferences. Traditionally, it has been assumed that benefit preferences ought to differ among males versus females, blue collar versus white collar, and married versus single. Few of these expectations have been born out by these studies. Rather, the studies have tended to be more valuable in showing preference trends that are characteristic of all employees. Among the benefits available, health/medical and stock plans are highly preferred benefits, while such options as early retirement, profit sharing, shorter hours, and counseling services rank among the least-preferred options. Beyond these conclusions, most preference studies have shown wide variation in individuals with respect to benefits desired. The weakness of this demographic approach has led some organizations to undertake a second and more expensive empirical method of determining employee preference: surveying individuals about needs. One way of accomplishing this requires development of a questionnaire on which employees evaluate various benefits. For example, Exhibit 12.8 illustrates a questionnaire format. A third empirical method of identifying individual employee preferences is commonly known as a flexible benefit plan (also called a cafeteria-style plan or a supermarket plan). As previously noted, employees are allotted a fixed amount of money and permitted to spend that amount in the purchase of benefit options. From a theoretical perspective, this approach to benefit packaging is ideal. Employees directly identify Chapter 12 The Beneﬁt Determination Process EXHIBIT12.8 429 Questionnaire Format for Benefit Surveys Employee Benefit Questionnaire 1. In the space provided in front of the benefits listed below indicate how important each benefit is to you and your family. Indicate this by placing a “1” for the most important, and “2” for the next most important, etc. Therefore, if life insurance is the most important benefit to you and your family, place a “1” in front of it. Importance Improvement Dental insurance Disability (pay while sick) Educational assistance Holidays Life insurance Medical insurance Retirement annuity plan Savings plan Vacations Now, go back and in the space provided after each benefit, indicate the priority for improvement. For example, if the savings plan is the benefit you would most like to see improved, give it a “1,” the next a priority “2,” etc. Use the blank lines to add any benefits not listed. 2. Would you be willing to contribute a portion of your earnings for new or improved benefits beyond the level already provided by the Company? ❏ Yes ❏ No If yes, please indicate below in which area(s): ❏ Dentali nsurance ❏ Medical insurance ❏ Disabilitybenefi ts ❏ Retirement annuity plan ❏ Lifei nsurance ❏ Savings plan the benefits of greatest value to them, and by constraining the dollars employees have to spend, benefit managers are able to control benefit costs. NCR has adopted a variant on flexible benefits that is part of its “customer-oriented” benefit push. Employees who wish can actually exchange some of their base salary for greater coverage on desiredbe nefits,a sillu stratedin Exhibit12.9. ADMINISTERING THE BENEFIT PROGRAM The job description for an employee benefit manager at Warner Brothers, shown in Exhibit 12.10, indicates that administrative time is spent on three functions requiring further discussion: (1) communicating about the benefits program, (2) claims processing, and (3) cost containment.53 430 –$180 None Current None –$1,800 Base Opt Out None A –$840 –$4,800 Opt Out Base +$1,200 Base $900 +$540 1/2 Salary +$1,800 12-Week Leave Full Salary $2,400 10% Match No Vesting +$960 +$720 6% Match 1-Year Vesting 4 Times Your Salary +$480 70% of Your Salary +$1,300 PPO $11,460 $11,460 $0 3 Times Your Salary 12-Week Leave +$240 6% Match 5-Year Vesting Current A Base +$480 +$1,000 TraditionalEnhanced 60% of Your Salary 2 Times Your Salary Current 3-Day Leave A 3% Match 5-Year Vesting +$240 –$800 HMO 50% of Your Salary Current A 1 Times Your Salary Base Traditional-Basic Current A ALTERNATIVE LEVELS Base Benefit Package Chosen Benefit Package Change in cash pay Source: Lynn Gaughan and Jorg Kasparek, “Employee a Customer” NCR Corp., and Jeff Hagens and Jeff Young, Workspan, September 2000, pp. 31–37. Paid Parental/ Family Leave 401(k) Plan Life Insurance Long-Term Disability Plan Medical Plan FEATURE EXHIBIT 12.9 Administering the Benefits Program A. Costs. Please modify this "base" benefit package into another which you would most prefer, bearing in mind that selecting different levels will impact your cash pay (see box to right). Chapter 12 The Beneﬁt Determination Process EXHIBIT 12.10 Entertainment Inc. Seeks an Employee Benefits Manager for the Compensation and Benefits Department. 431 • General responsibility for health, welfare, and retirement questions from employees. • Oversees Executive Health, Medical Reimbursement, and Flexible Spending Account Programs. • Liaison for Appeals Committee and the Emergency Allocations Committee. • Will assume leadership role in special projects such as intranet communications system. • Charged with identification and maintenance of benefits’ communications programs coming from a variety of different media (intranet, newsletter, computer-generated individual benefit accounts). • Performs and completes benefit surveys as required. • Evaluates performance of vendors and processes/facilitates employee complaints about delivery systems. • Resolves benefits administration problems emanating from MIS, finance, accounting, and legal departments. • Serves on committees to improve policies and processes in benefits strategy development and implementation. • Assists in Development of Strategic Benefits Survey, including identification of sample groups. • Provides input into design of benefits satisfaction survey and suggests format and conclusions for final report. • Attends benefits conferences to network with other benefits professionals. • Maintains working knowledge of new benefits studies, research, and practices. • Leads committee to evaluate benefits costs and reduction strategies. • Incorporates into benefits program relevant changes in state/federal law. EmployeeBenef itCom munication Benefits communications revolves around four issues: What is communicated, to whom, how it’s communicated, and how frequently. Much of the effort to achieve benefit goals today focuses on identifying methods (how) of communication. The most frequent method for communicating employee benefits today is probably still the employee benefit handbook.54 A typical handbook contains a description of all benefits, including levels of coverage and eligibility requirements. To be most effective, the benefit manual should be accompanied by group meetings and videotapes.55 While some organizations may supplement this initial benefit discussion with periodic refreshers (e.g., once per year), a more typical approach involves one-on-one discussions between the benefit administrator and an employee seeking information on a particular benefit. In recent years the dominance of the benefit handbook is being challenged by personalized benefit statements generated by computer software programs specially designed for that purpose. These tailor-made reports provide a breakdown of package components and list selected cost information about the options. Despite these and other innovative plans to communicate employee benefit packages, failure to understand benefit components and their value is still one of the root causes of employee dissatisfaction with a benefit package.56 One study of 500 employees in seven Canadian organizations found that perceived fairness of a plan was significantly higher 432 Part Five Employee Beneﬁts EXHIBIT 12.11 Employees Happy With Their Benefits Versus Employees Happy With Communication About Their Benefits My organization does a good job communicating about benefits programs I am satisfied with the customer service I receive when I have questions about my benefits 79% 33% 77% 40% Employees agreeing with statement and satisfied with benefits overall Employees disagreeing with statement and satisfied with benefits overall *Multiplere sponsespe rmitted Source: “Rx for Rewards in the Downturn: Insights From Towers Perrin’s Total Rewards Study,” (New York: Towers Perrin, March 2009). when there was extensive communications and employee participation in plan design.57 We believe an effective communications package must have two elements. First, an organization must spell out its benefit objectives and it must ensure that any communications achieve these objectives. Exhibit 12.11 shows that employees who think company communications about benefits are effective are in turn more satisfied with those same benefits. Second, an effective communications package should match the message with the appropriate medium. Technological advances have made tremendous improvements in employee benefit communication. In the last several years, a new medium has emerged for communicating benefits—the intranet. In today’s corporations, benefit administrators are aiming to maintain communication with employees in a timely, consistent, and accurate manner, and many are selecting an intranet as their chosen avenue of communication.58 An intranet is an internal organizational online Web through which all forms of communication within the organization can be streamlined. Advantages of an intranet include employee access to benefit information 24 hours a day, 7 days a week without added cost; employee’s ability to directly post changes to their accounts without completing lengthy paperwork; and an increased ease of updating information.59 Employers are increasingly posting their employee benefit handbook components on their intranets.60 This change is beneficial to employers because of the decreased cost and increased ease of making revisions in the employee benefit handbook components. More than 100,000 employees at IBM get benefit communications and enrollment data through the intranet, at savings estimated as $1 million per year. Joining IBM in this intranet-based enrollment process are such organizations as Lucent and Continental Airlines. Experts say “e-benefits” are a huge trend waiting to reinvent human resource practices.61 Benefit administration over the Internet is also growing at a rapid pace. One report suggests that perhaps as many as 80 percent of the Fortune 1000 companies will utilize at least some form of Internet-based employee benefit application.62 A wide range of applications will be offered, from online benefit information to annual benefit enrollment processing, personal data changes, 401(k) changes, and complete employee self-service.63 Chapter 12 The Beneﬁt Determination Process 433 The Cedar Group estimates that the cost of a single hands-on HR-based benefits transaction is $35.65. The same transaction over the Internet or intranet is just $16.38.64 Another example of the recent advances in benefit communication is the streamlined call center operation that Kellogg Company launched in 1999 and that still operates today.65 The call center decreased costs by as much as $105 million while improving service levels and maintaining close employee interaction. At a cost equal to approximately one-fifth of its paper-based predecessor, which required that specialists be located at every Kellogg’s facility in the United States and Canada, the call center allows users to access benefit plan information, download and print documents, and retrieve basic information regarding Kellogg’s benefit vendors. Annual cost savings of this system equal $500,000. Kellogg’s anticipates that the future technological initiatives will include setting up kiosks, which will be Web-enabled personal computers that allow employees to access the information they presently access over the telephone and to contact specialists over the Internet in live chat rooms. ClaimsPr ocessing As noted by one expert, claims processing arises when an employee asserts that a specific event (e.g., disability, hospitalization, unemployment) has occurred and demands that the employer fulfill a promise of payment.66 As such, a claims processor must first determine whether the act has, in fact, occurred. If the answer is yes, the second step involves determining if the employee is eligible for the benefit. If payment is not denied at this stage, the claims processor calculates the payment level. It is particularly important at this stage to ensure coordination of benefits. If multiple insurance companies are liable for payment (e.g., working spouses covered by different insurers), a good claims processor can save from 10 to 15 percent of a claims cost by ensuring that the liability is jointly paid.67 CostCont ainment Increasingly, employers are auditing their benefit options for cost containment opportunities. The most prevalent practices include: 1. Probationary periods—excluding new employees from benefit coverage until some term of employment (e.g., 3 months) is completed. 2. Benefit limitations—it is not uncommon to limit disability income payments to some maximum percentage of income and to limit medical/dental coverage for specific procedures to a certain fixed amount. 3. Copay—requiring that employees pay a fixed or percentage amount for coverage. 4. Administrative cost containment—controlling costs through policies such as seeking competitive bids for program delivery. So prevalent is the cost issue today that the terminology of cost containment is becoming a part of every employee’s vocabulary. Exhibit 12.12 provides definitions of some common cost containment terms. Probably the biggest cost-containment strategy in recent years is the movement to outsourcing. By hiring vendors to administer their benefits programs, many companies, such as GTE and Tenneco, claim greater centralization, consistency, and control of costs and benefits.68 Other companies, like Digital Equipment Corporation, outsource so that they may focus on their core businesses, “leaving benefits to the benefits experts.”69 434 Part Five Employee Beneﬁts EXHIBIT12.12 Basic Primer of Cost Containment Terminology Deductibles: An employee claim for insurance coverage is preceded by the requirement that the first $x be paid by the claimant. Coinsurance: A proportion of insurance premiums are paid by the employee. Benefitc utbacks: Corresponding to wage concessions, some employers are negotiating with employees to eliminate employer contributions or reduce them to selected options. Definedc ontributionplans : Employers establish the limits of their responsibility for employee benefits in terms of a dollar contribution maximum. Definedbenef itp lans: Employers establish the limits of their responsibility for employee benefits in terms of a specific benefit and the options included. As the cost of these options rises in future years, the employer is obligated to provide the benefit as negotiated, despite its increased cost. Dualc overage: In families where both spouses work there is frequently coverage of specific claims from each employer’s benefit package. Employers cut costs by specifying payment limitations under such conditions. Benefitc eiling: Employers establish a maximum payout for specific claims (e.g., limiting liability for extended hospital stays to $150,000). Your Turn WorldM easurement World Measurement is the global leader in product testing for safety. The recent problem with Chinese-made toy products (for example, Mattel recalled 19 million toys with evidence of lead paint) combined with the global recession has caused a 7 percent decline in sales and a 12 percent decline in net profits. The president of the company, Lewis Jacobs, is convinced that he must get concessions from the workers if World Measurement is to compete effectively with increasing foreign competition. In particular, Jacobs is displeased with the cost of employee benefits. He doesn’t mind conceding a competitive wage increase (maximum 3 percent), but he wants the total compensation package to cost 3 percent less. The current costs are shown in Exhibit 1. Your assistant has surveyed other companies that are obtaining concessions from employees. You also have data from a consulting firm that indicates employee preferences for different forms of benefits (Exhibit 2). Based on all this information, you have two possible concession packages that you can propose, labeled “Option 1” and “Option 2” (Exhibit 3). 1. Cost out these packages given the data in Exhibits 1 and the information obtained from various insurance carriers and other information sources (Exhibit 4). 2. Which package should you recommend to Jacobs? Why? 3. Which of the strategies do you think will require less input from employees in terms of their reactions? EXHIBIT1 Current Compensation Costs Averagey earlywage Average hourlyw age Dollar value of yearly benefits, per employee Totalc ompensation(wages pl usb enefits) Daily average number of hours paid $26,769 $13.12 $8,923 $35,692 8.0 Benefits(byCat egory) Dollar Cost/Employee/Year 1. Legally required payments (employer’s share only) a. Old-age, survivors, disability, and health insurance (FICA) taxes b.U nemploymentc ompensation c. Workers’ compensation (including estimated cost of self-insured) d. Railroad retirement tax, railroad unemployment and cash sickness insurance, state sickness benefits insurance, et

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