Employee Benefits

Employee benefits, sometimes called fringe benefits, are indirect forms of compensation provided to employees as part of an employment relationship. To compete for quality employees in today's marketplace, employers must do more than offer a “fair day's pay.” Workers also want a good benefits package. In fact, employees have grown accustomed to generous benefits programs, and have come to expect them.

Employee benefits exist in companies worldwide, but the types and levels of benefits vary greatly from country to country. Generally speaking, companies in industrialized countries in Europe and North America offer employees the most generous benefit packages. Even within the industrialized world, however, employee benefits can vary significantly. For example, employees in Germany and other European countries receive more vacation days than the average U.S. employee. Conversely, most employers in the United States offer some form of medical/health insurance to employees. But most companies in European countries don't offer this employee benefit, because it is provided through government-sponsored socialized medicine programs.

HISTORICAL OVERVIEW

Employee benefits were not a significant part of most employees' compensation packages until the mid-twentieth century. In the United States, for example, benefits comprised only about 3 percent of total payroll costs for companies in 1929. According to the U.S. Chamber of Commerce, however, employee benefits in the United States now comprise approximately 42 percent of total payroll costs. Several things account for the tremendous increase in the importance of employee benefits in the United States. In the 1930s, the Wagner Act significantly increased the ability of labor unions to organize workers and bargain for better wages, benefits, and working conditions. Labor unions from the 1930s to 1950s took advantage of the favorable legal climate and negotiated for new employee benefits that have since become common in both unionized and non-union companies. Federal and state legislation requires companies to offer certain benefits to employees. Finally, employers may find themselves at a disadvantage in the labor market if they do not offer competitive benefit packages.

LEGALLY REQUIRED BENEFITS

In the United States, legislation requires almost all employers to offer the social security benefit, unemployment insurance, and workers' compensation insurance. Larger companies (those with fifty or more employees) are also required to offer employees an unpaid family and medical leave benefit. Each of these legally required benefits is discussed briefly below.

Social Security. The Social Security Act of 1935, as amended, provides monthly benefits to retired workers who are at least sixty-two years of age, disabled workers, and their eligible spouses and dependents. Social Security is financed by contributions made by the employee and matched by the employer, computed as a percentage of the employee's earnings. Monthly benefits are based on a worker's earnings, which are adjusted to account for wage inflation. The Social Security Act also provides Medicare health insurance coverage for anyone who is entitled to retirement benefits. Medicare is funded by a tax paid by the employer and employee. The tax rate for Medicare is a combined 2.9 percent of the employee's total wage or salary income.

Unemployment Insurance. Unemployment compensation provides income to unemployed individuals who lose a job through no fault of their own. Eligible workers receive weekly stipends for twenty-six weeks. The specific amount of the stipend is determined by the wages the claimant was paid during the previous year. Unemployment compensation laws in most states disqualify workers from receiving benefits under the following conditions:

1. Quitting one's job without good cause
2. Being discharged for misconduct connected with work
3. Refusing suitable work while unemployed

Workers' Compensation Insurance. Millions of workers are hurt or become sick for job-related reasons each year. All fifty states have workers compensation insurance laws that are designed to provide financial protection for such individuals. Specifically, these laws require the creation of a no-fault insurance system, paid for by employers. When workers suffer job-related injuries or illnesses, the insurance system provides compensation for medical expenses; lost wages from the time of injury until their return to the job (employees are given a percentage of their income, the size of which varies from state to state); and death (paid to family members), dismemberment, or permanent disability resulting from job-related injuries.

Nationwide, payouts for workers' compensation are relatively high and curbing costs is a priority for many U.S. companies. The increase in costs is primarily due to rising medical costs that now account for as much as 60 percent of total workers' compensation costs in some states. Fraudulent claims also increase costs.

PARENTAL LEAVE

Maternal and paternal leave are both popular topics in today's business world. Currently, federal law requires up to twelve weeks of unpaid leave for new parents, although legislation has been considered to raise the time limit. Globally, this is a very low amount of time, and many other nations, including Canada, offer a longer leave and pay their employees.

While some American employers use the national minimum, other companies recognize the global imbalance and offer their employees paid parental leave, or a contribution plan that will allow them to take more time off with their newborn child. Only California and Washington require paid leave for employees, but recent trends are encouraging more generous behavior in the private sector. One popular method companies are currently practicing is the inclusion of maternal benefits other than parental leave. This can include compensation plans for medical visits, extended health coverage for pregnant workers, or on-site facilities to make newborn and childcare easier for the employee.

OPTIONAL EMPLOYEE BENEFITS

Other employee benefits are quite common, but are not required by federal law in the United States. Some of the more significant optional benefits are summarized below.

Health Insurance. Basic health-care plans cover hospitalization, physician care, and surgery. Traditional fee-for-service health care coverage became increasingly expensive in the late twentieth century. As a result, many U.S. companies adopted “managed care” health care plans. In general, managed care plans cut health care costs for employers by requiring them to contract with health care providers to perform medical services for their employees at an agreed upon fee schedule, in exchange for the employer encouraging (sometimes requiring) the employees to receive their medical care within the approved network of health care providers.

Health Maintenance Organizations (HMOs) are one type of managed care plan. HMOs are organizations of physicians and other health care professionals who provide a wide range of services for a fixed fee. When participants need medical services, they pay a nominal per-visit charge of $5 or $10. Because members visit their health care facility more frequently, potential problems can be discovered and eliminated before they can become major health threats. Thus, HMOs can save money through preventative medicine. However, employees have a limited number of doctors from which to choose and must get approval from a primary care physician for specialized treatment.

Preferred Provider Organizations (PPOs) provide services at a discounted fee in return for the company's participation, which creates increased business for the health facility. Employees may choose the member facility of their choice. PPOs are somewhat less restrictive of patient choice than HMOs, since they allow employees

to receive health care outside the approved network if the employee is willing to shoulder a higher percentage of their health care expenses.

Point of Service (POS) plans are more flexible versions of PPO plans. In a point of service plan, there is a company-authorized network of medical centers and physicians that the employees can choose from, but the employee can also go outside the network for particular medical needs. Some sort of discount usually applies to the medical network the company offers, to encourage employees to stay within the plan, but the choice is theirs.

Employers are not legally required to offer health insurance to employees. If they do, however, the Consolidated Omnibus Budget Reconciliation Act (COBRA) provides for a continuation of health insurance coverage for a period of up to three years for employees who leave a company through no fault of their own. Such employees are required to pay the premiums themselves, but at the company's group rate.

CDHPs and FSAs. Due to rising health costs, many companies are choosing to repeal their health care benefits or offer alternative plans for their employees to find health insurance. In 2004 alone, the average cost of health premiums rose 7.5 percent, and companies continued to raise copayments and deductibles to follow the market. This has resulted in high costs all around for employees seeking competent health insurance, especially for those working in small to mid-sized companies. The smaller companies cannot handle the higher premiums very easily, so they must move the cost onto their employees. Larger companies are able to shoulder more of the cost, but they, too, are struggling under the rising costs.

In response to these issues, several alternative employee benefit plans have gained popularity. One of these options is the Consumer Directed Health Plan, or CDHP, which has gained more support in recent years. In CDHPs, employees work with companies to choose their own health coverage plan, tailored for them specifically. Companies offer CDHPs because analysis has shown employees often chose more streamlined, simpler plans that result in less cost for the companies. Many organizations also give employees the necessary resources to research health coverage so that they can choose the best components for themselves.

According to a 2008 study by Watson Wyatt and the National Business Group on Health (NBGH), more than half of United States companies are expected to offer some kind of CDHP by 2009, and the number is expected to increase even more. In 2006, a similar study found that only 33 percent of companies offered consumer-directed health plans. This increased to 39 percent in 2007, and then to 47 percent in 2008.

Nearly a third of American companies offering CDHP also offer a health savings account, or HSA. Deposits in an HSA account can be used by the employee in the event of a medical crisis, and provide yet another supplement to CDHPs.

Another form of the HSA is the flexible spending account (FSA), an option some companies are offering instead of—or in addition to—the CDHP. At the beginning of each year, employees are able to select specific health benefits and the amount they are willing to pay for the insurance. The cost is then deducted from their pretax salary, giving better benefits to both the company and the employee than they would receive.

Voluntary Leave. Voluntary leave includes all the leave companies offer employees for extraneous reasons (vacations, holidays, emergencies, etc). Paid sick leave is especially common for companies to establish and can be offered in a variety of ways. Employers can offer sick days based on how long an employee has been with a company and what position the employee has, or they can offer a flat number of sick days for all employees alike. Other companies use a paid-time-off plan that incorporates sick days, vacation days, and other types of voluntary leave into one cache of days that an employee can draw from when needed. Some states are considering making a certain amount of paid sick leave mandatory.

Long-Term Disability (LTD) Insurance. This benefit provides replacement income for an employee who cannot return to work for an extended period of time due to illness or injury. An LTD program may be temporary or permanent. The benefits paid to employees are customarily set between 50 and 67 percent of that person's income.

Pensions. Pensions, or retirement incomes, may be the largest single benefit most employees receive. In most instances, employees become eligible to participate in company pension plans when they reach 21 years of age and have completed one year of service. After they have satisfied certain age and time requirements, employees become vested, meaning that the pension benefits they have earned are theirs and cannot be revoked. If they leave their jobs after vesting, but before retirement, employees may receive these benefits immediately or may have to wait until retirement age to collect them, depending on the provisions of their specific pension plan.

Employers may choose from two types of pension plans—defined benefit plans or defined contribution plans. Defined benefit plans specify the amount of pension a worker will receive on retirement. Defined contribution plans specify the rate of employer and employee contributions, but not the ultimate pension benefit received by the employee. If a defined benefit plan is

chosen, an employer is committing itself to an unknown cost that can be affected by rates of return on investments, changes in regulations, and future pay levels. Consequently, most employers have adopted defined contribution plans.

Companies establish pension plans voluntarily, but once established, the Employee Retirement Income Security Act of 1974 (ERISA) requires that employers follow certain rules. ERISA ensures that employees will receive the pension benefits due them, even if the company goes bankrupt or merges with another firm. Employers must pay annual insurance premiums to a government agency in order to provide funds from which guaranteed pensions can be paid. Additionally, ERISA requires that employers inform workers what their pension-related benefits include.

Stock Options. A publicly traded company has the ability to offer its employees stock option benefits, if it chooses. If an employee takes part in a stock option plan, then part of their annual income will be invested in the company's own stock, usually at a lower than market price. This allows the company to gain extra investment from willing employees, if so needed, and also to bolster employee interest in the success of the company.

The company must come to an agreement on several factors before offering a stock option benefit plan to employees. First, the company must decide how many shares to set aside for stock option possibilities; this is usually somewhere between 5 percent and 20 percent of outstanding stocks. Many companies also choose to create a vesting time, a period that the employee must stay with the company before his shares become exercisable. This period differs for all companies.

Of course, companies should have full approval of the stockholders before installing an employee stock option plan. If they are too careless, the company can lose a controlling interest through overselling their stock. Along with shareholder approval, the corporate board should create applicable caveats for employee termination, options to exercise stock by employees, and refusal rights to limit the number of shareholders.

401(k) Plans. A 401(k) plan is a retirement plan offered by many companies. Essentially, it offers employees a possible contribution of their income into several different investment opportunities. Some companies offer a limited list of investment plans, while others work with the customer to form an investment plan including stocks the employee is interested in. A portion of the employee's income is then automatically contributed to that investment, with the employer acting as fiduciary. 401(k) plans are protected from creditors under national legislation and have an annual contribution limit of $15,000.

The money withdrawn for 401(k) plans is not taxed as an investment, but only as earned income. If an employee withdraws investment money before retirement, then a fee is taken, usually 10 percent, payable to the IRS. Some employees are allowed to take loans from their 401(k) plans. Such investment opportunities are becoming more commonly considered necessary for a successful retirement in the United States. It is a helpful benefit to offer employees who are not part of a public company, so that they can still participate in a company-contribution stock plan.

Life Insurance Plans. These employee benefits are very common. The premiums for basic life insurance plans are usually paid by the employer. Employee contributions, if required, are typically a set amount per $1,000 in coverage based on age. Employees are often given the opportunity to expand their coverage by purchasing additional insurance.

BENEFITS ADMINISTRATION

Two issues that are crucial to the management of employee benefits are flexible benefit plans and cost containment. Many employers now offer flexible benefit plans, also known as cafeteria plans. These plans allow employees to choose among various benefits and levels of coverage. Under a cafeteria plan, employees may choose to receive cash or purchase benefits from among the options provided under the plan. Flexible benefit plans present a number of advantages:

• Such plans enable employees to choose options that best fit their own needs. New workers, for example, may prefer cash; parents may prefer to invest their benefit dollars in employer-sponsored childcare programs; and older workers may decide to increase their pension and health care coverage.
• Deciding among the various options makes employees more aware of the cost of the benefits, giving them a real sense of the value of the benefits their employers provide.
• Flexible benefit plans can lower compensation costs because employers no longer have to pay for unwanted benefits.
• Employers and employees can save on taxes. Many of the premiums may be paid with pretax dollars, thus lowering the amount of taxes to be paid by both the employee and the employer.

Because of these advantages, flexible benefit plans have become quite popular: such plans are now being offered by many U.S. companies. However, some companies are shying away from cafeteria plans because they create such an administrative burden. Moreover, the use

of such plans can lead to increased insurance premiums because of adverse selection. Adverse selection means that people at high risk are more inclined than others to choose a particular insurance option. For instance, a dental plan option would be chosen primarily by employees with a history of dental problems. Consequently, insurance rates would increase because the number of low-risk individuals enrolled in the programs would be insufficient to offset the claims of high-risk individuals.

Companies can contain costs in several ways. Because an employer's workers' compensation premiums increase with each payout, firms can prevent unnecessary costs by scrutinizing the validity of each claim. Some employers cut costs by deleting or reducing some of the benefits they offer employees. This approach, however, can negatively affect both recruitment and retention. A more viable approach is to offer benefits that are less costly, but equally desirable. Companies can continue to offer attractive benefits by implementing some of the cost-containment strategies discussed next.

Many companies implement utilization review programs in order to cut health care costs by ensuring that each medical treatment is necessary before authorizing payment, and ensuring that the medical services have been rendered appropriately at a reasonable cost. These programs require hospital pre-admission certification, continued stay review, hospital discharge planning, and comprehensive medical case management for catastrophic injuries or illnesses.

Some employers have been able to increase the attractiveness of their benefit programs while holding costs constant, allowing an organization to get more of a “bang for its buck” from these programs.

CURRENT TRENDS IN EMPLOYEE BENEFITS

According to a 2008 article in the Insurance Journal, employee benefits are likely to remain balanced in the coming years, despite rising health care costs. Alternatives such as FSAs and other flexible plans are allowing employees to have more choice in health coverage and giving employers ways to save money. In addition to the new forms of coverage, employers are offering more subtle benefits at a lesser cost—benefits such as telecommuting options, stipends for gas, childcare options, and cross-training for skill development.

While some of the more traditional forms of employee benefits have declined in the past few years, other more innovative forms are on the rise. Personal use of company-sponsored cell phones is one of the growing benefit fields, as are fitness-center memberships and on-site vaccinations for employees. Companies are also becoming more family conscious, offering more long-distance calling for business trips, compressing work weeks, and providing legal assistance and other personal benefits.

SEE ALSO Employee Assistance Programs; Employment Law and Compliance

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