Chapter Eleven
Discretionary Benefits
Origins of Discretionary Benefits
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World War II & Korean War, 1940s-1950s; governmentmandated salary freezes led to increases in benefits –
welfare practices.
National Labor Relations Act of 1935, which legitimized
union bargaining for employee benefits:
Mandatory: health insurance, disability, retirement, pay for
time not worked.
Permissive: funds administration, retiree benefits,
workers’ comp.
Illegal: none related to benefits as of today.
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Recent tax laws that provide tax incentives to employers
(and employees) for contributions to benefit plans
Income Retirement Protection Plans:
Employee Retirement Income Act (ERISA) of 1974
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Goal: provide protection of employee benefit rights
Disclosure: updates, changes, annual synopsis.
Funding: ensure sufficient funding when employees
reach retirement age.
Fiduciary: Forbid transactions with parties that have
interests adverse to those of employees and
transactions in their own interests.
Vesting: employees’ acquisitions of non-forfeitable
rights by specified timeframe (e.g., partially vested
after 3 years; fully vested after 5 years).
Income protection programs
Disability insurance (supplements disability
benefits mandated by SSA of 1935 & Employee
Retirement Income Security Act of 1974):

Short term (<6 months): inability to perform any and
every duty of one’s occupation; 50-100% of pre-tax
salary.

Long term (6 months to lifetime), more stringent
definition: inability to engage in any occupation for
which the individual is qualified; 50-75% of pretax
salary.
Income protection programs
Life insurance:

Typically a multiple of salary or a fixed amount.
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Typically include accidental death
dismemberment claims.
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Term coverage: protection during employee’s
work years,
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Life coverage: lifetime coverage.
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Premiums increase exponentially with age;
therefore employer-provided group rates are
usually better than those that individuals may find
for themselves.
Income protection programs
Pension Plans (have considerable growth lately out of
concerns re the future of Social Security):

Contributory vs. noncontributory: whether or not
they require employee contributions.
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Qualified vs. Nonqualified: whether or not they
qualify for favorable tax treatment of
contributions (for both employers and employees) –see
characteristics.
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Defined contribution or defined benefits: whether
or not they guarantee specified retirement
benefits. Most plans (401(k), employee stock
ownership plans –ESOP, etc.) are defined
contribution plans.
Characteristics of Qualified Retirement Plans
Eligibility:
No initial eligibility criteria concerning age or
service.
Nondiscrimination:
No preferential treatment to highly
compensated employees –unless employer contributions
are solely based on compensation level or years of service.
Vesting
Requirements: Nonforfeitable right to contributed
funds after (typically) 5 years.
Penalty
(typically 10%) for early withdrawal before early
retirement age (59.5 years-old).
Income protection programs
Economic
Growth & Tax Relief Reconciliatory Act
(EGTRRA) (signed by President Bush in June 2001) :
»Increased employee contribution limits
»Catch-up contributions for workers 50 and older ($1,000 a
year until reaching $5,000 in 2006)
»Tax credit on contributions up to $2,000 to retirement plans
and IRAs
»Speeded-up vesting.
»New contributions can be rolled over to ANY plan type, not
just a same-type plan or IRA.
Health Protection Plans:
Consolidated Omnibus Budget Reconciliation Act of
1985 (COBRA)
•Provide employees with an opportunity to temporarily
continue receiving their employer-sponsored health
insurance after change in employment status.
Continued coverage for up to 18 months; extension to 36
months for spouses and dependents due to qualifying
events.
Companies permitted to charge COBRA beneficiaries a
premium of 102% of the costs of plan coverage (extra 2%
due to administrative costs.
COBRA violations subject to excise tax & civil penalty
(includes notices to employees)
COBRA Administration Case
An employee was terminated and later sued his former employer for
failing to notify him of his right to continue health coverage under
COBRA. The employer had contracted with a third-party
administrator (TPA) to send COBRA notices, and argued that it
complied with COBRA by providing the TPA with the necessary
information and by instructing the TPA to send a COBRA election
notice to the employee. The court held that the employer had not
met its COBRA obligations. Did contracting with an agent to send
COBRA notices like this employer did constitute Good Faith
Compliance? What are the lessons learned regarding the content of
contracts with TPAs?
COBRA Administration Case (continued)
ANSWER
COBRA does not require actual receipt of notification by the
plan participant; to the contrary, only a good faith attempt to
notify is required. The courts consider (1) evidence of the plan's
regular COBRA notification procedures; (2) the COBRA
coordinator's testimony that the election notice was mailed to
the participant's most recent address on file in accordance with
the plan's usual practice; and (3) a computer entry in the plan's
records indicating when the notice was sent.
Contracting with an agent or Third Party Administrator (TPA)
might have alleviated the workload for the employer’s staff but
in fact, it does not constitute Good Faith Compliance with
COBRA.
COBRA Administration Case (continued)
ANSWER (continued)
Some recommendations are as follows:
•The employer should conduct research before contracting
a TPA to assure them that they have not had problems of
such nature in the past and that they are a secure and
serious company.
•Make sure that standards are set between the employer
and the TPA as to how COBRA notices should be sent, the
time frame, the procedures, etc.
•The TPA should keep their own records as to when
(date/time) the notice was sent to the qualified employees.
Bottom line is that the ERISA Plan Administrator is responsible
for COBRA notices. The norm is that the COBRA Third Party
Administrator does not accept to become the plan administrator.
Cost-shifting in Health Care
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Raising healthcare costs
Advances in medicine, technology, and life
expectancy.
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Cost sharing:
Increase in premiums, deductibles, & coinsurance/co-payment
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Cost containment:
Reduced choices –Primary Care Physician in
HMOs acts as gatekeeper; pre-negotiated
charges; limited list of healthcare providers &
hospitals.
Types of Health Protection Plans
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Commercial insurance (fee-for-service): usual,
customary, and reasonable charges; deductible, coinsurance, out-of-pocket maximum.
Self-funded insurance.
HMOs: pre-paid medical services for a set premium,
rather than fee-for service. Primary Care Physician
acts as a gatekeeper of referrals to the more costly
specialists. It restricts the patient’s options to a very
limited choice of providers.
PPO (preferred provider organization): providers
agree to provide services at a higher level of
reimbursement; do not provide benefits on a pre-paid
basis; wide choice of providers.
Table 11-4
U.S. Health Care Expenditures, 1960 to 1999 (1 of 3)
TOTAL
YEAR
1960
1965
1970
1971
1972
1973
1974
1975
1976
TOTAL HEALTH SERVICES AND
SUPPLIES (BILLIONS OF DOLLARS)
TOTAL
PER
(BILLIONS OF CAPITA
DOLLARS) (DOLLARS)
27.1
41.6
74.3
82.2
92.3
102.4
115.9
132.6
151.9
143
204
346
379
421
464
521
591
671
PRIVATE
PRIVATE
19.8
29.9
44.0
48.1
53.9
59.7
65.9
74.1
85.7
5.7
8.3
25.0
28.2
31.8
35.9
42.8
50.2
56.9
Table 11-4
U.S. Health Care Expenditures, 1960 to 1999 (2 of 3)
TOTAL
YEAR
1977
1978
1979
1980
1981
1982
1983
1984
1985
TOTAL HEALTH SERVICES AND
SUPPLIES (BILLIONS OF DOLLARS)
TOTAL
PER
(BILLIONS OF CAPITA
DOLLARS) (DOLLARS)
172.6
193.2
218.3
251.1
291.4
328.2
360.8
396.0
434.5
755
836
937
1,068
1,227
1,369
1,490
1,620
1,761
PRIVATE
PRIVATE
96.6
109.7
124.0
141.3
164.3
186.5
205.3
228.0
252.9
64.7
73.6
84.0
96.1
113.9
126.9
139.5
151.6
165.2
Table 11-4
U.S. Health Care Expenditures, 1960 to 1999 (3 of 3)
TOTAL
YEAR
1990
1995
1996
1997
1998
1999
(est.)
TOTAL HEALTH SERVICES AND
SUPPLIES (BILLIONS OF DOLLARS)
TOTAL
PER
(BILLIONS OF CAPITA
DOLLARS) (DOLLARS)
699.4
993.3
1,039.4
1,088.2
1,149.1
1,228.5
2,689
3,637
3,772
3,912
4,094
-----
PRIVATE
PRIVATE
416.2
537.3
559.0
586.0
626.4
-----
283.2
456.0
480.4
502.2
522.7
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Source: US Health Care Financing Admin., Health Care Financing Review (Winter 1994); Table 150. U.S. Health
Care Financing Administration, Office of the Actuary: National Health Statistics Group (1999). [Online]
http://www.hcfa.gov/stats.
Pay for Time-Not-Worked Practices in Medium and
Large Private Establishments, 1997
BENEFIT
PERCENT OF FULL-TIME
EMPLOYEE RECIPIENTS
Holidays
96
11 days per year
Vacation
96
Depends on tenure
Personal leave
14
3.5 days per year
Jury duty
90
No stated maximum
Funeral leave
85
3.7 days per year
Military leave
57
15.3 days per year
AVERAGE AMOUNT
Source: US Bureau of Labor Statistics, Employee benefits in medium and large private establishments, 1997
(Washington, D.C.: US Government Printing Office, 1999).
Employer-Provided Services
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Employee Assistance Programs
Family Assistance Programs
Flexible schedule.
Telecommuting.
Day care.
Wellness management & facilities –weight control &
nutrition, smoking cessation, stress management,
gym.
Tuition reimbursement (typically less than full tuition).
Disaster relief –tangible and/or socio-emotional
support.
Designing A Benefits Program
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Strategic choice: differentiation or cost.
Becoming an “employer of choice” (talent is in short
supply): turnover & employee morale.
Identify beneficiaries: part and/or full time employees,
retirees (medical benefits to retirees no longer taxdeductible), probationary employees.
Financing: contributory vs. non-contributory.
Communication plan: wise usage (cost containment),
understanding & appreciation of benefits (retention).
Employee choice. Cafeteria plans:
» flexible spending accounts –FSA (employees pay for certain
expenses with pre-tax dollars)
» core plus option (some benefits are mandatory).
Example: Designing a Cafeteria-style Benefits
Package
Employees have various needs, and therefore it is often costeffective to let them choose among a number of benefit
options. In this kind of cafeteria-style benefits plan, each
benefit is priced according to two factors: (1) how much the
benefit is valued by employees, and (2) the cost associated
with the benefit. The value that employees place on each
benefit item is typically determined through an employee
survey.
Each employee is asked to answer a benefits survey like the
one on the next slide. Then, the average rating for each
benefit and its corresponding weight are computed. Next,
points are allocated to each benefit. Typically, employees
would be allowed to choose benefits from this list to a
maximum of, for instance, 50 points.
Cafeteria-style Benefits Survey
Indicate your interest in the following benefits:
Rating: 1 = not interested at all, 2 = not interested, 3 =undecided,
4 = interested, 5 = very interested
Benefit
Term life insurance of 1-year salary
Health coverage (HMO)
Health coverage (PPO)
Disability insurance
Dental insurance
Vision insurance
Child care
Tuition reimbursement
Wellness program
Your rating
Avg. Group Rating (A)
Weight = 6 - A
Allocating points to benefit items
Benefit
Cost
(C)
Term life insurance of 1-year salary
$40
Health coverage (HMO)
$250
Health coverage (PPO)
$400
Disability insurance
$20
Dental insurance
$15
Vision insurance
$10
Child care
$350
Tuition reimbursement
$200
Total
$1,285
Weight (W)
CxW
[(CXW) / T]x100
Points
Total
(T)
100
Discussion Question 11-1
1.
2.
The cafeteria-style system is predicated on the
assumption that the employer should “subsidize”
those benefits in which employees are most
interested. Describe the pros and cons of these
“subsidies” for the organization.
Will the interest in each benefit will vary as a
function of demographic categories such as age,
number of dependents, gender, ethnicity and type of
industry? Please provide examples of such
variation.
Discussion Question 11-2
The Pros and Cons of the privatization of retirement
benefits
Concerns about the future of the Social Security have led the Federal
Government to stimulate the creation of individual retirement funds,
e.g., 401(k) plans, through favorable tax treatment. Do some online or
library research the pros and cons of this privatization process, as well
as the administrative measures that would minimize its social and
financial risks.
Pros
Cons
Administrative Measures
that minimize social and
financial risks.