Overview of Employee Benefits

Noncash compensation, or employee benefitsAll noncash compensation items sponsored by employers for their employees; includes group insurance, educational assistance, legal assistance, childcare, discounts, and so forth., today is a large portion of the employer’s cost of employment. The Employee Benefit Research Institute (EBRI), an important research organization in the area of employee benefits, reported that, in 2007, employers spent $1.5 trillion on major voluntary and mandatory employee benefit programs, including $693.9 billion for retirement programs, $623.1 billion for health benefit programs, and $138 billion for other benefit programs.Employee Benefit Research Institute, EBRI Databook on Employee Benefits, ch.2: Finances of the Employee Benefit System, updated September 2008. http://www.ebri.org. More information can also be found in the U.S. Chamber of Commerce Survey at uschamber.com at http://www.uschamber.org/Research+and+Statistics/Publications/Employee+Benefits+Study.htm (accessed April 12, 2009). The complete picture of employee benefits costs over the years is provided in Table 20.1 "Employer Spending on Noncash Compensation, 1960–2007" As you can see in this table, benefits make up a significant amount of the pay from employers, equating to 18.6 percent of total compensation in 2007. The largest shares of the benefits go toward legally required benefits (social insurance), paid leave, and health insurance.

As noted above, employee benefits have tax incentives. Some benefits such as health care, educational assistance, legal assistance, child care, discounts, parking, cafeteria facility, and meals are deductible to the employer and completely tax exempt to the employees. Retirement benefits, both the contributions and earnings on the contributions, are tax deductible to the employer and tax deferred to the employees until their retirement. Some of the benefits paid by employees themselves are tax deferred, such as investment in 401(k) plans (discussed in Chapter 21 "Employment-Based and Individual Longevity Risk Management"). Other benefits are partially tax exempt, such as group life. The employee is not required to pay taxes on the cost of life insurance up to coverage in the amount of $50,000 in death benefits. For greater amounts of death benefits, the employer’s contributed premiums are counted as taxable income to the employee. The largest expense comes in the form of health benefits, with $532.1 billion out of $1,454.9 billion of the total benefits spent by employers in 2007 (see Table 20.1 "Employer Spending on Noncash Compensation, 1960–2007"). Health benefits receive the most favorable tax exemption of all employee benefit programs.

When we do not pay taxes, the government is forgoing income. Each year, the White House Office of Management and Budget calculates the amounts forgone by the tax benefits. EBRI reports that the foregone taxes from employer-provided benefits are projected to amount to $1.05 trillion for 2009 through 2013.Employee Benefits Research Institute, “Tax Expenditures and Employee Benefits: Estimates from the FY 2009 Budget,” February 2008, http://www.ebri.org/pdf/publications/facts/0208fact.pdf (accessed April 12, 2009).

With the tax incentives comes a very stringent set of rules for nondiscrimination to ensure that employers provide the benefits to all employees, not only to executives and top management. The most stringent rules appear in the Employee Retirement Income Security Act, which will be explored in Chapter 21 "Employment-Based and Individual Longevity Risk Management" in the discussion of pensions. Keep in mind that employee benefits are a balance of tax incentives as long as employers do not violate nondiscrimination rulesRules set forth by the IRS stipulating that employee benefit plans must be for the benefit of all employees, not just executives and top management in order to qualify for tax incentives. and act in good faith for the protection of the employees in their fiduciary capacity. The efforts to protect employees in cases of bankruptcies are featured in the box “Your Employer’s Bankruptcy: How Will It Affect Your Employee Benefits?” Ways to detect mismanagement of certain benefit plan funding are described in the box “Ten Warning Signs That Pension Contributions Are Being Misused.”

Employer Objectives

The first step in managing an effective employee benefits program, as with the other aspects of risk management discussed in Part I of the text, is setting objectives. Objectives take into account both (1) the economic security needs of employees and (2) the financial constraints of the employer. Without objectives, a plan is likely to develop incrementally into a haphazard program. An employer who does not have an on-staff specialist in this field would be wise to engage an employee benefits consulting firm.

Employers can use several methods to set objectives for benefit plans. They may investigate what other organizations in the region or within the industry are doing and then design a competitive package of their own to recruit and retain qualified employees. Benefits may be designed to compete with plans offered for unionized workers. Employers may survey employees to find out what benefits are most desired and then design the benefits package with employees’ responses in mind.

Employer objectives are developed by answering questions such as the following:

• Who is eligible for each type of benefit?
• Should seniority, position, salary, and other characteristics influence the amount of each employee’s benefit? (Care in observing nondiscrimination rules is very important in this area.)
• How might a specific benefit affect employee turnover, absenteeism, and morale?
• How should benefits be funded? (Should the employer buy insurance or self-insure?)
• Should the benefits program be designed to adjust to the differing needs of employees?
• How do laws and regulations influence benefit plan design?
• To what extent should tax preferences affect plan design?

In answering questions like these, management must keep in mind the effect of its benefits decisions on the organization’s prime need to operate at an efficient level of total expenditures with a competitive product price. Efficiency requires management of total labor costs, wages plus benefits. Thus, if benefits are made more generous, this change can have a dampening effect on wages, all else being equal. Financial constraints are a major factor in benefit plan design. It is critical to note that health insurance is a key benefit employees expect and need. As shown in Table 20.1 "Employer Spending on Noncash Compensation, 1960–2007", group health insurance is a major part of the average compensation in the United States. Most people regard the employer as responsible to provide this very expensive benefit, which is discussed in detail in Chapter 22 "Employment and Individual Health Risk Management" (unless and until proposed changes are enacted by the Obama administration, that is).