Ch 12 Compensation

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Chapter 12
The Benefit Determination
Process
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Overview
Controlling labor costs is not possible without controlling benefits costs.
• Employers seek to make benefit costs move in line with revenues and
profits – rather than a fixed cost.
Benefits seem to influence whether employees come to work for a
company, whether they stay, when they retire – maybe how they perform.
• However, different employees look for different types of benefits.
Benefits can be used to differentiate an employer from competitors.
• They may also do it cheaper, giving them an edge on rivals.
Though it makes sense to think of benefits as part of total compensation,
benefits are unique in some important aspects.
• Benefits are unique is their complexity.
The pandemic helped us see that benefits and benefits flexibility are
critical in dealing with a crisis.
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Why the Growth in Employee Benefits?
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 (for example, life insurance, pension, workers’
compensation, vacation).
• The cost of employer benefits has risen over time.
• Pension costs are a major challenge with many underfunded plans.
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EXHIBIT 12.1 Total Hourly Compensation and Benefits Costs,
U.S. Private Industry Workers, by Establishment Size
Employee benefits can no longer realistically be called “fringe benefits.”
Establishment
Size for All
Establishment
Size for 1-99
Employees
Establishment
Size for 500 Or
More Employees
Total Compensation $36.23 $29.99 $53.83
Wages and Salaries $25.48 $22.21 $34.94
Benefits $10.74 $7.78 $18.88
Benefits/Total
Compensation
30% 26% 35%
Benefits/Wages and
Salaries
42% 35% 54%
Source: Bureau of Labor Statistics, U.S. Department of Labor. Employer Costs for Employee Compensation—December 2020. USDL-20-0437. March 18, 2021. www.bls.gov. 4

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Exhibit 12.2 Benefits as a Percentage of Wages/Salaries and
Total Compensation
Benefits costs have grown over time and now represent 31.7 percent of
total compensation.
Access text alternative for this image.
Source: Data through 1990, U.S. Chamber of Commerce Research Center, Employee Benefits 1990, Employee Benefits 1997, Employee Benefits 2000, Washington, DC: U.S. Chamber of Commerce,
1991, 1997, and 2000. Data from 1995 onward: Bureau of Labor Statistics, U.S. Department of Labor. “Employer Costs for Employee Compensation.”
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Why the Growth in Employee Benefits? Wage and Price
Controls and Unions
During both World War II and the
Korean War, the federal government
instituted strict wage and price
controls.
• Both unions and employers
sought new benefits to satisfy
worker demands.
• This was the catalyst for
pensions, health care coverage,
time off and more.
This was a perfect opportunity for
unions to exercise these rights
acquired under the Wagner Act of
1935.
• Largely through the efforts of
unions, several common
benefits arose.
• Pension plans.
• Supplementary
unemployment.
• Extended vacation days.
• Guaranteed annual wages.
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Why the Growth in Employee Benefits? Employer Impetus
Many benefits in existence today were provided at employer initiative.
• This 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 to improve
performance and provide increased security for worker retirement.
• Benefits were designed to create a climate in which employees
thought of management as genuinely concerned for their welfare.
• Benefits slowly became a costly entitlement of the U.S. work force.
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Why the Growth in Employee Benefits? Cost (Including Tax)
Effectiveness of Benefits
Another 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.
• An extra dollar paid in cash is not an extra dollar received in the
paycheck.
A second cost advantage is that group-based benefits can often be
obtained at a lower rate than could be obtained by individual employees.
• Group insurance also has relatively easy qualification standards.
• Giving security to a set of employees who might not otherwise qualify.
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EXHIBIT 12.3 Example of Marginal Tax Rates for an Employee
Salary of $80,000
(Marginal) Tax Rate
Federal 25.00%
State (New York) 6.09%
City (New York) 3.82%
Social Security 6.20%
Medicare 1.45%
Total tax rate 43%
Note: Local taxes (state, city, and property taxes) up of to $10,000 total are deductible on the federal return, if itemizing
deductions. In this case, the effective marginal tax rate would be 40% (rather than 43%).
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Why the Growth in Employee Benefits? Government Impetus
Three employee benefits are mandated by either the state or federal
government.
• Workers’ compensation (state).
• Unemployment insurance (federal).
• Social security (federal).
In addition, most other employee benefits are affected by such laws as
the Employee Retirement Income Security Act (ERISA).
• Which affects pension administration, and various sections of the
Internal Revenue Code.
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The Value of Employee Benefits
Medical benefits continue to be ranked tops in importance for most
employee groups.
• A firm with 10,000 employees spends roughly $119 million on health
insurance alone.
A major concern is evidence that employees frequently undervalue the
benefits provided by their organization, or are even unaware of them.
One possible way to improve employer return on investment in benefits is
to provide employees with greater choice in the benefits they receive.
• The perceived value of benefits rises when employers introduce choice
through a flexible benefit package.
• Some experts speculate that a key element in reward attractiveness
(and benefits) may be their visibility.
• Not only do employers have to plan and design an effective benefit
program, they also need to communicate their value to employees.
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Benefits Planning and Design Issues
Employers need to decide the role of benefits in their overall
compensation package.
• The planning process also should include strategies for ensuring
external competitiveness and adequacy of benefits.
Ensuring that benefits are adequate is a somewhat more difficult task.
• There is no magic formula for defining benefit adequacy.
The answer may lie in the relationship between benefit adequacy and the
third plan objective: cost of effectiveness.
• Organizations need to consider whether employee benefits are cost
justified.
• Employers are shifting increased benefit costs to employees through
higher deductibles and co-pays, for example.
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Benefit Administration Issues
Who should be protected or benefited?
• A whole set of questions need to be answered with policy decisions.
How much choice should employees have among an array of benefits?
• The level will depend on advantages and disadvantages.
• Another way to increase awareness is to offer market-based, or
customer-driven health care.
How should benefits be financed?
• Noncontributory, contributory, or employee financed.
Are the benefits legally defensible?
• Benefit administrators should develop a compliance checklist and
conduct regular audits of benefits.
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EXHIBIT 12.6 Advantages and Disadvantages of Flexible
Benefit Programs
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 that constraint.
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 high-benefit utilization
increases its cost.
4. Flexible benefit plans are subject to nondiscrimination requirements in Section 125 of the Internal
Revenue Code.
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Components of a Benefit Plan
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Components of a Benefit Plan Employer Factors
Relationship to total compensation costs.
• Benefit costs are only one part of a total compensation package.
Costs relative to benefits.
• Administrators should adopt a broader, cost-centered approach.
Competitor offerings.
• Benefits must be externally equitable, too.
Role of benefits in attraction, retention, and motivation.
• First we need to show that benefits are well-designed.
Legal requirements.
• A benefit package that complies with all aspects of the law.
Absolute and relative compensation costs.
• Evaluation must be placed in the context of total compensation costs.
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Components of a Benefit Plan Employee Factors
Equity.
• The perceived unfairness of difference must be considered in
determining employee needs.
• Benefits obtained by a unionized competitor are frequently passed
along to nonunion employees.
Personal needs of employees.
• One way to gauge employee preferences is demographic differences.
• There is some evidence these assumptions are only partially correct.
• Some organization survey individuals about needs.
• Also identify employee preferences with a flexible benefit plan.
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Administering the Benefit Program Employee Benefit
Communication
Benefits communications revolves around four issues: what is
communicated, to whom, how it is communicated, and how frequently.
• One method still used is the employee benefit handbook.
• An effective communications package should match the message with
the appropriate medium.
• Failure to understand benefit components and their value is still one of
the root causes of employee dissatisfaction with a benefit package.
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Administering the Benefit Program Cost Containment
• Probationary periods exclude
new employees from benefits.
• Benefit limitations to some
maximum percentage or to a
certain fixed amount.
• Copay requires employees pay
a fixed or percentage amount.
• Deductible.
• Seeking competitive bids for
program delivery.
• Deny service for pre-existing
conditions.
• Claims processing.
• Negotiate lower fees by
providers.
• Develop programs that
encourage wellness.
• Outsource benefits and
administration.
• Self insure.
• Provide accommodations for
employees to return to work
after illness or disability.
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Administering the Benefit Program Claims Processing
Claims processing arises when an employee asserts a specific event
has occurred and demands the employer fulfill a promise of payment.
• A claims processor must first determine whether the act has, in fact,
occurred.
If the event did occur, the second step involves determining if the
employee is eligible for the benefit.
• If the 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.
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