30 Slide

Managing Employee Benefits • In addition to the uses in protecting the organization and its owners, life and health insurance are also used extensively as an employee benefit. • It is common for an employer to offer an employee some life insurance, health insurance, or retirement benefits in the employment setting. • These arrangements fall under the broad classification of employee benefits. 30-1

Responsibility for Employee Benefits • Surveys of risk managers generally indicate that something less than half of the responding risk managers have responsibility for employee benefits. • The reason that firms assign responsibility for employee benefits to a department other than risk management is that employee benefits are considered both by the employer and by employees as a part of the compensation package. 30-2

The Risk Manager and Employee Benefits • Some firms recognize that the design of an employee benefit plan involves essentially the same types of decisions that are involved in managing the organization’s own risks. • Although employee benefits are a part of the employee-compensation function and are therefore within the realm of the human resource managers of the organization, the risk manager’s expertise in insurance buying has direct relevance to the design and funding of employee benefit plans. 30-3

Employee Benefits Defined Broadly speaking, any non-monetary compensation provided by an employer to its employees can be termed an "employee benefit." In a more narrow sense, “employee benefits” is used by different people to mean what the user intends it to mean.

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Employee Benefits Generally Broad Definition (Chamber of Commerce) • Any benefit provided to employees other than wages and salary. • Includes workers comp, unemployment compensation, and social security contribution. • Under this definition, employers pay roughly 38% to 40% of payroll on employee benefits.

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Limited (Social Security) Definition Narrow Definition (Social Security Administration) Any type of plan sponsored or initiated unilaterally or jointly by employers or employees and providing benefits that stem from the employment relationship and that are not underwritten or paid directly by government... 1. income maintenance during periods when regular earnings are cut off because of death, accident, sickness, retirement, or unemployment; and 2. benefits to meet medical expenses associated with illness or injury. 30-6

Limited (Social Security) Definition • This definition of employee benefits used by the Social Security Administration limits the term to death benefits, sickness and disability benefits, retirement income, and medical expense insurance or reimbursement. • This coincides with the insurance-related benefit plans that might fall within the risk manager’s responsibility. • The cost of benefits under the narrow definition probably ranges from about 12% to 13% of payroll. 30-7

Employee Benefits Generally • Over half of all employees are covered by employer-sponsored retirement plans. • Over two-thirds of all employees are covered by life insurance offered by their employer. • Although private disability insurance is less likely to be offered by an employer, it is estimated that about one of every four employees is covered by employer sponsored long-term disability plans. 30-8

Reasons for Popularity of Employee Benefits • There are several reasons for the prevalence of employer sponsored insurance benefits. • First, employees may find it advantageous to accept insurance as part of their compensation, primarily because of the favorable tax treatment of employee benefits. • In addition, most life and health insurance provided by employers is part of a group contract which tends to be less expensive than individual insurance. 30-9

Employer Objectives in Establishing Employee Benefit Plans • In addition to the fact that employees may find insurance benefits to be an attractive form of compensation, employers may have other objectives for offering employee benefits. • Some plans are established in the hope that they will improve employee morale and motivation. • Plans may designed to address certain specific goals, such as reducing employee turnover or encouraging early retirement. 30-10

Considerations in Plan Design • The design of an employer’s plan must consider the employer’s objectives and employee’s needs, the various options available, and their cost. • Typically, the employer will want to consider how its employee benefit plan compares to other firms that it competes with for employees. • In addition, the employer must decide how the plan will be financed (whether through insurance or some other mechanism) and who will administer the plan. 30-11

History of Employee Benefits • The first formal employee benefit plan in the United States was probably the pension plan started in 1875 by the American Express Company for its employees. • In 1910, Montgomery Ward and Company, which had funded an employee establishment fund for its employees, replaced the fund with what is generally regarded to be the first group health insurance contract. • Depression of the 1930s left the employee benefits arena in complete disarray.

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World War II • During World War II, the federal government imposed price and wage controls throughout the economy in an attempt to control inflation. • Interestingly, despite the freeze on wages and salaries, the Wage Stabilization Board did not free employee benefit plans. • Because labor was in short supply, employers used employee benefits to enhance the compensation package for workers. 30-13

Post World War II and Organized Labor • After World War II, organized labor adopted employee benefits as an integral part of its negotiation efforts. • More importantly, federal legislation, in the form of the National Labor Relations Act of 1935 gave workers the specific right to bargain over wages, hours, and conditions of employment. • The interest on the part of organized labor in employee benefits was based on the favorable tax treatment afforded such benefits. 30-14

Tax Treatment of Qualified Employee Benefits • Qualified employee benefits are granted one of two types of preferential treatment: • Contributions for some employee benefit are deductible by the employer, but are not taxable to the employee as income. • Contributions for other benefits (qualified retirement plans), are deductible by the employer at the time made, but are not taxable to the employee until they are distributed. Tax on the earnings on the accumulation is also deferred. 30-15

Cafeteria Employee Benefit Plans 1. Authorized by Section 125 of the I.R.C. 2. Employees are granted credits that may be used to “buy” from a range of benefits. 3. Employee selects benefits most appropriate to personal need from a range that may include any nontaxable benefits. 4. The employer may also permit the employee to take some or all of the credit in the form of additional taxable compensation. 30-16

Flexible Spending Accounts 1. A Flexible Spending Account (FSA) is a cafeteria plans funded through salary reduction. 2. The employee contributes to a flexible spending account and his or her taxable income is reduced by the amount of the contribution. 3. Expenses not covered by the insurance are covered by the FSA and the reimbursement is not taxable to the employee.

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ERISA • The Employment Retirement Income Security Act of 1974 (ERISA) is the principal federal law regulating employee benefits. • Although ERISA was enacted to address flaws in the nation’s pension system, it addresses other employee benefit programs as well. • Tax aspects of ERISA are administered by the IRS. • Otherwise, the law is administered by the Department of Labor. 30-18

General Requirements of ERISA ERISA addressed three general responsibilities of the sponsors of employee benefit plans: disclosure and reporting, fiduciary responsibility, and claim procedures.

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Summary Plan Description • For employee benefit plans that cover 100 or more lives, ERISA requires the plan administrator to file a description of the plan with the U.S Department of Labor. • The plan administrator (usually the plan sponsor) must file a Summary Plan Description (SPD) with the Department of Labor within 120 days after the plan is initiated. • All plan participants must be provided a written copy of the SPD within 90 days of becoming a participant. 30-20

Reporting Requirements • Besides the initial filing of the SPD plan, sponsors must file an annual report (Form 5500) summarizing the plans financial operation. • Separate information is required for pension plans and for welfare plans. • The required data includes information on the name of the insurance company providing the coverage, the number of persons covered during the year, and the total amount of fees and commissions paid to agents or brokers. 30-21

ERISA Preemption • One of the more controversial features of ERISA is a provision in the law preempting state laws covering employee benefits plans. • The major exception is that while the states may not regulate employee benefit plans, the employers who maintain them, or trust funds established in connection with such plans, the states may regulate insurers and insurance policies that are used to provide coverage under such plans. 30-22

Group Insurance Funding Issues 1. Factors that influence funding choices are the same as those in risk management decisions: • in cases of high frequency, low severity, insurance is not cost-effective • for low frequency, high severity exposures, retention is inappropriate 2. Because of potential loss severity, only very large employers have historically self-funded life insurance or medical expense plans. 30-23

Group Insurance Funding Issues • Considerations that lead an employer to selffund employee benefits are the same as those that lead firms to self-insure their own risks. • Where the risk is characterized by a high frequency and low severity, and, therefore, relatively predictable expenses, insurance is not likely to be cost-effective. • Retention, on the other hand, is likely to be appropriate where costs are highly predictable. 30-24

Reasons for Growth of Self-Funding • The reasons for the greater interest in selffunding in recent years are numerous. • Self-funded plans are not subject to state insurance laws, due to a preemption in the Employee Retirement Income Security Act (ERISA). • Some see the increasing growth of self-funded plans as driven by a desire to escape state regulation. 30-25

Reasons for Growth of Self-Funding • In health insurance, for example, many states have mandated-benefits laws, which require that certain benefits be included in insured plans. • Self-insured plans are not subject to these mandates. • In addition, most states have passed small group reform laws that impose rate limitations, require guaranteed issue of small employer policies, and limit preexisting conditions exclusions. 30-26

Funding Issues 1. Self-funding employers typically purchase stoploss insurance to protect against catastrophe losses. 2. Self-funding employers generally retain an outside party to handle administration. •

third party administrator

•

insurance company under Administrative Services Only (ASO) contract 30-27

Stop-Loss Insurance. • Stop loss insurance puts a limit on the amount of loss the employer is required to fund. • The most common form of stop-loss insurance is aggregate stop-loss. • With aggregate stop-loss insurance, the employer agrees to pay all claims up to an agreed upon limit for the year, and the insurer pays for all claims beyond the limit.

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Third Party Administrators • Most employers that self-fund their benefit plans seek the assistance of an outside administrator. • Administering a benefit plan can require significant expertise, and the employer is often not interested in developing and maintaining that expertise internally. • In addition, some employers are concerned that internal administration creates the possibility for conflict between the employer and employee over benefit decisions. 30-29

Administrative Services Only • Where the employer has arranged stop-loss insurance, it is common for the insurer to be the administrator. • Where the plan is fully self-funded, the contract between the administrator and employer is often called an administrative services only (ASO) agreement, in recognition of the fact that no insurance is being provided.

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Funding Through a 501(c)(9) Trust 1. Section 501(c)(9) of the I.R.C. allows employers to establish a voluntary employee benefit association (VEBA) and to use the trust fund to obtain certain benefits for members. 2. Benefits that may be funded include those payable because of death, medical expenses, disability, legal expenses, and unemployment. 3. Retirement and deferred compensation benefits may not be funded through a VEBA. 30-31

Levels of Benefits • Benefit levels vary by industry and employer size. • Employee benefits are more likely to be offered by large employers than by smaller employers. • In addition, employers typically differentiate between full-time and part-time employees in the design of their plans. • Often, full-time employees are eligible for a variety of benefits for which part-time employees are not eligible. 30-32

Insurance and Disability Benefits Benefit

Workers Covered

Medical care

2 out of 3

Life insurance

2 our of 3

Defined benefit pension plans

1 out of 5

Defined contribution plans Deferred profit sharing plans Savings and thrift plans 401(k) plans

3 out of 10 1 out of 7 1 out of 10 1 out of 6 30-33