Compensation and Benefits
15
Scope—The Benefits Discipline deals with the various forms of indirect employee compensation—commonly referred to as “benefits”—that employers use to attract, recognize and retain workers. It includes designing and administering benefits such as paid leave, insurance, retirement income and various employee services, as well as various benefits mandated by federal, state or local laws and regulations.

It also includes matters that focus on benefits-related careers, communications, legal and regulatory issues, technology, metrics, and outsourcing, as well as effective benefits practices and global benefits issues.

It does not include “direct benefits,” i.e., various forms of employee pay, which are encompassed in the Compensation Discipline. Nor does it cover flexible work arrangements, such as telecommuting and flextime, that employees may perceive as benefits. These are included in the Staffing Management Discipline. It also does not include equal employment opportunity matters that deal with incumbent employees’ terms and conditions of employment, which are encompassed in the Employee Relations Discipline.



Overview

Employee benefits in the United States constitute a large, complex and ever-changing set of programs. They are either mandated by federal and/or state law (such as Social Security, unemployment insurance and workers’ compensation) or voluntarily provided by the employer to help attract, retain and motivate employees and to contribute to the organization’s strategic objectives. Such voluntary benefits include pensions and other retirement income programs, health insurance, and paid time off. The distinction between mandated and voluntary benefits has become somewhat blurred in recent years, as the federal and state governments mandate requirements to all employers that once were voluntary (e.g., medical and family leave and state mandates to health insurance contracts).


Another distinction exists between the private and public sectors. Public sector employment practices, including benefits, have had somewhat of a separate development. Not-for-profit organizations, the “third sector,” are also different, but receive relatively little attention. This discussion will focus primarily on the private sector.


History

While the origins of employee benefits in the United States go back the 19th Century or earlier, as a mass phenomenon they are largely a post-World War II development. In 1949, the Supreme Court let stand a lower court ruling that pensions, and by extension other employee benefits, were a “mandatory subject of bargaining” under the National Labor Relations Act (Inland Steel v. NLRB). This had the effect of reducing political pressure from organized labor and others to enhance government-provided retirement and health care benefits.


The 1950s and 1960s were a period of rapid development of retirement income and health insurance programs, as unionized employers responded to the demands of the then much stronger labor movement and as nonunion employers intent on remaining union-free followed suit. By the 1960s, employer-provided benefits had become a major component in the compensation package.


Other than the qualification provisions of the Internal Revenue Code (IRC) and some toothless reporting and disclosure requirements, benefit programs were virtually unregulated by the federal government. This changed in 1974 with the enactment of the Employee Retirement Income Security Act (ERISA), which was aimed most directly at traditional defined benefit (DB) pension plans but applicable as well to “other employee welfare programs.” Henceforth, private-sector employers that sponsored retirement income and health care benefits would be required to comply with the provisions of ERISA and the companion provisions of the IRC. Under ERISA and the various laws that followed, employee benefits became increasingly technical, legalistic and risky—which added to their cost. See, Legal & Regulatory Issues.


There is no area in the employment relationship that is as complex and subject to change as employee benefits. Every time Washington or the state capital passes a new law or amends an old one, it adds to the demands on the human resources professional’s time and attention. This is unlikely to diminish. The continually increasing complexity of benefits administration, not to mention planning and design, demands that the HR professional stay abreast of the field through continuing education, certification and recertification.


The two most important aspects of the benefits package as measured by cost to the employer or perceived value to the employee are retirement income programs and health care benefits.


Retirement Income

The retirement income system of the United States is a combination of government, employer and individual programs often referred to as a “three-legged stool.” Many employers offer employees assistance with retirement planning to help them with their choices. See, Retirement, Financial Planning Education Proves Popular.


Social Security

One leg is the Old Age Survivor and Disability Insurance (OASDI) portion of the Social Security program. It is funded equally by a payroll tax on employees and employers and provides a defined benefit pension for life based on contributions over the highest-paid 35 years of covered employment. Workers who become totally and permanently disabled are entitled to disability insurance benefits. Benefit levels are relatively modest; yet, millions of elderly Americans rely on them for all or almost all of their income. See, Social Security in the United States.


Employer-sponsored retirement plans

The second leg of the retirement income stool is an employer-provided plan. Private sector employer-provided retirement income plans are regulated by the U.S. Department of Labor and the Internal Revenue Service. State and local governments are precluded from passing laws and regulating private-sector pensions by “ERISA preemption.” This is important to multi-state employers with corporate pension plans. It would be disruptive to have to contend with assorted state-specific mandates (as they now do in other areas of employee benefits).


Defined benefit plans. The defined benefit (DB) plan or traditional pension typically is funded by the employer and compliant with the participation, vesting, accrual and funding standards of ERISA and insured by the Pension Benefit Guaranty Corporation (PBGC).


Defined contribution plans. Since the mid-1980s, the number of traditional DB pension plans has declined drastically as they were replaced by defined contribution (DC) plans. In the private sector, the Section 401(k) plan allows the employee to defer a significant amount of pretax earnings—that may be fully or partially matched by the employer—into a personal account under the investment control of the participant.


The public and third sector equivalents are the 403(b) plan, available to public sector education and some NPOs, and the 457(b) plan available to state and local governments and some nonprofits. In the public sector, the employer seldom matches the employee’s contribution, and the DC plans serve as a tax-favored savings arrangement that supplements the traditional pension plan.


In the private sector, DC plans often started as augmentations to the employer’s traditional DB plan; however, they are now often the employer’s only retirement plan. Many small and medium size employers have discontinued or frozen their DB pension plans and replaced them with a 401(k) plan. See, More Employers Cut DB Plans, Add to 401(k)s. Many large employers have shifted from a traditional DB plan to a cash-balance (CB) plan, which has many of the advantages of a DC plan for the employer. See, Cash Balance Plans: The Basics and FedEx Shifts from Traditional DB to Cash-Balance Plan, Ups 401(k) Match. Both frozen and cash-balance plans are counted as defined-benefit plans, thus masking the full extent of the shift.


Small employer plans. A number of other arrangements are available to small employers. They include the Simplified Employee Pension (SEP), the Savings Investment Match Plan for Employees (SIMPLE), and the Keogh or H.R. 10 plan. A significant number of employers in unionized industries and their employees participate in multi-employer pension plans. They are covered by ERISA, but operate under different rules and PBGC termination insurance arrangements. See, PRIMER: Small Employer Pension Plans.


Individual savings

The third leg of the retirement income stool is individual savings that may be in a tax-favored arrangement such as an Individual Retirement Account or a supplementary 401(k), 403(b) or 457(b) plan. That is, a 401(k) plan may be the employer’s primary retirement income vehicle or it may be supplementary to a traditional defined benefit pension plan. See, Helping Gen Xers Build Retirement Savings.


Health Care Benefits

The employer’s role in the area of health care benefits is largely that of a consumer who selects the benefits to be offered and pays all or most of the cost. The choices have changed drastically over the years, and include conventional fee-for-service arrangements to an array of managed care plans (HMO, PPO, POS, etc.).


The salient feature of health benefit management is how to cope with the ever increasing cost. As health care costs have increased, the federal government has found ways to transfer some of its costs to the health care providers. That has put the hospitals and other providers under cost pressure. They have transferred the cost to the other big payer, the employers, through higher premiums for health insurance plans. The employers have shifted some of that cost to the employees through deductibles, co-payments, co-insurance, and reducing dependent and retiree coverage. See, Controlling Health Costs: Success Tips Shared and SHRM Makes Available Online Guide To Help HR Lower Health Care Costs. The employees have responded, by putting pressure on their elected officials to fix the problem.


There is a national debate in progress on what to do about health care. Everyone agrees that there is a problem; however, not everyone agrees on the nature of the problem. To some, it is the escalating cost. To others, it is the 17.9 percent of the non-elderly population (in 2006) that do not have access to health insurance and are therefore denied access to quality health care services. See, Unequal Health Care. To others, it is the quality of health care available.


The proposed solutions include a single-payer arrangement, play-or-pay, or tinkering with the existing system via tax incentives and requirements.


Health Care Continuation

For most Americans, health care benefits are a function of employment. In the past, when an employment relationship terminated, health benefits ceased. Even when the individual found another job quickly, most health plans had a waiting period and preexisting condition exclusions. The premium on an individual health insurance policy is more expensive than an employer’s group plan. This was a major problem for many former employees, especially if they or their dependents had medical problems.


Congress addressed the problem with the health care continuation provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA). A former employee may continue his or her coverage in the employer’s health plan at 102 percent of the group rate for up to 18 months following a “qualifying event” (such as loss of employment or reduction of hours). Covered dependents may do the same for up to 36 months after the death of the covered employee, divorce or legal separation, or children “aging out” of the plan. COBRA eligibility usually ends when the beneficiary gains coverage under another health plan or becomes covered by Medicare at age 65.


The employer has important notification and record-keeping responsibilities under COBRA. While most terminated employees and their dependents do not exercise their COBRA rights, it is critical that the employer properly notify them of those rights. Failure to do so may extend eligibility indefinitely. See, A Plan Administrator's Roadmap for Compliance with COBRA Notice Rules.


Insurers are concerned with “adverse selection” (those who buy the product are more likely to use it). Efforts to mitigate the effects include the “preexisting-condition exclusion,” under which an existing medical condition is not covered for a specified period. This caused many problems for participants and had the effect of discouraging labor mobility. Congress addressed this with the Health Insurance Portability and Accountability Act of 1996 (HIPAA), which limits preexisting-condition exclusions to one year minus the number of months of recent coverage under another health plan.


Leave

To attract and retain valued employees, many employers voluntarily offer some combination of paid and unpaid time off, including vacation leave, sick leave, personal leave, holiday leave, bereavement leave, etc. See, Employer Incentives for Offering Paid Leave. The following sample policies illustrate various types of paid time off and how they are administered.

•Vacation Policy
•Sick Leave Policy
•Paid Personal Time Policy
•Holiday Pay Policy
•Bereavement Leave Policy

Instead of maintaining different policies and leave balances for some or all of the above types of leave, many employers have adopted a paid-time-off model that grants employees a specified number of paid leave days—often based on tenure with the company—and allows the employees to use it for whatever purpose they choose. See, Paid Time Off: Giving Employees More Control Over Leave.


In 1993, Congress passed the Family and Medical Leave Act (FMLA). It allows employees of an employer with 50 or more employees up to 12 weeks of unpaid leave per year (which may be taken intermittently). Family and medical leave may be used for the birth or adoption of a child, becoming a foster parent, a serious health condition of a spouse or child, the employee’s own health problem or that of the employee’s parent.


Except for “key employees,” the leave taker must be restored to the same or an equivalent position. The employer must continue the employee in its group medical plan.


The FMLA provides only unpaid leave, which many employees cannot afford to take. There is pressure on Congress to provide some measure of paid leave. A number of states already have such programs. California, Hawaii, New Jersey, New York, Rhode Island and Puerto Rico have programs that provide partial replacement income for employees disabled by off-the-job injuries or ailments.


In 2004, California established the first Paid Family Leave program (within its existing State Disability Insurance program). It provides up to six weeks of partial income replacement for various family and medical reasons. In 2007, the State of Washington passed similar legislation. Several other states are considering adopting similar programs.


Workers’ Compensation

Workers’ compensation laws and programs are state-specific, and therefore vary from state to state. However, they all pay medical, rehabilitation, death and burial benefits and partial wage loss indemnification to employees who experience on-the-job injury or illness. See, A Primer on Workers’ Compensation Laws and Programs.


Workers’ compensation protects the employer as well as the employee. If the employer has coverage from a private insurer, state fund or is self-insured (the requirements vary among the states), its liability for on-the-job accidents is limited to the cost of providing the insurance. Claimants are limited to the statutory benefits provided by the insurer. The quid pro quo of workers’ compensation is that employers accept responsibility for workplace accidents as a cost of production and the employees forego their right to sue, and the possibility of a larger recovery, for certain and timely medical and wage loss benefits.


Unemployment Insurance

Unemployment compensation in the United States is a creature of the Social Security Act of 1935. The federal government required that the states set up a program that met certain standards, or the government would do it for them. By 1936, all states had complied. See, Unemployment Claims: Inner Workings of the Unemployment System.


While there is variation from state to state, most state programs look a lot alike. They typically pay wage-replacement benefits of two-thirds of the claimant’s pay up to a specified maximum (which varies greatly from state to state) for up to 26 weeks. Under the Federal Unemployment Tax Act the program is financed by a payroll tax on employers that is subject to experience rating. Funds are deposited with the federal government and part of the tax is allocated to Washington for administrative expenses and to pay for extended benefits during periods of high unemployment.


Flexible Benefits

Until about 1980, employee benefits were structured on the traditional one-income, two-parent with-children family. With the increase in the number of women in the workforce, the growth of nontraditional family structures, the emergence of the idea that “choice” is good, and the rapidly rising cost of benefits to the employer, there was a shift toward letting the employee choose some of the benefits he or she would have. During the 1980s and 1990s, a complex development occurred that resulted in what we now call “flexible benefits” or “cafeteria plans” or “Section 125 plans.” See, Flexible Benefit Plans.


Section 125 of the Internal Revenue Code allows the employer to establish an arrangement under which the employees have some discretion over their benefits package. Section 125 has some basic rules, to the effect that the plan must be in writing; the benefits may cover only employees and dependents; the benefits must be elected in advance and the election be irrevocable for one year; and the plan may not discriminate in favor of highly compensated employees.


Flexible benefit plans are usually promoted as giving the employees some control over their benefits package, which they do; however, they often also result in the employees being entitled to fewer benefits or to less of them than they formerly had—and to a reduction in employer cost.


Other Benefits

Employers offer a wide variety of other benefits, each of which presents its own opportunities and challenges with respect to planning, funding, administering and evaluating. For resources on some of these, see the following topics.

•Adoption benefits
•Dependent care
•Disability benefits
•Disease management
•Domestic partner benefits
•Educational assistance
•Employee assistance programs
•Employee services
•Flexible spending accounts
•Long-term care insurance
•Wellness benefits

Facets of the Benefits Discipline

In addition to specific types of employee benefits, the Benefits Discipline includes facets of HR practice in common with other disciplines, but applied in ways that are specific to benefits. These include:

•Careers in benefits
•Benefits communication
•Effective practices in benefits
•Global benefits
•Legal and regulatory issues in benefits, in particular the fiduciary duty of plan administrators, and reporting and disclosure rules
•Benefits metrics
•Outsourcing employee benefits

Acknowledgement—This article was prepared for SHRM Online by John G. Kilgour, Ph.D., Professor Emeritus in the Department of Management and Finance at California State University, East Bay. Dr. Kilgour is the author of multiple SHRM White Papers in the employee benefits field. In addition to relying on his own professional expertise and research, the author has incorporated existing SHRM Online content in developing this treatment.