Employee Benefits

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Contents

Overview

In the United States, employees can be broadly grouped into two classes, those with employee benefits and those without employee benefits. Temporary, part time and low wage employees typically receive only a salary and the minimum benefit protection permitted by law (typically, worker's compensation coverage and social security system participation). Most permanent, full time, middle or high wage employees receive a variety of benefits. Small employers tend to be more stingy with the benefits, large corporate employers tend to provide more benefits.

Generally speaking, employee benefits are not subject to Federal Income Taxation when earned, and except for retirement benefits, are generally never taxed.

Typically employee benefits include:

  • health insurance
  • A retirement plan
  • stock options
  • sick and vacation days
  • life insurance

Health Insurance

Health insurance costs in the United States have been increasing above the rate of inflation, and in many cases, at double digit annual rates, since at least the early 1990s. As a result, many smaller employers have dropped health insurance coverage all together for their employees, most employers have started making deductions from employee pay for health insurance (particuarly for employees with dependents) which was previously paid for entirely by the employer, and many employers are choosing plans which either require employees to pay more out of pocket for services rendered (traditional insurance) or give employees less choice over who their doctors can be (the HMO model). Many of the major labor actions (strikes, threatened strikes, work to rule, etc.) in the past decade have involved disputes between employers interested in reducing the value of employee health insurance benefits (motivated by increasing health insurance costs) and employees seeking to retain the full value of their health insurance benefits.

Source of Cost Increases

Rising health insurance costs have largely been provider driven. Health insurance companies have not materially increased their profits over the past decade (with the possible exception of Kaiser Permanente, which is the only major health insurer to have verticle integration by hiring providers as employees, rather than entering into independent contractor relationships with them, hence making it both a provider and an insurer), although declining investment returns of health insurance companies on their reserves has had an impact.

Furthermore, as noted in the entry on Health Care rising health insurance costs are not materially related to increasing medical malpractice insurance costs. Malpractice insurance accounts for only about 0.5% of the cost of medical care and health insurance costs have increased dramatically even in those states where malpractice insurance costs have fallen dramatically. "Defensive medicine" costs have also been shown to be linked more to provider profits than malpractice litigation.

There is considerable dispute over the extent to which rising provider costs are due to (1) supply and demand (as the baby boomers need more health care costs and the supply of educated health care workers remains stagnant), (2) an increasing quality of care being provided as science finds ways to provide better health care at greater costs when no treatments were previously available, or (3) failures in the structure of the market since many health care purchasing decisions are made by doctors and patients who are spending someone else's money to pay for the care.

Impact of Declining Coverage

Declining employer investments in health insurance coverage for workers has resulted in significant socially borne costs.

  • The rising number of jobs which do not provide health insurance has made welfare an attractive option compared to work for millions of Americans, because welfare recipients are entitled to medical care through the means tested Medicaid program, while working class employees generally are not entitled to Medicaid paid medical care.
  • The rising number of uninsured Americans has placed a heavy burden on the emergency room network in the United States, because federal law requires emergency rooms to provide emergency care regardless of ability to pay. This forces hospitals to try to shift emergency room costs onto non-emergency care (which in turn creates an incentive to establish providers such as surgical centers which provide only non-emergency care). This means that the uninsured are receiving care, when they receive it, in the most expensive to provide environment, with long waits, when problems are accute as opposed to when they can be more easily and cheaply dealt with at an earlier stage or with preventative medicine.
  • Health care costs discourage the formation of small businesses, because insurers charge higher health insurance rates to small businesses (out of fear that they will seek coverage only when they anticipate they will need it), than they do to big businesses (who purchase health insurance continuously).
  • Declining coverage has lead to large quantities of bad debt for medical providers who try to operate a two-tier service charge schedule (one for the insurered with no bad debt premium and another for the uninsured with a large bad debt premium) as a result.
  • Health care bills have been a major driver in the increasing number of personal bankruptcies filed in the United States.

Retirement Plans

Retirement plans come in three main types, defined benefit plans, defined contribution plans and non-qualified plans.

Defined Benefit Plans

A defined benefit plan pays a fixed pension to an employee typically based on years of service and the average of the employees highest three years of compensation at a firm. Investment risk is the responsibility of the employer. An actuarial formula based on projected investment return, retiree longevity and the proportion of employees that quit before earning a right to receive benefits determines how much the company sponsoring the plan must contribute each year to a trust for the sole benefit of pension plan members for it to remain solvent. Some of the benefits promised are guaranteed by the Pension Benefit Guarantee Corporation (PBGC) but in most cases a majority of the benefits are contingent upon the continued financial health of the company. If United Airlines abandons its defined benefit pension plan, for example, it is expected that promised pensions of $140,000 a year for pilots would be reduced to $28,000 per year. See Newspaper Report.

The percentage of employees covered by defined benefit plans has dropped from 40% to 20% in the past twenty years, and 75% of defined benefit plans are currently underfunded according to a PBGC formula which while probably ill tuned to very low interest rates and market declines in the early 2000s, never the less reflects a real possible pension bailout problem. Changes from a defined benefit to a defined contribution plan can provoke serious litigation and employee dissatisfication as in the case of such an attempt by International Business Machines (IBM) to make such a change. Poor investment returns or changes in longevity and employee retention can create serious funding issues for employers even if they have acted in good faith in managing the plan by dramatically increasing annual contribution requirements.

Defined contribution plans are unpopular with employers and very few new ones are being created except as asset protection devices for very small employers, because the administration costs are high due to the actuarial calculations that are required and because companies are not interested in bearing the investment risk that comes with operating such a plan.

Defined benefits plans are currently offered largely to government employees and to employees of large corporations.

From the employee's point of view, defined benefit plans provide a strong incentive to work for an employer for the number of years necessary to reach the plan's target retirement age, while severely penalizing employees who work either less (often due to moving from employer to employer in today's less stable employment market) or those who work longer than the target date (who find that they could make almost as much by retiring as they could from working under the plan).

Some retirement plans also provide health insurance benefits to retirees and termination of these benefits by companies in or out of bankruptcy has also been particularly controversial.

In Europe, much of the responsibility for providing pensions is a government, rather than a private employer function, and high social insurance payroll taxes provide in the public sector many of the benefits that would be provided by large corporate employers in the United States. This makes the tax burdens in Europe seem artificially high.

Defined Contribution Plans

In a defined contribution plan, employees can make tax preferrenced contributions to their own account on an individualized basis which an employer often matches. In some plans matching contributions are immediately the property of the employee (fully vested), and in others, the matching contributions may be partially forfeited if the employee leaves the company within a few years of receiving them. An employee is typically given one of several moderate investment choices for the account and bears all of the risk of declines in the market.

The most common, but not the only, type of defined contribution plan is known as a 401(k), after the tax code section that authorizes it. (Indeed, one of the controversies surrouding retirement plan law generally is that there are so many similar, but not identical, types of plans out there).

Defined contribution plans are relatively neutral with between employees with less seniority and employees with more seniority, and do not have an incentive to retire after any particular numbers of years of service or at any particular age. Most smaller employers who provide retirment plans as an employee benefit have defined contribution plans.

As with a defined benefit plan, defined contribution plan assets must be kept in a separate trust. By definition, defined contribution plans are almost never seriously underfunded in the absence of serious fraud on the part of an employer.

One of the major political debates in the 2004 Presidential election is whether Social Security, which is a hybrid of a income support program and a defined benefit pension plan with numerous frills (like disability insurance and survivor's insurance) shoudl be partially converted into a defined contribution pension plan. Because the employee bears the investment risk, this is problematic for the income support mission of social security, and also poses real transition costs because social security is operated on a pay as you go basis with significant accrued liabilities for people who have already paid into the system which were supposed to be paid for out of contributions by the next generation of workers.

Non-Qualified Plans

Both defined contribution plans and defined benefit plans are regulated by ERISA (see below). But, the tax law limits the benefits under these plans (directly in the case of defined benefit plans and indirectly in the case of defined contribution plans through limits on the amount that can be contributed) to roughly $170,000 a year. The precisely limits for 2005 can be found here.

Many senior executives with incomes more than this amount receive additional retirement benefits in the form of "non-qualified plans" which serve as a tax preferenced way to receive larger retirement packages, but which also typically have only the solvency of the firm providing them to guarantee that they will actually be paid. The American Jobs Creation Act of 2004 has imposed significant new restrictions on non-qualified deferred compensation plans.

Stock Options

Stock options are a right to buy stock in a firm at a certain fixed price, which become valuable if the price of the firm increases. For example, a stock option might given an employee the right to buy 1000 shares of stock of the company at $10 per share at a time when the stock of the company is selling for $9 per shares. If the stock price stays at $9 per share, the options won't be used and the employee will receive no benefit. But, if the stock price grows to $100 per share, the employee will be able to make a tidy profit by buying shares for the agreed $10 per share and selling them forthe market price of $100 per share.

During the early 2000s technology bubble, many high technology company employees received stock options. This allowed start up companies with little cash to provide potentially high compensation to lure quality employees to their firms. Those who exercised their stock options before the crash got rich. Those who didn't got nothing.

The more common use of stock options has been to compensate senior executives at large corporations. The idea is to give executives an incentive to make the stock price of a corporation increase. But, this incentive was so strong that it lead to widespread accounting fraud in publically held companies in the 1990s, and through manipulation of stock option prices and the general increase in stock prices across the board, allowed even mediocre executives to receive phenomenally large compensation packages.

The tax and financial accounting treatment of stock options (the "expensing of stock options issues") is controversial, because typically corporations do not show the expenses associated with issuing stock options as a business expense and hence have earnings which overstate the returns to non-insider shareholders. Critics of expensing argue that sophisticated investors who set stock market prices already consider the impact of stock options which are disclosed in footnotes on corporate accounting statements.

ERISA

ERISA (the Employee Retirement Income Security Act) is a federal law which governs most employer provided benefits. Through bad drafting and a serious of court decisions, it has been held to have an unusually great pre-emptive effect. For example, generally applicable laws relating the liability for injuries caused by malpractice and failure to comply with contracts, and generally applicable laws relating to termination of beneficiary designations upon divorce have been held to be pre-empted by ERISA when employee benefits are involved. The main effect of these pre-emptions has been to greatly reduce the impact of state law which protects consumers, and to place a great emphasis on form over substance in this area of the law.

On the other hand, ERISA is the main reason that employers provide benefits to all of their employees, rather than only to senior management, and provides protection against employer efforts to raid pension funds to pay for operations.

Bankruptcy laws and state judgment enforcement laws largely prevent creditors, other than a divorcing spouse, from obtaining assets in an ERISA retirement plan.

Sick and Vacation Days

Most salaries jobs allow employees paid sick and vacation days in modest quantities. Many, lower paid hourly jobs, simply pay you when you work and have no paid vacation.

Until activism on the part of Labor unions secured a change, most Americans worked six day weeks. Now, most employees work five days weeks, and the federal Fair Labor Standards Act (FLSA) guarantees many blue collar and pink collar works overtime pay at time and a half if they work more than 40 hours a week. Professional and managerial employees are generally not entitled to overtime and the dividend line between workers who are and are not entitled to overtime has been a controversial one in recent years.

Western Europe has, by and large, struck a different balance between work and vacation, than American and Japanese employers. While two weeks of vacation per year is customary in the United States for mid-level jobs, in much of Europe, a month or more of vaction per year, is typical. Maternity leave and other "need based" leave from work (often paid) is common in Europe, but rare in the United States.

The Simplicity Movement in the United States is one major response to the increasing feeling that Americans spend to much time working in order to gain material posessions while sacricing leisure. Work schedules have become so institutionalized in the American economy that it is often impossible, even for employees who would like to trade more leisure for lower pay to do so. Thus, important parts of the simplicity movement have seen the need to achieve change through political action.

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