Despite the current temporary economic slowdown, employers are still competing hard to attract and retain the best talent. And they’re spending the money to do it in a variety of ways: salary, bonuses, vacations, pensions, stock options—the list goes on. Now add to that list yet one more form of employee reward that has been accepted as a critical element in competitive compensation strategies: group benefits.
Group benefits costs now exceed 4.5 per cent of gross payroll and are climbing at a rate that exceeds both inflation and GDP.
CUTTING OR COMPENSATING
The fact that group benefit plans are continuing to face significant cost pressures is hardly news to plan sponsors. Among the litany of explanations for the increasing bulge in the bill for benefits, some themes have a familiar ring:
•newer drug therapies are more expensive;
•plan members are using more benefits more often for longer periods of time;
•the cost for time not worked is adding up; and
•the mandate for profitability across the insurance industry as a whole is introducing pricing discipline long absent from the industry resulting in some upward pressure on prices.
Against this backdrop, it is understandable that some plan sponsors are asking the cost-management questions. Should they be increasing deductibles, implementing more cost sharing with employees through greater co-insurance, limiting or excluding benefits, capping their contributions through flexible benefits and health spending accounts? All of these tactical measures are levers that can rein in benefit expenditures.
Yet none by itself is likely to be the answer for the plan sponsor also concerned with protecting the plan that protects the organization’s most valuable assets: the human capital that is the single resource for the development of intellectual and financial capital.
Rather than implementing selective cost cutting as an end in itself, the answer lies in identifying the structural elements of group benefits and managing those elements as part of a total compensation strategy.
MANAGING VALUE
To approach benefits as a form of employee compensation is to recognize the strategic dimensions of the various plans that typically make up employer-sponsored group benefit programs, such as life insurance, accidental death and dismemberment coverage, extended health benefits, dental benefits and income replacement insurance (weekly income and long-term disability). Consideration is now directed to opportunities for adding value (and thereby contributing to cost containment) through benefits management by focusing on the:
•function of cost sharing with employees;
•most tax-effective funding of benefits and delivery of compensation; and
•role of benefits in contributing to employee recruitment, retention and wellness.
Formulating a benefits philosophy and a set of corresponding objectives is an important early step that has direct implications for cost control. The plan sponsor might think about, for example, why drug benefits are being provided in the first place. Are certain drugs covered or excluded based on an overall formulary definition or is the objective a specific outcome such as a healthier workforce that contributes to cost savings through enhanced productivity? If the goal is merely to maintain the lowest direct cost of health-related products and services, then it is simple enough to restrict access to benefits. But if the focus is on maximizing employee health and gaining the consequent cost advantages of improved productivity and reduced absenteeism, then a more co-ordinated approach to benefit and risk management is called for.
To support such an approach to a managed benefit program, the plan sponsor must, by necessity, not focus in isolation on cutting benefit bills but instead think critically about how those bills can be put in the service of the total compensation strategy for both current and prospective employees.
TAXING ISSUES
How should the budget for benefits be allocated within the total compensation portfolio? Any cost sharing arrangements through which employees contribute to the premium costs of their benefits should take advantage of the tax effectiveness of such contributions. Even though all expenses for group benefits can be written off by employers, it may be appropriate to use employee contributions to pay for the long-term disability coverage. When any part of the premiums for disability benefits is contributed by the plan sponsor, subsequent benefits paid out to a disabled employee are taxable when received. However, if employees pay their own premiums for such coverage, any benefits they may receive later are not subject to income tax.
It’s also more tax effective to compensate employees, particularly those who make regular use of their benefits, with a well designed benefit program rather than the equivalent cash. Consider that employer amounts allocated to benefits on behalf of an employee are paid in pre-tax dollars, effectively buying more benefits for the buck than the after-tax cash in the pocket of the employee that is subsequently spent on benefits. As well, employer contributions toward benefits do not attract CPP/QPP contributions, Employee Health Tax, Employment Insurance premiums and other such payroll taxes.
DEFINING VALUE
What about strategies for capping the contributions plan sponsors make to their benefit programs? Much of the appeal of the flexible benefit program is that it is perceived as a “defined contribution” approach to a portion of the costs associated with group benefits. But it’s important to remember that group life and health benefits still have a decidedly “defined benefit” orientation that can mitigate against attempts to limit employer contributions to fixed amounts.
Consider a flexible benefits program with an attached health spending account for which the plan sponsor’s contribution is set at $2,000 per year per employee. Because there is risk attached to the benefits that is driven by claims experience, there is an implicit commitment to a defined benefit. If the claims experience goes up, the insurer will seek premium increases to fund the benefits. Without increases, it may not be possible to maintain the fundamental integrity of the plan design year over year. The consequence? The “defined contribution” strategy may not limit plan sponsor costs but simply shift costs to employees or spread them out over a longer period of time. Such approaches do not change the fact that group life and health benefits are still largely viewed as “defined benefit” programs by employees. Consequently, opportunities for cost control rest less in limits on employer contributions than they do in combining benefit and health services with risk management strategies as part of a total employee compensation plan.
A clearly established cost sharing strategy that defines the relative responsibilities of the plan sponsors and employees is helpful in managing increases in benefit program costs. The strategy might, for example, call for the plan sponsor to pick up 80 per cent of the benefit program costs with 20 per cent funded by employees. As costs change each year, the plan sponsor has the opportunity to share increases with employees. If the cost sharing strategy is well communicated to employees, it helps them appreciate the costs of the benefit program, raising its perceived value, and makes them aware of the increases their employer is expected to deal with on a periodic basis.
FUNDING RISK
Fully insured, retention accounting, or administrative services only (ASO) and combinations thereof? All funding arrangements present their own unique opportunities for managing costs based on the plan sponsor’s tolerance for risk and commitment to effective risk management strategies.
Although the size of the group, the industry sector and the mix of benefits are factors in the availability of certain funding mechanisms, the benefit management question comes down to what the plan sponsor wishes to purchase through a group benefits arrangement. Both fully insured and retention accounting agreements are true insurance contracts in which financial risk is outsourced to the insurer.
An ASO arrangement may offer cost advantages as various insurance charges are avoided because the risk for plan expenses, including claims costs, stays with the plan sponsor. With such arrangements, typically only claims adjudication and related administration services are purchased by the plan sponsor (although some “stop-loss” coverages may be supplied by the insurer against catastrophic claims).
Making changes to the group benefit program without reference to its value as an effective form of employee compensation is not likely to produce results that are satisfactory over the longer term. On the other hand, looking at it as one component of a total compensation strategy undeniably makes it a rewarding experience.
Ashim Khemani is senior vice-president, group markets with Toronto-based Liberty Health. He can be reached at [email protected] or www.coverme.com.
Group benefits costs now exceed 4.5 per cent of gross payroll and are climbing at a rate that exceeds both inflation and GDP.
CUTTING OR COMPENSATING
The fact that group benefit plans are continuing to face significant cost pressures is hardly news to plan sponsors. Among the litany of explanations for the increasing bulge in the bill for benefits, some themes have a familiar ring:
•newer drug therapies are more expensive;
•plan members are using more benefits more often for longer periods of time;
•the cost for time not worked is adding up; and
•the mandate for profitability across the insurance industry as a whole is introducing pricing discipline long absent from the industry resulting in some upward pressure on prices.
Against this backdrop, it is understandable that some plan sponsors are asking the cost-management questions. Should they be increasing deductibles, implementing more cost sharing with employees through greater co-insurance, limiting or excluding benefits, capping their contributions through flexible benefits and health spending accounts? All of these tactical measures are levers that can rein in benefit expenditures.
Yet none by itself is likely to be the answer for the plan sponsor also concerned with protecting the plan that protects the organization’s most valuable assets: the human capital that is the single resource for the development of intellectual and financial capital.
Rather than implementing selective cost cutting as an end in itself, the answer lies in identifying the structural elements of group benefits and managing those elements as part of a total compensation strategy.
MANAGING VALUE
To approach benefits as a form of employee compensation is to recognize the strategic dimensions of the various plans that typically make up employer-sponsored group benefit programs, such as life insurance, accidental death and dismemberment coverage, extended health benefits, dental benefits and income replacement insurance (weekly income and long-term disability). Consideration is now directed to opportunities for adding value (and thereby contributing to cost containment) through benefits management by focusing on the:
•function of cost sharing with employees;
•most tax-effective funding of benefits and delivery of compensation; and
•role of benefits in contributing to employee recruitment, retention and wellness.
Formulating a benefits philosophy and a set of corresponding objectives is an important early step that has direct implications for cost control. The plan sponsor might think about, for example, why drug benefits are being provided in the first place. Are certain drugs covered or excluded based on an overall formulary definition or is the objective a specific outcome such as a healthier workforce that contributes to cost savings through enhanced productivity? If the goal is merely to maintain the lowest direct cost of health-related products and services, then it is simple enough to restrict access to benefits. But if the focus is on maximizing employee health and gaining the consequent cost advantages of improved productivity and reduced absenteeism, then a more co-ordinated approach to benefit and risk management is called for.
To support such an approach to a managed benefit program, the plan sponsor must, by necessity, not focus in isolation on cutting benefit bills but instead think critically about how those bills can be put in the service of the total compensation strategy for both current and prospective employees.
TAXING ISSUES
How should the budget for benefits be allocated within the total compensation portfolio? Any cost sharing arrangements through which employees contribute to the premium costs of their benefits should take advantage of the tax effectiveness of such contributions. Even though all expenses for group benefits can be written off by employers, it may be appropriate to use employee contributions to pay for the long-term disability coverage. When any part of the premiums for disability benefits is contributed by the plan sponsor, subsequent benefits paid out to a disabled employee are taxable when received. However, if employees pay their own premiums for such coverage, any benefits they may receive later are not subject to income tax.
It’s also more tax effective to compensate employees, particularly those who make regular use of their benefits, with a well designed benefit program rather than the equivalent cash. Consider that employer amounts allocated to benefits on behalf of an employee are paid in pre-tax dollars, effectively buying more benefits for the buck than the after-tax cash in the pocket of the employee that is subsequently spent on benefits. As well, employer contributions toward benefits do not attract CPP/QPP contributions, Employee Health Tax, Employment Insurance premiums and other such payroll taxes.
DEFINING VALUE
What about strategies for capping the contributions plan sponsors make to their benefit programs? Much of the appeal of the flexible benefit program is that it is perceived as a “defined contribution” approach to a portion of the costs associated with group benefits. But it’s important to remember that group life and health benefits still have a decidedly “defined benefit” orientation that can mitigate against attempts to limit employer contributions to fixed amounts.
Consider a flexible benefits program with an attached health spending account for which the plan sponsor’s contribution is set at $2,000 per year per employee. Because there is risk attached to the benefits that is driven by claims experience, there is an implicit commitment to a defined benefit. If the claims experience goes up, the insurer will seek premium increases to fund the benefits. Without increases, it may not be possible to maintain the fundamental integrity of the plan design year over year. The consequence? The “defined contribution” strategy may not limit plan sponsor costs but simply shift costs to employees or spread them out over a longer period of time. Such approaches do not change the fact that group life and health benefits are still largely viewed as “defined benefit” programs by employees. Consequently, opportunities for cost control rest less in limits on employer contributions than they do in combining benefit and health services with risk management strategies as part of a total employee compensation plan.
A clearly established cost sharing strategy that defines the relative responsibilities of the plan sponsors and employees is helpful in managing increases in benefit program costs. The strategy might, for example, call for the plan sponsor to pick up 80 per cent of the benefit program costs with 20 per cent funded by employees. As costs change each year, the plan sponsor has the opportunity to share increases with employees. If the cost sharing strategy is well communicated to employees, it helps them appreciate the costs of the benefit program, raising its perceived value, and makes them aware of the increases their employer is expected to deal with on a periodic basis.
FUNDING RISK
Fully insured, retention accounting, or administrative services only (ASO) and combinations thereof? All funding arrangements present their own unique opportunities for managing costs based on the plan sponsor’s tolerance for risk and commitment to effective risk management strategies.
Although the size of the group, the industry sector and the mix of benefits are factors in the availability of certain funding mechanisms, the benefit management question comes down to what the plan sponsor wishes to purchase through a group benefits arrangement. Both fully insured and retention accounting agreements are true insurance contracts in which financial risk is outsourced to the insurer.
An ASO arrangement may offer cost advantages as various insurance charges are avoided because the risk for plan expenses, including claims costs, stays with the plan sponsor. With such arrangements, typically only claims adjudication and related administration services are purchased by the plan sponsor (although some “stop-loss” coverages may be supplied by the insurer against catastrophic claims).
Making changes to the group benefit program without reference to its value as an effective form of employee compensation is not likely to produce results that are satisfactory over the longer term. On the other hand, looking at it as one component of a total compensation strategy undeniably makes it a rewarding experience.
Ashim Khemani is senior vice-president, group markets with Toronto-based Liberty Health. He can be reached at [email protected] or www.coverme.com.
