1. What is the difference between the probationary period and the eligibility period in group
insurance?
2. What are the factors for pricing a group plan?
3. How do employers protect themselves from the risk of catastrophic financial loss when
they self-insure a benefits program?
4. How are FSAs funded? What are the limitations of FSAs?
5. The intent behind the passage of COBRA was to reduce the number of uninsured
persons. How does COBRA work to achieve this objective?
Chapter 20 from Risk Management Enterprises was adapted by The Saylor Foundation under a Creative
Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested by the
work's original creator or licensee. © 2014, The Saylor Foundation.
Chapter 20
Employment-Based Risk Management (General)
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The mandatory benefits that employees obtain through the workplace—worker’s compensation,
unemployment compensation, and Social Security—were discussed in earlier chapters. In this chapter we
move into the voluntary benefits area of group insurance coverages offered by employers. We begin with
an overall explanation of the employee benefits field and group insurance in this chapter. Our first step is
to delve into the specific group benefits provided by employers through insurance or self-insurance. In
addition to being regulated by the states as insurance products, employee benefits are also regulated by
the federal government (under the Employee Retirement Income Security Act of 1974), especially when
the employer self-insures and is not subject to state insurance regulation. Because many tax incentives are
available to employers that provide employee benefits, there are many nondiscrimination laws and
specific limitations on the tax advantages. Employee benefits are regulated by the Department of Labor
and the Internal Revenue Service (IRS).
To ensure your clear understanding of the main features of employee benefits, this chapter includes a
general discussion of group insurance. The second part of the chapter includes a discussion of group life,
group disability, and cafeteria plans. Some federal laws affecting employee benefits, such as the
Americans with Disabilities Act, the Age Discrimination in Employment Act, and the Pregnancy
Discrimination Act, are also covered. Chapter 22 "Employment and Individual Health Risk
Management" delves into the most expensive noncash benefit, health care coverage. All types of managed
care plans will be discussed along with the newest program of defined contribution health care plans, the
health savings accounts. Relating to health insurance are long-term care and dental care, also discussed
in Chapter 22 "Employment and Individual Health Risk Management". Two important federal laws, the
Health Insurance Portability and Accountability Act (HIPAA) of 1996 and the Consolidated Omnibus
Budget Reconciliation Act (COBRA) of 1986, will also be explained inChapter 22 "Employment and
Individual Health Risk Management".Chapter 21 "Employment-Based and Individual Longevity Risk
Management" is devoted to employer-provided qualified pension plans under the Employee Retirement
Income Security Act (ERISA) of 1974 and subsequent reforms such as the Tax Reform Act of 1986 and the
most recent Economic Growth Tax Reform and Reconciliation Act (EGTRRA) of 2001
(EGTRRA). Chapter 21 "Employment-Based and Individual Longevity Risk Management" also describes
deferred compensation plans such as 403(b), 457, the individual retirement account (IRA), and the Roth
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IRA. We will focus on qualified retirement plans, in which the employer contributes on the employee’s
behalf and receives tax benefits, while the employee is not taxed until retirement.
The field of employee benefits is a topic of more than one full course. Therefore, your study in this and the
following two chapters, along with the employee benefits Case 2 of Chapter 23 "Cases in Holistic Risk
Management", is just a short introduction to the field. This chapter covers the following:
1.
Links
2. Overview of employee benefits and employer objectives
3. Nature of group insurance
4. The flexibility issue, cafeteria plans, and flexible spending accounts
5.
Federal regulation compliance, benefits continuity and portability, and multinational employee
benefit plans
Links
At this point in our study, we are ready to discuss what the employer is doing for us in the overall process
of our holistic risk management. Employers became involved in securing benefits for their employees
during the industrial era, when employees left the security of their homes and families and moved to the
cities. The employer became the caretaker for health needs, burial, disability, and retirement. As the years
passed, the government began giving employers tax incentives to continue to provide these so-called
fringe benefits. Today, these benefits are called noncash compensation and are very significant in the
completeness of our risk management puzzle.
As noted in our complete risk management puzzle of Figure 20.1 "Links between Holistic Risk Pieces and
Employee Benefits", we need to have coverage for the risks of health, premature death, disability, and
living too long. These benefits and more are provided by most employers to their full-time employees.
These types of coverage are the second step in the pyramid structure in the figure. Benefits offered by
employers are critical in the buildup of our insurance coverages. As you will see in the next section of this
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chapter, there is no individual underwriting when we are covered in the group contract of our employer.
As such, for some employees with health issues, the group life, disability, and health coverages are
irreplaceable.
Two important federal laws will be discussed later in this chapter. COBRA provides for continuing health
care coverage when an employee leaves a job or a breadwinner dies, and HIPAA enforces coverage for
preexisting conditions when a person changes jobs. The reader can realize the enormous importance of
this coverage in the holistic picture of risk management.
In our drill down into the specific pieces of the puzzle, we will again learn in this chapter that each risk is
covered separately and that coverages from many sources protect each risk. It is up to us to pull together
these separate pieces to provide a complete risk management portfolio. Whether the employer pays all or
requires us to participate in the cost of the different types of coverage, the different coverages are
important to consider and do not allow us a complete understanding of the holistic risk management
process if they are not. Better yet, some of the benefits provide wonderful tax breaks that should be clearly
recognized.
Figure 20.1 Links between Holistic Risk Pieces and Employee Benefits
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20.1 Overview of Employee Benefits and Employer
Objectives
L EA R N IN G O B JEC T IV ES
In this section we elaborate on the general subject of noncash compensation to
employees known as employee benefits:
•
The significance of employee benefits to total compensation
•
Tax incentives associated with employee benefits
•
Considerations in employee benefit plan design
Overview of Employee Benefits
Noncash compensation, or employee benefits, today is a large portion of the employer’s cost of
employment. The Employee Benefit Research Institute (EBRI), an important research organization in the
area of employee benefits, reported that, in 2007, employers spent $1.5 trillion on major voluntary and
mandatory employee benefit programs, including $693.9 billion for retirement programs, $623.1 billion
for health benefit programs, and $138 billion for other benefit programs.
[1]
The complete picture of
employee benefits costs over the years is provided in Table 20.1 "Employer Spending on Noncash
Compensation, 1960–2007" As you can see in this table, benefits make up a significant amount of the pay
from employers, equating to 18.6 percent of total compensation in 2007. The largest shares of the benefits
go toward legally required benefits (social insurance), paid leave, and health insurance.
As noted above, employee benefits have tax incentives. Some benefits such as health care, educational
assistance, legal assistance, child care, discounts, parking, cafeteria facility, and meals are deductible to
the employer and completely tax exempt to the employees. Retirement benefits, both the contributions
and earnings on the contributions, are tax deductible to the employer and tax deferred to the employees
until their retirement. Some of the benefits paid by employees themselves are tax deferred, such as
investment in 401(k) plans (discussed inChapter 21 "Employment-Based and Individual Longevity Risk
Management"). Other benefits are partially tax exempt, such as group life. The employee is not required
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to pay taxes on the cost of life insurance up to coverage in the amount of $50,000 in death benefits. For
greater amounts of death benefits, the employer’s contributed premiums are counted as taxable income to
the employee. The largest expense comes in the form of health benefits, with $532.1 billion out of $1,454.9
billion of the total benefits spent by employers in 2007 (seeTable 20.1 "Employer Spending on Noncash
Compensation, 1960–2007"). Health benefits receive the most favorable tax exemption of all employee
benefit programs.
When we do not pay taxes, the government is forgoing income. Each year, the White House Office of
Management and Budget calculates the amounts forgone by the tax benefits. EBRI reports that the
foregone taxes from employer-provided benefits are projected to amount to $1.05 trillion for 2009
through 2013.
[4]
With the tax incentives comes a very stringent set of rules for nondiscrimination to ensure that employers
provide the benefits to all employees, not only to executives and top management. The most stringent
rules appear in the Employee Retirement Income Security Act, which will be explored in Chapter 21
"Employment-Based and Individual Longevity Risk Management" in the discussion of pensions. Keep in
mind that employee benefits are a balance of tax incentives as long as employers do not
violate nondiscrimination rules and act in good faith for the protection of the employees in their
fiduciary capacity. The efforts to protect employees in cases of bankruptcies are featured in the box “Your
Employer’s Bankruptcy: How Will It Affect Your Employee Benefits?” Ways to detect mismanagement of
certain benefit plan funding are described in the box “Ten Warning Signs That Pension Contributions Are
Being Misused.”
Employer Objectives
The first step in managing an effective employee benefits program, as with the other aspects of risk
management discussed in Part I of the text, is setting objectives. Objectives take into account both (1) the
economic security needs of employees and (2) the financial constraints of the employer. Without
objectives, a plan is likely to develop incrementally into a haphazard program. An employer who does not
have an on-staff specialist in this field would be wise to engage an employee benefits consulting firm.
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Employers can use several methods to set objectives for benefit plans. They may investigate what other
organizations in the region or within the industry are doing and then design a competitive package of
their own to recruit and retain qualified employees. Benefits may be designed to compete with plans
offered for unionized workers. Employers may survey employees to find out what benefits are most
desired and then design the benefits package with employees’ responses in mind.
Employer objectives are developed by answering questions such as the following:
•
Who is eligible for each type of benefit?
•
Should seniority, position, salary, and other characteristics influence the amount of each
employee’s benefit? (Care in observing nondiscrimination rules is very important in this area.)
•
How might a specific benefit affect employee turnover, absenteeism, and morale?
•
How should benefits be funded? (Should the employer buy insurance or self-insure?)
•
Should the benefits program be designed to adjust to the differing needs of employees?
•
How do laws and regulations influence benefit plan design?
•
To what extent should tax preferences affect plan design?
In answering questions like these, management must keep in mind the effect of its benefits decisions on
the organization’s prime need to operate at an efficient level of total expenditures with a competitive
product price. Efficiency requires management of total labor costs, wages plus benefits. Thus, if benefits
are made more generous, this change can have a dampening effect on wages, all else being equal.
Financial constraints are a major factor in benefit plan design. It is critical to note that health insurance is
a key benefit employees expect and need. As shown in Table 20.1 "Employer Spending on Noncash
Compensation, 1960–2007", group health insurance is a major part of the average compensation in the
United States. Most people regard the employer as responsible to provide this very expensive benefit,
which is discussed in detail in Chapter 22 "Employment and Individual Health Risk Management" (unless
and until proposed changes are enacted by the Obama administration, that is).
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K E Y TA K EA WAYS
In this section you studied the following general features of employee benefits and
important considerations for employers:
•
Employee benefits make up a significant portion of total compensation to
employees.
•
Employers and employees enjoy tax deferrals, exemptions, and deductions on
benefit expenditures.
•
The economic needs of employees and the financial constraints of employers
must be balanced in designing benefit programs.
D I SCU S S ION Q UE ST IO N S
1. What is the significance of adherence to nondiscrimination rules in employee
benefit plan design?
2. What are some of the tax incentives available to employers who provide
employee benefits?
3. Which benefit is the most costly to the employer?
4. Which benefit receives the most favored tax exemption?
5. What methods do employers use to set objectives for a benefits plan?
[1] Employee Benefit Research Institute, EBRI Databook on Employee Benefits, ch.2: Finances of
the Employee Benefit System, updated September 2008. http://www.ebri.org. More
information can also be found in the U.S. Chamber of Commerce Survey at uschamber.com
athttp://www.uschamber.org/Research+and+Statistics/Publications/Employee+Benefits+Study.
htm (accessed April 12, 2009).
[2] Includes paid holidays, vacations, and sick leave taken.
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[3] Consists of payments for medical services for dependents of active duty military personnel
at nonmilitary facilities.
[4] Employee Benefits Research Institute, “Tax Expenditures and Employee Benefits: Estimates
from the FY 2009 Budget,” February
2008,http://www.ebri.org/pdf/publications/facts/0208fact.pdf (accessed April 12, 2009).
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20.2 Nature of Group Insurance
L EA R N IN G O B JEC T IV ES
In this section we elaborate on the following insurance aspects of employee
benefits:
•
Administration of group insurance
•
Ways of providing group insurance
•
How premiums are paid
•
Key underwriting determinants for placing a group insurance program and for
pricing a group insurance program
•
Cost advantages of group coverage
•
Cost features of group coverage
•
Tax treatment of payments and benefits
Individuals receive economic security from individually purchased insurance and from group insurance.
Both types of coverage may provide protection against economic loss caused by death, disability, or
sickness. To the covered person, the differences between the two types of coverage (shown in Table 20.2
"Comparison of Group Insurance and Individual Insurance") may not be noticeable.
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Table 20.2 Comparison of Group Insurance and Individual Insurance
Individual
Insurance Contract
Group Insurance Contract
Administration/contract
Issued to the person
insured
Master contract issued to employer or a trust; each
employee is issued a certificate of insurance (not a contract)
Underwriting
Evidence of insurability
Characteristic of the group to minimize adverse selection
and administrative costs
Eligibility
At inception of contract
Related to employment periods
Experience
rating/pricing
Experience of the
insurance company
Experience of the large group
Administration
The administration of group insurance differs from individual insurance because the contract is made
with the employer rather than with each individual. The employer receives a master contract that
describes all the terms and conditions of the group policy. The employer, in turn, provides each insured
employee with a certificate of insurance as evidence of participation. Participants in the benefit plan
may include employees, their dependents (including a spouse and children under a specified age, such as
twenty-one, when enrolled in school), retirees, and their dependents. Participants receive a booklet
describing the plan, distributed by the employer at the time the plan goes into effect or when eligibility
begins, whichever is later.
Administration of group insurance also differs from individual insurance because the employer may be
responsible for the record keeping ordinarily done by the insurer, especially if the group is large.
Administration is simplified by the employer paying periodic premiums directly to the insurer. If
employees are required to contribute toward the premium, the employer is responsible for collection or
payroll deduction of employee contributions, as well as for payment to the insurer of the total group
premium amount.
Many large employer plans are self-insured, and employers, rather than insurers, pay claims and bear
the risk that actual claims will exceed expected claims. Some employers with self-insured plans also
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party administrators (TPAs) administer many (even large) self-funded plans under
an administrative services only (ASO) contract. The employer transfers record keeping and claim
payment functions to the insurer or TPA, paying about 5 to 10 percent of the normal premium for
administrative services.
In addition, the employer may purchase stop-loss insurance from the same or another insurer through
the TPA for protection against unexpectedly high claims. Stop-loss coverage is a form of reinsurance or
excess insurance for self-insured plans. The two basic forms of coverage are specific stop loss, in which
a limit is set per claim, and aggregate stop loss, in which a limit is set for the total claims in a year. The
insurer reimburses the employer for claim amounts above the limit, also called the attachment point.
Purchase of an ASO contract and stop-loss insurance gives the employer the potential cash flow and
expense advantage of self-funding, while reducing the employer’s administrative burden and potential for
catastrophic risk.
Underwriting
Individually purchased life and health insurance contracts involve individual underwriting. The purchaser
files an application and, in some cases, takes a medical examination. On the basis of this and other
information, the underwriter decides whether or not to issue insurance, and on what terms. The merits of
each application are decided individually. Group underwriting does not involve an application to the
insurer by each participant, or a medical examination (except in some very small employer groups). The
group as a whole is being underwritten. The employer makes one application for the entire group and,
instead of selecting individual insureds, the insurer makes an underwriting decision based on group
characteristics.
Characteristics of the Group as Key Underwriting Determinants
Reason for the Group’s Existence
It is imperative that the group was not created for insurance purposes. Insurance should be incidental to
the group’s formation. Under state laws, the following are eligible groups for group insurance:
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•
Individual employer groups
•
Negotiated trusteeships
•
Trade associations
•
Labor union groups
•
Multiple-employer trusts (METs) or multiple-employer welfare arrangements
Some, mostly smaller, employers may have trouble finding an insurance carrier willing to service their
group if one or more individuals are in ill health. Many of these firms, however, have access to group
insurance by participating in a multiple-employer trust (MET). The MET makes available to small
employers, often in the same industry group and with as few as one or two employees each, benefits
similar to those available to large groups. METs are often organized for a trade association, union, or
other sponsoring organization by an insurer or third-party administrator. When small employers come
together through a MET to purchase insurance, they have access to group underwriting treatment,
products, and services similar to those available to large employers.
Financial Stability of the Employer
Insurers prefer to work with firms that will exist from year to year and be able to pay the premium.
Because the cash flow is very fast in group insurance such as health insurance, financial stability is critical
to underwriters accepting the business. This requirement is really fundamental to all types of
underwriting, not only group underwriting.
Your Employer’s Bankruptcy: How Will It Affect Your Employee
Benefits?
The Department of Labor’s Employee Benefits Security Administration (EBSA) administers the Employee
Retirement Income Security Act (ERISA) of 1974, which governs retirement plans (including profit
sharing and 401(k) plans) and welfare plans (including health, disability, and life insurance plans). ERISA
also includes the health coverage continuation and accessibility provisions of the Consolidated Omnibus
Budget Reconciliation Act (COBRA) and the Health Insurance Portability and Accountability Act
(HIPAA).
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EBSA educates and assists the nation’s 200 million participants and beneficiaries in pension, health, and
other employee benefit plans and the more than 3 million sponsors of those plans. In carrying out its
responsibility to protect participants’ and beneficiaries’ benefits, EBSA has targeted populations of plan
participants who are potentially exposed to the greatest risk of loss. One such group of individuals is the
group of participants and beneficiaries of plans whose sponsor has filed for bankruptcy. In such cases,
EBSA provides the following.
If an employer declares bankruptcy, it will generally take one of two forms: reorganization under Chapter
11 "Property Risk Management" of the Bankruptcy Code or liquidation underChapter 7 "Insurance
Operations". A Chapter 11 "Property Risk Management" (reorganization) usually means that the company
continues in business under the court’s protection while attempting to reorganize its financial affairs.
A Chapter 11 "Property Risk Management" bankruptcy may or may not affect your pension or health plan.
In some cases, plans continue to exist throughout the reorganization process. In a Chapter 7 "Insurance
Operations"bankruptcy, the company liquidates its assets to pay its creditors and ceases to exist.
Therefore, it is likely your pension and health plans will be terminated. When your employer files for
bankruptcy, you should contact the administrator of each plan or your union representative (if you are
represented by a union) to request an explanation of the status of your plan or benefits. The summary
plan description will tell how to get in touch with the plan administrator. Questions that you may want to
ask include the following:
•
Will the plan continue or will it be terminated?
•
Who will act as plan administrator of the health and pension plans during and after the
bankruptcy, and who will be the trustee in charge of the pension plan?
•
If the pension plan is to be terminated, how will accrued benefits be paid?
•
Will COBRA continuation coverage be offered to terminated employees?
•
If the health plan is to be terminated, how will outstanding health claims be paid, and when will
certificates of creditable coverage (showing, among other things, the dates of enrollment in your
employer’s health plan) be issued?
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Prior Experience of the Plan
This factor is important not only in accepting a group for coverage but also in pricing the group plan.
Insurers look at past losses—the frequency, severity, and length of illnesses or disabilities—when deciding
whether to accept a business and then how to price it. Pricing factors will be discussed later in this section.
Size of the Group
As you recall from the first two chapters of this text, the law of large numbers is very important to the
functioning of insurance. Therefore, large groups can be rated on their own experience, while small
groups have to be rated based on the insurer’s experience with groups of similar type and size.
Source and Method of Premium Payment
Insurance laws may require that a minimum percentage of the group be enrolled in the benefit plan to
ensure that there are enough healthy employees and dependents to help offset the high claims that can be
expected from unhealthy employees or dependents. Every group, insured or self-insured, can anticipate
enrollment by the unhealthy. The likelihood of achieving minimum participation (meaning at least 75
percent) is increased by employer sharing of costs. Most states and insurers require that
noncontributory plans, in which employees do not pay for the cost of their coverage, enroll 100 percent of
employees. In contributory plans, where employees pay all or part of the premium amount, 75 percent of
employees must participate. This helps protect the plan from adverse selection.
Stability of the Group
To avoid the problems associated with high employee turnover, employers use waiting periods or
probationary periods before insurance coverage begins. There are some advantages to turnover, however;
for one, the age composition does not get older when more new employees join the plan.
Persistency of the Group
Group business is costly for the insurer in the first year. An employer that changes carriers every year is
an undesirable client. Insurers look for a more permanent relationship with employers.
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Method of Determining Benefits
To avoid adverse selection, employers are required under nondiscrimination laws to offer the same
benefits package to all employees. In reality, many groups provide flexible benefit programs, which allow
employee input into the amount of each benefit, and supplemental plans, which allow employees to
purchase additional amounts of a specific benefit on a fully contributory basis. These options undoubtedly
invite adverse selection, which is reflected in higher rates for flexible and supplemental benefits. However,
given the diversity in needs among single, married, divorced, younger, older, male, and female employees
in the typical group, the advantages of giving employees a voice in benefit decisions may well outweigh the
cost of some adverse selection. Flexible benefit programs, also known as cafeteria plans, are discussed
later in this chapter.
Supplemental plans allow employees to choose additional group insurance coverage paid for entirely by
the employees themselves. For example, supplemental life coverage can allow an employee to increase the
face amount of group life insurance coverage, and supplemental group disability coverage can allow for a
cost-of-living benefit increase for periods of long-term disability. In recent years, the use of supplemental
plans has grown, largely due to the flexibility they provide to employees at little or no cost to employers,
other than facilitating the payroll deductions.
The potential for adverse selection may be greater with supplemental benefits than with nonsupplemental
benefits. Because employees pay the premium for supplemental coverage, it is likely that those who
anticipate that they need the benefit are more willing to participate. Despite this, supplemental plans are
popular because they allow employees to tailor benefits to meet their individual needs through a
convenient payroll deduction plan.
Provisions for Determining Eligibility
Generally, employees are first eligible for benefits either immediately upon hiring or following a three- to
six-month probationary period. Following hiring or the probationary period (whichever the employer
requires), the employee’s eligibility period usually extends for thirty-one days, during which employees
may sign up for group insurance coverage. This period is called open enrollment. In order for coverage
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to become effective, most group plans require that the employee be actively at work on the day that
coverage would normally become effective. Being at work provides some evidence of good health and
helps reduce adverse selection.
Enrollment after the eligibility period usually means that the employee will have to provide evidence of
insurability. The employee may have to complete a questionnaire or have a medical examination to show
that he or she is in good health. This provision helps reduce adverse selection. Most employers allow only
full-time employees to participate in the benefit plan. (The definition of full-time differs from employer to
employer; the minimum may be as low as twenty hours per week, but it is more often thirty-two to thirtyfive hours). To lower adverse selection, part-time employees are not included (some part-time employees
join the work force only for the benefits). Some employers provide minimal benefits for part-time
employees, such as burial cost only instead of full death benefits.
Administrative Aspects
The most important part of this requirement is to what extent the employer plans to help in the
enrollment and claims process.
Pricing
Some employers pay the entire cost of the group insurance premium. These
are noncontributory plans. In contributory plans, employees pay part of the cost. Frequently,
group life and disability insurance plans are noncontributory, but they require the employees to
contribute if other family members are covered. Health insurance is more likely to be contributory
because of rising premiums, a situation described in the box “What Is the Tradeoff between Health Care
Cost and Benefits?” in Chapter 22 "Employment and Individual Health Risk Management". The employer
makes the premium payment to the insurer; contributory amounts, if any, are deducted from the
employee’s paycheck.
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Important factors in underwriting for pricing are (1) the age and gender composition of the group, (2) the
industry represented by the group, and (3) the geographical location of the group.
Group insurance is usually less expensive than individual insurance for several reasons: (1) with group
coverage, the insurer deals with one insured instead of many, streamlining marketing costs; (2) the
employer takes care of much of the administrative detail; (3) commission scales on group business are
lower than they are on individual policies; (4) medical examinations are not needed because the
employees are at least healthy enough to work; (5) the employer collects the premiums and pays the
insurer in one lump sum, which is more efficient for the insurer; and (6) the employer often does some
monitoring to eliminate false or unnecessary claims for health care benefits. In addition, group insurance
theory maintains that the replacement by younger employees of employees who retire or quit keeps
average mortality and morbidity rates from rising to prohibitive levels. That is, a flow of persons through
the group tends to keep average costs down. This is often true when the number of employees in a group
is growing, but it is less true for an organization that is downsizing.
Group life and health insurance rates are usually quoted by insurers as one monthly rate (e.g., $0.15 per
$1,000 of coverage in the case of life insurance) for all employees. This rate is based on a weighted
average, taking into account the age, sex, and accompanying mortality and morbidity rates for each
employee in the group. Because mortality and morbidity rates increase with age, life insurance rates are
quoted in age brackets. Someone in the thirty-one to thirty-five age bracket will pay slightly more than
someone in the the twenty-six to thirty bracket. Thus, groups with a higher proportion of older people will
have relatively higher premiums.
Most small organizations (e.g., those with fewer than fifty employees) have their entire premium based on
pooled claims experience for similar-size firms. However, larger employers are likely to have
experience-rated premiums in which the group’s own claims experience affects the cost of coverage,
as described in Chapter 16 "Risks Related to the Job: Workers’ Compensation and Unemployment
Compensation" for worker’s compensation. Experience rating allows employer groups to benefit directly
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from their own good claims experience, and it provides a direct economic incentive for risk managers to
control claims.
With experience rating, the weight or credibility given to a group’s own experience increases with the
number of participants. The experience of smaller groups (e.g., those with fewer than 500 or 1,000
employees) is not considered sufficiently statistically credible or reliable to determine premiums
completely. Therefore, insurers use a weighted average of the group’s loss experience and the pooled
experience for groups of similar size and characteristics in developing the claims charge. For example, the
group’s actual loss experience may be weighted at 70 percent of the claims charge, and the pooled
experience for groups of similar attributes may carry a weight of 30 percent. If the group had a loss
experience of $80,000 and the pool experience was $100,000, then the claims charge for the experiencerated premium would be $86,000 per year. A larger group would have more statistically reliable
experience and might receive an 80 percent weighting for its own experience and a 20 percent weighting
for the pooled experience, resulting in a claims charge of $84,000. Thus, the larger the group, the more
credit the group receives for its own claims experience. The experience-rated claims charge makes up the
bulk of the total premium due, but the final experience-rated premium also includes administrative
charges and fees.
Premiums for larger organizations, however, may reflect only the group’s own loss experience. With
prospective experience rating, the group’s claims experience for the previous few years, plus an inflation
factor, partly or completely determines the premium for the current year. A retrospective experience
rating plan uses loss experience to determine whether premium refunds (or dividends) should be paid at
the end of each policy year.
Group insurance premiums paid by the employer are a deductible business expense and are not taxable
income to employees except for amounts of term life insurance in excess of $50,000 per person and all
group property-liability insurance. Employee premium contributions are not tax deductible, except if they
are allowed to be used in a cafeteria program under a premium conversion plan or flexible spending
account (FSA), discussed later in this chapter. The other tax-sheltered accounts available under health
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savings account (HSA) plans are discussed in Chapter 22 "Employment and Individual Health Risk
Management". Proceeds paid from group life insurance at death are not taxable income to the beneficiary,
as noted in Chapter 19 "Mortality Risk Management: Individual Life Insurance and Group Life
Insurance", but are included in the estate of the insured, if he or she is the owner, for federal estate tax
purposes.
Group disability insurance (discussed in Chapter 22 "Employment and Individual Health Risk
Management") premiums paid by the employer are also a deductible business expense for the employer,
and they do not result in an immediate tax liability for the employee. If an employee receives disability
benefits, the portion paid for by the employer is taxable to the employee. For example, if the employer
pays one-third of the premium amount for disability coverage, and if the employee becomes disabled and
receives benefits, one-third of the benefits are taxable income to the employee. Benefits attributable to
coverage paid for by the employee with after-tax dollars are not taxable. Thus, in this example, two-thirds
of the disability benefit amount would not be taxable income. Explaining taxation of disability income to
employees can be a challenge for the benefits manager. However, many employers are successful in
conveying the importance of after-tax premium payment to the level of benefits if disability occurs. The
tax savings on the premiums are very small relative to the tax savings on the disability benefits.
Ten Warning Signs That Pension Contributions Are Being
Misused
Increasingly, employees are asked to make voluntary or mandatory contributions to retirement and other
benefit plans. This is particularly true for 401(k) savings plans (as will be discussed in Chapter 21
"Employment-Based and Individual Longevity Risk Management"). These plans allow you to deduct from
your paycheck a portion of pretax income every year, invest it, and pay no taxes on those contributions
until the money is withdrawn at retirement.
An antifraud campaign by the Department of Labor uncovered a small fraction of employers who abused
employee contributions by either using the money for corporate purposes or holding on to the money too
long. Here are ten warning signs that your pension contributions are being misused.
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1.
Your 401(k) or individual account statement is consistently late or comes at irregular intervals.
2. Your account balance does not appear to be accurate.
3. Your employer failed to transmit your contribution to the plan on a timely basis.
4. You notice a significant drop in account balance that cannot be explained by normal market ups
and downs.
5.
Your 401(k) or individual account statement does not reflect a contribution from your paycheck.
6. Investments listed on your statement are not what you authorized.
7.
Former employees are having trouble getting their benefits paid on time or in the correct
amounts.
8. You notice unusual transactions, such as a loan to the employer, a corporate officer, or one of the
plan trustees.
9. Investment managers or consultants change frequently and without explanation.
10. Your employer has recently experienced severe financial difficulty.
If you think the plan trustees or others responsible for investing your pension money have been violating
the rules, you should call or write the nearest field office of the U.S. Department of Labor’s Employee
Benefits Security Administration (EBSA). The Labor Department has authority to investigate complaints
of fund mismanagement. If an investigation reveals wrongdoing, the department can take action to
correct the violation, including asking a court to compel plan trustees and others to put money back in the
plan. Courts can also impose penalties of up to 20 percent of the recovered amount and bar individuals
from serving as trustees and plan money managers.
If you suspect that individuals providing services to the plans have gotten loans or otherwise taken
advantage of their relationship to the plan, the Employee Plans Division of the Internal Revenue Service
may want to take a closer look. The Internal Revenue Service is authorized to impose tax penalties on
people involved in unlawful party-in-interest transactions.
Cases of embezzlement or stealing of pension money, kickbacks, or extortion should be referred to the
Federal Bureau of Investigation or the Labor Department field office in your area. If illegal activities are
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discovered, the case can be referred to the U.S. Department of Justice for prosecution. Criminal penalties
can include fines or prison sentences, or both.
Federal pension law makes it unlawful for employers to fire or otherwise retaliate against employees who
provide the government with information about their pension funds’ investment practices.
Sources: Portions reprinted from “10 Warning Signs,” U.S. Department of Labor, Employee Benefits
Security Administration,http://www.dol.gov/ebsa/publications/10warningsigns.html, accessed April 12,
2009; “What You Should Know About Your Retirement Plan,” a handbook from the U.S. Department of
Labor, at http://www.dol.gov/ebsa/publications/wyskapr.html, accessed April 12, 2009. This booklet is
available online. You can find explanation of all qualified retirement plans discussed in this chapter.
K E Y TA K EA WAYS
In this section you studied the following:
•
Employers handle many administrative aspects of group insurance that are
normally dealt with by insurers.
•
Employers may purchase group insurance from a private insurer or they may
self-insure programs.
•
Employers and employees may share in the cost of insurance premiums, and it
is an important underwriting issue.
•
Key underwriting determinants of accepting a group for insurance and pricing
the group insurance include the reason for the group’s existence, the
employer’s financial stability and persistency, prior experience of the plan, the
size of the group, the source and/or method of premium payment, stability of
the group, eligibility provisions, geographical location, industry, and
employees mix.
•
Group insurance is less expensive than individual insurance due to
streamlined marketing costs, employer responsibilities, and lack of medical
examinations.
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•
Monthly life and health insurance rates in group plans are weighted to
account for age, sex, mortality, and morbidity features of employees in the
group.
•
Large employers can pay experience-rated premiums based on employer’s
own experience.
•
Group health insurance premiums paid by the employer are tax deductible
and not taxable income to employees; benefits are not taxable to the
employees as well.
•
Employee premium contributions are not tax deductible unless they are used
in cafeteria plans under premium conversion arrangements or flexible
spending accounts.
•
Benefits attributable to coverage paid for by employees with after-tax dollars
are not taxable.
D I SCU S S ION Q UE ST IO N S
1. What is the difference between the probationary period and the eligibility
period in group insurance?
2. What factors do underwriters consider when accepting an employer group
plan?
3. Describe several group insurance underwriting requirements that reduce the
potential for adverse selection.
4. What are the factors for pricing a group plan?
5. Why might a large employer self-insure?
6. How do employers protect themselves from the risk of catastrophic financial
loss when they self-insure a benefits program?
7. Under what circumstances are benefits that are received by employees under
a group arrangement considered taxable income?
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20.3 The Flexibility Issue, Cafeteria Plans, and Flexible
Spending Accounts
L EA R N IN G O B JEC T IV ES
In this section we elaborate on the flexible features of employee benefits,
including the following:
•
How flexible benefits allow employees to have choices
•
The major components of cafeteria plans
•
The tax incentives of premium conversion plans
•
Savings made possible by flexible spending accounts (FSAs)
The Flexibility Issue
Employers have been interested in flexible benefit plans since the early 1970s. These plans give the
employee the ability to choose from among an array of benefits or cash and benefits. Few flexible plans
were adopted until tax issues were clarified in 1984. At that time, it became clear that employees could
choose between taxable cash income and nontaxable benefits without adversely affecting the favorable tax
status of a benefit plan. These are the cafeteria plans and flexible spending account (FSA) rules. Rules
regarding these plans have continued to change, resulting in some employer hesitancy to adopt them.
Despite the uncertain legislative environment, flexible plans became very popular in the mid-1980s,
particularly among large employers. Employers are attracted to flexible benefit plans because, relative to
traditional designs, they do the following:
•
Increase employee awareness of the cost and value of benefit plans
•
Meet diverse employee economic security needs
•
Help control total employer costs for the benefit plan
•
Improve employee morale and job satisfaction
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How flexible benefit plans accomplish these goals will become clear through discussion of cafeteria plans
and flexible spending accounts.
Cafeteria Plans
Flexible benefit plans are frequently called cafeteria plans because they allow selection of the types and
amounts of desired benefits. A cafeteria plan usually involves five elements: flexible benefit credits,
minimum levels of certain benefits, optional benefits, cash credits, and tax deferral.
In a cafeteria plan, the employer generally allows each employee to spend a specified number of flexible
credits, usually expressed in dollar amounts. The options in a cafeteria plan have to include a choice
whether or not to take cash in lieu of benefits. The cash element is necessary in order for the plan to be
considered a cafeteria plan for tax purposes. There may be a core plus cafeteria plan where basic
benefits are required, such as $50,000 death benefits in a group life insurance and basic group long-term
disability. The employee then has a choice among a few health plans, more disability coverage, dental
coverage, and more. The additions are paid with the flexible credits. If there are not enough credits, the
employee can pay the additional cost through payroll deduction on a pretax basis using a
premium conversion plan. Usually, employees pay for dependents’ health care on a pretax basis using
the premium conversion plan.
Another cafeteria plan may be the modular cafeteria plan. This type of cafeteria plan includes a few
packages available to the employees to choose from. It is less flexible than the core plus plan and requires
less administrative cost. The number of credits assigned each year may vary with employee salary, length
of service, and age. Cafeteria plans are included under Section 125 of the Internal Revenue Code. Qualified
benefits in a cafeteria plan are any welfare benefits excluded from taxation under the Internal Revenue
Code. The flexible spending account (explained later) is also part of a cafeteria plan. Long-term care is not
included, while a 401(k) plan is included.
Benefit election must be made prior to the beginning of the plan year and cannot be changed during the
plan year unless allowed by the plan; they can be changed because of changes in the following:
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1.
Legal marital status
2. Number of dependents
3. Employment status
4. Work schedule
5.
Dependent status under a health plan for unmarried dependents
6. Residence or worksite of the employee, spouse, or dependent
The employer may restrict employee benefit choice to some degree because the employer has a vested
interest in making sure that some minimal level of economic security is provided to employees. For
example, the organization might be embarrassed if the employee did not elect health coverage and was
subsequently unable to pay a large hospital bill. Most flexible benefit plans specify a minimum level of
certain benefits judged to be essential, such as those in a core plus plan. For example, a core of medical,
death, and disability benefits may be specified for all employees. The employee can elect to opt out of a
core benefit by supplying written evidence that similar benefits are available from another source, such as
the spouse’s employer or the military retirement system.
Cafeteria plans also help control employer benefit costs. Employers set a dollar amount on benefit
expenditures per employee, and employees choose within that framework. This maximizes employee
appreciation because employees choose what they want, and it minimizes employer cost because
employers do not have to increase coverage for all employees in order to satisfy the needs of certain
workers.
Cafeteria plans have been especially effective in controlling group medical expense insurance costs.
Employees often are offered several alternative medical plans, including health maintenance
organizations (HMOs) and preferred provider organizations (PPOs), plans designed to control costs
(discussed in Chapter 22 "Employment and Individual Health Risk Management"). In addition,
employees may be charged lower prices for traditional plans with more cost containment features. For
example, a comprehensive medical insurance plan may have an option with a $100 deductible, 90 percent
coinsurance, a $1,000 out-of-pocket or stop-loss provision, and a $1 million maximum benefit. A lowerSaylor URL: http://www.saylor.org/books
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priced comprehensive plan may offer the same maximum benefit with a $2,000 deductible, 80 percent
coinsurance, and a $4,000 stop-loss provision. The employee uses fewer benefit credits to get the lower
option plan, and the cost-sharing requirements likely reduce claim costs, too. Likewise, long-term
disability insurance choices attach lower prices per $100 of monthly benefit with an option that insures 50
percent of income rather than 60 or 70 percent. Here again, lower prices attract employees to options
with more cost sharing, and the cost sharing helps contain claims.
Cafeteria plans are well suited to meet the needs of a demographically diverse work force. The number of
women, single heads of households, and dual-career couples in the work force (as discussed in Chapter 17
"Life Cycle Financial Risks") has given rise to the need for different benefit options. A single employee
with no dependents may prefer fewer benefits and more cash income. Someone covered by medical
benefits through a spouse’s employer may prefer to use benefit dollars on more generous disability
coverage. An older worker with grown children may prefer more generous medical benefits and fewer life
insurance benefits. Clearly, economic security needs vary, and job satisfaction and morale may improve
by giving employees some voice in how benefits, a significant percentage of total compensation, are spent.
However, both higher administrative costs and adverse selection discourage employers from
implementing cafeteria plans. Record keeping increases significantly when benefit packages vary for each
employee. Computers help, but they do not eliminate the administrative cost factor. Communication with
employees is both more important and more complicated because employees are selecting their own
benefits and all choices must be thoroughly explained. Employers are careful to explain but not to advise
about benefit choices because then the employer would be liable for any adverse effect of benefit selection
on the employee.
Cafeteria plans may have some adverse selection effects because an employee selects benefits that he or
she is more likely to need. Those with eye problems, for example, are more likely to choose vision care
benefits, while other employees may skip vision care and select dental care to cover orthodontia. The
result is higher claims per employee selecting each benefit. Adverse selection can be reduced by plan
design and pricing. The employer may require, for example, that employees who select vision care must
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also choose dental care, thus bringing more healthy people into both plans. Pricing helps by setting each
benefit’s unit price high enough to cover the true average claim cost per employee or dependent, while
trying to avoid excessive pricing that would discourage the enrollment of healthy employees.
Flexible Spending Accounts
Flexible spending accounts (FSAs) allow employees to pay for specified benefits (which are defined
by law) with before-tax dollars. In the absence of a flexible spending account, the employee would have
purchased the same services with after-tax dollars. An FSA can either add flexibility to a cafeteria plan or
can accompany traditional benefit plans with little other employee choice. The employer may fund the
FSA exclusively, the employee may fund the account through a salary reduction agreement, or both may
contribute to the FSA.
The employee decides at the beginning of each year how much money to personally contribute to the FSA,
and then he or she signs a salary reduction agreement for this amount. The legal document establishing
the employer’s program of flexible spending accounts specifies how funds can be spent, subject to the
constraints of Section 125 in the Internal Revenue Code. For example, the simplest kind of FSA is funded
solely by an employee salary reduction agreement and covers only employee contributions to a group
medical insurance plan. The salary reduction agreement transforms the employee contribution from
after-tax dollars to before-tax dollars, often a significant savings. A more comprehensive FSA, for
example, may allow the employee to cover medical premium contributions, uninsured medical expenses,
child care, and legal expenses. Dependent care is a nice addition in the FSA. The catch with an FSA plan is
that the employee forfeits to the employer any balance in the account at year-end. This results in flexible
spending accounts primarily being used to prefund highly predictable expenses on a before-tax basis.
Employees also pay their portion of the health premium in a premium conversion plan, which allows the
funds to be collected on a pretax basis. These are usually the premiums for dependents.
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K E Y TA K EA WAYS
In this section you studied the following ways that employee benefit plans can give
flexibility to diverse employee groups at low cost to employers:
•
Flexible benefit programs like cafeteria plans and flexible spending accounts
allow the employee to choose from among an array of benefits or cash and
benefits.
•
Flexible benefit plans allow employers to retain the tax advantages of group
coverage, give employees more choice, increase employee awareness and
morale, and control costs.
•
Cafeteria plans allow employees to spend flex credits on a selection of types
of benefits at desired amounts.
•
Cafeteria plans must have an option for cash in lieu of benefits.
•
Some basic types of coverage (such as choice of death benefits, health plans,
disability, dental, etc.) may be required in cafeteria plans.
•
Employees can purchase additional coverage on a pretax basis under a
premium conversion plan after exhausting flexible credits.
•
Flexible spending accounts (FSAs) allow employees to pay for eligible out-ofpocket health care costs with before-tax dollars.
•
FSAs may be part of a cafeteria plan selection or they can accompany
traditional nonflexible benefit plans.
•
Funds (from the employer or employee) must be contributed to an FSA at the
beginning of the year and exhausted by year-end (use it or lose it).
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D I SCU S S ION Q UE ST IO N S
1. Cafeteria plans have become increasingly popular. What factors contributed
to the increased use of these plans?
2. How might a flexible benefit plan achieve desirable goals for your employer as
well as for you?
3. Create examples of core plus and modular cafeteria plans that include many
benefits and cash.
4. Under what circumstances can employees change flexible benefit elections
during the year?
5. In what ways are costs controlled by allowing employees more choice among
benefits?
6. How can adverse selection be combated in benefit selection?
7. How are FSAs funded? What are the limitations of FSAs?
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20.4 Federal Regulation Compliance, Benefits
Continuity and Portability, and Multinational
Employee Benefit Plans
L EA R N IN G O B JEC T IV ES
In this section we elaborate on regulatory and multinational issues in employee
benefits, including the requirements of the following pieces of legislation:
•
The Age Discrimination in Employment Act (ADEA)
•
The Civil Rights Act
•
The Americans with Disabilities Act (ADA)
•
The Family Medical Leave Act (FMLA)
•
The Consolidated Omnibus Budget Reconciliation Act (COBRA)
•
The Health Insurance Portability and Accountability Act (HIPAA)
Federal Regulation: Compliance with Nondiscrimination Laws
As noted above, the administration and design of group employee benefit plans have been affected by
federal regulation through ERISA, EGTRRA 2001 (discussed in Chapter 21 "Employment-Based and
Individual Longevity Risk Management"), the Age Discrimination in Employment Act, the Civil Rights Act
(which includes pregnancy nondiscrimination), and the Americans with Disabilities Act. The Social
Security Act was discussed in Chapter 18 "Social Security"; the Health Maintenance Organization Act will
be discussed in Chapter 22 "Employment and Individual Health Risk Management", along with medical
care delivery systems. Federal legislation is concerned with nondiscrimination in coverage and benefit
amounts for plan participants. Some legislation relating to health care in general that also affects group
underwriting practices is described in the box “Laws Affecting Health Care.” Individuals called to military
duty and the families they leave behind have certain rights regarding group health and pension coverages.
These rights are discussed in the box “Individual Coverage Rights When Called to Military Duty.”
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Age Discrimination in Employment Act
The Age Discrimination in Employment Act (ADEA) was first passed in 1967 and is known
primarily for eliminating mandatory retirement on the basis of age. That is, employees cannot be forced to
retire at any age, with the exception of some executives who may be subject to compulsory retirement.
Employee benefits are also affected by the ADEA because the law was amended to require that benefits
must be continued for older workers. Most benefits can be reduced to the point where the cost of
providing benefits for older workers is no greater than for younger workers except health care benefits.
The act makes this an option; employers are not required to reduce benefits for older workers. Employers
choosing to reduce some benefits for older workers generally do not reduce benefits except for workers
over age sixty-five, even though reductions prior to age sixty-five may be legally allowed based on cost.
The employer may reduce benefits on a benefit-by-benefit basis based on the cost of coverage, or may
reduce them across the board based on the overall cost of the package. For example, with the benefit-bybenefit approach, the amount of life insurance in force might be reduced at older ages to compensate for
the extra cost of term coverage at advanced ages. Alternatively, several different benefits for an older
worker might be reduced to make the total cost of the older worker’s package commensurate with the cost
of younger workers’ packages.
Life and disability insurance may be reduced for older workers. Acceptable amounts of life insurance
reductions are specified by law. For example, employees age sixty-five to sixty-nine may be eligible for life
insurance benefit amounts equal to 65 percent of the amounts available to eligible employees under age
sixty-five; employees age seventy to seventy-four may receive only 45 percent. Disability benefits provided
through sick leave plans may not be reduced on the basis of age. Reductions in benefit amounts for shortterm disability insured plans are allowed, but they are relatively uncommon in actual practice. Long-term
disability benefits may be reduced for older workers through two methods. Benefit amounts may be
reduced and the duration may remain the same, or benefit duration may be curtailed and amounts remain
the same. This is justified on the basis of cost because the probability of disability and the average length
of disability increase at older ages.
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Medical benefits may not be reduced for older employees. Employers must offer older workers private
group medical benefits that are equal to those offered to younger participants, even if active workers over
age sixty-five are eligible for Medicare. Medicare is the secondary payer for active employees over age
sixty-five, covering only those expenses not covered by the primary payer, the employee’s group medical
insurance.
The Civil Rights Act
Traditionally, employee benefit plans have not been required to provide benefits for pregnancy and other
related conditions. Including disability and medical benefits for pregnancy can significantly increase
costs. However, in 1978 the Civil Rights Act was amended to require employers to provide the same
benefits for pregnancy and related medical conditions as are provided for other medical conditions. If an
employer provides sick leave, disability, or medical insurance, then the employer must provide these
benefits in the event of employee pregnancy. Spouses of employees must also be treated equally with
respect to pregnancy-related conditions. This federal regulation applies only to plans with more than
fifteen employees, but some states impose similar requirements on employers with fewer employees.
Americans with Disabilities Act
As described in Chapter 13 "Multirisk Management Contracts: Homeowners", the
1990 Americans with Disabilities Act (ADA) forbids employers with more than fifteen employees
from discriminating against disabled persons in employment. Disabled persons are those with physical or
mental impairments limiting major life activities such as walking, seeing, or hearing. The ADA has
important implications for employee benefits. The ADA is not supposed to disturb the current regulatory
system or alter industry practices such as underwriting. Under ADA, therefore, disabled employees must
have equal access to the same health benefits as other employees with the same allowances for coverage
limitations. The guidelines allow blanket preexisting conditions, but they do not include disability-based
provisions. For example, if the medical plan does not cover vision care, the employer does not have to
offer vision care treatment to disabled employees. However, if vision care is provided by the plan, then
vision care must also be offered to employees with disabilities. Recent Supreme Court cases clarified the
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intent of the ADA. Most important is the clarification that the ADA is concerned with a person’s ability to
perform regular daily living activities and not his or her ability to perform a specific job.
Family Medical Leave Act
Under the Family Medical Leave Act (FMLA) of 1993, an employer with fifty or more employees
must grant an eligible employee (one who has been employed by the employer for at least twelve months)
up to a total of twelve work weeks of unpaid leave during any twelve-month period for one or more of the
following reasons:
•
For the birth and care of the employee’s newborn child
•
For placement with the employee of a child for adoption or foster care
•
To care for an immediate family member (spouse, child, or parent) with a serious health
condition
•
To take medical leave when the employee is unable to work because of a serious health condition
This law may sometimes create conflicting interpretations, especially in relationship to workers’
compensation and disability leaves. Employee benefits administrators are advised to track the leave taken
by employees under different programs and ensure compliance with the law.
[1]
Compliance issues require
clarifications; a recent Supreme Court decision clarified that only material denial of the FMLA statute
should trigger penalties.
[2]
Benefits Continuity and Portability
Continuity: COBRA
The Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1986 directs that employers of more
than twenty employees who maintain a group medical plan must allow certain minimum provisions for
continuation of benefit coverage. COBRA’s continuation provisions require that former employees, their
spouses, divorced spouses, and dependent children be allowed to continue coverage at the individual’s
own expense upon the occurrence of a qualifying event (one that otherwise would have resulted in the loss
of medical insurance). The qualifying events are listed in Table 20.3 "COBRA Qualifying Events for
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Continuation of Health Insurance". Most terminations of employment, except for gross misconduct,
activate a thirty-one-day right to convert the health insurance that the employee or dependent had before
the qualifying event (vision and dental benefits need not be offered). The employer can charge for the cost
of conversion coverage, but the charge cannot exceed 102 percent of the cost of coverage for employees,
generally (including the portion the employer paid). Some events require coverage continuation for
eighteen months, and others require thirty-six months of coverage.
Table 20.3 COBRA Qualifying Events for Continuation of Health Insurance
1.
Voluntary (and in some cases, involuntary) termination of employment
2. Employee’s death
3. Reduction of hours worked resulting in coverage termination
4. Divorce or legal separation from an employee
5. Entitlement by an employee for Medicare
6. Dependent child ceases to meet dependent child definition
7. Employer filing for Chapter 11 bankruptcy
Note: For each event, it is assumed that the person was covered for group medical benefits immediately prior
to the qualifying event.
The employee has a valuable right with COBRA because continuation of insurance is provided without
evidence of insurability. In addition, the group rate may be lower than individual rates in the marketplace.
However, COBRA subjects employers to adverse selection costs and administrative costs beyond the
additional 2 percent of premium collected. Many terminated healthy employees and dependents will
immediately have access to satisfactory insurance with another employer, but many unhealthy employees
may not. This is because of the preexisting condition clauses that many group insurance plans have
(though this is less of a concern since the passage of HIPAA, as you will see below). After September 11,
Congress worked on creating subsidies for the payment of COBRA premiums to laid-off employees. This
law was part of the 2002 trade legislation. As of 2003, the law provides subsidies of 65 percent of the
premiums to people who lose their jobs because of foreign competition.
[3]
The American Recovery and
Reinvestment Act (ARRA) of 2009—intended as a stimulus against the economic recession—contains
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significant provisions regarding COBRA benefits (similar to the 2002 trade legislation) for involuntarily
terminated workers. This and other features of ARRA are discussed in the box “Laws Affecting Health
Care.” The application of COBRA for military reservists called to active duty is explained in the box
“Individual Coverage Rights When Called to Military Duty.”
Retiree Eligibility for Group Medical Benefits
Most active, permanent, full-time employees are eligible for group coverage. Employers that offer group
medical insurance are required to offer it to active workers over age sixty-five, under the Age
Discrimination in Employment Act (ADEA) discussed above. For these employees, Medicare becomes a
secondary payer. Some employers choose to offer continuation of group medical benefits to employees
who have retired. This coverage is like Medigap insurance (discussed in Chapter 22 "Employment and
Individual Health Risk Management"), where Medicare is the primary payer and the group plan is
secondary. Typically, the retiree plan is less generous than the plan for active workers because it is
designed simply to fill in the gaps left by Medicare.
Historically, employers have paid medical premiums or benefits for retirees out of current revenues,
recognizing the expense in the period that it was paid out. However, in 1993 the Financial Accounting
Standards Board (FASB 106) began phasing in a requirement that employers recognize the present value
of future retiree medical expense benefits on the balance sheet during the employees’ active working years
rather than the old pay-as-you-go system. The negative effect of these new rules on corporate earnings has
been significant. Consequently, most employers have been cutting back on health benefits promised to
retirees, and only about a third of the companies that had retiree health care in 1990 still had them a
decade later.
Portability: HIPAA
Title I of the Health Insurance Portability and Accountability Act (HIPPA) of 1996 protects employees
who change jobs from having to start a new waiting period before a preexisting condition is covered. For
example, before HIPAA, a person with diabetes might not want to change jobs, even for a much better
position, because it would mean going for a time without coverage for daily insulin shots and possible
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complications of the illness. Many employees were trapped in such situations before HIPAA. After the
enactment of HIPAA, a person with diabetes could change jobs, and health insurance providers, without
fear of losing coverage on that specific condition.
HIPAA provides protection for both group and individual health insurance. In essence, it
provides portability of coverage: when an employee leaves one job and starts a new job, the coverage of
health insurance under the new employer’s program cannot exclude benefits for preexisting condition, as
long as the break in health coverage is no longer than sixty-three days. Portability does not mean carrying
the actual coverage of the old employer to the new one, but rather carrying forward the qualification for
preexisting conditions. For example, Joe was employed by Company A for ten years and had health
coverage under that employer. He accepted a job offer from Company B. One month before changing his
job, he broke his leg in a skiing accident. Under HIPAA, the new company cannot limit coverage for the
injured leg. If Joe needs surgery on this leg in three months, the health coverage under Company B will
pay for the surgery. Before HIPAA, Joe would have had to stay covered under his old employer, paying the
full amount himself through COBRA, until the preexisting condition period of the new employer was met.
That could have been six months, a year, or even longer.
Under HIPAA, an employer can impose only up to twelve months preexisting conditions exclusions for
regular enrollment and up to eighteen months for late enrollment. During an exclusion period, the health
plan has to pay for all other conditions except the preexisting condition. Prior group health coverage
applies to these limits. Thus, if an employee’s only previous group health coverage was for six months
with Company A, the preexisting conditions exclusion from new Company B would last for just six
additional months rather than the full twelve. Under HIPAA, a preexisting condition is defined as a
condition for which the employee received any treatment within the six-month period before enrolling
with the new employer.
The details of HIPAA are complex, but the gist is that an employee without a break in health coverage will
never have to meet a preexisting condition period more than once in a lifetime, if at all. When an
employee leaves a job, the employer is required to provide a certificate of health coverage. This certificate
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is then taken to the next employer to ensure that no preexisting conditions are imposed on the employee.
Employers who neglect to give the certificate are subject to penalties of $100 per day. More on HIPAA and
other recent health care-related laws is featured in the box “Laws Affecting Health Care.” Further, the
application of HIPAA for military reservists called to active duty is detailed in the box “Individual
Coverage Rights When Called to Military Duty.”
Laws Affecting Health Care
The Health Insurance Portability and Accountability Act (HIPAA)
The Health Insurance Portability and Accountability Act (HIPAA) provides rights and protections for
participants and beneficiaries in group health plans. HIPAA was signed into law on August 21, 1996, and
became effective for all plans and issuers beginning June 1, 1997. The act protects workers and their
families by doing the following:
•
Limiting exclusions for preexisting medical conditions
•
Providing credit against exclusion periods for prior health coverage and a process for showing
periods of prior coverage to a new group health plan or health insurance issuer
•
Providing new rights that allow individuals to enroll for health coverage when they lose other
health coverage, get married, or add a new dependent
•
Prohibiting discrimination in enrollment and in premiums charged to employees and their
dependents based on health status-related factors
•
Guaranteeing availability of health insurance coverage for small employers and renewability of
health insurance coverage for both small and large employers
Newborns’ and Mothers’ Health Protection Act
The Newborns’ and Mothers’ Health Protection Act of 1996 requires plans that offer maternity coverage to
pay for at least a forty-eight-hour hospital stay following childbirth (a ninety-six-hour stay in the case of a
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cesarean section). It was signed into law on September 26, 1996, and became effective for group health
plans for plan years beginning on or after January 1, 1998.
All group health plans that provide maternity or newborn infant coverage must include a statement in
their summary plan description advising individuals of the Newborns’ Act requirements: a mother may
not be encouraged to accept less than the minimum protections available to her under the Newborns’ Act,
and an attending provider may not be induced to discharge a mother or newborn earlier than forty-eight
or ninety-six hours after delivery.
Women’s Health and Cancer Rights Act
The Women’s Health and Cancer Rights Act (WHCRA) contains protections for patients who elect breast
reconstruction in connection with a mastectomy. It was signed into law on October 21, 1998, and became
effective immediately. WHCRA requires that any plan offering mastectomy coverage must also include
coverage for the following:
•
Reconstruction of the breast on which the mastectomy was performed
•
Surgery and reconstruction of the other breast to produce a symmetrical appearance
•
Prostheses and physical complications at all stages of mastectomy, including lymphedemas
Under WHCRA, mastectomy benefits may be subject to annual deductibles and coinsurance consistent
with those established for other benefits under the plan or coverage. Group health plans covered by the
law must notify individuals of the coverage required by WHCRA upon enrollment, and annually
thereafter.
Mental Health Parity Act
The Mental Health Parity Act (MHPA), signed into law on September 26, 1996, requires that annual or
lifetime dollar limits on mental health benefits be no lower than any such dollar limits for medical and
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surgical benefits offered by a group health plan or health insurance issuer offering coverage in connection
with a group health plan. The law does not apply to benefits for substance abuse or chemical dependency.
American Recovery and Reinvestment Act
Signed by President Barack Obama on February 17, 2009, the American Recovery and Reinvestment Act
(ARRA, or H.R. 1) authorizes $787 billion in federal spending toward infrastructure, direct aid, and tax
cuts as a stimulus for the U.S. economy in recession. Within the framework of that objective, it includes
provisions affecting health care. H.R. 1 allows up to nine months of COBRA premiums to be subsidized at
65 percent for workers involuntarily terminated between September 1, 2008, and December 31, 2009,
whose income is under $125,000 for individuals or $250,000 for families (to receive full benefits).
Workers involuntarily terminated during this period who could not initially afford COBRA continuation
are given an additional sixty days to elect COBRA coverage through the subsidy. This provision is
designed to help an estimated 7 million people maintain health insurance and is expected to account for
$24.7 billion of the ARRA funds. H.R. 1 also directs about $338 million in Medicare payment reductions
for teaching hospitals, hospice care, and long-term-care hospitals. In another provision, the act aims to
invest $19 billion in health information technology, thus encouraging the use of electronic health records
for the exchange of patient health information. Ideally, this would see 90 percent of doctors and 70
percent of hospitals convert to electronic health records over the next decade, saving taxpayers $12 billion
in the long run. Finally, ARRA sets aside $1.1 billion for federal agencies to draw upon for conducting
studies on cost-benefit comparisons of various health care treatments.
Sources: Publications of the U.S. Department of Labor, Employee Benefits Security Administration
athttp://www.dol.gov/ebsa/faqs/faq_consumer_hipaa.html; “Link to H.R. 1 Conference Report
Summary,” National Underwriter Online News Service, February 13,
2009,http://www.lifeandhealthinsurancenews.com/News/2009/2/Pages/Link-To-HR-1-ConferenceReport-Summary.aspx, accessed March 13, 2009; Allison Bell, “Obama Signs H.R. 1,” National
Underwriter, Life/Health Edition, February 19,
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2009,http://www.lifeandhealthinsurancenews.com/News/2009/2/Pages/House-Passes-HR-1-Ball-OnTo-Senate.aspx, accessed March 13, 2009.
Individual Coverage Rights When Called to Military Duty
With so many U.S. armed forces in Iraq and Afghanistan, the Department of Labor answers the following
questions about the benefits-related rights and responsibilities of those called to active duty and their
civilian employers.
My family had health coverage through my employer when I was called for active duty in
the military. What are my rights concerning health coverage now?
If you are on active duty for more than thirty days, you and your dependents should be covered by military
health care. For more information on these programs, contact your military unit.
In addition, two laws protect your right to continue health coverage under an employment-based group
health plan. The Consolidated Omnibus Budget Reconciliation Act (COBRA) provides health coverage
continuation rights to employees and their families after an event such as a reduction in employment
hours. Also, the Uniformed Services Employment and Reemployment Rights Act (USERRA) of 1994 is
intended to minimize the disadvantages that occur when a person needs to be absent from civilian
employment to serve in the uniformed services.
Both COBRA and USERRA generally allow individuals called for active duty to continue coverage for
themselves and their dependents under an employment-based group health plan for up to eighteen
months. If military service is for thirty or fewer days, you and your family can continue coverage at the
same cost as before your short service. If military service is longer, you and your family may be required to
pay as much as 102 percent of the full premium for coverage. You should receive a notice from your plan
explaining your rights.
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The Health Insurance Portability and Accountability Act (HIPAA) may give you and your family rights to
enroll in other group health plan coverage if it is available to you (e.g., if your spouse’s employer sponsors
a group health plan). You and your family have this opportunity to enroll regardless of the plan’s
otherwise applicable enrollment periods. However, to qualify, you must request enrollment in the other
plan (e.g., your spouse’s plan) within thirty days of losing eligibility for coverage under your employer’s
plan. After special enrollment is requested, coverage is required to be made effective no later than the first
day of the first month following your request for enrollment. If you are on active duty more than thirty
days, coverage in another plan through special enrollment is often cheaper than continuation coverage
because the employer often pays part of the premium. For more information on the interaction of COBRA
and HIPAA, see IRS Notice 98-12: “Deciding Whether to Elect COBRA Health Care Continuation
Coverage After the Enactment of HIPAA,” on the Employee Benefits Security Administration (EBSA) Web
site athttp://www.dol.gov/ebsa, which can be found at the link Publications. You can also call toll-free
(
1.866.444.EBSA[3272]) for a free copy.
Note: When considering your health coverage options, you should examine the scope of the coverage
(including benefit coverage and limitations, visit limits, and dollar limits); premiums; cost-sharing
(including copayments and deductibles); and waiting periods for coverage.
My family and I had health coverage under my employer’s group health plan before I was
called on active duty. We let this coverage lapse while I was away and took military health
coverage. When I return to my employer from active duty, what are our rights to health
coverage under my old plan?
Under USERRA, you and your family should be able to reenter your employer’s health plan. In addition,
your plan generally cannot impose a waiting period or other exclusion period if health coverage would
have been provided were it not for military service. The only exception to USERRA’s prohibition of
exclusions is for an illness or injury determined by the Secretary of Veterans Affairs to have been incurred
in, or aggravated during, performance of service in the uniformed services, which is covered by the
military health plan.
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While I am on active duty, is my employer required to continue to make employer
contributions to my 401(k) plan?
There is no requirement for your employer to make contributions to your 401(k) plan while you are on
active duty. However, once you return from military duty and are reemployed, your employer must make
the employer contributions that would have been made if you had been employed during the period of
military duty. If employee contributions are required or permitted under the plan, the employee has a
period equal to three times the period of military duty or five years, whichever ends first, to make up the
contributions. If the employee makes up the contributions, the employer must make up any matching
contributions. There is no requirement that the employer contributions include earnings or forfeitures
that would have been allocated to the employee had the contributions been made during his or her
military service.
Sources: Adapted from “Reservists Being Called to Active Duty,” U.S. Department of Labor, Employee
Benefits Security Administration, December 2007,http://www.dol.gov/ebsa/newsroom/fsreservists.html,
accessed April 13, 2009.
Multinational Employee Benefit Plans
Multinational corporations manage the human resource risk across national boundaries. The most
common concern of multinational employers is the benefit needs of expatriates, U.S. citizens working
outside the United States. However, the employer is also concerned with managing benefits for employees
who are not U.S. citizens but who are working in the United States. In addition, benefits must be
considered for employees who are not U.S. citizens and who work outside the United States.
The corporation designs multinational benefit policy to achieve several objectives. First, the plans need to
be sufficient to attract, retain, and reward workers in locations around the world where a corporate
presence is required. The plan needs to be fair for all employees within the corporation itself, within the
industry, and within the country where employees are located. In addition, the multinational benefit
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policy needs to facilitate the transfer of workers across national boundaries whenever necessary with a
minimum of overall transaction costs.
Typically, the multinational employer tries to protect the expatriate from losing benefits when the
employee transfers outside the United States. A premium may be paid at the time of the move to
compensate the employee for international relocation. The corporation often provides the expatriate with
the same life, long-term disability, medical, and pension benefits as those provided to their U.S.
employees. However, in some cases the employee may receive medical care or short-term disability
benefits like those of the host country. When employers provide benefits in several international
locations, they may use an international benefit network to cover employees across countries under
one master insurance contract. This can simplify international benefit administration. The employer must
also consider the social insurance systems of the host country and coordinate coverage as necessary with
the employee’s home country’s system.
Cultural and regulatory factors differ among countries and affect benefit design, financing, and
communication. This makes international employee benefits management a dynamic and challenging
field. With the continued globalization of business in the new millennium, career opportunities in
international benefits management are likely to grow.
K E Y TA K EA WAYS
In this section you studied federal legislation affecting employee benefit plans and
employment changes as well as international employee benefits coverage and
concerns:
•
The Age Discrimination in Employment Act (ADEA) stipulates that benefits
must be continued for older workers, but it allows proportional reduction of
some benefits.
•
The Civil Rights Act requires employers to provide the same benefits for
pregnancy and related medical conditions as are provided for other medical
conditions.
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•
The Americans with Disabilities Act (ADA) states that disabled employees must
have equal access to the same health benefits as other employees, with the
same allowances for coverage limitations.
•
The Family Medical Leave Act (FMLA) states that employers must give eligible
employees up to twelve weeks of unpaid leave during any twelve-month
period for qualifying reasons.
•
COBRA requires employers to allow employees, their spouses, and their
dependents to continue health coverage at the individual’s expense (up to 102
percent of group coverage and in the event that medical coverage would
otherwise end) for eighteen to thirty-six months without new evidence of
insurability.
•
HIPAA protects employees who change jobs from having to start a new
waiting period before a preexisting condition is covered.
•
Multinational employee benefit plans covering noncitizen employees and
expatriates must be sufficient to attract, retain, and reward workers; must be
fair for all parties affected; and must facilitate transfer of workers
internationally when necessary and at minimum cost.
D I SCU S S ION Q UE ST IO N S
1. Recall the discussion of integrated benefits in Chapter 16 "Risks Related to the
Job: Workers’ Compensation and Unemployment Compensation" . How do
you think a good integrated benefits program would be coordinated with
workers’ compensation, FMLA, and ADA? See the box, “Integrated Benefits:
The Twenty-Four-Hour Coverage Concept” in Chapter 16 "Risks Related to the
Job: Workers’ Compensation and Unemployment Compensation" .
2. In what ways can the FMLA create conflicting interpretations?
3. The intent behind the passage of COBRA was to reduce the number of
uninsured persons. How does COBRA work to achieve this objective?
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4. Now that we have HIPAA, do we need COBRA? Give an example.
5. The Meridian Advertising Agency has 1,340 employees in six states. The main
office is in Richmond, Virginia. Meridian has employed Dan Smith for the last
ten years. Three months ago, Dan had a foot injury for which he is still being
treated. He recently accepted a job offer from a Washington, D.C., advertising
agency. Before Dan leaves, Meridian’s human resources department invites
him for an exit interview. If you were Meridian’s employee benefits specialist,
what would you tell Dan about his rights? Explain to Dan about COBRA and
HIPAA.
6. If Phoebe, who has a heart condition, leaves her current job (which provides
group health benefits) for another one with similar benefits, will she
immediately be covered for her heart condition? What if she is laid off from
her job and does not find another job for eight months?
7. Mandy’s employer will not provide coverage for claims relating to her chronic
asthma until she satisfies the group health plan’s twelve month preexisting
condition exclusion period. Nine months into the job, Mandy obtains
employment elsewhere. The new employer also imposes a twelve-month
exclusion period for preexisting conditions. When will Mandy’s condition be
covered by her new employer?
8. Why might the benefits manager of a multinational corporation use an
international benefits network?
[1] Rebecca Auerbach, “Your Message to Employers: Manage FMLA with Other Benefit
Programs,” National Underwriter, Life & Health/Financial Services Edition, April 22, 2002.
[2] This case, Ragsdale v. Wolverine worldwide, No. 00-6029 (U.S. March 19, 2002), hinged on
the extent that employers are obligated to inform employees of their rights when they begin a
leave of absence. Wolverine had given Tracy Ragsdale time off for cancer treatment, but when
she was unable to return to work after thirty weeks, Wolverine ended her employment.
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Ragsdale filed suit, citing a FMLA regulation that a leave of absence counts against the
employee’s FMLA allowance only if the employer specifically designated it as FMLA leave. She
claimed she was still entitled to her twelve weeks of FMLA leave. The Court disagreed and
declared that regulation invalid. One of the Court’s reasonings was that Ragsdale had not been
harmed—she would not have been better off if Wolverine had designated her original leave as
FMLA. See Steven Brostoff, “U.S. High Court Ruling Helps RMs,” National Underwriter Online
News Service, March 20, 2002.
[3] Jerry Geisel, “COBRA Subsidy Could Increase Beneficiaries: Survey,”Business Insurance,
August 30, 2002.
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20.5 Review and Practice
1.
What are the main ways in which group insurance differs from individual insurance?
2. Why is group insurance proportionately less expense than individual insurance?
3. Rosa Sanchez, single, age twenty-five, received two job offers after college graduation. Both were with
organizations that she respected, and the nature of the work at each place sounded very interesting to
her. One job was with a larger, well-established firm and offered $22,000 per year in salary plus
noncontributory benefits worth $7,000 per year. The other job was with a small business and offered
a salary of $30,000 per year without employer voluntary benefits (the employer is required to pay for
social insurance programs). Rosa’s mother suggested that she make the choice between the two jobs
based on which offered better total compensation.
a.
What factors should Rosa consider in determining the better package? Which package do
you think maximizes her total compensation?
b. Which employer is economically better off (all else being equal), the one offering salary
plus benefits or the one offering salary only? Explain your answer.
Henry Zantow, the comptroller for Kado Industries, was discussing the supposed advantages of a
true cafeteria plan versus a traditional plan with Lloyd Olsen. Lloyd agreed with Henry that a cafeteria
plan certainly seemed the better of the two plans. Both Henry and Lloyd looked at each other and in
the same breath said, “I wonder why anyone would choose a traditional plan?”
a.
What is your answer to this question?
b. If the corporation decides to use a cafeteria plan, why might it want a minimum level of
core benefits?
What does it mean to self-insure and have the stop-loss programs for workers’ compensation and
for group health insurance?
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Jan Czyrmer, the employee benefits manager at Ludlow Enterprises, wants to restructure the
leave policy for the company. He is concerned that employees abuse the sick leave policy, taking sick
leave time for personal reasons not related to illness. He wants to abolish particular types of leave
(such as sick leave, vacation leave, personal leave) and give employees a certain number of general
leave days per year to use as they choose.
a.
What advantages might Jan cite to convince upper management that consolidating leave
time may be helpful for Ludlow Enterprises?
b. If upper management rejects Jan’s idea of a major restructuring of leave time, what can
he do to prevent abuse of the current sick leave policy? What steps can be taken to reduce
moral hazard within the traditional leave system?
Knowledge Networking, Inc., provides a growing business of high-tech and electronics equipment
and software. It is a specialty retail and online business that has tripled its revenues in the past seven
years. The company started fifteen years ago and includes fifty outlets on both the East and West
coasts. In 2005, the company went public and now, despite the major financial crisis, it is doing very
well with innovation and creative offerings. The company has 5,600 full-time employees and 1,000
part-time employees. Knowledge Networking, Inc., provides all the social insurance programs and
offers its employees a cafeteria plan with many choices. Employees have generous choices of health,
life insurance, and disability coverages; dental and vision care; premium conversion plan; and flexible
spending accounts as part of the cafeteria plan. Each employee receives $5,500 a year from the
employer to pay for the benefits.
a.
Describe in detail your understanding of the structure of the cafeteria plan of Knowledge
Networking, Inc. (design this cafeteria plan). What are the advantages and disadvantages
of this cafeteria plan?
b. Knowledge Networking, Inc., follows the federal laws: FMLA, ADA, Civil Rights Act, and
Age Discrimination in Employment Act. If you were the employee benefits manager, how
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would you explain the impact of each of these acts on the employee benefits of the
employees?
c.
How would the group insurance rates be computed (what factors play into the
computation) for such a company?
d. Why might Knowledge Networking, Inc., prefer to self-insure their workers’
compensation and health insurance rather than buy insurance?
Yolanda Freeman is evaluating whether federal nondiscrimination laws have helped or hurt
employees.
a.
Which federal laws particularly affect employee benefits? Which workers are particularly
affected by each law?
b. Who pays the cost of requiring that benefits be paid on a nondiscriminatory basis? Do
additional benefit costs have any effect on employee wage levels?
c.
If federal laws did not require coverage for certain employees and their dependents, who
would pay for benefits for these individuals? Do you think that social welfare is
maximized by mandating coverage for certain workers and their dependents through
these nondiscrimination laws?
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