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When I agreed to write an article on the current state of employee benefits for Global Benefits Vision, it was suggested that I address issues that were worrying our clients. And I kept coming back to the same answer: there just aren’t any!
We tend to work with boards and C-suites on strategic HR activities and employee benefits—this latter topic having rarely been mentioned by a CEO in the past 10 years. So while benefits practitioners may be worried about many issues, the corner office appears to believe that everything is in a nicely sealed box and under control, managed two or three levels below even the head of HR.
How different from when I began my career in the late 1970s. I haven’t thought much about the historical evolution of employee benefits, but I realized that in order to comment on employee benefits today and more importantly their future, we were first going to have to consider the past.
In an early role I managed the investment and accounting administration for a significant U.K. public sector pension plan, and then later the pension finance function for a manufacturing company. My career in internal benefits management ended in a role that reported to the Office of the President of a global manufacturing company. Benefit liabilities were a big, important, strategic deal, with major financial consequences. I like to think (probably mistakenly) that was why someone with a finance background had been appointed to manage them in a global capacity. If we were not able to fix the benefits “problem” we literally were not going to survive as an organization, or so we were led to believe.
The “problem” was too big a surplus in pension plans and not enough funding for health benefits, particularly those for retirees in North America. My job was to try to rebalance benefit funding while reducing the overall cost and maintaining the promises made to our current and former employees. The cause of the imbalance was years of what in retrospect were irresponsible assumptions that caused overfunding in pension plans, and union negotiations that promised deferred retirement benefits without any real understanding of how these were going to be financed. The assumption was that manufacturing would continue to grow and future cash flows would take care of the growing deficit. Deferred benefits were popular as a negotiation feature because they did not require any immediate cash outlay, nor any accounting requirement for strict, consistent recognition of the cost.
This strategy ran into difficulties with the largely unanticipated demise of manufacturing in North America and Europe culminating in a reducing number of active employees supporting a growing retiree base ironically incented into retirement by the aforementioned negotiated benefits! As manufacturing capability relocated to Mexico and Asia, the unfunded deferred health-care liabilities in North America increased and the surpluses in U.K. pension plans decreased as they were absorbed into financing an increasing number of early retirements.
We were a task force to address international imbalances between operations in order to transfer techniques and methodologies for managing liabilities, cash flow, and employee obligations. In other words, our role was to build scale from a knowledge base that eventually led to physically combining some risks for the purposes of insurance to reduce cost.
Legislation governing benefits management in Europe was mostly based around tax or trust law; in North America it was more prescriptive but also limited. There were virtually no systematic accounting requirements that enabled investors to compare costs between companies on a comparable basis. For example, we adopted a three- year amortization of pension surplus to secure greater recognition in our income statements; more stable companies used longer periods. The end of the 1980s and early 1990s was a wild time in employee benefits, before legislation and accounting rules caught up to employers who were dealing with the competitive pressures of a shrinking manufacturing base.
The benefits “problem” affected other aspects of business too. For example, often companies walked away from acquisitions where projected unfunded retiree liabilities could not be met with projected cash flows, while others purchased companies with the surplus in their pension funds.
As business deteriorated and the payroll became harder to fund, we negotiated with our unions a “holiday” from their pension contributions in lieu of an inflation adjustment to their pay. The avoided employee contributions were funded by pension fund surpluses – an effective method of liberating these. In a particularly difficult period we persuaded accountants to recognize a small surplus in a funded disability plan in the company’s financial statement, so that the company was able to meet ratios that satisfied debt covenants and thus avoid a cash call from the banks.
At one point we confronted legal action simultaneously from trade unions in the United Kingdom and the United States who felt that the company had reneged on bargaining commitments to active and retired employees. The issue centered on less potential benefits for a temporary period or no benefits permanently, because the company would have ceased to exist. These were challenging times for many Rust Belt organizations that were forced to undertake a permanent change to their business models as the global economy transitioned. Employee benefits may have been the “problem” but they also became an important component of the solution. But there needed to be a catalyst that brought order to their management.
I recall a discussion with our senior executive committee around this time that centered on a prediction that the next major business fraud would be perpetrated on a pension fund. This was just months before Robert Maxwell’s Mirror Group uncovered a major shortfall in its pension fund – a turning point that identified the need to tighten the administrative framework around employee benefits.
A CHANGED LANDSCAPE
Today, legislation, accounting rules, and public opinion have finally combined to permanently change the management and financing of employee benefits. Unfunded deferred liabilities are recognized in financial statements and are no longer added to with new designs or features, and superior management of key elements such as health care has further mitigated exposure. Pension surpluses discouraged by taxation systems have vaporized with poor investment performance and off-the-mark mortality and pay projections, and have turned to deficits.
Employee benefits for most companies today are a competitive necessity. But as a strategic tool for attracting and motivating employees their importance has declined significantly.
This compliance framework created to control activity and regulate the scoreboard now defines the work of professionals. Tighter accounting, tax and funding rules started in the 1980s began to define the “box” in which we work today.
Companies subject to global accounting standards had to be more disciplined about managing design changes and mitigating the risk of recreating deferred entitlements. They began to limit the autonomy of subsidiaries to enact design changes or add new plans. Design changes, however, were needed and were being made more frequently to provide employee choice, especially in countries with company sponsored health care plans, but primarily as an attempt to reduce future cost exposure.
The first flex plans enabled employees to choose the level of coverage they wanted by selecting features that reflected their usage. (How did we ever think that would reduce claims?) As demographics changed employees wanted more choice and this was eventually aided by legislation. In the United States, for example, this has led to Health Exchanges. But choice means more administration and experience cost—two features that employers were trying to avoid.
Home Offices began to focus on supply management and more cost effectiveness. Ironically they began to consider prior levels of unfunded liability, to feel comfortable again with self-insurance, but this time in a controlled and calculated setting.
Scale purchasing of risk through captive insurance companies and multinational pooling, and their various hybrids, have grown in sophistication. Most employers are not expert in, and would prefer not to be in the business of, managing employee mortality and investment risk – it is too difficult to predict and costly to put right when assumptions prove to be incorrect. We have therefore seen employers exit management of these risks where they can, for example transferring mortality and investment risk to employees through defined contribution plans. With companies’ improved understanding of the risks that they have to retain and cannot transfer to employees comes a recognition that the best way to achieve further scale savings benefits is by outsourcing to professionals or those who can achieve greater scale, e.g., pension risk exchanges.
Today most employers would rather not have the obligation of providing employee benefits but they appear to have managed to keep employee benefits costs reasonably under control. They are no longer the strategic imperative they once were, and neither serve to motivate or retain staff as they once did. (This is arguable in some parts of the United States with regard to health care, but that may be about to change.)
Baby Boomers are leaving the workplace and employers are facing the biggest upheaval in work culture since World War II. This generational shift is causing employers to question how far they can go in meeting the needs of a new employee cohort. They are certainly not going to be persuaded to return to the heavy administrative responsibilities they once had. The pressure to care for their employees no longer exists, and new employees who treat work as a commodity will see no logic in having their health care and retirement savings attached to an employer for whom they plan to work for just a few years.
Employers began to provide their employees with benefits initially for three reasons: benevolence, scale, and taxes.
REASON FOR BENEFITS #1: BENEVOLENCE
Employers were expected to take care of workers injured on the job or taken sick. They reluctantly recognized that a healthier workforce would probably minimize staffing costs and help succession planning, and over time “benefits” would make an attractive employment feature that better positioned the company to compete for scarce skills.
Today, though, employees no longer need to be taken care of by their employers. Younger people are pushing back against an outdated patriarchal approach to healthcare where cost-containment masquerades as benevolence through wellness programs. Employees resent being faced with their employer’s definition of wellness and perceive high deductibles as a cost transfer device for benefits they don’t really want. With a growing interest in holistic and personalized health and wellness solutions, employer plans are just not flexible or attractive enough, and employers will resist adding the increased administration cost to make them so.
Having a retirement fund for when workers became too old to function was important to employers who needed to transition to more productive, younger workers. The average tenure of new employees today is three to four years with recruiters, suggesting that any longer than four and people will think that there must be something wrong with you. Work is a commodity and single careers with one employer are being replaced with concurrent jobs with multiple employers. Savings and retirement plans that offer a deferred company match as an incentive for employees to contribute will make no difference to whether an employee goes or stays. There really is no compelling logic to this design as an attraction or retention motivator for modern workers.
Employers are generally distrusted, albeit working hard to correct that in the age of engagement. Given a choice, the majority of employees would likely prefer to uncouple their healthcare and retirement savings from their work and be able to select an offering that meets their personal needs. Benefit plans have ceased to be just safety nets and now include life-style enablers, such as teeth whitening and massage. And employers would prefer this to the complex administration and associated cost of providing employee benefit plans. If they were confident that competitors would do the same, most would probably jettison employee benefits and replace them with a cash allowance and a comprehensive worker’s compensation program.
REASON FOR BENEFITS #2: SCALE
Employees originally needed basic protection from life’s misfortunes, and having employers purchase this safety net for them was less costly than purchasing it individually, as employers were able to secure scale pricing.
Technology provides a huge opportunity to improve on employer-based scale purchasing. Today we can buy a travel policy from a smartphone on the way to the airport. Direct access to consumers should enable delivery of better designed and more acutely priced products— the “Uberization” of employee benefits. Scale is no longer limited to the size of an employer or even a group of employers. What’s to stop all high blood pressure patients in Florida forming a medication buyers’ club or everyone in Ontario who needs regular chiropody grouping together for an improved supplier arrangement? The advantage that employers had—their ability to purchase insurance in bulk and more effectively than their employees—is rapidly shrinking.
Defined benefit pension plans were designed around similar principles. Companies had scale advantage in mitigating mortality, investment, and inflation risk. We now know that only governments (and then only sometimes!) have the financial wherewithal to provide defined benefit retirement plans. The personal defined contribution retirement savings plan is already well-established in many jurisdictions and will grow in popularity as the preferred retirement savings vehicle. It is also easily portable and easily funded by, but does not necessarily need to be attached to, an employer.
REASON FOR BENEFITS #3: TAXES
The most compelling of all the reasons for which employers provide benefits is that they can tax-deduct the cost with no corresponding tax levied on employees. If individuals were to purchase similar coverage, for the most part it would have to be with after-tax dollars. Tax incentives encouraged employers to shoulder the financial burden and are the primary motivation for their continuing to do so.
Australia, the United Kingdom, the United States, and Canada have all nibbled away at the tax effect, but transferring the tax benefits to individuals may not be as simple as it appears. When social change is necessary, governments have found it helpful to deflect responsibility onto employers, and to have them subsidize what otherwise would be part of the general tax burden. Governments have become used to employers contributing toward the health care and other safety net coverage of their populations. The UK government for example has suggested following the Brexit vote and the deterioration in investment values in pension plans that funding requirements be temporarily relaxed to allow employers time to fund the shortfall.
The clamor from employees to be able to self-direct their benefit choices will eventually come into conflict with this prevailing tax regime and lead to reform that allows workers to buy benefits with pre-tax dollars. However, don’t expect employers to completely leave the scene. They will no doubt be required to contribute or even administer their employee’s membership of legitimate external savings or insurance programs and ensure that minimum contributions are made, perhaps with some of the characteristics of the programs in France.
Several market efficiencies would result if this were to happen. For example, the “buyer” and “consumer” of health care services would be the same person, helping to clarify real consumer demand. Responsibility for consumption would also rest in the hands of the buyer. Clarity around the role of all participants would improve. An employer’s role in helping employees pay for their benefit programs will no longer be cluttered with issues of insurance, administration, or risk.
Retirement savings in a number of countries already have begun the exodus away from employers allowing employees more discretion in how they manage their savings and the risks they want to take.
SUMMARY
With a level tax playing field and no obvious advantages to retention or attraction of their (increasingly temporary) workforce, the road would be clear for employers to exit the sponsorship of traditional employer benefit programs and shed cost and administrative staff. Their participation would likely continue with a direct allowance paid to an institution of the employee’s choice. Employees want to be in control of their safety net or lifestyle enhancer (it would be their choice) and not have it subject to the perspective of an employer colored by the need to reduce cost.
They want to purchase benefits plans according to a budget that suits them, rather than one designed around their employer’s financial wherewithal.
Employers would of course be required to provide or contribute to Workers Compensation plans for injuries incurred on the job, including improved extended coverage for conditions that drain company productivity and negatively affect culture. Travel and Accident insurance would also continue to be provided for business travel. Expatriate coverage, where scale and purchase opportunities are less prevalent, would also make sense.
Corporate wellness initiatives would take on a more focused purpose, with employers removed from the temptation to direct them as a tool for reducing the exposure to medical claims. Wellness programs could focus on specific physical and mental causes of reduced productivity. Education and physical changes to the use of equipment and furniture in the workplace would be the direct result.
The workforce is in transition. Happier employees are more productive. Forward- thinking employers are asking themselves and their employees how to respond. Are we at a point where employees have more choice in where and how they secure benefits? Imagine an employee Wellbeing Center offering a selection of life and disability insurance, health, and dental plans, where individuals can choose the combination and design that suits them. Employers would provide a fixed contribution and employees would pay the balance, with part being tax deductible. Maybe not yet but soon employees will demand such a change and employers will react, unless of course together we start lobbying for choice now. Perhaps the time is approaching for employees to leave their employer out of their safety net decisions other than providing an allowance to a fund it.