RMI 2101 Topic 8: Managing Human Capital Risk

RMI 2101 Temple U

Employee Benefits

- Any type of compensation other than direct current salary or wages

- Total compensation = Current wages (cash) + Value of EE benefits

Why employee benefits are important

- Spend high $$ on EE benefits, approx. 40% of payroll

- Rate of increase in cost is high - growing much faster than cash wages

> Results in labor strike

> Serious financial impacts for employers

Why do firms offer employee benefits?

- Attract and retain capable employees

- Tax advantages

- Productivity and better EE relations

- Employers can take advantage of group insurance

Benefit Financing

Non-Contributory:

- Employer pays the full cost of the plan

- Employee is covered without making a financial contribution

- All eligible employees must be covered

- Eligibility = participation

Contributory:

- Employer and employee share in the cost of the plan

- For an eligible employee to become a participant, they must make a financial contribution

Voluntary:

- Employee pays the entire cost of the insurance plan

Section 125 Plans

- Section 125 (or cafeteria) plans is an employer-sponsored benefit plan that gives employees access to certain taxable and non-taxable pretax benefits

- Employees contribute a portion of their salary on a pretax basis to pay for the qualified benefits

> that portion is not considered wages for federal income tax purposes

- Cafeteria plan contributions are not usually subject to FICA taxes, SUI taxes and Workers Compensation premium

- ER can deduct the cost of employee benefits as an ordinary business expense (same as salary)

Income Taxes

- The employee is sometimes not taxed on the value of their employer provided benefits

- Method to compensate an employee tax free (for some benefits)

Health insurance example

Premium cost is entirely income tax free for the employee (no limit)

- Suppose an employee has a choice between:

> $5000 cash

> Health insurance - cost of $5000

Health insurance

Employer's pov:

- Health insurance is the same as an increase in salary of $5000

- Both are tax deductible

Employee's pov:

- Choose cash

- Creates tax liability

- If tax rate is 20% - employee takes home $4000 of the $5000

What is the pre-tax salary equivalent of a tax-free benefit of $5000? Employee has a 20% tax rate.

x = salary

t = tax rate

x - t(x) = after tax salary

x - 0.20(x) = $5000

0.8x = $5000

x = $6250

Flexible spending accounts

An employee agrees to reduce their salary pre-tax by a certain amount and money is deposited into a FSA

Three type:

1. Healthcare FSA

2. Dependent FSA

3. Transportation Spending Accounts

Dependent care FSA

- Child care expenses

- Elders care expenses

Medical care FSA

- Certain medical procedures not covered by medical plan

- Co-payments

Transportation FSA

- Public transit or parking

Flexible spending accounts cont.

- Any unused funds at the end of the plan year remaining in a FSA are forfeited to the ER

- Used to fund administrative costs of FSA

- "Use it - or lose it" rule

FSA Maximums

Medical

- IRS sets limit at $3,300

Dependent

- IRS sets limit at $5,000
Transportation
- IRS sets limit at $4,000

Section 125 Plans

- Favorable tax treatment exists only for qualified plans

- Does not discriminate in favor of key employees or highly compensated employees

- IRS sets the guidelines

Mandated/Compulsory Benefits

- AKA Social Insurance Programs

Common Traits:

- Mandate Participation (required)

- Require the employer to act in a risk bearing capacity to provide the insurance and/or pay benefits

- Include Social security, Workers' Compensation, and Unemployment Compensation Insurance

Group Insurance

- Group Insurance (GI) vs. Individual Insurance (II)

- Exposure unit is a group of individuals

> Insure group as a whole

> No individual underwriting

> Looks at broad characteristics of group to determine rates
Usually experience rated

> Premium/rate now is based upon past claims experience of the group

> Low claims = save in rates

> High claims = penalized

> Provides an incentive to control losses

Group Insurance Advantages

Rates are generally lower than II

- For the same level of Expected Cost, GI is less expensive per EE than II

- No individual underwriting

> Especially helpful if a bad risk

> Creates a possible adverse selection issue

- Commissions tend to be lower

- ER helps collect the money

Methods to control Adverse Selection

1 - Waiting periods

- A period of time an EE must work before being covered by GI

2 - Pre-existing condition exclusions (PCEs)

- Condition that has been treated and a claim filed for with an insurer

- Coverage is somehow limited

3 - Minimum Participation Requirements

- Insurer may require a minimum % of eligible EEs can be covered under the group plan

4 - A minimum group size

- Rate smaller groups separately

- No experience rating

- Possibly engage in some individual underwriting

5 - Steady flow of persons through the group

- Newer, younger, better risks should enter to replace older, less healthy risks

- If group is closed, the premium increases dramatically and good risks drop out if it is optional coverage exists

6 - The reason the group exists

- Should exist for reasons other than the purchase of insurance

- Acceptable groups

> ER/EE based group

> Professional associations

> Alumni associations

> Veterans groups

Disadvantages to benefit plans

- Coverage may be temporary

- An EE leaves the group - coverage might terminate

Married with Children

Two EEs

- EE (A) is single

- EE (B) is married and has 3 kids

- Salespeople - Equally productive

- Make 100,000 annually in commission

- Also receive Health insurance

- EE (B) is over compensated by virtue of the value of their benefit plan

> If compensation is equalized

> Pay EE (A) more in salary

> Pay EE (B) less than EE (A) in salary

> Make EE (B) pay more for benefit plan