Risk Management Mcloskey Exam 3

What are Employee Benefits?

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

What is the formula for total compensation?

Total compensation = current wages (cash) + value of EE benefits

What percentage of payroll do firms spend on EE benefits?

Approximately 40% of payroll

How does the cost of employee benefits grow compared to cash wages?

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

What are two negative results of high employee benefit costs?

Labor strife and Serious financial impacts for employers

Why do firms offer employee benefits? (reason 1)

To attract and retain employees

Why do firms offer employee benefits? (Reason 2)

Tax advantages

Why do firms offer employee benefits? (Reason 3) 

Productivity and better employee relations

Why do firms offer employee benefits? (Reason 4)

Employer can take advantage of group insurance

What is Non-Contributory benefit financing?

Employer pays the full cost of the plan

In non-contributory financing, does the employee make a financial contribution?

No, the EE is covered without making a financial contribution

In non-contributory plans, which employees must be covered?

All eligible EEs must be covered

What is Contributory benefit financing?

For an eligible EE to become a participant, they make a financial contribution (both ER and EE share the cost)

What is Voluntary benefit financing?

EE pays the entire cost of the insurance plan (100% employee paid)

What is another name for a Section 125 Plan?

Cafeteria Plan

What does a Section 125 Plan allow employees to do?

Contribute a portion of their salary on a pretax basis to pay for qualified benefits

Are Section 125 contributions considered wages for federal income tax purposes?

No, that portion is not considered wages for federal income tax purposes

Are Section 125 contributions subject to FICA taxes?

No, usually not subject to FICA taxes

Are Section 125 contributions subject to SUI taxes?

No, usually not subject to SUI taxes

Are Section 125 contributions subject to worker's compensation premiums?

No, usually not subject to worker's compensation premiums

How can an employer deduct the cost of employee benefits?

As an ordinary business expense (same as salary)

Is an employee taxed on the value of employer-provided health insurance premiums?

No, premium cost is entirely income tax-free for the EE (no limit)

If an EE chooses $5,000 cash with a 20% tax rate, how much tax do they pay

$1,000 in taxes (20% of $5,000)

If an EE chooses $5,000 cash with a 20% tax rate, how much do they take home?

$4,000

What is the formula to find pre-tax salary equivalent?

X - T(X) = after tax salary, where X = salary and T = tax rate

If a tax-free benefit is worth $5,000 and the tax rate is 20%, what is the pre-tax salary equivalent?

$6,250

How do you calculate the pre-tax equivalent? (Step by step for $5,000 benefit at 20% tax

X - 0.20(X) = $5,000 → 0.8(X) = $5,000 → X = $6,250

What is a Flexible Spending Account (FSA)?

An account where an EE agrees to reduce their salary pre-tax by a certain amount to pay for qualified expenses

How many types of FSAs are there?

Three types

What is the first type of FSA?

Health Care FSA

What is the second type of FSA?

Dependent Care FSA

What is the third type of FSA?

Transportation Spending Account

What does a Dependent Care FSA cover?

(Type 1) A: Child Care Expenses

What does a Dependent Care FSA cover? (Type 2)

Elder Care Expenses

What does a Medical Care FSA cover? (Type 1)

Certain medical procedures not covered by the medical plan

What does a Medical Care FSA cover? (Type 2)

Co-Payments

What does a Transportation FSA cover?

Public Transit or Parking expenses

Without an FSA, if you have $80,000 income and 25% tax rate, how much tax do you pay?

$20,000

Without an FSA, if you have $80,000 income, pay $20,000 tax, and have $5,000 child care costs, what's your net income?

$55,000 ($80,000 - $20,000 - $5,000)

With a $5,000 FSA contribution, what is your taxable income if you earn $80,000?

$75,000 (the FSA reduces taxable income)

With FSA: $75,000 taxable income at 25% tax rate = how much tax?

$18,750

How much do you save in taxes by using a $5,000 FSA at 25% tax rate?

$1,250 ($20,000 - $18,750)

What happens to unused FSA funds at the end of the plan year?

They are forfeited to the employer

What are forfeited FSA funds used for?

To fund administrative costs of the FSA

In a Medical FSA, if you contribute $1,200 per year, how much is available in January

$1,200 (the full annual amount is available immediately)

Who is at risk in the medical care FSA account?

The employer (ER) is at risk

Why is the employer at risk in a medical FSA?

Because the full annual amount is available immediately, but contributions are spread throughout the year

What is the 2025 IRS limit for Medical FSA?

$3,300

What is the 2025 IRS limit for Dependent Care FSA?

$5,000

What is the 2025 IRS limit for Transportation FSA?

$4,000

Can Section 125 Plans discriminate in favor of key employees?

No, they cannot discriminate in favor of key EEs or highly compensated EEs (HCEs)

Who sets the guidelines for Section 125 Plans?

The IRS

What is another name for Mandated/Compulsory Benefits?

Social Insurance Programs

What is the first trait of mandated benefits?

Mandate Participation (Required)

What is the second trait of mandated benefits?

Require employers to act in a risk-bearing capacity to provide insurance and/or benefits

Name one example of a mandated benefit

 Social Security

Name a second example of a mandated benefit

Worker's Compensation

Name a third example of a mandated benefit

Unemployment Compensation Insurance

What is the exposure unit in Group Insurance?

A group of individuals (not individual people)

Does Group Insurance use individual underwriting?

No, there is no individual underwriting

What does the insurer look at to determine rates in Group Insurance?

The broad characteristics of the group

What does "experience rated" mean?

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

In experience rating, what happens if the group has low claims?

They save on rates (rates go down)

In experience rating, what happens if the group has high claims?

They are penalized (rates go up)

What incentive does experience rating provide?

An incentive to control losses

Why is Group Insurance less expensive than Individual Insurance? (Reason 1)

No individual underwriting

Why is Group Insurance less expensive than Individual Insurance? (Reason 2)

Commissions tend to be lower

Why is Group Insurance less expensive than Individual Insurance? (Reason 3)

Employer helps collect the money

What is Method 1 to control Adverse Selection?

Waiting Periods

How do waiting periods control adverse selection?

Requires employees to wait before coverage begins, preventing people from joining only when they need coverage

What is Method 2 to control Adverse Selection?

Pre-existing Condition Exclusion (PCE)

What is a pre-existing condition?

A condition that has been treated and a claim filed for with an insurer

How is coverage affected by pre-existing conditions?

Coverage is somehow limited

What is Method 3 to control Adverse Selection?

Minimum participation requirements

What do minimum participation requirements mean?

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

What is Method 4 to control Adverse Selection?

A minimum group size requirement

How are smaller groups rated in group insurance?

Rate smaller groups separately

Do smaller groups get experience rating?

No, no experience rating for small groups

What might insurers do for smaller groups?

Possibly engage in some individual underwriting

What is Method 5 to control Adverse Selection?

Steady flow of persons through the group

What should replace older, less healthy risks in a group?

Newer, younger, better risks

What happens if a group is closed (no new members)?

The premium increases dramatically and good risks drop out

For what reason should an acceptable group exist?

For reasons other than the purchase of insurance

Name an acceptable type of group (Example 1)

EE/ER based group (employee/employer)

Name an acceptable type of group (Example 2)

Professional Association

Name an acceptable type of group (Example 3)

Alumni Association

Name an acceptable type of group (Example 4)

Veterans Groups

What is disadvantage 1 of benefit plans?

Coverage may be temporary

What is disadvantage 2 of benefit plans?

When an EE leaves the group, coverage might terminate

In the "Married with Children" example, what do both EEs earn?

$100,000 annually in commission

In the "Married with Children" example, what benefit do both receive?

Health Insurance

In the "Married with Children" example, what's the difference between EE (A) and EE (B)?

EE (A) is single; EE (B) is married with 3 kids

Why is EE (B) overcompensated?

The health insurance covering a family of 5 is much more valuable than insurance for a single person

What is Issue 1 in Healthcare?

High cost of healthcare

What is Issue 2 in Healthcare?

High rate of inflation compared to overall rate of inflation

What is Issue 3 in Healthcare?

High premiums for errors

What is Issue 4 in Healthcare?

High costs for government

What is Issue 5 in Healthcare?

High % of uninsured or underinsured persons

What is the consequence of having a high % of uninsured persons?

Access problems

How many uninsured people are there currently?

27 million uninsured