Trieschmann, Hoyt & Sommer Employee Benefits: Life and Health Benefits Chapter 19 ©2005, Thomson/South-Western.

Trieschmann, Hoyt & Sommer

Employee Benefits: Life and Health Benefits

Chapter 19

©2005, Thomson/South-Western

22

Chapter Objectives

• List three features that distinguish group insurance from individual insurance and describe the characteristics of a group that would be desirable from a group insurance underwriting perspective

• Explain the overall approach used to provide Social Security survivor and disability benefits

• Explain the typical eligibility requirements associated with premature death benefit programs and health expense benefit plans offered by employers

• Distinguish among the different types of group life insurance used in premature death benefit plans

33

Chapter Objectives

• Explain the important considerations in choosing among health benefit providers

• List several approaches used to contain health expense benefit costs and give examples of each approach listed

• Determine the amount and order of payment among several different health plans covering the same loss to the same individual

• Compare sick leave plans with both short-term and long-term disability income plans

44

Introduction

• Employee benefits have become an important aspect of total compensation in the United States – Average employer costs for employee benefits equaled about

39% of payroll in 2001

• Some benefits are provided by employers primarily to enhance the overall compensation package offered to their employees, such as – Paid holidays, paid vacations, discounts on products sold by the

employer, subsidized meals, free parking spaces

• However, this chapter focuses on identifying and explaining the employee benefits that can be used as risk management tools in dealing with life, health, and loss of income exposures

55

Reasons for Employee Benefits

• Usually, employers make benefits available to employees in order to – Improve employee relations – Take advantage of the special income tax

status granted to many benefit programs

66

Employee Relations

• In earlier years, employee benefits were frequently referred to as fringe benefits – Many employers viewed them as forms of

extra compensation that were not required– Some employers suggested that they viewed

employee benefits essentially as freely given goods

• Employers expected employees to be grateful for their benefits

– And to respond with increased loyalty, improved productivity, and better morale in the workplace

77

Employee Relations

• Over time, however, attitudes of both employers and employees evolved

• Benefits that address basic security issues are no longer viewed as frills that command special gratitude – Such as health care expenses, survivor needs due to premature

death, and retirement income – Rather, they are an expected part of most compensation

packages • Inclusion of such benefits does not often affect employee attitudes

because the employer is only doing what is expected • However, excluding such benefits could have a negative impact on

employee relations – Leading to increased employee turnover and difficulty in recruiting

workers

88

Employee Relations

• Employers hoping to significantly improve employee relations from their benefit packages must go beyond what is expected

• Also, employers are becoming more flexible and allowing employees to select the benefits that best meet their individual needs – It is becoming harder for a standard benefit package

to efficiently meet the varying needs of all workers

99

Tax Advantages

• Many employee benefits are treated more favorably for tax purposes than are wages and salaries

• When such tax advantages exist, it is usually to an employee’s advantage to receive the benefit – Rather than to receive a higher salary and

then purchase the product separately

1010

Tax Advantages

• In general, tax advantages may be associated with employee benefits if qualification rules are met – The ability of the employer to deduct the cost of the

benefit from current taxable income – The ability of employees to avoid reporting benefit

costs paid by their employers as taxable income – Benefit payments may be partially or totally exempt

from income taxes – The employer’s ability to fund some benefit costs in

advance • With taxes on associated investment earnings either

deferred or avoided completely

1111

Tax Advantages

• Although favorable tax status is a major factor affecting an employer’s willingness to grant employee benefits – The continuation of current tax advantages is not

assured

• Frequent changes in the U.S. tax laws affecting employee benefits are common

• Periodic proposals are made to restrict the tax advantages associated with one or more benefits – And qualification rules are changed regularly

1212

Premature Death Benefits

• From an individual employee’s perspective, the financial needs likely to be associated with premature death include – The cost of funeral, burial, and other executor fund

expenses – As well as the possible provision of income for

surviving dependents • Employers usually provide death benefits

through group life insurance – However, both employers and employees should

recognize that some death benefits also may be available to employees through Social Security or workers’ compensation

1313

Social Security Benefits

• The Old Age, Survivors’, Disability and Health Insurance Program was established in 1935

• The four major categories of Social Security benefits are – Retirement – Disability income – Survivors’ income – Medicare

1414

Social Security Benefits

• Social Security benefits are financed through a tax on employees and employers – Originally, an employee paid a 1% tax on the first

$3,000 of annual income earned, but this base has increased gradually

• By 2004, workers and their employees each paid 6.2% on the first $87,900 of earned income

– This level of income is referred to as the OASDHI wage base

» The wage base increases automatically each year as earnings levels rise

– To finance Medicare, an additional 1.45% tax is payable on all earned income

1515

Social Security Benefits

• Are payable only if the worker meets certain tests based on the length of service in a job for which OASDHI taxes have been paid

• A person becomes fully insured after meeting either of two tests – Having worked in covered employment for 40 quarters – Subject to a minimum of six calendar quarters, having worked in

covered employment for at least one-fourth of the number of calendar quarters elapsing from the starting date

• Until age 62 is attained, or disability or death occurs, whichever happens first

– Workers are currently insured if they have worked in covered employment at least six of the last 13 quarters

• Including the quarter in which death occurs or in which they become entitled to benefits

1616

Social Security Benefits

• Dependents of covered workers who die are entitled to Social Security survivors’ benefits – Payable as a monthly income for as long as the

survivors meet specified eligibility criteria• Widows and widowers may receive survivor income benefits

as long as they have dependent children under 16, and again, upon reaching age 60

• Benefits may be reduced if the surviving spouse earns more than a specified amount

– Children of deceased workers also receive survivors’ benefits until age 18

1717

Underwriting Unit is a Group

• Group insurance plans cover more than one person

• Underwriting is based on group characteristics rather than on evidence of insurability for individuals within the group

• Membership in a group that has been formed for purposes other than obtaining insurance is often sufficient evidence of insurability for an insurer – For example, if an employee is well enough to go to

work, he or she likely will be judged well enough to be insured without passing a medical examination

1818

Underwriting Unit is a Group

• One of the underwriting considerations for group insurance is the purpose for which the group exists – If members have been assembled for the sole

purpose of obtaining group coverage • The prospective insurer will be very concerned

about the presence of adverse selection

– For employee groups, however, this possibility is not a problem

1919

Underwriting Unit is a Group

• Other factors that may be important in underwriting employee group insurance include – The group’s size

• Insurers prefer larger groups to smaller ones in order to minimize the likelihood of severe adverse selection

– Age composition• It is also considered best from an underwriting perspective if

there is a flow of persons through the group so that the younger members replace the older members over time

– The average age of persons in the group is fairly constant and loss experience tends to be more stable

– Expected losses • Insurers are often interested in specific design features of a

group insurance program because such features may have an impact on the losses experienced by the group members

2020

Lower Expenses

• Three factors tend to lower some other expenses when insurance is purchased on a group basis – Insurers usually pay lower commissions to their group

sales force than to those selling individual insurance – Because individual selection is not required, group

underwriting expenses tend to be lower than would be the case if a similar number of persons were to be insured on an individual basis

– Employers may handle some administrative tasks for employee groups

• Such as recordkeeping and the collection of employee-paid premiums

2121

Experience Rating

• With group insurance, the losses experienced by the group influence the rates charged – Known as experience rating

• The group will have greater or smaller premiums in the year ahead if its losses are larger or smaller, respectively, during the preceding year

• Provides employers with an incentive to try to lessen group losses through various types of loss control activities

2222

Group Life Insurance

• Most medium- and large-sized firms in the United States provide group life insurance benefits for some or all of their employees

• By 2002 group life insurance accounted for over 40 percent of all life insurance in force in the United States – With most of that group life coverage

attributable to employee groups

2323

Eligibility for Benefits

• The first step is to determine whether the person is eligible to participate in the employer’s plan

• Eligibility requirements often specify that a person be employed on a full-time basis – Although some employers provide death benefits for

permanent part-time workers and many employers continue death protection after an employee retires

• Eligibility may be restricted to those working in particular job classifications – Some employers limit eligibility to those persons who

have worked for the firm for some minimum period of time

2424

Eligibility for Benefits

• Employers must adhere to various state laws regarding employment discrimination – As well as federal laws that discourage

employers from favoring very highly paid workers

• Employees generally have little or no control over their eligibility for death benefits

2525

Eligibility for Benefits

• Many death benefit plans have two other eligibility requirements – Employers usually specify the employees who want to

participate in the plan must elect to do so soon after meeting the eligibility requirements

• Employees are usually not required to participate even if they are eligible

• However, if they do not elect to participate within a specified time after becoming eligible

– They will not be allowed to enter the plan at a later date unless they prove at that time that they are insurable

– The death benefit usually does not become effective for a particular employee unless that person is actively at work on the day the coverage is scheduled to go into force

• This provision only relates to initial eligibility

2626

Contributory versus Noncontributory Plans • Contributory

– Requires employees to pay part of the cost

• Noncontributory – Employer pays the full cost of the death benefits – Generally assumed that all eligible employees will participate

• If the contributory plan is established, the primary decision for eligible employees is whether to participate – Employees should compare the required contribution to the

benefits to be received, both currently and in future years – Group life insurance is usually less expensive than individual

insurance, but exceptions exist – The tax consequences should be considered as well

2727

Structure and Level of Death Benefit • The amount of group life insurance provided for a particular

worker is usually a function of either salary or job classification • If the employer’s goal is to provide for funeral and burial costs

– All participating employees may be given a flat amount of coverage • More often the amount of the death benefit depends on other

factors – Salary bracket approach

• Workers whose earnings are within various ranges are eligible for a specified amount of death protection

– Job classification approach • Devised for various job classifications such as secretaries, factory workers,

sales personnel – Earnings multiple approach

• Death benefit for a particular employee is a specified multiple of that person’s salary for the year

2828

Type of Insurance

• Group term insurance – More death protection can be purchased on a term insurance

basis than with any other form of life insurance

• Income tax laws also tend to reinforce this – A portion of all premiums paid by the employer for cash value life

insurance is usually treated as currently taxable income for employees

– However, employer-paid premiums for the first $50,000 of term insurance for each worker are not taxable for employees

• Term insurance can also be provided to cover the death of an employee’s dependent – Known as dependent life

2929

Type of Insurance

• Survivor income benefit insurance – Benefit is expressed as income to specified survivors rather than

as a flat amount – If no eligible survivors exist at the time the employee dies, no

benefits are payable • Group accidental death and dismemberment coverage

– Payable only for deaths due to accidents – The death usually must occur within 90 days of the accident’s

occurrence – Commonly excluded causes of death are suicide, disease,

mental infirmity, infection, war, and flight in an aircraft other than a regularly scheduled commercial flight

– The premium is much less than for regular group term coverage and employees often pay most or all of the cost

– Policy also pays in the event of dismemberment

3030

Type of Insurance

• Some employers are interested in helping employees provide for financial needs because of death after retirement – Employers can continue term insurance coverage for

retirees – Employers can facilitate their employees’ purchase of

permanent insurance protection • Two forms of group coverage for retiring employees are

group ordinary insurance and group universal life – Group universal life is growing in usage

» Employees must often pay the entire premium but it may be less expensive than comparable protection purchased individually

3131

Contractual Provisions

• Group life insurance policies have many of the same contractual provisions found in individual policies

• The misstatement of age clause differs in that the amount of death benefit payable is not affected due to a misstatement of age – Rather, the employer is subject to an

adjustment in the premium payable

3232

Contractual Provisions

• One provision in group life contracts not found in individual policies is the conversion clause – Provides that when an employee is no longer eligible

for group coverage he or she has the right to convert the coverage to an individual policy without having to prove insurability

– Required by all states – To take advantage of the conversion feature, an

individual generally must apply within 31 days after termination from the group

• Must pay the premium applicable at that person’s current age – In many cases, group coverage can be converted

only into an individual cash policy

3333

Eligibility

• The first step in integrating employer-provided health expense benefits into an individual’s personal risk management plan – Is to determine the extent to which a person and his or her

dependent family members are eligible for the employer’s plan

• Most of the same considerations that were important for premature death benefits are also relevant for health expense benefits

• Benefits may be limited to those employees who work at least a stated minimum number of hours each week – And/or those persons employed in particular job classifications

3434

Eligibility

• For a person to be eligible for benefits as a dependent of an employee – The employee must be participating in the employer’s plan – Dependent benefits are restricted to those persons who meet

other specified requirements • For example, if dependent coverage is offered, the spouse of an

employee is nearly always eligible for the benefits • For the employees’ children to be eligible, they usually must be

unmarried and under a certain age • Some plans provide dependant coverage regardless of age for

mentally or physically handicapped children who are completely dependent on the employee for financial support

• A newborn is covered from birth in many plans– But in less generous plans, coverage for the newborn may not become

effective until the child reaches a specified age

3535

Eligibility

• Another eligibility consideration is whether retirees are included in the health benefit program – When benefits are granted to retirees, it is

usually through a Medigap policy that pays for items not covered by Medicare or through it a Medicare carve-out arrangement

• Applicable Medicare payments are deducted before paying promised benefits

3636

Eligibility

• Coverage for retirees of many employers is not as generous as it used to be – In 1993 FASB required firms to report retiree health

benefits as a liability that is accrued over employees’ working lives

• Whereas before firms could report such expenses on a pay-as-you-go basis

– Only the actual expenses paid for health benefits and or insurance during the year were charged against income

– Resulted in reduced corporate earnings • Many employers have made substantial cuts in their retiree

health benefits and others have eliminated the benefits entirely

3737

Contributory Versus Noncontributory Plans • Many employers provide noncontributory

death benefits – But it is quite common to require employee

contributions for a patient in an employer’s health expense benefit program

• As health care costs continue to rise, it can be expected that the level of contributions required of employees will also increase

3838

Contributory Versus Noncontributory Plans• When an employee pays part of the cost for health

expense benefits – Employers are allowed to offer their employees a premium

conversion option • Premiums are paid with pre-tax dollars rather than after-tax dollars

• According to the tax law, medical expenses are deductible only from an individual’s current taxable income – To the extent that total medical expenses exceed a threshold

level equal to 7.5% of adjusted gross income • Thus, many persons are unable to benefit from the tax deductibility

of contributions for health expense benefits

– An example is summarized in Table 19-1

3939

Table 19-1: Deductibility of Medical Expenses

4040

Contributory Versus Noncontributory Plans• Whether the premiums are paid with pre-tax dollars or

after-tax dollars – The opportunity to participate in an employer’s health expense

benefit plan will prove cost effective for most people

• However, in some instances it makes sense to reject coverage under a contributory plan – For instance, a husband and wife may be covered under

different employee health plans and coverage for their dependents could be an option under each plan

• They must decide whether to cover their children under one or possibly both of their employee health plans

• They need to compare benefits, exclusions, and limitations, and the relative costs

4141

Providers of Coverage

• The major providers of health expense coverage are insurance companies, Blue Cross-Blue Shield organizations, health maintenance organizations (HMOs), point-of-service (POS) plans, and preferred provider organizations (PPOs)

• Employers often use more than one of these providers and some employers often also set up self-funded benefit programs

• It is important to analyze the choices offered by each of the programs

4242

Choice of Physician

• When an insurer, the Blues, or a self-funding arrangement is used to provide health expense benefits – The employee will typically have freedom of choice regarding the

physicians, hospitals, etc.• Employees covered by an HMO must obtain medical

services from doctors and others who belong to the HMO – Except in emergency situations while the employee is out of

town • When a PPO or POS plan is used, the employee can

make a choice regarding physicians each time medical services are needed – But higher cost-sharing will be required if an out-of-network

provider is chosen

4343

Coverage and Exclusions

• No standard set of medical needs is always covered or always excluded

• Employees must analyze all of the programs available to find one likely to meet their needs

• Health care expenses often are categorized as to whether they include – Hospitalization, physicians and surgeons’ services,

dental care, mental health care, long-term care, prescription drugs, etc.

• Not all benefit programs cover all of these needs to the same extent

4444

Coverage and Exclusions

• Traditional insurance plans may exclude routine types of medical expenses – On the grounds that insurance benefits should be

reserved for unexpected medical problems • However, HMOs or POS plans place more

emphasis on preventing small problems from becoming larger ones

• In some jurisdictions, state-mandated benefits apply only to plans offered through insurers and the Blues – Examples include coverage of at least a specified

amount for alcohol and drug abuse treatment

4545

Cost to the Employee

• Two cost aspects should be considered – The amount of monthly contribution that is required of

the participating employee – The amount of cost-sharing that will be incurred by

the employee at the time medical services are sought

• Plans offered by insurers and the Blues usually have both coinsurance and deductibles

• Cost-sharing for participants in HMOs is usually minimal – Maximum benefit limits may not exist

4646

Cost Containment • Health care costs have increased rapidly in recent years • Employers now include a number of cost-containment provisions

– Generically called managed care • Cost containment methods include

– Trying to reduce the unnecessary use of health services by employees and their families by

• Requiring use of primary care physicians rather than allowing direct access to specialists

• Precertification of benefits – Requires that certain nonemergency medical services be authorized before the

delivery of treatment – If precertification is not obtained, the benefits provided by the employer’s plan are

usually reduced

– Try to have treatment provided at the least costly locations – Authorizing the use of hospice care by terminally ill employees or

dependents – Trying to avoid payments for charges never incurred

• Increased efforts to detect fraud and eliminating overpayments resulting from billing errors by hospitals

4747

Cost Containment

• Employers are increasing their efforts to try to prevent medical problems in the first place – Development of aggressive fitness and wellness

programs for employee groups can have a major impact on the frequency and severity of medical claims

• Many employers are moving toward consumer-driven health care – Try to make employees better consumers of health care

by • Giving them financial incentives to control costs

– Generally take the form of high deductibles

• Providing them the information they need to make sound health care decisions

4848

Coordination of Benefits

• Sometimes an employee or a dependent is covered by both the employer’s health expense benefit plan and another benefit program or insurance arrangement

• The amounts payable by the various plans are covered by their coordination of benefits (COB) provisions

• Individual states generally specify the COB provisions to be included in plans offered by employees

4949

Coordination of Benefits

• Four basic principles are involved – When a person owns personal insurance, the amount payable

from the insurance does not lessen or otherwise affect the amount payable from benefit programs provided by employers

– The maximum reimbursement from all employer-sponsored plans is 100 percent of necessary and reasonable medical expenses incurred and covered by least one of the employers’ plans

– Dependent coverage is provided in excess of coverage as an employee

– Children are covered first by the plan of the parent whose birthday is earlier in the year

• Unless the parents are separated or divorced – The plan of the parent who has custody of the child pays first

5050

Pre-Existing Conditions

• A health problem that exists before health expense coverage becomes effective

• Before the 1996 passage of the Health Insurance Portability and Accountability Act (HIPAA)– Employees often were provided no coverage under employers’

health plans for a period of time for problems arising out of pre-existing conditions

– Employers can now impose pre-existing conditions limitations in their health plans for maximum of one year

• Employees must receive credit for the time that they were covered under previous employers’ plans, individual health insurance policies, Medicare and/or Medicaid if it has not been more than 63 days since this previous coverage was in effect

5151

Termination Rights

• What happens to an employee’s health expense benefits when he or she terminates employment with the sponsoring employer? – If the termination is due to retirement

• The employee may be eligible for coverage in a special retiree health plan

– If the termination is due to disability • Some employers will continue to cover this

employee in the group plan

5252

Termination Rights

• When neither of the previous alternatives exist or is relevant – Conversion to an individual health plan may be desirable

• Many states require that an individual health insurance policy be offered in place of a group policy when an employee ceases to be an eligible group member

• Under HIPAA individuals are assured of the availability of individual coverage – But this protection does not have to be as broad as the

group insurance and the cost is nearly always more than before

5353

Termination Rights

• In 1985 Congress passed the Consolidated Omnibus Budget Reconciliation Act (COBRA)– Applies to firms employing 20 or more employees – Grants former employees and previously covered dependents

the right to continue participation in their group health plans for a specified period

• Even after they’re no longer eligible under the plan’s eligibility rules

– Can be required to pay the full cost of coverage plus an additional amount to cover expenses

• But the total paid is often less that what would be required if they converted to individual health insurance

– The maximum length of time for continued participation in the group program is generally 18 months for former employees and 36 months for formally covered dependents

5454

Disability Income Benefits

• The loss of health can result not only in substantial medical expenses but also in a reduction or cessation of income due to the inability to work

• Some disabilities are temporary whereas others are permanent

• Employee benefit programs vary considerably to the extent to which they address workers’ potential loss of income due to injury or illness – When offered, benefits are usually restricted primarily to full-

time workers and are designed as one or more of the following types

• Sick leave plans, short term disability income plans, and long-term disability income plans

5555

Social Security Disability Income Benefits • The amount of the benefit is dependent on the disabled

person’s previous earnings history • Benefits are increased if the worker has dependents

– With each dependent receiving 1/2 of the benefit payable to the disabled worker, subject to a family maximum

• To be eligible for disability benefits, workers must have a specified minimum work record – Generally, must one must have worked half of the ten years

before the time one applies for disability benefits – Medical evidence must be provided to prove disability

• A five month waiting period is required and the impairment must be such that it is expected to continue at least twelve months

5656

Sick Leave Plans

• Often called salary continuation plans • Usually designed to pay the full amount of an employee’s

salary during periods of temporary disability • Usually do not involve either disability income insurance

or any other formal mechanism for funding the promised benefits

• If the period of illness or other health problem is only a few days – Verification by a physician usually is not required – But if the inability to work extends beyond about a week

• Many employers require medical certification of the illness or injury

• Employees should be aware of the rules regarding the accrual of benefit rights

5757

Disability Income Plans

• Short-term disability (STD) income plans – Have maximum benefit periods of about two

years

• Long-term disability (LTD) income plans – Any arrangement that might pay for longer

than two years

5858

Definition of Disability

• Under an STD, the usual definition is the one requiring that the employee be unable to perform the major duties of his or her occupation

• For LTD plans, the definition usually has two parts – For the first one or two years the own occupation

definition usually applies – After that an individual is classified as disabled only if

unable to perform the major duties of any occupation for which he or she is qualified through education, training, or experience

5959

Elimination Periods

• The waiting period before the payment of benefits

• Employees should note the relative limits of the elimination periods and maximum benefit periods for STD, LTD and sick leave plans – Gaps and overlaps in payment periods sometimes

result – Employees who are confronted with potential gaps

may want to make individual arrangements to fill those gaps

• With either individual disability income insurance or personal savings dollars

6060

Benefit Levels

• Most sick leave plans are designed to provide full income replacement

• Disability income plans usually provide only partial income benefits – STD plans usually provide a higher percentage of salary than

LTD plans • In both cases dollar maximums may also apply

• Benefits payable under most employer-sponsored STD and LTD plans are reduced to reflect any disability payments the employee receives from – Social Security, workers’ compensation, the employer’s pension

or other retirement plan, and the employer’s sick leave plan

6161

Contributory Versus Noncontributory Plans • Because sick leave plans generally have no formal funding

arrangements, in most cases they are noncontributory • STD plans are often established on a noncontributory basis • Most LTD plans are contributory and some are financed

entirely by employee contributions – Employers receive a tax deduction equal to the contributions they

make to fund disability income plans • The extent to which disability income benefits paid to an

employee are taxable as income – Depends on how much the employee has contributed during a

specified period toward the cost of the employer’s plan – For noncontributory plans, all disability income benefits are fully

taxable – Benefits paid from employee-pay-all plans are completely exempt

from income taxes