STRATEGIC COMPENSATION A Human Resource Management Approach

STRATEGIC COMPENSATION A Human Resource Management Approach
Chapter 10: Employer-Sponsored Retirement Plans and Health Insurance Programs Copyright © 2015 Pearson Education, Inc.

Copyright © 2015 Pearson Education, Inc.
Learning Objectives State the definitions of qualified plans and nonqualified plans and indicate the main difference between them. List nine minimum standards for qualified plans. Explain what defined benefit plans are. Explain what defined contribution plans are. Copyright © 2015 Pearson Education, Inc.

Learning Objectives List and summarize two types of defined contribution plans. Identify and summarize three broad classes of health insurance programs. Briefly state the rationale for consumer-driven health care. Copyright © 2015 Pearson Education, Inc.

Learning Objective 1 State the definitions of qualified plans and nonqualified plans and indicate the main difference between them. Until World War II, pension plans were adopted primarily in the railroad, banking, and public utility industries. The most significant growth occurred since the favorable tax treatment of pensions was established through the passage of the Revenue Act of 1921 and government-imposed wage increase controls during World War II in the early 1940s. This led companies to adopt discretionary employee benefits plans such as pensions that were excluded from those wage increase restrictions. Copyright © 2015 Pearson Education, Inc.

Nonqualified and Qualified Plans
Nonqualified plans refer to pension plans that do not meet at least one of the minimum standard provisions of the Employee Retirement Income Security Act (presented shortly). Neither employee nor employer contributions are permitted on a pretax basis. Qualified plans meet all of the minimum standard provisions, which permits employer and employee contributions to be made on a pretax basis. Copyright © 2015 Pearson Education, Inc.

Minimum Standards for Qualified Plans
The Employee Retirement Income Security Act specifies 13 minimum standards: Participation requirements Coverage requirements Vesting rules Accrual rules Nondiscrimination rules: testing Key employee and top-heavy provisions Minimum funding standards Social Security integration Thirteen minimum standards for qualified plans include participation requirements, coverage requirements, vesting rules, accrual rules, nondiscrimination rules, key employee and top-heavy provisions, minimum funding standards, Social Security integration, contribution and benefit limits, plan distribution rules, qualified survivor annuities, qualified domestics relations orders, and plan termination rules and procedures. Copyright © 2015 Pearson Education, Inc.

Minimum Standards for Qualified Plans (cont’d)
Contribution and benefit limits Plan distribution rules Qualified survivor annuities Qualified domestics relations orders Plan termination rules and procedures We briefly review five standards: vesting, accrual rules, nondiscrimination rules, plan distribution rules, and plan termination types Thirteen minimum standards for qualified plans include participation requirements, coverage requirements, vesting rules, accrual rules, nondiscrimination rules, key employee and top-heavy provisions, minimum funding standards, Social Security integration, contribution and benefit limits, plan distribution rules, qualified survivor annuities, qualified domestics relations orders, and plan termination rules and procedures. Copyright © 2015 Pearson Education, Inc.

Vesting Rules Vesting is an employee’s nonforfeitable rights to pension benefits Employees must be allowed to participate in pension plans after they have reached age 21 and have completed 1 year of service (based on 1,000 work hours) Vesting refers to an employee’s nonforfeitable rights to pension benefits. Employees must be allowed to participate in pension plans after they have reached age 21 and employees must be allowed to participate in pension plans after they have completed one year of service (based on 1,000 work hours). Copyright © 2015 Pearson Education, Inc.

Vesting (cont’d) Companies must grant full vesting rights to employer contributions on one of the following two schedules: Cliff vesting schedules must grant employees 100% vesting after no more than three years of service The six-year graduated schedule allows workers to become 20% vested after two years and to vest at a rate of 20% each year thereafter until they are 100% vested after six years of service Companies must grant full vesting rights to employer contributions on one of the two schedules. Cliff vesting schedules must grant employees 100% vesting after no more than three years of service. 6-year graduated schedule allows workers to become 20% vested after 2 years and to vest at a rate of 20% each year thereafter until they are 100% vested after 6 years of service. Copyright © 2015 Pearson Education, Inc.

Accrual Rules Qualified plans are subject to minimum accrual rules based on the Internal Revenue Code (IRC) and ERISA Accrual rules specify the rate at which participants accumulate (or earn) benefits Defined benefit and defined contribution plans use different accrual rules Qualified plans are subject to minimum accrual rules based on the Internal Revenue Code (IRC) and ERISA. Accrual rules specify the rate at which participants accumulate (or earn) benefits. Defined benefit and defined contribution plans use different accrual rules. Copyright © 2015 Pearson Education, Inc.

Nondiscrimination Rules
Prohibits employers from discriminating in favor of highly compensated employees in contributions or benefits, availability of benefits, rights, or plan features Employers may not amend pension plans so that highly compensated employees are favored Nondiscrimination rules prohibit employers from discriminating in favor of highly compensated employees in contributions or benefits, availability of benefits, rights, or plan features. Employers may not amend pension plans so that highly compensated employees are favored. Copyright © 2015 Pearson Education, Inc.

Plan Distribution Rules
Distribution refers to the payment of vested benefits to participants or beneficiaries Lump sum distributions are single payments of benefits In defined contribution plans, lump sum distributions equal the vested amount Annuities represent a series of payments for the life of the participant and beneficiary Plan distribution rules refer to the payment of vested benefits to participants or beneficiaries. Distributions are payable in a variety of ways. Lump sum distributions are single payments of benefits. In defined contribution plans, lump sum distributions equal the vested amount. Annuities represent a series of payments for the life of the participant and beneficiary. Annuity contracts are usually purchased from insurance companies, which make payments according to the contract. Copyright © 2015 Pearson Education, Inc.

Plan Termination Types
Standard Distress Involuntary Qualified plans must follow strict guidelines for plan terminations including sufficient notification to plan participants and distribution of vested benefits to participants and beneficiaries in a reasonable amount of time Applies only to defined benefit plans There are three types of plan terminations such as standard termination, distress termination, and involuntary termination. Copyright © 2015 Pearson Education, Inc.

Defined Benefit Plans Guarantee retirement benefits specified in the plan document Usually expressed in terms of a monthly sum equal to a percentage of a participant’s preretirement pay multiplied by the number of years he or she has worked for the employer Benefit is fixed by a formula Defined benefit plans guarantee retirement benefits specified in the plan document. They are usually expressed in terms of a monthly sum equal to a percentage of a participant’s preretirement pay multiplied by the number of years he or she has worked for the employer. Benefit is fixed by a formula. Copyright © 2015 Pearson Education, Inc.

Defined Benefit Plans (cont’d)
Level of required employer contributions fluctuates from year to year Level depends on the amount necessary to make certain that benefits promised will be available when participants and beneficiaries are eligible to receive them Level of required employer contributions fluctuates from year to year. Level depends on the amount necessary to make certain that benefits promised will be available when participants and beneficiaries are eligible to receive them Copyright © 2015 Pearson Education, Inc.

Factors Determining Funding Level
Life expectancies of employees and their designated beneficiaries Projected compensation levels Likelihood of employees terminating their employment before they have earned benefits Actuaries periodically review several kinds of information to determine a sufficient funding level including life expectancies of employees and their designated beneficiaries, projected compensation levels, and likelihood of employees terminating their employment before they have earned benefits. Copyright © 2015 Pearson Education, Inc.

Defined Contribution Plans
Employers and employees make annual contributions to separate accounts established for each participating employee, based on a formula contained in the plan document Formulas typically call for employers to contribute a given percentage of each participant’s compensation annually Employers and employees make annual contributions to separate accounts established for each participating employee, based on a formula contained in the plan document. Formulas typically call for employers to contribute a given percentage of each participant’s compensation annually. Copyright © 2015 Pearson Education, Inc.

Contribution Sources Employer contributions: expressed as a percentage of an employee’s wage or salary Employee contributions: expressed as a percentage of the employee’s wage or salary Forfeitures: from the accounts of employees who terminated their employment prior to earning vesting rights Return on investments Contributions to each employee's account come from four possible sources such as employer contributions, employee contributions, forfeitures, and return on investments. Employer contributions are expressed as a percentage of an employee’s wage or salary. Employee contributions are usually expressed as a percentage of the employee’s wage or salary. Forfeitures come from the accounts of employees who terminated their employment prior to earning vesting rights. The fourth contribution source is return on investments. In the case of negative returns (or loss), the corresponding amount is debited from employees’ accounts. Copyright © 2015 Pearson Education, Inc.

DC Plan Accrual Rules The accrued benefit equals the balance in an individual’s account Companies must not reduce contribution amounts based on age Companies may also not set maximum age limits for discontinuing contributions The accrued benefit equals the balance in an individual’s account. Companies must not reduce contribution amounts based on age. Companies may also not set maximum age limits for discontinuing contributions. Copyright © 2015 Pearson Education, Inc.

Investment Vehicles Defined contribution plan documents specify how contributions may be invested. For example: Company stocks Diversified stock market funds Federal government bond funds Investment vehicles are company stocks, diversified stock market funds, and federal government bond funds. Copyright © 2015 Pearson Education, Inc.

Learning Objective 5 List and summarize two types of defined contribution plans. The fifth learning objective addresses specific types of defined contribution plans. Copyright © 2015 Pearson Education, Inc.

Defined Contribution Plan Types
Section 401(k) plans Profit sharing Stock bonus plans Employee stock ownership plans (ESOPs) Types of defined contribution plans include section 401(k) plans, profit sharing, stock bonus plans, and employee stock ownership plans (ESOPs). Copyright © 2015 Pearson Education, Inc.

Section 401(k) Plans Named after the section of the IRC that created them Also known as cash or deferred arrangements (CODAs) Permit employees to defer part of their compensation to the trust of a qualified defined contribution plan Only private sector or tax-exempt employers are eligible to sponsor 401(k) plans Section 401(k) plans are named after the section of the IRC that created them. They are also known as cash or deferred arrangements (CODAs). They permit employees to defer part of their compensation to the trust of a qualified defined contribution plan. Only private sector or tax-exempt employers are eligible to sponsor 401(k) plans. Copyright © 2015 Pearson Education, Inc.

Profit-Sharing Plans Set up to distribute money to employees Establish a profit-sharing pool (i.e., the money earmarked for distribution to employees) May choose to fund profit-sharing plans based on gross sales revenue or some basis other than profits May take a tax deduction for their contributions not to exceed 25% of the plan participants’ compensation in 2013 Companies set up profit-sharing plans to distribute money to employees. Companies start by establishing a profit-sharing pool. Companies may choose to fund profit-sharing plans based on gross sales revenue or some basis other than profits. Companies may take a tax deduction for their contributions not to exceed 25% of the plan participants’ compensation in 2011. Copyright © 2015 Pearson Education, Inc.

Employer Contribution Formulas in Profit-Sharing Plans
Fixed first-dollar-of-profits Graduated first-dollar-of-profits Profitability threshold Three common formulas establish employer contributions such as fixed first-dollar-of-profits, graduated first-dollar-of-profits, and profitability threshold. Fixed first-dollar-of-profits formula uses a specific percentage of either pretax or after-tax annual profits contingent upon the successful attainment of a company goal. Graduated first-dollar-of-profits formula is not a fixed percentage and varies by profit levels. Profitability threshold formulas fund profit-sharing pools only if profits exceed a predetermined minimum level, but fall below some established maximum level. Copyright © 2015 Pearson Education, Inc.

Stock Bonus Plans May be the basis for a company’s 401(k) plan Reward employees with company stock (i.e., equity shares in the company) Benefits are usually paid in shares of company stock Participants of stock bonus plans possess the right to vote as shareholders Stock bonus plans may be the basis for a company’s 401(k) plan. Reward employees with company stock. Benefits are usually paid in shares of company stock. Participants of stock bonus plans possess the right to vote as shareholders. Copyright © 2015 Pearson Education, Inc.

ESOPs May be the basis for a company’s 401(k) plan Invest in company securities, making them similar to profit-sharing plans and stock bonus plans ESOPs are essentially stock bonus plans that use borrowed funds to purchase stock Types of ESOPs Nonleveraged Leveraged ESOPs may be the basis for a company’s 401(k) plan. They invest in company securities, making them similar to profit-sharing plans and stock bonus plans. ESOPs are essentially stock bonus plans that use borrowed funds to purchase stock. Types of ESOPs are nonleveraged and leveraged. In the case of nonleveraged ESOPs, company contributes stock or cash to buy stock, which is then allocated to participants. In the case of leveraged ESOPs, the plan administrator borrows money from a financial institution to purchase company stock which may then be used for financing of existing debt, estate planning, or financing an acquisition or divestiture. Copyright © 2015 Pearson Education, Inc.

Hybrid Plans—Cash Balance Plans
Combine features of traditional defined benefit and defined contribution plans Cash balance plans are defined benefit plans that define benefits for each employee by reference to the amount of the employee’s hypothetical account balance Hybrid plans combine features of traditional defined benefit and defined contribution plans. Cash balance plans are defined benefit plans that define benefits for each employee by reference to the amount of the employee’s hypothetical account balance. Copyright © 2015 Pearson Education, Inc.

Learning Objective 6 Identify and summarize three broad classes of health insurance programs. The Great Depression of the 1930s gave rise to employer-sponsored health insurance programs. Widespread unemployment made it impossible for most individuals to afford health care. During this period, Congress proposed the Social Security Act of 1935 to address many of the social maladies caused by the adverse economic conditions, incorporating health insurance programs. President Franklin D. Roosevelt, however, opposed the inclusion of health coverage under the Social Security Act. Health insurance did not become part of the Social Security Act until an amendment to the act in 1965 established the Medicare program. The government’s choice not to offer health care benefits created opportunities for private sector companies to meet the public’s need. Copyright © 2015 Pearson Education, Inc.

Fee-for-Service Plans
Provide protection against health care expenses in the form of a cash benefit Three types of eligible health expenses Hospital expenses Surgical expenses Physician charges Types: Indemnity plans Self-funded plans Fee-for-service plans provide protection against health care expenses in the form of a cash benefit paid to the insured or directly to the health care provider after the employee has received health care services. Three types of eligible health expenses are hospital expenses, surgical expenses, and physician charges. Two types of fee-for-service plans are indemnity plans and self-funded plans. Indemnity plans are based on a contract between the employer and an insurance company, which specifies the expenses that are covered, and the rate. Self-funded plans are those in which companies pay benefits directly from their own assets, either current cash flow or funds set aside in advance for potential future claims. Copyright © 2015 Pearson Education, Inc.

Fee-for-Service Plan Features
Deductibles Coinsurance Out-of-pocket maximums Preexisting condition clauses Preadmission certification Second surgical opinions Maximum benefits limits Common fee-for-service stipulations include deductibles, coinsurance, out-of-pocket maximums, preexisting condition clauses, preadmission certification, second surgical opinions, and maximum benefits limits. Employees must pay for services (i.e., meet a deductible) that they have to pay before insurance benefits become active. Coinsurance refers to the percentage of covered expenses paid by the insured. Out-of-pocket maximum protects individuals from catastrophic medical expenses or expenses associated with recurring episodes of the same illness. Preexisting is a condition for which medical advice, diagnosis, care, or treatment was received or recommended during a designated period preceding the beginning of coverage. Many insurance plans require preadmission certification of medical necessity for hospitalization. Second surgical options reduce unnecessary surgical procedures (and costs) by encouraging an individual to seek an independent opinion from another doctor. Maximum benefit limits are expressed as a dollar amount over the course of one year or over an insured’s lifetime. Copyright © 2015 Pearson Education, Inc.

Managed Care Plans Health maintenance organizations (HMOs) Preferred provider organizations (PPOs) Point-of-service plans (POSs) Manage care plans emphasize cost control by limiting an employee’s choice of doctors and hospitals. Three common forms of managed care plans are Health maintenance organizations (HMOs), preferred provider organizations (PPOs), and Point-of-service plans (POS). Copyright © 2015 Pearson Education, Inc.

HMOs Provides prepaid medical services Copayments represent nominal payments Common copayment amounts Between $15 and $50 for each doctor’s visit Between $10 and $50 per prescription drug Primary care physicians determine when patients need the care of specialists HMOs provides prepaid medical services. Most medical services are either fully covered or, in the case of some HMOs, participants are required to make nominal copayments. Common copayment amounts vary between $15 and $50 for each doctor’s office visit, and $10 to $50 per prescription drug. Primary care physicians determine when patients need the care of specialists. Copyright © 2015 Pearson Education, Inc.

PPOs Select group of health care providers Employees choose from a list Financial incentives to use list Physicians must Meet quality standards Abide by PPO cost containment Accept PPO fee structure Does not provide prepaid benefits In preferred provider organizations, select group of health care providers agrees to furnish health care services to a given population at a higher level of reimbursement than under fee-for-service plans. Physicians qualify as preferred providers by meeting quality standards, agreeing to follow cost-containment procedures implemented by the PPO, and accepting the PPOs reimbursement structure. Copyright © 2015 Pearson Education, Inc.

Point-of-Service Plans
Combine features of fee-for-service systems and health maintenance organizations Employees pay a nominal copayment for each visit to a designated network of physicians Employees possess the option to receive care from health care providers outside the designated network of physicians, but they pay somewhat more for this choice Point-of-service plans combine features of fee-for-service systems and health maintenance organizations. Employees pay a nominal copayment for each visit to a designated network of physicians. Employees possess the option to receive care from health care providers outside the designated network of physicians, but they pay somewhat more for this choice. Copyright © 2015 Pearson Education, Inc.

Consumer-Driven Health Care Plans
Refers to the objective of helping companies maintain control over costs while also enabling employees to make greater choices about health care Enables employers to lower the cost of insurance premiums by selecting plans with higher employee deductibles Consumer-driven health care plans refer to the objective of helping companies maintain control over costs while also enabling employees to make greater choices about health care. The most popular consumer-driven approaches are flexible spending accounts and health reimbursement accounts. In the following slides flexible spending accounts, health reimbursement accounts, and health savings accounts will be discussed. Copyright © 2015 Pearson Education, Inc.

The most popular consumer-driven approaches are flexible spending accounts and health reimbursement accounts Provide employees with resources to pay for medical and related expenses not covered by higher deductible insurance plans at substantially lower costs to employers Consumer-driven health care plans refer to the objective of helping companies maintain control over costs while also enabling employees to make greater choices about health care. The most popular consumer-driven approaches are flexible spending accounts and health reimbursement accounts. In the following slides flexible spending accounts, health reimbursement accounts, and health savings accounts will be discussed. Copyright © 2015 Pearson Education, Inc.

Flexible-spending accounts (FSAs) Health reimbursement accounts (HRS) Health savings accounts (HSA) Consumer-driven health care plans refer to the objective of helping companies maintain control over costs while also enabling employees to make greater choices about health care. The most popular consumer-driven approaches are flexible spending accounts and health reimbursement accounts. In the following slides flexible spending accounts, health reimbursement accounts, and health savings accounts will be discussed. Copyright © 2015 Pearson Education, Inc.

FSAs Permit employees to pay for specified health care costs that are not covered by an employer’s insurance plan Prior to each plan year, employees elect the amount of pay they wish to allocate Advantage  ability to make contributions on a pretax basis Disadvantage  “use it or lose it” provision of FSAs Flexible spending accounts permit employees to pay for specified health care costs that are not covered by an employer’s insurance plan. Prior to each plan year, employees elect the amount of pay they wish to allocate to this kind of plan. An advantage to employees is the ability to make contributions to their FSAs on a pretax basis. Disadvantage is the “use it or lose it” provision of FSAs. Copyright © 2015 Pearson Education, Inc.

HRAs Purpose of HRAs and FSAs are similar but with three differences Employees do not contribute to HRAs Permit employees to carry over unused account balances from year to year Employees may offer HRAs as well as FSAs and use of these accounts isnot limited to participation in high-deductible health care plans There are three differences between HRAs and FSAs. First, employers make the contributions to each employee’s HRA whereas employees fund FSAs with pretax contributions deducted from their pay. Second, HRAs permit employees to carry over unused account balances from year to year, whereas employees forfeit unused FSA account balances present at the end of the year. Third, employers may offer employees HRAs as well as FSAs, and the use of these accounts are not limited to participation in high-deductible health care plans, which is the case for HSAs. Copyright © 2015 Pearson Education, Inc.

HSAs Medicare Prescription Drug, Improvement and Modernization Act of 2003 permits eligible individuals to establish HSAs to help employees pay for medical expenses Three advantages HSAs are portable HSAs are subject to inflation-adjusted funding limits Do not limit employee choice The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 permits eligible individuals to establish HSAs to help employees pay for medical expenses. HSAs offer three main advantages to employees relative to FSAs and HRAs. First, HSAs are portable. Second, HSAs are subject to inflation-adjusted funding limits. Third, employees may receive medical services from doctors, hospitals, and other health care providers of their choice, and they may choose the type of medical services they purchase, including such items as long-term care, eye care, and prescription drugs. Copyright © 2015 Pearson Education, Inc.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2015 Pearson Education, Inc.

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