When he took the podium at a recent Western Pension & Benefits Conference (www.westernpension.org) seminar, Thomas Terry, CEO of JPMorgan Compensation and Benefit Strategies, promised both a glimpse at the possible future of employee benefits, and some creative mathematics. The audience was willing to consider his forecasting, and could even be persuaded to accept his assertion that, in employee benefits, 1+1=3. He is, after all, an actuary.
In order to see into the future, said Terry, one needs to look backwards. Each generation has brought with it a unique way of looking at things, and these often became the drivers behind the age's view of employee benefits. In the early 20th century, for example, paternalism drove the move toward providing workers with more than just their pay. Loyalty between companies and their employees created a desire to provide for workers in ways not considered in earlier times.
With World War II raging overseas, wages froze. Other societal changes contributed to the move toward employee benefits. Social Security took hold, and, in the case of Inland Steel vs. NLRB (National Labor Relations Board) in 1948, the U.S. Supreme Court clarified the rights of labor unions to bargain for benefits. Employers realized they needed to find another way to provide for their employees, and employee benefits gave them that opportunity.
The paternalism of the first half of the 20th century led to the entitlement mentality of the 1950s, says Terry. People expected that their employer would continue to provide for them. New kinds of pension plans were formed, some of which included a provision for employee contributions. These contributory pension plans encouraged a shared sense of responsibility for one's future.
'Better Benefits,' Higher Costs
The 1960s saw an expansion of employee benefits. "It was no longer a situation of companies going from no benefits to benefits," said Terry. "Rather, it was from benefits to better benefits." Benefits became more costly as they were enhanced. However, the war in Vietnam, financed largely through debt, had an unexpected impact on retirement benefits in particular: by the end of the decade, people began to realize that stocks, the primary funding vehicle of retirement plans, could go down as well as up.
In the 1970s, regulation of employee benefits took hold. The new driver behind employee benefits was the government. The Employee Retirement Income Security Act of 1974, better known as ERISA, enacted as a result of the devastating impact of a drastically underfunded retirement plan (Studebaker), remains the guiding set of laws for pensions today. Inflation continued, and its effects were felt by retirees. Despite their former employers' best intentions, these pensioners had declining purchasing power as time passed. Corporations felt pressure to implement cost-of-living adjustments to their retirees' pensions.
By the 1980s, the cost of benefits began to surge in earnest. "Healthcare costs began to skyrocket," Terry says, "and it started to feel like we had let things go too far. We needed to hold the line, maybe even pull back a bit." Various answers to escalating costs were tried. Would HMOs, with their gatekeeper approach to health care, be the key to cost containment? Should the company discontinue health insurance for future retirees?
The 1990s saw companies streamlining operations in an effort to control the costs of doing business. "Before the 1990s, downsizing was seen as an indictment of management," says Terry. "Overnight, that changed. One large company cut its workforce, and its stock shot up. The marketplace had weighed in, and it approved. The strategy was repeated in other companies."
While they had been created in the 1980s, investment-based retirement plans like 401(k)s exploded in popularity in the 1990s. Defined benefit plans, the old standard of paternalism, began to succumb to their lack of transparency. After all, why spend the money if employees don't understand the plan, or even how much money they will receive until they near retirement?
The new millennium brought with it a difficult stock market. When the market faltered, losses in retirement plan investments were epic. Companies that had not previously been required to contribute to their pension plans were suddenly required to do so, and 401(k) participants who were heavily invested in the stock market suffered dramatic losses. Especially hard-hit were participants invested mainly in their own company stock. Corporate scandals came one after another, and workers lost account values in record amounts.
Is Transparency Always Best?
Following the scandals and the subsequent stock market decline, lawmakers and the public demanded more accountability. The only way to achieve it, they said, is through transparency. "There is a cost to transparency, though," Terry says, explaining that subsidies have always played a part in employee benefits. Group health insurance is based on the idea that the healthier subsidize the costs of those who are sicker. And in the retirement plan arena, actual costs for employees who are nearing retirement are much higher than those for younger employees. With the new focus on transparency, the accepted concept of pooling was exposed in a way that it had not been before.
This worry about fairness entered the political realm. Politicians began to ask, 'What is fair?' Is it fair to use genetic information to determine insurance rates? Does segregation of benefits, such as individual accounts in retirement plans and healthcare accounts, equal fairness?
New Math: Maybe 1 + 1 Does Not Equal 2
This is where the new math comes in, says Terry. If employee benefits can be broken down to their absolute cost in other words, if 1+1 always = 2 then companies can eliminate benefits altogether, simply increasing pay to offset the loss. It would be a simple and transparent solution. If that concept is making your hair stand on end, it is likely that you understand that more is at stake. "Employee benefits help distinguish a company's culture," says Terry. "They are part of the glue that holds a company together." That is why he suggests that 1+1 actually equals 3: the value of employee benefits is actually greater than their cost.
Transparency can indeed help a company identify problems in their benefits. "It is mostly beneficial," Terry says. "Retiree medical benefits are a good example. They came about in an opaque environment, but the emphasis on transparency shone a light on the true cost of retiree medical benefits, and that led to their demise." The upside, then, is that transparency can help a company identify and define trade-offs. For example, is it reasonable for younger, healthier employees to pay the same amount for their health insurance as older employees with chronic conditions?
Terry points out that there is also a downside to transparency. "Reducing everything to simple accounting severely limits a company's ability to define itself," he says. Ultimately, employee benefits will have to add value to an organization or be eliminated. They are valuable beyond their tax advantages, says Terry, if we accept his creative mathematics.