|Trends and Challenges for Work in the 21st Century|
Portability of Benefits, Job Changes, and the Role of Government Policies
by Robert L. Clark, Professor
Task Force Working Paper #WP12
Prepared for the May 25-26, 1999,
September 1, 1999
2. Compensation, HR Policies, and Job Tenure
Employee benefits are an important component of total compensation. Some benefits provide significant noncash current compensation while other promise deferred income streams after the worker leaves the firm. Individuals assess the value of these benefits when considering initial job offers, when deciding whether to quit the firm, and when deciding on their retirement age. The conditional nature of some employee benefits and their lack of portability across employers can result in considerable differences in lifetime income and welfare depending on whether workers remain with a single company throughout their work life or whether their career is marked by repeated job changes.
It is important to understand the role of employee benefits and how the lack of portability affects the welfare of workers. This requires an understanding of existing company policies and the effect of government regulations on employee benefits. This section begins our analysis by examining the portability of todays retirement plans and health insurance and how government policies alter the structure of these benefits.
If workers were paid entirely with cash in a spot labor market, each worker and each firm could assess the best job match for them each period. Movement across firms would not involve the loss of any promised compensation and portability would not be an issue. While such compensation structures may have characterized earlier U.S. labor markets, the second half of the twentieth century has seen the development of more complex systems of compensation including the use of pension plans, health insurance, and other types of employee benefits as important components of total compensation. The introduction of employee benefits has been due to a variety of factors including the lack of national programs for pensions and health insurance, government tax policy, the desire by employers to tie workers to firms in an effort to reduce labor costs associated with turnover, union interests in negotiating a wider range of compensation, and the ability of workers to benefit from group rates on health insurance.
Government regulations associated with the provision of pension plans and health insurance generally is linked to the preferential tax status they receive. In the case of pensions, company and worker contributions to pension plans are not taxed as current income for the purposes of federal and state income taxes provided the plan meets certain federal standards. Instead, retirement income is taxed when it is received often many years after it is earned. In addition, pension contributions are not subject to payroll taxes. The avoidance of payroll taxes and the deferment of income taxes means that workers covered by pension plans can receive greater total compensation per dollar of employer costs when a portion of compensation is provided in the form of pension contributions.
Company expenditures for health insurance also are not subject to either income or payroll taxes. Payments for health insurance permanently avoid both types of taxes. In exchange for qualifying for this preferential tax status, pension and health insurance plans must meet certain standards. These standards require that benefits be offered to a broad range of employees and not just highly compensated employees and managers (nondiscrimination) and in the case of pensions, there are additional vesting, management, and funding requirements that firms must meet (McGill, et. al, 1996).
Pension plans are of two basic types: defined benefit and defined contribution. In a defined benefit plan, workers are promised a specific benefit in retirement. The benefit is typically based on years of service times a percent of average salary during the final working years. Defined contribution plans provide for periodic contributions into an individual pension account for each worker. The contributions may be made by the firm and/or the worker. The eventual retirement benefit is dependent on the amount of the contributions and the rate of return on the individuals retirement assets.
Defined benefit plans are considerably less portable than defined contribution plans and therefore, job changes may result in substantial reductions in retirement benefits. Current regulations require that promised benefits must be vested after five years of service. This means that workers leaving the firm with fewer than five years of service will receive zero retirement benefits. Workers with more than five years of service will receive promised benefits in accordance with the existing benefit formula and retirement age requirements. For most workers, this means that benefits are determined on the basis of average earnings before leaving the firm. Thus, when a worker leaves the firm at a relatively young age, the future pension benefit is frozen in nominal terms until benefits are actually received in retirement. Over time, as consumer prices increase and the earnings rise, the real and relative value of this benefit declines. It is easily shown that workers with the same lifetime earnings who move across firms with identical retirement plans will accumulate lower total pension benefits than workers who remain with the same firm throughout their careers (Clark and McDermed, 1988).
Defined benefit pension plans offer workers retirement income conditional on their meeting certain age and service requirements. As a results, these pension plans also can be used to alter worker behavior such as effort on the job (Lazear, 1979), the timing of retirement (Quinn, Burkhauser, and Myers, 1990), and the probability of quitting (Allen, Clark, and McDermed, 1993). Workers desire employer-provided pensions primarily because of the tax advantages associated with this type of retirement savings and the ease of saving prior to receiving the money in their paychecks.
In contrast, workers covered by defined contribution plans typically do not incur such capital losses when they change employers. In general, these workers have a legal claim on a pension account in which all pension contributions have been invested. If the funds remain in the account after the worker leaves the firm, the account will continue to grow with the returns on the invested assets. Alternatively, the funds can usually be withdrawn from the pension of a former employer and rolled over into an IRA or a new pension account. In either case, the worker who has changed jobs retains the full value of the pension funds. Thus, in general, defined contribution plans are completely portable and workers can change jobs without the loss of pension benefits.
This analysis shows that issues relating to the portability of retirement benefits are primarily limited to defined benefit plans. Thus, two primary areas of concern remain. First, how portable are current defined benefit pension benefits and what policies should be considered to make these benefits more portable? Second, what is the mix of pension coverage among current workers and what policies should be considered to alter this mix? Of course, workers covered by generous defined contribution plans who are considering a job change must assess the likelihood that their new employer will offer a pension plan. This assessment of the full compensation may affect mobility decisions.
The United States does not have a national system of health care providing insurance coverage to all of its citizens. Instead, two government programs, Medicare and Medicaid, provide health insurance to the aged and those poorest members of our society. Most Americans under the age of 65 acquire their health insurance as part of their compensation from their employer. Employer-provided health insurance may be wholly or partly paid by the firm. Workers may have to pay a portion of the health insurance premium, deductibles, and co-payments. The primary advantages of this type of benefit to employees are the access to the group insurance plans, payment with pre-tax dollars, and often the avoidance of qualifying medical exams. Companies provide several different forms of health insurance including fee-for-service plans, preferred provider plans, and health maintenance organizations. Often workers are given the option of choosing which of these plans they would prefer; however, the cost of participation in the various plans may differ.
Company-provided health insurance is not portable. Workers can not retain their coverage under their former companys policy when they change jobs. An exception to this statement is that the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) which allows workers to pay the full cost (102 percent of average cost of their former employers health insurance) and remain covered in their old health plan for up to 18 months. Thus, individuals considering moving to a new employer must consider how long they will be between jobs and whether their prospective new employer offers health insurance. This potential period of not having employer health insurance imposes significant costs on workers who are involuntarily terminated and may deter other workers from leaving their positions. The importance of gaps in health insurance coverage depends on the workers age, gender, family status, and current health status.
Another problem that often confronted workers attempting to change employers was associated with pre-existing medical conditions and the ability to purchase health insurance after leaving a plan provided by the former employer. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) prevents health plans from applying pre-existing condition limits on newly employed workers.
Workers currently considering leaving an employer that provides health insurance must consider their future employment prospects and whether they will find new employment with another company that offers health insurance or whether they will have to consider purchasing health insurance in the private market. The value of current company-provided health insurance will vary across individuals and the key issue for worker-initiated job changes is the value of the insurance to the worker, not the cost to the employer. Thus, workers thinking about changing jobs must consider the expected duration of time between jobs, the probability of finding new employment with health insurance, and the importance of any pre-existing health conditions. The enactment of COBRA and HIPAA reduced the importance of these factors but do not eliminate portability concerns associated with health insurance.
Many large companies extend health insurance coverage to their retirees. Individuals who meet qualifying conditions can retire and remain covered by the company health insurance plan. This coverage is especially important to early retirees (those less than 65) who may wish to completely withdraw from the labor force or shift to part-time employment. Some companies terminate retiree health insurance when the retiree reaches age 65 and qualifies for Medicare. Qualifying conditions that specify a certain number of years of service may mean that workers who leave the company after only a few years of service will forfeit future health insurance. This lack of portability would impose costs on mobile workers and may reduce turnover. Active workers covered by employer-provided health plans that do not extend coverage to retirees are more likely to defer retirement until age 65 and the attainment of eligibility for Medicare while workers covered by plans that do extend coverage to retirees are more likely to retire from their career employer prior to age 65 (Madrian, 1994a). These workers may then shift to other full-time jobs, change to part-time employment, or withdraw from the labor force.