How smaller companies are profiting from flexible-benefits plans.
Clo Ross seldom rejects an idea flat out, but when she first read a writeup on flexible benefits, she couldn't wait to get it off her desk. "An absolute nightmare," declared the administrative vice-president of Clairson International Corp., a 400-employee, $20-million manufacturer of closet shelving and storage systems based in Ocala, Fla. "Too expensive, too much trouble to administer -- we're just plain not big enough for this." Besides, Ross told chief executive officer Donald Sauey, these so-called cafeteria plans, in which employees design their own benefits packages from a menu of insurance policies and perquisites, were "bound to be a passing fad."
Sauey, however, thought the concept too innovative to be so quickly dismissed Give it more study, he told Ross, and "maybe we'll find we can make a go of it."
Study she did -- and the more Ross read and heard about flexible benefits, the less faddish they seemed. Group-benefits plans had been great, she realized, only so long as employees were predominantly 30-to-50-year-old males. Most of them sole breadwinners, these men wanted security -- health care for themselves and their dependents, disability coverage, and life insurance. So that was how the group plans that came into vogue in the 1950s were patterned. But society changed, and the numbers of workers who met this traditional description dwindled to just 15% of the labor force. The majority of the work force now and for the foreseeable future is a conglomeration of young singles, women, and partners in two-paycheck marriages. For many of them, group-benefits plans provide coverage that is at once too much, too little, and not of the right kind.
"Take me, for example," Ross says. "I'm married, and I have good medical insurance through my husband's employer. Yet, for the five years I've worked here, Clairson has been throwing money out the window for [group-medical] coverage that I don't use." Speaking as an employee, she would much rather have used that money "to get something else -- like a dental policy, better life insurance, or more vacation time." As a manager, she found it nonsensical not to allow such flexibility. "If you're going to spend money on benefits, you might as well be paying for something that people want." Especially these days, when the average annual claim for medical coverage alone is $1,158 per year and rising fast.
Nevertheless, for all her new-found enthusiasm, Ross remained ruefully convinced that a flexible-benefits plan was more than Clairson could afford. First there was the time and expense of shuffling -- or more likely, computerizing -- the paperwork. According to what Ross had read, that alone could run into the hundreds of thousands of dollars. Then there was the cost of selecting and pricing the additional insurance coverage. Ross didn't want to fix the premiums too high for employees, yet she didn't want to set them so low that Clairson would have to subsidize the program. But finding the right figures was a catch-22 situation. Ross's insurance agent said that he couldn't quote premiums until he knew which and how many of her employees intended to take what policies, and Ross replied that she couldn't provide that information until the program was actually installed. "How could I sign people up," Ross says, "if I couldn't tell them what the premiums would be?"
Ross was about ready to shelve the whole idea when she paid a visit to the Atlanta office of Hewitt Associates, a benefits-consulting firm based in Lincolnshire, Ill. Of the dozens of consulting firms, insurance companies, accounting firms, and financial-services organizations that claim some expertise in the area of flexible benefits, Hewitt -- with about 65% of the market -- is widely regarded as the leader. The purpose of Ross's visit was to pin down the cost of a cafeteria-style plan, but she soon found herself listening to an explanation of a new variation on the flexible-benefits theme, involving something called a reimbursement account.
It was the centerpiece, she was told, of a flexible-benefits plan that Hewitt had developed for its own employees in 1980 -- and it was so easy to administer that Hewitt was able to track plans for more than 400 employees on note cards (until 1983, when employment growth made it necessary to computerize the system). Ross was sold. Last January -- a year after her first visit to Hewitt, and nearly two years after she told Sauey it couldn't be done -- Ross presented a flexible-benefits plan to Clairson's employees.
A reimbursement account -- sometimes also called a "benefits bank," or a "flexible-spending account" -- operates like a checking account. Employees draw against an individual annual benefits allotment that is set aside by the company for reimbursement of certain eligible expenses that are not covered elsewhere in the benefits package. Clairson, for example, provides employees with a free-of-charge core package consisting of life insurance, short-term disability coverage, educational-assistance eligibility, and the usual time off for vacations, holidays, and illnesses -- much as it did when the company was still under the traditional groupbenefits plan. But thatis where the similarities end. Clairson now allots $500 per employee, plus I% of salary -- money that employees can use to buy such things as supplemental life insurance and/or long-term disability coverage. The one requirement is that those who cannot claim medical coverage elsewhere must purchase the company policy, which costs $486 per individual, or $850 per family.
Any money left over when the shopping is through goes into the reimbursement account, known in-house as the Clairson Care Account. These so-called flex-dollars can be used to reimburse expenses for dental work, child care, vision or hearing treatment, and miscellaneous medical expenses -- including the deductibles on the aforementioned insurance policies. Those who still find themselves with unspent money at the end of the year can roll it into the following year's reimbursement account or sock it away in a deferred compensation program. The sum can also be taken as cash -- but those who elect to do so must pay tax on it. On the other hand, those who find that their needs exceed their benefits allotment can boost their buying power by selling back some vacation time or by entering into a salary-reduction program whereby payroll deductions serve to reduce an employee's taxable income as they increase the size of his or her reimbursement account.
"Finding out about the reimbursement account was the key for us, and I think it's going to be the key for a lot of smaller companies that didn't think they could go flex," says Ross. "We're maximizing our benefits expenditures, we're giving our employees access to more benefits than they've ever had before, and we're doing it all in a way that's more tax-effective than ever [thanks to the salary-reduction and deferred-compensation options]." Ross has also found the package to be as easy to administer as Hewitt had predicted -- although she prefers to use the office minicomputer instead of a card file.
Best of all, says Ross, aside from the onetime expense of about $10,000 in consulting fees and other start-up costs, "we're not spending any more on 1984 benefits than we did in '83." She had expected a 25% hike in the cost of the old group plan.
The arrival of the reimbursement account represents the third generation of a flexible-benefits evolution that began 10 years ago. Recognizing a growing diversity in the work force, the pioneers of flexible-benefits plans sought to expand benefits in a way that would allow employees to become more involved in determining the shape and scope of their packages. Most of these first-generation plans did little more than offer employees a choice between the additional insurance and cash. The growth of these plans stalled, however, when a small section of the Employee Retirement Income Security Act of 1974 put a hold on them until Congress could study the tax implications.
But these tax difficulties were apparently resolved with the passage of the Revenue Act of 1978, which has been construed to permit employees to take the unused portion of a benefits allotment as either cash (taxable) or deferred compensation (nontaxable until distribution). A second generation of flexible-benefits plans was thus ushered in, and they became known as cafeteria plans. It was soon recognized that not only were these plans more responsive to employees' needs than the old group plans, but they often worked to meet the employer's need for benefits cost-containment as well.
No longer did the company simply absorb premium increases; under cafeteria plans, the employees themselves were now seeing the prices, making the economic judgments on how much and what kind of coverage they needed, and deciding how much of their benefits allotment they were willing to pay for it. It was the solution to a lot of previously insoluble problems -- but only for those who had the sophisticated computer capabilities to handle the administrative intricacies of the plan. And, in the mid-to-late-'70s, that meant only such giants as American Can Co. and TRW Inc.
But now virtually all companies have computers that facilitate administration of these plans. That is one reason why flexible-benefits plans are gradually filtering down into smaller businesses. The other, more important reason hinges on the latest development in this evolution -- the introduction of the reimbursement account. Because so many employee-benefits needs can be satisfied from a single, budgeted fund, the need for an extensive menu of benefits options is gone. The reimbursement account, like a short-order cook, provides more flexibility and has simpler administrative requirements than the cafeteria line ever could.
Not only does the reimbursement-account structure provide more categories of benefits than were available under group plans, but it actually provides more benefit to the employee than do the cafeteria-style plans. When employees present receipts for reimbursement of benefits-related expenses instead of filing insurance claims, they get dollar-for-dollar coverage -- not the typical 80-20 or 50-50 split that insurance companies offer. And those companies that choose the reimbursement account over the cafeteria structure effectively do an end-run around a technical problem that makes cafeteria plans more difficult to design. That technical problem is something the insurance industry refers to as "adverse selection."
Actually, it could be as easily called intelligent selection, because adverse selection refers to an employee's natural tendency to select the benefits that will do him or her the most good. The trouble is, in the already-small groups served by each policy within a cafeteria-style plan, this predilection sorely hampers an underwriter's ability to spread risk and set premiums. The response of some insurance carriers has been to require companies embarking on cafeteria plans to team policies that attract different constituencies -- dental with medical, for example. This grouped approach is not a bad benefits plan; it is just a less-flexible version of a flexible-benefits plan.
Clairson's employees know little or nothing of how their reimbursement account compares with the cafeteria plans that larger companies have installed, but they can tell you plenty about how it stacks up against their old group plan. "What I've got now is a big improvement," says set-up operator Eleanor Poole. She had planned to buy an additional life-insurance policy "on the street" until she found she could get it more tax-effectively through Clairson's salary-reduction option. "This company is 100% for its people," she declares. "I never [imagined] that they would have come to us with this. Everybody's talking nothing else -- just what a good deal it is."
Jim and Sherry Hillebrandt are equally enthusiastic. "As a married couple, both working at Clairson, we have a much broader benefits package now," says Jim, the company's director of manufacturing. The pair has been able to develop something of a joint benefits package, now that they no longer carry duplicate coverage. Jim uses his allotment -- augmented with salary-reduction money, plus the proceeds from selling back some vacation time -- to buy the medical policy for himself and his family. Sherry -- an administrative assistant -- puts all of her money into the reimbursement account, where it can be used to pay the medical-policy deductible, plus dental and child-care expenses.
But Ross is quick to point out one thing: "This is by no means a beefed-up benefits plan, and it hasn't been sold as that. What we're selling is the fact that, where once we had one plan, we now have 400 -- one for each employee. These employees have freedom -- new options, new flexibility -- and that's the big selling point."
It is such a selling point, in fact, that some companies are using it to ease an increasingly imperative move away from the first-dollar medical coverage they once provided. It's amazing, says Hewitt partner Dale Gifford, "what changes and cut backs people will accept when they are given the ability to make some of their own choices at the same time. The mere fact of the flexibility is viewed more positively by employees than any given benefit they might receive." Clairson had already imposed measures to discourage the overuse of insurance benefits before the flexible-benefits plan went into effect, he says, but other companies are finding flexibility and cost-containment can go hand in hand. One such company is Quill Corp., an $80-million mail-order distributor of office supplies and equipment located just down the road from Hewitt's Lincolnshire headquarters.
"We had been experiencing premium increases of 40% and 50% a year in our group-benefits medical plan. That's what woke us up and got us to thinking about going flex," says treasurer Arnold Miller, one of three brothers who control the company.
"We had to find a way to make our employees think of their benefits dollars as their money they were spending," agrees president Jack Miller, "because nobody gave a damn about medical costs as long as it was our money."
The Millers decided to phase in a flexible-benefits plan built around the Hewitt reimbursement account, but with a new twist or two. They decided to replace their old group-medical policy with a new one that, unlike Clairson's, would be provided free to its 500 employees, as part of a core package or "Shield of Benefits" that also includes sick pay, life insurance, and short- and long-term disability coverage. That medical policy, however, was to be a modified, self-insured version of its former self. A 12-member employee committee was appointed to fashion the coverage.
"Everybody was a little leery at first," recalls Grace Finedore, an order-entry operator who served on the committee. "We thought they were going to shaft us, until we realized these changes were to help us -- to educate us to use benefits more constructively. But we had a knock-down, drag-out [fight] or two [about it within the committee] before then."
In July of 1982, at the committee's recommendation, the company initiated several hard-nosed changes: Claims for in-patient care would be paid at 80% instead of 100%, but outpatient expenses, usually less costly, would still warrant the full coverage. Those who didn't seek second opinions (which are also covered) before undergoing surgery would be penalized with lower insurance payments. And a $200 deductible would be established for individual medical coverage, while the deductible on a dependent-care policy would be doubled to $400.
But, at the same time, the company gave some of that money back -- by expanding the availability of disability coverage to all employees and by establishing a reimbursement account much like Clairson's, which provides each employee with $200 a year to spend on eligible expenses. There is no provision yet for accumulating any leftover funds from year to year, but that is coming -- along with a number of other gradual improvements to the plan. The company has another committee working on expansion of the reimbursement account, and it is hoped that its recommendations will result in a full-fledged flexible-benefits plan by this coming July. If all goes well, there will be not only new eligible categories of reimbursement, but also money available for each employee's individual benefits needs.
"Our costs are down," Arnold Miller explains, noting that the cost-containment measures in the medical policy probably had much to do with that. "We stayed even in 1982, saving the premium increase we'd normally have had, and in the second year it looks like we've saved 33%. We are increasing the flex account from $200 to $300 this year."
Jack Miller doesn't want employees to expect similar increases in coming years, however. "We'd told the employees that if the costs had gone up this year, or any year, they'd have a reduction in their flex accounts. There's no question it can change with circumstances, and they know it. But they also know they have some control over those circumstances -- by using their benefits wisely."
The reason both Claitson and Quill have seen such good response from their work forces, says Gifford, is their dedication to informing their employees of the changes coming. "If you don't want a lot of disgruntled employees," he says, it is crucial to keep the lines of communication open. "You have to explain to the work force what you're doing, and why. Most of the time flexibility isn't really a money-saving proposition, but if you know you are going to save money, you'd better be upfront about it. Because you know your employees are going to find out."
In addition, the switch from a group plan to a flexible-benefits plan puts employees in more of a decision-making role than ever before, and Gifford believes it is the company's duty to make sure the new responsibility is discharged well. "You have to remember you're asking people to make decisions that have an impact on their security and that of their families. You have to inform them [about the costs and tax ramifications of various benefits selections] in a way that doesn't frighten them."
Both Clairson and Quill held a series of meetings and distributed notebooks, pamphlets, and paycheck inserts explaining the finer points of flexible benefits. Many contained examples of how benefits packages could be designed and tax charts from which to gauge the impact of the salary-reduction portion of the program. Each management team encouraged its supervisors to discuss the plans with their coworkers on the job.
"I think it helped that I was too excited about the program to keep my mouth shut," says Ross with a laugh. "I was talking about it for more than a year, and it got to be that somebody would ask me when we were going to get those new benefits whenever I walked into the plant. By the time we signed everybody up" -- in a yearend gathering resembling a stockholders' meeting -- "they were ready to go."
But both companies are quick to point out that the planning that took place behind closed doors, before any announcements were made, was at least as important. "There were, and are, many decisions to make," says Ross. "For example, do you allot the same amount of flex-dollars for a single employee as for a married employee? I say yes -- to do otherwise is discriminatory, morally if not legally, I think." Quill made the same decision, although both companies became acquainted with others -- most notably, PepsiCo Inc. -- whose programs do provide for differing amounts.
Each of the two companies wrestled over the matter of medical insurance and whether it should be mandatory for those who would otherwise have no coverage. Both answered yes. "You can't let them risk a catastrophic illness without it," says Jack Miller.
Clairson allows employees to claim reimbursements quarterly; Quill every six months. Ross has made the flat decision that employees will be allowed to alter their benefits packages only once a year -- despite what hardship conditions might arise. At Quill, however, that matter is still under debate. "What happens if a spouse who works somewhere else dies," muses Arnold Miller, "leaving one of our employees without medical coverage? That's one I can't answer yet."
Another unresolved issue at Quill is whether to design the final version of the reimbursement account in such a way that employees can opt to take only cash -- no benefits. Some managers say yes -- that flexibility and freedom of choice ought to mean just that. But Arnold Miller says, "I'd rather see them roll it into a profit-sharing fund or spend it on benefits. I think if we started paying cash, employees would start seeing that as salary -- and that's not the intention of the plan at all." But both companies have decided that employees who quit should be entitled to whatever is left in the flex fund. "That's their money -- they've already earned it," says Ross.
As time goes on, each company will have to consider how far to expand the flexibility of the benefits package. Should the benefits allotment, or flex-dollars, be increased? Should new options be added? The two companies say they are certain they will do both. Clairson and Quill are discussing such additional coverage as personal legal expenses and costs connected with car or homeowner's insurance.
But the biggest unanswered questions for any company that has, or is about to install, a flexible-benefits plan involve the government. The section of tax code that has been interpreted to permit the proliferation of reimbursement accounts has been on the books since 1978, yet its definition has not progressed beyond the proposed-rule stage -- and almost nobody is betting on when it will. What is more, there are indications that the Treasury Department is looking at sections of the tax code enacted many years earlier that could be read as prohibiting the sort of transformation of benefits into cash or deferred compensation that reimbursement accounts are based upon. If that were to happen, benefits packages would have to revert to the more cumbersome cafeteria plan -- or, worse, the old group plan -- in which, in both cases, insurance coverage is only worth money if there is a claim.
Still, Gifford and other consultants say there is little risk in installing a reimbursement-account-based plan, so long as a couple of precautions are taken in their design. First, he advises, companies should make sure that there is nothing discriminatory about the plan, either in terms of the groups covered by it or the benefits offered within it. Second, Gifford sees merit in restraining the use of salary reduction. A figure he is "comfortable with" is $250 a month, or $3,000 a year per employee, although he has little quarrel with those who might choose to go up to $5,000. Just be prepared, he says, to justify the policy and, perhaps, change it.
"I'm reasonably certain that Congress or the Department of the Treasury is going to want to cap the amount of money that can be taken off the tax rolls via salary reduction," Gifford explains. "It's inconceivable to me that it's going to remain as wide open as it has been."
Be that as it may, Gifford is one of many consultants who is proceeding under the assumption that any penalties the government might attach to future rules and regulations pertaining to flexible benefits would be prospective, and not intended to punish those that have installed plans thus far. "We're telling our clients that, to the best of our knowledge, all they'll have to do is make some changes for the future."
That prospect doesn't bother Ross in the least. "Whatever changes the government comes up with, I'm sure I can modify the plan to meet them," she says. After all, it is flexible, "and that's the beauty of it."