Can Employee Benefits Rise Again?
What HR recruiters and managers need to know.
August 20, 2009
Recent news has been discouraging. The Society for Human Resource Management has featured an article about Watson Wyatt’s study of Fortune 1000 firms that have frozen (i.e., eliminated benefit accruals) their defined benefit (DB) pension plans. Watson-Wyatt found that out of 607 pension plan sponsors in the Fortune 1000 (a reduction from 20 years ago), 190 have frozen their benefit accruals, up from 169 last year. Freezes peaked in 2007 for firms in the Fortune 1000 for at least six years. Only 42 percent of Fortune 1000 firms accrue benefits in DB pension plans.
At the same time, some proponents of private plans are concerned about President Obama’s proposal for a national health plan. While the proposal that was reported out of the House Energy and Commerce Committee did not suggest supersession of employer-sponsored plans (see the The Wall Street Journal, August 1, 2009), some might construe it as a first step. In the workers’ compensation field, public plans like New York’s State Insurance Fund have long competed, often unsuccessfully, with private plans. Nevertheless, the establishment of a health plan of last resort would suggest at least partial failure of the private system.
Nor have 401(k) defined contribution (DC) plans earned a great reputation, even as they have grown. The Enron scandal of 2001 led to a wide range of criticisms. Even if we accept that employees can competently choose investment direction (and there is no evidence that employees are worse at it than professionals) DC plans have seen a considerable degree of volatility. The future will show us whether or not DC plans can provide retirement security to baby boomers.
There are four reasons for these trends: uncompetitive wages; rising health costs; riskiness; and over-reaction. Recent terminations reflect a failure of imagination to design plans that elicit employee performance as well as harvest tax breaks. Alternative approaches might include changing the tax code to view benefit contributions as tax-exempt deferred (but direct) compensation and revising human-resource strategy to make benefit levels contingent on individual and corporate performance.
Uncompetitive Wages and Benefits
The table below shows the broad trend with respect to the real hourly wage in current and 2009 dollars. While the nominal wage has risen steadily since World War II, the real hourly wage fell from 1973 to 1990 and then rose from 1990 to 2008. From 2000 to 2008 there was a 2.9 percent increase in real wages, much of which occurred in the past year or two. Because many industries, such as retail, have been increasingly competitive, termination of employee plans might be necessary at times.
Hourly Wages in Current and 2009 Dollars
(Source: Bureau of Labor Statistics)
Notice that the real hourly wage in 2008 was below 1980’s. In contrast, in 1889, David Ames Wells in his book Recent Economic Changes noted that the American economy was able to produce consistent growth in real wages of about two percent per year. Real wages doubled from the 1840s to 1889, a period of heavy immigration, increasing American competitiveness, laissez-faire economic policies, rapid technological advance and labor unrest. Wells catalogs the nearly infinite number of ways that 19th century American industry innovated to increase productivity and reduce unit costs despite rising wages, falling profits and improved quality. Twentieth century economic policies failed to repeat this performance.
Rising Health Benefit Costs
In May 2009, the Milliman actuarial firm found that the cost of health coverage for a family of four rose from $15,609 to $16,711, an increase of 7.4 percent. This was lower than increases in preceding years, but it occurred in the rare (since 1945) context of deflation for the 12 months ending June 2009. Health costs continue to increase at a much higher rate than prices. Faced with increases, firms may need to cut in other areas, such as pension plans.
DB plans present several elements of risk. Employer contributions are tax deductible, but the deduction loses some of its value in periods of bottom-line losses. The projection of future costs of DB plans depends on the relationship of real wage to real interest-rate growth. If employers fear that real wages will increase more rapidly than interest rates or stock-market returns, or that profits will be volatile, then DB plans pose risks. Recently, the Federal Reserve Bank dramatically increased the quantity of monetary reserves and money. This may affect wages as well interest rates in unpredictable ways, increasing the level of risk.
This calculation is further complicated by a phenomenon that the Oracle of Omaha, Warren Buffett, has noticed. Actuarial interest rate assumptions tend to lag financial markets. This may be related to the well-known “rear-view mirror” phenomenon in investing. Investors tend to assume that future returns will be the same as the recent past, ignoring that the Federal Reserve Bank tends to infuse more new money into the economy (i.e., reduce interest rates) when markets fall. The new money increases stock-market values, so booms follow busts and busts follow booms. This would suggest that plan sponsors tend to freeze plans at bottoms and initiate them at tops.
Re-thinking Benefit Policies
Many commentators have noticed that the “three-legged stool” of retirement — Social Security, private plans and individual savings — has wobbled. The Fed has pursued an aggressive strategy for the past decade and markets have been volatile, resulting in uncertainty about retirement. As a society, we cannot retire if we do not produce sufficient wealth. Herbert Croly’s claim that 20th century economic polices can result in 19th century levels of growth has faltered.
Firms might consider linking benefit payments to productivity increases, i.e., thinking about benefits as motivational devices rather than tax vehicles. As well, employees have not understood and have tended to ignore the importance of benefits to their own economic welfare. One way around this would be to reformulate benefits as deferred direct compensation included in the paycheck that is allocated across a benefit portfolio, generalizing the Section 125 concept. In other words, view and communicate benefits as cash first and include their amount directly in employees’ pay checks. These ideas would only be possible with a reformulation of the tax treatment of benefits. Unfortunately, the current model is too esoteric for employees to understand. Most importantly, employee benefits can rise again if we revivify competitive thinking.
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Mitchell Langbert, PhD, is an Associate Professor, Brooklyn College. Widely published on the subject of human resource management, Langbert has consulted and served as an expert witness.