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One of the toughest jobs for CFOs is building a quality benefits package that won't collapse under its own weight.
Joseph McCafferty, CFO Magazine
February 22, 2005
Over the years, U.S. corporations have built up the package of benefits they offer their employees. The added compensation represented by health care, retirement plans, and other perks has grown impressively.
Today, however, those packages are in danger of falling apart. Soaring health-care costs, aging workers, and a slack economy have made providing decent medical coverage and adequate pensions — without gutting profits or paychecks — a difficult balancing act. And increasingly, that task has fallen to the CFO.
By any reckoning, the price of employee benefits has gotten out of hand. According to the U.S. Bureau of Labor Statistics, health-care and retirement benefits now make up about a third of the total cost of employee compensation. That percentage is almost certain to go higher, too. In 2004, the cost of worker benefits surged 6.9 percent, more than twice the increase in wages and salaries.
Outside of vendors, this painful increase in the cost of benefits hurts almost everyone. While employers top that list, employees are not far behind. Elise Gould, a labor economist at the Economic Policy Institute, in Washington, D.C., says the escalating cost of benefits could have a dampening effect on hiring, as managers look to get more hours out of current staffers rather than add more workers.
"Hiring is not happening at a pace you would expect in a recovery," notes Gould. Neither are raises. Wages and salaries grew by just 2.4 percent last year — a puny increase that can be attributed in part to burdensome benefit costs.
Then there is the impact on competitiveness. On average, American corporations pay 5.5 percentage points more for benefits than companies operating in the nine countries that do the most business with the United States. Not surprisingly, this added cost plumps up SG&A, which in turn, eats away at profit margins. At General Motors Corp., for example, the price of providing health-care coverage works out to about $1,400 per automobile built. That's more than what GM spends on steel for each car.
The upshot? Consulting firm McKinsey & Co. estimates that without cuts in expenditures — and lacking a dramatic pickup in the economy — the average Fortune 500 company will soon spend as much on health care as it makes in profits. If the trend in health care continues, many companies will begin axing other benefits, including education and 401(k) matches. "Probably the only benefit that is relatively safe," says SAP America CFO Mark White, "is vacation days."
The $5,000 Deductible
That's not great news for employees. Neither is the corporate strategy for dealing with runaway health-care premiums, which have shot up nearly 60 percent over the past four years. In a move that harkens back to the switch to defined-contribution pension plans in the late 1980s, many businesses have begun to off-load risk. In the case of medical insurance, that means asking employees to pay a larger share of their health-care costs. The plan, while understandable, doesn't necessarily solve the underlying problem — sky-high medical charges. And it has some serious drawbacks. In an exclusive survey (see "Uncertain Benefits: The 2005 CFO Human-Capital Survey"), we asked finance chiefs if they could continue to shunt medical-care costs to employees without harming workforce morale. No surprise here: 55 percent said they could not.
Nevertheless, when questioned about how they plan on controlling rising health-care costs in the future, the majority of respondents indicated that they intend to ask workers to pitch in. Toward that, many businesses are experimenting with defined-contribution plans such as health savings accounts. Like 401(k) plans, HSAs (and their predecessors, health retirement accounts) promise to give employees more control over their plans. But critics argue that taking money out of the system to fund the accounts of healthy workers will add more costs than it cuts.
What's more, requiring employees to pay a hefty portion of their medical costs seems like the Rx equivalent of Russian roulette. Faced with a $5,000 deductible, workers may choose to forgo medical treatment; "well care," the single surest way to control health-care costs, would go out the window for most.
Backers of HSAs — and that list includes President Bush — point out that the tax-free accounts can be invested. Since HSAs roll over, unused funds can be turned into something of a nest egg, which can be used to pay for medical bills when workers retire. The question is, Will employees manage their accounts wisely?
Hard to say. But since HSAs and other defined-contribution plans are modeled on 401(k)s, the answer may lie in how workers are managing those retirement accounts. And that's troubling. According to experts, many employees are not diverting nearly enough of their salaries to the plans to retire comfortably. Furthermore, most workers simply aren't savvy investors. Too many young employees, for example, put their money into safe vehicles like money market accounts, leaving the funds vulnerable to the ravages of inflation. And as the vaporized 401(k) plans of many Enron employees painfully revealed, lots of workers have no clue about diversifying their portfolios.
A Little Sanity
The wild card in all of this, of course, is the tendency for people to want to extend their expiration dates. The reality is, Americans will continue to live longer, stretching their retirements out for decades, not years. A graying population will put further stress on an already stressed-out system. Reining in medical malpractice will undoubtedly boost profit margins for doctors, but most experts believe tort reform will have a minor impact on overall health-care costs.
Universal health care would help take some of the costs out of the system, particularly expenses that arise from treating the uninsured. Indeed, some executives believe universal health care is the only answer to the health-care crisis in the United States. But given the yawning government deficit — and with Congress's attention firmly focused on Social Security and Medicare — it's not likely universal medical coverage is coming anytime soon.
Employers, therefore, will continue to bear the brunt of double-digit increases in health-care insurance prices. To reduce those premiums, corporate customers will have to put more pressure on providers to prove that products are both effective and cost effective. Technology, too, holds promise. Digitizing medical information will go a long way toward streamlining the system and creating price transparency. Down the road, insurers may figure out a way to put some bite back into managed care. Despite complaints from workers, HMOs brought a little pricing sanity to the medical-care system.
But there is a risk here. An aging population may well create a labor shortage. Then, employers that provide "Cadillac" plans, particularly medical packages with strong out-of-network coverage, will hold a decided hiring advantage over competitors with stripped-down HMOs.
Until then, expect the balancing act to continue. "I don't want to see my employees not getting the care they need," says the owner of a small public-relations firm. "But at the same time, if I keep paying more for health care, we'd go out of business. And then where would we be?"