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The future of health and retirement plans presents big challenges for employers and employees.
David M. Katz, CFO Magazine
February 15, 2006
Employee benefits have been a lose-lose situation for years.
Even as companies have asked workers to absorb a higher percentage of health-care costs; cut benefits for retirees; and shifted away from richer defined-benefit (DB) plans in favor of more-predictable 401(k)s, CFOs have still had to face their corporate boards and explain how — despite all the rejiggering — the increasing cost of benefits continues to erode profitability. And when they return to their offices, they have to listen to a chorus of employee protests.
It's only going to get worse. At least that's the outlook of employee-benefits guru Dallas Salisbury. The CEO of the Employee Benefit Research Institute, a well-regarded, nonpartisan think tank in Washington, D.C., paints a bleak picture of the future of employee benefits over the next 15 years.
For starters, cuts to benefits will continue, he says. By 2020, the ranks of the medically uninsured will be much higher. The significance of that date is that by then, Social Security, if let alone, is expected to become cash-flow negative. Employees will have a difficult time retiring, because they haven't saved enough. Retiree medical coverage, which has been cut in half, will be halved again. And the number of Americans with traditional DB plans, currently at 17 percent, will fall to 8 to 10 percent.
Employers won't have it any easier. For the most part, they'll be pulled in opposite directions. Global competition will force companies to continue scaling back to remain viable against rivals from nations without a history of rich benefits, such as China and India.
But at the same time, many companies will be forced to offer generous benefits to at least a portion of the domestic workforce, as a shortage of labor — already seen in some high-end manufacturing and health-sector jobs — intensifies due to demographic trends (see "The Retirement Age"). CFOs will have to stretch benefit dollars further to balance these competing interests.
That balancing act is likely to have three major side effects that could shape the debate on benefits for decades:
1. The shift to defined-contribution health and retirement benefits promotes less-efficient use of resources.
401(k) plans have been the preferred method of providing retirement benefits for years. Now health care, with account-based plans such as health savings accounts and health reimbursement arrangements, is heading in the same direction. The simple truth is that the defined-contribution model weakens the shared-risk aspects of insurance. Taking health-care dollars out of the risk pool and putting them into accounts will shift more of the burden of paying for health onto those who are less healthy. Critics also worry that individuals will be poor purchasers of care on their own and susceptible to scam artists.
On the retirement side, Salisbury points out that 401(k) plans do a poor job of spreading the risk of outliving one's nest egg. A 401(k) plan participant will likely run out of money if he or she lives to be 100 years old. A traditional pension plan spreads funds more evenly over the average life span of the pool, and the benefits are delivered in annuities, which are generally cheaper.
These drawbacks need to be weighed against the positive attributes of defined-contribution-style plans: they are more portable, employees have more control and accountability, and employers have cost outlays that are more predictable.
2. A shift away from the insurance concept will continue to swell the ranks of the uninsured and increase the need for government intervention.
As costs rise and small employers drop coverage altogether, many employees will be forced to go without. It's not just cuts to benefits at individual companies that are increasing the number of uninsured; a shift in the workforce from manufacturing to services, which typically provides fewer benefits, is taking place. Just compare the benefits that Wal-Mart, America's current largest employer, provides its workers with those of General Motors, which once held that distinction. Increasingly, state and federal governments will have to pick up more of the tab, with the Medicare Reform Act a sign of what's to come.
3. Cuts to benefits could create less buying power for consumers, hurting employers as well.
Everyone knows that consumers are the engine of the American economy. The theory goes that cuts in benefits will mean lower consumer income, which "translates into lower consumption," says Salisbury. "And to an economy extraordinarily dependent on consumer spending, that creates problems for American business."
What can employers do to avoid these difficulties? A partial answer is to structure plans to secure as much future purchasing power for employees as possible. And one way to do that is to redesign 401(k)s so that all the assets stay in the account at all times. That means rethinking provisions that allow workers to get their hands on the cash through lump-sum distributions, hardship withdrawals, and loans. While those options were intended to make 401(k) plans more appealing to younger workers, they make them less effective at providing for retirement.
Similarly, consumer-driven health plans could be rebuilt for more staying power. If they increase the tendency of some people to skip, avoid, or delay medical treatment and that leads to additional health problems — especially among poorer workers — the backlash against such accounts might be substantial. The incentives in the plans need to be adjusted so that employees aren't deterred from seeking needed care because their health accounts are too scanty. Already, many companies are structuring their plans so that preventive medicine is always covered, shielding the assets in the accounts.
Ultimately, Salisbury says, anything that employers can do to encourage workers to save more for their retirements and health care will help.
David M. Katz is deputy editor of CFO.com.