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How Flexible Are You?
by David H. Hart


Index
The Evolution of Flexible Benefits
The Current Benefit Environment
The Change in Relationship
The Employer Role
The Employee Role
Paradigm Change
Acknowledgements
About the Author

It is more than ten years since I decided to make flexible benefits plans the principal focus of my consulting practice. Only now does there appear to be a real momentum for widespread implementation of these plans because of the need for employers to meet cost control and containment objectives. This, in my view, is great news for actuaries, since few areas of activity afford as clear an opportunity for the use of actuarial skills as flexible benefits. I trust the following information will tempt some of you to turn your attention to this area.

The Evolution of Flexible Benefits

The first flexible benefits programs were introduced in Canada in the early 1980’s. The principal reasons for implementing them were to:
  • Meet the needs of a changing and diversified work force
  • Increase employees’ awareness of benefits and their costs
  • Manage rising benefit cost
  • Maintain a progressive company image and help recruit personnel
When the growth of flexible benefits in Canada is compared to that of new benefits such as dental plans, the growth of flexible benefits programs has been negligible. When first implemented in the 1970’s, dental plans became part of the benefits programs of more than 2000 companies within 5 years. Currently, there are probably less than 300 companies in Canada who have implemented some form of flexible benefits.

The slow growth of flexible benefits programs to date can be attributed to the following factors:
  1. Plan Design—When people talk about flexible benefits programs, they generally think about one of the following plan designs: core plus options, modular, or cafeteria. To date, most flexible benefits programs have been of the "core-plus options" design. The advantage of this design approach is that employers can ensure that all employees are covered for basic needs (i.e., at least minimum coverage for health, disability and life insurance), while providing various optional coverages to meet additional requirements.

  2. A major disadvantage of program designs of the 1980’s was that they retained the entitlement basis of traditional group programs. As a result of being entitlement-based, flexible benefits of the 1980’s did not solve the over-utilization problem associated with traditional programs, and this created and open-ended liability for the employer.

  3. Administration—The cost of programs developed or available for administering this kind of program in the 1980’s was very high. Employers implementing flexible benefits programs had to look at spending a significant amount of money to develop a less-than-perfect administration system. As a result, employers who may have considered flexible benefits found the administrative costs prohibitive. Administration is no longer an issue as software is now available for flexible administration at a reasonable cost.

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The Current Benefit Environment

Traditional benefit programs and most flexible benefit programs are "entitlement-based". Once an employee has qualified for inclusion in a program, the benefits are payable as an entitlement, regardless of cost.

Such traditionally designed defined benefit programs establish an open-ended liability for the employer as the plan sponsor. Employees perceive that they are entitled to maximize their utilization of the program, and third-party suppliers of services and products pursue a pricing policy which constantly seeks to test the maximum level of tolerance.

More recently, provincial and federal governments have actively and successfully sought to transfer liabilities from public programs over to private plans.

The consequence of these factors has been rapid and continuing cost escalation of employer-sponsored entitlement programs. This cost escalation is systemic in nature and does not lend itself to control if the "entitlement" basis of the program is maintained.

As well, double-digit inflation in the total benefits budget has occurred over the last several years for many organizations, driven primarily by the cost of the health and dental plans.

Some employers have sought financial relief by shifting a greater portion of the total cost over to employees. This is achieved either in the claims area through greater coinsurance or deductibles, or in the premium area by increasing the employee contribution. This approach creates the difficulty that direct employee costs are tax-ineffective and actually drive the employees to greater utilization to "get their money’s worth.’ This is a self-defeating process in both financial and employee-relation terms.

There is a growing awareness that the solution to this problem is, first and foremost, to correct the flaw in the system—the defined benefits entitlement basis is converted to a defined contribution approach. The instrument through which this can be achieved is a flexible benefits program. By transferring the responsibility for cost containment directly to employees as consumers, an employer will avoid significant and continuing cost escalation beyond its control.

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The Change in Relationship

It is important to recognize that the introduction of a flexible benefits program is much more than an adjustment to the indirect compensation package. In particular, it is an intervention in the employee/employer relationship that must be dealt with as a strategic organizational change. What an employer will strive to achieve is the treatment of benefits as a part of a total compensation package, the total cost of which is firmly in its control.

A flexible benefits program compels an ongoing dialogue between the employer and employee, and this is highlighted once a year in the annual re-enrollment process. This annual dialogue can only be successful if it follows through on a strategy that has been communicated to, and accepted by, the employees. Absence of such a strategic basis will normally result in a short-term gain (the joy of choice) and long-term pain (clashing expectations at renewal). For this reason, it is vital to realize that flex is a partnership that must benefit both the employer and the employees and redefines the roles of both.

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The Employer Role

An employer seeks to move form being a guarantor of benefits to being a source or facilitator of benefits plans. The role is restricted as much as possible to providing basic insurance, tax effectiveness, volume discounts and payroll convenience.

An employer would set out a specific defined contribution as his commitment of financial support and communicate this to employees. This not only guarantees stability and predictability of employer costs, but also predetermines, in absolute terms, an employer’s future liability.

An employer must also provide responsible financial management. This involves a guarantee of first-class administration and financial effectiveness. An employer will use the claims data to adjust the content and price of any particular program choice to better serve the employees’ needs and to highlight expensive and wasteful utilization. An employer is given the opportunity to be seen at all times as working for the employees and against third-party predators.

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The Employee Role

The employee is given a budget in the form of employer/employee financed flex credits and is converted into an informed purchaser of benefits. Employees make their purchases from an array of benefits in the most tax-effective manner permitted.

By re-establishing the link between the user of the product (the employee) and the cost of the product (the flex premium), this flex approach attacks the over-utilization inherent in all entitlement programs. The employee becomes the key source of cost containment as it becomes clear that sound utilization results in lower prices for benefit choices. In addition, employees select only those programs necessary to meet their needs and any unused credits are automatically added to gross salary.

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Paradigm Change

When an employer offers individual choice of coverage to employees in a flex program, the traditional group insurance principles no longer apply. With individual choice comes the need for individual insurance principles. The employer-sponsored flexible benefit paradigm is not a group insurance purchase, but rather, a number of individual purchases arranged through a group. This is a paradigm change which will have a profound impact on the future of group insurance programs. Age-and-sex rating for long-term disability for limited benefit periods are starting to appear, and smoker/non-smoker rates for health and dental are not far away.

The actuarial architect of future flex plans will be compelled to respect this paradigm change in order to meet sponsor objectives. Creativity and imagination will be necessary to develop appropriate models for design and pricing. I believe that flexible benefits present a wonderful challenge to the actuarial profession. For the young (and perhaps not so young) members of the Institute, this is an area where you can readily spread your wings and fly. This is the best opportunity that I have encountered since I first had the word "actuary" explained to me 40 years ago.

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Acknowledgements

This article originally appeared in the October 1996 issue of the Bulletin of the
Canadian Institute of Actuaries. It is reproduced here with their kind permission.

About the Author

David H. Hart is the founder, Chairman and CEO of PerQ-uP Inc. He is a member of the
Canadian Institute of Actuaries , an Associate of the Society of Actuaries and has practiced in Canada for more than 30 years. Over the course of his career, Mr. Hart has provided management consulting services to some of Canada’s largest companies, including Bata Ltd, Sears, Westinghouse, Mobil Oil, Norcen Energy, Eatons, Canada Trust and many more. Mr. Hart founded PerQ-uP Inc. with the intention of making truly effective benefits solutions available to employers of all sizes through the aid of internet-based communications and data management technologies.

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