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Re-printed with permission from Morneau Sobeco*

RISING BENEFITS COSTS

It is no surprise that the rising cost of benefits is the number one HR concern for organizations. This was identified as a major issue by 57% of the respondents to our 2004 Compensation Trends and Projections Survey. In addition, 95% of the respondents to our 60 Second Survey from May 2004 expressed a medium or high level of concern about rising pension and benefits costs.

As the chart below shows, costs for employersponsored benefits programs are expected to continue rising steeply over the next decade.

Employers can take a number of actions to keep their own costs in check. Before we get to them, let’s begin by outlining the reasons for the trend:

Aging population - Health care costs tend to be fairly steady until age 50, at which point they start rising steeply with age. The chart below shows the costs by age for employer-sponsored health, disability and dental benefits. In the next ten years, most organizations will have a higher proportion of employees in the 50 category. One reason is because organizations will try to entice more of their older employees to stay in the workforce, if and when baby-boomer induced labour shortages start to materialize. Second, the trend to defined contribution pension arrangements will cause workers to delay retirement. Indeed, U.S. statistics show that the average retirement age stopped declining around 1985, about the time that 401(k)plans started to become popular.

Surge in stress-related disability - A decade ago, mental and nervous conditions were a primary or secondary factor in about 25% of all disability illness. Today, that figure is 55%. One might wonder what sudden and adverse change in the work environment was responsible for such an increase. More likely, a problem that always existed has now been given a label, and this has led to increased claims. Either way, it is a real problem and comes with a hefty price tag.

Drug use - Total expenditures on drugs have been rising rapidly. This has little to do with cost increases for existing patented drugs, which have been rising more slowly than general inflation, but a great deal to do with greater utilization of drugs by a growing and aging population. In addition, more illnesses (e.g. HIV/AIDS) are being successfully treated by drugs. Rising drug expenditures by themselves are not necessarily bad news, provided that the increased costs are offset by reductions in the cost of surgery and hospital stays and less absenteeism.

Government offloading - Governments have put an increased share (over 30%) of total healthcare costs onto the private sector. Apparently, it is not over.The recent Ontario budget continued this trend as Ontario partly or fully delisted services related to chiropractics, physiotherapy and optometry.

Post-employment benefits coverage - The cost attributed to post-employment benefits has soared in recent years, not because true costs suddenly rose dramatically but because accountants now measure costs differently.Thanks to the adoption of CICA section 3461 in Canada and FAS 106 in the U.S., what would have been a financial time bomb many years from now has simply been brought forward.

Insufficient corporate governance - While governance has received a lot of press in recent years, most of it has revolved around pension plans.The oversight of non-pension benefits has not received the same level of scrutiny, which is a problem now that benefits are having a greater financial impact.

WHAT ORGANIZATIONS CAN DO

Take a future snapshot - For starters, employers should get a better handle on how their own costs are expected to change in the next few years. This is not as difficult as it sounds since rising costs depend largely on demographic changes, which can be predicted with a high degree of confidence. By reviewing data on new hires and turnover, an actuary can project the future demographics of an organization’s workforce and use it to estimate future costs.This knowledge can help prepare employers for what to expect and to plan accordingly.

Change the cost-sharing equation - No one likes to pay more, but surveys show that employees are fairly open to increasing their share of benefits costs if this is what it takes to maintain health coverage. (See the sidebar Cost-sharing Ideas.) Before making any changes, an employer will probably want to benchmark current practices against their peer group.

Better governance - More diligent oversight of the benefits program is likely to reap some savings.A good place to start is with a claims audit. Some findings from past audits have uncovered unauthorized expenditures such as:

• Co-ordination with Medicare being ignored for retirees, hence the employer plan paying for benefits that should have been covered by government.

• Paramedical limitations not coded into the system.

• Out-of-pocket maximums being ignored resulting in the employer’s plan paying more than promised.

• Reimbursement for drugs not eligible for coverage under the plan.

• Reimbursement of eye glasses that were not an eligible expense.

Review rationale for providing post-retirement life, health and dental coverage - Many organizations committed to providing post-retirement benefits when they thought the cost was minimal (pre-CICA 3461). As the cost has become better understood, post-retirement benefits coverage has been declining. Our 2004 Trends and Projections survey showed that 37% of respondents provided post-retirement health coverage, a drop of about 5% over two years.The one hurdle preventing an even more rapid decline is that the courts consider post-retirement benefits to be vested at the point of retirement. Hence, they cannot be easily taken away from retirees. Post-retirement benefits are similar to defined benefit pension plans in that both take many years to phase out and few organizations are launching new plans.

Focus on wellness - The traditional emphasis of the medical system and by extension of employersponsored benefits programs has been on diagnosing and treating illness, not on prevention. This is changing. A growing number of employers have implemented wellness programs. Our data indicates that 33% of organizations have an employee wellness program, up from 24% just two years earlier. Another 14% of those who don’t have a program indicate they are likely to add one in the next year. Most practitioners are convinced that wellness programs can improve the health of the workforce and hence improve productivity. The challenge is to quantify it. Doing so is critical since this is one of the few benefits areas where intervention might significantly reduce claims without cutting back on benefits or increasing costs.This area is sure to evolve rapidly in the next few years.

Partner with employees - Consider having employee representatives on an advisory committee to deal with benefits issues.This may be the best way to get employees to buy in to remedies that may involve cut-backs in coverage or increasing cost-sharing on the employees’ part.

Consider a DC approach - Just as defined contribution pension plans can help employers contain costs while giving employees more choice, the same is true with benefits, but only to a degree.

THE RISE OF “DEFINED CONTRIBUTION” BENEFITS

The concept of defined contribution as it applies to pension arrangements is quite well known. From an employee perspective, DC pensions can be attractive since they suggest greater empowerment and transparency.The main advantage for the employer is reduced cost volatility.The same principle can apply to benefits as well, but only in the case of benefits where incidence is fairly high and the financial implications to the individual are manageable. This is especially true if utilization has a discretionary element to it. In the case of DC benefits, the employee would accept some or all of the cost. Catastrophic benefits coverage - where incidence is low and the financial implications are major is almost always offered as a defined benefit. The following chart indicates when a DC approach makes the most sense:

Even though employees would be taking on more risk under this approach, they would continue to be protected against catastrophic expenses. Employees could manage their share of the risk by adjusting future contribution and coverage levels to match their personal situation.

There is one big difference between the DC concept in benefits versus pensions.With pensions, an employer can maintain a fixed contribution rate for decades. If that rate proves to be inadequate, it does not become apparent until retirement. (This suggests DC pensions could be a ticking time bomb, but that is another topic.) In a DC benefit program, however, the inadequacy of a given contribution rate is felt immediately, for instance when a dental fee guide changes.The employer is, therefore, under constant pressure to increase the contribution rate, which limits the effectiveness of DC arrangements for benefits as a cost-containment tool. This is not to say that the DC concept is totally ineffective. DC gives employers some cost control, though not as much as might be hoped.

CONSOLIDATION OF SERVICE-PROVIDERS

The number of players in the insurance industry has been shrinking rapidly (see the table in the centre of this issue). Among the surviving major insurers, the price gap is narrowing.This begs the question of whether there is still any point to conducting a market survey. Historically the main reason for a market survey was to reduce premiums and/or expense factors. While this is still a consideration, the bigger reason to initiate a market survey now is to ensure a good fit with your insurer. For instance, the insurer you selected five years ago may have since changed ownership and its focus may have changed or service may have deteriorated. Another reason to canvas the market is because technology and employee self-service options have become more important and service offerings vary from one insurer to the next.

ONGOING EVOLUTION

Pension plans seem to go through a major overhaul every five to ten years because of external events such as provincial pension reform in the late 1980s and tax reform in the early 1990s. In the case of benefits programs, changes tend to be less dramatic but occur more frequently, so change is almost certain to be a constant. Here are some reasons why organizations will constantly need to review their benefits programs:

Government downloading of costs - As governments pass along the responsibility for certain benefits, employers need to be diligent in managing the impact on their own plans.The default can be an automatic increase in employer costs that could have been avoided.The most recent Ontario budget, for instance, introduced individual healthcare “premiums”. In some cases, employers may be required to bear the cost because of inadvertent wording in their collective bargaining agreements dating back to the 1980s, when Ontario last had OHIP premiums.

Changing demographics - The effect of demographic change on benefits programs is profound, but is masked by the fact it seems to occur at a glacial pace. Employers need to review their coverage in light of their changing demographics every five years or so.

New health problems - Although they are not new problems, factors such as obesity,Type 2 diabetes, and stress-related health issues are becoming increasingly prominent.The prevalence of these conditions will trigger changes in coverage.

New treatments - The emergence of employee health risk assessments and various wellness programs can assist employees in improving their own health outcomes.To be successful, employers need to be clear on their objectives when they introduce new programs.

New technology - Access to the Internet (and employer Intranets) is now commonplace. Perhaps the biggest impact of technology in terms of benefits program design is that it facilitates flexible benefits programs and healthcare spending accounts. Online enrolment, for example, has proven to be much more effective than paper-based enrolment.Technology can also be effective in improving the communication of plan changes and wellness programs to employees.

AND NOW, THE GOOD NEWS

It is easy to see the gloom in the current situation. We have identified the rather daunting challenges employers face in delivering an effective benefits program to their employees at a manageable cost. There is, however, some good news.

The vast majority of Canadians believe we have an effective healthcare system. According to an Aventis healthcare survey, 86% of Canadians would rate the quality of services in our healthcare system as good to excellent. This is a higher percentage than we have seen in years. In the same survey, 94% of plan members say their employer benefits program meets their needs either “somewhat well” or “extremely/very well”. Canadians are living longer than ever. There are fewer illnesses that cannot be treated effectively. And for some illnesses, new treatment (e.g. via drugs) is less invasive and more effective than it once was (e.g. surgery).

We need to celebrate our successes while continuing to seek improvements.

*ABOUT MORNEAU SOBECO - Morneau Sobeco is a leading human resource consulting firm focusing on the design and delivery of compensation, retirement, and employee benefits programs.With over 950 professionals working in twelve cities across North America, it serves more than 3,000 clients. In addition to its in-depth consulting practice, Morneau Sobeco is recognized for its expertise in the provision of integrated administrative solutions and for its vision in terms of progressive employee self-service tools.