Quick History of Employee Benefits in America
A. Retirement Benefits
Prior to the industrial revolution, most people lived and worked on farms or as craftsmen and “retirement” was something that usually occurred when you could no longer do manual labor. Of course, many were struck down by illness, disease or accident and never made it to retirement age. In 1900, for example, without the life saving drugs and medical care we have today the average life expectancy (compounded by infant mortality and mothers dying in childbirth) was barely thirty years.
If you were lucky enough to live to a so-called old age, your children or relatives would assume your chores and you likely would stay right where you were until your death – which often came soon after retirement: no condo in Florida or an assisted living facility. Informal “pension” plans existed but were rare, and often took the form of the legendary “pass the hat” pension fund first used for wounded Plymouth Colony militiamen.
With the advent of the industrial revolution, however, many farm dwellers traded their independence for membership in the ranks of a growing urbanized workforce searching for adequate wages and job security. Employers had a dilemma – they wanted to attract and retain workers (while still paying no more than necessary), but also needed workers to leave employment when they became too old or costly. The evolving field of actuarial science was being applied to the fledgling life insurance industry and in turn used to develop pension plans to meet this employer objective.
Thus, the initial rise of pensions was due in large part to the demand for workers far exceeding their ready supply. A company competing for laborers who often toiled in undesirable conditions had to increase pay as well as find a way to keep workers around for the long term.
In 1875, the American Express railroad company established the first private pension plan in the U.S. Banks, utilities, and large manufacturing companies soon followed suit. Of course, these early pre-ERISA pension plans — while paternalistic in the manner of then common company towns — nonetheless had very stringent rules to earn a benefit. While many may have been covered by the plan, many also never received a meaningful or any benefit payout. For example, participation requirements were typically 20 or more years of service to receive any benefit, “vesting” only after attainment of age 60 or older, and not very large benefits. In 1884, for example, the B&O Railroad pension plan provided a benefit of up to 35% of pay but only to those workers retiring at age 65 with at least 10 years of service.
The income tax was created in 1913, and subsequent Revenue Acts in the 1920’s codified the tax-exempt nature of pension plans and allowed employer contributions to the retirement plans to be tax deductible, a huge boost to their adoption. Pension plans soon became a subject of collective bargaining and prevalent in unionized and regulated industries, as well as for many state government workers. In 1920, the federal government finally established a pension plan for its employees.
Despite these developments, many workers at smaller companies lacked access to pension plans. In 1935, Congress passed the Social Security Act for the same reason many employers had adopted private pension plans – to encourage and allow older workers to retire so younger ones (at that time many who were jobless) could take their place.
The Revenue Act of 1942 established minimum coverage rules in the tax code that prohibited employers from providing richer pension benefits to only higher paid employees. Employers also were now able to “integrate” and offset their contribution to Social Security benefits against the employer-provided pension benefit. This offset could result in a smaller or no pension benefit, especially for lower paid employees but allowed the employer to pass the minimum coverage rules.
During and after WW II pension plans reached their zenith as the U.S economy and unionized work forces grew rapidly. The Labor-Management Relations Act of 1947 (also called the “Taft-Hartley” Act) provided guidelines for the establishment and operation of pension plans administered jointly by an employer (or employers) and a union. In 1948, the NLRB ruled pensions to be considered wages that they fell under “conditions of employment” and, hence, subject to collective bargaining. In 1962, self-employed people finally were allowed to establish their own tax-deferred retirement plans (known as the “Keogh” Act).
Not surprisingly, in the absence of comprehensive regulation and funding requirements, pension abuses arose. This became a particular problem for employees working in troubled industries. The Welfare and Pension Plans Disclosure Act (WPPDA) made the Department of Labor the chief regulator of employee benefits (outside the tax area) but had few substantive provisions outside of disclosure rules. The Act was amended in 1962 to give DOL investigative and regulatory powers.
However, the galvanizing event was in 1963 when the Studebaker Company terminated its underfunded pension plan, leaving over 10,000 employees and pensioners with diminished or no benefits — and no legal recourse.
This incident became the impetus for comprehensive legal reform that began in 1967 with Sen. Jacob Javits and legislation addressing the funding, vesting, reporting and disclosure issues identified by the President Kennedy’s Committee on Corporate Pension Plans. A Peabody award winning 1972 NBC News documentary by Edwin Newmann shed further light on these pension abuses. Finally in 1974 comprehensive legislation was enacted as ERISA. ERISA established (1) plan reporting and disclosure obligations, (2) minimum standards for participation, vesting, benefit accrual and funding, (3) fiduciary rules applicable to plan administrators, trustees, and asset managers, and (4) the Pension Benefit Guaranty Corporation to collect premiums like the FDIC and ensure a minimum level of benefits for participants in terminated defined benefit plans that were underfunded.
In 1970, about 45% of private sector workers were covered by a pension plan — the apex of the pension movement before its downward slide. Other workers were covered by defined contribution plans, typically profit sharing plans funded solely by employer contributions. However, the Revenue Act of 1978 established qualified deferred compensation plans (called 401(k) plans) under which employees would not be taxed on pay deferred to the plan rather than received as wages.
The 401(k) was originally an arcane and overlooked sub-paragraph of the Code but it became a phenomenon after the IRS ruled in 1981 that this 401(k) subsection clearly allowed workers to use tax-deferred salary money to build a retirement savings account. These plans would soon surpass pension plans as the prevalent retirement vehicle in America — with far reaching consequences to employee retirement security since savings now became largely dependent on the employee’s contributions and investment decisions.
Inflation, longevity, increased regulation, and financial reporting requirements for plan sponsors all contributed to the demise of the traditional pension plan. The simpler 401(k) alternative helped accelerate the process.
The 1980’s saw a flurry of pension legislation and associated regulations: TEFRA, DEFRA, REA, TRA 86, OBRA. Changes included:
• Reduction in maximum DB and defined-contribution (DC) benefits
• Age 70½ minimum distribution rules
• Restriction on the elimination of optional benefit forms (anti-cutback rules)
• Qualified domestic relations orders (QDROs)
• Effective elimination of integrated plans that took SS benefits into account
• Limits on the compensation that can be taken into account in the plan’s formula
• Nondiscrimination rules that required testing on a controlled group basis
The Retirement Equity Act (1984) responded to public concerns that working women were not receiving their fair share of private pension benefits. The law addressed survivorship benefits, vesting and domestic relations orders.
The Omnibus Budget Reconciliation Act of (OBRA) 1986 ended the practice of employers limiting the ability of newly-hired older workers from participating in retirement plans and also made it illegal to freeze benefits for participants over age 65.
The Federal Employees’ Retirement System Act of 1986 applied to employees hired after December 31, 1983. This departure from the Civil Service system required employees to participate in Social Security and for FERS participants to contribute up to 10% to a thrift savings plan with partial matching by the government.
The excess assets in those pension plans fortunate to be overfunded became the target of corporate raiders in the 1980’s so in 1988 Congress placed a 100% excise tax on any reversion following plan termination. This change, coupled with increasing plan administrative costs, tightening of funding rules, and competition from non-union, non-pension employers accelerated the demise of traditional pension plans.
In 1985, Bank of America converted its pension plan to the first cash balance pension plan to reduce future plan funding costs and balance sheet volatility. The cash balance plan is a hybrid plan combining features of both a pension plan and defined contribution plan. Much litigation would ensue over these conversions as participants close to retirement argued that their benefits had been improperly reduced.
The Federal government, like many other employers, joined this cost-reduction trend in 1987 as new employees were moved into a less generous pension plan that was combined with an enriched 401(k) matching contribution feature.
In April 2003 the Pension and Welfare Benefits Administration was renamed the Employee Benefits Security Administration to more accurately reflect its mission.
The PPA of 2006 required companies with underfunded their pension plans to pay higher PBGC premiums and extended this requirement to companies that terminate their pension plans. The law also raised the cap on the amount employers are allowed to invest in their own plans. While the goal of PPA was to strengthen the PBGC, its mandating of various funding assumptions and higher premiums drove more employers to terminate or freeze their pension plans.
As the 21st century and stock market turmoil arrived, plan participants and experts wondered whether the voluntary 401(k) phenomena would leave many employees woefully underfunded for retirement. As a meteorologist might say, a retirement storm warning has been posted.
The following excerpt is from a post is by Tyler Bond (8/4/16), What Happened to Private Sector Pensions?
It is one of the most well-known stories about American retirement: the decline of defined benefit pensions in the private sector. At one time, 88 percent of private sector workers who had a workplace retirement plan had a pension. That number is now 33 percent. So what happened? Where did all the private sector pensions go? While the advent of the 401(k) certainly played a role, the true cause may have more to do with a series of laws passed from the mid-1980s to the mid-2000s. These laws had the inadvertent effect of causing the decline of defined benefit pensions.
Defined benefit pensions were once the most common retirement plan in the private sector (for those employers that offered a retirement plan). Workers knew that if they worked for a company for 20 or 30 years, they would be able to retire with a reliable and secure pension. That promise is now gone for most private sector employees. There are several reasons for this. One is changes in the economy and the decline in unionization. Good-paying union jobs at manufacturing plants throughout the industrial Midwest also came with defined benefit pension plans. As manufacturing jobs have been shipped overseas, those good jobs with pensions have also left. Newer sectors like information technology, for example, are less likely to offer jobs that come with a defined benefit pension.
Changes in the economy are only part of the story though. The driving force behind the decline in private sector pensions was a series of laws beginning in the 1980s. Three laws passed during the Reagan administration did the bulk of the damage:
- The Tax Equity and Fiscal Responsibility Act (1982)
- The Retirement Equity Act (1984)
- The Tax Reform Act and Single Employer Pension Plan (1986)
By the 1990s, private sector pension plans were already becoming a thing of the past. The Pension Protection Act of 2006 further accelerated the decline of private pension plans.
What exactly did these laws do? First and foremost, they increased the volatility of the pension fund from year to year. They did this by making annual contributions to the pension plan less predictable. The Pension Protection Act specifically increased funding requirements from 90 percent to 100 percent; shortened the amortization period from 30 years to just 7; and reduced the number of years plans are allowed to use to calculate the interest rates on their assets and liabilities.
This is all very technical, but the point is this: private pension plans must now have more money on hand and have less time to get to 100 percent funded status if they suffer losses in a market downturn. The two year period to calculate interest rates, in particular, increases the volatility of the funding because two years is a short time to calculate an interest rate. When you’re calculating the interest rate on assets and liabilities, the value of your assets can change significantly from year to year, depending on the financial markets. If you only have a two year window in which to judge the value of your assets, then you are going to be more vulnerable to market swings, whether from extremely high returns or unusually low returns.
Beyond increasing the volatility of the pension fund, these laws increased the complexity and the scope of the regulatory burden facing private sector pension plans. The increased volatility of the funding levels made pension plan contributions less consistent from year to year. The less consistent contribution levels have a negative impact on a firm’s cash flow and overall balance sheet. In fact, multiple surveys have shown that private companies did not abandon their pensions due to the inherent cost of the pension itself, but rather because of the complex regulatory burden they faced.
The decline of private sector pensions has consequences. As pensions have become less common, the retirement security of employees in the private sector has decreased. One study found that when companies switched from defined benefit pensions to defined contribution plans, the amount they contributed on behalf of each employee was cut almost in half. To quote The Economist magazine: “Whatever the arguments about the merits of the new wave of [DC plans], if you put less money in, you will get less money out.” In other words, if you don’t contribute enough for a secure retirement, then you won’t have a secure retirement.
B. Group Health Coverage in America
Why is the American health care model voluntary and employer-based unlike the government-based model used by most of the developed world? History and a recent NPR report state this situation came about through a confluence of American capitalism and sheer accident.
At the turn of the 20th century, healthcare in the U.S. (and most other places) didn’t cost much – because it couldn’t do much for you and the cures (still often medieval in nature) often could be worse than the disease. Life expectancy was short, people lived with chronic pain, and most women still endured childbirth at home rather than a hospital, as many towns did not even have one. Hence, the average American spent little on health care and health insurance wasn’t a necessity.
With the development of more effective medicines, like antibiotics, improved medical school training and sanitary conditions, hospitals evolved from destinations of “last resort” to places to where one actually could get well — and also have babies. Of course, clean hospitals, well-trained doctors, and pharmaceutical research all cost money. People would pay for this care only when they were really sick, but not for merely preventable or survivable illnesses.
To attract and help their local residents, communities began to create hospitals (like town squares) as an integral part of the societal fabric and public welfare. However, (1) these hospitals generally remained underutilized because only the very ill sought care, and (2) even patients who sought care often could not fully pay their bills.
Against this discouraging backdrop, Baylor University Hospital in Dallas came up with a clever idea to make money — even if hospital beds were not being utilized! Local residents could pay for health care the same way they paid their mortgage, utilities, or grocery store food bill — a little bit each month. In 1929, Baylor hospital officials offered a non-profit medical plan to 1,300 area public school teachers that cost 50 cents/mo. in exchange for 21 annual days of free hospital visits. Importantly, these rates were the same regardless of the employee’s health condition, age or utilization level.
With the Great Depression, almost every hospital saw vanishing patient loads so the Baylor pre-pay model became very popular and eventually became known as “Blue Cross.” The model quickly evolved into plans with multiple hospital and doctor participation and extended coverage for employee dependents.
A counterpart medical program called “Blue Shield” evolved on the West Coast from medical clinics serving lumber and mining camps. These clinics eventually became pre-paid medical care programs like Kaiser Permanente, which began for employees of the Kaiser Construction company. (Blue Cross and Blue Shield would eventually merge into one association in 1982 and now cover about 1/3 of all U.S. health plan participants.)
In 1932, the National Labor Relations Act was enacted and later was interpreted to make health benefits a mandatory issue of collective bargaining. For-profit insurance companies, many formed in the late 1800’s to provide life insurance, also entered into the fray to offer group health plans, like Aetna in 1936.
While health plan availability spread, employer participation was still spotty. World War II, however, changed this as factory owners under wage and price controls had to lure employees to meet growing production demand. Thus, employers used fringe benefits, like health plans (and pension plans), to attract and retain workers.
With the spreading use of these plans, it was imperative that the IRS clarify their tax treatment. In 1943, the IRS ruled that the employer’s contribution to an insurer to provide health care coverage for its workers was not taxable to employees. In 1954, Congress codified this exclusion in what is now Code section 106 and also expanded Code section 105 to exclude benefit payments (or reimbursements) made to employees under self-insured, as well as insured, health plans. In 1959, Congress finally created a program of health benefits for federal employees.
Prevalence of employer health plans skyrocketed from 9% in 1940 to 70% of all employers by the 1960’s. Today, employer health plan coverage has declined to about 60% of all insured Americans under age 65. In total, about 83% of Americans under age 65 are covered by an employer, individual health plan, or Medicaid but the other 17% remain uninsured because they do not have such coverage or are not poor enough to qualify for Medicaid.
In recent years, many employers have terminated or curtailed their retiree health plans due to rising costs and financial reporting requirements. Thus, most seniors are dependent on Medicare and related “gap” policies to provide coverage during their so-called golden years. The cost of Medicare Part B and for “gap” policies continue to rise and other important health needs, like vision an dental are typically not covered at all by these policies.
Legislation has not been wanting in this area:
COBRA (signed in April 1986) establishes rules for how and when continuation of health coverage must be offered and provided, how employees and their families may elect continuation coverage, and what circumstances justify terminating continuation coverage. Notably, it provides for the continuation of health care coverage for employees and their beneficiaries for a limited time if certain life events (such as loss of employment or death) would otherwise result in a reduction in benefits.
HIPAA (1996) amends ERISA by limiting the restrictions a group health plan can place on benefits for pre-existing conditions. It also attempts to limit fraud and abuse within the healthcare system by mandating nationwide standards for electronic healthcare transactions
The Newborns’ and Mothers’ Health Protection Act of 1996 requires insurance plans to cover a minimum 48-hour hospital stay following childbirth.
CHIP (1997) provides free or low-cost health coverage for more than 7 million children up to age 19. The legislation provides matching funds to states for health insurance to families with children and was designed to cover uninsured children in families with incomes that are modest but too high to qualify for Medicaid.
Women’s Health and Cancer Rights Act of 1998 protects patients who elect breast reconstruction after a mastectomy by mandating coverage for surgery and establishing a federal minimum requirement for post-operative hospital stays.
GINA (May 2008) prohibits group health plans and health insurers from denying coverage to a healthy individual or charging that person higher premiums based solely on a genetic predisposition to developing a disease in the future
MHPAEA (Oct. 2008) requires group health plans and health insurance issuers to ensure that the financial requirements and treatment limitations applicable to mental health or substance use disorder benefits are no more restrictive than those applied to all other medical benefits.
CHIPRA (Feb. 2009) provides states with significant new funding, programmatic options and incentives for covering children through Medicaid and the Children’s Health Insurance Program (CHIP).
The Patient Protection and Affordable Care Act (March 23, 2010) creates public healthcare marketplaces and requires that insurance companies cover all participants at the same rate regardless of pre-existing conditions or gender.
C. Is It Broken? Then Fix It. But How?
It seems that our retirement and health care systems are in need of overhaul and reconsideration. An aging population and rising costs has us heading toward the perfect storm. Let’s first look at health care.
Choice? If your employer does have a health plan, 86% offer only one plan. Take it or leave it.
Cost? Total expenditures for health care are predicted to exceed 20% of US GDP by 2018. The % of workers in plans with deductibles of $1,000 or more has risen to 22%. Why? Likely because they can’t afford to pay the rapidly rising employee premiums associated with lower deductible plans. With tight budgets and lean times, many employers are raising premiums and co-pays, and lowering co-insurance levels.
Commonwealth Fund’s rankings of the performance of seven health care systems, including Australia, Canada, New Zealand, and the United Kingdom, the U.S. ranked dead last overall. Moreover, we came in last on the specific dimensions of health outcomes, access, patient safety, coordination, efficiency, and equity. In terms of health expenditures per capita, as of 2007, the U.S. was off the charts at $7,290 versus an Anglo range from $2,454 in New Zealand to $3,895 in Canada.
As for retirement, if you don’t have a substantial employer-pension, you had better accumulate significant savings before you retire. Yet the average 401(k) account balance with Fidelity Investments (which covers 11 million workers) is just over $50,000. Perhaps this number is not so bad as it looks because it does not consider IRAs or other retirement savings held by these workers from prior employment or otherwise. Nonetheless, the raw numbers are disturbing.
Before the current recession, 43% of American households were ‘at risk’ of not being able to maintain their standard of living in retirement. This number rose to 51% in the second quarter of 2009, according to the National Retirement Risk Index (published by the Center for Retirement Research at Boston College). In the absence of any quick fix (which Health reform is not), we may be approaching full circle with those early farmers. You’ll have to keep on working because you can’t afford to stop.