Barry’s Pickings: What Are Benefits?

Art by Joe Ciardiello

As I thought about (and then wrote) my book (shameless plug: Retirement Savings Policy: Past, Present, and Future), I found myself coming back to this question again and again.

In the early 1980s, as both 401(k) plans and cafeteria plans were emerging as powerful benefits design tools, there was a movement led by the big consulting firms to view benefits as compensation—to, in effect, treat a dollar in benefits cost as equivalent to a dollar of cash compensation. As some firms put it (when they rolled out their cafeteria plans): “Benefits dollars.”

But as employers began working with these new tools, some of them found that, in fact, there was not always a compensation “explanation” for the way their benefit plans operated. This phenomenon was most obvious with respect to medical benefits, where two employees identical in every way (including cash compensation), except that one was single and the other was part of a family of, say, five, got (in terms of cash value) dramatically different medical coverage. The family coverage that one employee got was worth significantly more than the single coverage the other employee got. Different employers addressed this issue in different ways.

With respect to retirement benefits, defined benefit (DB) plan accruals produced a similar issue: two identical employees, differing only in their age, got (in terms of cost) significantly different benefits, not explainable by any theory of benefits-as-compensation. One output of the implementation of a more compensation-like retirement benefits program at certain large employers (e.g., IBM) was the cash balance conversion controversy of the late 1990s/early 2000s.

That’s all from the employer/sponsor’s point of view. Looked at from the participant’s point of view, there is another issue: a particular benefit—even with the same cost to the employer—is not worth the same to different participants. Again, the issue is most vividly illustrated by medical benefits. Medical benefits are (whatever quibbles you may want to insert here) worth less to a robustly healthy individual than they are to, say, a diabetic.

Even the most transparent retirement benefits—say, a fully vested $1,000 contribution to a participant’s defined contribution (DC) plan account—have a different value to different participants. For a participant in a high tax bracket, this contribution may be worth more than $1,000, because of the related tax benefits. For a participant whose greatest financial challenge is to figure out how to pay the rent, it may be worth considerably less—indeed, he may be prepared to withdraw it as soon as possible, and pay a 10% penalty tax, just to convert it to cash.

I think that, very interestingly, this problematic—that benefits do not always translate easily into cash compensation—reflects a deeper economic reality that is often ignored. In his paper The Nature of the Firm (1937), R. H. Coase characterized firms as “islands of conscious power in [an] ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk” (quoting D. H. Robertson). Thus, many firms are “islands” in the stream of commerce where market-based decisions do not (always) operate inside the firm.

This phenomenon is different in different industries and at different firms. Differences in firm “culture” may be one way of explaining or characterizing it.

Some firms are subject to a rigid calculus—the capital markets and the markets in which they sell their goods and services require that every cost be explicitly justified. Other firms—for a variety of reasons—are able to make, or see a “benefit” in making, decisions on a different basis. This may be true at a public utility, where costs can often be passed on to rate-payers. At owner-dominated companies, where the owner may feel a personal obligation to her employees. At firms where reputation—including a reputation for treating employees well—may matter as much as price or maximizing shareholder value.

Benefits—as most HR professionals will generally (and sooner or later) intuit—are at the heart of this firm culture issue. They are a critical place in which a firm defines itself.

Every firm is, in some sense, a 1+1=3 proposition: the group of individuals who make up the firm—employees and managers—are (or at least should be) more productive together than they are apart. That is, they are somehow more productive operating as a group, pursuant to a set of rules, top-down direction and ways-of-doing-things that constitute the firm’s culture, than they would be if they all simply operated as independent contractors (think Uber drivers).

In that regard, an employee (call him employee A) might (often) be called on to sacrifice an evening or a weekend for the good of the firm—without any explicit understanding that he will be paid for it. And, reciprocally, the firm might undertake to take care of (in a sense, to “carry”) a fellow employee (employee B) during a period when she cannot be productive—because of an illness or the birth of a child or a family crisis.

And if the firm’s culture, very much including the firm’s benefit programs, are working well, employee A does not resent the fact that employee B is getting something (often including benefits) that he is not. Because, among other things, he understands that there may come a time when he will need those same benefits.

So that, in addition to their cost, the perceived fairness of the firm’s benefits is a fundamental element in the benefit calculus. With all of the ambiguity and disputes-over-meaning that the word “fairness” carries with it.

With respect to retirement benefits, these issues are perhaps less complicated, since we are mainly talking about money (as opposed to medical benefits/services). But at companies that, for instance, invest a lot in training employees and as a consequence depend on a certain amount of employee loyalty, a robust retirement savings program signals a long-term commitment: “We make an effort to provide for those who stay with us a long time.”

As our tools for developing economic cooperation outside the “conscious power” of the firm become more sophisticated (again: think Uber), all of this—“firm culture” and benefits that don’t strictly equate with compensation—may be becoming less important. But it’s not going away any time soon.

Michael Barry is president of October Three (O3) Plan Advisory Services LLC, and author of the new book, “Retirement Savings Policy: Past, Present, and Future.” He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.