Page 241 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 227

companies with financial problems, however, benefits are no longer being expanded but
rather are being cut back—especially health-care and pension plans.
Many perks simply supplement the basic benefit program by lifting or completely
removing dollar maximums. This applies essentially to disability, retirement, and survivor
protection plans. A prime advantage of such supplemental plans is that the company can be
selective in determining participation, extent of coverage, forfeiture and vesting provisions,
and period of protection. The disadvantage is that the company receives no tax deduction
until the benefit is paid. The advantage is that the executive receives a greater benefit than
otherwise available, at reasonably attractive income tax rates. However, frequently the bene-
fit is lower than comparable after-tax cash value. Thus, perquisites must be structured very
carefully, especially since employees will press for extended coverage of existing programs
and the addition of new ones for top executives. However, Securities and Exchange
Commission (SEC) requirements on disclosing executive perks has slowed their expansion
and even resulted in cutbacks in some companies.
Because the main appeal of perquisites is their restricted use, they either (1) identify a
group more exclusive than that covered by the long-term incentive plan or (2) reinforce the
distinction between those covered under long-term incentives and all others, by defining
eligibility as participation in the long-term plan.
Although some forms of employee benefits can be traced back a hundred years or so,
due to their limited application, employee benefits truly were “fringe” in nature until
World War II. The Stabilization Act of 1942 froze wages and salaries but allowed limited
benefit improvements; needless to say, there were almost limitless “limited-benefit improve-
ments.” Then, after the war, the U.S. Supreme Court ruled that pension plans were negotiable
items for collective bargaining agreements. Shortly thereafter, inflationary pressures caused by
the Korean conflict forced the Defense Production Act of 1950, which again allowed “limited”
benefit improvements. Within 10 years, “fringe benefits” exploded into “employee benefits.”
To provide some employee benefits, companies have turned to group insurance plans
rather than individual plans. By clustering individuals under a group plan, the carrier mini-
mizes “adverse selection,” in other words, that someone will receive a payment far in excess
of premiums paid. Individual risk is dispersed through a large group. This permits the insur-
ance carrier to provide a lower premium per person than under individual contracts. Reduced
administrative and selling expenses are also a factor in the lower rate per employee.
Designing benefit plans raises a number of questions. What benefits should be provided?
Who will be eligible? What will be covered? Will there be degrees of coverage? How will it
be administered? What portion of the cost will employees pay? How will the plan be funded
(e.g., insurance contract, trust agreement, or self-administered)? What program balance is
consistent with the organization’s culture?
Cost Definitions

Before proceeding any further, let me stress the importance of carefully defining benefit costs
as a percentage of pay. While variations are numerous depending on what is and what is not
a benefit, essentially there are three major definitions.

1. Total cost for all benefits (numerator) divided by gross pay or W-2 (denominator).
On the surface, this appears sound and logical. The problem is that a number of
benefits are cash benefits, which are reflected in the W-2, and thus are present in both