Understanding the Financial Risks of Employee Benefits

The business costs related to employee benefits plans are significant, and they’re growing. In fact, many businesses now see employee benefits as a top-five corporate expenditure when viewed in isolation from other payroll costs. As well, the annual inflation rate for employee benefits has been running well above consumer inflation levels and generally above inflation levels for other business expenditures for most of the past 20 years. While we have seen some relief over the last decade, with the inflation rate for benefits dropping to about 5% or 6% per year, we are likely to return to double-digit inflation in the near future¹.

Given these financial risks, it’s surprising to note that few organizations manage employee benefits with the same strategic focus they bring to other areas of their business.

Annual benefits plan costs

According to research from the Conference Board of Canada (CBoC), the average annual cost for an employee benefits plan in Canada was approximately $4,400 per employee in 2018². This data was drawn from the CBoC’s triennial survey, which also showed that the average increased by approximately 6% per year between 2015 and 2018. Based on an estimated annual renewal cost increase of 5% in 2019, the average annual per employee cost is now approximately $4,600³.

Extended health benefits account for the largest portion of plan costs, with prescription drugs, paramedical practitioners (e.g., physiotherapists), vision care, and medical supplies usually making up 40% to 45% of total benefits plan costs. At the same time, extended health benefits are usually those most valued by employees and those subject to the highest inflationary risk. Dental benefits account for the next largest area of spending, usually accounting for 25% of total plan costs. Among the remaining costs are life and disability insurance and, increasingly, health-care spending accounts.

A perfect storm

Three converging factors are creating additional financial risk in this area:

• Use – According to our research, more than 90% of employees are now using their benefits plans, and this high percentage correlates to an aging workforce and an increasingly unhealthy population. As well, governments have continued to offload or not take on new health-care costs. (On a more positive note, earlier detection and treatment of rare and complex diseases are providing better health outcomes.)
• Frequency – Employees are also using their benefits plans more often and for a broader array of services. In particular, the use of paramedical services, particularly massage therapy and mental health care, has increased significantly. Moreover, we’re finding that disability claims are increasing in number and duration, as mental health issues become more prevalent.
• Cost – While benefits plans have benefited significantly from the impact of lower-priced generic drugs over the last decade, those savings have essentially been exhausted. Going forward, there is little motivation for the pharmaceutical industry to develop more low-cost drugs for issues like blood pressure or cholesterol; instead, we’re seeing many new specialty drugs that cost $15,000 to $50,000 per year. The future also holds potential for customized high-cost cell and gene therapies.

Benefits plan management strategies

The most common strategy to manage costs is trying to manage vendors and marketing the benefits plan to different insurers. Although marketing the employee benefits plan is part of good governance and should be conducted every four to five years, it’s not the best cost-containment strategy over the long term given the significant reduction in the number of insurers in the Canadian marketplace. Insurers often submit proposals that feature notable savings, only to follow up with whiplash-inducing first and second annual renewals after short-term marketing discounts have evaporated.

That’s why organizations should take a longer-term view and develop a more formalized strategy. To begin with, they should assess how employee benefits fit within their broader people strategies and business plans. They should determine whether they want to be reactive and simply keep pace with the rest of the market or be proactive and lead with innovative plan design. Organizations also need to assess the needs and desires of a multi-generational workforce with varying needs and wants. Most importantly, they need to determine how the costs of employee benefits plans fit into their long-term business strategies and/or whether there are specific financial targets they’ll need to meet each year to accommodate these costs.

What about COVID-19?

At the time of this writing, the insurance industry is facing added uncertainty due to the global COVID-19 pandemic. While it’s difficult to forecast the long-term effects of the pandemic on employee benefits plans, we can make certain predictions for the coming year:

• We don’t expect group life insurance rates to see any direct impact as a result of the pandemic, as the fatality rate, thus far, has been highest among seniors.
• We’re starting to see an impact on disability insurance, due to an increase in mental health claims related to the pandemic. We expect the severity and duration of these claims to correlate with the severity and duration of the pandemic.
• Between March and June 2020, many benefits plan sponsors benefited from reductions in claims or insurer premium credits related to extended health and dental plans, as paramedical and dental practitioners shut down operations. Since then, however, these types of claims have largely returned to pre-pandemic levels, and we expect this trend to continue.
• With respect to any potential COVID-19 vaccine, we expect the federal and provincial governments to pick up the cost, based on current information.

Where do you go from here?

Organizations need to recognize that the financial risks related to employee benefits plans are both significant and increasing. Unless they’re prepared to accept inflation rates three to five times higher for these plans than for other areas of their business, they’ll need to gain a better understanding of the current reality and develop strategies that are best suited to their own unique needs. If they don’t, they risk having employee benefits plans that are neither financially sustainable nor effective in helping to attract, retain, and engage the key talent they need to deliver on their business plans.

Author

Dan Eisner is an employee benefits advisor with ZLC Financial in Vancouver, where he works with human resources and finance professionals to create proactive, creative, and innovative employee benefits plans and broader workforce planning strategies. Dan has taught “Understanding the Financial Risks of Employee Benefits” for CPABC’s PD program.

Footnotes

1. Trend data and other figures are from ZLC Financial unless otherwise noted.
2. Monica Haberl, Nicole Stewart, Benefits Benchmarking 2019: Innovation and Flexibility Lead the Way, February 28, 2019, conferenceboard.ca. While this average was drawn from a variety of industries across Canada, the actual results varied significantly according to business size and industry type.
3. Annual employee benefits plan cost increases have been relatively low over the last couple of years, compared to the increases of 10% to 12% seen in the early 2000s.