Greater interest in managing risk and increasing employee engagement means boards are playing a more active role in employee benefits
Today, there is a great deal of focus in mainstream media on how inadequately prepared Canadians are for retirement. Regulatory demands, combined with funding and solvency challenges, mean that pension plans have received most of the attention. But sitting on the sidelines is an equally important social and economic issue: healthcare.
Given that our healthcare system is not pre-funded and is constrained by federal transfers and strained budgets, provinces are reducing the scope of coverage that is provincially funded—and shifting that responsibility downstream to plan sponsors. Plan sponsors, in turn, are frequently revisiting their benefits programs to calibrate their relative affordability. Benefits plans, therefore, experience more design and contribution changes than any other component of a company’s total rewards spend—and the potential impact on employee engagement and firm competitiveness is significant.
Consider Fiat’s US$4.35-billion acquisition of Chrysler, announced on Jan. 2, 2014—an agreement with the United Auto Workers’ (UAW) healthcare trust for retired Chrysler union workers for its 41.5% of the once-bankrupt U.S. automaker. The healthcare trust—known as a voluntary employee beneficiary association, under federal tax law—was created by the UAW and each Detroit automaker in 2007 to help alleviate the crippling costs of retiree healthcare under contracts negotiated years earlier, before healthcare costs soared much higher than the general inflation rate. Could boards and management have been more deliberate in understanding the systemic and long-term risks associated with their commitments, as well as the impact on their organization’s competitive position and survival? Their inability to renegotiate these commitments played a major role in having to reshape their entire business.
Understanding Benefits Risks
Most benefits are treated on a pay-as-you-go basis—with the exception of post-retirement benefits obligations, which are generally unfunded but must still be included as a liability in the company’s financial statements, per accounting rules. Employee benefits can pose serious risks to an organization. For example, one listed Canadian company was recently exposed to a $12-million liability associated with the administrative services only (ASO) and retention funding arrangements in connection with its employee benefits. The combination of excessive rate guarantees, significant risk retention and poor experience put the company in an untenable position.
In another case, a medium-size company with approximately 150 employees was advised by its broker to participate in a risk group in which it could sign up for an ASO arrangement to avoid paying risk charges and eliminate the liability of reserves incurred but not reported. The broker had negotiated some underwriting authority with the insurer and therefore was able to manage the volatility in his pool and disproportionately subsidize the premiums in order to retain most of his clients.
By Year 3, however, the program fell apart. Groups with more favourable experience left the plan, and the broker was unable to replace them with others with a similar or improved risk profile. The remaining clients were saddled with a liability exceeding 30% of their annual premium, due to be paid immediately. The plan sponsor’s exposure and the negative member experience generated a great deal of friction and distraction.
With these risks in mind, senior management and boards in some organizations are moving toward a more integrated, comprehensive and effective risk management system that encompasses a total rewards focus.
An Emerging Discipline
The responsibility for employee benefits does not usually fall under formal committee oversight and may rest with HR and/or Finance, or sometimes a fluid combination of the two. The ability of the board to perform its oversight role effectively is, to a large extent, dependent upon the relationship and flow of information between the directors, senior management and the risk management function in the company. Directors should ensure that they are receiving sufficient information regarding the benefits risk environment, the specific material risk exposures, how these risks are assessed and prioritized, risk response strategies, implementation of risk management procedures, and the strengths and weaknesses of the overall system. If they are not, they need to be proactive in asking for more.
Senior management should consider establishing a benefits committee—or adding to the pension committee—to ensure active oversight of the company’s benefits program, with an appropriate review of its compliance program and how it addresses the organization’s benefits risk profile. Risk and compliance programs will need to be tailored to the specific company’s needs. However, there should be a strong “tone at the top” from the board and senior management, emphasizing the importance of understanding the underlying risks and their related impact not only on financials, but also on employees.
Benefits risk management should not be viewed as an impediment to corporate progress or isolated as a specialized corporate function. Instead, it should be treated consistently with other risk factors and be part of how the company measures and rewards success. Companies need to incur a suitable level of risk to operate competitive benefits programs and run their businesses, and there is vulnerability in excessive risk aversion just as there is danger in excessive risk-taking. It’s important for companies to incorporate risk assessment, accurate calculation of risk versus reward and prudent mitigation of risk into their decision-making.
Clearly, anticipating future risks is a key element of avoiding or mitigating those risks before they become a problem. The company’s risk management structure should include an ongoing effort to assess and analyze the most likely areas of future risk associated with the decisions around plan design, guarantees, funding and financial arrangements, technology and employee engagement. In reviewing benefits risk management, the board should ask the organization’s executives to discuss the most likely sources of material future risks and how the company is addressing any significant potential vulnerability, as well as its ability to handle the velocity and volatility of benefits-related risk and expenditure.
Building a Framework
The board and the senior management team have a key role to play in setting the framework for the business and assigning responsibilities. While the precise design of the framework will vary for each organization, all organizations should consider the following elements in addressing benefits-related risks:
- benefits design and financial risk management framework;
- benefits compliance strategy and structure;
- benefits compliance monitoring; and
- committee ownership for oversight.
Most organizations use a traditional “three lines of defence” model: business line management; risk and compliance functions; and internal audit. To ensure that the risk management framework operates effectively, each element must have a clear understanding of its role and the risks it is tasked with managing, as well as the tools at its disposal and how to deploy them. Looking at benefits risk on an integrated basis will help stakeholders to understand where a change in the risk profile of one part of the business will affect other business areas.
Developing and maintaining risk policies is also critical. A formal process for policy design and approval will enable organizations to put in place policies that are relevant, while ongoing monitoring and maintenance will ensure that they remain appropriate. Organizations that recognize the link between regulatory and non-regulatory risk assessment and the development of risk policies can better tailor policies to specific risks.
Concerns about the sustainability of pension plans, increased scrutiny of executive compensation and the most recent financial crisis have prompted regulators to focus on a program of increasingly forceful supervision while also introducing a wide-ranging set of new initiatives to shore up the regulatory framework. Meanwhile, increased incidence of unexpected risk exposure is influencing boards across industries to pay closer attention to a broader set of risk measures.
Best practices in risk management and compliance can help to establish the right oversight associated with benefits management, reduce a company’s potential liability and keep employee engagement front and centre by respecting the role of benefits within total rewards.
Ashim Khemani is CEO of Stem Capital Inc.
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