REDUCING LABOR COSTS TO SAVE JOBS
This article originally appeared in the Grand Rapids Business Journal
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MAJOR COMPONENTS OF LABOR COSTS
DIRECT LABOR COSTS
- Wages
- Paid Time Off
- Health Care
- Disability
- Life Insurance
- Retirement
INDIRECT LABOR COSTS
- F.I.C.A.
- Workers' Compensation
- Unemployment Insurance
- Scheduling Hours of Work
In today’s extreme economic crisis, businesses are faced with decreased sales revenue from canceled or reduced orders. As revenue declines, employers grapple with reducing expense to remain profitable. To the extent labor costs are a significant part of a company’s expenses, there may be options to reducing those costs without resorting to terminating employees. The following is a discussion addressing the major components of the cost of labor and what might be done to mitigate it. The suggestions may seem extreme coming from the working environment of the past, but the intent is to retain valuable employees while companies try to remain profitable in a business climate that is extreme.
WAGES
Pay freezes and reductions are becoming prominent as the economy worsens. This is unsatisfactory to employees, but may be more desirable than losing a job. This approach not only immediately impacts the “pay” aspect of labor costs, but may reduce the cost of contributions to programs that are a function of pay:
- F.I.C.A. (OASDI & Medicare); 2009-6.2% on $106,800 of wages and 1.45% on total wages, respectively.
- Unemployment Insurance (SUTA & FUTA); Michigan has a 3 part contribution formula using wages and benefits paid over 3 & 5 year periods. 2009-Max.10.3% on $9,000.
- Short & Long Term Disability (STD & LTD); Premiums are usually based on wages.
- Life Insurance; Premiums are often based on annual income levels.
- Retirement Plans; Employer contributions are usually wage based.
- Workers’ Compensation; Costs are more a factor of accident experience, but also have a wage component in the annual premium calculation.
- Wage Adjustments; For companies with the ability to continue giving pay increases, the implementation could be changed from annual to longer periods…15-18 months.
RESCHEDULING HOURS
Reduction of hours can be a useful alternative to reducing wages in managing labor costs. If a company wants to take 10% out of payroll cost, it becomes a very sensitive issue if employees’ wages are cut, or they are laid off. However, if the cost reduction is linked to a reduction in hours, it may turn a negative situation into a positive one.
Everyone enjoys time away from work; reducing hours gets there without severely impacting the individual employee’s wages, but combined with all employees, it can have a significant impact on company costs.
For example, if a business is able to close on Friday at noon and people are paid 10% less (40 minus 4hrs.), the work week stays in basic balance. This also doesn’t have the negative impact of loading up more work on the people left behind in a typical down-sizing or lay off. Utility costs may decrease and increases in unemployment tax rates are not incurred, which would be an added expense in later years. Error rates and injury rates may decrease, and some employees may be more motivated trying to get 40 hours of work done in 36. It can result in a more productive work force with higher morale, while maintaining the continuity of working friendships and social networks.
Finally, the company may be positioned for effectively installing a future variable pay plan. If productivity and profitability reach previous levels (before the economic crisis), employees can be paid more money without reverting to higher wages and salaries. If the 36 hour work week stays, it also may be a valuable recruiting tool when hiring new employees.
PAID TIME OFF (PTO)
Many companies pay little attention to the time employees are paid for not working, but these hours of non-work time have to be made up somewhere. There are six national holidays for which many companies pay employees for not working. Some companies provide even more. Vacations may account for a month of paid time off for longer service employees. These programs are designed to give people a break from the work place, however, companies may want to consider offering this time off without pay to reduce costs. Some employers allow employees to NOT take the paid time off yet receive pay “in lieu of” that time. When that pay is added to wages for time worked, it increases the cost of labor. Companies may want to consider changing their policies to require employees use the time off as intended, rather than incurring additional labor costs. Many companies, particularly those with unions, have programs that provide Sick Pay for days employees are ill and unable to work. Most of these days are “earned” based on previous time worked and accumulated year after year. Personal Days may also be a component in an employer’s benefit plans. Companies should consider changing this accumulation provision to not exceed the waiting period before STD and/or LTD benefits become payable. Otherwise the payment of unused Sick Days & Personal Days becomes added wages, along with their accompanying company paid taxes, which was not their intended use.
DISABILITY
Probably every company has some kind of plan for employees to take time off when ill. An employee’s absence without pay may reduce that employee’s wages, but doesn’t significantly reduce the company costs if they have to hire a replacement. Several larger production companies even hire more employees than are needed (sometimes referred to as “on call” workers) to make up for anticipated absence of employees and meet production demands. Everyone gets sick at some time, and it’s not healthy for others to report for work with a contagious illness, however, excessive absences should be addressed by policy and enforced. That doesn’t mean exceptions can’t be made in specific instances, but abusers are a drain on labor costs and need to be managed.
Many companies provide income to sick employees through Sick Pay, Personal Days and Short and Long Term Disability plans. These plans should be written to encourage employees to earn the benefits through working and longevity with the company. The income replacement level should not encourage malingering, but be sufficient to financially assist the employee on a temporary basis. Even though most disability pay plans are subject to income taxes, (Workers’ Compensation benefits are NOT), they may not be subject to other taxes the employee pays while working. Additionally, some people have private disability insurance policies on mortgages, car loans and credit cards that pay the employee’s monthly obligation when they are unable to work. Private plans also provide the employee cash during certain illness situations. An employee with a company paid disability plan and these types of personally insured debt plans may have more spendable income while they are sick than when they are working. “Sick Pay” and “Personal Day” plans should be evaluated to assure they are appropriately serving their intended purpose, rather than resulting in additional labor costs and taxes to the company.
Companies with over 50 employees are required to follow the Family Medical Leave Act (FMLA). While complying can be complex, there are ways to minimize the negative impact on employers.
WORKERS’ COMPENSATION COSTS (WC)
Many small to mid-size employers believe they have little impact on premiums they pay for Workers’ Compensation coverage. It is often viewed as just another liability cost of doing business. Attempts to reduce those costs are limited to “funding arrangements”, i.e. high deductibles, self-insurance, retrospective programs, captives, etc. While these arrangements are an important aspect to the liability analysis, individual claim costs and reserves are what drive premiums.
How each claim is managed is critical to reducing costs. Employers who leave claims management to their Insurance carrier miss an important role in reducing labor costs. If an employer doesn’t take an active role in managing the details, particularly immediately following an injury, avoidable costs will be incurred. The average caseload of an Insurance carrier adjuster can be 150-175. This kind of caseload reduces time spent focusing on the initial stages of a claim. Often claims develop into problems when close scrutiny in the beginning could prevent them from ever becoming an issue.
EMPLOYERS SHOULD:
- Daily monitor lost time costs. If the employer pays attention to critical times in the claim progression, it can have a significant impact on costs. Paying specific attention to the "7day” and “14day" waiting period provisions of the Michigan Law can have an immediate, as well as long term impact. One additional day of lost time can cost a week of benefits being paid and impact reserves.
- Assure timely payment of lost time benefits & medical bills. If benefits are not paid in the same cycle as wages, employees’ income suffers, and they may incur additional debt to cover daily living expenses. If medical bills are not paid promptly the employee may receive bills and collection notices from medical providers which are properly the Insurance carrier’s responsibility. This reflects negatively on the employer and may result in employees seeking attorneys for help.
- Become familiar with local medical providers. The employer should develop close working relationships with area doctors, which allows timely communications and removes misunderstandings that contribute to costs, both in medical expenses and in lost time.
- Request detailed Management Reports from their Insurance carrier. Reports which summarize losses are not specific enough to see where costs can be reduced. Reports should be customized to illustrate how individual claim costs can be reduced.
- Analyze Reserves on their loss runs. Many times reserves are significantly greater than what has been paid. A comprehensive knowledge of how reserves are established by the Insurance carrier has a direct impact on premiums and funding arrangements.
As employers review WC costs, paying attention to the details will result in reduced labor costs.
HEALTH CARE
50 years ago, health care plans were purchased, like other insurance, to protect against catastrophic financial loss from major medical expenses. The premiums for those plans were relatively inexpensive. The majority of medical costs themselves were not out of reach for most people, as doctors and hospitals received payment from their patients and some tax payer supported programs. As companies looked to attract employees and tax laws changed, impacting taxable wages, companies began offering health care plans that covered medical expenses that were less catastrophic. Insurance companies insuring large employers “grouped” employees to spread their risk. As competition for labor increased these group plans decreased up front patient deductibles to insignificant levels. HMO’s removed them entirely if care was “managed” by a select group of providers. Coverage was expanded to include dependents and spouses. Dental, Vision, and Hearing coverage became available along with Prescription Drugs. Medical providers no longer were paid by patients, but by a third party – Insurance Companies. Patients no longer cared about the costs as “insurance” paid for it. With Insurance companies’ deep pockets providing funding, medical technology exploded and providers were able to do procedures and tests not dreamed of a few years earlier. Pharmaceutical firms had seemingly unrestricted funds to develop drugs for every ailment with out regard to cost as Insurance paid for it.
We are now at a point where health care is 20% of GDP, and the “boomers” have just attained the age of needing more medical care. This has resulted in premium increases that many companies can no longer afford. In today’s global business climate, U.S. companies are competing with businesses which do not have the burden of providing health care for employees. This has resulted in U.S. companies reversing the previous trends of plans with minimal costs to employees. Some companies are dropping coverage altogether which increases the number of uninsured. These people still have access to care but if it’s not paid for, the cost care is shifted to the prices for services to others.
Many local employers wising to reduce their labor cost should consider going back to the intent of medical insurance in the first place – protection from catastrophic financial loss. In the 1950’s patients out-of-pocket spending represented 50% of total health spending; in 2006 it was 13% (Newsweek, January 14, 2009). Several areas for companies to consider:
- Drop spouse coverage, if the spouse is eligible for coverage elsewhere.
- Reduce the company’s contributions for dependent and employee coverage.
- Increase up front deductibles resulting in coverage for catastrophic events.
- Drop Dental, Vision & Hearing coverage as these plans, at most, are discount arrangements with providers and provide minimal benefits to employees.
- Consider a Health Reimbursement Arrangement (HRA) and reimburse employees for individual policy premiums.
While these actions will do little to impact the national crises of health care coverage and cost, it can reduce the labor costs of employers, allowing them more control over their financial future.
LIFE INSURANCE
This is a relatively inexpensive insurance when provided on a “term” basis. The amount of insurance should be at a level that allows the beneficiary (spouse, family) to live reasonably following the loss of the deceased employee’s income for a period of time until they can regroup and determine their future. Excessive amounts provide wealth accumulation beyond the intent of company provided insurance.
RETIREMENT
When company provided retirement plans became popular 50 years ago, they were intended to supplement Social Security benefits which are funded by both the company and employee. Most were Defined Benefit (DB) arrangements; commonly know as “pension” plans. The ideal income replacement for a retired worker was 1/3 Social Security, 1/3 Pension, and 1/3 personal savings. Pension plans had a defined benefit upon retirement based on length of service and some method of applying wages (highest 5, last 3 etc.). The plans were funded by companies after annual actuarial evaluations determined the contribution necessary to keep them “fully funded”. Full benefits were generally paid for retirement at age 65 and some allowed reduced benefits for earlier retirements. As companies are faced with more retirees living longer and a decline in the investments of the DB plans, they are required to increase contributions to meet “fully funded” requirements. These, in addition to retiree medical plan costs, are now referred to as “legacy” costs. Companies with these plans may want to consider alternatives such as a “cash balance plans” for DB plans and a “capped allowance” format to provide retiree medical coverage.
30 years ago Defined Contribution (DC) arrangements became popular and most commonly are known as 401(k) plans. These plans do not provide a monthly “benefit” to retirees, like DB plans do, but provide contributions from the employee and employer to be invested in a fund on a pre-tax basis. Employees’ contributions reduce gross wages, for both the employee and the company, eliminating Federal taxes (including Social Security) and some State & Local taxes. Invested contributions earnings are also allowed to accumulate tax free until withdrawn. Companies with DC plans may want to reduce matching contributions, or if a match is in place, look into “safe harbor” provisions to eliminate costly annual non-discrimination testing. It’s also good to analyze the investment vehicles themselves and the fees associated with their management; which, unfortunately are often laced with charges that are rarely focused upon.
UNEMPLOYMENT INSURANCE
Unemployment Insurance (UI) costs can be minimized with diligence to the details of claim processing and funding. Some employers are not aware this is not a welfare benefit, but one employees have to qualify for based on wages and reasons for being unemployed. A terminated employee is only entitled to UI benefits if they are unemployed through no fault of their own. An employee who “quits without good cause” or “discharged for misconduct” is not entitled to benefits. These “legal” phrases have many years of court interpretation, but the employer’s answer to an initial claim will be a determining factor of whether benefits are charged against their account and impact costs for years to come.
Assuring that employees discharged for misconduct or who quit without good cause do not impact UI costs begins with how the employer records communications and documents before the employee leaves. If a claim is filed the employer has the burden of proof to establish why the employee is no longer working. Employers should respond timely with all documented records available in response to the initial claim filing. Failing to do so may result in benefits being charged to an employer’s account based solely on the statements by the employee.
Additionally, employers should pay attention to “Determinations” from the state and file timely appeals if they believe them to be incorrect. There are several opportunities for appeal, all the way to the Supreme Court. Most cases, though, are determined at lower administrative levels. These are opportunities for employers to appear in person with relevant witnesses and an attorney is not required.
The current maximum UI tax rate an employer may pay in Michigan is 10.3% of the first $9,000 of wages to each employee. The rate is based on several factors, including the employers “experience” of benefits paid out vs. taxable payroll. The effects of one employee receiving benefits can impact an employer’s tax rate for many years. An employer who is diligent to paying attention to the details can see labor cost savings that impact their bottom line.
—Tom Cole is a principal with P3HR Consulting & Services LLC of Grand Rapids, which has more than 100 combined years of experience in HR management.