A flexible benefits program is a type of employee benefit program that allows plan members to choose a portion, or all of their benefits through an election process.
Flexible benefits enjoyed a significant increase in popularity in the late 1980’s, 1990’s and early 2000’s, and are an approach that has been refined based on the U.S. experience and made available for Canadian plan sponsors. While not initially supported, with increased technological innovation and clarifications from the Canada Revenue Agency (CRA) on tax and legal issues surrounding flexible benefit implementation, the environment for increased adoption was opened and many Canadian employers considered, and implemented, flexible benefit programs.
Flexible benefit programs allow employers to meet the diverse needs of their workforce, family dynamics and lifestyle while providing a mechanism to help control the cost and cost escalation of their employee benefit programs.
There are different variations of flexible benefit programs and can range from very little choice such as offering optional benefits to employees within a traditional benefit program to providing a program that allows for complete customization and choice to the plan member. The type of program, and structure, can be customized to meet the specific needs of the employer based on their plan objectives. The flexible benefit structures include:
- Add on
- Core + Options
- Flexible (cafeteria)
- Health Care Spending Account
This structure provides optional coverage to a traditional employee benefits program. The most common optional coverage is optional life insurance (employee, spouse, child), optional accidental death and dismemberment (AD&D) coverage, or critical illness coverage and these benefits are typically provided on an optional employee-paid basis through payroll deductions.
This structure provides employees the option to elect coverage levels that are either higher or lower than the employer-paid coverage. Choosing a benefit level that is higher than the employer-provided coverage requires the employee to lower the level of coverage in another benefit area or increase the contribution towards coverage through payroll deduction. Choosing a benefit level that is lower than the employer-provided coverage frees up flexible benefit credits that can be used to purchase new benefits or enhance benefit coverage levels in another area.
The modular flexible benefit structure provides employees the ability to choose between pre-defined benefit packages using employer-provided flexible benefit credits. Packages are provided either on an employer-paid fixed value basis or on an increasing value basis where employees can choosing increasing benefit value packages by paying for the incremental value through payroll deductions.
Core + Options
This structure provides a base level of employer-provided coverage, or core level of benefits provided to all employees on a mandatory basis and then layers on various benefit options that the employee can either waive or choose to purchase using employer-provided flexible benefit credits. If there are not enough available credits to purchase the desired options, the difference can be paid through payroll deduction. Should the employee have excess flexible benefit credits available, they can typically be distributed to the employee using various tax-advantaged or after tax methods.
The core level of coverage ensure equity among the employee population and ensures a base level of protection for all employees. The option component allows employees to customize the benefit program to their needs and introduces an element of choice.
This structure allows employees the choice to completely customize their benefit package. Employees are provided flexible benefit credits and are able to use those credits to purchase any combination of available benefits. If the value of the benefits chosen exceed available flexible benefit credits, then the difference can be paid through payroll deduction. Should the employee have excess flexible benefit credits available, they can typically be distributed to the employee using various tax-advantaged or after tax methods.
Health Care Spending Account (HCSA)
A HCSA provides an employee with an employer-funded account to pay for CRA approved health and dental services. HCSA’s are important structures that can be used in combination with a traditional benefits program to add additional value and provide flexibility, or can be used as components of any of the flexible benefit structures mentioned above.
Flexible benefit programs may allow employees to waive coverage of particular benefits, or the entire benefit program. The employer has complete decision making authority on mandating that employees choose a minimum level of mandatory coverage or not placing any restrictions at all on employees. If we go back to one of the key reasons to provide a benefit plan employees, providing protection for catastrophic loss, most employers will mandate that employees take a core level of coverage, usually for Life, Disability, Out-of-Country coverage and Prescription Drug benefits after a certain level of out-of-pocket claims which are the key areas where an employee and his/her family can suffer a catastrophic loss. In many cases, where employers allow a waiver or declination of coverage, they may request that the employee provide proof of coverage under a spousal plan, before allowing a waiver of coverage.
The potential for employees to select against the plan, otherwise known as adverse selection, is always prevalent within a benefits program that allows choice. Adverse selection can occur when an employee is aware of his/her upcoming claims and selects the flexible benefit option that provides the highest level of coverage at the least cost compared to the out-of-pocket expense that the employee will incur. For example, an employee may be aware of upcoming expensive prescription drug claims and then chooses a flexible benefit health plan option that is priced lower than the costs the employee will have to pay otherwise. When a Benefits Consultant is pricing a flexible benefit program, the impact of adverse selection is always included within the pricing model to protect the employer from the impact of adverse selection on the plan. Some of the features that can be used to protect the plan against adverse selection include:
- Step rules
- Locking-in provisions
- Packaged options
- Opt-out options and/or incentives/disincentives to participating in the plan
- Health Care Spending Accounts
Having said that, typically exceptions are made to the above rules for particular life events such as marriage, divorce, loss of coverage and birth/adoption of a child.
Step rules stipulate a maximum flexible benefit level increase or decrease that may be opted for from year to year. For example, in a four-option Health and Dental modular flexible benefit program, an employee may only choose one level higher than their current election, or one level lower than their current election. This feature prevents an employee from choosing the highest available Health/Dental option after being informed of a medical condition that may require expensive Health or Dental treatment.
Locking-in provisions prevent employees from changing their flexible benefit plan election for a period of time, typically two or three years when certain options are chosen. For example, an employee that chooses the highest value Health and Dental option in year 1 must remain in that option for a period of two years. This feature prevents employees from choosing the highest-level option on only those years where they may have higher than normal claims, then dropping down to the least expensive option within the flexible benefits program. This provision also ensures that employees choosing the higher level options also pay for the contributions associated with that option for a longer period of time to help offset the claims cost associated with the higher utilization.
Packaging combinations of Health and Dental benefits coverage can help protect the plan from adverse selection. For example, combining coverage for possibly catastrophic and non-predictable claims, such as Prescription Drugs within the Health plan, with more predictable and budgetable expenses, such as those found under the Dental benefit. This approach is more indicative of the modular flexible benefits structure mentioned above.
Opt-Outs and Incentives/Disincentives
Allowing employees to opt-out of coverage for less than the average cost or value associated with the providing coverage. Reasons that employees may choose to opt-out of coverage include:
- Alternate coverage through another plan, such as a spousal plan
- Avoidance of any employee contributions required under the plan
- Incentives, such as flat dollar Health Care Spending Account allocations
Health Care Spending Accounts
When eliminating coverage for predictable expenses, and replacing with flat dollar Health Care Spending Account allocations adverse selection is minimized within the flexible benefits program. There is an inherent trade-off of reducing adverse selection versus proving the optimal amount of flexibility.