THE PENSION BENEFIT GUARANTY CORPORATION AND ITS PLAN INSURANCE

If an employer encounters financial difficulty and is forced to terminate or curtail a qualified defined-benefit plan, the ultimate payment of plan benefits is often jeopardized. If the plan uses an insurance company contract as the funding medium, the employee's benefit is usually to some extent guaranteed by the insurance company. However, the use of trust funds predominates in defined-benefit plans, and these funds usually involve no insurance company guarantees. Actuarial funding methods assume that plans will be in existence indefinitely. As a result, the plan fund in many cases is, at a given moment, inadequate to fund all of the benefits accrued under the plan if the plan terminates at that moment.

Recognizing this problem, Congress established a scheme of mandatory plan insurance for certain defined-benefit plans as part of ERISA (Title 4) in 1974. The insurance is administered by a quasi-governmental corporation called the Pension Benefit Guaranty Corporation (PBGC). Defined-contribution plans do not involve the same benefit security problems as defined-benefit plans because the participant's accrued benefit is always equal to the participant's account balance. Therefore, the PBGC plan insurance scheme does not apply to defined-contribution ("individual account") plans.

Plans Covered

PBGC coverage can be summarized by stating that, in general, all qualified defined-benefit plans are covered, while individual account (defined-contribution) plans are not covered. With respect to defined-benefit plans, the usual exclusions applicable to ERISA provisions apply: there is no PBGC coverage for federal, state, and local government plans; church plans (unless the plan elects coverage); plans with no employer contributions; plans for highly compensated individuals or substantial owners; plans frozen prior to ERISA; and various other exclusions.

Benefits Insured

The PBGC does not insure or guarantee all benefits provided under a qualified defined-benefit plan covered by PBGC insurance. A distinction is made between basic and nonbasic benefits. The PBGC is required under the terms of its federal charter to insure basic benefits. PBGC is allowed to extend coverage to nonbasic benefits, but it has not yet done so.

There are numerous conditions and limitations on what qualifies as a guaranteed basic benefit, set out in Part 2613 of the PBGC regulations. The most significant limitations are as follows:

• The benefit must be nonforfeitable or vested. This refers to vesting that existed under the terms of the plan immediately prior to plan termination, not to benefits that became vested solely on account of plan termination.

• The benefit must be a "pension benefit"-a benefit payable as an annuity to a retiring or terminating participant or surviving beneficiary, providing a substantially level retirement income to the recipient. Consequently, the PBGC generally does not insure a lump-sum benefit.

• There is a dollar limitation on the amount of monthly payment the PBGC will guarantee. Regardless of the plan provisions, the insured monthly benefit is limited to one-twelfth of the participant's average annual gross income from the employer during the highest paid five consecutive calendar years or lesser number of years of active participation. Furthermore, in no event will the insured benefit exceed a dollar limit, originally $750 monthly in 1974, which is subject to an indexation procedure. For plans terminated in 2000, the limit was $3,221.59 monthly. The dollar limitation applies to a benefit in the form of a straight-life annuity beginning at age 65 and payable monthly. The limit is adjusted actuarially for other forms of benefits.

• The participant must be "entitled" to the benefit as of the date of plan termination. Generally, this means that the recipient must have satisfied the conditions of the plan necessary to establish the right to receive the benefit (other than mere application for it or satisfying a waiting period) prior to the plan termination date. Also, the benefit must be payable to or for the benefit of a natural person (not, for example, a corporation).

PBGC Funding and Premiums

The PBGC has established several funds to provide benefit guarantees. It has the power to borrow up to $100 million from the U.S. Treasury if necessary. However, the PBGC is expected to be self-supporting and is therefore required to charge insurance premiums for its guarantees. For single employer plans, the basic annual premium for 2000 is $19 per participant. For certain underfunded plans, an additional annual premium may be required, depending on the amount of the plan's unfunded vested benefits. Congress has the authority through a joint resolution procedure to review and change PBGC rates from time to time, based on various factors set out in the law. Payment of the premiums is mandatory, and is enforced by various penalties.

Plan Termination Procedures

Reportable Events

The PBGC becomes involved with a plan that is terminating or encountering various difficulties in somewhat complex ways. First of all, the plan administrator is obligated to report to the PBGC certain events that could potentially cause financial difficulty. There is a long list of these reportable events; some significant ones are these:

• An IRS or Department of Labor disqualification of the plan

• A plan amendment decreasing retirement benefits

• A decrease in the number of active participants to less than 80 percent of the number at the beginning of the plan year or 75 percent of the number at the beginning of the previous plan year

• A determination by the IRS that there has been a termination or partial termination of the plan

• A failure to meet the minimum funding standards

• An inability by the plan to pay benefits when due

• Certain large distributions to a substantial owner

• A plan merger, consolidation, or transfer of its assets

• The occurrence of another event indicative of a need to terminate the plan-the regulations refer to such items as insolvency of the employer or a related employer and certain breakups of commonly controlled groups of employers

If the consequences of these reportable events are significant enough, the plan can be involuntarily terminated by the PBGC. Also, of course, a voluntary termination can be carried out by the plan administrator under one of the two procedures described below. In any event, the actual termination of a plan covered by PBGC guarantees is carried out under detailed procedures set out in the law.

Allocation of Plan Assets on Termination

The PBGC termination procedures revolve around the rules for allocation of the assets of a terminated defined-benefit plan under ERISA Section 4044. On termination, such plan assets must be allocated in descending order to the following categories:

• Benefits attributable to voluntary employee contributions.

• Benefits attributable to mandatory employee contributions.

• Annuity benefits attributable to employer contributions that were, or could have been, in "pay status" as of three years prior to termination. A benefit in "pay status" means a benefit being paid to a retired (nonactive) employee. The high priority reflects the fact that such employees are least able to protect themselves against a failure of the plan fund.

• All other PBGC guaranteed benefits.

• All other vested benefits.

• All other plan benefits.

Any amount remaining after these categories may revert to the employer, if the plan so provides.

Voluntary Plan Termination

ERISA Section 4041(a) provides for two types of voluntary termination procedures, the standard termination and the distress termination. A plan is eligible for the standard termination only if assets at the termination date are sufficient to provide for all benefit commitments as of the termination date. A benefit commitment to a participant or beneficiary means all benefits guaranteed by the PBGC as described earlier, but determined without certain limitations, such as the maximum dollar limit or the restriction on benefits in effect for less than 60 months before plan termination. Certain early retirement supplements and plant closing benefits also come within the definition of benefit commitments. If benefit commitments are not met, a voluntary termination must follow the distress termination procedures.

With a standard termination, the plan administrator must provide 60 days advance notice of intent to terminate to participants, beneficiaries, and other affected parties.

The plan administrator must begin distributing plan assets at the end of the 60-day determination period if the PBGC has not issued a notice of noncompliance and if the plan assets are sufficient to meet benefit commitments. The assets are distributed in accordance with the priorities of ERISA Section 4044 described above. Assets must be distributed either through the purchase of annuities from an insurance company to provide plan benefits or in some other manner providing adequate benefit security.

A distress termination is available only if one of three distress criteria is met:

1. Each contributing sponsor of the plan or substantial member of a controlled group sponsoring the plan must be in a liquidation proceeding under federal bankruptcy law or similar state law; or

2. The sponsor must be involved in a reorganization in bankruptcy or an insolvency proceeding; or

3. The plan administrator demonstrates to the PBGC that unless the termination occurs, the sponsor will not be able to pay its debts and will be unable to continue in business, or the cost of providing benefits under the pension plan has become unreasonably burdensome (for example, because of a declining work force).

On a distress termination, the plan administrator must submit to the PBGC information similar to that required under a standard termination, plus information related to the distress criteria. If the PBGC determines that there are sufficient plan assets to fulfill benefit commitments, the plan administrator may begin to distribute the assets in accordance with ERISA Section 4044.

Contingent Liability of Employer

In the event of a plan termination covered by PBGC insurance, the employer must reimburse the PBGC for the PBGC's liability for guaranteed benefits in excess of the plan's assets. However, under ERISA Section 4062, any amount of the employer's liability that exceeds 30 percent of the employer's net worth, can be deferred under "commercially reasonable" terms. This PBGC remedy may be of limited value for large bankrupt employers with no net worth or financial resources.

Multiemployer Plans

The previous discussion of termination procedures applies primarily to single employer plans or plans of controlled groups of employers. The termination problems are somewhat different where contributions to the plan are made by a number of unrelated employers-that is, a multiemployer plan such as a plan adopted under industrywide collective bargaining agreements. For such plans, there are different asset allocation provisions and somewhat different provisions for involuntary termination by the PBGC.

The most significant difference from single employer plans involves the withdrawal liability of an employer that completely or partially withdraws from a multiemployer plan. A sale of the employer's assets in an arm's-length transaction will not be treated as a withdrawal as long as the purchaser of the business continues the plan, the purchaser provides an acceptable surety bond or escrow deposit for five years after the sale, and the seller of the business remains secondarily liable for five years. If an employer withdraws from the plan, the employer's withdrawal liability is an amount based on the withdrawing employer's share of unfunded vested benefits under the plan. The withdrawing employer must pay all or a substantial portion of the withdrawal liability to the plan on a periodic basis over a number of years. The law provides for the PBGC to establish a supplemental fund to reimburse multiemployer plans for any uncollectible employer withdrawal liabilities.

FEDERAL ESTATE TAX TREATMENT OF QUALIFIED PLAN BENEFITS

The federal estate tax is a tax separate from the income tax that is imposed on the value of a decedent's property at the time of death. The estate tax is payable out of the decedent's estate and, therefore, reduces the amount available to the beneficiaries. Only a small percentage of decedents—less than 5 percent—have enough wealth to be concerned about the estate tax because of a high initial minimum tax credit applicable to the estate tax. No estate tax return need be filed for a decedent whose gross estate is less than $675,000 (in 2000). This amount is scheduled to rise incrementally to $1,000,000 in 2006. Also, there is an unlimited marital deduction for federal estate tax purposes—that is, there is no federal estate tax imposed on property transferred at death to a spouse, regardless of the amount.

As a general rule, a lump-sum death benefit, or the present value of an annuity payable to a beneficiary from a qualified plan, is includable in the estate of a deceased participant for federal estate tax purposes. For some high-income participants, avoiding federal estate taxes on the plan benefit will be important. Their estates may be large enough to attract imposition of some federal estate tax. The marital deduction may not be significant, because they may not wish to pay the plan benefit to a spouse—they may be widowed or divorced or may wish to provide for another beneficiary. Also, even if the benefit is payable to a spouse, a spouse is often about the same age as the decedent, and thus within relatively few years most of the property transferred to the spouse is potentially subject to federal estate tax again at the spouse's death. As a result, it is often useful to design a qualified plan death benefit that can be excluded from the participant's estate.

The general rule of the federal estate tax is that all items of property are includable unless a specific code provision excludes them. Thus, qualified plan death benefits are generally includable because there is no specific exclusion. However, the estate tax law does have a specific provision dealing with life insurance, Section 2042. Under Section 2042, life insurance proceeds are includable in a decedent's estate if the decedent has "incidents of ownership" in the insurance policies. Incidents of ownership are various rights under the policy, particularly the right to designate the beneficiary. If a qualified plan death benefit is provided through a life insurance policy, in most places this provision would require inclusion because the participant retains the right to name the beneficiary. Noninsured death benefits presumably would not be excludable in any event.

BENEFITS AT TERMINATION OF EMPLOYMENT

The vesting provisions of a plan determine the amount of benefit that a participant is entitled to receive upon terminating employment prior to retirement.

In a defined-contribution plan, the termination benefit is the vested portion of the participant's account balance. In defined-contribution plans, particularly profit-sharing plans, the account balance usually is distributed to the participant in full at termination of employment. It is technically possible to defer the distribution to the participant's normal retirement date, but this is rarely done in defined-contribution plans because it causes additional expense to the plan with little or no corresponding benefit to the employer or the plan. However, the plan may give the participant the option to leave the funds on deposit in the plan for withdrawal at a later date, to allow the participant to take advantage of the tax-deferred investment medium afforded by the plan, with a possible loss of favorable income tax treatment on the later plan distribution.

For a defined-benefit plan, the benefit on termination of employment is more complicated. The benefit will be the vested accrued benefit as of the date of termination, determined under the vesting and the accrual rules already described. Use the same example as in the discussion of the fractional accrued-benefit rule, again supposing that an employee terminates employment at age 55 after 20 years of service and the plan's normal retirement age is 65. If the participant is fully vested and the accrued benefit is $8,000 as discussed in the earlier example, an annuity of $8,000 per year will be payable beginning at age 65.

To make sure that terminated participants actually receive deferred vested benefits at retirement, which may be many years after termination, the employer must report all deferred vested benefits of terminated participants to the Social Security Administration, which then can inform retirees of their rights to benefits from plans of former employers. This reporting is done on the Form 5500 series.

In some cases, the deferred vested benefit may be such a small amount that keeping track of it until the participant's retirement is merely a nuisance for both employer and employee. The employer can cash-out a distribution—that is, pay cash to the employee in lieu of the deferred vested benefit—without the employee's consent, so long as the entire benefit is distributed and the employer portion of the benefit so distributed does not exceed $5,000. The involuntary cashout must be within one year of termination of participation in the plan; the plan must have a provision permitting the employee to repay the cashout to the plan if the employee was not fully vested at the time of termination, in case the employee should resume participation in the plan. A cashout of a benefit that exceeds the $5,000 limit can be made, but only with the consent of the employee.

Determination of Benefits: Some Complexities

In actual practice, the determination of benefits payable may be much more complex than the previous simple example. While many of these complexities are beyond, a few issues are addressed. These include the following:

Determination of benefits payable by each plan

Benefit banks

Coordination of benefits with self-funded plans

Before proceeding farther, however, one important point needs to be made: Coordination of benefits is between two (or more) specific plans, each of which has its own rules. While generalizations can be made, the ultimate benefits paid depend on the specific rules of each plan.

Determination of Benefits Payable by Each Plan
The earlier example lumped expenses together into three broad categories and assumed that they were fully covered by each plan, except for any deductibles and percentage participation by the insured. An actual benefit calculation looks at every charge billed by the hospital and surgeon and determines to what extent that charge is covered. It is possible that some charges will not be paid in full because they exceed reasonable and customary charges or because of exclusions. In addition, some managed care plans limit benefits for nonnetwork services to what is paid to network providers. It is common for this to be significantly below billed charges.

Benefit Banks
Some medical expense plans have benefit banks (also called benefit reserves) in which COB savings from being a secondary payer accumulate for future claims when the plan is also the secondary payer. Assume, for example, that a plan is secondary and pays $1,000 of a claim for which the plan would have paid $15,000 if it had been primary. The $14,000 savings is credited to an account for the insured and can be withdrawn for reimbursement of future allowable medical expenses to the extent they that are not 100 percent reimbursed. Assume further that $4,000 of allowable expenses result from a future claim, and for some reason the primary and secondary payers pay only a total of $3,500. This $500 shortfall will be withdrawn from the $14,000 balance in the benefit bank so that the insured has a 100 percent reimbursement. Balances in the benefit bank usually revert to zero at the end of a specified period, most commonly a calendar year.

Coordination of Benefits with Self-Funded Plans
Self-funded plans are not bound by the state COB rules that apply to insurance contracts and HMO plans, but as a rule they use provisions that are identical or very similar. However, they are free to use any type of COB provision.

Some self-funded plans use a provision so that their payment as a secondary payer is limited to the amount that would reach the limits of their own plan. For example, assume that two self-funded plans would each cover only 80 percent of an insured's medical expenses after a $250 deductible. The secondary payer would pay nothing because the limits of its own plan had already been reached by the primary plan. If the secondary plan had a lower deductible, such as $200, the secondary plan would pay $50. This type of provision, which in effect preserves deductible and coinsurance in the COB process, is not allowed under the NAIC model regulation previously discussed.

A few self-funded plans coordinate benefits with plans under which an individual is eligible for coverage, even if the individual is not covered under that plan. For example, the self-funded plan might provide coverage for an employee's dependents. If a dependent spouse works outside the home and is eligible for his or her own employer-provided coverage, the self-funded plan would pay on a secondary basis, whether or not the spouse signed up for his or her employer's plan.

Finally, self-funded plans have been designed so that they are excess or "always secondary" to any other medical expense plan. The most extreme situation occurs if a person is covered under two self-funded plans, each of which takes an always-secondary approach. Each plan pays as if it were secondary. In the earlier example where the insured has $10,500 of covered expenses, this means that plan A pays $2,200 and plan B pays nothing. This total of $2,200 is less than either plan would pay if it were primary. This issue has been the subject of several court cases, and some (but not all) courts have stated that the always-secondary position cannot prevail. While these courts have ordered an equitable payment of benefits to the covered person, that person has been forced to take the matter to court.

A similar situation exists if a person is covered under a self-funded plan that is always secondary (but would be primary if the state's rules applied) and an insured plan that is legitimately secondary because of the state's COB rules. However, the results are usually somewhat different. In most states, the insured plan must pay the covered person two amounts—the first, what the insured plan is obligated to pay as the secondary plan, and the second, the difference between what the self-funded plan pays on a secondary basis and what it would have paid if it had settled the claim as the primary payer of benefits. This second amount is considered an advance to the covered person, and the insured plan receives a right of subrogation. In other words, the insured plan has the right to take legal action to recover the amount of the advance from the self-funded plan. If the amount is recovered, the advance is, in effect, repaid. If there is no recovery, the covered person has no obligation to repay the insured plan.

Determination of Benefits Payable: A Simple Example

The actual mechanics of the previously described COB provision are demonstrated in the following example, which assumes that a person has coverage under the plans of two employers:

Plan A has PPO coverage that pays allowable expenses in full as long as network preferred providers are used. If nonnetwork providers are used, there is (1) a $500 annual deductible, (2) 80 percent coinsurance subject to a $3,000 out-of-pocket limit and (3) a $1 million lifetime maximum.

Plan B has traditional comprehensive major medical expense coverage with (1) a $200 calendar-year deductible, (2) 80 percent coinsurance subject to a $1,000 out-of-pocket limit and (3) a $2 million lifetime maximum.

Assume also that this person incurs the following expenses for a surgical procedure:

Semiprivate room for 5 days at $800 per day
$4,000

Other hospital charges
3,500

Surgeon's fees
3,000

Total expenses
$10,500

Assume that (1) neither plan contains a COB provision, (2) plan A is primary, and (3) network providers were used. In this case, plan A would pay the full $10,500, and plan B would pay $9,300 after deductions for the $200 deductible and the $1,000 out-of-pocket limit that applies to the coinsurance provision. Consequently, the insured would collect a total of $19,800, or $9,300 in excess of his or actual expenses.

If the example is changed so that plan B is primary and nonnetwork providers are used for plan A, plan B will still pay $9,300. However, plan A only will pay $8,000, which is 80 percent of the expenses above the nonnetwork deductible. In this case, the insured would collect $17,300, still significantly more than his or her actual expenses.

Before the COB provision is used, it must first be determined whether the provision applies to a given claim. It applies only if the sum of the benefits under the plans involved (assuming there is no provision) exceeds an individual's allowable expenses. Allowable expenses are defined as any necessary, reasonable, and customary items of expense, all or a portion of which are covered under at least one of the plans that provides benefits to the person for whom the claim is made. However, under a primary plan, the amount of any benefit reductions resulting from a covered person's failure to comply with the plan's provisions (such as second opinions or precertification) is not considered an allowable expense. In addition, the difference between the cost of a private hospital room and the cost of a semiprivate hospital room is not considered an allowable expense unless the patient's stay in a private room is medically necessary. When the allowable expenses are determined, any deductibles, percentage participation from coinsurance, and plan maximum are ignored.

In the previous example, the entire $10,500 is considered allowable expenses. Because the sum of the benefits otherwise payable under the two plans (either $19,800 or $17,300, depending on which plan is primary) exceeds this amount, the COB provision applies. If the sum of the benefits did not exceed the allowable expenses, the COB provision would not apply and each plan would pay its benefits as if it were the only existing plan.

When the COB provision applies, a person receives benefits equal to 100 percent of his or her allowable expenses and no more. The primary plan pays its benefits as if no other coverage exists, and the secondary plan (or plans) pays the remaining benefits. If plan A in this example is primary, it will pay $10,500, and plan B will pay nothing because 100 percent of the insured expenses have been paid. If plan B is primary, it will pay $9,300 and plan A will pay the remaining $2,200 of the insured's expenses.

Vision Benefits | BENEFIT CARVE-OUTS

Carve-out vision benefits may be provided by insurance companies, Blue Cross-Blue Shield plans, plans of state optometric associations patterned after Blue Shield, closed-panel HMO-type plans established by local providers of vision services, vision care PPOs, or third-party administrators.

More than half of the persons covered under employer-provided medical expense plans have some type of vision coverage, and the majority of this coverage is provided under some type of carve-out arrangement. Despite concerns with rising benefit costs in recent years, vision care is one type of benefit that employers continue to add. Routine eye exams can result in better overall health care because certain other types of health problems—such as high blood pressure, diabetes, and kidney problems—are first discovered during the course of such exams. Proper vision correction can also result in fewer accidents and greater productivity by minimizing eyestrain and headaches.

Benefits are occasionally provided on a reasonable-and-customary basis or are subject to a flat benefit per year that may be applied to any covered expenses. Normally, however, a benefit schedule will be used that specifies the type and amounts of benefits and the frequency with which they will be provided. Table 11-4 is an example of one such schedule. If the plan is written by a provider of vision services, it is common for a discount, such as 20 percent, to be available for costs incurred with the provider that are not covered by the schedule of benefits. Under some plans, most benefits are provided on a service basis rather than being subject to a maximum benefit. However, these plans usually cover only the cost of basic frames, which the covered persons can upgrade at an additional expense.



Exclusions commonly exist for any extra charge for plastic lenses or the cost of safety lenses or prescription sunglasses. Benefits are generally provided for eye examinations by either an optometrist or an ophthalmologist, and larger benefits are sometimes provided if the latter is used. Vision care plans do not pay benefits for eye surgery or treatment of eye diseases because these are covered under the regular coverage of a medical expense plan.

Preapproval of Visits to Specialists

Many persons elect to bypass primary care physicians, such as family physicians and pediatricians, and use specialists and the emergency room as their primary access to medical care; this results in additional costs but does not improve medical outcomes, in the opinion of much of the medical community. To counter this practice, some traditional medical expense plans require that a visit to a specialist be preceded by a visit to a primary care physician. It is not necessary for the primary care physician to actually certify that a trip to a specialist is necessary, only that he or she has been told that the patient plans to make such a visit. The rationale for this procedure is that the primary care physician may convince the patient that he or she is able to treat the condition and that a specialist is unnecessary, at least at that time. If a specialist is needed, the primary care physician is also in a better position to recommend the right type of specialist and to coordinate health care for persons seeing multiple specialists.

Failure to use the primary care physician as a quasi gatekeeper will result in a reduction in benefits. Usually, benefits will still be paid, but at a lower level.

Benefits for Preventive Care
Most traditional medical expense plans provide at least a few benefits for preventive care. Probably the most frequently found benefits, because of state mandates for group insurance contracts, are well-baby care, childhood immunizations, and mammograms. Plans may also go as far as providing routine physicals for children at specified ages and, perhaps, for all covered persons, typically subject to an annual maximum benefit, such as $150 or $200. However, coverage for routine adult physicals is much more likely to be covered under managed care plans.

Surgical Expense Benefits

Surgical expense coverage provides benefits for physicians' charges associated with surgical procedures. While one tends to think of a surgical procedure as involving cutting, insurance contracts typically define the term broadly to include such procedures as suturing, electrocauterization, removal of a stone or foreign body by endoscopic means, and the treatment of fractures or dislocations.

Even though surgical expense coverage is frequently sold in connection with hospital expense coverage, surgical expense coverage normally provides benefits for surgery performed not only for patients in the hospital (either as inpatients or outpatients) but also for outpatients in a free-standing (that is, separate from a hospital) ambulatory surgical center and in a physician's office. To discourage unnecessary hospitalization, some surgical expense benefit contracts actually provide larger benefits if a procedure is performed as outpatient surgery.

Outpatient surgery also results in charges for medical supplies, nurses and the use of facilities. As mentioned, these charges are often covered if surgery is performed on an outpatient basis in a hospital or outpatient surgical facility.

Benefits
Surgical expense coverage traditionally provided benefits only for the fee of the primary surgeon. However, newer contracts often provide separate benefits for assistant surgeons and anesthesiologists as well. Because both hospital expense coverage and surgical expense coverage often cover anesthesia, it is important that an overall medical expense plan be properly designed to make sure this benefit is neither omitted nor overlapping. The major difficulty in this regard occurs when different providers are used for the hospital and surgical benefits.

In providing basic surgical expense benefits, some insurance companies and some Blue Shield plans use a surgical fee schedule in which charges are paid up to the maximum amounts specified in the schedule of surgical procedures in the master contract. However, the majority of surgical expense plans follow the approach used in major medical contracts and provide benefits to the extent that surgical charges are reasonable and customary. Unfortunately, the precise meaning of these terms in insurance contracts is vague, and each company determines what it considers reasonable and customary. In general, reasonable-and-customary charges (sometimes referred to as usual, customary, and reasonable charges or prevailing charges) are considered to be those that fall within the range of fees normally charged for a given procedure by physicians of similar training and experience within a geographic region.

The usual practice of insurance companies is to pay charges in full as long as they do not exceed some percentile (usually ranging from the 85th to the 95th) of the range of charges for a specific surgical procedure within a certain geographic region. For example, if an insurance company uses the 90th percentile and if for a certain procedure 90 percent of the charges are $300 or less, this is the maximum amount that is paid. The covered person is required to absorb any additional charges if he or she uses a more expensive physician. Through the use of computers, insurance companies now have statistics that categorize expenses by geographic regions that are as small as the ZIP codes of medical-care providers. Thus, while $300 may be the maximum reasonable-and-customary amount in one part of a metropolitan area, $350 may be considered reasonable and customary in another part of the same metropolitan area.

Blue Shield plans often use a somewhat modified approach in determining the maximum amount that is paid. Each year, physicians file their charges for the coming year with the Blue Shield plan, and during that year the plan pays charges in full up to some percentile of these filed charges. Under some plans, the physicians agree not to charge Blue Shield patients amounts in excess of their filed fees. Participating physicians in other Blue Shield plans agree to accept any Blue Shield payment as payment in full, particularly for employees with an income level below a certain amount, such as $10,000 for an individual and $15,000 for a family.

Second Surgical Opinions
In an attempt to control medical costs by eliminating unnecessary surgery, many medical expense plans, both traditional and managed care, provide benefits for second surgical opinions. While such opinions undoubtedly cause some patients to decide against surgery, it is still unclear whether the cost savings of second surgical opinions are illusory. For example, surgery may still be required at a later date, or long-term costs for alternative treatment may be incurred.

A voluntary approach for obtaining second surgical opinions is often used. If a physician or surgeon recommends surgery, a covered person can seek a second opinion and the cost is borne by the medical expense plan. In some instances the benefit is limited to a specific maximum, but in most cases the costs of the second opinion, including X-rays and diagnostic tests, are paid in full. Some plans also pay for a third opinion if the first two opinions disagree. When there are divergent opinions, the final choice is up to the patient, and the plan's regular benefits are usually paid for any resulting surgery. As an incentive to encourage second opinions, some plans actually provide larger benefits for a covered person who has obtained a second opinion, even if it does not agree with the first opinion.

In the last few years, it has become increasingly common for medical expense plans to require mandatory second opinions, which may apply to any elective and nonemergency surgery but frequently apply only to a specified list of procedures. In most cases, a surgeon selected by the insurance company or other provider of benefits must give the second opinion. If conflicting opinions arise, a third opinion may be obtained. The costs of the second and third opinions are paid in full. In contrast to voluntary provisions, mandatory provisions generally specify that benefits are paid at a reduced level if surgery is performed either without a second opinion or contrary to the final opinion.

The trend toward mandatory second opinions has had an interesting result. Because many employers felt money was being saved under their voluntary programs, wouldn't it be logical to save more money by making the program mandatory? Unfortunately, the opposite situation has often been the case: people who voluntarily seek a second opinion are frequently looking for an alternative to surgery, while those who obtain a second opinion only because it is required are more likely to accept surgery as the best alternative. Employers have also found that a second opinion by a surgeon is still likely to call for surgery. As a result, there seems to be a growing feeling that the cost of mandatory second opinions may exceed any decrease in surgical benefits paid. Consequently, some employers have returned to voluntary programs or stopped providing coverage for second opinions altogether.

Exclusions
As with hospital expense coverage and virtually all other types of medical expense coverage, exclusions exist under basic surgical expense contracts for occupational injuries or disease, certain services provided by government agencies, and cosmetic surgery. All surgical expense contracts have an exclusion for certain types of dental surgery. However, the extent of the exclusion varies and care must be taken to properly integrate any dental coverage with other basic coverages. At one extreme, some contracts exclude virtually any procedures associated with the teeth or disease of the surrounding tissue or bone structure. At the other extreme, a more common exclusion eliminates coverage for most dental procedures but does provide surgical benefits if a covered person is hospitalized for the removal of impacted teeth or for surgery of the gums or bone structure surrounding the teeth. It is interesting to note that although benefits for oral surgery may not be paid even if a covered person is hospitalized, the hospital expenses are often covered under hospital expense contracts.

Hospital Expense Benefits

Hospital expense coverage provides benefits for charges incurred in a hospital by a covered person (that is, the employee or his or her dependents) who is an inpatient or, in some circumstances, an outpatient. Every medical expense contract discussed defines what is meant by a hospital. While the actual wording may vary among insurance companies and in some states, the following definition is typical:

The term hospital means (1) an institution that is accredited as a hospital under the hospital accreditation program of the Joint Commission on Accreditation of Healthcare Organizations or (2) any other institution that is legally operated under the supervision of a staff of physicians and with 24-hour-a-day nursing service. In no event should the term hospital include a convalescent nursing home or include any institution or part thereof that (1) is used principally as a convalescent facility, rest facility, nursing facility, or facility for the aged; or (2) furnishes primarily domiciliary or custodial care, including training in the routines of daily living; or (3) is operated primarily as a school.

Inpatient Benefits
Hospital inpatient benefits fall into two categories: coverage for room-and-board charges and coverage for "other charges."

Room and Board. Coverage for room-and-board charges includes the cost of the hospital room, meals, and the services normally provided to all inpatients, including routine nursing care. Separate charges for such items as telephones and televisions are usually not covered. Benefits are normally provided for a specific number of days for each separate hospital confinement, a time period that may vary from 31 days to 365 days. Some contracts provide coverage for an unlimited number of days. For purposes of this time period, as well as for other benefits, most contracts stipulate that successive periods of hospital confinement are treated as a single hospital confinement unless they (1) arise from entirely unrelated causes or (2) are separated by the employee's return to continuous full-time active employment for some specified period of time, such as two weeks. For dependents, this latter requirement is replaced by one specifying that they must completely recover or remain out of the hospital for a certain period of time, such as 3 months.

The amount of the daily room-and-board benefit may be expressed in one of two ways: either a flat-dollar maximum or the cost of semiprivate accommodations. Under the first approach, benefits are provided for actual room-and-board charges up to a maximum daily amount, such as $500.

The majority of hospital expense contracts cover actual room-and-board charges up to the cost of semiprivate accommodations (that is, two-person rooms). The cost of a private room may be covered in full if it is medically necessary, and a few insurance plans provide additional coverage, usually a fixed daily dollar amount, for elective private room occupancy. Many hospital expense contracts include additional room-and-board benefits for confinement in an intensive care unit.

Other Charges. Coverage for "other charges" (often referred to as miscellaneous charges, ancillary charges, or hospital extras) provides benefits for certain services and supplies ordered by a physician during a covered person's hospital confinement, such as drugs, operating room charges, laboratory services, and X-rays. With a few exceptions, only the hospital portion of these charges is covered; any associated charges for such professional services as physicians' fees are not covered. The exceptions often include charges for ambulance services and anesthesia if anethesia is not covered as part of surgical expense benefits.

The amount of the benefit for other charges is usually expressed in one of the following three ways:

1. Full coverage up to a dollar maximum. This approach is most commonly found in contracts when the daily room-and-board benefit is also subject to a dollar limit. In most cases, this maximum is some multiple (often 20) of the daily room-and-board benefit. For example, a contract with a daily room-and-board benefit of $750 might have a $15,000 maximum for other charges.

2. Full coverage up to a dollar maximum (again, often expressed as a multiple of the room-and-board benefit) and partial coverage for a limited amount of additional expenses.

3. Full payment subject only to the duration for which room-and-board benefits are payable.

When coverage for ambulance services is provided, it is common to limit the benefit to a dollar maximum, such as $50 per hospital confinement. A few plans have a mileage limit in lieu of a dollar limit.

Preadmission Certification. As a method of controlling costs, most medical expense plans have adopted utilization review programs. One aspect of these programs, is preadmission certification. Such a program requires that a covered person or his or her physician obtain prior authorization for any nonemergency hospitalization. Authorization usually must also be obtained within 24 to 48 hours of admissions for emergencies.

The initial reviewer, typically a registered nurse, determines whether hospitalization or some type of alternative care is most appropriate and what the appropriate length of stay for the medical condition should be. If the preapproved length of stay is insufficient, the patient's physician must obtain prior approval for any extension.

Most plans reduce benefits if the preadmission certification procedure is not followed. Probably the most common reduction is to pay only 50 percent of the benefit that would otherwise be paid. If a patient enters the hospital after a preadmission certification has been denied, many plans do not pay for any hospital expenses, whereas other plans provide a reduced level of benefits.

Outpatient Benefits
Although hospital expense contracts did not originally cover outpatient expenses, today it is common to find coverage for such expenses arising from the following:

Surgery. The purpose of this benefit is to provide comparable coverage and thus lower hospital utilization when surgical procedures can be performed on an outpatient basis. It should be noted that this benefit covers only hospital charges or charges of outpatient surgical centers (such as the use of operating room facilities), not the surgeon's fee.

Preadmission testing. The first day or two of hospital confinement, particularly for surgical procedures, were historically devoted to necessary diagnostic tests and X-rays. This benefit requires the performance of these procedures on an outpatient basis prior to hospitalization and covers the costs as if the person were an inpatient. For benefits to be paid, these procedures must generally be (1) performed after a hospital confinement for surgery has been scheduled, (2) ordered by the same physician who ordered the hospital confinement, (3) performed in the hospital where the confinement will take place, and (4) accepted by the hospital in lieu of the same tests that would normally be performed during confinement. Benefits are paid even if the preadmission testing leads to a cancellation of the scheduled confinement.

Emergency room treatment. Hospital expense contracts commonly provide coverage for emergency room treatment of accidental injuries within some specified time period (varying from 24 to 72 hours) after an accident. In a few cases, similar benefits are also provided for sudden and serious illnesses. It should be noted that any emergency room charges incurred immediately prior to hospitalization are considered inpatient expenses.

Exclusions
While variations exist among the providers of hospital coverage (some of which result from state legislation), most hospital expense contracts do not usually cover expenses resulting from the following:

- Occupational injury or disease to the extent that benefits are provided by workers' compensation laws or similar legislation.

- Cosmetic surgery, unless such surgery is to correct a condition resulting from an accidental injury incurred while the covered person is insured under the contract or coverage of such surgery is mandated by the Women's Health and Cancer Rights Act.

- Most physical examinations (including diagnostic tests and X-rays), unless such examinations are necessary for the treatment of an injury or illness.

- Convalescent, custodial or rest care.

- Private-duty nursing.

- Services furnished by or on behalf of government agencies, unless there is a requirement for either the patient or the patient's medical expense plan to pay for the services. Under federal law, medical expense plans must generally pay benefits to the government for care in Department of Veterans Affairs (VA) or military hospitals on the same basis as they pay for care received elsewhere. However, if a plan does not pay charges in full because of deductibles, coinsurance, or plan limitations, the patient is not responsible for the balance. The exceptions to the law—meaning that the plan is not responsible for payment—include treatment in VA hospitals for service-connected disabilities and treatment of active-duty members of the armed services in military hospitals.

Mental Illness, Alcoholism, and Drug Addiction. In the absence of state mandates to the contrary, some hospital expense contracts either exclude (or provide limited benefits for) expenses arising from mental illness, alcoholism, and/or drug addiction. Benefit plans that cover more than 50 employees and that have benefit limitations pertaining to mental illness must be in compliance with the Mental Health Parity Act, on major medical coverage.

Maternity. Until the passage of the Pregnancy Discrimination Act, it was not unusual to exclude maternity-related expenses from hospital expense contracts. However, the act requires that benefit plans of employers with 15 or more employees treat pregnancy, childbirth, and related conditions the same as any other illness.

In the absence of state laws to the contrary, pregnancy may be and is sometimes excluded under group insurance contracts written for employers with fewer than 15 employees. If these employers wish to provide such coverage, it can usually be added as an optional benefit. In some cases, pregnancy is treated like any other illness covered under the contract. In other cases, benefits are determined in accordance with a schedule that most commonly provides an all-inclusive benefit for hospital, surgical, and certain other expenses associated with delivery. Regular physician visits and diagnostic tests may or may not be covered. Table below is an example of a maternity schedule.



A variation of this schedule that is often used by Blue Cross—Blue Shield plans provides a surgical benefit (possibly including visits prior to delivery) but covers hospital expenses on a semiprivate room basis.

An expense associated with maternity is the nursery charge for a newborn infant, which in most cases is equal to at least 50 percent of a hospital's normal room-and-board charge. This expense is not part of a maternity benefit, and a few hospital expense contracts do not cover the expense if the infant is healthy (since the contract covers only expenses associated with accidents and illnesses). However, many contracts do cover nursery charges, and a number of states require that they be covered.

Since 1998, group health plans have been subject to the provisions of the Newborns' and Mothers' Health Protection Act. This federal act is very broad and, with one exception, applies to all employers regardless of size and to self-funded plans as well as those written by health insurers and managed care plans. The exception is for plans subject to similar state legislation, which exist in more than half the states. The impetus for such legislation at both the state and federal levels arose over consumer backlash from the practice of an increasing number of HMOs and insurance companies limiting maternity benefits to 24 hours after a normal vaginal birth and 48 hours after a cesarean section. The act affects maternity benefits if they are provided. It does not mandate that such benefits be included in benefit plans. Of course, many employers are subject to other state and federal laws that do mandate maternity benefits.

The act prohibits a group health plan or insurer from restricting hospital benefits to less than 48 hours for both the mother and the newborn following a normal vaginal delivery and 96 hours following a cesarean section. In addition, a plan cannot require that a provider obtain authorization from the plan or insurer for a stay that is within these minimums. While a new mother, in consultation with her physician, might agree to a shorter stay, a plan or insurer cannot offer a monetary or nonmonetary incentive to the mother for this purpose. For example, follow-up visits from a home health nurse cannot be provided to mothers and children who are discharged early unless these visits are also provided to mothers and children who stayed in the hospital for the full period specified in the act. In addition, the plan or insurer cannot limit provider reimbursement because care was provided within the minimum limits or make incentives available to providers to render care inconsistent with the minimum requirements.

If a plan has deductibles or other benefit restrictions, these cannot be greater during the 48- or 96-hour period than those imposed on any preceding portion of the hospital stay prior to the birth.

Effect of Women's Health and Cancer Rights Act. The Women's Health and Cancer Rights Act amended ERISA and applies to group health plans as well as to individual medical expense insurance. Under the provisions of the federal act, any benefit plan or policy that provides medical and surgical benefits for mastectomy must also provide coverage for the following:

- Reconstruction of the breast on which the mastectomy has been performed

- Surgery and reconstruction of the other breast to produce a symmetrical appearance

- Prostheses and physical complications of all stages of mastectomy, including lymphedema

Prior to the act's taking effect, such coverage often was not available because of exclusions, particularly exclusions that applied to cosmetic surgery. Such coverage can be subject to deductibles and coinsurance provisions as long as it is consistent with those provided for other procedures under the plan or policy. Plan participants must be notified of the existence of these benefits on an annual basis.

Deductibles and Coinsurance
It is common for deductibles and coinsurance to apply to major medical expense coverage. In contrast, hospital expenses under basic hospital expense coverage (and benefits under other basic medical expense coverages as well) usually are not subject to deductibles or coinsurance. Rather, any limitations that exist are most likely to be in the form of maximum amounts that will be paid. It should be noted, however, that deductibles and coinsurance are more likely to be used for basic coverages than was once the case.

State Reforms

Often overlooked in the debate over national health insurance is the role of the states in health care reform. Since 1989, almost all states have passed some type of legislation to make medical expense coverage more available and less costly to certain segments of the population. Some of this legislation was passed before the initial national health insurance proposal of the Clinton administration, and it is interesting to note that some of the administration's ideas reflected practices already instituted in some states. Other states continued to pass their own reforms as the debate over national health insurance continued at the national level during most of the first Clinton administration. The potential importance of state actions should not be overlooked. There has been and continues to be considerable support in Congress for having the states, rather than the federal government, take the initiative in health care reform.

State reforms fall into two categories. One category is laws and regulations aimed at uninsured individuals other than employees. The other category is those laws and regulations that constitute what is commonly referred to as small-group reform. It is in these groups of fewer than 25 or 50 employees that the majority of employees without employer-sponsored coverage is found. Most states have passed National Association of Insurance Commissioners (NAIC) model legislation, and a few states have gone even farther with other types of legislation. Unfortunately, the results seem to be somewhat mixed. Some states report modest results, but the national percentage of employees with medical coverage under small-employer plans has remained static. In addition, several insurers no longer choose to write business for small groups because of the limitations imposed by the legislation. While coverage is still more readily available, the legislation does not make it more affordable. Some small employers cannot afford to pay a significant share of the cost for their employees, and the employee share under contributory plans is often in excess of what employees can or are willing to pay.

NAIC Model
The most common approach to state reform has been the adoption of one of the versions of the NAIC Small Employer Health Insurance Availability Model Act. The stated purpose and intent of the model act are "to promote the availability of health insurance to small employers regardless of their health status or claims experience, to prevent abusive rating practices, to require disclosure of rating practices to purchasers, to establish rules regarding renewability of coverage, to establish limitations on the use of preexisting-conditions exclusions, to provide for development of basic and standard health benefit plans to be offered to all small employers, to provide for establishment of a reinsurance program, and to improve the overall fairness and efficiency of the small-group health insurance market." While some provisions of the model act may result in lower costs for certain employers, the main emphasis of the model act is on the availability of coverage, not on the employer's or employees' ability to afford the coverage.

Although the following discussion focuses on the provisions of the NAIC model act, it is important to remember that states often adopt model acts with variations. Some of the more significant variations are described.

Plans Subject to the Act
The model act defines a small employer as one who had 25 or fewer employees working on at least 50 percent of the days during the previous calendar quarter. Several states extend their legislation to employers with as many as 50 employees and/or exclude groups of one or two employees.

The model act applies to most medical expense products provided by insurance companies, HMOs, and prepaid service plans. Certain types of coverage are specifically excluded from the act's provisions: dental insurance, vision insurance, Medicare supplements, long-term care insurance, and disability income insurance. In addition, payroll deduction plans of individual medical expense insurance under which the employer pays no portion of the cost may or may not be subject to a specific state's legislation.

The small-group legislation does not force the providers of medical expense coverage to operate in the small-employer market. However, if a provider of coverage does sell medical expense coverage to small employers, the provisions of the legislation must be followed.

Benefit Provisions
The model act establishes a committee representing providers of medical expense coverage, employers, employees, health care practitioners, and agents to recommend the form and level of coverage to be made available to small employers. The committee must recommend a basic plan and a more comprehensive standard plan and make decisions regarding benefit levels, cost-sharing levels, exclusions, and limitations. In designing the basic plan, the committee can ignore any state mandates for benefits unless the small-group legislation specifically requires them.

Preexisting-conditions provisions are allowed, but with limitations. A medical condition can be treated as preexisting if it was treated (or if a prudent person would have sought treatment) within a specified prior period, which cannot exceed 6 months. Coverage for preexisting conditions cannot be excluded for more than 12 months following the effective date of coverage. Preexisting conditions must be covered as any other medical conditions if a person had benefits for the medical condition under a prior medical expense plan for at least 90 continuous days prior to the effective date of the new coverage.

One unfortunate and probably unintended side effect of the small-group legislation is that the policies that must be made available in many states are very precisely prescribed, making it impossible for insurance companies to use the same policies in multiple states. The expense of designing and refiling policies for many states, coupled with rate controls and the inability to underwrite for medical conditions, has resulted in several insurers leaving the small-group market.

Underwriting
With few exceptions, coverage must be written for all small employers. An insurance company or other provider of medical expense coverage is permitted to have requirements for minimum participation and minimum employer contributions as long as these requirements are the same for all similarly sized groups. These requirements cannot be increased after an employer has been accepted for coverage.

Coverage must be made available to all employees and their dependents. However, persons who did not enroll when initially eligible can be denied coverage for up to 18 months or have coverage excluded for preexisting conditions for up to 18 months.

Rates and Renewability
The model act prescribes a procedure for determining an "index rate" to be charged by each provider of medical expense coverage. Under certain circumstances, such as the use of more than one type of marketing system, the provider can use different rates for different classes of business to reflect substantial differences in expected claims experience or administrative costs. However, the index rate for any class of business cannot be more than 20 percent higher than the index rate for any other class of business.

Although the act allows rate differences among groups because of variations in age, sex, industry, geographic area, family composition, and group size, far fewer refinements are allowed than would be the case without this legislation. Some states have adopted more restrictive legislation and require community rating.

At annual renewals, rates can be changed because of changes in the index rate, changes in the mix of employees, and possibly group experience. In the latter case, the size of the adjustment is limited to a modest amount. The provider of medical expense coverage must renew all policies subject to certain exceptions, such as nonpayment of premium or the failure to meet any minimum participation requirement. The provider may also elect not to renew all policies for small employers in a state. However, proper notification (usually 180 days) must be given to the insurance commissioner and all employers.

Relation to New Federal Legislation
The Health Insurance Portability and Accountability Act (HIPAA) contains provisions that are similar to many provisions of the NAIC model act. State law continues to apply to insured medical expense plans unless it interferes with the new federal legislation. Provisions of the state law supersede the federal legislation if they are more generous toward insured individuals. For example, the maximum allowable length of preexisting-conditions periods may be shorter in some states than under the federal legislation.

Other State Reforms
Other reforms passed by the states include the following:

Tort reform. Several states have passed legislation to control medical malpractice suits. This legislation ranges from limiting recovery for noneconomic loss to mandatory arbitration.

Claim administration reform. A few states now require the use of standardized claim forms, including a uniform system of coding diagnoses and procedures.

The establishment of health insurance purchasing cooperatives (HIPCs). Several states have laws that establish HIPCs, entities that act as brokers between the purchasers and providers of medical expense coverage. They negotiate alternative plans of coverage on the basis of price and quality. Those eligible to use the HIPC, which may vary from all purchasers to small employers only, may elect one of the available plans directly from the HIPC. With some HIPCs, an employer deals directly with the cooperative without using agents or brokers. In one state, however, an employer can purchase coverage through an agent or broker or deal directly with the cooperative and receive a discount equal to the commission that would be paid to an agent or broker. An unexpected result of this arrangement is that almost 70 percent of the employers have elected to use an agent or broker. Clearly, these employers feel that the services agents and brokers provided are worth the extra cost.

SICK-LEAVE PLANS : Eligibility, Benefits

SICK-LEAVE PLANS
Employers use two approaches to provide short-term disability benefits to employees: sick-leave plans and short-term disability income insurance plans. Sick-leave plans, often called salary continuation plans, are uninsured and generally fully replace lost income for a limited period of time, starting on the first day of disability. In contrast, short-term disability income insurance plans usually provide benefits that replace only a portion of an employee's lost income and often contain a waiting period before benefits start, particularly for sickness. While it is impossible to obtain precise statistics, surveys indicate that about half the employees with short-term coverage obtain benefits under sick-leave plans, about one-quarter under insured plans, and about one-quarter under plans that combine the two approaches.

Traditionally, many sick-leave plans were informal, with the availability, amount, and duration of benefits for an employee being at the employer's discretion. Although some plans used by small firms or for a limited number of executives still operate this way, informal plans are generally inappropriate. There is a possibility that the Internal Revenue Service (IRS) will consider benefit payments to be either a gift or a dividend and therefore not tax deductible by the employer. In addition, an informal plan increases the likelihood of suits brought by persons who do not receive benefits. As a result, the vast majority of sick-leave plans are now formalized and have specific written rules concerning eligibility and benefits.

Eligibility
Almost all sick-leave plans are limited to permanent full-time employees, but benefits may also be provided for permanent part-time employees. Most plans require that an employee satisfy a short probationary period (commonly one to three months) before being eligible for benefits. Sick-leave plans may also be limited to certain classes of employees, such as top management or nonunion employees. The latter is common when the union employees are covered under a collectively bargained, but insured, plan.

Benefits
Most sick-leave plans are designed to provide benefits equal to 100 percent of an employee's regular pay. Some plans, however, provide a reduced level of benefits after an initial period of full pay.

Several approaches are used in determining the duration of benefits. The most traditional approach credits eligible employees with a certain amount of sick leave each year, such as ten days. The majority of plans using this approach allow employees to accumulate unused sick leave up to some maximum amount, which rarely exceeds six months (sometimes specified as 180 days or 26 weeks). A variation of this approach is to credit employees with an amount of sick leave, such as one day, for each month of service. Table 1 is an example of a benefit schedule that uses this variation.


Table 1: Benefit Schedule Based on Months of Service

Another approach, illustrated in Table 2, bases the duration of benefits on an employee's length of service.


Table 2: Benefit Schedule Based on Length of Service

An alternative to this approach provides benefits for a uniform length of time to all employees, except possibly those with short periods of service. However, benefits are reduced to a level less than full pay after some period of time that is related to an employee's length of service. Table 8-3 is an illustration of this increasingly common approach.


Table 3: Benefit Schedule With Varied Coverage Based on Months of Service

In some instances, an employee is not eligible for sick-leave benefits if he or she is eligible for benefits under social insurance plans, such as workers' compensation. However, most sick-leave plans are coordinated with social insurance programs. For example, if an employee is entitled to 100 percent of pay and receives 60 percent of pay as a workers' compensation benefit, the salary sick-leave will pay the remaining 40 percent.

A problem for the employer is how to verify an employee's disability. In general, the employee's word is accepted for disabilities that last a week or less. Most sick-leave plans have a provision that benefits for longer periods will be paid only if the employee is under the care of a physician, who certifies that the employee is unable to work.

CONTRACT PROVISIONS : Beneficiary Designation

Beneficiary Designation
With few exceptions, an insured person has the right to name the beneficiary under his or her group life insurance coverage. The exceptions include dependent life insurance, where the employee is the beneficiary. In addition, the laws and regulations of some states prohibit naming the employer as beneficiary. Unless a beneficiary designation has been made irrevocable, an employee has the right to change the designated beneficiary at any time. While all insurance contracts require that the insurance company be notified of any beneficiary change in writing, the effective date of the change may vary, depending on contract provisions. Some contracts specify that a change will be effective on the date it is received by the insurance company; others make it effective on the date the change was requested by the employee.

Under individual life insurance policies, death benefits are paid to an insured person's estate if no beneficiary has been named or if all beneficiaries have died before the insured. Some group term life insurance contracts contain an identical provision; others stipulate that the death benefits will be paid through a successive beneficiary provision. Under the successive beneficiary provision, the proceeds are paid, at the option of the insurance company, to any one or more of the following survivors of the insured person: spouse, children, parents, brothers and sisters, or executor of the employee's estate. In most cases, insurance companies will pay the proceeds to the person or persons in the first category that includes eligible survivors.

Settlement Options
Group term life insurance contracts covering employees provide that death benefits be payable in a lump sum unless an optional mode of settlement has been selected. Each employee insured under the contract has the right to select and change any available mode of settlement during his or her lifetime. If no optional mode of settlement is in force at the employee's death, the beneficiary generally has the right to elect any of the available options. The most common provision in group term insurance contracts is that the available modes of settlement are those customarily offered by the insurance company at the time the selection is made. The available options are not generally specified in the contract, but information about them is usually given to the group policyholder. In addition, many insurance companies have brochures that describe either all or the most common options available to employees. Any guarantees associated with these options will be those that are in effect when the option is selected.

In addition to a lump-sum option, most insurance companies offer all the following options and possibly other options as well:

- An interest option. The proceeds are left on deposit with the insurance company, and the interest on the proceeds is paid to the beneficiary. The beneficiary can usually withdraw the proceeds at any time.

- An installment option for a fixed period. The proceeds are paid in equal installments for a specified period of time. The amount of any periodic installment is a function of the time period and the amount of the death proceeds.

- An installment option for a fixed amount. The proceeds are paid in equal installments of a specified amount until the proceeds plus any interest earnings are exhausted.

- A life income option. The proceeds are payable in installments during the lifetime of the beneficiary. A choice of guarantee periods is usually available during which a secondary beneficiary or the beneficiary's estate will continue to receive benefits even if the beneficiary dies. The amount of any periodic installment is a function of the age and sex of the beneficiary, the period for which payments are guaranteed, and the amount of the death proceeds.

Premiums
Group insurance contracts stipulate that it is the responsibility of the policyholder to pay all premiums to the insurance company, even if the group insurance plan is contributory. Any required contributions from employees are incorporated into the employer's group insurance plan, but they are not part of the insurance contract and therefore do not constitute an obligation to the insurance company by the employees. Rather, these contributions represent an obligation to the employer by the employees and are commonly paid by payroll deduction. Subject to certain limitations, any employee contributions are determined by the employer or as a result of labor negotiations. Most states require that the employer pay at least a portion of the premium for group term life insurance (but not for other group insurance coverage), and a few states impose limitations on the amounts that may be paid by any employee.

Premiums are payable in advance to the insurance company or any authorized agent for the time period specified in the contract. In most cases, premiums are payable monthly but may be paid less frequently. The rates used to determine the premium for any policyholder are guaranteed for a certain length of time, usually one year. The periodic premium is determined by applying these rates to the amount of life insurance in force. Consequently, the premium actually payable will change each month as the total amount of life insurance in force under the group insurance plan varies. A detailed explanation of premium computations is contained in the discussion on group insurance rate making.

Group insurance contracts state that any dividends or experience refunds are payable to the policyholder in cash or may be used at the policyholder's option to reduce any premium due. To the extent that these exceed the policyholder's share of the premium, they must be used for the employees' benefit. This is usually accomplished by reducing employee contributions or increasing benefits.

Claims
The provision concerning death claims under group life insurance policies is very simple. It states that the amount of insurance under the contract is payable when the insurance company receives written proof of death. No time period is specified in which a claim must be filed. However, most companies require that the policyholder and the beneficiary complete a brief form before a claim is processed.

Assignment
For many years, the owners of individual life insurance policies have been able to transfer any or all of their rights under the insurance contract to another party. Such assignments have been commonly used to avoid federal estate taxation by removing the proceeds of an insurance contract from the insured's estate at death. Historically, assignments have not been permitted under group life insurance contracts, often because of state laws and regulations prohibiting them. In recent years, most states have eliminated such prohibitions; consequently, many insurance companies have modified their contracts to permit assignments, or they will waive the prohibition upon request. Essentially, an assignment is valid as long as it is permitted by and conforms with state law and the group insurance contract. Insurance companies generally require any assignment to be in writing and to be filed with the company.

Grace Period
Group life insurance contracts allow for a grace period (almost always 31 days) during which a policyholder may pay any overdue premium without interest. If the premium is not paid, the contract will lapse at the end of the grace period unless the policyholder has notified the insurance company that an earlier termination should take place. Even if the policy is allowed to lapse or is terminated during the grace period, the policyholder is legally liable for the payment of any premium due during the portion of the grace period when the contract was still in force.

Entire Contract
The entire-contract clause states that the insurance policy, the policyholder's application that is attached to the policy, and any individual (unattached) applications of any insured persons constitute the entire insurance contract. All statements made in these applications are considered to be representations rather than warranties, and no other statements made by the policyholder or by any insureds can be used by the insurance company as the basis for contesting coverage. When compared with the application for individual life insurance, the policyholder's application that is attached to a group insurance contract may be relatively short. Often, most of the information needed by the insurance company is contained in a preliminary application that is not part of the insurance contract. When a group insurance contract is delivered to the policyowner, it is common practice to have the policyholder sign a final "acceptance application," which in effect states that the coverage as applied for has been delivered. Consequently, a greater burden is placed on the insurance company to verify the statements made by the policyholder in the preliminary application.

The entire-contract clause also stipulates that no agent has any authority to waive or amend any provisions of the insurance contract and that a waiver of or amendment to the contract is valid only if certain specified corporate officers of the insurance company have signed it.

Incontestability
Like individual life insurance contracts, group insurance contracts contain an incontestability provision. Except for the nonpayment of premiums, the validity of the contract cannot be contested after it has been in force for a specified period, generally either one or two years. During this time, the insurance company can contest the contract on the basis of policyholder statements in the application attached to the contract that are considered to be material misrepresentations. Statements made by any insured person can be used as the basis for denying claims during this period only if such statements relate to the individual's insurability. In addition, the statements must have been made in a written application signed by the individual, and a copy of the application must have been furnished to either the individual or his or her beneficiary. It should be pointed out that the incontestability clause does not concern most covered persons because evidence of insurability is not usually required and, thus, no statements about individual insurability tend to be made.

Misstatement of Age
If the age of any person covered under a group term life insurance policy is misstated, the benefit payable is the amount that is specified under the benefit schedule. However, the premium is adjusted to reflect the true age of the individual. This is in contrast to individual life insurance contracts, where benefits are adjusted to the amount that the premium paid would have purchased at the true age of the individual. Under a group insurance contract, the responsibility for paying any additional premium or the right to receive a refund belongs to the policyholder and not to the individual employee whose age is misstated, even if the plan is contributory. If the misstated age has affected the employee's contribution, this is a matter to be resolved between the employer and the employee.

WORKERS' COMPENSATION LAWS : Benefits, Disability Income, Death Benefits

Benefits
Workers' compensation laws typically provide four types of benefits:

- Medical care

- Disability income

- Death benefits

- Rehabilitative services

Medical Care
Benefits for medical expenses are usually provided without any limitations on time or amount. In addition, they are not subject to a waiting period.

Disability Income
For an employee to collect disability income benefits under workers' compensation laws, his or her injuries must result in one of the following four categories of disability:

Temporary total. The employee cannot perform any of the duties of his or her regular job. However, full recovery is expected. Most workers' compensation claims involve this type of disability.

Permanent total. The employee will never be able to perform any of the duties of his or her regular job or any other job. Several states also list in their laws certain disabilities (such as loss of both eyes or both arms) that result in an employee's automatically being considered permanently and totally disabled even though future employment might be possible.

Temporary partial. The employee can perform only some of the duties of his or her regular job but is neither totally nor permanently disabled. For example, an employee with a sprained back might be able to work part-time.

Permanent partial. The employee has a permanent injury, such as the loss of an eye, but may be able to perform his or her regular job or may be retrained for another job.

Most workers' compensation laws have a waiting period for disability income benefits that varies from two to seven days. However, benefits are frequently paid retroactively to the date of the injury if an employee is disabled for a specified period of time or is confined to a hospital.

Disability income benefits under workers' compensation laws are a function of an employee's average weekly wage over some time period, commonly the 13 weeks immediately preceding the disability. For total disabilities, benefits are a percentage (usually 66⅔ percent) of the employee's average weekly wage, subject to maximum and minimum amounts that vary substantially by state. Benefits for temporary total disabilities continue until an employee returns to work; benefits for permanent total disabilities usually continue for life but have a limited duration (such as ten years) in a few states.

Benefits for partial disabilities are calculated as a percentage of the difference between the employee's wages before and after the disability. In most states, the duration of these benefits is subject to a statutory maximum. Several states also provide lump-sum payments to employees whose permanent partial disabilities involve the loss (or loss of use) of an eye, an arm, or other body member. These benefits, which are determined by a schedule in the law, may be in lieu of or in addition to periodic disability income benefits.

Death Benefits
Most workers' compensation laws provide two types of death benefits:

- Burial allowances

- Cash income payments to survivors

Burial allowances are a flat amount in each state and vary from $300 to $5,000 with benefits of $1,000 and $1,500 being common.

Cash income payments to survivors, like disability income benefits, are a function of the worker's average wage prior to the injury resulting in death. Benefits are usually paid only to a surviving spouse and children under age 18. In some states, benefits are paid until the spouse dies or remarries and all children have reached age 18. In other states, benefits are paid for a maximum time, such as ten years, or until a maximum dollar amount has been paid, such as $50,000.

Rehabilitation Benefits
All states have provisions in their workers' compensation laws for rehabilitative services for disabled workers. Benefits are included for medical rehabilitation as well as for vocational rehabilitation, including training, counseling, and job placement.

A difficulty faced in providing vocational rehabilitation is that employers are reluctant to hire workers with permanent physical impairments because a subsequent work-related injury may result in their total disability and thus an increased workers' compensation premium. For example, a worker who lost an arm in a previous work-related accident would probably be totally and permanently disabled if the other arm was lost in a later accident. Consequently, most states have established second-injury funds. If a worker is disabled by a second injury, the employer is responsible only for providing benefits equal to those that would have been provided to a worker who had not suffered the first injury. Any remaining benefits are provided by the second-injury fund.

TEMPORARY DISABILITY LAWS : Eligibility & Benefits

TEMPORARY DISABILITY LAWS
At their inception, state unemployment insurance programs were usually designed to cover only unemployed persons who were both willing and able to work. Benefits were denied to anyone who was unable to work for any reason, including disability. Some states amended their unemployment insurance laws to provide coverage to the unemployed who subsequently became disabled. However, five states—California, Hawaii, New Jersey, New York, and Rhode Island—and Puerto Rico went one step farther by enacting temporary disability laws under which employees can collect disability income benefits regardless of whether their disability begins while they are employed or unemployed. While variations exist among the states, these laws (often referred to as nonoccupational disability laws because benefits are not provided for disabilities covered under workers' compensation laws) are generally patterned after the state unemployment insurance law and provide similar benefits.

In the six jurisdictions with temporary disability laws, most employers are required to provide coverage for their employees. In most jurisdictions, except Rhode Island, which has a monopolistic state fund, coverage may be obtained from either a competitive state fund or private insurance companies. Self-insurance is also generally permitted. Private coverage must provide at least the benefits prescribed under the law, but it may be more comprehensive. Depending on the jurisdiction, the cost of an employer's program may be borne entirely by employee contributions, entirely by employer contributions or by contributions from both parties.

Eligibility
Before an employee is eligible for benefits under a temporary disability law, the employee must satisfy (1) an earnings or employment requirement, (2) the definition of disability, and (3) a waiting period.

Earnings or Employment Requirement
Every jurisdiction requires that an employee must have worked for a specified time and/or have received a minimum amount of wages within some specific period prior to disability to qualify for benefits.

Definition of Disability
Most laws define disability as the inability of the worker to perform his or her regular or customary work because of a nonoccupational injury or illness including maternity. As with workers' compensation laws, certain types of disabilities are not covered. In most jurisdictions, these include disabilities caused by self-inflicted injuries or by illegal acts.

Waiting Period
The usual waiting period for benefits is seven days. However, in some jurisdictions the waiting period is waived if the employee is hospitalized.

Benefits
Benefits are a percentage, usually ranging from 50 percent to 66⅔ percent, of the employee's average weekly wage for some period prior to disability, subject to maximum and minimum amounts. Benefits are generally paid for at least 26 weeks if the employee remains disabled that long.

UNEMPLOYMENT INSURANCE : Benefits, Problems and Issues

Benefits
The majority of states pay regular unemployment insurance benefits for a maximum of 26 weeks; the remaining states pay benefits for slightly longer periods. In most states, the amount of the weekly benefit is equal to a specified fraction of a worker's average wages for the calendar quarter of the base period during which the highest wages were earned. The typical fraction is 1/26, which yields a benefit equal to 50 percent of average weekly earnings for that quarter. Other states determine benefits as a percentage of average weekly wages or annual wages during the base period. Some states also modify their benefit formulas to provide relatively higher benefits (as a percentage of past earnings) to lower-paid workers. Benefits in all states are subject to minimum and maximum amounts. Minimum weekly benefits typically fall within the range of $20 to $75, maximum benefits in the range of $200 to $375, and the average benefit in the range of $150 to $225. In addition, a few states currently provide additional benefits if there are dependents who receive regular support from the worker.

States also provide reduced benefits for partial unemployment. Such a condition occurs if a worker is employed less than full-time and has a weekly income less than his or her weekly benefit amount for total unemployment.

Since 1970, there has been a permanent federal-state program of extended unemployment benefits for workers whose regular benefits are exhausted during periods of high unemployment. The availability of these benefits is automatically triggered by a state's unemployment rate exceeding a specifed level. The benefits are financed equally by the federal government and the states involved, and they can be paid for up to 13 weeks, as long as the total of regular and extended benefits does not exceed 39 weeks. This program is operable when the insured unemployment rate in a state exceeds a specified level. The insured unemployment rate is the percentage of workers covered by unemployment insurance who are receiving regular benefits. Benefits can also be triggered if a state's total unemployment rate exceeds specified criteria. In this case, an additional 20 weeks of benefits can be paid.

In periods of severe unemployment, the federal government often enacts legislation to provide additional benefits that are financed with federal revenue. The last such program expired in 1994.

Problems and Issues
The current system of unemployment insurance has become increasingly subject to criticism, especially regarding the level of benefits. At current levels, the majority of employees would receive benefits that are less than half of their former wages. Because of maximum limits on the amounts of benefits, higher-income employees would receive proportionately smaller benefits than lower-paid employees.

In addition to the level of benefits, the percentage of persons receiving benefits at any point in time has dropped over the last two decades. Typically, fewer than 40 percent of the unemployed are receiving benefits. Some persons have benefits denied because of more stringent rules, particularly those dealing with initial benefit disqualification. Other persons exhaust the benefits that are available. Of course, there are those who argue that without disqualifications and limits on benefits, there would be little incentive for many of the unemployed to seek work.

Few employers provide any type of supplemental unemployment benefits. The plans that do exist are in highly unionized industries and result from collective bargaining.

There seems to be a feeling among economists that unemployment insurance programs today are less effective in dealing with unemployment issues than they were in the past. In theory, unemployment compensation insurance should be a counterbalance against recessions. In practice this is often not the case, perhaps because of the low percentage of persons receiving benefits. In addition, the degree of experience rating has declined over time, reducing the incentive for employers to retain employees in bad times rather than laying them off. It also has shifted an increasing burden for financing the program to employers in industries with stable employment.