59

sponding to the survey in 1994; 25 percent of the employers con-
tributed to health and medical plans for retirees. The other cat-
egories that we studied, dental and vision care, in 1994, 46 percent
and 38 percent maintained such plans, at least partially at em-
ployer cost.

During 1994, employers expended an amount equal to 9.7 per-
cent of their direct payroll in providing medical and health care.
That disregards sick pay and short term disability that are some-
times counted as medical expenses. That’s slightly down from 1993,
primarily due to the fact that employees are bearing a slightly
higher proportion of the expense, not because there has been a de-
crease in medical expense costs.

The next most frequent employee benefit feature is life insurance
to protect employees and dependents from the risk that the em-
ployee may die without leaving sufficient resources. In that sense,
life insurance is actually death insurance.

During 1994, 87 percent of all employers responding to the sur-
vey maintained life insurance at employer cost, but the burden of
maintaining that life insurance was relatively slight, in that em-
ployers only expended about .4 percent of payroll for providing that
protection.

Now, that slightly underreports the expense, because, since
ERISA was passed, employers are mandated to provide some death
benefit protection through their pension plans—defined benefit
pension plans, and that isn’t reported in that figure.

The next most frequent type of plan is disability plans, protecting
employees and employees’ dependents from the risk that the em-
ployee may be so severely sick or hurt as to be unable to work for
either a short or a long period of time. Short-term disability of this
type is reported under two categories in the survey, either as sick
pay, which you would ordinarily think of as the pay for relatively
short periods of time while ill, and formal short-term disability
plans.

The other category of disability, of course, is long-term disability.
During 1994, 57 percent of employers reported that they were pro-
viding long-term disability coverage. Thirty-seven percent reported
that they were providing short-term disability coverage under a for-
mal STD or short-term disability policy, and 71 percent reported
that they were providing disability protection in the form of sick
pay.

The cost of those programs for all three of those categories of dis-
ability coverage in 1994 was 1.9 percent of payroll.

In 1994, 56 percent of employers contributed to section 401(k)
salary reduction plans; 36 percent reported that they were contrib-
uting to defined benefit pension plans; 27 percent reported that
they were contributing to profit-sharing plans; and 7 percent re-
ported that they were contributing to employee stock ownership
plans.

During 1994, employers expended 7.2 percent of their direct pay-
roll in providing retirement benefits. That’s slightly up from 1993.
Severance pay has been studied separately in this survey only re-
cently, within the last few years, and it basically is less than 1 per-
cent of pay at this point.


128

have not been practically eliminated receive differentials
ranging from four percent to 100 percent depending on the
severity of the hazard. These are in conformance with the
commonly accepted private sector practice.

Another area of compensation that could be compared between
the private and federal sectors is the way in which pay and
benefit levels are established. Under the National Labor
Relations Act, wages and fringe benefits are mandatory subjects
of collective bargaining between a private sector employer and a
union that holds exclusive recognition. In the federal sector,
the right to bargain over compensation is denied to virtually all
employees.! Almost 60% of the eligible federal workforce are
represented by labor unions, compared to just ten percent in the
private sector. AFGE believes that collective bargaining over
compensation would serve the interests of the government as an
employer, the federal employees and the taxpaying public.

Federal employees’ pay should stop being the political
football it has become over the years. Compensation levels are
set according to some arbitrary figures that have nothing to do
with market rates or the need for government to be able to
attract and retain qualified workers. Federal managers should be
trusted to negotiate fair and responsible contracts with unions

that meet these interests.

‘some employees of nonappropriated fund activities, and some
craft and trade employees who were exempted from the provisions
of PL 92-392 are permitted to negotiate over some aspects of
compensation.

20


25

+ Defined contribution plans are also easier to communicate, particularly to younger
employees, because they are able to see their benefits accumulate in an account while
‘working rather than being told they will receive a monthly income on retirement.

+ Some employers choose to integrate pension benefits with Social Security in order to spend

an equal amount, as a percentage of pay, on retirement benefits for all employees. Employers
are able to integrate benefits with Social Security more effectively through defined benefit
plans because the integration can be done by adjusting benefit formulas.

+ Employers may have a philosophy about who should bear investment return and inflation
risks. In a defined benefit plan, employers generally absorb the investment retum risk by
providing a specific benefit regardless of investment income. in a defined contribution plan,
the employee bears the investment risk.

+ Employers that have uncertain or volatile profits, such as small employers or new
businesses, may prefer a defined contribution plan in order to have flexibility in contribution
to the plan. Profit-sharing plans allow employers to use discretion in making plan
contributions and are only required to contribute on a “substantial and recurring” basis.
Defined benefit plans do not allow for as much flexibility in determining the level of plan
contributions, and their actuarial determination depends on many factors that may be out of
the sponsor's direct control, such as investment performance.

+ Employers may use profit-sharing or company stock plans to improve productivity. Some
401(k) plans are also used to improve productivity by increasing the employer's matching
contribution when profitability improves. These plans provide employees with direct
incentives to increase productivity and identify more strongly with the employer.

Role of Work Force Demographics

+ Acchange in work force patterns affects pension coverage to the extent that different types of
employers are more likely to offer different plan types, and different types of employees
prefer different plans.

‘+ While a smaller percentage of employees in the service sector are covered by defined benefit
plans than are covered by defined contribution plans, the number of participants in both types
of plans increased between 1985 and 1989.

+ While defined benefit plans have remained the primary form of pension coverage for a
growing number of participants in large firms, a decrease in the proportion of workers
‘employed in manufacturing and unionized industries and an increase in the proportion of
workers employed in service industries should increase the role of defined contribution plans
in providing retirement income.


154

By 1994, the Department of Labor was reporting that the
average pay gap between comparable private and federal sector jobs
stood at 27.5 percent. This was despite enactment of the Federal
Employees Pay Comparability Act of 1990 (FEPCA) which mandated a
mix of local and national raises to finally bring federal pay more
into line with that received in the private sector and check the
legitimate and well-founded fears of major recruitment and
retention problems in the federal sector. As we know only too
well, despite enactment of this landmark piece of legislation,
federal employees continue to be compensated well below their

private sector counterparts.

Had the pay law been allowed to function as written, federal
employees would receive a 2.4 percent across the board pay
adjustment in 1996 based on the Employment Cost Index (ECI). In
addition, they would receive an average locality adjustment of 3.5
percent, based on Bureau of Labor Statistics (BLS) surveys of the
differences between private and federal sector pay in 28 localities
around the country. Instead, this Congress has mandated a woefully
inadequate average 2.4 percent increase in federal salaries for the
next fiscal year -- less than half of what is called for in the pay
law, and less even than the rate of inflation which has been pegged

as rising 2.6 percent over the last year.

We constantly ask federal workers to do more with less, and
for less compensation -- we ask for more productivity with fewer

workers, more effort, more supervisory responsibilities, more


149

tant tasks—you also have private employees that are involved in
those same important tasks.

No, I would not advocate, as the first step, for privatization,
privatizing police functions, that kind of thing. That can be done.
That should probably be the last thing that is done. I think that
you should be looking at other functions before that. You should be
looking at functions where there are private sector suppliers imme-
diately available to do that kind of thing.

Mr. Mica. Mr. Sturdivant, you spoke about Xerox, IBM, AT&T,
and the State of California. Maybe you could be more specific in
some of the things they’re doing that we are not doing in the Fed-
eral Government to reward employees as compensation incentives,
somewhere where you would like to see us, where these companies
possibly are.

Mr. STURDIVANT. Well, I think that when I was talking about
some of the larger private sector companies, when we look at
health insurance—and everybody’s under a crunch in health insur-
ance—but, certainly, the CRS compared the Federal Employee
Health Benefits Plan with some of those companies and found that
the Federal Government spent $1,100 less per employee than a pri-
vate sector company of that size.

I think that, probably, if you’re looking at some of the other
things that some of these private sector companies are doing,
they're some of the things that we've talked about to try to move
toward rewarding people for productivity and efficiency.

Where we would be on that whole issue would be to—like dealing
with this whole award system, where you have individual rewards
now—and we would be looking toward some systems similar to,
like, in a Saturn, where, basically, you have group awards. You
have team awards; you build teamwork.

So I think that there are some innovative—I think that there are
some innovative ideas in the private sector that we could look at.
Certainly, having employees more involved, more participative in
determining how the work is done, who does the work, and how do
we move toward productivity and efficiency, I think a lot of that
is going on in the private sector as they fight for market share and
as they fight for profit. I think we can bring a lot of those practices,
and certainly our union has insisted on trying to bring a lot of
those practices to the Federal sector.

On this whole issue of privatization, one of the things—I’m glad
Mr. Cox brought that up. No, that’s right, Mr. Cox was on my side
on that. That’s the only thing he was on my side on, probably.

But you brought up privatization, and we just finished an exten-
sive study on contracting out and privatization. We just finished an
extensive revamping, so to speak, of the AFGE policy on contract-
ing out and privatization. In fact, I think some members of your
staff participated and attended some of those sessions.

We're prepared to take that issue on, if the playing field is level,
if the factor is who can give the taxpayer the best bang for the
buck. If we can get away from this stupid idea of FTE ceilings and
determine who can do the best possible job, who can do it more ef-
fectively, who can do it more efficiently, and start from the same
place, we are prepared to compete.


COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT
WILLIAM F. CLINGER, Jr. Pennsylvania, Chairman

BENJAMIN A. GILMAN, New York CARDISS COLLINS, Illinois
DAN BURTON, Indiana HENRY A. WAXMAN, California
J. DENNIS HASTERT, Illinois TOM LANTOS, California
CONSTANCE A. MORELLA, Maryland ROBERT E. WISE, Jk., West Virginia
CHRISTOPHER SHAYS, Connecticut MAJOR R. OWENS, New York
STEVEN SCHIFF, New Mexico EDOLPHUS TOWNS, New York
ILEANA ROS-LEHTINEN, Florida JOHN M. SPRATT, Jr., South Carolina
WILLIAM H. ZELIFF, Jr, New Hampshire LOUISE McINTOSH SLAUGHTER, New
JOHN M. McHUGH, New York York
STEPHEN HORN, California PAUL E, KANJORSKI, Pennsylvania
JOHN L. MICA, Florida GARY A. CONDIT, California
PETER BLUTE, Massachusetts COLLIN C. PETERSON, Minnesota
‘THOMAS M. DAVIS, Virginia KAREN L. THURMAN, Florida
DAVID M. McINTOSH, Indiana CAROLYN B. MALONEY, New York
JON D. FOX, Pennsylvania THOMAS M. BARRETT, Wisconsin
RANDY TATE, Washington GENE TAYLOR, Mississippi
DICK CHRYSLER, Michigan BARBARA-ROSE COLLINS, Michigan
GIL GUTKNECHT, Minnesota ELEANOR HOLMES NORTON, District of
MARK E. SOUDER, Indiana Columbia
WILLIAM J. MARTINI, New Jersey JAMES P. MORAN, Virginia
JOE SCARBOROUGH, Florida GENE GREEN, Texas
JOHN B. SHADEGG, Arizona CARRIE P. MEEK, Florida
MICHAEL PATRICK FLANAGAN, Illinois CHAKA FATTAH, Pennsylvania
CHARLES F. BASS, New Hampshire BILL BREWSTER, Oklahoma
STEVEN C. LaTOURETTE, Ohio TIM HOLDEN, Pennsylvania
MARSHALL “MARK” SANFORD, South ——_

Carolina BERNARD SANDERS, Vermont
ROBERT L. EHRLICH, Jr., Maryland (Independent)

James L. CLARKE, Staff Director
Kevin Sano, General Counsel
Jupiri McCoy, Chief Clerk

Bup MYERS, Minority Staff Director

SUBCOMMITTEE ON Civil. SERVICE
JOHN L. MICA, Florida, Chairman

CHARLES F. BASS, New Hampshire JAMES P. MORAN, Virginia
BENJAMIN A. GILMAN, New York BERNARD SANDERS, Vermont (Ind.)
DAN BURTON, Indiana ‘TIM HOLDEN, Pennsylvania

CONSTANCE A. MORELLA, Maryland

Ex OFFICIO

WILLIAM F. CLINGER, Jk., Pennsylvania CARDISS COLLINS, Illinois
GrorGE NesTERCZUK, Staff Director
Daniet. R. MOLL, Senior Policy Director
CAROLINE FIEL, Clerk
Cepric HENDRICKS, Minority Professional Staff

ap


19

improvements in the pay setting process. These improvements
include moving federal compensation to reflect local rates of
salaries, widening the comparability process to include state and
local government entities, providing Congress and the Executive
Branch with the anticipated cost of salary increases early in the
budget cycle, and providing agencies additional pay flexibilities
to meet unique recruitment and retention problems.

It is important for those responsible for federal
compensation issues to remember that any method that is used to
arrive at a single comparability number, even in local labor
markets, cannot be expected to apply with precision to every
individual being compared. Any single number is an average of
many differently paid individuals with different skills and
responsibilities. ‘The fact is that according to the 1995 report
of the President’s Pay Agent, the federal non-federal pay
Gisparity still averages 22.58 percent. This varies from a high
of 40 percent in Houston to a low of 17 percent as reflected in
the wage area designated as "Rest of the United States."

The inability to substantially reduce the pay disparity
since the enactment of FEPCA lies in the failure of the Executive
Branch and the President to recommend pay increases in line with
results of the survey process. This is not new. Virtually every
President since Richard Nixon has used his authority to issue
alternative pay plans under a variety of excuses. As a result,
between 1970 and 1994 federal pay had declined in real terms by a

total of 23.0 percent, due in large part to the failure of

16


68

standardized as will claims procedures and claim forms. Employers will continue to
rely on managed care features but will experience little savings compared to
current costs. If health reform produces significant savings, it will only be by a
leveling-off of the rate of growth in costs, and not by an overall reduction in costs.
The most significant changes in health care will come in provider/insurer
realignments which are already underway.

The beneficial impact of health reform will be dramatically influenced by
local factors. In those companies where employer and provider groups become

deeply involved in reform, tremendous benefits should be produced.

b. Flexible Compensation. Cafeteria plans and other flexible compensation
concepts do not fit well in the context of a reformed health system. There is.
considerable question whether they will remain viable in this context. However,
flexible compensation is a concept that is well established and it should survive in
the context of other employer-sponsored welfare benefits.

¢. Continued Innovation in Welfare Benefits. The emphasis on service
workers will produce continued competition for skilled workers. Employers will
continue to develop new welfare plan and other employee benefit/fringe benefit
innovations designed to attract and retain skilled workers. Some of the growth
areas may well be in the long-term care and training of employees so they will be
better able to meet the new demands of our service economy

3. Interdependence of Retirement and Welfare Plans. Employers have finite

resources which must be spread among an array of employee benefit plans and


152

TESTIMONY OF
ROBERT M. TOBIAS
NATIONAL PRESIDENT

Chairman Mica, Members of the Subcommittee, I appreciate this
opportunity to present testimony for your hearing today exploring
the differences and similarities in private and federal sector
compensation and benefit practices. The more than 150,000 federal
employees represented by the National Treasury Employees Union

welcome the opportunity for our views to be heard.

As we know only too well, there are some who seek to rewrite
the "contract" that exists between the federal government and its
employees, not only for those employees who may choose careers in
federal service in the future, but for those who have committed
their lives to public service as well as for those who have already
completed their careers. Indeed, this Committee, as well as others
in the House and Senate have received testimony this year from
witnesses who unfortunately did not feel bound by the facts in

presenting their views on federal compensation practices.

I think it’s imperative to set the record straight on the most
critical compensation issues surrounding federal employment -- pay,
retirement and health benefits. This Union’s goal, and I am sure

your goal as well, is to insure that the federal government


79

Companies have come to realize that they need to align their
strategies and goals, work cultures, and human resource manage-
ment systems in order to obtain maximum return on investment.
The primary method that they have been looking to accomplish
this, in addition to aligning their total remuneration package prop-
erly with their work culture, is to focus more attention on focusing
compensation more on organization, unit, and employee perform-
ance.

For example, organizations are extending incentive pay programs
to larger segments of the total employee population. Perhaps more
importantly, they are implementing new programs which focus
more precisely on the performance they expect of employees by
paying for competencies or quality or for working effectively in
teams.

These newer programs focus on base salary, as well as incentive
plans. It’s important to recognize that such innovative programs,
adopted by prominent organizations in both the public and private
sectors, are met with significant employee acceptance, as a result
of survey data that we have, and do seem to contribute to improved
organizational performance. Where properly implemented, such
programs do work.

Turning to benefits, as we've heard in the first panel, organiza-
tions have been refocusing their benefit programs to meet the
needs of a diverse work force. Our survey data of medium and
large organizations shows that, over the last 10 years, there has
been significant growth in flexible benefits programs and in person-
nel policies oriented toward individual and family needs of employ-
ees.

For example, we’ve seen growth to the point where most
medium- and large-sized U.S. employers provide flexible spending
accounts, and one out of five medium- and large-sized employers
have a full cafeteria plan, and more than one-third of very large
employers have a full cafeteria plan.

In addition, organizations have been orienting their benefits to
the mobile work force. Employers recognize that they have a mobile
work force, and employers in a very competitive market are in-
creasingly becoming aware that they cannot have a cultural ori-
entation where they are generally guaranteed job security. As a re-
sult, they’ve been focusing benefits to the more mobile work force.

key component of that has been the shift from the defined ben-
efit to the defined contribution plan. Mr. Salisbury indicated that
there has been a de-emphasis there, that employers have not been
improving defined benefit plans. In addition, our survey data show
that there has been a drop in the prevalence of defined benefit pen-
sion plans. That is, some employers have chosen to discontinue
them.

It should be noted, however, that particularly among very large
employers, the typical practice of medium- to large-sized employers
is still to have both a defined benefit and a defined contribution
plan.

Another aspect of trying to manage the work force is that we've
seen continuous activity in employers offering early retirement
windows, as the Federal Government has recently done, where em-
ployers provide a financial incentive for employees near retirement


5

STATEMENT OF DALLAS SALISBURY
PRESIDENT, EMPLOYEE BENEFIT RESEARCH INSTITUTE (EBRI)
HEARING BEFORE THE HOUSE COMMITTEE ON GOVERNMENT REFORM AND
OVERSIGHT SUBCOMMITTEE ON CIVIL SERVICE
OCTOBER 31, 1995

Introduction

‘Mr. Chairman, I am pleased to appear before your subcommittee today to discuss the
structuring of compensation and benefit programs in the private sector. My name is Dallas
Salisbury. I am president of the Employee Benefit Research Institute (EBRD), a nonprofit,
nonpartisan public policy research organization based in Washington, DC. ?

EBRI has been committed, since its founding in 1978, to the accurate statistical analysis
of economic security issues. Through our research we strive to contribute to the formulation of
effective and responsible health, welfare, and retirement policies. Consistent with our mission,
we do not lobby or advocate specific policy solutions.

CHARACTERISTICS OF PRIVATE-SECTOR EMPLOYEE BENEFITS

Criteria Used To Establish Employee Compensation and Benefit Programs

+ Employers seek to provide a total compensation package that will be sufficient to attract,
‘motivate, and retain an appropriate work force for the particular functions that need to be
accomplished while allowing the enterprise to operate without losses. Employers make use
of a wide range of surveys to assess what this appropriate package is, and they ultimately
market test the package: does it allow them to attract, motivate, and retain

+ Cash compensation is the base in all cases, with a movement in recent years toward a
growing component of “at risk” or “incentive” compensation. For most of this century,
profit-sharing plans have been a common form of at risk compensation, particularly for small
businesses, Cash is the most important employee benefit, according to worker surveys.

+ Employers also seek to have a healthy work force, with low rates of absenteeism. This has
been the primary motivator in the continued sponsorship of health insurance and disability
income benefits. Family coverage increases the likelihood that employees will remain at
work when a family member has health problems and that health problems will not cause

Mr. Salisbury joined EBRI as its first executive director in 1978. His previous assignments were wit the
Pension Benefit Guaranty Corporation: the Pension and Welfare Benefits Admunistration of the U.S. Department
‘of Labor the Office of the Deputy Attorney General at the U.S. Department of Justice: and the Committee on
Elections and Reapportionment, Washington State House of Representatives

1


128

Statement of
Wendell Cox,
Principal,
Wendell Cox Consultancy

INTRODUCTION

My name is Wendell Cox. I am principal of Wendell Cox Consultancy in Belleville, Illinois
and served for three years as Director of State Legislation and Policy for the American.
Legislative Exchange Council. I am also principal author of the America's Protected Class
series (co-authored with Samuel A. Brunelli). which documents the comparative advantages
of public employment in the United States. Thank you for the opportunity to share our
research and views with you,

In his Jeter of invitation, Chairman Mica asked that [ deal with a number of issues. Most of

my testimony will relate to the first general issue: comparison of public and private sector
compensation and benefits

1 COMPARING PUBLIC AND PRIVATE SECTOR COMPENSATION AND BENEFITS

Market rate compensation can only be determined by the market. Market prices,
including the price of labor, cannot be reliably determined through administrative processes.
Nobel Laureate Frederik Hayek cautioned that the competitive price cannot be known until
there is competition. Indeed, the inability of Soviet planners to reliably establish market
prices — even after 70 years — produced gross economic misallocation that contributed
heavily to the collapse of that economy

Even so, administrative methods for estimating market compensation will be even less
reliable if they fail to account for readily quantifiable elements of value. This is the case of
the federal government. which bases its non-military employee compensation determination
entirely on wages and salaries, and excludes. other significant elements of compensation such
as employer paid benefits and paid time off, and superior job security. (Federal non-military
employees include federal civilian employees and federal government enterprise employees
{primarily US Postal Service employees).)

‘There is more to employee compensation than wages and salaries. The federal Office of
Personnel Management (OPM) has estimated that, on average, federal civilian wages and
salaries are 22.3 percent below that of comparable private employees — this is referred to as
a “pay gap.” But wages and salaries represent less than 75 percent of federal non-military
employee compensation. Moreover, academic studies often find federal pay premiums rather
than a pay gap

‘There is considerable inherent excess value in federal employment. I reviewed our
research before your subcommittee on April 5, 1995. This was published by the American.
Legislative Exchange Council under the title America's Protected Class: The Excess Value of
Public Employment, The research developed an “excess value factor,” which when applied to
assumed level of federal wage and salary comparability would provide a reasonable estimate
of the total compensation value for federal non-military employees compared to that of
comparable private employees.


134

taxation destroys economic growth in the amount of $1.39' — this is referred to as a
“deadweight tax loss” or "excess burden of taxation.” Based upon this finding, the excess
burden of taxation related to excess federal employee benefits would be $25 billion annually.
Based upon overall economic factors, this could translate into a loss of 425,000 private
sector jobs, which would have otherwise been created (and which would have reduced the
unemployment rate by 0.5 percentage points)

3. Tax TREATMENT OF EMPLOYEE BENEFITS

Any time government intervenes in the market, there will be misallocation of resources. It is
for this reason that government intervention should be kept to a minimum. For example,
government intervention in the employee compensation market was a major contributor to
misallocation in health care markets. Health care arose as an employee benefit as employers
and employees sought to increase employee compensation without violating federal wage and
price controls in the 1940s. Many experts believe that the escalation in health care
expenditures is a direct result of separating the responsibility for payment from the health
care recipient. As Nobel Laureate Milton Friedman noted, people are more careful with their
own money than with other people's money. From an economic perspective, it would be best
to treat all employee compensation as taxable income. And, of course, there should be no
difference with respect to the treatment of benefits or taxation of benefits between the public
and private sectors.

FEDERAL Pay DETERMINATION MUST BE REFORMED.

The evidence is overwhelming. Federal non-military employee compensation is above market
rates — it is higher than necessary. The differences in the composition of federal non-miliary
employment relative to private employment are not sufficient to account for the much higher
compensation received by federal employees.

Administrative pay determination mechanisms are inherently flawed. But these flaws do not
justify a federal system that is neither complete in the elements it considers nor credible in
the results that it produces. The federal pay determination systems need to be reformed. The
following principles should be followed.

Wherever possible, employee compensation should be determined directly by the
market. Federal services and programs should be converted to market mechanisms
such as competitive contracting and privatization to the greatest extent feasible.

"Where federal employee compensation is determined administratively, the

Dale W. Jorgerson and Kun-Young Kun. “The Excess Burden of Taxation in
the United States,” Journal of Accounting, Auditing and Finance, September
1990.


74

plans, plans like the defined benefit plan that used to exist, for ex-
ample, at Equitable Life Insurance Society, was at one time auto-
matically indexed for inflation up to 3 percent. That plan, for new
hires of the last 10 years, no longer exists, and the amount of in-
dexation has been decreased.

In terms of broader surveys, there has been data over the years
that about half of private sector plans did indexation equivalent to
about half of cost-of-living increases over time, and those numbers
have decreased, as well. It now appears that only about one-third
of private defined benefit plans are doing any post-retirement in-
dexation, and that is being reduced, as well.

In the private sector, the more general trend now is to say, if you
have a defined benefit plan, it will be, if you will, a frozen benefit.
You will have a 401(k) plan opportunity to aggressively save and
to create an account that essentially will allow you to adjust for in-
flation post-retirement.

Mr. Mica. Well, one of the things that we have to contend with
in government that the private sector doesn’t is that the employee
groups not only work for you, but they also vote for Members of
Congress, and that sort of messes up the equation. Any time you
talk about changing compensation, they all go crazy, and threaten
retribution at the polls, et cetera.

In the private sector, how do they deal with the employee
groups? I guess you don’t have the equation of being voted out of
office. To make any changes here, we have that equation, which I
want you to keep in mind.

Mr. SALisBury. I understand.

Mr. Mica. And then we must deal with employee groups. What
do you recommend as an approach?

Mr. Sa.ispury. I think the approach that private sector entities
that you are concerned about “voting plus productivity,” they are
concerned about continuing productivity. In most private sector en-
tities, when they make these adjustments, they make these adjust-
ments over relatively long periods of time.

For example, take retiree medical benefits. An employer might
well say those who are over the age of 55 will have no change in
their benefit. Those who are between 45 and 55 will move on to a
vesting schedule for retiree medical benefits, so that, instead of get-
ting a full benefit, if you happen to be here at retirement age, you
will accrue a benefit at a rate of, say, 3 percent a year, and only
if you have been here for a full career will you get a full retiree
medical benefit.

And then to say, as many companies have, if you are under the
age of 40, you should expect no retiree medical benefit whatsoever.
In terms of defined benefit plans, the adjustment when a com-
pany—and I attempted to underline, very few large employers in
the private sector have eliminated defined benefit pension plans.
The media has written as if they have. In general, it is false.

What private sector companies that have had traditional and still
have traditional defined benefit pension plans have done is they
have supplemented them, as did the Federal Government in 1984
with defined contribution programs. Then they have ceased to
make the defined benefit plan more generous prospectively, where-


32

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103

gress, and we reached an agreement on pay where we would tie
pay closer to the private sector.

I think the unions made a decision to get away from the one size
fits all, and we recognized that the Federal Government could pay
at a market rate. That’s a system that has not been allowed to op-
erate the way it should have. Otherwise, we would not have the
problems that we have in pay.

As far as civil service retirement is concerned, Mr. Chairman,
you know that you and I have had our disagreements over that
particular system, but the CSRS system is a defined benefit sys-
tem, but the FERS system is a defined contribution system. I
thought we fixed that particular benefit in 1984, when we grand-
fathered the CSRS people into the system and then began having
people come into FERS. So I don’t know where we are on that, as
far as what the problems are.

I would point out that there are some particular different aspects
of setting pay and compensation in larger, more progressive States,
and we do take into account data from the State and local area
when we do our rate surveys. There’s a process that we call collec-
tive bargaining that’s used in a lot of the States, and, of course, we
would be open to having that discussion and maybe pursuing that,
with setting pay and benefits.

I think, one other point I would like to point out on the Federal
employee health benefits program is, the program is not perfect. It
needs to be fixed; it needs to be refined.

I thought that the proposal, basically, this year, that would have
taken OPM out of the business of negotiating and removing its ne-
gotiating power on the basis of Federal employees, was a little
shortsighted, because, obviously, the Federal Government has ne-
gotiating power, and I think it can improve the system.

I think one of the other things that we need to take a look at
when we take a look at the Federal employee health benefits pro-
gram is that 400,000 Federal employees are not in that system,
and the reason why—as a result of some surveys—is that they sim-
ply cannot afford it because of the cost-shifting and because of the
increased cost.

So I look forward to working with you, Mr. Chairman, as we
have dialog on these issues, and I look forward to working with you
to improve the benefits for the members that I represent. Thank
you.

[The prepared statement of Mr. Sturdivant follows:]


39

Table 10
Trends in the Structure of Employee Benefits

Percentage of Employers with Cafeteria Plans Who Ince the Following Types of Benefits
in Program, 1987 and

‘Types of Benefits 19870 1994
Spending Account-Health Care 85% 87%
Spending Account-Dependent Care B 93
Health Plan Choices (Other Than HMOs) 94 n
Death Benefit Choices 46 39
Disability Benefit Choices 34 24
Time Off with Pay (buying/selling) 15 u
Profit Sharing or Savings Allocation (Other Than

Separate 401(k) or Tax-Sheltered Annuity Plans) B 6
‘Other (e.g., Financial Counseling) on a Post-Tax Basis 2 5

Source: Hewitt Astociates, Salaried Employee Benefits Provided by Major U.S, Employers, 1988 and 1994 (Lincolnshire, ino: Hew)
‘Associates, 1988 and 1994).

4 Survey summarizes principal benefit plans of 822 major U.S. employers
Survey summanzes principal benefit plans of 1,035 major US. employers


164

suggested in this proposal is abhorrent and ignores the fact that
400,000 eligible federal workers already decline health insurance
coverage, largely because they cannot afford the premiums. In its
analysis of this proposal, even the nonpartisan CBO pointed out to
Congress that the "downside" of this change is that when premium
rates rise faster than inflation, enrollees will pay an ever

increasing share of the premiums.

Despite these facts, there are those who will continue to come
before this Congress and claim that the FEHB program is overly
generous. It is ironic that I have never heard these critics point
out how federal workers, unlike private sector employees, are
constantly subject to legislated benefit changes such as
prohibitions on abortion coverage and restrictions on family

planning services that are unheard of in the private sector.

In conclusion, Mr. Chairman, the employees represented by NTEU
are devoted to providing services to their community and their
country. They are hard working public servants and they deserve to
be treated with respect. They deserve to be compensated fairly for
their work. The public sector should serve as a yardstick for the
private sector to emulate. There are many valid reasons why the
public sector should lead, not lag behind the private sector. This
Union will continue to use every opportunity to share the facts
concerning federal employee pay and benefits with the Members of
this body and the public. And we will continue to vehemently

oppose proposals which serve to belittle and disparage the federal


64

In relying on 401(k) plans (instead of or as a supplement to defined benefit
plans), employers have utilized a program that relies on employee savings. These
programs have been successful because, to a great extent, employees have been
willing to save toward their retirement through and attractive tax-favored
investment vehicle. However, many employees fail to save, and many other
employees have drawn down their retirement savings prior to retirement because
of job changes or other significant changes in their employment relationship.

Public policymakers have begun to critically examine the current reliance on
401(k) plans and have tentatively concluded that such a reliance - as the primary
retirement vehicle for employees - is undesirable. If this insight is shared by
enough policymakers, it is likely that ERISA and other laws and regulations
applicable to the operation of 401(k) plans will undergo changes to discourage
reliance on these plans. However, 401(k) plans have been so successful that it is
unlikely that such a policy shift will significantly reduce the number of these plans,
or their importance, in the foreseeable future. As with defined benefits pians,
small employers face similar statutory and regulatory obstacles to plan formation
and sponsorship. Unless small employers are provided with incentives to sponsor
such plans for their employees, coverage will continue at abysmally low levels
among small businesses.

cc. Employee Stock Ownership Plans. There has also been some growth in
employee stock ownership plans (ESOPs). These plans tie future retirement

security to the health and well-being of the plan sponsor. ESOPs often play an


148

Mr. Mica. Thank you, Mr. Cox. You’ve livened up an otherwise
rather dull subcommittee hearing, with some pretty startling testi-
mony, I might add.

How do we know that you’re not comparing apples and oranges?
You gave some statistics about private sector versus public sector
benefits and I guess you started out 18.5, 18.6, 1980. What were
you factoring into that to make your comparison? And then, did
you use the same criteria when you got to—was it 1993 that you
used?

Mr. Cox. Yes, sir. What I indicated—this is out of the National
Income and Product Accounts—OK? The 1980 data and the 1993
data are out of that. Now, I would argue that what I indicated, I
didn’t give you the whole story. The whole story is even worse, be-
cause, you see, there is this perception that the white-collar work
force gets a higher benefit load than the non-white-collar work
force. That’s not true.

The fact is, if you look at the data, you'll find in the private mar-
ket that, on a percentage basis, fringe benefits are higher in rela-
tion to total wages than in the white-collar sector, and so, as a
matter of fact, the straight comparison of Federal versus private—
which is what I have given you—actually should have been ad-
justed to reduce the Federal by about a percentage point, which
would make it more of an apples-to-apples comparison. In other
words, the percentage difference is bigger.

Mr. Mica. Your other comparison, which provided a startling
contrast between public and private sector employment is the aver-
age wage. In your $35,000 figure versus $53,000, was your $53,000
all non-Defense positions? And then, what is your basis for com-
parison to reach the $35,000 figure for the private sector?

Mr. Cox. OK. That, again, is Federal nonmilitary employment.
That would include the Federal civilian sector, as well as govern-
ment enterprises, the Post Office.

Mr. Mica. Right. And that would put you at $53,000?

Mr. Cox. Now, that includes, however, wages and employer-paid
benefits. That’s not just the salaries. That’s the salaries plus the
benefits.

Now, I think if you look at the data, it is reasonable to assume
that it would be acceptable for Federal employees to make more
than average. If you look at the data, you could make an adjust-
ment in the range somewhere of 10 to 15 percent, but you're not
going to find anything to be able to justify anything like 53 percent,
or 62 percent, if you adjust for the hours that they actually work.

Mr. Mica. You heard Mr. Sturdivant talk about some of the re-
sponsibilities that our public, Federal sector employees have—for
example, cancer and AIDS research, and I think he said military
research, and Social Security checks on time. He mentioned, as a
fourth category, drugs entering into the country, which would be
law enforcement.

Would you be countering by saying that all three of these func-
tions could be privatized and that, in fact—there could be some
savings by having the private sector perform these functions, as op-
posed to the public sector?

Mr. Cox. Well, first of all, I would argue—and not to, in any way,
take away from Federal employees who are involved in very impor-


35

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67

agencies have shifted their focus from an emphasis on voluntary compliance to an
audit based focus on deterrence. Although there has been a considerable backlash
against this shift, the future is likely to involve greater risks arising from plan

admi

tration than were present during the early years following enactment of
ERISA.

f. Growth in Litigation. There has also been a growing trend toward
litigation concerning employee benefits. In part this is a reflection of the maturing
of the retirement system and the completion of the ERISA statutory and regulatory
scheme over the past 20 years. This also reflects increased access to courts and
increased availability of attorney fee awards. It is likely that this trend will
accelerate with future enforcement litigation.

2. Health and Other Welfare Plans. Since enactment of ERISA, government
officials have emphasized retirement plan rules. The future will be marked by
greater changes in law and regulations affecting employer sponsorship of health
and other welfare benefit plans.

a. Health Reform. The next few years will almost certainly see enactment
of health reform legislation. These changes, along with the pending changes in
Medicare and in employer and health provider behaviors brought about because of
legislative initiatives, will help reshape the provision of health care.

Large employers will likely experience fewer changes in their health plans
than will any other categories of employers. However, all employers will

experience significant changes. Benefits and plan provisions will become more


104

STATEMENT BY
JOHN N. STURDIVANT
NATIONAL PRESIDENT

AMERICAN FEDERATION OF GOVERNMENT EMPLOYEES, AFL-CIO

Mr. Chairman and Members of the Subcommittee: My name is
John Sturdivant, and I am the National President of the American
Federation of Government Employees, AFL-CIO (AFGE). On behalf of
the more than 700,000 federal and District of Columbia employees
our union represents, I thank you for the opportunity to testify
here today on the differences between federal and private sector
compensation.

The question at issue is the adequacy of federal
compensation in the wake of twenty years of cuts, freezes, and
budget-driven "reforms." Historically, the intent has been ‘for
the federal government te provide compensation that is
"comparable" to prevailing practice in the private sector.

But salaries are still as much as 27 percent behind the non-
federal sector. Health benefits continue to be inferior, an@ the
measure of inferiority threatens to grow. Our retirement
systems, the last remaining aspect of compensation which fulfills
the promise of comparability, are under constant attack, having
succumbed this year to cuts worth several billion dollars.

There is a great wealth of information available with which
to assess the relative value of compensation packages in the
federal and private sectors. There are also some non-
quantifiable characteristics of compensation, such as pay-setting
systems themselves, which have so great a bearing upon pay that
they deserve to be included in any definition of compensation. I
refer here to pay-determining factors such as pay-for-knowledge,
pay-progression schemes such as longevity awards, productivity

gainsharing, and job evaluation schemes which seek to reward


126

the compensation of the composition of the work force, that the
Federal work force has a much higher percentage of white collar
employment, and, therefore, we should conclude that it’s justifiable
to pay them higher salaries and higher benefits.

Well, I would suggest some caution with respect to that, because
the fact is that half of the white collar employment in the Federal
service is clerical. In the private sector, clerical workers are paid
less; they are compensated less than average.

I don’t argue that some adjustment should be made for the com-
pensation of the Federal work force. I only argue that it is nowhere
near sufficient to make up for the difference that we see in the
Federal compensation, relative to the private work force.

But my most important message to you today has to do with ben-
efits. Something has happened with respect to Federal employee
benefits in the last 13 years that I’m not sure you’re aware has oc-
curred.

According to National Income and Product Account data, in 1980,
the average private sector employee had fringe benefits above
wages and salaries of 18.5 percent. The average Federal worker—
that is Federal nonmilitary worker—had benefits of 18.6 percent—
that is, employer-paid benefits.

By the year 1993, the private number had risen from 18.5 to
19.8; the Federal number had risen from 18.6 to 35.5. We have had
an escalation in employer benefits in the Federal sector, over the
last 13 years, 13 times that of the private sector.

What that means is that Federal employees, when you count the
tax-free nature of the Federal benefits, have gained $9,000 in an-
nual income relative to their private sector counterparts. What that
says is, if the market had been operating with respect to benefits
in the Federal sector, we would have spent in 1993, as a Federal
Government, $18 billion less on Federal employee compensation
than we did.

As a result of that escalation in Federal benefits, we have seen
the gap between average private and average Federal non-military
pay rise from 32 percent in 1980 to 53 percent in 1993.

in 1993, according to the National Income and Product Account
data, the average Federal employee was paid $53,000 in total
wages and benefits, the average private sector employee, $35,000.
If you adjust that for the excess time off taken by Federal employ-
ees, the gap per hour worked moves to 62 percent. Now, this has
happened, I believe, because we have a flawed system and because,
frankly, nobody is looking very closely at the change in benefits.

I’m running out of time, so I want to just comment on a couple
of other things. What about the effect on the private sector of the
escalation of benefits above market in the Federal sector?

Well, if we take our $18 billion number and we adjust it for the
dead weight tax loss, according to the research done by Dr.
Jorgerson at Harvard, that suggests that, for every excess dollar of
Federal taxation, there is a loss in the private market of $1.40 in
economic growth. That means it has cost us—the GDP—about $25
billion.

Now, if you look at overall economic factors, what you will find
is $25 billion creates about 425,000 private jobs, a very significant
number. A 0.5 reduction in the unemployment rate could have oc-


45

spend an average of 8.5 percent of their payrolls on health care, 6 percent on
pensions, and 0.6 percent on group life insurance. The remainder is generally
comprised of miscellaneous benefits, such as vacation time, accidental death
and/or long term disability insurance, and in some cases education assistance
or profit sharing

However, since the economies of scale favor larger companies, the level

of benefits provided to employees varies between small, medium and large

employers

mpany size (by number of emp lovee:
Percent of Payroll devored to 1-100 100-500 500+
Salaries. 74.1 71.3 68.8
Healch insurance: 5.2 6.5 7.2
Pensions. 2.3 2.9 4.0
Group life insurance 9.2 0.3 0.3
Miscellaneous: 18.1 19.0 7

In most instances, che large companies devote a greater percentage of
their payrolls to che provision of benefits. Therefore, employees of large
companies generally enjoy richer benefits packages. As one moves down the
scale from the large employers to those with small work forces, ic is almost
universally Crue that the level of benefits offered is significantly reduced
The reason is simple: it is more difficult for smaller employers co build
compensation packages which include the spectrum of benefits which larger
companies are able Co negotiate for their work force. In many cases,
prohibitive costs prevent small employers from offering any benefits at all
Non-provision of benefics is also common in specific industry sectors (notably
service industries), regardless of the size of the employer

A wide range of benefits options is available to employers. Since many
companies, and some industry sectors as a whole, tailor cheir benefits
packages specifically for their work force or to compete in their industry

sector, ic is not always easy to compare one set of benefits to another.


87

growth) depends upon recognition of, and the importance of, the competencies of
an employee as well as the performance of the team and program results.
Similarly, benefits levels are lower and more flexible than in the process model.

Retirement plans emphasize profit, portability and short-service; health insurance is
flexible and usually calls for more cost-sharing with the employee; life insurance
levels are minimal, and vacation benefits are low and depend upon position rather
than length of service.

Network cultures, also known as virtual organizations, are designed for maximum

flexibility and mobility. They normally focus on innovation, and the creation and
exploitation of new markets. The roots of virtual organizations can be found in the
entertainment and construction industries, among others. Network organizations
are expressly designed to adapt to constant change. The work is venture-driven,
and varies according to specific role in a particular situation. There are few if any
formal structures, and initiative, creativity and pragmatism are valued
Additionally, influence and value attach to critical competencies, and the ability to
build relationships.

Network organizations set their Total Remuneration so as to enable them to attract
the specialized talent and supporting staff necessary to produce innovative
ventures that meet immediate customers’ needs through the flexible configuration
of various assets. The focus is on the very short term. Network organizations
have limited compensation and benefit structures. Supporting employees are paid
minimum rates, while the critical employees are paid the levels necessary to attract
them to the endeavor. Variable pay is provided to some 20-40% of employees,
and the target payout level is 60% or more of base salary, paid after completion of
the venture. Network organizations have minimal if any retirement programs, very
flexible health care benefits (with high cost sharing), minimal life and disability
insurance, low vacation and only basic holidays off.


STATEMENT OF THE
HONORABLE CONSTANCE A. MORELLA
HEARING ON CIVIL SERVICE REFORM Ill:
PRIVATE SECTOR COMPENSATION PRACTICES
SUBCOMMITTEE ON CIVIL SERVICE
OCTOBER 31, 1995

In anticipation of this hearing being held on Halloween, |
decided to bring my goody bag. Since the Chairman was so
gracious in offering us acorns at an earlier hearing, | figured
today he would have some additional treats.

But in all seriousness, | would like to commend Chairman
Mica for calling this hearing. | have said before, and | will say
‘t again, that these hearings on civil service reform have been
excellent thus far, and | am certain this hearing will also yield
good information.

The issue of federal employee compensation has created
intense debate over the last few months. Members of this
Subcommittee have engaged in these debates, and in some

cases, we have expressed very divergent views. Yet, we all

have approached these debates with passion and compassion.


CIVIL SERVICE REFORM III: PRIVATE SECTOR
COMPENSATION PRACTICES

TUESDAY, OCTOBER 31, 1995

HOUuSE OF REPRESENTATIVES,
SUBCOMMITTEE ON CIVIL SERVICE,
COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT,
Washington, DC.

The subcommittee met, pursuant to notice, at 1:35 p.m., in room
2154, Rayburn House Office Building, Hon. John L. Mica (chair-
man of the subcommittee) presiding.

Present: Representatives Mica, Morella, Moran, and Holden.

Staff present: George Nesterczuk, staff director; Daniel R. Moll,
senior policy director; Caroline Fiel, clerk; Cedric Hendricks, minor-
ity professional staff; and Elisabeth Campbell, minority staff assist-
ant.

Mr. Mica. I would like to call this meeting of the House Civil
Service Subcommittee to order. We have some Members who will
be joining us, but they'll be deprived of my eloquent opening re-
marks. I’m going to start the hearing so we don’t delay our panel-
ists and witnesses.

Today’s hearing is a continuation of this subcommittee’s series of
hearings on topics related to civil service reform. This is the third
of four in the series. Today, we'll examine how the private sector
structures its benefits and compensation packages to meet specific
organizational goals.

Total compensation plays an important role in attracting and mo-
tivating any work force. The compensation issue is an integral part
of overall civil service reform.

We're well aware of the administration's reform, as is evidenced
by the “reinvention of government” agenda and the National Per-
formance Review. We've worked closely with the Vice President on
a number of his reform issues and feel we've received a positive re-
sponse from the administration in looking at all of these issues,
and in particular, compensation.

As we continue to downsize and restructure the Federal Govern-
ment, we must not overlook the needs of our work force. At the
same time, we have a responsibility to our citizens to ensure their
government is more responsive, more accountable, and more effec-
tive.

The key to blending these requirements is to enable government
agencies to recruit, motivate, and more effectively manage their
employees. The manner in which compensation and benefits are
structured has a dramatic effect on the ability of private sector

qd)


150

In fact, we want to compete. We say, bring it on, because, from
what we’ve seen, 90 percent of the work that has been either con-
tracted out or privatized, either Federal employees had to go back
and redo it or it ended up costing the taxpayer more money.

Now, I don’t know what—my executive council is in town, and
I don’t know what policy they're going to recommend that we
adopt. But I will tell you that, if we can come to closure on the
yardstick, and the yardstick being dollars and who can give the
best possible bang for the buck for the taxpayer, notwithstanding
politics, notwithstanding FTE ceiling, we will beat them 90 percent
of the time, and we're prepared to do it.

Mr. Mica. We may be prepared to give you that opportunity. In
the meantime, I will yield to our ranking member, Mr. Moran.

Mr. Moran. Thank you, Mr. Chairman. Yeah, I think we ought
to take John up on that challenge, as well. I think we really ought
to pursue that. In fact, I would start with looking at Federal fire-
fighter pay.

It turns out that when I was mayor 5 years ago, we were paying
our firefighters almost 75 percent more than Federal firefighters
received for the U.S. Government, and we didn’t get one single
complaint.

I’m amazed at how much less Federal firefighters get than mu-
nicipal firefighters, and if you look at qualifications, people that
perform whatever comparable functions there are in the private
sector get paid comparable to municipal firefighters, not Federal
firefighters.

But I want to talk to Mr. Cox here. In your calculation, Mr. Cox,
did you take into consideration the fact that retirement pay for
Federal employees is fully taxed, whereas Social Security is not?

Mr. Cox. We’ve looked at that issue. That would get you about
0.5 percent. It would take our number from 50.8 percent to 50.3
percent. We did not look at that in our original study, but we have
since looked at it.

Mr. Moran. Well, I would like to see that, because it seems to
me it would be considerably more. We’ve been getting into that
issue, obviously, with regard to taxation in the reconciliation bill,
and people that are dependent upon Federal retirement are paying
considerably more, thus have considerably less take-home pay, if
you will, or consumable income, because of the taxable nature.

I think we’re going to run out of time, though, to get into a de-
bate on some of these. One of the other issues, equivalent starting
salaries, you know, I was working on Wall Street. I left, and I went.
to work for the Federal Government. J started at $5,000 a year;
that shows you it was quite a while ago. I was a GS-5.

Mr. SrurDIVANT. Must have had some great COLA’s.

Mr. Moran. No. You know, I did it because I understood that it
was a learning and career track for me at the time, and I under-
stood that there would be later compensation. But when I left the
Federal Government and went into the private sector, I was mak-
ing about $50,000, and, the next month, when I went into the pri-
vate sector, I was making over $100,000 annually.

So my experience doesn’t seem to comport with your analyses.
My personal experiences, whatever assets I brought to the work
force, they were certainly much better compensated in the private


42

Small and mid-size companies are particularly vulnerable to the
negative effects of mandated benefits, because their operating mar-
gins are much tighter and, as previously noted, the economies of
scale favor large companies. In looking to reform the civil service,
we urge the Subcommittee to explore the range of cost-saving bene-
fits now being offered in the private sector.

I thank the committee for the opportunity to testify today and
would be glad to answer any questions at the appropriate time.

(The prepared statement of Ms. Strandjord follows:]


161

optimistic at best. Given the fact that federal pay increases have
not even kept pace with inflation, let alone the rate of wage
increases in the economy, conclusions concerning FERS relative
generosity cannot be factually established. Federal workers will
receive a lower pay raise in 1996 than their private sector
counterparts, they received less in 1995 and there is no reason to

think they will receive more, or even a comparable amount in 1997.

Contrary to popular misconceptions, the average CSRS retiree
is not getting rich off the federal government. The average
retiree will leave the government after 30 years of dedicated
public service with an annual pension of $18,444. Many of the
federal employees represented by this Union will retire with far
less. I submit that this is not a vast sum of money for the federal
government’s highly educated workforce. Nearly 40 percent of
federal civilian workers have at least a Bachelors Degree compared
to an estimated 20 percent of the population at large. Moreover,
unlike private sector pensions, CSRS pensions are in lieu of, not
in addition to Social Security benefits. Most CSRS retirees will

never be eligible for Social Security benefits upon retirement.

In addition, every dollar of federal pensions is taxable while
most Social Security payments remain exempt from federal taxation.
In 1990, the nonpartisan Congressional Budget Office (CBO) reported
that 20 percent of the earned annuities of federal civilian
retirees went to federal income taxes. Thus, in real terms,

because of the tax preference of Social Security benefits, federal


73

Mr. Mica. Thank you for your testimony, each of our witnesses
today. I have a couple of questions for Mr. Salisbury. You men-
tioned in your testimony that some of the State and local govern-
ment compensation trends are differing from the Federal Govern-
ment. Could you elaborate on that?

Mr. SALISBURY. One relates to the area of flexible spending ac-
counts. The Federal Government has not made available child care
or health care flexible spending accounts to its workers, whereas
State and local governments have very commonly made them avail-
able to their workers for flexibility in paying for child care and
health care.

A second change, which is—and that’s a fairly broad-based area,
flexibility in State and local government. The second area is in
terms of retirement plan creation. If we look simply at the District
of Columbia government, individuals going to work for the District
of Columbia government in the regular D.C. civil service, for the
better part of the last decade have no defined benefit pension plan.
They exclusively have a 7 percent employer contribution defined
contribution plan, plus Social Security.

So individuals, for lack of a better example, in the last 10 years,
going to work for the District of Columbia, relative to workers
going to work for the Federal Government of the United States,
have total compensation packages that are, in essence, for an
equally graded individual, worth about 40 percent less as a propor-
tion of cash compensation for a District employee, as compared to
a Federal Government employee.

If one looks at other States, we have a change in the freezing of
the defined benefit pension plan in the State of West Virginia and
a movement toward defined contribution, a movement toward cash
balance defined benefit, the so-called hybrid approach in the State
of Colorado, and studies in a number of other States, looking at
these issues for adjustment in the packages.

They did not make the statement in the testimony and don’t
make the statements here as necessarily saying what they're doing
is necessarily good. I’m simply underling that these types of eval-
uations and changes are not just taking place in the private sector.

Mr. Mica. I think you also stated that the trend is moving away
from cost-of-living adjustments.

Mr. SALISBURY. Automatic cost-of-living adjustments in a pension
form, like are available for Social Security and Federal and mili-
tary workers, at the time we were working with this committee and
others in the early 1980's, one of the bases on which COLA’s had
originally come into the Federal employee programs was because
Federal employees were not covered by Social Security, and if they
did not have Social Security, they would get no cost-of-living ad-
justments.

In the public sector, there was some of that similarity, yet, over
the last several, if you will, decades, as public employees have been
brought into the Social Security system, so they get that portion of
their income indexed, there have not been offsetting adjustments,
in many cases, to reduce indexation in their basic pension plan.

I compare that and contrast that to the private sector, in which
the principal basis for post-retirement benefit increases is, in fact,
what they get from Social Security. The handful of private sector


82

and internal factors, such as changes in the nature and expectations of today’s workforce
Gradually, we have witnessed realization of the need to strategically manage compensation
and benefits programs, and recognition of the importance of properly employing
compensation and benefits programs to help create, support and communicate effective

organization change.

Compensation and benefits are now being viewed as significant investments, rather than
simply as unavoidable costs of doing business, consequently, organizations have begun to

take a strategic perspective toward maximizing their return from these large investments.

Two of the main outcomes of this strategic perspective are:

© realization that compensation and benefits ought to be managed together, within what

we term the overall reward, or Total Remuneration perspective, and

* recognition of the need to develop a properly-tailored compensation and benefits
strategy, consistent with and supportive of the organization’s business and financial
strategies, its work culture, and its human resources management systems. In other
words, organizations have come to recognize the value of developing carefully
designed reward programs that fit their particular circumstances -- an evolution to
more dynamic, people and performance-oriented compensation and benefits strategies

developed within the context of clear organizational strategies and goals.

Total Remuneration

Many organizations have come to recognize that compensation and benefits are
interrelated and that the total employee “reward” program needs to be planned, evaluated,
structured, administered and communicated on an integrated basis, The rationale is that
the organization’s substantial investment in total employee rewards can be managed most

effectively, and generate the greatest return for the organization, if it is managed as a


CIVIL SERVICE REFORM Ill: PRIVATE SECTOR
COMPENSATION PRACTICES

HEARING

BEFORE THE

SUBCOMMITTEE ON
CIVIL SERVICE

OF THE

COMMITTEE ON GOVERNMENT
REFORM AND OVERSIGHT
HOUSE OF REPRESENTATIVES

ONE HUNDRED FOURTH CONGRESS
FIRST SESSION

OCTOBER 31, 1995

Printed for the use of the Committee on Government Reform and Oversight

ee

U.S. GOVERNMENT PRINTING OFFICE
37-465 CC WASHINGTON : 1997

For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington. DC 20402

ISBN 0-16-054235-9
a



108

adjusted annually on the basis of the Consumer Price Index (CPI}
(a voucher approach), would have left federal employees and their
families even farther behind the private sector. In any year
when the rate of growth of premiums exceeded the rate of growth
in the CPI, the government’s share of premium costs would fall
Using rather optimistic assumptions about the rate of growth in
premiums (seven percent annual growth rather than the 10 percent
which has been the historical average over the last two decades)
the Congressional Budget Office (CBO) estimated that in seven
years the government’s average contribution would fall from 72
percent to 55 percent

At first glance it would seem ironic that the proponents of
the voucher proposal chose the CPI as the adjustment factor for
the government's contribution to premiums, when the same
individuals have joined in the recent attack on the index’s
accuracy. An additional irony is that the CPI is a particularly
inappropriate measure of the rate of growth of health care costs

In a recent CBO study (Is the Growth of the CPI_a Biased

Measure of Changes in the Cost of Living?), sources of

overstatement and understatement of inflation were examined. The
CBO found that the health insurance component of the CPI counted

as "

costs of living only the difference between premiums paid by
consumers and benefits paid by insurance companies. In other
words, the CPI measures increases in the cost of administering
health plans and growth in insurance company profits. It does

not measure increases in the costs of purchasing health care


131

Employer Paid Benefits Compared to Wage and Salary Expense
1980 and 1993
40.0%
95.5%
30.0%
26.4%
1980
21.0%
1993 .
a 200%) 195% ummm 18.6%
Y
100% j/ UY
00% Z
Federal Nor-Military
Private State & Local Govt
Source: National Income and Product Accounts

If employer paid benefits for federal non-military employees had reflected the changes in the
market from 1980 to 1993, the taxpayers and consumers of government enterprise services
would have paid $18 billion less in 1993. The above market escalation in employer paid
benefits widened the average federal non-military employee's compensation advantage over
that of the average private employee by $6,400 — $9,000 in tax free equivalent income.

Federal employment is more lucrative than private employment. The result is that average
federal employee compensation increased 22.5 percent from 1980 to 1993, more than 3.5
times the private sector average of 6.1 percent. Federal non-military compensation increased
268.9 percent relative to private employee compensation over the period. The federal
increase is more than double the rate justified by the composition of federal employment.

In 1993, total compensation — wages and paid benefits — were 53 percent more than
average private compensation, an increase from the 1980 differential of 32.2 percent. The
federal non-military compensation advantage over the average private employee increased
from $10,500 in 1980 to $18,200 in 1993. The 1993 differential is approximately four times
the level justified by the federal work force composition.


159

of service and salary.

Furthermore, the BLS in its May 1993 report entitled,

“Employee Benefits in Medium and Large Private Establishments
states that common eligibility requirements for a normal, or
unreduced, private pension are: age 65 with no specified length of
service, age 62 with 10 years of service, and 30 years of service
at'any age -- the same practice followed in the federal retirement
programs. Most private sector workers retire at age 62. According
to the Office of Personnel Management, the average federal worker
leaves government service at 61.5 years of age. As is common
private sector practice, retirement from federal service is also

possible at age 55, but only after 30 years of service.

BLS also points out that one area where federal and private
pensions differ sharply is in the area of employee contributions.
While federal workers participating in the CSRS contribute at least
seven percent of their salaries toward their future retirement
benefit, 97 percent of private sector pension programs require no
employee contribution. Despite this fact and the goal stated by so
many federal pension reformers that they seek only to bring the
federal system more into line with private sector practice, this
Congress has just voted to increase federal employee contributions
toward their future retirement benefits. This is not a move that is
at all consistent with a desire for uniformity with private sector
pension plans. It is, in fact, based on little more than a desire

to extract additional savings from the federal pension programs in




109

services; these are calculated separately. Thus the CPI was
found to significantly underestimate increases in the cost of
obtaining actual health care through the private insurance
system.

In another study of this issue, the Bureau of Labor
Statistics (BLS) used an experimental index with a different
definition of health care costs: it showed that changes in
insurance premiums increased 5.6 percent faster than the existing
health insurance component of the CPI for the years between 1977
and 1983. The failings of the CPI to measure health care costs
for individuals is difficult to translate into an estimate of the
entire CPI. But the Economic Policy Institute ("Revising the
Consumer Price Index: Correcting Bias, or Biased Corrections?"),
estimates that if the CPI measured actual health care
expenditures for the insured population instead of administrative
costs and insurance company profits, the CPI would be increased
by anywhere from 0.06 percent to 0.22 percent annually.

The BLS has also contended that the CPI understates
inflation for the elderly because of the greater weight of
housing and medical care costs in their budgets. when the CPI
weights are adjusted to reflect the spending patterns of the
elderly, the index rises 0.3 percent faster each year because
health care costs rise more rapidly than the overall CPI, and
because these costs constitute a higher than average portion of

expenditures for this population


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89

Use of Innovative Compensation Programs

Type of Plan

‘Special One-time “Spot” Awards
(aher-the-fact)

Suggestion/Proposal Programs
(eashicash equivalent)
‘Group Incentives

Profi-sharing (non-retirement)
Pay for Competencies
Special Key Contributor

Programs (before-the-fact)
Pay for Quality

‘Team-based Pay

10% 30% 40% ——«40%
Percent of Organizations Indicating.
‘Soarce: Hay Compensation Conference Survey

o%

As can be seen from the chart, after-the-fact spot awards are most prevalent; and while
not noted as strong motivators, such programs can certainly be an appropriate option

under the right circumstances

Process model-related incentives, keyed to quality/employee participation/employee
empowerment (i.¢., suggestion/proposal programs) are becoming more prevalent. Also,
group incentives are becoming more frequent, while profit-sharing unrelated to retirement

is becoming less frequent.

A variety of much more ambitious and complex plans fall near the bottom of the chart in
terms of usage, including pay for competencies, pay for quality, pay for team performance.
But more and more companies are considering implementing such programs, because they

can be tailored to reinforce very specific company strategies and values, and alter


Organization Strategy

This refers to the organization’s business and financial goals, including its competitive and
financial strategies as well as a clear statement of mission for the organization overall, and
sub-elements where appropriate. Better-performing organizations have clear mission,
strategy and goal statements which are effectively communicated to employees and which
Jay out clear road maps for where they are headed, and how they intend to get there
These strategies determine the appropriate work cultures, which in tum drive optimal

Total Remuneration strategies
Work Culture and Total Remuneration Strategy

Work culture defines how people within organizations interact with each other, interface
with customers and suppliers, and do their jobs. Work culture is demonstrated by
organizational values and individual behaviors (e.g., competencies) and perceptions. We
have identified four distinct work culture models that are characteristic of most
organizations today, While complex and evolving organizations are often characterized by
fluid combinations, or intersections of these models, the models themselves serve to
highlight the importance of properly matching integrated reward systems -- Total
Remuneration systems -- to work culture. The four work cultures, and the implications

for integrated compensation and benefits programs are summarized below.

Functional organizations are the most well-known organizations, and probably
still comprise the majority of private and public sector organizations extant today.
Functional organizations emphasize the reliable application of specialized
technologies/processes, and attempt to limit risk. Work in functional organizations
is divided into relatively narrow, specialized positions, and it is organized and
controlled by the use of deep management hierarchies and many rules and
regulations. The individuals who best fit into such organizations value professional
expertise, security, order and stability; and they expect a long-term relationship


12

If one looks at that from an employee perspective, surveys that
we have taken over recent years through the Gallup organization
indicate that if one asks a worker in the public or private sector,
“If you can only have one benefit in addition to cash, what would
it be?” approximately 75 percent always say health insurance bene-
fits. In a survey released this last week by another organization,
that number had risen to 86 percent preferring health insurance.

When asked about a second benefit, in both the private and pub-
lic sector, you end up with about 22 percent saying retirement ben-
efits, with an equal number saying a traditional defined benefit
pension, as compared to those saying a more, if you will, new envi-
ronment-defined contribution program, such as the Federal Em-
ployee Thrift Plan.

Employers also seek to design programs that allow individuals,
as I noted, to retire or to exit from the work force. During the ear-
lier age of paternalism and family owned enterprise in the private
sector, these programs were primarily focused on those who were
still working for an employer at the point of reaching retirement
age.

Prior to the Employee Retirement Income Security Act of 1974,
many enterprises only vested an individual in the pension at the
point that they reached retirement age, and that was the vesting
test.

Since ERISA has been in effect and recent changes that moved
vesting in the private sector to 5 years, we've seen a significant
change in approach and attitude of enterprises as, increasingly,
they are focused on individuals and the accrual of benefits across
the working lifetime and the fact that, with faster vesting, individ-
uals may choose to leave at earlier points in time.

Employer recognition, as well, of economic and business instabil-
ity and boom and bust cycles, has combined with full recognition
of the cost of non-cash employee benefits and recognition of a high-
ly mobile work force to move the employer focus from worker exit
at retirement age to facilitation of worker exit whenever economic
circumstances require—in essence, the process of reengineering, of
right-sizing, of downsizing—and many employers in the private
sector have increasingly found that that is most facilitated by a
benefits structure with a great deal of choice.

Employer programs in the private sector do also vary signifi-
cantly by the size of employers. The very smallest businesses in the
Nation, if they provide any employee benefits other than cash com-
pensation and vacation time, almost always provide, as a first ben-
efit, health insurance, and, as a second benefit, some type of de-
fined contribution retirement program.

As one moves to the largest businesses in our Nation, one most.
readily finds a combination similar to the Federal Government’s—
a relatively generous active worker health program, some approach
to retiree medical benefit provision, a base-defined benefit pension
plan augmented by a defined contribution program similar to the
Federal Employee Retirement System, the thrift plan.

Cost in these companies also varies significantly with variation
by size of the company. As would be anticipated, the smaller the
enterprise, the less is spent on noncash compensation.


54

packages but also whether certain benefits are provided @

law has allowed emplovees co receive tax-free reimbursement

expense, many employers nai lished programs co pay for employee

education, This law expired at Aso resulr, many employers

are now reevaluaring whecher it

benefir. I underszand

recently passed reconciliation package

fb employee

pertanc factor co consider when de:

Tax law is 2 i

benetic packages. In general, because of the complexicy and expense of

nent plans and other cax

sponsoring qualified ret

kely than

ngs. large employers are more

4s part of an emplovee's compensation package

closing. 1 would caution againse the imposition of government

mandated benefits. Mandating benefits fails 20 take into account what effect

che provision of those benefits will Aave on a company’s cost of doing
business. Moreover, they do not recognize that some benefics have greater

Any company

relative importance in some industry sectors than in

uic and retain high-calibre employees will, co che maximum

which wishes to r

excent practicable, offer a benefics package whic
of those employees. Mandated benefits impair the ability co compete in a

global market place. Such impedimencs to competicion force companies ta: cut
other benefits in order co reduce overall costs; down-size tneir operations;

or, in some cases, to close down che business altogecher. Smali and mid-

erable co the negative effects of

sized companies are particularly vu
nandated benefits. because theic operating margins are much Cighter and. as

previously noted, che economies of scale favor large companies. Mandating

henefits will noc serve the long-cerm needs of che American work force


96

reduce their federal income and Social Security taxes on amounts that pay for premium
contributions, unreimbursed health expenses, and dependent care expenses. Another form
generally referred to as a “full” cafeteria or flexible benefits plan provides significant
choices of benefits. These plans are usually in the form of a core of fixed benefits and
“credits” that can be used to purchase benefits from a “menu” of choices. In addition,
some employers have “simple” flex plans without credits but some choices such as choice

of high and low medical plans

The table below shows the growth of flex plans in the last ten years, The “Choice of Fee-
for-Service Plan” category refers to choice of two or more fee for service medical plans
with various levels of benefits such as a high/low option. This does not include the
common situation where companies offer a choice of a fee-for-service and another type of
medical plan such as Preferred Provider Organization (PPO), Point-of-Service (POS), or
Health Maintenance Organization (HMO). The prevalence of flex plans increases with
company size with 36% of firms with over 10,000 employees providing a full flex plan
compared to only 7% in firms with less than 500 employees

Growth of Flexible Benefit Programs
(Percentage of Organizations Providing A Plan)

1985 1987 1989 1991 1993 1995
Flexible — Spending 6% 25% 38% 68% TB3% 76%
Account
Choice of Fee-For- 4% 14% 18% 25% 30% 29%
Service Plan
Full Flex Plan 2% 9% 11% 14% 18% 21%

In addition, many companies have implemented family oriented benefits as shown in the
table below.



75

as, in a prior point in history, they would have gone ahead making
it more generous over time.

So we're seeing adjustments, but some of what I have seen-—the
last time, the Washington Post put this on the front page. The
headline was essentially a headline that implied that the private
sector, en masse, was eliminating defined benefit pension plans,
and that is absolutely false.

Mr. Mica. Just one question and then I want to give my other
colleagues here an opportunity. You state there has been a move-
ment in recent years toward a growing component of at-risk or in-
centive compensation. What are some examples of at-risk or incen-
tive compensation?

Mr. Sauispury. What I’ll refer you to, Mr. Chairman, is the ex-
cellent testimony that has been submitted to you by Hay Associates
that has multiple charts in this area. This is gain-sharing; this is
one-time bonuses; this is team bonuses; this is extensive use of so-
called profit sharing, and there are percentages of the availability
and contemplation of those programs in the testimony from Hay.

Mr. Mica. We'll get to them in the second panel. I don’t want to
take any more time for questions at this point. I'll yield to our
ranking member, Mr. Moran.

Mr. Moran. Thank you, Mr. Chairman, but since my colleague,
Mr. Holden was here before me, would you care if he went first?
at; Mica. I would be glad to yield to Mr. Holden. Go right

ead.

Mr. HOLDEN. Thank you, Mr. Chairman. Mr. Chairman, I often
hear the Federal Employee Health Benefit Plan referred to as the
model program. I have to tell you that, in my prior life, I was a
county sheriff, and I wish I had those health benefits back again,
when I compare that to what I have right now.

Mr. Salisbury, I believe, in your testimony, you stated that Fed-
eral employees’ health benefits, the program is similar to large cor-
porations right now; is that correct?

Mr. SALISBURY. Relative to large corporations—that would be ac-
curate, sir.

Mr. HOLDEN. I know, in my district, we have a huge AT&T pres-
ence and Carpenter Technology, and the Dana Corp., and I do
know that their benefit packages are extraordinary. They’re better
than the Federal employees who work in my district right now.
But, in general, you believe they’re about the same?

Mr. SALISBURY. Of very large corporations and viewing the Fed-
eral Government as a very large employer, there is significant com-
parability, yes.

Mr. HOLDEN. And the CRS recently issued a report stating that
the Federal retirement is no better than the private sector retire-
ment plans. Do you agree with that?

Mr. SALISBURY. I do not, no. We’ve looked at that study and
other analyses and cannot find a basis for that judgment.

Mr. HOLDEN. Any specific areas where you can identify dif-
ferences?

Mr. Sa.ispury. Principally the issue of post-retirement index-
ation, which roughly triples the value of the defined benefit pension
plan and the cost of a pension plan. So, if you assume very low
rates of inflation, you don’t get a significant kick out of it.


36

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48

find wellness programs dei

g offered by smail employers. While che use of

chese programs is co:

exiscs for pursi

ng them in the

absence of other hea Among medium-sized companies, wellness

programs are becot as they enhance che value of the
benefit package ac

The overwhe

been 2 signi

che use of defined con:

scion pension plans
This erend has been particularly prevalent among small and medium-sized

emplovers Having reached 2 peak in the mid-1980s che number of defined

benefit plans being of

ered by small employers has declined steadily over the

decade Converse!y, small employer parcicipacion in defined concribucion

have seen @ sceacy

ncrease over che same period. Among larger

companies, defined benefice pians still constitute

he vasc majoricy of pension

benefits 70 percent). Def

ed benefit plans are increasingly

offered in conjunction with defined contribution plans, wh

a have steadily
increased among large employers as well. mid-sized companies Zall in che

middle, wich a good dea! of variation. To che extent chat defined benefic

plans are still offered by mid-sized companii

hey are most commonly found

among older companies
Despite the rising use of defined contribution plans, it is imporcane to
bear in mind chat many smaller firms do not provide any retirement income

benerics. Although nearly 65 percent of large employers offer pension plans,

that figure drops co approximately 45 percent among mid-sized companies. In

contrast, only about 13 percent of smal! dusiz

fer persion plans ¢
their employees
A second cautionary note with respect to defined concribution plans is

that che concribucion level is often voluntary. Many employees are choosing


117

Department noted that these once-a-decade increases varied in
size from 2-20 percent.

Some private sector practices should be condemned, not
emulated, by the federal government. Failure to protect the
value of earned pensions through regular COLAs (while at the same
time lobbying for the right to withdraw "surpluses" from their
funds for non-pension related purposes) is not an area of private
sector comparability AFGE would like the government to pursue

Any honest analysis of federal retirement benefits must
conclude that they are roughly equivalent to those in large
private sector firms: In some ways they are lower, in some ways
they are higher, but all in all, they are about the same. The
same can be said about CSRS and FERS; they are roughly comparable
to one another. CSRS provides better inflation protection and
lower risk than FERS; FERS provides Social Security and better
portability than CSRS. They both represent deferred income
earned by federal employees through years of work for their
government but paid after retirement. Federal workers value
their retirement systems, as should management, for they serve as
effective tools for recruitment and retention of a high quality,

devoted federal workforce.

edule: Federal wh: liar

The Federal Employees Pay Comparability Act, signed into law
in 1990 by President Bush, (FEPCA) represents the most recent

comprehensive reform of the federal pay setting process. FEPCA

14


53

code, also influence the design and structure of benefits packages

Hany employer provided benefits are not considered income for purposes
of federal and state taxation. The tax consequences to employees and
employers of benefits is a significant factor in the design of employee
benefit packages. For example, contribucions to qualified employee retirement
plans are currently tax deductible to the employer, however, such
contributions are not taxable co the employee until chey are withdrawn or
distributed from che plan. This favorable tax treatmenc makes such plans
appealing boch co employers and employees.

Similarly, the cax deduccibility of ealch insurance premiums is very

Amportant in allowing companies to offer high quality health care coverage to

their employees. For many smaller and mid-sized firms, che ability to offer
comprehensive healch care coverage is one of che essential elements in
competitive benefits programs. Were che provision of health benefits not cax
deductible, you would see a substantial reduction not only in the level of
benefit offered but also in che percentage of che work force covered

The cax law has a significant impact on more chan simply which benefits
are offered in 2 benefics package. Ic also impacts che manner in which
specific employee benefit offerings are designed and operated. For instance,
most tax favored benefits can not be discriminatory. The tax law provides
specific tests in many cases which mise be met in order to demonstrate that
the benefits is nondiscriminatory. The tax law also provides limits on
contributions which can be made to qualified retirement plans and benefits
which can be received from such plans. Retirement plans must be designed co
stay within these limits so that contributions and earnings in the plan will
continue co be tax deferred for participants

In many cases cax policy impacts not only the design of benefits


138

less in wages and salaries than their private counterparts. In contrast, most non-governmental
studies suggest the opposite --- that federal employees ate paid higher wages and salaries
than their private sector counterparts.

The significance of the excess value factor is this: With respect to any assumption of average
differential between the wages and salaries of federal and comparable private sector
employees, there is an additional value of 50.8 percent to federal employment (the excess
value factor is applied to the federal compensation package)

‘A broad statement estimating the average differential between federal and private employee
compensation is not inherently invalid. Indeed, the President's Pay Agent has produced such
an estimate —- that the average federal employee is underpaid by 22.3 percent. The
President's Pay Agent estimate is the result of a "bottom-up" analysis of job descriptions and
wage and salary comparisons (a process that we and others consider seriously flawed). Our
excess value estimate is based upon a "top-down" approach which attempts to estimate the
differences in the value of employee compensation using broad labor market factors. Our
approach, frankly, is superior for two reasons:

The excess value approach attempts to quantify more factors of value and is therefore
more complete.

* A “bottom-up” approach is prone to erroneous results at the “macro” level (because its
accuracy depends upon perfection in analysis of the numerous federal and private
jobs). The results of any “bottom-up” approach must be calibrated against overall
labor market factors (the estimation of which requires a “top-down” approach). One
overall labor market factor suggests that the President's Pay Agent estimate is grossly
inaccurate --- that average employee tenure in the federal sector is considerably longer
than for a comparable private work force composition. If federal employee
compensation were less than that of comparable private employees, average tenure
rates would be considerably less than in the private sector.

‘There is no question but that our approach would require further research for use in federal
compensation determination on a job by job basis. It is likely that only the Federal
government has the financial resources necessary to perform this task, and my October 31
testimony offers recommendations for improving the federal pay determination systems.

The federal and private sectors do not have an equivalent mix of positions, However, the
differing work force composition accounts for little difference with respect to fringe benefits,
paid leave, average annual compensation increase, and average employee tenure. Our
approach is thus valid. This is largely because the higher percentage of "white collar” jobs in
the federal sector includes contains relatively equal distributions of workers who are higher
paid and workers who are lower paid (clerical workers) in the private sector (see below).


49

not to participate in plans even when they are available. The majority of
these appear to be younger employees and chose in lower earnings categories
Therefore, chere is a significant segment of che current work force wichouc
retirement income savings, outside of Social Security.

The other commonly found element of employee benefits programs is group
life insurance. Plans under which both che employer and employee make
contributions comprise the vast majority of che group life insurance plans (88
percent in the case of large employers). In general, employer-paid plans have
less generous benefics chan those with boch employer and employee
contributions. 48 percent of employer-paid and contributory plans offer
benefics of up co five times salary, while 42 percent of employer-paid plans
offer benefits of no more chan one times salary. The level of employee
contribution for empiover-paid and contributory life insurance plans most
often is determined by che participants’ age

Most larger emplovers also offer shorc- and long-term disability, as
well as accidental death and dismemberment coverage. To che extenc this
coverage is offered by smaller employers. it is generally the case that the
employer simply adminiscers the plan and the employee is responsible for the
contributions.

In addition co these craditional benefics, many companies have embraced
the use of other benefits, including alternative vork arrangements and
dependent care. The advantage to these types of benefits is that they are
often far less costly, but are generally considered by employees to be
valuable additions co che overall compensation package

In order to retain valued employees, and overcome potential productivity
losses, an increasing number of companies now include alternative work

arrangements within che benefics framework. Flexible working hours,


78

Mr. Mica. You can see how we get in this fix. Well, I thank you
very much for the perspective you bring to our hearing today. I
may have additional questions to submit to you. We appreciate the
response you've given and, again, hope to work with you as we try
to improve our civil service compensation and total package for
Federal employees, and also meet our responsibility to the tax-
payers. Thank you.

Mr. KELLY. Thank you.

Mr. SALISBURY. Thank you, Mr. Chairman.

Ms. STRANDJORD. Thank you, Mr. Chairman.

Mr. Mica. I will call our second panel. We have a change here.
Since I probably mispronounced his name, he’s not going to show
up. [Laughter.]

With the Hay Group today, we have Michael Carter, instead of
Abe Zwany; John Sturdivant, again, president of the American
Federation of Government Employees; and Wendell Cox, with the
Wendell Cox Consultancy. Welcome, gentlemen. As is customary,
as soon as Mr. Sturdivant makes his way through the crowd, if you
would continue standing, I will go ahead and swear you in.

[Witnesses sworn.]

Mr. Mica. The witnesses answered in the affirmative.

Again, welcome to our subcommittee. We ask, for the newcomers,
that you try to summarize your comments. It will leave more time
for questions, and we will make your entire written statement part
of the record.

With that, we’ll recognize Michael Carter, who’s substituting for
Abe Zwany. You’re also with the Hay Group. We've already heard
a little bit about some of your ideas, and give you this opportunity
to be recognized and elaborate.

STATEMENTS OF MICHAEL F. CARTER, SENIOR VICE PRESI-
DENT, HAY/HUGGINS CO., INC., THE HAY GROUP; JOHN N.
STURDIVANT, NATIONAL PRESIDENT, AMERICAN FEDERA-
TION OF GOVERNMENT EMPLOYEES, AFL-CIO; AND WEN-
DELL COX, PRINCIPAL, WENDELL COX CONSULTANCY

Mr. CarTER. That's correct. Thank you. Mr. Abe Zwany is accom-
panying me, and I assure you he didn’t back out just because you
mispronounced his name.

Thank you, Mr. Chairman. My name is Michael Carter, and I am
here with Abe Zwany. We are both officers of the Hay Group, a
worldwide human resources consulting firm. We appreciate this op-
portunity to give you some quick observations about how the pri-
vate sector structures compensation and benefit programs, and we
ask that the full statement be entered into the record.

Mr. Mica. Without objection, so ordered.

Mr. CARTER. We'll summarize that statement in the next few
minutes. Given intense domestic and international competition, or-
ganizations have realized the need to take a strategic perspective
toward their investments in compensation and benefits and seek to
maximize the return from their investment in total compensation,
sometimes referred to as total remuneration. That is the sum total
of all reward components, which would be base salary, annual in-
centives, long-term incentive benefits, and executive perquisites.


88

In summary, we find that high-performing organizations today clearly define and articulate
their goals and strategies, create work cultures which support those strategies, and
develop Total Remuneration designs which are aligned with and reinforce those work
cultures. As a consequence, compensation and benefits programs today are more
dynamic, people and performance-oriented: pay is becoming ever more closely tied to
carefully-defined and measured performance.

Recent Trends in Compensation and Benefits

Compensation

Program Innovation

The effects of trying to tie pay more closely to performance are most clearly seen in the
prevalence of innovative compensation programs (mostly but by no means exclusively
incentive plans). There is a continuing trend to extend annual cash incentive programs to
more employees -- by extending the breadth of coverage to include more units, and by
extending the depth of coverage to all levels of employees, rather than just managers. But
there is also a great deal of activity in the use of more innovative programs. The
following chart depicts use, and consideration of various compensation programs which
transcend the traditional “‘merit salary increase” approach.


43

STATEMENT BY JEANNINE STRANDJORD
VICE CHAIR

COMMITTEE ON EMPLOYEE BENEFITS

FINANCIAL EXECUTIVES INSTITUTE

Good afternoon, I would like co thank che Chaicman for the opportunity
to tescify on behalf of Financial Executives Institute (FEI) before che
Subcommittee. My name is Jeannine Scrandjord. I am the Vice Chair of FEI’s
Committee on Euployee Benefits and am also the Senior Vice President and
Treasurer of Sprint Corporation. FEI is a professional association of more
than 14,000 senior financial executives of companies ranging from small
businesses to major corporations throughout che United States and Canada. The
Committee on Employee Benefits (CES), one of FEI’s eight technical commitcees,
is che policy-making body for FEI on employee benefit issues. CEB is
comprised of financial executives, from mid-sized co Forcune 50 companies, who
are responsible for the development, implementation and management of pension,
health, welfare and other pre- and post-retirement benefits.

CEB applauds the Subcommictee’s willingness co explore privace sector
experiences in its deliberacions on how best to reform the civil service. as
financial executives, responsible for the corporate bottom line, we are in a
unique position to advise on trends in the benefits arena with a view toward
cost effectiveness

From the outset I would like co note that, as a general rule, the larger
the company, the better the benefits programs tend to be. Smaller companies
offer less comprehensive benefits, with cruly small employers almost
universally not providing any benefits to cheir work force at all. Why?
Simply because the economies of scale favor larger organizations. This is
particularly true in the insurance arena, both for healch and life coverage,
because the risk pools are larger. That said, the general crend in employee
benefits, no macter where an individual is employed, is coward noc only cose
containment but also greater flexibility, to accommodate an increasingly

diverse work force


129

Using a hypothetical case, we estimated the extent to which inherent differences between
private and federal non-military employment impacted the value of total compensation (wages
and employer paid benefits adjusted for hours worked). The elements analyzed included
employer paid benefits; paid holidays, vacation days, and sick days; the federal income tax
free value of the higher employee benefits; larger annual compensation increases; and the
relative value of job security over a 40 year employment career. The resulting excess value
factor was 50.8 percent.

Our excess value estimate is consistent with previous research. A 1982 study estimated the
extent to which federal employee wages and salaries would need to be reduced to achieve
balance between the supply and the demand for federal jobs.’ Applying federal employee
composition-weighted relative compensation increases (1982 to 1991) to this study yields an
excess value factor of 55.0 percent — somewhat above our original estimate of 50.8 percent

Applying the original excess value factor of $0.8 percent, the following can be concluded:?

= If it is assumed that a federal employee's starting salary is 22.3 percent below that of
a comparable private employee (based upon the President's Pay Agent "pay gap"), the
value of the federal employee's compensation would exceed that of the private
employee by $261,000 over a career.

If it is assumed that a federal employee starting salary is equal to that of a comparable
private employee, the value of the federal employee’s compensation would exceed that
of a comparable private employee by $586,000 over a career.

= If it is assumed that a federal employee starting salary is 11 percent above that of a
comparable private employee (Based upon research by Krueger’), the value of the
federal employee's compensation would exceed that of a the private employee by
$777,000 over a career.

Only if it is assumed that a federal employee's starting salary is 33.7 percent or more below

Steven F. Venti, "Wages in the Federal and Private Sectors,” David A. Wise,
editor, Public Sector Payrolls, University of Chicago Press (Chicago, IL:
1987).

The first case uses federal non-military wages and salaries as the equal base for
both sectors. The second and third cases use private wages and salaries as the
base for both sectors.

Alan B. Krueger, “Are Public Sector Workers Paid More than their Altemative
Wage? Evidence from Longitudinal Data and Job Queues,” Richard B. Freeman
and Casey Ichniowski, When Public Sector Workers Unionize (Chicago:
University of Chicago Press: 1988).

2


118

ef a tage inal
Salary for Worker Earning $40,000
Age Years of | Private sector State CSRS
Service retiree retiree retiree
35 10 12.2 to 14.0% 9.6% None
55 30 38.8 to 45.5 35.9 56.25
62 20 45.6 to 48.7 40.5 36.25
62 30 65.1 to 70.3 57.8 56.25
65 20 53.9 to 56.5 48.5 36.25
65 30 74.2 to 77.3 64.5 56.25

ource: General Accounting Office, “Overview of Federal
Retirement Programs," May 1995.

The differences presented here are considerable, but even
these tell only part of the story because they include only
benefits accruing to the individual worker and do not measure
benefits relative to amounts paid into the system by the worker
For example, they exclude differences which derive from
participation in the Social Security system. Social Security
provides a spousal benefit of 50 percent of the primary benefit
and is paid in addition to the primary benefit while both spouses
are alive (unless the spouse is eligible for his/her own larger
primary benefit). Upon the death of the primary beneficiary, the
surviving spouse is paid the primary benefit. As CSRS workers do
not participate in the Social Security system, they are not
eligible for these spousal benefits. In fact, neither CSRS nor
the FERS pension plan provides a spousal benefit while the
retiree is alive, and survivor benefits in both systems are lower

than the amount the retiree received before death.

10


122

part of the country. As of the end of Fiscal Year 1995, the
average pay gap was 6.52 percent, with some wage areas as much as
23.48 percent behind. The system that Congress created in 1972
is sound, and it should be allowed to work as intended. Pay caps
have cost federal craft and trade employees tens of millions of
dollars since 1978. Congress should end the politically
motivated manipulation of the system and allow these workers to
be paid in accordance with the local prevailing rates

As in the private sector, employees are paid an overtime
premium for hours worked in excess of 40 in a week. The Fair
Labor Standards Act covers the federal sector workers and private
sector workers alike. Federal craft and trade employees, unlike
white collar workers, also are eligible for overtime premium pay
for hours worked in excess of eight in a day.

In addition to basic salaries or hourly wages, it is a
common compensation practice to pay employees differentials for
working late shifts or on Sundays or holidays, and for exposure
on the job to certain hazardous conditions. The Federal wage
System provides for the same differentials to be paid to covered
employees, government-wide. Employees receive a seven-and-a-half
percent differential when a majority of their shift occurs
between 3:00 pm and midnight, and a ten percent differential when
a majority of their shift occurs between 11:00 pm and 8:00 am.
Work performed on a non-overtime basis on a Sunday receives a 25%
differential. Work performed on a federal holiday is paid at

double-time. Employees exposed to hazardous conditions which

19


127

curred if the jobs had been created according to the overall rates
in the economy.

In conclusion, there is substantial evidence that Federal employ-
ees are compensated above market. I would suggest three reforms.
The first, we need to use the private market, the competitive mar-
ket, through privatization, competitive contracting, vouchers, wher-
ever possible, so that we can stop arguing about Federal employee
compensation and let the market determine it.

Second, to the extent that we don’t do that—and there will be a
considerable extent that we don’t do that—we need to include in
Federal pay determination systems those elements that are ex-
cluded now, such as excess paid leave, excess benefits, the tax-free
value of the excess benefits, the better increases, and, frankly, the
security.

But, as the Concord Coalition has indicated in a recent report,
job description comparisons, such as the Federal system, are notori-
ously unreliable, since Federal agencies, unlike most private em-
ployers, face strong incentives to inflate them. A better approach
to the entire comparability question, a market test that weighs the
total attractiveness of a job to everyone who might fill it, is to look
at job turnover rates.

would recommend, Mr. Chairman and the members of the com-
mittee, that the Federal system add another element, an element
that would compare its results to turnover rates in the private sec-
tor and manage its work force to achieve market turnover rates
and adjust wages and benefits downward until such point as that
is achieved.

Mr. Chairman, I would suggest that only inside the Beltway does
anybody truly believe that Federal employees are underpaid. In-
deed, if one were to accept the OPM study that suggests that
there’s about a 22 percent wage gap, then one would have to, based
upon the pay per hour at this point, conclude that Federal employ-
ees should be compensated at 210 percent of the private sector av-
erage. I do not believe, Mr. Chairman, that the average taxpayer
believes that.

The Federal Government has a duty to exercise stewardship with
respect to the public’s money to ensure that it is not paying more
than market for anything that it buys. I believe, Mr. Chairman,
that the Federal pay determination systems must be reformed, that
we must eliminate the waste of paying more than necessary. It’s
absolutely necessary for fairness to the taxpayers and for fairness
to future generations that are saddled with the debt that we are
creating for them. Thank you, Mr. Chairman, very much.

[The prepared statement of Mr. Cox follows:]


151

sector than they were in the Federal sector. That obviously doesn’t
appear.

But what I was most concerned about is the GAO study that
identified five assumptions that you made. I’m sure you've read the
study. All five of them do seem to raise some real question as to
the validity of the results. Unfortunately, we’ve got to vote now,
and then we've got a 5-minute vote right after that.

But I think we need to get at that, because if we’re going to be
using figures like this that seem to run in the face of all the other
figures, all the other studies that we’ve had, we need to look at this
and see where the differences are. The GAO says there are some
substantial differences that really undermine the validity of your
numbers.

How much time do we have here, John?

Mr. Mica. Two or 3 minutes.

Mr. Moran. I see Connie—I think Connie wants to raise an
issue, too.

Mrs. MorELLA. I cannot come back. If the gentleman could yield.

Mr. Moran. Go ahead, Connie. I'll yield to you.

Mrs. MORELLA. I just got your report, the GAO report. I look for-
ward to reading it, Mr. Moran, because I would be concerned, also,
Mr. Cox, in terms of how you arrived at the benefits are better, the
salary is better.

Mr. Cox. If I might, before you leave, I have responded to the
GAO report. You'll see our response there. You will see that the
GAO failed to look at our response seriously. We, on point, an-
swered every one of their criticisms and showed that their criti-
cisms were not substantial, that they would make about a 2 per-
centage point difference.

Now, we were talking about a situation where we're estimating
the value over a career of Federal employment equal employee pay,
starting salaries, is about 50 percent of a premium for Federal em-
ployees. I am saying our number would drop to about 48 percent,
based upon the GAO criticism. If it were to drop to 10, it should
be still a matter of great concern.

Mrs. MoRELLA. Incidentally, I’m also a co-sponsor of the Federal
Firefighter Fairness Act, which I think is an excellent example that
you pose on that. Maybe I could submit some questions, in terms
of strategic planning, to Mr. Carter, and Mr. Sturdivant.

Mr. Mica. Yes. Since we have run out of time—they’ve just in-
formed us we're going to have multiple votes—we will adjourn the
hearing at this point. We will submit additional questions, and also
have some informal discussions with all of you as we proceed.

We appreciate your testimony so much, Mr. Carter, Mr.
Sturdivant, and Mr. Cox. You've lightened up and stirred up a Hal-
loween eve, and we'll continue this. In the meantime, this sub-
committee is adjourned.

[Whereupon, at 3:35 p.m., the subcommittee meeting was ad-
journed.]

{Additional information submitted for the hearing record follows:]


155

complex issues to be handled, yet we are not willing to compensate
these hard working public servants for the work they do. If
anything, this Congress has shown that its real interest is in
continuing to take away from the federal employee pay and benefit
package. Ultimately, it is the public who loses when the federal

government is unable to recruit and retain the finest employees.

When FEPCA was adopted by a bipartisan group of House and
Senate legislators and signed into law by President Bush, it was
envisioned that by January, 1996, 40 percent of the gap between
federal and private sector salaries would have been closed. We are
nowhere close to that figure. FEPCA has been unable to remove
politics from the process by which federal employees are paid, yet
despite this, there are those who will come before this Congress
and complain -- ignoring the facts -- that federal workers are

overpaid in relation to their private sector counterparts.

As I just stated, federal workers are slated to receive an
average 2.4 percent pay raise in 1996. A June, 1995 survey of
1,383 companies by the respected Towers and Perrin consulting firm
showed that private company employee raises are at a six year low,
averaging 3.6 percent. This is a six year low for these private
companies. In 1995, federal workers only received an average 2.6
percent pay raise. Once again, private sector workers received

considerably more.

Yet another 1995 survey completed by the consulting firm of


CONTENTS

Hearing held on October 31, 1995
Statement of:

Carter, Michael F., senior vice president, Hay/Huggins Co., Inc., the
Hay Group; John’N. Sturdivant, national president, American Federa-
tion of Government Employees, AFL-CIO; and Wendell Cox, principal,
Wendell Cox Consultancy ...

Salisbury, Dallas, president, Employee Benefit Research Institute; Jean-
nine Strandjord, vice chair, employee benefits, Financial Executives
Institute; Peter Kelly, chairman, qualified plan subcommittee, U.S.
Chamber of Commerce

Letters, statements, etc., submitted for the record by:

Carter, Michael F.; senior vice president, Hay/Huggins Co., Inc., the
Hay Group, prepared statement of ..

Cox, ‘Wendell, principal, Wendell Cox Consultancy, prepared statement

Kelly, Beier, chairman, qualified pian subcommittee, US” Chamber of
Commerce, prepared statement of ... a

Mica, Hon. John L., a Representative in Congress from the State of
Florida, prepared statement of

Morella, Hon. Constance A., a Representative in Congress from the State
of Maryland, prepared statement of

Salisbury, Dallas, president, Employ.
pared statement of

Strandjord, Jeannine,
Institute, prepared statement of ..

Sturdivant, John N., national president,
ment Employees, AFL-CIO, prepared siatement of

(yy

Page
1

718

il

81
128
61

15
43
104


145

APPENDIX: CHARTS

Excess Value of Federal Employment
Equal Pay Assumption

150.8%

Excess Value = 50.8% of federal pay

Excess Value of Federal Employment
President's Pay Agent Assumption (Federal Pay 22.3% Below Private)
160%

40% |
117.2% ZA ra00
120% BB excess value
100%
20%
com
0%:

Excess Value = 50.8% of federal pay



106

average, provided more comprehensive coverage); rather, it
reflected the less generous financing by the government. Since
that time, the CRS has updated its estimates of the variation in
employer-financing between the Federal Employees Health Benefits
Program (FEHBP} and typical large private sector firms and found
that the size of the funding gap has remained the same from 1989
to the present.

The CRS study also offered several detailed comparisons
between the FEHBP and its constituent plans and those offered by
large private sector firms, such as General Electric (GE),
General Motors (GM), IBM, Marriot, Xerox and others, as well as
several public sector employers such as New York City and the
State of California. In this way, CRS was able to compare not
only differences in the level of employer-financing of health
insurance benefits, but differences in the benefit packages as
well.

Some of the unique practices of these other large private
and public sector employers include: tying employee cost-sharing
to salary (GE, Xerox), centralizing claims processing after
formerly contracting with 74 separate carriers for this service
(GM), self-insurance with no premium charges to employees and
deductibles only for highly-paid employees (IBM), paying entire
premium cost for basic coverage for employees and dependents to
assure universal coverage of workforce (NYC}, and flex plans to
pay for health insurance costs out of pre-tax income (California

and others)


66

fiduciaries. Such requirements may only act to deter, even further, small employer
participation in plan sponsorship.

e. Increased Complexity of Plan Provisions and Emphasis on Administrative
Enforcement. Over the past 20 years, retirement plans have been subjected to
almost annual legislation and even more frequent regulatory changes. These
changes have imposed more and more compliance burdens and contributed to an
undesirable complexity of plan design. The primary thrust of such changes has
been an effort to restrict the benefits of highly compensated employees in order to
encourage the delivery of more significant benefits to rank and file employees. As
the benefits of highly compensated employees have been cut back, many
employers have responded by offering highly compensated employees replacement
benefits on a non-qualified basis.

As a result of these changes, the administrative costs and the burdens of
maintaining retirement plans have dramatically increased. There is a serious
question as to whether the legislative and regulatory churning has achieved
anything beneficial. It has clearly had the effect of discouraging plan formation
and overburdening pian sponsors. This is especially true with small employers.
Becuase the administrative costs associated with plan sponsorship are so high.
large sections of the small business community have been effectively eliminated
from retirement plans for their employees. We are hopeful that at least some
reform is enacted during this Congress.

At the same time, the Internal Revenue Service and other regulatory


52

Flexible benefics plans being offered by many small businesses since they
often struggle to offer any benefits

The most common componencs of flexible benefit plans include: health
care coverage (99 percent of all plans); health benefits with che option of
dencal care (92 percent); group life insurance, including dependent life
coverage (86 percent); long-term disability coverage (62 percent); spending
accounts (96 percent); cash opcions (70 percent); vacation trading (26

percent); and 401(k) plans (19 percent). Individual components of flexible

ts plans and the number of op

ions available vary widely from one
company to the next. However, the following considerations generally drive
the process in designing the content of flexible benefits plans

How many options are appropriate?

What should those options look like?

Should employees be required to elect a minimum level of coverage?

Flexible benefits plans are most commonly found in che manufacturing
sector, which accouncs for slightly more than one third of the employers
offering flexible benefits plans; and che financial services sectors, which
provide a further cen percent of the plans. Flexible benefits plans are
significantly less common in che retail and wholesale trades, and in most
service Industries. These plans allow employers to maximize benefit dollars

and provide for a diverse range of employee needs. The value of specific

benefits can also be highlighted co employees--who are now empowered to
determine which benefics best address their parcicular needs

As I noted ac the outsec, maintaining the ability co compete in a global
marketplace is central to a company's design of ics employee benefits package.
In formulating cheir benefits policies, companies do the best to create an

environment which will allow them co attract and recain a high-calibre work

force. However, I should note that government policies, particularly the tax


101

the desired work culture are being developed and implemented, and most of these
programs focus on clearly tying contingent rewards to desired abilities, behaviors and
outcomes. More than ever before, organizations are carefully defining what it is they need
and wish to pay for, from a sound theoretical foundation, and making more and more of
total compensation contingent upon employees’ performing appropriately.

In the area of benefits, employer costs have risen gradually as a percentage of payroll in
the last 10 years in part due to statutory cost increases. Federal employee benefits are
more competitive than private sector benefits. Employers have been revising their benefit
programs to be more dynamic and effective -- more flexible, performance-oriented, family-
oriented, and attractive to and suitable for a more mobile workforce.

Thank you for the opportunity to address the Subcommittee on Civil Service: We will be
happy to address any questions concerning these issues.

21


26

+ Small employers are less likely than large employers to offer pension plans and more likely to
offer primary defined contribution plans if they offer a plan at all because they are faced with
‘economic circumstances that often discourage them from sponsoring plans, particularly
defined benefit plans. Pethaps the most important economic reason that fewer small
‘employers offer plans is the overall lower compensation levels common to small employers.

+ Lower paid employees typically face lower marginal tax rates than higher paid employees and
therefore have less incentive to defer income and taxes. In addition, given competing current
consumption needs, they may be reluctant to defer a substantial portion of their pay, whether
as elective contributions to a 401¢k) plan or as automatic employer contributions to some
other type of plan, Small employers may in tum be ill-equipped to add retirement plan
contributions on top of existing payroll, given tight or uncertain profit margins.

+ Other economic factors inhibit retirement plan sponsorship, particularly sponsorship of
defined benefit plans. Small employers, who pay lower wages, often employ less skilled
‘employees who may be easier to replace. The employees may also be younger or more
loosely attached to the labor force, Small employers would have little incentive to provide
defined benefit plans to encourage a long-lasting employment relationship with unskilled
workers. Moreover, because of gradual benefit accruals, vesting delays, and other plan
design features, shorter-term employees generally tend to benefit less from retirement
programs than do longer-term employees.

+ As work force age demographics change, employers may need to alter their benefit programs
to continue to attract the quantity and quality of workers they desire. According to Census
projections, the proportion of elderly persons in the population will increase in the future as
the baby boom generation ages.

CAFETERIA PLANS

+ Acaleteria plan is a flexible benefit plan that offers an employee certain choices in accordance
with Internal Revenue Code sec. 125. Cafeteria plans (which offer a wide range of benefit
options/choices) must offer a combination of qualified nontaxable benefits (health insurance,
sickness and accident insurance, long-term disability, etc.) and taxable benefits (or cash).
Flexible spending accounts (FSAs) are another type of flexible benefit plan that may exist as.
stand-alone plans or within cafeteria plans. In an FSA, employees set aside money for
qualified unreimbursed medical or dependent care expenses through pretax salary reduction
in separate accounts, Employees choose how much money they want to contribute to an FSA
a the beginning of the plan year, within limits. To the extent that these funds are not used for
expenses incurred during the plan year. they are forfeited.

12


22

+ States have atternpted to expand health insurance coverage and assure a minimum
level of health benefits to the insured population by mandating the benefits that must.
be included in all health insurance policies issued in the state. State mandates do not
extend to employers that self-fund their health insurance plans. The Employee
Retirement Income Security Act of 1974 (ERISA) exempts self-insured plans from
state benefit mandates,

+ There is limited evidence that government mandated benefits that increase the cost of
employing labor result in some form of cost shifting. One study found that several
state and federal mandates that stipulated that childbirth be covered comprehensively
in health insurance plans shifted the cost of those mandated benefits to workers in
the form of lower wages.7 Another study has also suggested that the increased
costs of workers compensation were largely shifted to wages with litte effect on
employment 8

+ The health care delivery and financing system is evolving rapidly. There have been
changes in the way health care is financed, the types of treatments available, the sites
of care. and the physician-patient relationship. These changes have resulted
primarily from reactions to health care cost inflation, and employers’ experiences in
managing health care costs have varied with the methods chosen. We can expect to
observe a continued increase in cost-sharing responsibilities of workers. the
monitoring of care, the movement of workers and their dependents into managed
care arrangements, especially those that offer greater choice of physician, such as
IPAs, PPOs, and POS plans, and the formation of employer coalitions to negotiate
for volume discounts for health care services

Retiree Health Insurance

+ The availability of health insurance for retived individuals is a growing concem of workers
and employers. Ever-increasing health care costs and the Financial Accounting Standards
Boards Statement No. 106° have caused many employers to reexamine their role in

7 Jonathan Gruber, “The Incidence of Mandated Maternity Benefits.” American Economic Review (June 1994)

8 Jonathan Gruber, and Alan B. Keveger. “The Incidence of Mandated Employer Provided Insurance. Lessons from
Workers’ Compensation Insurance.” in David Bradford ed. Tux Potiey and the Economy (Cambridge, MA. MIT
Press, 1991)

9 in December 1990, the Financial Accounting Standards Hoard approved Statement No. 106 (FAS 106). requiring
‘many employers ta record a lability for retiree health benefits on thea balance sheet sa nedar to comply with
‘enerally accepted accrunting standards. beginning with fiscal years atter December 15. 1992

8


105

speed, skill, experience, education, or which seek to address
issues such as pay equity for women and minorities. All of these
factors are widely used throughout the private sector, and
directly affect pay levels for private sector workers

I will restrict my testimony, however, to health insurance,
the retirement systems, and pay because these have been the
targets of the most misinformation, and because these have been
the victims of so many budget cuts. It is necessary to take a
close look at what remains of these programs, and ask: are they
still comparable to private sector practice? Are they still
capable of providing fair compensation for the ever-expanding
workload of an ever-shrinking federal workforce? Have budget -
driven reforms threatened their long-term prospects for

comparability?

Health Insurance .

The most recent comprehensive study comparing the value of
health insurance benefits available to federal employees to those
available to employees of large private sector firms was carried
out by the Congressional Research Service in 1989 ("The Federal
Employees Health Benefits Program: Possible Strategies for
Reform," May, 1989). That study found that the federal
government spent roughly $1,100 less per employee per year on
health insurance than the typical large private sector firm.
This variation was to a very small degree a function of a

difference in the level of coverage (the private sector, on


162

retirees receive less retirement income than private sector

retirees with comparable incomes.

There are several other critical penalties imposed on federal
workers as a result of their having chosen careers in federal
service that are rarely mentioned by those who seek to detract from
federal service. The Government Pension Offset (GPO), for example,
reduces, and often eliminates spousal Social Security benefits to
which a federal retiree might be entitled. Under this offset, two-
thirds of the amount of a federal retirement annuity is used to
offset any Social Security benefit based on a spouse’s work record
that the federal retiree might be expecting. Federal retirees are
denied this benefit simply because they chose careers in federal

service.

Yet another offset, the Windfall Reduction Formula, reduces a
federal retiree’s entitlement to his own Social Security --
benefits that may have been earned through previous or part-time
employment -- if that retiree is entitled to a federal pension not
based on Social Security. Federal retirees with less than an
additional 30 years of Social Security-covered employment often see
their earned Social Security benefit reduced by as much as 50

percent.

Health insurance benefits in the federal sector continue to
represent an area where federal workers receive inferior benefits

compared to average private sector workers. A 1989 study mandated


165

workforce.

Thank you for the opportunity to provide this testimony in
conjunction with your hearing comparing private and public sector
compensation practices. 1 look forward to continuing to work with

you on these issues.

(e)


34

Table 5
Percentage of Surveyed Employers with Utilization Review Programs,
‘Traditional Indemnity Plans,

1989-1994
ype of Program 1989 1990 1991 1992 1993 1994
Precertification of Elective Admissions 73% 81% 81% 83% 79% 80%
Concurrent Review cs 65 65 66 4 65
Catastrophic Case Management 55 65 7 9 8 80
Outpatient Utilization Review 9 20 9 2 36 36
Second Surgical Opinion 89 88 82 7m ot 87
Mandatory 59 35 49 45 40 44
Voluntary? 0 33 3 6 31 4B
None of These 9 7 8 7 10 5

Source A Foster Higgins & Co, Inc, Health Care Benefits Survey (Princeton, NJ. A. Foster Higgins & Co,, Inc,, 1990-
1993)

For specific procedures.
For all procedures

Note: Data for years 1989-1992 represent the full sample from the survey. Data for years 1993-1994 represent
employers with 500 or more employees.


115

matching, and is meant to offer portability and an opportunity to
supplement the retirement income from the other two sources.

FERS also differs from the CSRS in that COLAs are substantially
lower.

CSRS and FERS are both well in the mainstream of private
sector practice in terms of eligibility criteria for retirement
with unreduced benefits. The fact that CSRS allows retirement
with full benefits at age 55 with 30 years of service is cited by
would-be reformers as exceptional. But both the Hay Group and
the BLS employee benefits survey show that approximately half of
plans in medium and large firms allow retirement with unreduced
benefits at age 62 with 10 or fewer years of service. And some
private sector plans do allow long-service employees to retire
with full benefits before age 62. In fact, age 62 is both the
average age for eligibility for full benefits in the private
sector and the average age of retirement in both the federal and
private sectors.

It should also be noted that of employers who use 62 as the

minimum age for retirement, few require 30 years of service.
Thus retirement age provisions must be considered in conjunction
with length of service requirements. Considered in this context,
both FERS (which has a minimum retirement age of 57 with 30 years
of service) and CSRS are well in the mainstream, using BLS survey
data.

Regular inflation-adjustments for CSRS and FERS annuities

have frequently been characterized as "unheard of" outside the

12


136

INTRODUCTION

1am submitting supplemental testimony (Supplement I) with respect to the General
Accounting Office's analysis of America’s Protected Class: The Excess Value of Public
Employment. This issue was briefly discussed in your hearing on October 31, 1995.

On April 5, 1995 I testified before your subcommittee on the research findings of America's
Protected Class: The Excess Value of Public Employment (co-authored by Samuel A. Brunelli
and published by the American Legislative Exchange Council). The research developed an
“excess value factor,” which when applied to assumed level of federal wage and salary
comparability would provide a reasonable estimate of the total compensation value for federal
non-military employees compared to that of comparable private employees. Valuing such
federal advantages as excess paid leave, higher employer paid benefits, the tax free value of
higher fringe benefits, higher annual compensation increases and the value of superior
security, we estimated an inherent excess value to federal employment of 50.8 percent. Thus,
if it is assumed that comparable federal and private employees start with the same salary, the
federal employee can be expected to receive $586,000 more in value than the private
employee over a 40 year career.

In response to my Congressional testimony, Congressman James F. Moran asked the General
Accounting Office (GAO) review our research. GAO has now released its letter and our
response to the GAO's analysis (which we were able to review in draft). GAO dismissed our
response out of hand, despite the fact that we directly refuted the most important points in
the GAO analysis.

‘THE GAO ANALYSIS

‘The GAO analysis includes constructive criticisms. But, in sum, incorporation of the
recommendations would produce little difference from our original estimate that federal
non-military employment has an inherent excess value of 50.8 percent. As indicated in our
GAO published response, a downward adjustment of 2.6 percent would be required.

GAO's analysis in no way diminishes the public policy significance of our research —- that
federal pay determination excludes factors that add considerably to the value of federal
employment. If the excess value were one-half or even one-quarter of the 50.8 percent
estimate, there would still be considerable imperative for reform.

This supplemental testimony provides point by point comments on the GAO report, which
could not be accommodated in the space available for our formal response, In short, much of
the GAO report represents questionable criticism, which will be outlined in this testimony

= GAO's analysis is not balanced in that it considers only factors that would reduce our
excess value estimate. A balanced approach would have required consideration of
factors that would increase the excess value estimate.


58

Mr. Mica. Thank you. I think we’ve got about 10 minutes to vote.
1 would rather not rush you, Mr. Kelly.

Mr. KELLY. Thank you.

Mr. Mica. Why don’t we recess until about 25 after? I should be
back between 25 after and 2:30. We'll recess until that point.

Mr. KELLY. Very good.

[Recess.]

Mr. Mica. I would like to call the subcommittee back to order
and now recognize Mr. Peter Kelly, with the U.S. Chamber of Com-
merce. If you would like to summarize, we would appreciate it.

Mr. KELLY. Yes.

Mr. Mica. Thank you.

Mr. KELLY. Thank you, Mr. Chairman. I’m aware that there are
no unimportant votes that you are involved in nowadays and ap-
preciate the need for the recess.

My name is Peter Kelly. I’m an attorney in Chicago with the law
firm of Murphy, Smith & Polk, and I serve as chairman of the U.S.
Chamber of Commerce’s Qualified Plans Subcommittee and as a
member of its Health and Employee Benefits Committee.

The Chamber has approximately a quarter million business
members, 3,000 State and local Chambers of Commerce, 1,200
trade and professional association members, and 73 American
Chambers of Commerce abroad. Approximately 96 percent of the
Chamber's members are businesses employing less than 100 em-
ployees.

T will not read my statement or the attachment, but will request
that they be submitted for the record.

Mr. Mica. Without objection, so ordered.

Mr. KELLY. We appreciate the opportunity to appear before the
committee to present the information that has been requested. In
that spirit and by agreement with the other members of the panel,
I am going to turn to the issue of numbers and statistics.

1 am basically going to give you an advance look at the Cham-
ber’s 1995 benefits survey. This is a survey that’s sent out to
Chamber members every year since—well, every year since 1986,
I believe, and before that, every other year since 1929. That survey
measures employee benefit expenditures compared to the cash
wages. We measure it a little differently from some of the statistics
you heard a few minutes ago, in that we take 100 percent of direct.
payroll as our basis for measurement of indirect payroll.

Working off of that number, if we look over the past 20 years,
employers have consistently expended an amount in each of those
years on employee benefits which is in excess of one-third of their
direct payroll costs. In 1994, employee benefit payments rep-
resented an amount equal to 40.7 percent of direct payroll costs.
One of the charts attached to the more lengthy piece will show
graphically how this has increased over the years since 1955, when
it was below 20 percent, to the present 40.7 percent figure.

Focusing on particular plans and the purposes they serve, if we
think of major medical, that’s primarily to protect employees from
the financial risks they may incur as a result of expenses for sick-
ness or injury.

Conventional medical and health plans, financed at least in part
by employers, are maintained by 98 percent of the employers re-


112

to compare CSRS and FERS to one another), the federal retirement
systems are considered by experts to be comparable to those of
large private sector firms.

This year both the Congressional Research Service and the
General Accounting Office have studied the federal retirement
systems in order to gauge the impact of various proposed changes
Comparisons to private sector practice were integral parts of
these studies. The most straightforward comparisons use the
bottom line for enrollees: benefits as a percentage of final
salary. In other words, comparisons of the structural aspects of
the different systems provide useful and interesting information,
but from the perspective of employee compensation, what matters
most is how much retirement income the system will provide

There is wide agreement that the best data on this question
has been provided by the Hay Group, which compared benefits as a
percentage of final salary, holding age and length of service
constant In comparing benefits for the CSRS retiree, the Hay
Group found that income replacement for a worker with a $40,000
final annual salary was lower for the CSRS worker than either the
state government or private sector worker, at ages ranging from

55 to 65, and with service ranging from 10 to 30 years.


76

But if you look at periods such as the 1970’s and very high infla-
tion, one way you can cut the numbers, which is to use the civil
service assumption, which is the assumption that you would never
have a point in history where inflation would exceed 5 percent.

If you make that assumption, then it holds down the expected
cost of the plan, but if you used dynamic assumptions and, for ex-
ample, the long-term inflation assumptions of the Social Security
trustees, then you would get higher cost variation in the plan. But
the principal differential is not in the basic benefit formula, it is
in the long-term cost of post-retirement indexation.

I will add, Congressman, that I would love nothing more than to
have a nice defined benefit plan with post-retirement indexation,
myself. [Laughter.]

Mr. HoLpEN. I believe just about every member of the panel
talked about flexibility. In general, have employees been receptive
to flexible benefit plans and so-called cafeteria-style plans?

Mr. SA.isBurRY. I think the surveys clearly indicate a preference
for choice. We've done several years’ worth of surveys through the
Gallup organization, and that is a consistent finding.

Mr. HOLDEN. For those companies that use these types of plans,
do you find their compensation costs to be significantly different
from those companies that do not?

Mr. SALIsBuRY. In the larger enterprises, no; in some of the
smaller enterprises, yes. And that’s principally because, in the larg-
er enterprises that use the full cafeteria plan, they are really not
generally using it overall as a cost control mechanism. They really
are using it as a choice mechanism. As I said, that is a relatively
small population. It’s 13 percent of private sector workers.

Mr. HOLDEN. This might be a premature question, but we all
know that there’s going to be changes to the Medicare and Medic-
aid system. Have you done any research to try to factor in the cost-
shifting that will absolutely have to occur because of the cutbacks
in the Medicare and Medicaid programs and how that would affect
the private sector’s insurance premiums?

Mr. SALISBURY. We've looked at it over time, and the extant re-
search would clearly indicate that, in the absence of significant re-
ductions in the profit margins of managed care organizations—
meaning the cost shift would be to the shareholders of those enti-
ties, rather than to premium payers—in the absence of that type
of squeezing of profit margins, then you would have an inevitable
amount of cost shifting to hospitals, doctors, and to other payers,
meaning to the private sector.

In the historical studies, you show that as potentially adding 1
to 1¥2 percent to private sector medical inflation, but that, as I say,
is old studies. Those are not studies looking at the new proposals.

Mr. HoupeEn. Adding 1 or 1¥2 percent in addition? Thank you.

Mr. Mica. I thank the gentleman and recognize Mr. Moran.

Mr. Moran. I don’t think I need to ask questions of the panel.
Most of it is in their testimony. Thank you.

Mr. Mica. Before we conclude, I had asked a couple of questions
during my questioning time, and I wondered if Ms. Strandjord
wanted to respond, or Mr Kelly, before we dismiss the panel.

Of the questions that I posed, one was related to the differences
between the public sector and private sector, and some of the con-


28

plan choices (other than HMOs) as an option, compared with 94 percent in 1987 (Hewitt
Associates, 1987 and 1994).13

+ There has been a clear increase in the number of employers offering cafeteria benefits (and
FSAs) to their workers. Employees working in medium and large private establishments are
‘more likely than workers in small private establishments to be eligible for cafetena benefits
‘The increase in availability of cafeteria benefits and FSAS is likely to continue. Contributing
to the increase are the changing needs of a work force with large numbers of dual-earner
families. In addition, flexible benefit plans are viewed as a way to help control the rising
costs of health care. where duplicate coverage can be avoided

TAXATION AND THE FEDERAL ROLE IN BENEFIT PROGRAMS

+ Employers have designed their employee benefit programs around government mandated
programs for decades. Pension plans—both defined benefit and defined contnbution—have
been imegrated with Social Security to avoid excessive employer-funded retirement income.
Disability insurance is integrated with Social Secunty disability, and health incurance is being
integrated with workers compensation on an increasing basis as employers seek to manage
total health cost. As government increases the age of benefit elegibility under Social Security
and Medicare, and as it changes actual benefit levels, pnvate programs will be adjusted.

+ Tax treatment has been a driving force in the growth of employee benefit programs. When
Congress has acted to allow a benefit to be provided to the worker, without the dollar value
being treated as taxable income to the worker, employers have responded by putting the
programs into place. The size and profitability of the business, as well as employees’ relative
carings levels, lead to variation in sponsorship, but the responses are clear. Employers with
primarily minimum wage employees ase the least likely to respond to tax preferences and
establish programs,

+The dramatic growth of 401(k) plans. the dramatic growth of health insurance, and flexible
spending accounts, are all recent examples of the effect of new tax incentives. Were tax
incentives eliminated so that all income (cash and in-kind) was taxable to the individual,
dramatic changes in employer provision of employee benefits could be expected

+ The revenue required through taxes to suppor public employee benefit programs has not had
any direct impact on employers in terms of the compensation packages they offer. The actual
employee benefits provided to public-sector employees have created pressure for private
employers to maintain programs in order to compete in the market place for workers. The

H3ptewitt Associates, Salaried Employee Benefits Provided by Major U S. Emplovers. 1988 and 1994
dLincolnshire. I. Hewit Assovistes, 1988 and 1994)

14


94

Employer Benefits Cost Expressed as a Percentage of Payroll

Plan Type Percentage of Payroll (Salary)
Statutory Benefits 8.44%
Health Care Benefits for Active 8.35%
Employees

Health Care Benefits for Retirees 081%
Defined Benefit Pension Plans 2.94%
Capital Accumulation (Defined 3.38%
Contribution Retirement/Savings Plans)

Death Benefits 0.59%
Disability Benefits 0.57%
Other Benefits 0.87%
Total Benefits 25.95%

The cost has gradually increased from 24.55% in 1985 to 25.95% in 1995. During that
time, statutory cost increased 0.73% of payroll from 7.71% to 8.44%. This increase is
about half of the 1.40 percentage point overall difference (25.95% - 24.55% = 1.40%). It
appears that increased statutory costs did mot cause a reactionary reduction in non-

statutory benefits cost levels.

Employer costs vary widely. While the average is a 25.95%, the 10th percentile is
17.13%, the 25th percentile is 21.15%, the 75th percentile is 30.03% and the 90th
percentile for net benefits cost is 35.31%. Thus there is a 42% difference between the low
and high end of the middle half of the companies (25th compared to 75th percentile:
30.03% / 21,15% = 142%).


There will be change. | think all the Members of this
Subcommittee know that you cannot have true civil service
reform without an integrated approach to the redesign of all
human resource management systems, including the
compensation system. But, the necessity for change and the
kind of change have always been at the crux of this issue.

1 would get little agrument if | said that a poorly conceived
compensation system can have damaging and lasting effects
on the government's ability to recruit and retain a high quality
workforce. | think we must remember this in our deliberations.
In fact, | believe that if you were to ask federal workers what
attracts them most to federal service, behind service to their
country, they would answer the compensation package. So
whatever we uncover today, we must understand its
relationship to the federal sector and its culture.

This is not to say that certain factors that dictate the
creation or redesign of private sector compensation plans are
not applicable to government. Economic concerns and

demographic changes clearly affect both the private sector and

2


17

straints we face in making these changes. If you wanted to re-
spond, you're welcome.

Ms. SrRANDIORD. I would very much agree with Mr. Salisbury’s
comments on that, that those are usually done over time. I also be-
lieve that some companies use going to a flexible benefits plan or
a cafeteria plan as an opportunity to make some changes in their
benefits. So I think I would very much agree, though, with Dallas’
point of view on this.

I would point out one other thing. Especially, I believe, with
large companies, as they go to more and more of the salary struc-
ture really being based on some kind of a bonus based on the com-
pany’s profitability, it makes the employee really part of the whole
plan, as opposed to looking at it as a take-away, strictly a take-
away.

Mr. Mica. Thank you. Mr. Kelly.

Mr. KELLY. Yes. I would just like to add a comment on COLA’s.
I also am in agreement with the observations that were made by
Dallas Salisbury. However, I was very much struck by your de-
scription, Mr. Chairman, of the dilemma that’s faced with COLA’s,
where the voters are involved.

It reminded me of the Medicare problem and the Social Security
problem, where similar concepts are at work. In trying to make the
shift over to private employment, the question arises why is it that
COLA’s are not as big a problem in the private employment?

I guess it’s because COLA’s are almost a Faustian deal. It’s a
problem that, once you’ve made the deal you can’t unmake it. Once
the culture of COLA’s has settled in, you’re stuck with it, and
you’re damned if you do and you’re damned if you don’t.

I think employers increasingly, over the years, have approached
it from the point of view of their fiduciary duty to shareholders—
who often are institutions, themselves, pension funds and others—
their fiduciary duties to shareholders to manage the financial af-
fairs of the enterprise in a way where the promises that are made
in a time and under circumstances where they know or they have
a reasonable plan for how they’re going to pay for those promises.

When you begin making COLA promises, substituting an auto-
matic formula, you can have some fairly dramatic adverse con-
sequences that flow from it that may have no relationship to how
well the enterprise is doing when the COLA comes due.

In fact, you can get caught in some very serious countercyclic
forces, where a COLA kicks in just when the business is down, and
you've essentially turned over the keys to the treasury and the net
worth of the company if you do it, almost like the proverbial drunk-
en sailor, so that I think that the typical private employer, the
manager of a private company, would say, “Just say no, and don’t
st it.”

Mr. Mica. Well, you know, over the past two or three decades,
we've gotten ourselves hooked on this. You have only to take a sec-
ond look at the Federal budget, and look at what we were spending
money on 20 or 30 years ago, and what we're spending it on today,
then factor in the COLA’s, when you've got two-thirds of the budget
on automatic pilot, and then your two biggest programs with 10 to
13 percent increases on top of that.

Mr. KELLY. It’s almost like a drug.


83

carefully tailored and completely integrated package. Thus, many companies have
modified their overall strategies, including their employee reward strategies, to consider
compensation and benefits together as the components of a “Total Remuneration” (Total
R) package. The Total R package includes base salary/wages (hereafter referred to as
base salary), variable annual cash (e.g., cash incentive or bonus), long term incentive

(typically just for executives), benefits, and executive perquisites (cars, clubs, etc.).

Under this approach, an organization would assess its Total Remuneration position in
relation to its competitors for employees. It then determines the appropriate mix for its
package (e.g., the proportion of cash versus benefits, how the cash compensation is
delivered, how the benefits package is designed) in light of the organization’s business and
financial strategy, its work culture, and its human resource management systems. For
example, an established, security-oriented company in a stable marketplace may wish to
have average base salary levels, below average annual incentive, and above average
benefits -- resulting in an average Total R practice. In contrast, an entrepreneurial firm
bent on growth may also have an average Total R practice, but one designed to further its
goals, by establishing below average base salary, very high annual incentive to motivate

performance and growth, and below average benefits levels

Designing Appropriate Total Remuneration Strategies

We have found that the effectiveness of reward strategies, be they integrated or focused
on compensation and benefits separately, depends upon their alignment with
organizational strategies and mission, work culture, and the other human resources
management strategies employed. In fact, all three of these factors need to be carefully
defined and aligned with one another in order for an organization to achieve superior
performance. The following sections discuss the links between organization strategy,
work culture, and Total Remuneration (compensation and benefits) strategy.


As the population ages, as corporations face increasing competition in the global marketplace,
and as the needs of their employees change, the private sector is adapting its human resource
management strategies. As Congress seeks to better allocate available resources within realistic budget,
constraints, it makes sense to revisit our own personnel management strategies.

To help the Subcommittee explore these issues, we have convened two panels. Our first panel
consists of Mr. Dallas Salisbury, President of the Employee Benefit Research Institute, who will
present us with data that employers use to establish their human resources strategy. He will be
followed by Jeannine Strandjord, Vice Chair of Employee Benefits at the Financial Executive Institute,
who will examine some specific examples of benefit designs in individual companies. Mr. Strandjord
is also a Senior Vice President at Sprint. Mr. Peter Kelly, Chairman of the U.S. Chamber of
Commerce Qualified Plan Subcommittee, will testify on the range of benefit packages offered by their
members.

ur second pane! will be led by Abe Zwany, who will testify on the basis of the Hay Group's
consulting experience for private sector corporations. The perspective of federal unions will be
represented by the President of the American Federation of Government Employees, Mr. John
Sturdivant. Our last witness is Wendell Cox, @ consultant who will examine the relationship of private
sector compensation practices to the public sector.

look forward to the testimony of our witnesses and hope we can thoroughly examine the
options and obstacles that confront private sector employers as the formulate employee benefit
packages.


1

consumers. Taking away the government’s ability to leverage its
huge buying power simply makes no sense.

One last issue regarding federal practice in the area of
health insurance: As the health care industry undergoes changes
which have made managed care an inevitability for so many
workers, both large private sector employers, and to an
increasing degree OPM have taken steps to assure that plans be
held accountable for quality and accessibility. To achieve this
goal, large private and public employers are requiring managed
care plans to seek and receive annual certification from
independent quality assurance auditors, such as the National
Center for Quality Assurance (NCQA) Requiring NCQA
accreditation, conducting and responding to customer satisfaction
surveys, and pursuing various quality and coverage issues are all
ways in which OPM is following private sector practice in the
provision of health insurance. Congress should not deprive OPM

of these opportunities.

Retirement Systems

The two main federal retirement systems, the Civil Service
Retirement System (CSRS) and the Federal Employees Retirement
System (FERS), have persistently been accused of exceeding
private sector standards in the areas of retirement eligibility
criteria, benefit formulas, accrual rates, and cost-of-living
adjustments. The fact is that although comparisons among

retirement plans are notoriously difficult (it is even difficult


81

Statement of:
Michael F. Carter Abram Zwany
Senior Vice President Vice President
Hay/Huggins Co., Inc. Hay Management Consultants
The Hay Group The Hay Group

Mr. Chairman and Members of the Subcommittee:

We appreciate the opportunity to address the Subcommittee on Civil Service of the
Committee on Government Reform and Oversight on the issues concerning how private
sector employers structure their salary and benefits programs. We are both officers of the
Hay Group, a world-wide human resources consulting firm. Mr. Carter specializes in
benefits and Mr. Zwany specializes in compensation. First we discuss how many
organizations strategically structure their compensation and benefits packages in an
integrated “total remuneration” context, and then we focus on specific compensation and
benefits trends and issues.

The information provided in this statement is based on the Hay Group’s more than 50
years of experience in compensation, over 80 years in benefits, and our personal combined
50 years experience in consulting to private and public sector organizations, as well as
data from proprietary surveys and public sources. Specifically, compensation data are
from the Hay Compensation Report (HCR), an annual survey of the compensation
practices of almost 1,000 employers. Benefits data are from the Hay/Huggins Benefits
Report (HHBR), an annual survey of the benefits practices of over 1,000 organizations.
Both surveys sample various U.S. industries, geography, and medium, large and very
large size employers, Small employers (less than 100 employees) are not represented, so
our comments will not pertain to these organizations. All the data provided in this

statement are from those two reports unless otherwise indicated
Strategic Management of Compensation and Benefits
Background
In recent years, public and private sector organizations alike have struggled with the need

to change. This need to change derives from both extemal factors, such as increasing
global competition, the pace of technological innovation, pressure to reform and improve,


107

The FEHBP does not include any of these features. Most
notably, the FEHBP’s relatively high premium costs for employees
have left roughly 400,000 federal employees uninsured. These
employees are eligible for participation in the FEHBP, but when
surveyed by OPM -- have cited prohibitive costs as the reason for
declining to participate.

The CRS study's concluded that "(0)verall, the private
sector’s total health benefit package is usually more generous
than that available to federal employees, particularly with
respect to the share of the premium paid by the employer,
deductible amounts, and dental coverage." (1989 CRS study, page
134). Subsequent studies by the General Accounting Office and
the private benefits consulting firms have confirmed these
findings

The proposals to change the financing system for the FEHBP
which were briefly considered this fall would have only widened
the gap between the health benefits received by federal workers
under the FEHBP and those received by private sector employees.
The factor most responsible for FEHBP’s inferiority is the
relative parsimony of the government's financing of premiums.
Second is the size of deductibles and co-payments (out-of-pocket
costs) which are almost universally higher for federal employees
than for employees of large private sector firms.

Changing the financing formula from a dollar amount based on
a percentage of the average premium of the largest plans, to a

dollar amount based on average 1995 government contributions,


92

In contrast, group incentives are seen as most effective, which seems to be attributable to
the fact that the employees can directly influence the performance they are measured on in
such programs (a cardinal rule of good performance management plan design). Similarly,
team-based pay, and pay for quality also are perceived as effective. Other plans also are

seen as relatively effective.

One of the most distressing things in the chart is the large percentage of respondents who
don’t know if such programs have helped performance. We would hope that all
organizations have incorporated self-assessment plans into their new compensation
programs, and that the “don’t know” responses are therefore due to the newness of the

programs.

If this is true, then it seems that: (1) organizations are indeed implementing a variety of
innovative compensation programs which are specifically focused on motivating and
rewarding the kinds of abilities, behaviors and outcomes which will support their desired
work cultures and strategic initiatives; (<} ‘hat such programs are generally well-accepted
by employees, and (3) that such programs are seen as effectively meeting the goals
established for them.

Benefits

Private Sector Benefits Cost and Comparison to Federal Benefits

According to the Hay/Huggins Benefits Report (HHBR), the average 1995 cost of
benefits expressed as a percentage of payroll(salary) is shown below, broken out by major
plan area and generally shown in descending order of cost. The cost shown is the
employers’ net cost, ie. the cost remaining after reducing the total cost for employee
contributions. The cost shown for the plan breakouts is the arithmetic mean of all
respondents including those with no benefit plan. Thus the average cost is higher just for


60

Focusing for a moment on the primary objective of this commit-
tee, which is to study the private system in order to find parallels
or possible learning to apply in the Federal system, I will offer a
couple of observations, and then I'll stop talking. One thing that
has marked the private system, that may be good to keep in mind
in looking at the public system, is a great deal of flexibility.

It’s an employment-based system, and there are variations, sig-
nificant variations that reflect the particular needs of the employ-
ment setting. Even in the public sector, there can be significant dif-
ferences in different tasks or different assignments.

In addition to that, we would certainly advise that whatever is
done in the public sector, keep in mind, on the retirement side,
that pre-funding is probably the most important criteria for sound
retirement planning.

With that, thanks for the opportunity to appear, and I think the
entire panel is available for questions.

{The prepared statement of Mr. Kelly follows:]


56

Flexible Program Design Example

The following diagram illustrates an example of benefit options under a
flexible benefit program.

‘Employer ‘Employee
Ceeaite Contsibutons
——
Flexible
Credit Pool
f x £ — 1
Employee Dependent |
Medical Dental Spending Life Life insurance |
Accounts
Insurance” |
Option A Option A Health Care Option & pron A
S250 Deducnbie Cament Pan | || Up s2000/year | | [1 x Pay 55000 Spowse
52.00 Crider
Opton 8 Option 8 Dependent Care| | | Option & Option 8
$500 Deducnbie oMo Up © s5.000/year | | |2 x Pay 525.000 Spouse
$5000 Chuld(ren)
Opaen No Coverage | | | No Coverage ‘Opuon No Coverage
$1,000 Deductible
Coverage
Long-Term
tine Vacation ony 40100
Option A Buy 15 Days
66-2/5% of Pay
Option 8 Sell 1-5 Days
30% ot Pay
No change 1
base scheile

"No opt-out provision: employee must select coverage.

Hewitt Associates


leave,

18

insurance, and retirement and savings make up 6.6 percent, 8.0 percent, and 4.0

percent of total compensation, compared with 6.3 percent, 6.2 percent, and 2.6 percent for
the service-producing industry

TRENDS IN THE STRUCTURE OF EMPLOYEE BENEFITS
There are a number of central trends in employee benefits today:

4.

More focus on incentive compensation, leading to the growth of profit sharing; at risk
cash compensation; and equity ownership by employees
More focus on employee choice and responsibility, leading to the growth of
participant-directed defined contribution savings plans; flexible spending accounts for
health and dependent care; multiple option health plans; in some cases, cafeteria or
total flexible benefit plans; and education regarding benefits choice tied to concepts of
life-cycle stages and what the indiviudal must do for the individual
More focus on employment as a function of the state of the business versus a right to
tenure, leading to a growing use of programs that were originally established as
retirement plans as life transition resources that may be used at retizement but may
also be used during periods of unemployment or reeducation. This trend has also
centered the realm of Social Security, with defined benefit retirement plans being
changed to “cash-balance” and other “hybrid” approaches that more readily conform
to the realization that few workers who eam a benefit will still be with the employer at
retirement age.

‘The rising age of the work force is influencing employers. It is leading to an
increasing focus on employee education regarding financial planning and retirement
planning and education about taking full advantage of the programs that are being
made available by the employer. It is leading to recognition of the implications of
future demographics and future growth of the retiree population and is resulting in
efforts to redesign programs to produce manageable future costs for retiree income
and health programs. Future retirees who want postretirement COLAS will have to
have saved enough in a defined contribution plan to make these payments to
themselves, Retirees who want retiree medical protection will have to have saved
money so they can afford the premium copayments and deductibles, as more
employers facilitate the purchase of retiree health insurance but do not provide the
money for the premiums during the postretirement period.


47

Employers have been the driving force in the reform of the health care
market. We have been aggressive in demanding cost-effective, quality care and
developing best practice standards in order to evaluate the effectiveness of
plan administrators. We have demanded that programs provide demonstrated
results in the areas of quality and cost management. The need to manage costs
has led employers to take an increasingly proactive role in defining che
health benefits programs and requiring our healch plan administrators co
manage those programs effectively. There has been some success as a result of
these changes: last year, after years of increasing healch care costs, the
average cost of employer-sponsored healch plans decreased by 1.9 percent. 4
caveat to chis, however, is chat small employers experienced an increase of
6.5 percent in health care costs in 1994

Another significance crend in health care benefits is che growing shift

in the focus of health care from illness to "wellness." Healch promocion and
disease prevention strategies are being integrated into their benefit plans.
Participants in wellness programs are offered incentives to adopt healthier
lifestyles (some plans use disincentives to discourage unhealthy lifestyles)

The underlying theory in the adopcion of wellness programs is that an
ounce of prevention is indeed worth a pound of cure. By identifying health
risks and adopting strategies to reduce, eliminate or reverse these risks
before they require treatment, employers can reduce their health care costs
while maincaining the employees’ quality of care. Common components of
wellness include

Health assessments and/or appraisals,

Prenatal and well baby care

Fitness facilities or subsidized health club memberships, and

Employee assistance programs (EAPs)

Approximately 85 percent of large employers now offer wellness programs to

their employees. To the best of my knowledge, it is exceptionally rare to


51

services are highly cost effeccive: they provide che employee with a highly

de: @ cost co the employer, Use af these benef

able benefit ac ver’

is still limited among smail businesses: however, given their cose

effectiveness and desirability, i¢ is likely chac all but che smallest

employers will continue to move in this direction

The design of employee benefics is influenced co a large extent by che

demographics of the work force. One of the most significenc demographic

shifts we have seen over che last chirty years

women into the work force. When the cyp.

1 employee was a married man whose

wife stayed home co care tor the children, a single benefits package could be

created co suie che

eeds of nearly ali employees. Today. vomen compr

fifty percent of che work force; and the majority of them are mothers. Many
employees, both male and female, are single parents; some are also caring for

elderly parencs, Moreover. che work force in general is aging, Simply puc

the benefits needs of the work force are no longer uniform. Designing benef ic

plans which meee the needs of employees. without discriminating for or against

@ particular group, has become increasingly challen

g- This challenge has
given rise to the growing use of flexible benefits, or "safeceria" plans
Flexible benefits have undergone a significant expansion in both scope

and practice over che last decade Although flexible denefics plans were

initially adopted as a means of offering tax-effeccive beuefics, they have
increasingly been used as @ tool to enhance the overall value of benefits

while managing benefit cost. Flexible benefic plans tend co be most commonly
found among iarge empiovers. As of January 1994, approximately one chird of

Fortune 500 companies offered flexible benefits plans to their employees; and

half of the Fortune 100s made hese plans available. Ic is rare to find


80

to retire early. This serves to reduce the work force and, also, stim-
ulate promotional opportunities.

In terms of cost containment, employers’ focus has primarily
been on the shift from traditional fee-for-service medical plans to
managed care plans, such as PPO’s, HMO’s, and point-of-service
plans. This strategy is apparently working, because our data shows
a dramatic drop in the increases in costs of medical plan in the last
few years.

Another significant component is that the orientation of com-
pensation for performance is not limited to pay plans. Our survey
shows that, of the for-profit organizations in our data base, almost
one-half of them have a capital accumulation plan that is either
based on performance or on stock ownership.

In summary, organizations are increasingly planning and admin-
istering reward systems on a total compensation or total remunera-
tion basis, recognizing the important interrelationship. Pay is be-
coming more strongly linked to performance. In the area of bene-
fits, employer costs have risen gradually as a percentage of payroll
in the last 10 years, in part due to statutory cost increases.

Employers have been revising their benefit programs to be more
dynamic and effective, more flexible, more oriented toward per-
formance, more family oriented, and more attractive to and suit-
able for a more mobile work force.

We thank you again for the opportunity to address the sub-
committee, and we'll be happy to answer any questions later.
Thank you, Mr. Chairman.

[The prepared statement of Mr. Carter follows:]


142

GAO Point:

Federal Employees’ Compensation Cannot be Assumed to Be the Same as State and Local
Government Employees.

RESPONSE:

We did not assume that federal employee compensation to be the same as state and local
government employees.

This assumption is supplied by GAO. It is not to be found in our paper. By listing
unquantified advantages of public employment, we did not imply that all were advantages of
all federal employment, nor did we generally imply that compensation factors were the same
between the federal and state-local sectors. We did assume that federal and state-local sick
day usage was the same, but we have since obtained data indicating that federal sick day
usage is above that of state and local government employees. GAO's analysis lacks even-
handedness in failing to cite this factor that would have increased the excess value estimate
with respect to federal employment.

GAO exaggerates by indicating that "several other" factors may result in private instead of
federal advantage. In general usage, “several” denotes more than two but less than many
GAO cites only two examples. And, only one of these could actually be a federal advantage
(otal work hours). With respect to the other, GAO indicates that comparison of paid personal
leave to private sector practice could produce a private, rather than federal, advantage. But
GAO's analysis is not balanced in that it fails to note that seven percent of federal paid leave
is not included in paid holidays or vacations, which more than offsets any private employee
use of both personal and other paid leave days. We made no representation that all of the
cited factors convey federal advantage

GAO Point:
Other Considerations May Change the Perspective on Advantages

RESPONSE:
No point made by GAO switches the perspective from federal advantage to private
advantage with respect to any area we reported as conveying federal advantage.

GAO indicates that consideration of Social Security leads to “less contrast” in a comparison
of federal and private sector retirement benefits. GAO does not dispute federal advantage.
only the extent of federal advantage. But GAO stretches unnecessarily to make the point.
We did not seek to quantify the extent of public advantage, much less federal advantage,
Moreover, in attempting to equate the Civil Service Retirement System with Social Security,
GAO failed to note that Social Security benefits are reduced for recipients under 70 years of
age whose employment level exceeds a threshold. In contrast, federal pension benefits
continue regardless of outside income. GAO's criticisms are irrelevant and unfair.


185

methodology should include all quantifiable elements of compensation. At a minimum
this should include wages and salaries, employer paid benefits, the tax free value of
excess employer paid benefits (including the fully funded value of employer pension
contributions), the value of excess paid leave, and relative compensation increases.

© But, as a Concord Coalition report puts it, job description comparisons are
notoriously unreliable, since federal agencies (unlike most private employers) face
strong incentives to inflate them. A better approach to the entire comparability
question — a market test that weighs the total attractiveness of a job to everyone who
‘might fill it — is to look at job turnover rates. Routine and comprehensive reference
checks should be established to ensure that federal non-military labor outcomes
balance with labor market outcomes. Administratively determined compensation
should be adjusted (generally downward) to achieve turnover rate parity with that of
comparable private positions.

And, it must be recognized that even if these reforms were implemented, employment in
federal functions not competitively contracted or otherwise privatized would still be
determined by inherently flawed administrative mechanisms. The market rate can only be
established by the market.

Academic research routinely produces estimates of federal pay comparability that imply
considerable underestimation by federal systems. It is safe to say that a large portion of the
public perceives that federal employees are comparatively well paid. Only “inside the
beltway" is there an broadly held view that federal employees are underpaid.

Government has a responsibility to exercise stewardship over the funds that it compels from
taxpayers — a moral duty to spend no more than necessary to produce the services it has
determined are necessary. The federal government appears to be failing in this duty with
respect to employee compensation

It is imperative that federal pay determination systems be reformed to eliminate wasteful
excess spending for federal employee compensation. Fairness to taxpayers requires reform.
‘And reform is required for fairness to future generations, who are already obligated by the
burdensome federal debt

> Neil Howe and Richard Jackson, The Facts Abour Federal Pensions
(Washington: The Concord Coalition: May 1995).

8


13

In an industry sense, goods-producing industries provide employ-
ees with benefits that are a much greater proportion of compensa-
tion than the newer service-producing industries, which have tend-
ed to focus far more readily on the existence of a younger labor
force, relatively short product lives, and the need for the entity to
adjust very quickly to changing market conditions.

This has ended up with more of a focus on enterprises wanting
to be able to manage the work force from year to year with very
limited focus on an issue of, if you will, ultimate retirement income
provision.

As a result, major enterprises such as Microsoft Corp. and others
in the high tech industry have a tendency to have relatively limited
employee health insurance benefits, relatively generous 401(k) pro-
grams, and no other retirement programs of any type.

There are a number of central trends, then, in employee benefits
today. First, a move to focus on incentive compensation above cash;
second, the move that you mentioned, a focus on employee choice,
employee flexibility, and employee responsibility.

A recognition that lifetime job tenure is something that was
never there, for the vast majority of workers, was only taken full
advantage of by, in the private sector, on average, 10 to 15 percent
of workers, in the Federal civil service, only by about 23 to 25 per-
cent of all those who entered the service, meaning that a tradi-
tional, paternalistic approach would only provide retirement in-
come delivery for a small proportion.

More focus, as well, on employment as a function of the state of
business versus a right of tenure. In the private sector, that is
based on business cycles. In the public sector, one might view it as
tied to deficits and unfunded liabilities. The rising age of the work
force is influencing employers at this point, as well as they have
come to focus far more readily on the cost of benefits and liabilities.

We've seen employers in the private sector move almost entirely
away from cost of living adjustments and defined benefits pension
plans, automatically providing them in basically no cases and in-
creasingly making them much less frequent. We now look at data
that says that about half of employers provide some post-retire-
ment COLAs, but that number is declining.

We've seen in the retiree medical area, as a result of the Finan-
cial Accounting Standards Board and recognition of the cost of re-
tiree medical benefits, a significant pull-back in the provision of re-
tiree medical benefits.

In the pension area, we've seen announcements just this week of
one major corporation, employing over 37,000 employees, announc-
ing the change from a traditional defined benefit pension plan to
a new individual account approach. Yesterday, a second company
with 26,000 employees announced that they were freezing perma-
nently their defined benefit pension plan and replacing it with a
new 401(k) program which would become, in the future, the retire-
ment income and savings vehicle for their work force.

I mention those two changes. They are significant, and they rep-
resent only 2 of approximately 10 major enterprises since 1974 that
have made these types of changes, and they appear to be part of
a growing movement.


187

= Some of GAO's criticisms are immaterial.
= Some of GAO's findings are simply erroneous.

Worse, however, in some respects GAO analyzes a report we did not produce, rather than the
one we presented:

. GAO devised objectives for our research which we did not intend, which is inherently
unfair.
. GAO attributed to us conclusions and assumptions that we did not make.

On balance the GAO analysis falls short of the objective standard that is the right of Congress
and the American people to expect.

THE GAO ANALYSIS AND OUR RESPONSES

GAO EVALUATION QUESTION #1:
Does the Methodology Provide a Reasonable Basis for Comparing Equivalent Positions
Across Private and Federal Sectors?

(RESPONSE:
Yes, to the extent that we sought to produce such a comparison.

See discussion below.

GAO Point:
No Clear Basis for Comparing Similar Employees Is Provided.

[RESPONSE:
Our comparison was a “macro” level comparison. The GAO evaluation unfairly applied a
"micro" level standard.

GAO indicated that our methodology should have either matched comparable positions in the
two sectors or made the case that the two sectors have an equivalent mix of positions. The
following discussion outlines the erroneousness of these criticisms.

Our intention was not to compare equivalent positions across the two sectors at the
“micro” level. It was rather to quantify inherent differences in value (an excess value factor,
which would be expressed as a percentage) that could be applied to any general assumption
with respect to the relative wages of comparable private and federal employees at the “macro”
level. There is considerable debate about the level of federal employee wages and salaries
compared to those of comparable employees in the private sector. The official federal
estimate (the "President's Pay Agent” estimate) is that federal employees are paid 22.3 percent


55

The realities of global competition mean that we mst ail make choices
and set priorities. Our abilicy to attract and retain a high-quality work

force is paramount to our survival in the world market place. This has been

achieved through aggressive cost containment and innovative new strategies to
ensure that available benefit dollars are maximized. In looking to reform the
civil service, I urge che Subcommittee to explore che range of cost-saving
benefits now being offered in che private sector

That concludes my prepared remarks. I thank che Commictee for the

opportunity co tescify and would be glad to answer any quescions.


2

companies to recruit, motivate, and manage their employees. There
is no reason to believe that the public sector is any different.

Portability, flexibility, and greater employee choices appear to be
the growing trends in benefit design throughout the private sector.
This is in response to the priorities of today’s more mobile work-
place.

The field of private sector employee benefits is one of rapid and
continuous change. Every budget bill passed by Congress since the
mid-80’s has included provisions affecting private employer-spon-
sored benefit programs. Private employers are also burdened by
Federal regulations that spell out compliance requirements.

In addition to these dramatic changes, employers continually re-
evaluate benefit packages, not only for cost effectiveness, but also
to respond to employees’ needs. As people live longer and alter
their lifestyles and patterns of work, their expectations change
about what they need | to ensure their economic stability.

The integration of benefit policy with both short- and long-range
personnel planning is essential in the private sector. I think any-
one who has dealt with the private sector knows that. Employers
who deal with a more mobile work force will often dedicate a great-
er percentage of compensation to salaries and thereby reduce their
level of benefits.

Those employers with a need to retain their work force over a
longer period of time might structure a compensation package with
a higher proportion of benefits, but temper this with vesting re-
quirements to reduce turnover. Due to the realities of a highly com-
petitive global marketplace, total compensation, combining high
benefit levels with high salaries, is much more difficult to sustain
today.

Federal compensation strategies are caught somewhere between
the 1930’s and 1940’s when the focus was on job and benefit secu-
rity, and the more mobile work force of today, with its focus on
flexibility and portability. Somehow, we seem to be stuck in an-
other era, at least in the public sector.

As the population ages and as corporations are facing increasing
competition in the global marketplace and the needs of their em-
ployees change, the private sector is adapting its human resource
management strategies. As Congress seeks to better allocate avail-
able resources within realistic budget constraints, it makes sense
to revisit our own personnel management strategies, and that’s
what we're going to G here today.

To help the subcommittee explore these issues, we’ve convened
two panels of witnesses today. Our first panel consists of Mr. Dal-
las Salisbury, president of the Employee Benefits Research Insti-
tute, who will present us with data on employers who have estab-
lished their own human resource strategy and how they utilize that
human resource strategy.

He will be followed by Jeannine Strandjord, vice chair of Em-
ployee Benefits at the Financial Executives Institute, who will ex-
amine some of the specific examples of benefit designs in individual
companies. Ms. Strandjord is also a senior vice president at Sprint.

We have also, Mr. Peter Kelly, chairman of the U.S. Chamber of
Commerce Qualified Plan Subcommittee, who will testify on the
range of benefit packages offered by their members.


163

by Congress and completed by CRS with assistance from experts in
the health care field continues to be the model on which federal
vs. private health care discussions can be based. (The Federal
Employees Health Benefits Program, Congressional Research Service,

May 24, 1989)

The CRS study concludes that "A comparison of Federal benefits
with those in the private sector shows that health benefits for a
typical employee are worth $1,100 more in the private sector."
Typically, private sector employers bear the entire health
insurance premium for their workers and roughly 75 percent of the
premium for dependent coverage. The federal government currently
pays an average of 72 percent of its employees’ health insurance

premiums.

Yet, this Committee had earlier suggested as part of its FY 96
Reconciliation instructions that health insurance premiums paid by
the government as employer should be capped. Furthermore, the
Committee proposal suggested that future increases in premiums
should be shifted away from the government and on to the enrollees.
This scheme would have increased the government’s share of future
premium increases by only the simple rate of inflation. While
increases in the Consumer Price Index (CPI) have hovered around
three percent over the last several years, health care inflation
has run well above those levels. In fact, over the last five
years, health insurance premiums for medium and large firms have

increased an average of 10 percent. Cost shifting of the degree


72

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27

Availal
+ There has been a small but steady increase in the percentage of cafeteria plans offered by
employers, In 1993, 12 percent of full-time employees working in medium and large private

ity of Cafeteria Plans

establishments were eligible for cafeteria benefits, compared with 5 percent in 1988, Four
percent of full-time employees working in state and local governments were eligible for
cafeteria benefits in 1992, compared with 1 percent in 1987. Approximately 2 percent of full-
time employees working in small private establishments were eligible for cafeteria benefits in
1992, up from I percent in 1990.10

+ Inrecent years, FSAs (and to a limited extent cafeteria plans) have expanded in both the
public and private sector (table 9). In 1993, 53 percent of full-time employees working in
medium and large private establishments were eligible to participate in FSAs and/or cafeteria
plans, compared with 13 percent in 1988, In 1992, 14 percent of full-time employees
‘working in small private establishments were eligible to participate in FSAs and/or cafeteria
plans. compared with 8 percent in 1990. Fifty-one percent of full-time employees working in
state and Jocal governments were eligible to participate in FSAs and/or cafeteria plans in
1992, compared with 9 percent in 1987.11

Cafeteria Plan Options

+ According to a 1994 study by Hewitt Associates, the most common types of benefits offered
under cafeteria plans were FSAs-dependent care (93 percent of employers offering cafeteria
plans offered this benefit) and FSAs-health care (87 percent) (see table 10). Other common
benefits offered under cafeteria plans include health plans choices other than HMOs (71
percent), death benefit choices (39 percent), and disability benefic choices (24 percent).'2

+ The greatest changes in benefits offered under cafeteria plans has occurred with health plan
choices (other than HMOs) and spending accounts (dependent care). [n 1994, 93 percent of
employers who provided cafeteria plans offered dependent care spending accounts as an
‘option, compared with 78 percent in 1987. in 1994, 71 percent of employers offered health

Employee Benefit Research Institute, EBRI Databook on Employee Benefits, Third edition (Washington, DC:
Employee Benefit Research Insutue, 1995)

"pig

2 plewitt Associates, Salaried Emplovee Benefits Provided by Mayor U.S. Employers, 1988 (Lincolashute, 1.
Hewitt Assuciates, 193840



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146

Excess Value of Federal Employment
Moulton Study Assumption (Federal Pay 3.1% Above Private)

160% 155.5%

Yj rroce
BB excess vate

Excess Value = 50.8% of federal pay



63

overfunded defined benefit pension plan terminated.

The diminished reliance on defined benefit plans to provide retirement
benefits has not been uniform throughout the economy. Larger employers
continue to rely on defined benefit plans as the most inexpensive method for
providing retirement security to a large workforce.

The defined benefit plan termination insurance system remains at risk
because of the failures (or the projections of future failures) of insured defined
benefit plans in certain troubled industries. This concern has been alleviated
somewhat by the success of Pension Benefit Guaranty Corporation (PBGC)
legislative initiatives. Although it is widely perceived that defined benefit plan
problems stem from weak industries, those industries have always been with us
and do not fully explain the financial problems of the PBGC. A more fundamental
problem is the trend away from defined benefit plans. This trend has drastically
shrunk the termination insurance premium base.

Despite employers’ concerns about the cost burdens and potential liabilities
of maintaining a defined benefit plan, the aging of the baby boom generation will
likely force many employers to reconsider such plans. Over the next decade these
new pressures for adequate retirement benefits will force many employers to
establish such plans.

b. 401(k) Plans. ERISA placed an embargo on the formation of new salary
reduction and cash and deferred plans (now known as 401(k)) plans. That

embargo was lifted 16 years ago. Since that time, there has been an explosive


20

care, up from 62 percent in 1989. In 1992, 83 percent of employers required
coinsurance of 20 percent for physician visits, up from 77 percent in 1989. In
1992, 26 percent of employers limited out-of-pocket expenses to between $1,500
and $2,499, an increase from 21 percent in 1989.

‘+ Employers have increased their use of utilization review (UR) programs (table 5)
‘These programs are designed to monitor the progress and appropriateness of health
care services on a case-by-case basis. In 1992, 83 percent of surveyed employers
required prior authorization for certain procedures, nonemergency hospital
‘admissions, and elective surgery, up from 73 percent in 1989, In 1992, 66 percent
of employers required health care to be monitored as it was provided and/or
determined the length of a hospital stay and the scope of the treatment prior to
treatment, up from 52 percent in 1989. Second surgical opinions were the only type
of UR whose use decreased between 1989 and 1992

+ The use of HMOs has been one of the most prevalent methods utilized by employers
to control rising health care costs. In 1980, there were 236 HMOs, with 9.1 million
enrollees.4 By 1994, there were 547 HMOs, with 43.4 million enrollees.5 These
plans range from staff models where the HMO owns its health care facility and
‘employs health care providers on a salaried basis, to independent practice
arrangements (IPAS), where groups of physicians practicing independently contract
with an HMO to provide health care services to the HMO enrollees. The recent
‘movement of individuals into HMOs has not been into the more controlled staff or
group model HMOs but into the IPAs, where patients have a greater choice of
physician. Between 1993 and 1994, there was a 42.6 percent increase in enroliment
in mixed models, followed by a 7.6 percent increase in enrollment in IPAs. Group-
based plans. 1., staff, group, and network models, experienced a decline in
enrollment between 1993 and 1994,

+ Preferred provider organizations (PPOs) and point-of-service (POS) plans have also
‘emerged as strong alternatives to fee-for-service plans and HMOs. The number of
individuals enrolled in these arrangements increased significantly between the mid-
1980s and today. Recently, the growth rate of enrollees in these plans has exceeded
the growth rate of enrollees in HMOs because they allow greater choice of
physician, Evidence on the savings from these plans is largely lacking but does

4 Nancy Kraus, Michelle Porte. and Patricia Ball, Managed Care 4 Decade in Review 1980-1990 (Excelsior
MN. The InterStady Edge, 1991)

5 The ImerStudy Competitive Edge, 5.1 (Minneapolis, MN: Interstudy, 1995),


37

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157

told to stay home from their jobs, that they might be unable to
meet their mortgages, their car payments and their many other
family obligations. Legislation preventing a federal government
shutdown and widespread federal worker furloughs was passed by this
Congress with only hours to spare before the October 1 deadline.
And as this testimony is prepared, the date on which yet another
federal shutdown could occur rapidly approaches. As November 13
draws near, federal employees are again concerned that they may
soon be prevented from doing the jobs they have been hired to
perform; that their obligations and responsibilities may be in
jeopardy. This is no way to treat our dedicated federal workforce.
Moreover, to hold federal workers out as having more job security
than workers in the private sector is ludicrous and has no basis in

fact.

According to the Bureau of Labor Statistics, the government
employs one of every 90 Americans today. In 1946, that ratio was
one in 62. The number of federal employees stood at 2.2 million in
1946. Today, not counting employees of the U. S. Postal Service,
that number stands at just two million. During this same time
period, the Nation’s population rose from 140 million to 250

million. The facts speak for themselves.

Equally disturbing are the increasingly frequent attacks on
the federal retirement system as overly generous and excessive
relative to retirement benefits available to private sector

employees. These statements represent little more than myths and


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23

providing health benefits for current and future retirees. One survey shows that between
1988 and 1992, the percentage of large employers providing health insurance coverage to
retirees declined from 62 percent to 52 percent (table 6). In addition, an increasing
percentage of retirees now share the cost of their health insurance with their former
employers,

RETIREMENT PLANS

Plan Type Trends

‘+ While the number of private employment-based retirement plans and plan participants has
been increasing, proportionately fewer are defined benefit plans and defined benefit plan
participants

+ The total number of private tax-qualified employment-based plans (both primary and
supplemental) more than doubled from 311,000 in 1975, when the Employee Retirement
Income Security Act (ERISA) became effective, to 699,000 in 1991 (see table 7). The total
number of private defined benefit plans increased from 103,000 in 1975 to 175,000 in 1983,
then decreased to 102,000 in 1991. The total number of private defined contribution plans
increased from 208,000 to $98,000 between 1975 and 1991

+ There is no evidence of a widespread “shift” from defined benefit to defined contribution
plans. Although some plan sponsors, particularly small employers, have replaced defined
benefit plans with defined contribution plans, such replacements are not driving the trends in
defined benefit and defined contribution plans. Most large employer with more than 5,000
employees now have both types of plans.

+ Almost three-quarters (73 percent) of the net decrease in the number of defined benefit plans
involved very small plans, consisting of fewer than 10 active participants (see table 8).
Between 1986 and 1990, there was a net decrease in the number of primary defined benefit
plans of 67,995, and the net decrease in plans with fewer than 10 active participants was
49,700. Statistics from the Internal Revenue Service indicate that these trends have
continued through 1995.

+ Between 1985 and 1991, the net increase in the number of primary defined contribution plans
with fewer than 10 participants was 66,594 plans; this accounted for 42 percent of the net,
increase of 160,052 in the number of primary defined contribution plans. Statistics from the
Internal Revenue Service indicate that these trends have continued through 1995.

+ The rapid growth in defined contribution plans cannot simply be explained by a replacement
of defined benefit plans with defined contribution plans, because the net increase in defined
contribution plans is far greater than the net decrease in defined benefit plans. Many

9


144

= In that the aggregate value is above market rates, it is of necessity true that the value
of a great many federal jobs is above market rates.

Thank you for the opportunity to submit this testimony,


90

individual and group behavior. We expect significant growth in these areas as companies
reengineer work and come to rely more on the development of competencies, or organize
more around teams. Leading edge organizations in both the public and private sectors are

taking such approaches, and implementing pay for competency programs, for example

Acceptance of Innovative Programs

Perhaps even more revealing than widespread experimentation with alternative pay
programs is the acceptance of newer plans by employees, as reported by human resources
professionals. As the chart below shows, every program is reported as being accepted by
the majority of the population.

Has Program Been Accepted by Most Employees?

‘Special One-time “Spor” Awards am.
(hersthe-fact)

Suggestion Propossl Program Tem.
(cash or cash equvalent awards)

Group tncentives 13

Profitaharng (exclusive
‘of retirement programs)

ry for Competencies

‘Special Key Contnbutor
Programs ( ict)

ay for Quality

Gsinaharing
(producuviry-bared)
‘Teamrbased Pay

0% 10% 20% 30% 40% 50% 0% 70%  —BO% 90% 100%

‘Percent of Organizations Responding
CoO Leal
Ye No Can't Tel

‘Source: Hay Compeasaton Conference Report



44

What strategies are employers using co achieve these ends while

remaining compet

ve in che markecplace and maintaining a qualicy work force?

a

of background

useful co touch upon how companies formulace their

compensation packages
In general, most companies create compensation and benefits programs

wich che goal of

cruiting and retaining high-calibre employees. However

this guse be achieved wichin a reasonable budgec in order co maintain a

company’s competitiveness. The ability co compere

crucial not only within

a parcicular induscry sector or geographic region. but also in

e global
marketplace As world markets have expanded and more liberalized crade is
embraced, U.S employers have been put under increasing pressure to cut costs
in al! areas of operation. It is no longer possible for employers in the
privace sector to offer both high cash and high benefits compensation packages
to their work force, The crend in the privace sector, therefore, has been a
novenent toward maximizing the benefit dollars available to the company

This has been achieved using a number of different benefit approaches,
including the utilization of managed medical care, flexible benefits plans,
and alternative work arrangements. Taken cogether, these strategies allow
greater flexibilicy--for both employers and employees--while keeping costs at
a minimum; thereby maintaining or enhancing the ability to compete in the
world market

The goa! for employers is to ensure thac the benefit dollars available
are utilized co maximum advantage. [Irrespective of a company’s size, a
significant proportion of ics payroll is devoted co employee benefits. A

recent study conducted by Coopers & Lybrand found that, on average, the total

cose of employee benefits is eighteen percenc of payroll. This excludes

payroll caxes. vacations and other paid time off, Broken down, companies


85

with a paternalistic employer. We should note that this traditional, hierarchical
culture has evolved, in some settings, so that some of the more negative elements,
such as rigid command and control structures have been replaced with more

positive approaches that emphasize people and performance.

tions flow from the functional model. Overall,
the level of Total Remuneration is set in relation to marketplace levels so as to

Clear Total Remuneration impli

attract, retain and motivate employees with adequate skills and knowledge. The
strategy is to reward increasing levels of specialized knowledge over the life of a
career in order to build reliable delivery of technology. The compensation system
is keyed to the use of fairly narrow grades and ranges for base salary, with target
levels keyed to the desired position in the marketplace. Internal equity of
compensation is an important value; and salary progress depends upon sustained
performance (often called merit pay) and movement of the salary ranges, Variable
pay is limited to a small minority of employees -- usually those at the top. Benefits
levels would typically be at or above average, and oriented toward security and
service; for example, retirement would be career-based and service-related, health
benefits would be uniform with low cost-sharing, and vacation benefits would be
high and service-based

Process organizations focus on their customers and continuous improvement. The
work is organized into customer-driven processes, teams rather than individuals
are the key unit of performance, and performance is normally measured in terms of
progress, rather than specific, discrete events. Performance is measured through
customer satisfaction and process benchmarking. Process organizations therefore
value service, affiliation, influence rather than direction, and tenacity. Much of the
recent change seen in both private and public sector organizations involves the
attempt to change from a traditional bureaucracy to a customer-focused,
streamlined, empowered, team-based model -- shifting from the functional to the
process model.


62

including statistics from the Chamber's most recent survey of employee benefits
practices. | will devote these remarks to a brief summary of the attachments and a
discussion of certain employee benefit trends of which this subcommittee should
be aware as it considers the enclosures.

1. Retirement Plan Trends. As we look ahead to future developments
affecting retirement plans, it is important to note that after 20 years of intense
pressure for a shift to a mandatory system, we still have a voluntary private
retirement system which offers far-sighted employers important tools for attracting

and retaining a world class workforce. Economists predict that the future growth

and profitability of our nation will depend upon service sector businesses. in a
very real sense, skilled workers are the tools of the trade upon which much of our
nation’s future depends. Their continued contribution to business growth and
profitability will depend upon continued satisfaction of their personal needs for
retirement security.

a. Defined Benefit Pension Plans. No retirement plans are more important
to the future of American business than are defined benefit pension plans. Since
enactment of the Employee Retirement Income Security Act of 1974 (ERISA), the
rate of growth of defined benefit plans has decreased. During the past six years,
there has been a negative net growth of such plans. Sponsors of defined benefit
pension plans have been subjected to increased funding burdens and they have
been required to pay increasingly burdensome annual per capita termination
insurance premiums. In addition, during the past 15 years employers have seen a

significant diminishment of their right to recover excess assets in the event that an


86

Process cultures seek to reward employees for developing and making
contributions to the team-based process. Employees share in group rewards (based
on customer satisfaction) in order to cultivate reliable deliveries that fulfill
customer needs. Process work cultures employ wider grade and salary ranges for
most levels than do functional organizations. Salary progress depends upon
demonstration of knowledge of the process, and market movement of ranges.
More pay depends upon performance: variable pay plans are inclusive, often
encompassing 80% or more of all employees in team or group-based
bonus/incentive plans which are supported by continuous performance feedback
and communication about results. Payouts are often quarterly, rather than annual,
to support the process organization's need for continuing communication about
performance and progress. Retirement plans are keyed to company performance
(profits), and there is greater cost sharing on health plans, less life insurance, and
less vacation than in functional work cultures. Exhibiting less of a paternalistic
approach to benefits relative to functional cultures, process organizations would

have lower overall levels of benefits, and more flexibility and profit orientation.

Time-Based organizations are designed to quickly exploit flexible technologies in
order to dominate markets and maximize return on investment in assets. Such
organizations are found in financial services as well as manufacturing. Work in
these organizations is organized around multi-functional program teams, and
relatively flat management structures are used to facilitate speed and flexibility
Time-based organizations value self-confidence, initiative, flexibility, and the desire
for personal impact. Performance in measured in terms of “speed to market” and

market share.

‘Time-based organizations emphasize flexibility in almost all aspects of their Total
Remuneration programs. They focus on ensuring the availability of the talent
necessary to achieve schedule, cost and productivity targets. Time-based
organizations normally employ broad salary ranges where movement (salary


121

It is important for federal policy makers to realize that
both the federal government and private industry rely heavily on
salary surveys to define the parameters of salary schedules. For
federal workers under FEPCA, the government is required to use
annual wage surveys produced by BLS. These surveys are the most
sophisticated and unbiased source of wage data that exist.
Because of their unparalleled quality, many large corporations
also rely on the BLS wage surveys in the ongoing administration

of their salary programs.

The Federal Wage Systet Federal Blue Collar Pa’

The Federal Government's 294,000 craft and trade employees
are paid under the provisions of the Federal Wage System, which
was enacted in 1972 under Public Law 92-392. This system
provides that workers will be paid according to the prevailing
rates in the local private sector. The country is divided into
134 local wage areas and surveys of private sector pay rates are
made annually. These surveys produce reliable data. We are very
confident in our determination of local prevailing rates.

Unfortunately, this system, which was enacted with strong
bipartisan support and signed by a Republican president, has not
been allowed to function as intended. For the past 17 years,
Congress has imposed artificial “pay caps" on the Federal wage
System, limiting the amount of any pay increase, regardless of
changes in the local prevailing rates. This has made federal

blue collar pay lag behind the private sector in nearly every

18


124

Conclusion

Federal compensation has suffered enormously over the past
two decades, for reasons which were entirely unrelated to changes
in private sector compensation practices. Salaries lag by as
much as 27 percent, health benefits lag by $1,100 per worker per
year with almost 18 percent of those eligible left uninsured.
Retirement benefits have been cut time and again. The federal
government's promises to federal employees have been continually
broken

AFGE has embraced change in the workplace, breaking new
ground in labor management relations in order to reinvent the way
the government does business. No union has been more willing to
work toward the goals of improving efficiency and service
delivery to the American public. But our efforts have earned us
increased attacks on federal compensation. Enough is enough
Federal compensation as a whole lags behind prevailing private
sector standards, and no reasonable case can be made to the
contrary

This concludes my testimony. I will be happy to respond to

any questions.

21


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156

William M. Mercer, Inc., detailed chief executive salaries and
found that pay for chief executives only rose by 11.4 percent last
year. Only 11.4 percent. Federal workers -- regardless of their
level of responsibility will only receive a 2.4 percent pay raise
in 1996 and received only 2.6 percent the year before. This
certainly seems to throw additional water on the preposterous
notion that federal workers are overpaid in relation to private
sector workers. I hope that those who would come before this
Committee to assert the ridiculous notion that federal workers are

overpaid would be asked by the Chairman to stick to the facts.

The same critics who assert that federal workers are overpaid
are fond of adding to their rhetoric that federal employees have
greater job security than private sector workers. While the number
of Americans served by the federal government has grown
tremendously in the last two decades, the number of federal
employees has steadily declined. Federal employment has continued
to drop since 1991 with the last Congress having written into law
a further reduction of 272,000 federal jobs. This reduction will
result in the lowest level of federal employment since John F.

Kennedy was President.

Furthermore, Congress’ inability to complete action on the
Fiscal Year 1996 appropriations measures has created an
unprecedented level of uncertainty for our Nation’s public
servants. As the beginning of the new Fiscal Year approached,

federal workers grew increasingly apprehensive that they might be


7

I think, Mr. Chairman, that we will learn a lot from our wit-
nesses today and look forward to the testimony. Thanks for calling
this hearing.

[The prepared statement of Hon. Constance A. Morella follows:]


189

GAO Pornt:
Contrary Evidence about Comparability of Positions Not Addressed

RESPONSE:
The "contrary" evidence is of far less significance than GAO implies.

GAO notes differences in the composition of the federal and private work forces might be
responsible for differences in compensation between the two sectors, largely because the
federal sector has a higher percentage of “white collar” workers. But not all white collar
occupations exhibit higher than average compensation. A large percentage of federal white
collar employment is administrative support and clerical employees, who account for twice
the share of federal non-military employment as private sector employment. In the market,
compensation for administrative support and clerical employees is less than the private sector
average. Differences in the composition of federal non-miliary employment relative to private
employment are not sufficient to account for the much higher compensation received by
federal employees. Our future reports will deal with this issue in greater detail.

GAO EVALUATION QUESTION #2:
Does the Methodology Represent a Balanced Approach to Measuring Both the
Compensation Advantages and Disadvantages of Federal Employment?

RESPONSE:
The methodology is balanced.

See discussion below.

GAO PoINi
Areas of Possible Private Sector Advantage not Addressed.

RESPONSE:
GAO is wrong. Each of the elements addressed was potentially an area of possible private
sector advantage.

In the case of each area considered, we evaluated the extent to which the element might be a
private or federal advantage. In each of the cases we identified there was an overall public
advantage. GAO identified one element that we did not study, and which conveys private
advantage in relation to federal employment: the tax free value of Social Security income.
Federal employees on the Civil Service Retirement System are not covered by Social Security
and, therefore, do not receive this benefit. Inclusion of this private sector advantage would
have reduced our 50.8 percent excess value factor by a small amount --- less than 0.5
percentage points. We will include this factor in future analyses.


147

1am submitting supplemental testimony (Supplement Il) with respect to federal employee
compensation.

There is a need to reform the Office of Personnel Management (OPM) employment reporting
system so that Congress and the American people are provided a genuine picture of the cost
of federal non-military employment. OPM's annual reports should be required to include all
payments by all federal agencies on behalf of all federal employees or formal employees. For
example, the 1993 Civil Service Retirement and Disability Fund Annual Report reflects $23
billion in federal payments to federal civilian employee retirement programs that are not
included in the OPM annual report. Further, OPM's annual reports should reflect a reasonable
value for unfunded pension liabilities for the year reported upon. Finally, OPM should be
required to restate historical data to conform to these requirements.

Such “full disclosure” requirements would place on OPM and the federal government the
same burden that federal regulatory agencies routinely require of commercial advertisers and
others.

Thank you for the opportunity to submit this testimony.


153

continues to be able to attract the best and the brightest to
careers in federal service. Federal employee bashing by those who
seek to discredit the federal workforce serve only to bring disdain
upon our Nation. As issues become more complex, the federal
government’s mission becomes increasingly critical -- we simply

must be able to attract the best individuals to serve our Nation.

However, as you may know, a 1994 General Accounting Office
(GAO) Report entitled, "How Government Jobs Are Viewed On Some
College Campuses" showed that little interest existed in pursuing
a career with the federal government, The report indicated that
low, non-competitive starting salaries and the poor image of
government work helped fuel this decision. This was not the first

study to arrive at such a disturbing conclusion.

A September, 1990 GAO Report (Recruitment and Retention:
Inadequate Federal Pay Cited As Primary Problem By Agency
Officials) also cited evidence that low federal pay was the most
frequently stated reason for employees to leave federal government
service, or to decline a federal job offer in the first place. At
that time, the GAO warned that “recruitment and retention problems
pose a major risk of reducing the quality of government services
and programs." GAO went on to point out that “limitations on
federal pay adjustments since the late 1970’s have created a
federal/private pay gap where average private sector salaries

exceed federal salaries by about 25 percent.”


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6

Mr. Mica. So, with those opening remarks, I will turn to Mr.
Holden and see if he has any opening statement.

Mr. HOLDEN. Well, thank you, Mr. Chairman. I commend you for
holding this hearing on civil service reform, and I look forward to
hearing the testimony of the witnesses as we compare private sec-
tor compensation practices with that of the public sector. Again,
Mr. Chairman, I thank you for holding this hearing, and I believe
Mr. Moran will be with us shortly.

Mr. Mica. I thank the gentleman and now yield to the
gentlelady, Mrs. Morella.

Mrs. More.a. Thank you, Mr. Chairman. In anticipation of this
hearing being held on Halloween, I decided to bring a goody bag.
Since the chairman was so gracious in offering us acorns at an ear-
lier hearing, I figured today he would have some additional treats,
such as “filet of fenny snake, in the cauldron boil and bake, eye of
newt and toe of frog, wool of bat and tongue of dog, for a charm
of powerful trouble, like a hellbroth boil and bubble.” Sound a bit
like Macbeth? [Laughter.]

Mr. Mica. Our specialty in this subcommittee is hellbroth.
(Laughter.]

Thank you for your Halloween comment.

Mrs. More... Thank you. But, in all seriousness, I would really
like to commend you, Mr. Chairman, for calling the hearing, and
as I’ve said before, I'll say it again, that these hearings on civil
service reform have been excellent thus far, and I’m certain that
this hearing is going to yield some excellent information.

The issue of Federal employee compensation has created intense
debate over the last few months. Members of this subcommittee
have engaged in these debates and, in some cases, we’ve expressed
very divergent views, yet we've all approached these debates with
passion and compassion.

There will be change. I think all members of the subcommittee
know that you cannot have true civil service reform without an in-
tegrated approach to the redesign of all human resource manage-
ment systems, including the compensation system. But the neces-
sity for change and the kind of change have always been at the
crux of this issue.

I think I would get little argument if I said that a poorly con-
ceived compensation system can have damaging and lasting effects
on the government’s ability to recruit and to retain a high quality
work force. I believe that if you were to ask Federal workers what
attracts them most to Federal service, behind service to their coun-
try, they would answer, the compensation package. So whatever we
uncover today, we must understand its relationship to the Federal
sector and its culture.

That’s not to say that certain factors that dictate the creation or
redesign of private sector compensation plans are not applicable to
government. Economic concerns and demographic changes clearly
affect both the private sector and the Federal sector. But what I
am suggesting is that we recognize and appreciate the differences
in private and Federal employment and seek to seamlessly inte-
grate, not force, private sector principles into the framework of gov-
ernment.


40

Mr. Mica. We thank you, and I will turn to Jeannine Strandjord,
with the Financial Executives Institute. Welcome.

Ms. STRANDJORD. Thank you very much. Good afternoon. I would
like to thank the chairman for the opportunity to testify on behalf
of Financial Executives Institute before this subcommittee. I have
also submitted prepared remarks, but, in the interest of time,
please let me summarize them.

In general, most companies, as has been mentioned here today,
create compensation and benefit programs with the goal of recruit-
ing and retaining high caliber employees. However, this must be
achieved within a reasonable budget in order to retain a company’s
competitiveness.

The trend in the private sector has been toward maximizing the
benefit dollars available to the company. On average, the total cost
of employee benefits is 18 percent of payroll, excluding such things
as payroll taxes, vacations, and other paid time off—8.5 percent
goes to health care; 6 percent to pensions; .6 percent to group life
insurance.

The remainder is generally comprised of miscellaneous benefits,
such as vacation time, accidental death, and/or long-term disability
insurance, and in some cases, educational assistance or profit shar-
ing.

However, since the economies of scale favor large companies, the
level of benefits provided to employees varies between small, me-
dium, and large employers. This variation in benefits is due to the
simple fact that it is more difficult for smaller employers to build
compensation packages which include the spectrum of benefits
which larger companies are able to negotiate for their work forces.

In many cases, prohibitive costs prevent small employers from of-
fering any benefits at all. Non-provision of benefits is also common
in specific industries, such as many in the service industry, regard-
less of the size of the employer.

While benefit options vary widely among employers, it is possible
to identify a number of distinct trends in the provision of these
benefits. Most employers provide some health care benefits.

Among large employers, the current coverage rate is 99 percent,
but, despite the company’s size, the overwhelming trend has been
away from traditional indemnity and fee-for-service delivery sys-
tems into managed care. Large companies have increasingly begun
to self-insure, while smaller employees have, to the extent possible
under current law, created purchasing alliances for health care.

Employers have been the driving force in the reform of the
health care market by aggressively demanding cost-effective, qual-
ity care and developing best practice standards in order to evaluate
the effectiveness of plan administrators.

As a result, last year, after years of increasing health care costs,
the average cost of employer-sponsored health care plans decreased
by 1.9 percent, although small companies increased, so there is still
room for improvement here.

Another significant trend is the growing shift in the focus of
health care from illness to wellness. By identifying health risks and
adopting strategies to reduce, eliminate, or reverse these risks be-
fore they require treatment, employers can reduce their health care
costs overall, while maintaining the employee’s quality of care.


120

government to keep its promise of comparability. Since 1981,
federal employees and retirees have given up more than $175
billion in lost wages and benefits’ for purposes of deficit
reduction.

The failure to deliver on the promise of comparability
between federal and non-federal pay has not been a bargain for
taxpayers. As the federal workforce ages and is downsized,
retirements will force the government to recruit new employees to
take on a workload which is increasing in size and complexity
To be successful in recruiting and retaining a high quality
workforce, the government will have to offer pay which is
competitive with that offered in the market. If the government
continues to refuse to follow even the slow path to comparability
set forth in FEPCA, it will have undermined its own objectives,
at the same time it has undermined the living standards of two
million federal workers.

Private corporations typically have an explicit or implicit
compensation strategy regarding their own pay levels relative to
the prevailing rates. It is not unusual for large corporations
to set their pay targets above or beyond average competitive
rates in order to maintain world class leadership in keeping
skilled employees. By contrast, the federal government policy
has remained constant over the last 50 years to pay workers
somewhere near the average or mid-point of rates paid workers in

the same labor pool.

17


19

HEALTH INSURANCE

+ Currently, a majority of workers receive health insurance through their employers.2
‘Over 60 percent of nonelderly Americans participate in an employment-based health
plan, The employment-based health system has been evolving since World War II,
with employers being very active in the development and implementation of cost
‘management strategies.

‘+ Employers’ use of cost management strategies in health care has become more
prevalent as a result of the growth in employment-based health insurance, third party
reimbursement, and technological advances. Responding to rising health care costs,
‘employers have moved to managed care, which can be defined as any type of
intervention in the provision of health care services or reimbursement of health care
providers that is intended to provide health care services in the most efficient
settings. These interventions not only include the movement of individuals into
health maintenance organizations (HMOs) but also include increased employee
contributions for health insurance premiums and increased cost sharing in traditional
fee-for-service health insurance.

+ Firms have been increasingly requiring workers to contribute to health insurance
premiums and subjecting them to direct out-of-pocket provisions. In 1979,
‘employers fully paid for single coverage health insurance for 73 percent of full-time
workers employed in medium and large private establishments. By 1993, only 37
percent of workers had their individual coverage fully paid for. In 1979, employers
fully paid for family coverage health insurance for 54 percent of full-time workers
employed in medium and large private establishments. By 1993, only 21 percent of
workers had their family coverage fully paid for.3

+ There has also been a simultaneous increase in the cost-sharing provisions of
traditional fee-for-service health insurance (table 4). In 1992, 26 percent of
surveyed employers required a deductible of over $200, up from 11 percent in 1989.
In 1992. 65 percent of employers required coinsurance of 20 percent for inpatient

2 In 1993, $4.2 percent of workers aged 18-64 received health insurance coverage from their employer. See Sarah
Snider and Pau! Fronstin, “Sources of Health [nsurance and Characteristics of the Uninsured: Analysis of the
March 1994 Current Population Survey,” EBRI Special Report SR-281Issue Brief no, 158 (Employee Benefit

Research Institute, February 1995).

8 US. Department of Labor. Bureau of Labor Staustes, Emplovee Benefits in Medium and Large Firms, 1979-
1989 (Washington, DCU S. Government Printing Office, selected years): Emplovee Benefits in Medium and
Large Private Establishments, 1991 and 1993 (Washington, DC: US. Government Printing Office, 1993 and

1995)


14

Another realm that was asked about in your testimony was the
growth of cafeteria plans and choice plans. So-called full cafeteria
plans continue to be relatively, should we say, non-extensive, about
12 percent of private sector workers with full choice plans.

Flexible spending accounts have been, on the other hand, quite
fast in growth, about 50 percent of private sector employees with
so-called health care flexible spending accounts. For child care ac-
counts, the State and local sector actually has more flexible spend-
ing accounts than does the private sector.

Finally, the issue you raised of taxation of private sector and the
Federal role of benefits, employers have explicitly designed their
programs over the years to take into consideration public programs
and public policy. Direct integration with defined benefit and de-
fined contribution plans relative to Social Security has always been
present in the private sector, and increasingly so today.

Medicare has been reflected as a program to build around. Very
few private employers provided any retiree medical benefits until
Medicare came into existence in 1965. It is as Medicare has been
cut back in the last 10 years and as discussions continue of cutting
it back further that employers are cutting back their commitment,
as well.

The dramatic growth of the 401(k) plans, the dramatic growth of
health insurance, and flexible spending accounts are all examples
of response to explicit vax incentives and an attitude of employers
that if there is a tax advantage to the individual, then it is, in es-
sence, an obligation of the employer to pass that tax preference on
to the individual.

The revenue acquired through taxes to support public employee
benefit programs has not had any direct impact on employers to
date, but if we were to see significant increases in payroll taxes for
pensions and Medicare, we could expect to begin to see some offset
prospectively.

In conclusion, Mr. Chairman, I note that employers have spent
decades building a structure of employment-based employee bene-
fits to assist workers in planning lifetime economic security.

The end of paternalism in the wake of family control of enter-
prises and the rise of the global economy and global competition
have begun to shape many changes in the private employee bene-
fits system. As your invitation letter noted, the same is beginning
to occur in the public sector workplace, particularly at the State
and local level.

As the Congress deals with the future of Social Security, Medi-
care, public employee benefits, and issues such as tax reform, we
can expect significant secondary effects on workers and the struc-
ture of their compensation packages. These changes may never be
sufficient to stop legislative actions from being taken, but they
should always be considered as policy is being designed and as im-
plementation schedules are contemplated.

I very much appreciate the opportunity to appear today. It has
been a pleasure to work with this committee for more than 20
years, and I look forward to that opportunity in the future.

[The prepared statement of Mr. Salisbury follows:]


3

Our second panel will be led by Abe Zwany, who will testify on
the basis of the Hay Group’s consulting experience for private sec-
tor corporations. The perspective of Federal unions will be rep-
resented by the president of the American Federation of Govern-
ment Employees, no stranger to our subcommittee, Mr. John
Sturdivant. Our last witness is Wendell Cox, a consultant who will
examine the relationship of private sector compensation practices
to the public sector.

I look forward to the testimony of our witnesses today and hope
that we can give a thorough examination of the options and various
obstacles that confront private sector employers as we formulate
employee benefit packages and look at alternatives for the Federal
work force.

[The prepared statement of Hon. John L. Mica follows:]


132

(CHANGE IN AVERAGE ANNUAL EMPLOYEE COMPENSATION:
1980 To 1993

[1980 | 1993 | Change [

Private Employees

Wages & Salaries $27,557] $28,907] $1,349 +4.9%
Employer Paid Benefits $5,093 | $5,721 $627 | +12.3%
Total $32,651 | $34,627[ $1,977 +6.1%

State & Local Government Employees
Wages & Salaries $26,492 | $30,039] $3,547] +13.4%
Employer Paid Benefits $5,559, $7,931] $2,373 | 442.7%
Total $32,050| $37970| $5,920] +18.5%

Federal Non-Military Employees
Wages & Salaries $36,406 | $39,024] $2,617 +7.2%
Employer Paid Benefits $6,759] $13,868] $7,110] +105.2%
Total $43,165 | $52,892] $9,727] +22.5%

Compared to Private +322% | +52.7% | +3920%] +268.9%

Inflation Adjusted (1993$}) Full time equivalent employees
Caleulared from National income & Product Account data

But there's more. Federal employees are granted paid leave of at least 10 days more annually
than can be justified by the federal work force composition. When applied to the 53 percent
differential above, the federal compensation advantage becomes 62 percent

Then there is the nearly $1 trillion in unfunded federal civilian pension liabilities. These are
payroll expenses that do not show up in federal compensation figures but which must be
paid, OPM estimates that a 40 year amortization of unfunded federal civilian pension would
add another 20 percent to federal compensation costs relative to wages and salaries

There are other advantages of federal employment. For example

Virtually all federal employees are eligible for severance pay compared to less than
40 percent of private sector “white collar” workers.


110

Changing the financing formula for FEHBP into a cash voucher
whose purchasing power for health care or health insurance would
diminish in value every year is not only an open-ended
compensation cut for federal employees, it has no precedent in
the private sector. To the extent that the purpose of
compensation policy is to enhance the government’s ability to
recruit and retain the very best people in a competitive job
market, this change in the FEHBP is a federal recruiter's
nightmare

Another legislative proposal considered this year would have
deprived the Office of Personnel Management (OPM) of the right to
negotiate the terms of contracts with insurance carriers who wish
to participate in the FEHBP. This misguided proposal would have
the dubious distinction of giving the government and the
taxpaying public less bang for more bucks. The FEHBP is the
largest employer-sponsored health insurance program in the
nation, which gives the government the opportunity to exercise
tremendous bargaining power over the rates it and federal
employees pay for health insurance, Mandating minimum levels of
coverage mitigates the destructive and costly effects of adverse
selection, which tend to occur in a competitive system like
FEHBP’s when there is no intervention to try to normalize benefit
levels. Only when plans offer similar benefit packages does
competition proceed on the basis of price and quality, and

therefore promote cost containment and the interests of


69

programs. In fact, the growth of health plan expenditures has had a depressing
impact on the resources available for retirement benefits. The interdependence of
plans is reflected in this and many other ways. The payroll and other data
collected for one plan typically are essential for the administration of other plans.
There is considerable overlap in the skilled personnel used to manage retirement
and welfare benefit plans. This interdependence is likely to grow, representing a
practical reality with which employers must contend and which policymakers
should accept.
Conclusion

The above represents a brief overview of the benefits programs that private
sector employers currently offer their employees, with discussion of the trends that
are occurring, and will continue to occur, in these plan areas. | would be glad to
answer any questions that the members of this subcommittee may have on my

remarks.


24

‘workers, particularly those in small firms, now have a defined contribution plan, very likely
2 401(k) plan, when in the past they likely would have had no employment-based retirement
plan. In addition, shorter service workers (the majority of the work force) will gain more
benefit from a defined contribution plan than they would from a defined benefit plan.

Managerial Considerations

+ Traditional defined benefit and defined contribution plans have their relative merits and
drawbacks in terms of their use as management tools. Within legal and cost constraints,
employers design pension plans to match their management goals for attracting a specific type
of worker, retaining workers for a desirable time period, and encouraging them to leave or
retire at a specified age or afier a specified amount of time.

+ Employers are able to provide employees with a moderate, but predictable, retirement benefit
with a defined benefit plan because retirement income is independent of investment
performance. In a defined contribution plan, even though employers can structure
contribution schedules to meet target levels of retirement income, the actual benefits at the
point of retirement, or separation from service, can be far below or far above the target,
depending on the investment experience and the level of contributions.

‘+ Defined benefit plans allow employers to influence retirement and job tenure by including
specific provisions such as normal and early retirement age, benefits accruing afier retirement
age, and vesting schedules, Defined contribution plans are retirement neutral; they allow
employers to influence job tenure through vesting schedules, but their ability to control
retirement age is limited.

+ In this era of continued corporate downsizing, employers often find it highly desirable to be
able to reduce their work force on a voluntary basis by offering incentives through a defined
benefit pension plan. Early retirement incentives are a more positive way to reduce the labor
force than involuntary work force reductions, Employers desiring this type of retirement
incemtive flexibility through a qualified retirement vehicle are virwally forced to adopt
defined benefit plan as opposed to a defined contribution plan

+ In addition to encouraging retirement, pension plans may also be used to attract and retain
employees. Employers attempting to attract younger, more mobile workers would be more
likely to choose a defined contribution plan, while employers attempting to retain workers for
longer time periods would be more likely to offer a defined benefit plan. Since benefits in
defined benefit plans accrue at a slow rate for the initial years of service and accrue at faster
rates for older employees with more service, they reward long-tenure employees. Defined
contribution pans do not cause large benefit losses for mobile employees, assuming that each
of their employers has an equally generous plan.

10


143

GAO's CONCLUSION IS ERRONEOUS

GAO concludes that “In some areas that the authors cite as federal advantages, the available
evidence suggests the opposite.” This is simply wrong. In no case did we cite a factor as a
‘federal advantage for which evidence suggests otherwise, and no such example is cited by
GAO.

Finally, in contrast with GAO"s conclusion, the fact that our excess value estimate captures
the minimal size of the federal excess value is unquestionable (even though no such federal
specific conclusion was stated in the paper). The $0.9 trillion federal civilian unfunded
pension liability, which would require annual payments of 31 percent relative to federal
wages and salaries to retire over 40 years far exceeds any conceivable private advantage with
respect to the non-quantified factors. (Private pension under funding per employee is less than
0.5 percent of federal pension under-funding per employee.)

‘THE GAO REPORT IS UNBALANCED

GAO's criticism is not balanced, because it considers only issues that would reduce the
excess value estimate. For example, GAO failed to note that we could have justifiably used a
marginal rather than average income tax rate with respect to the tax free value of excess
federal paid fringe benefits. GAO further failed to note that our general conclusion that the
non-quantified factors would further increase the excess value estimate would have been far
stronger if we had referenced the unfunded federal pension liability. Finally, GAO failed to
point out that our use of private sector average compensation as a base, rather than the
substantially higher federal non-military compensation skewed our dollar estimates of federal
advantage downward. A balanced report would have considered both elements that would
decrease and increase our excess value estimate.

THE GAO ANALYSIS Is IMMATERIAL TO OUR CONCLUSIONS

America's Protected Class: The Excess Value of Public Employment was not offered as the

last word in valuing public employment --- it was rather meant to serve as a first attempt to
value factors that are routinely excluded from analysis by the federal government and state

and local governments. The facts remain:

©The federal government determines non-military pay without quantifying the value of
a number of factors of employee compensation.

= The value of the excluded factors is considerable
= Inthe aggregate, the value of federal employment exceeds market value. Indisputable

evidence of this is the far higher average tenure of federal employees relative to their
private sector counterparts.


10

federal sector. But what | am suggesting is that we recognize
and appreciate the differences in private and federal
employment and seek to seamlessly integrate, not force,
private-sector principles into the framework of government.

1 feel strongly we will learn a lot from our witnesses
today, and | look forward to their testimony.

Again, | thank Chairman Mica for calling this hearing.


141

GAO EVALUATION QUESTION #4:
Is the Available Evidence Sufficiently Compelling to Assert Advantages to Federal
Employment in Areas Where Sector Comparisons are not Quantified?

RESPONSE:
GAO has unfairly attributed to us and evaluated a conclusion that we did not make.

We cited 12 additional factors that are generally advantages of public employment, but which
are not easily quantified. These factors were not analyzed in detail, in that they were not
critical to our excess value analysis. Yet GAO devoted considerably more space to their
analysis of this secondary issue than any of the other three.

GAO made a fundamental logical error with respect to this section of our report. Our
conclusion is that the 12 factors, in the aggregate, produce a net advantage for public
employees in relation to private employees. GAO analyzes this section as if we contended
that all 12 factors produce a federal advantage. We did not, As a result, GAO's analysis of
this section is largely irrelevant. Nonetheless, some further comments are appropriate.

GAO Pornt:
Comparisons Should Be Based upon Data from Both Sectors.

RESPONS!
Our comparisons are based upon data from both sectors.

GAO's criticism is simply wrong. Virtually every factor listed was selected based upon an
analysis of information from both the public and private sectors. GAO implies that we should
have analyzed each of the 12 factors in much greater detail. This was not our intention.

GAO's two cited examples do not survive scrutiny:

. GAO's criticism with respect to productivity is both irrelevant and wrong. It is
irrelevant because the Reinventing Government initiative (which we used to estimate
the potential for productivity improvement) is improving federal government
productivity. It is wrong because we did consider data from the private sector --- the
evidence with respect to productivity improvement through the use of private service
providers (privatization).

= GAO's criticism of our severance pay discussion is also incorrect. Out claim is that
some governments provide generous severance pay. The term “generous” is used to
compare public severance pay with private. Generous severance pay is indisputably a
‘federal advantage in that it is available to virtually all federal employees, but is
available to less than one third of private employees.


29

future effect on employers will primarily come from the massive unfunded liability of public
pension and retiree medical programs as they are paid for in the future.

+ The revenue required to pay for Social Security and Medicare has had a major effect on total
compensation packages and on the funds employers an¢ workers have available for funding
their own pension and retirement savings programs. Should payroll taxes continue to rise,
employers and workers can be expected to cut back on private pension savings as well,

CONCLUSION

Employers have spent decades building a structure of employment-based employee benefits to
assist workers in planning lifetime economic security. The end of patemalism, in the wake of the
end of family control of enterprises and the rise of a global economy, have begun to shape many
changes in the private employee benefit system. As your invitation letter noted, the same is
beginning to occur in the public-sector work place. As the Congress deals with the future of
Social Security, Medicare, public employee benefits, and issues such as tax reform, we can
expect significant secondary effects on workers and the structure of their compensation
packages. These changes may never be sufficient to stop legislative actions from being taken,
but they should always be considered as policy is being designed and as implementation
schedules are contemplated.

I very much appreciate the opportunity to appear today. It has been my pleasure to work with
this committee for over 20 years, and I pledge the availability of myself and the Employee
Benefit Research Institute in the years ahead as you seek to deal with these major economic
issues.



98

dropped steadily to 64% in 1995. The prevalence of defined benefit pension plans varies
by company size with 82% of firms with over 10,000 employees providing a plan
compared to only 45% in firms with fewer than 500 employees.

In contrast to the decline in the defined benefit pension plan, employers have been
adopting and improving capital accumulation (defined contribution) plans in significant
numbers in the last decade. In 1985, 72% of companies had one or more capital

accumulation plan, compared to 98% in 1995.

Capital accumulation plans appeal to mobile employees because they understand them
better and value having an individual account balance. In addition, these plans are
portable; that is, they can be rolled over into an IRA and sometimes a subsequent

employer's plan.

Employers have also used benefit plans to offer early retirement “windows” where
employees are provided a financial incentive to retire early. This reduces labor costs and
allows for promotional opportunities. In 1995, twelve percent of HHBR participants
reported offering an early retirement window in the last 12 months, compared to 15% in
1994, 16% in 1993, and 17% in 1992.

In addition to the retirement changes, employers have refocused their programs away from
‘fixed security to benefit choices where non-security benefits, e.g. paid time off, might be

selected


140

GAO Point:
Approach to Valuing Factors Requires Justification

RESPONSE:
This is unfair. These GAO comments evaluate our work based upon its objectives, not ours.

GAO's lengthy analysis of this issue misses the point. Our purpose was to estimate the value
of employer payments made on behalf of employees over a career. Based upon this objective,
our valuing of each factor was consistent and appropriate. GAO's analysis is based upon
objectives that we did not seek to achieve.

One GAO comment deserves special attention: "If the value to the federal employer is equal
to the value to the employee, then one would not interpret this situation as one of excess
value.” This is patently incorrect. Market value can only be established in the market.
Federal employee compensation is established outside the market. A non-market employer has
no mechanism for determining market value, and this is especially true with respect to the
federal government, which compels its revenues from the public (through taxes, borrowing, or
monopoly prices). Where employee compensation exceeds market rates, then there is excess
value. On average, federal employee compensation is above market rates, and excess value is
thus present.

GAO EVALUATION QUESTION #3:
Is the Assumption of Equal Starting Salaries for the Federal and Private Sectors
Reasonable?

RESPONS!
This criticism is unfair. We provided a number of assumptions with respect to starting
salaries, all within the range of published studies.

GAO has misrepresented our research with respect to this issue. Federal and private
salaries were assumed to be equal only for the purpose of calibrating our model, Specific
examples of excess value calculations are provided for an array of starting salary assumptions
(private higher than federal, equal, and federal higher than private), and are illustrated in
charts in the Appendix to this testimony. Our low assumption used the President's Pay
Agent's estimate of a 22.3 percent federal pay gap. Our high estimate used a report that found
a 3.1 percent federal pay premium. Other reports have found as much as a 17 percent federal

pay premium. Any assumption within this wide range of federal-private salary disparity would
have been reasonable



91

1 spot

Note that the programs in which employees have no pay at risk (e.g., one-
awards, profit-sharing plans and suggestion programs) are particularly popular, while the
mote innovative and demanding programs (e.g., team-based pay, gainsharing, pay for
quality, and pay for competencies) are less well accepted

Innovative Programs and Performance

Not surprisingly, there is no strong relationships between program acceptance and
program effectiveness. For example, spot awards, suggestion programs, and profit-
sharing programs -- which are popular with employer and employee alike -- are not
perceived by human resources professionals as helping improve performance (see figure
below).

Has Program Helped Improve Performance?

Special One-time “Spot” Awards
(after-the-fac)

‘Suggestion/Proposal Program|
(casiveash eq, awards]

Group Incentives

Profit-sharing|
(Xclusive of retirement programs)

Pay for Competencies

Special Key Contributor
Programs (before-the-fact)

Pay for Quality

Gainsharing (productivity based

‘Team-based Pay

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Percent of Organizations Responding
oo
Yes No Can't Tell

‘Source: Hay Compensation Conference Report



11

Mr. Mica. I thank the gentlelady and want to assure our panel-
ists and our audience, for the record, that we don’t intend to scare
any Federal employees, and whatever hellboil we brew, we hope
doesn’t burn anyone. So with those Halloween comments in mind,
we'll proceed and welcome our panel.

Our first panel is Dallas Salisbury, president of the Employee
Benefits Research Institute, and Jeannine Strandjord. She is vice
chair of the Employee Benefits, Financial Executives Institute; and
Peter Kelly, for the U.S. Chamber of Commerce.

To our witnesses, this is an investigations and oversight sub-
committee. It’s the custom to swear in our panelists and witnesses,
so if you'll stand and raise your right hands.

[Witnesses sworn.]

Mr. Mica. Thank you. The record reflects that they answered in
the affirmative.

We'll start with your comments, Dallas Salisbury. I might add
that you can submit an entire statement or commentary for the
record. However, we like our panelists to summarize in about 5
minutes, and that gives us the opportunity for some discussion.
With that you’re recognized, Mr. Salisbury.

STATEMENTS OF DALLAS SALISBURY, PRESIDENT, EMPLOYEE
BENEFIT RESEARCH INSTITUTE; JEANNINE STRANDJORD,
VICE CHAIR, EMPLOYEE BENEFITS, FINANCIAL EXECUTIVES
INSTITUTE; AND PETER KELLY, CHAIRMAN, QUALIFIED
PLAN SUBCOMMITTEE, U.S. CHAMBER OF COMMERCE

Mr. SALIsBuRY. Mr. Chairman and members of the committee,
it’s a pleasure to be here this morning. I would ask that the full
submission I’ve made be included in the record of the hearing.

Mr. Mica. Without objection, so ordered.

Mr. SALISBURY. Thank you. EBRI has been committed to working
with the Congress, since its founding in 1978, on these issues. We
took great pleasure in working with this committee and other com-
mittees of the House in the early 1980’s, looking at private sector
practices and their applicability to the public sector in redesignin,
the Federal Employee Pension Plan and in creation of the Federal
Employee Thrift System.

ose changes, as well as much of what is taking place in terms
of employment today and the criteria employers use, reflect some
of what you said, Mr. Chairman, in your opening statement, that
the bottom line is productivity.

The bottom line is a total compensation package that will be suf-
ficient to attract, motivate, retain, and then, ultimately, to have in-
dividuals leave the work force at an appropriate point in time.
Cash compensation, as with the Federal Government, is the base
in all of these cases.

There has been an increasing movement in the private sector to-
ward at-risk or incentive compensation being built on top of that
basic cash compensation, and, as you noted, focus on a total bene-
fits package that will provide for a healthy work force with low
rates of absenteeism. This has been the primary motivator toward
a very strong health insurance system in the private sector, as well
as disability insurance.


97

Family Oriented Benefits

hid Care

Empbyee
Assistance Program I =
oa
Flexible Hours |
Dependent Care fy a
Days =
Living Benefits -

pole Pena
eer:

Job Sas
va Foam Hl oe
Adoption Expenses:
‘Work-at-Home Policy

Long Term Care

Benefit programs were initially designed with a long service orientation under the
assumptions that many employees wished a career with one company and that the
employer could offer reasonable job security. Such benefits included defined benefit
pension plans that focused benefits on long service retirees, strong replacement income
protection in the event of death and disability, family medical benefits, and service-based
benefits.

The current employment environment is very different with a mobile workforce (although
less so during economic downturns). Moreover, many companies are no longer willing to
make commitments to job security as they manage their costs to succeed in very
competitive domestic and international markets.

As a result, companies have changed benefit programs to be attractive to a more mobile
workforce. The most significant change has been in the area of retirement benefits. In
1985, a full 87% of HHBR participants provided a defined benefit pension plan. This has

7


102

Mr. Mica. Thank you, Mr. Carter.

Mr. CarTER. Look at that timing.

Mr. Mica. Fantastic. I would like to welcome back Mr.
Sturdivant, who put everything on the table last time and is back
to offer another deal. Welcome back.

Mr. STURDIVANT. Thank you, Mr. Chairman. I am glad to be
back, glad that you invited me. I’m John Sturdivant, president of
the American Federation of Government Employees, one of your
friendly employee groups, speaking on behalf of our members and
the people that we represent.

My staff has prepared a well-researched and scholarly testimony
that I can’t add anything to it, so I would just ask that it be en-
tered into the record.

Mr. Mica. Without objection, so ordered.

Mr. SturpIvanr. I would just, maybe, have a few comments,
with the idea that, perhaps, after we hear from the other panelists,
we can engage in some give-and-take. I was heartened by your
comment earlier that the purpose of these hearings is to improve
civil service benefits. Once you and I can agree on what “improve”
means, then perhaps we can put something else on the table.

I would just say, though, that given, as you know, we have been
having these discussions all year on various benefits of Federal em-
ployees, and I believe that, at the beginning of the year, you start-
ed out with the position that we had too much, and I started out
with the position that we had too little, perhaps, with some dialog,
we can reach some understanding of just what we have.

I would suggest that, when we are looking at the Federal Gov-
ernment, we compare the benefits with a large private sector high-
performance workplace, someone like Xerox, AT&T, IBM, Marriott,
or even some States, such as New York City or California. After all,
the Federal Government is the largest employer in this country,
and we have people who do all types of work.

We have people who are researching and looking for a cure for
cancer and AIDS. We have people who are working on sophisti-
cated military equipment. We have people who are involved in
making sure that Social Security beneficiaries get their checks on
time. We have individuals who are making sure that drugs and
contraband do not get in the country.

And, of course, we want to retain and recruit the most highly
qualified, the most competent, the most highly innovative employ-
ees that we can.

We do not want to compare the compensation system—and al-
though I don’t have anything against McDonald’s or 7-11, we don’t
want to compare the compensation system with those types of em-
ployers or some mom-and-pop store. These are not individuals who
are flipping hamburgers, although I do have some members who
flip hamburgers, and I would submit that, under the current wage
grade system, they are not paid right, either.

I would also point out, Mr. Chairman, that on health insurance,
I think it’s well settled—and I’m sure that there will be some dis-
agreement—that, basically, the Federal Government pays $1,100
less than the average private sector employer.

On pay, I thought—in 1970, we had a good, bipartisan agreement
between a good Republican President and a good Democratic Con-


pbt:)

was a broadly supported bipartisan effort which reaffirmed that
federal employees’ pay should be comparable to nonfederal sector
pay in order to recruit, retain, and motivate a highly skilled
professional workforce which is responsible for carrying out the
vast array of duties and responsibilities on behalf of all
Americans

Under FEPCA, federal pay is compared to that of non-federal
{including employees in state and local governments) employees
rather than only those in the private sector. The annual
government adjustment has been separated into two components, a
national and a local adjustment. The national component is
designed to prevent federal salaries from falling further behind
nonfederal sector salaries. This is accomplished by linking the
annual governmentwide increase to the percentage increase in the
Employment Cost Index (CI). Locality adjustments are to be made
based on pay disparities in local labor markets. Under the law,
the pay disparities are to be eliminated over a nine year period.
This pay setting process relies directly upon a position
comparison method for gathering and interpreting the data needed
to determine local pay comparability. The nonfederal pay data is
compiled from annual Bureau of Labor Statistics Occupational Pay
Surveys

While current federal pay policy under FEPCA has its
critics, AFGE believes that the pay comparability principle is
the soundest method of setting salaries for the government's

approximately two million workers. FEPCA has made major

as


65

important role in the financing of changes in corporate ownership between
different groups of investors or between different generations of the same family.

There are many ESOP success stories. There are also disastrous ESOPs or
ESOP disasters in the making. Because such programs offer a unique method for
changing business ownership and diffusing ownership among an employee group,
there appears to be no question that ESOPs are here to stay. However, celebrated
cases of ESOP losses will fuel pressure for reforms. Depending on the strength of
‘the public outcry, those reforms could be excessive and threaten the use of ESOPs
as a viable business financing technique.

d. Retirement Plan investment Trends. Throughout the post ERISA
enactment period, retirement plans have been the most important single source of
investment capital in our financial markets. This role is not likely to change
anytime soon. The increasing awareness of the importance of retirement plans has
been accompanied by an alarming rise in reports of investment losses stemming
from careless, fraudulent, or criminal conduct. This has been particularly
noteworthy during periods of economic hardship. The large size of many
retirement plans and the complexity of the investment techniques used by those
plans has contributed to the risk of such losses. There will likely be a trend toward
higher standards of fiduciary behavior and more safeguards to prevent such losses.
This will be marked by increased reporting obligations and greater financial
controls. Hopefully, federal regulators will not lose sight of the limited resources

available to small employers when crafting reporting requirements for plan


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16

financial disaster. Health insurance is the second most important employee benefit in the
eyes of workers

+ Employers also seek to design programs that allow individuals to retire (work force exit)
During the earlier age of paternalism and family-owned enterprise, these programs were
primarily focused on those who were stil! working for an employer at the point of reaching
retirement age. That has changed with the effective end of family ownership and
management of large enterprise, combined with federal law that “vests” workers in the value
of pensions as benefits accrue. Early vesting, which carried a high cost, caused employers to
focus clearly on the relatively small number of full career workers they had, and the high
rates of turnover among most workers. The complex web of legal and accounting standards
that make it nearly impossible for an employer to promise retirement income or retiree health
benefits without immediate understanding of what those benefits will cost has also led to
change. The legally required move from pay-as-you-go to advance funding of pensions, and
the accounting-motivated move for retiree health recognition, have caused a much greater
focus on cost: significant redesign of benefit programs: and a growing recognition of the
amount that individuals must save for themselves in order to achieve economic security in
retirement

‘+ Employer recognition of economic and business instability (boom and bust cycles) has
combined with full recognition of the cost of noncash employee benefits and recognition of a
highly mobile work force to move the employer focus from worker exit at retirement age to
facilitation of worker exit whe.. “=r economic circumstances require. This employment-at-
‘will doctrine is changing the face of both employement and employee benefits. Many large
private employers are only now at the stage of thinking through what this change means, as
baby boomers move into senior management positions to replace those who grew up in the
paternalistic work place. These employers are beginning to structure their benefit packages to
conform with work force mobility. The “golden handcuff” pension plan is seldom seen as.
desirable as we progeess into this new age of rewarding talent versus tenure

Employer Costs Per Hour Worked for Employee Compensation in the Private
Sector

Establishment Size

+ In March 1995, wages and salaries averaged 71.6 percent of employer costs for employee
compensation, while benefit costs averaged 28.4 percent (see table 1). Included in the 28.4
percent in benefit costs: 6.4 percent of compensation was in the form of paid leave, 6.7


160

the name of deficit reduction and serves to increase, not decrease

the differences between public and private sector pension plans.

In a June, 1995 study comparing federal and private sector
retirement benefits, the Congressional Research Service (CRS)
points out that because federal workers covered by the CSRS program
are required to make retirement contributions that the majority of

their private sector counterparts are not, CSRS is less generous

for the typical federal employee, following a typical career path,
than retirement plans provided in the private sector. (Federal
Civil Service Retirement: Comparing the Generosity of Federal and
Private-Sector Retirement Systems, June 5, 1995) Despite the
actions just taken by this Congress, this study shows beyond a
shadow of a doubt that federal workers are already being asked to
contribute too much toward their future pensions, not too little as

some in this body might suggest.

Although the CRS study finds that the newer FERS retirement
system can be said to provide somewhat more generous retirement
benefits than the private sector plans to which it was compared,
the relative generosity vanishes upon closer examination. FERS is
an immature system and drawing comparisons between future benefits
it might pay and a similar private sector plan requires assumptions
concerning federal pay. For purposes of their report, "It was
assumed that the employee would have the same promotion pattern as
today’s retiree and that Federal salaries would grow at the same

rate as average wages in the economy." This assumption is


99

Cost Containment and Orientation to Company Performance

Employers have been actively involved in cost containment efforts. Much of the focus has
been on health care benefits cost containment. The major emphasis in the last five years
has been to move away from traditional fee-for-service (FFS) plans to managed care plans:
preferred provider organizations (PPO), point-of-service plans (POS), and health
maintenance organizations (HMO). The table below shows the significant movement
away from FFS plans to managed care in the last five years. The chart shows the

prevalence of employers’ “primary” plan, defined as the plan with the highest percentage

of participants. Since 1991, the prevalence of FFS primary plans has been cut in half.

Design of Primary Medical Plan

80% ee ames

70% 2 ee

ms a ee

Som | 1991

40%

* 1902
1989

20% 1994

10% 1995

0%

Companies are also increasingly orienting benefits to company performance and
ownership. Almost half (47%) of for-profit companies have one or more performance-
based capital accumulation plan. Indeed, 10% have more than one, Twenty-three percent
offer a deferred profit sharing plan and 13% have a profit-based match to a 401(k) plan
Thirteen percent have Employee Stock Ownership Plans (ESOPs) while 11% have

19


21

suggest there is a potential for savings. For example, AT&T was able to reduce its
annual growth rates for medical expenses from 12.9 percent in 1991 to under 5
percent in 1992 because they moved their workers into POS plan. In 1991, the
Pacific Telesis Group moved their fee-for-service enrollees into POS plans and
reduced its annual growth rate from 12 percent to 5 percent. Surveys of their
employees found that they were generally satisfied with the system once they
understood it.

* In 1991, Cincinnati Bell, General Electric Aircraft Engines, Proctor and Gamble,
and the Kroger Company formed a health care coalition to increase bargaining power
for discounts with area hospitals. monitor quality improvements, and search for
other ways to control costs. Annual savings in the Cincinnati area have been
estimated at $75 million for all private and public payers of health care because of a 5
percent decrease in the average charge per patient and a 10 percent decrease in the
average hospital length of stay. This coalition has now grown to over 120
employers and a new agreement was just signed to provide for quality standards and
‘a more coordinated community move to managed care.

+ Coalitions have also been formed in Denver, CO; Memphis, TN; Cedar Rapids, 1A;
Houston, TX; Minneapolis, MN; Kingsport, TN; and many other cities. The
activities of these coalitions have varied greatly, including the selection of preferred
providers on the basis of efficiency, assistance in the purchase of cardiovascular
care, the provision of mental health and substance abuse programs al reduced rates,
the enactment of healthy lifestyle programs for adults and children, and the provision
of small business insurance options. These coalitions are successful in reducing
expenditures on health care because they create a competitive market with sound
economic principles such as volume purchasing and competitive bidding.

+ States have responded to growing health care costs not only as government entities
but also as employers. ‘The California Public Employees’ Retirement System
(CalPERS) has had success with its own purchasing cooperative for health care
services. CalPERS experienced premium decreases in both 1994 and 1995 by
negotiating more aggressively with health care providers and asking HMOs to forgo
rate increases; the state introduced a standard benefits package in 1993, requiring
copayments of its employees.

Danae A. Manus, Rober J. Strub, and Thomas R. Werner, “The Cincinnati Inivative,” Managed Care Quarterly

Winter 1994y 20-26,


50

compressed work weeks, telecommuting, job sharing and allowing staff co work
permanently on a parc-Cime basis are becoming common components of corporate
benefits programs. In 1992, CEB conducted a survey of FEI members during the
Family and Medical Leave act debate, and found that 63 percent of respondents
offer their employees some form of flexible working hours. Additionally, 30
percent allowed employees co work a compressed week, 0 percent have employees

who telecomm

27 percent offered job sharing; and 86 percent had permanent
part-time positions available

Clearly there has been a move in the private sector toward greater
Flexibility in working arrangements. Experience has demonstrated that not
only have such policies improved productivity, they make employers more
“competitive” with respect to recruiting and retaining high-quality employees

Po.

ies such as these create a win/win situation because they are highly
desirable to employees: and can be offered at Jiccle or no cost to the
employer. Alternative work arrangements are particularly usefully employed by
smaller businesses, as they allow smaller businesses to compete on a more
equal footing with large corporacions.

The last benefit I wanc co comment on is dependent care, Although
employer-provided day-care facilicies are rare in all but very large
companies; many employers offer other forms of dependent care benefits. These
can range from resource and referral services, to employer-arranged discounts
with local child care providers, to dependent care spending accounts. Among
these, spending accounts are by far che most common, Dependent care spending
accounts allow parents to set aside pre-tax dollars to provide for their child
care needs. CEB’s survey found chat 61 percent of companies offered dependent
care spending accounts and that they were the most popular element in che

benefits package chose companies offered. Spending accounts and referral


95

There are differences by industry, size and region. Chemical/petroleum, financials,
utilities/transportation and heavy manufacturing companies have the highest benefits cost
levels while high technology and service organizations have the lowest levels. As one
would expect, cost levels generally increase with firm size. Cost levels are highest in the
northeast, mid-atlantic, central and western regions and lower in the south and plains

states.

‘As part of our ongoing benefits consulting services to the Congressional Research Service,
Hay has conducted comparisons of private sector and federal benefits. Our most recent
comparison conducted in February of this year, showed the following major findings:

© Federal benefits are higher in aggregate than private sector employer benefits.

© The federal advantage in retirement/savings benefits is the major reason for the overall
advantage.

© Federal vacations and holidays are higher than average private sector practice.

* Federal health care benefits are lower than private sector average practice due to

higher than typical federal required employee premium contributions.

Orienting Benefits to Workforce Needs

Earlier in the century, employers generally developed their initial benefits program to meet
the needs of a long service male employee with a non-employed spouse and dependent
children. In the last two decades, most employers revised their programs to better meet

the needs of a diverse workforce.

‘One change has been the move to flexible(flex) or “cafeteria” benefits. One type of
flexible benefit is the flexible spending account. These accounts allow employees to

15


Individual Deductible
Amount

$100 or less
$150

$200
Over $200

Coinsurance Rate

0%
10%
15%
20%
25%
Other

Coinsurance Rate
Physician Visits

0%
10%
15%
20%
25%

Employee
Qut-of Pocket
Maximums

<$1,000
$1,000-51,499
$1,500-$2,499
$2,500-$4,999
$5,000+

33

Tabled

Percentage of Employers With Cost-Sharing Provisions,

1989
40%

29
i

1989

eyreg

1989

35%
38
2

4

2

by Level of Cost Sharing and Year
for Traditional Indemnity Plans

Inpatient Care
1990

25%
5

2
65

2

6%

Rena

1991

34%

28

199)

30%
3»
Pr
6

2

1992 1993 1994
29% 29% 16%
B 6 10
2 2 OM
% 3640

Major Medical
1992 19931994
25% 6% 5%
4 na
2 wa
65 87 8B
1 n/a

7 8

1992
5%
4
2
8
1
1992 1993 1994
28% 27% 21%
38 Ow
%® 2 w
6 8 4
205 05

Source. A. Foster Higgins & Co., Inc., Health Care Benefits Survey, Report 1: Indemnity Plans: Cost
Design and Funding (Princeton, NJ: A. Foster Higgins & Co , Inc., 1990-1993)

Data not available

Note: Data for years 1989-1992 represent the fall sample from the survey. Data for years 1993-1994
represent emiployers with 500 or more employees.


133

= In the 40 states with income taxes — which comprise more than 80 percent of the
population — the excess employer paid benefits represent a further tax free value to
federal employees.

= In states comprising more than 25 percent of the population, federal (and state)
employee pensions are exempt from state income taxes unlike private pensions.

= Federal employee pensions are of the more lucrative "defined benefit" type and
provide annual cost of living increases. Private employees are much less likely to be
covered by pensions. Further, private pensions are more typically of the less lucrative
“defined contribution” type and generally do no provide cost of living increases.

The causes: deficient pay determination methods and failure to apply administrative
tests of results against the market. Why is the federal non-military compensation system
producing results that are so at odds with the market? Obviously, as has been noted above, a
major contributing factor has been the design deficiencies of the federal pay determination
systems. But there is another factor — that the federal pay determination system results are
not modified to reflect actual labor market outcomes. It is not enough to categorize jobs as
comparable in the federal and private sectors. Job categorization is a difficult and subjective
process. If the comparability determination process is reliable, then labor market outcomes
will be similar — average turnover rates will be simitar. If the comparability determination
process is unreliable, then there will be substantial differences in turnover rates between the
two sectors. And, as noted above, that is the case ~~ average federal employee tenure is
substantially greater than that of the private sector even after adjusting for the federal work
force composition. This huge difference indicates that the value of federal jobs is well above
the market.

The federal government is not subject to the competitive market, It does not have to compete
for revenues against other entities offering the same products to consumers. It cannot be
challenged by new entrants, nor does it face Siquidation as a penalty for failure in the market
Unlike firms in the competitive market, the federal government can afford to pay above
market employee compensation, because it can compel taxpayers to pay, unlike private
entities. The public is paying more than necessary for federal non-military employee
compensation.

2 EFFECT OF EXCESS FEDERAL BENEFITS ON THE PRIVATE SECTOR

‘As was indicated above, federal employer paid benefits are considerably higher than
employee benefits in the market. The excess amount taken from the private sector has
impacted the private sector and probably by more than the direct amount taken (which is
estimated at $18 billion for 1993). Research has indicated that each excess dollar in federal


VW

percent was for insurance costs, 3.0 percent was for retirement and savings costs, and 9.3
percent was in the form of legally required benefits.

+ Asestablishment size increases, the amount spent on wages and salaries as a percentage of
total compensation decreases. In March 1995, 74.} percent of employee compensation was
in the form of wages and salaries for employers with 1-99 workers, compared with 71.3,
percent and 68.8 percent for employers with 100-499 workers and 500 or more workers,
respectively.

+ Asestablishment size increases, the amount spent on benefits as a percentage of total
employee compensation increases. In March 1995, for employers with 1-99 workers, 5.3
percent, 5.7 percent, and 2.3 percent of compensation was in the form of paid leave,
insurance, and retirement and savings, respectively, compared with 6.2 percent, 7.0 percent,
and 2.9 percent of compensation for employers with 100-499 workers. In establishments
with 500 or more workers, 7.9 percent, 7.9 percent, and 4.0 percent of compensation was in
the form of paid leave, insurance, and retirement and savings, respectively.

‘+ In March 1995, employers with $00 or more workers contributed a significantly higher
percentage of employee compensation in the form of paid leave (2.6 percent more) than
employers with ]—99 workers.

‘+ The wages and salaries compensation component is a smaller percentage of total
compensation for union employers than for nonunion employers (see table 2). In March
1995, wages and salaries averaged 64.3 percent of employer costs for union employee
compensation, compared with 73.2 percent for nonunion employers, Paid leave, insurance.
and retirement and savings made up 6.9 percent, 10.0 percent, and 5.1 percent of total
compensation for union employers, compared with 6.3 percent, 6.0 percent, and 2.6 percent
for nonunion employers,

+ In March 1995, union employers contributed a significantly higher percentage of employee
compensation in the form of insurance (4 percent more) than nonunion employers.

Major Industry Group

+ Service-producing industries provide wages and salaries as a higher percentage of total
‘compensation than goods-producing industries (table 3). In March 1995, 73.5 percent of
{otal compensation for service-producing industries was in the form of wages and salaries,
compared with 67.3 percent for goods-producing industries.

+ Goods-producing industries provide their employees with benefits as a greater portion of
compensation than service-producing industries. In the goods-producing industry, paid

3


61

STATEMENT
on
PRIVATE EMPLOYEE BENEFIT PRACTICES
before the
SUBCOMMITTEE ON CIVIL SERVICE
of the
HOUSE COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT
by
Peter M. Kelly
October 31, 1995

Mr. Chairman, my name is Peter M. Kelly. | am an attorney in the Chicago
law firm of Murphy, Smith & Polk and also serve as chairman of the U.S. Chamber
of Commerce Qualified Plan Subcommittee and as a member of its Health and
Employee Benefits Committee. | appear before you on behalf of the U.S. Chamber
of Commerce Federation of 215,000 businesses, 3,000 state and local chambers
of commerce, 1,200 trade and professional associations, and 73 American
Chambers of Commerce abroad. We appreciate the opportunity to appear before
this subcommittee to present the information requested concerning employee
benefit practices of private employers.

lam accompanied by David Kemps, the U.S, Chamber's Manager of
Employee Benefits Policy in its domestic policy division. Mr Kemps has a legal
background in employee benefits having practiced law at the PBGC for four and a
half years.

In order to fully respond to the Subcommittee’s questions without imposing
unduly upon the schedules of Subcommittee members and staff, we have attached

a detailed description of the employee benefits practices of private employers,


130

that of a comparable private employee would there be no excess value for the federal
employee. And, if federal employee compensation were truly below market rates, the federal
government would, frankly, be unable to retain its employees. This is not the case.

Federal pay determination mechanisms yield untenable results. If federal pay systems
were reliable — that is, if they produced results consistent with labor market outcomes, then
average employee tenure (period of employment with the current employer) among federal
non-military employees would be similar to that of comparable employees in the private
sector. The federal government would not be able to retain its employees. But the opposite is,
the case. Average federal employee tenure has been estimated at three times that of private
employees. This is a strong indicator that federal non-military employee compensation is well
above market rates.

Whenever contrasts between federal employment are highlighted, objections are raised that
there are significant differences between the two sectors — that there is a higher
concentration of white collar employment in the federal government than in the private
sector. But a higher white collar work force composition does not necessarily justify
substantially higher federal compensation. One category of white collar employment,
administrative support and clerical workers, is paid less than in the market than the private
sector average. Approximately half of federal non-military white collar employment consists
of administrative support and clerical workers.

Differences in the composition of federal non-military employment relative to private
employment are not sufficient to account for the much higher compensation received by
federal employees. Average employee tenure is an indicator of the value of particular types
of employment to employees. The composition of the federal work force justifies a difference
in average tenure of not more than 10 percent — a small fraction of the actual difference.

Federal employee benefit costs are excessively high and have escalated unreasonably. It
is important to consider not only the design of federal employee benefits from the "bottom

up,” but also the overall impacts of any package of benefits from the "top down." Most of

the testimony you hear is likely to be "micro" in its approach, while mine will be "macro"

("top-down").

‘The average cost of federal employee benefits — as a percentage compared to wage and
salary expense — is nearly double that of private employees. Yet the composition of the
federal work force justifies only a small differential from the private sector average

Federal employee benefits were not always so far out of reconciliation with the market.
Indeed, in 1980, federal employee benefits were similar to the private sector average. Since
that time, federal employee benefits have increased by 105 percent — 13 times that of the
average private employee (Chart). The federal employee increase has been 3.5 times that of

state and local government employees. No conceivable work force composition could justify
this extent of federal advantage.


114

According to the BLS, 90 percent of large private sector
firms with defined benefit pension plans require no contribution
from employees. They are one hundred percent employer-financed.
After this year, CSRS employees will likely have to contribute
7.5 percent of salary, and FERS participants will have to
contribute 1.3 percent of salary, exclusive of Social Security
To add insult to injury, these "contributions" will not go to
finance federal retirement benefits. Rather, they are a
compensation cut to federal employees which will go to pay for
huge tax cuts targeted largely to wealthy individuals and
corporations. Recently, AFGE has had to fend off proposals for

even larger increases in employee "contributions" (which even the

CBO has agreed is a tax increase on federal employees), as well
as proposals to lower the government's matching contributions to
the Thrift Savings Plan (TSP). These budget-driven "reforms" are
at odds with private sector practice.

CSRS has been closed to new entrants since the end of 1983.
FERS was established as a result of changes to Social Security
which required that all federal employees hired after 1983 be
included in the system. CSRS, established in 1920, is a defined
benefit plan without Social Security coverage. FERS, implemented
in 1987, was a conscious attempt to design a federal retirement
system which reflected current private sector practice, and thus
includes a combination of Social Security coverage, a defined
benefit pension plan, and a Thrift Savings Plan (TS). The TSP

is a voluntary capital accumulation plan with some employer-

a.


116

federal government. This is not true. Many public and some
private sector employers provide regular COLAs for their
retirees. Unfortunately, many private sector employers provide
COLAS only in response to angry protests from retirees and their
unions, or when media attention focuses upon the encroaching
poverty (Seniors eating dog food in order to save money for their
medications) of elderly "fixed income" recipients who may have
provided 30 years of devoted service to a prosperous corporation.
And of course, Social Security provides annual inflation
adjustments, a feature which can be credited with protecting most
elderly people from the type of poverty which was so widespread
before the establishment of the program. while Social Security
COLAS are always paid in full and on time, COLAs for federal
retirees have been reduced, delayed and even cancelled several
times over the past decades for political and budgetary reasons
Unlike CSRS and FERS where annual COLAs are part of the
systems’ structures, COLAs in the private sector are rarely
actual features of the pension plan. According to a Department
of Labor study, between the years of 1973 and 1979, retirees in
plans with at least 10,000 participants had received COLAs which
compensated them for 57.2 percent of the change in the CPI in
that period. Studies using data from the period of 1984-1993
have shown some improvement in this record, with most employers
giving adjustments at least once during this period, but varying

them on the basis of when the last COLA was received. The Labor

13


Opening Statement of the Honorable Joba L. Mica
Chairman, Subcommittee on Civil Service
Hearing on Private Sector Compensation Practices
October 31, 1995

Good afternoon, and welcome to this hearing, a continuation of this subcommittee’s series of
hearings on topies related to civil service reform. Today we will examine how the private sector
structures its benefit and compensation packages to meet specific organizational goals. Total
compensation plays an important role in attracting and motivating any workforce.

Tackling compensation issues is a critical component of any serious effort to reform civil
service. We are well aware of the Administration’s interest in reform as evidence by the “reinvention
‘of government” agenda in the National Performance Review. As we continue to downsize and
restructure the federal government, we must not overlook the fuel that runs the engine of our
workforce, We have a responsibility to our citizens to ensure their government is more responsive,
‘more accountable . and more effective.

The key to blending these requirements is to enable government agencies to recruit, motivate,
and more effectively manage employees. The manner in which compensation and benefits are
structured has a dramatic effect on the ability of private sector companies to recruit, motivate, and
manage employees. There is no reason to believe the public sector is any different. Portability,
flexibility and greater employee choice appear to be the growing trends in benefit design throughout
the private sector. This is in response to the priorities of today's mobile workforce

The field of private sector employee benefits is one of rapid and continuous change. Every
budget bill passed by Congress since the mid-1980's has included provisions affecting private
‘employer-sponsored benefit programs. Private employers are also burdened by federal regulations that
spell out compliance requirements. In addition to these dramatic changes, employers continually
reevaluate benefits packages not only for cost effectiveness, but also to respond to employee needs,
‘As people live longer and alter their lifestyles and pattems of work, their expectations change about
what they need to ensure their economic security

The integration of benefit policy with both short and long range personnel planning is essential
in the private sector. Employers who deal with a more mobile workforce will often dedicate a greater
percentage of compensation to salaries, and thereby reduce their level of benefits. Those employers
with a need to retain their workforce over a longer period of time might structure a compensation
package with a higher proportion of benefits, but temper this with vesting requirements to reduce
turnover. Due to the realities of a highly competitive global marketplace, total compensation
combining high-benefit levels with high salaries is much more difficult to sustain. Federal
compensation strategies are caught somewhere between the 1930's and 40's with their focus on job and
benefit security and the more mobile workforce of today with its focus on flexibility and portability.

1


93

those respondents with a plan where plan areas are not universal: retiree health, defined
benefit pension and capital accumulation,

Costs are shown for all benefits other than paid time off, e.g., vacations, holidays and
uninsured sick days. Using a “cost” of a day's pay for a paid day off, based on 5 work
days a week and 52 weeks per year, the additional “cost” for vacations, holidays, and

uninsured sick leave averages about 13% of pay. This would result in a “total cost/value”
of general and paid time off benefits equal to 39% of payroll (26% + 13%)

Statutory benefits includes Social Security, workers’ and unemployment compensation.
Retiree health benefits is the actual annual cash payment and not the required accounting
expense (FAS 106).

Capital Accumulation plans refers to any Defined Contribution plan including 401(k),
403(b) tax deferred annuities, post-tax savings plans, profit sharing plans, discount stock
‘purchase, stock bonus, broad-based (not executive only) stock option plans, money
purchase, and Employee Stock Ownership Plans (ESOPs)

Disability benefits include statutory state short term disability plans. In addition to long
term disability, they include insured short term disability, but not uninsured short term
disability or sick days. “Other” benefits includes food cafeteria, child care, severance pay,

tuition reimbursement, subsidized facilities, activities, etc.


38

Table 9
Trends in the Structure of Employee Benefits

Percentage of Full-Time Employees Eligible for Cafeteria Plans and Flexible Spending Accounts (FSAs): Medium

and Large Private Establishments, 1988, 1989, 1991, and 1993: Small Private Establishments, 1990 and 1992; and
State and Local Governments, 1987, 1990, and 1992

Medium and Large Small Private State and Local

Private Establishments Establishments" _Gove
19881989199) 1992. tom 1992 _19ET_1990 1992
Toul 100 100% 10 100% NE HO HOR YOO s00%
Providing Cafeteria Benefits andor FSAs BoM oe 8 SE
Cafeteria Benefits with FSA ox 9 Hor 2 4 34
Cafeteria Benefits with no FSA Porta 8 # 5s 2 4
Freestanding FSA B18 en ee
Not Provided Catetenia Benefits or FSA, 876 tT Hwa

Source. Employee Benefit Research Institute, EBRI Daxabook. Thitd edition (Washington, DC: Employee Benefit Research Insitute
1995),

* These tabulations provide representative data for ul-time employees in private nonagnculura establishnents with 100 or more
employees inthe District of Columbis and all states except Alaska and Hawai In 1991 and following years, the survey includes
establishments in Alaska and Hawaii,

© These tabulations provide representative data fr full-time employees in private, aonagasultual establishments with fewer than 100,
employees,

© The Bureau of Labor Statistics survey scope was expanded significantly in 1990 o include par-ime workers, all governments
regardless of size. and Alaska and Hawaii The former survey coverage. which included oals fll-ame workers in goverament units
‘employing $0 0c more warkers in the 48 contiguous states and the Distnct of Columbia, referred to as old scope, The expanded survey
overage is referred to as new scape, In this table, 1987 is old scope and 1K) and 1992 are new scape

Less nan 0 5 percent



158

are patently untrue, as has been borne out again and again by

surveys and studies comparing federal and private sector retirement

benefits.

A pension system is an important tool for an employer. It
enables a company to attract and retain an experienced workforce as
well as to encourage turnover among older workers and afford a
younger, more diverse workforce the opportunity for upward
mobility. The original Civil Service Retirement System (CSRS) as
well as the newer Federal Employees Retirement System (FERS) were
designed to meet these needs for the federal government. The
federal retirement system was overhauled less than ten years ago
and FERS was the result of that effort. Its adoption followed
several years of analysis and review of private sector practice.
It mirrored private sector practice in 1986 and it continues to
mirror that practice today. Nonetheless, critics of the federal
retirement programs continue to spread misconceptions and

falsehoods concerning its generosity.

The Wyatt Company, an independent economic research firm, in
its "Survey of Retiree Benefits Provided by Plans Covering Salaried
Employees of 50 Large U. S. Companies" (January, 1993), indicates
that the federal FERS system and the average private sector company
provide almost identical pension benefits. This same study shows
that 43 of the 50 surveyed companies offer their employees a
defined benefit plan like the federal pension system where the

employees’ benefits are based on a formula that includes age, years


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Mr. Mica. Thank you, Mr. Sturdivant. I look forward to respond-
ing to some of your comments when we get into the questioning.
Also, I would like to welcome back Mr. Wendell Cox. Mr. Cox is
with the Wendell Cox Consultancy. Thank you.

Mr. Cox. Thank you, Mr. Chairman. Thank you for the oppor-
tunity to testify in front of you today. I am principal of Wendell
Cox Consultancy in Belleville, IL, and I’m principal author of the
“America’s Protected Class” series, which has been published by
the American Legislative Exchange Council. I would ask that my
written remarks be made a part of the record.

Mr. Mica. Without objection, so ordered.

Mr. Cox. Thank you. I’m going to go at the subject, perhaps,
from a bit different perspective than some of the others today. One,
I will tell you right out—and I'll give you evidence of this—that it
is my firm belief that Federal employees are overpaid, not under-
paid. Second, that we need, I believe, in looking at Federal com-
pensation issues, to begin with the top-down approach. That is,
look at the total cost, rather than, as it were, a bottoms-up ap-
proach. We need to be aware of those costs.

Starting out from a basic position that only the market can de-
termine market compensation, and any time you attempt to deter-
mine market compensation through administrative mechanisms, it
is going to be rough, at best.

T would suggest, in the case of the Federal system, which ex-
cludes consciously major elements of compensation, it misses by a
long shot. Indeed, it was the failure and the inability of Soviet
planners to set market prices that caused the fall of that economy.

We've all heard about the OPM studies that suggest that Federal
civilian employees are paid to 20 to 25 to even 30 percent below
their compatriots in the private sector doing similar work. I don’t
think that’s true. I think most of the academic studies indicate that
Federal wages are, in fact, above, not below, private wages for com-
parable work.

But I would suggest, even beyond that, we need to recognize that
the OPM system deals even with wages. It does not deal with bene-
fits. It does not deal with retirement issues and that only about 75
percent of the cost of total Federal compensation is in wages.

I spoke to you before in April and described to you research in
which we concluded that the value of Federal employment was
about 50 percent, dollar for dollar, above that of private employ-
ment, if you assumed equal starting pay, and that, even if you ac-
cepted the OPM estimate of about 22 percent below on the part of
Federal employees, you would still have a Federal employee pre-
mium at the end of a 40-year career.

I would argue that the Federal pay system is flawed. It does not
include major elements of compensation, and one of the major dif-
ficulties with the Federal pay determination system is it does not
check itself against the market. For evidence of that, I would sug-
gest to you that in the Federal civil service, where the average ten-
ure is 15 years, is three times that of the private sector and more
than three times that of the private sector, adjusted for the com-
position of the Federal work force.

Now, oftentimes, when we compare public and private compensa-
tion, we hear advocates who suggest, well, you’ve got to compare


100

discount stock purchase plans where employees can purchase company stock at a
discount. A small number (5%) have broad-based employee stock option plans. Similar
to executive stock option plans, these plans permit employees to purchase stock in the
future at the current price. If the stock price rises, then the employee can purchase the

stock at a discount.

One other method of benefits cost containment is a by-product of changing the
compensation mix to have lower base salary and higher annual incentive. If benefits are
based only on base salary, then the benefits costs, which are a function of base salary, are
similarly reduced. If benefits are based on base salary plus incentive, then the benefits
costs related to the incentive portion are only incurred when the incentive is paid -- when

company/unit and/or individual performance has been good.

Taxation Impact on Benefits

Like other situations, tax policy drives employer and employee actions in the benefit area
It is widely considered that employers offer the current extensive types and amounts of
benefits because of favorable tax status to the employer and employee. The strong
prevalence of tax deferred savings plans compared to the lesser prevalence of post-tax
savings plan is but one example. It seems likely that employers would focus total
remuneration budgets more on cash compensation if the more favorable tax status for
benefits was reduced.

Summary

It appears that employers have come to recognize the need to strategically manage their
overall reward programs on an integrated basis in order to maximize the return on these
large investments. Employers are clearly defining their business and financial strategies,
and then articulating the work cultures which best support and reinforce those strategies
and goals. In turn, compensation programs which align with, and positively contribute to,

20


41

Approximately 85 percent of large employers, although still very
few small companies, now offer wellness programs to their employ-
ees. Wellness programs are becoming increasingly popular for mid-
sized companies, as they enhance the value of the benefit package
at little or no additional cost.

The overwhelming trend in the private sector retirement income
arena has been a significant migration to the use of defined con-
tribution pension plans, especially among small and medium-sized
employers. Among larger companies, defined benefit plans still con-
stitute the vast majority of pension benefits, although many are
now combining them with defined contribution plans, since these
have been on the increase, also, with large employers.

Many small firms still do not provide any retirement income ben-
efits, however, and it should be noted that with defined contribu-
tion plans, the contribution level is most often voluntary. There-
fore, because of nonparticipation, especially among younger work-
ers, there is a significant segment of the current work force without
retirement income savings outside of Social Security.

Many companies have embraced the use of other benefits, includ-
ing alternative work arrangements and dependent care, because
they're often far less costly but are generally considered by employ-
ees to be valuable additions to the overall compensation package.
Clearly, there has been a move toward greater flexibility in work-
ing arrangements, particularly with smaller businesses.

Finally, more companies are providing some form of dependent
care. These follow a wide range of possibilities, but spending ac-
counts are still the most common possibility with this type of bene-
fit.

The design of employee benefits is influenced to a large extent
by the demographics of the work force. Today, women comprise 50
percent of the work force, and many of these are mothers. Many
employees, both male and female, are single parents, and some are
caring for elderly parents.

Designing benefit plans which meet the needs of these employ-
ees, without discriminating for or against particular groups, has be-
come increasingly challenging, giving rise to the growing use of
flexible benefit plans or cafeteria plans, which have undergone a
significant expansion in both scope and practice over the last dec-
ade, except with small employers who are still struggling to offer
any benefits at all.

We have submitted an explanation of what is involved in most
flexible benefit plans. Government policies, particularly the tax
code, also influence the design and structure of benefits packages.
Were the provision of tax benefits not tax deductible, you would see
a substantial reduction not only in the level of benefits offered but,
also, in the percentage oi the work force covered.

Also, this impacts the manner in which specific employee benefit
offerings are designed and operated, since most tax-favored benefits
cannot be discriminatory.

In closing, I would also caution against the imposition of govern-
ment mandated benefits, which are impediments to competition
and force companies to either cut other benefits in order to reduce
overall costs in some instances, could downsize their operations or,
in some cases, might cause them to close down business altogether.