The Cutting Edge of Benefit-Cost Control

Robert B. Catell, chairman and CEO of KeySpan Corporation, the largestdistributor of natural gas in the Northeast, closed out 2002 with anannouncement that no CEO wants to make: Rising expenses from employee benefitswill shave 20 to 30 cents off earnings of $2.86 per share that had been expectedfor 2003. Something has to be done.

With 12,000 mostly long-tenured employees spread over several states andorganized into different unions, the Brooklyn-based company is short oncost-cutting options. The CEO’s aim traditionally has been to keep costincreases in line with the general rate of inflation. “In the past, this was areasonable goal,” says Elaine Weinstein, senior vice president of humanresources. “However, given the escalating cost of health care, this is now avery aggressive target.” In 2002, KeySpan’s benefit costs rose 13 percent.For 2003, “our stretch goal is to keep the increase at 7 to 10 percent. If Iachieve 7 percent, I’ll be a hero.”

Weinstein faces the same deadly combination of rising pension contributionsand runaway health-benefit costs that now preoccupies human resources executivesat other top companies. Employers absorbed health-benefit cost increasesaveraging 15 to 20 percent in 2002 and budgeted for increases averaging 15percent this year. Many must also ante up huge pension contributions forced bypoor investment returns. “Equities have tanked, so our cash contribution is updramatically,” she says. “Our assumption is that equity markets will remainflat for 2003, and all HR planning is based on that assumption.” Watson WyattWorldwide reports that 30 percent of companies were forced to make cashcontributions to their pension plans in 2002; 65 percent will have to do so thisyear.

With little or no revenue growth to cover these additional expenses, risingbenefit costs are ripping a hole in the bottom line. Human resources executivesare on notice from top management to contain or cut costs–now. Depending on thedegree of economic pressure, the composition of the workforce, and conditions inthe local labor market, executives are pursuing different objectives andstrategies. Some are cutting benefits and slicing salary budgets to offsetrising costs. Others are turning to aggressive vendor management to achieve costreductions without cuts or greater employee cost-sharing. In all cases,successful cost control hinges on well-defined objectives, careful workforceanalysis, and a holistic approach to the problem.

Long-term, incremental change
    Given KeySpan’s workforce composition, Weinstein’s goal of simply holdingcosts constant is daunting. Hemmed in by heavy contractual obligations andextremely low employee turnover, she focuses on long-term, incremental changesin both retirement and health-care benefits, and begins laying the groundworkbefore cost increases hit crisis proportions. “HR is extremely tough thesedays,” she says, “and controlling costs is difficult, but my job is easierbecause my CEO and my company are very employee-sensitive, and I have tremendousaccess to and dialogue with top management.”

Weinstein has the information and leverage she needs to make major changesbecause she sits on the company’s executive committee. “When I came into thecompany seven years ago and saw that there was no cash-balance plan, forexample, I said to the committee, ‘Let me show you some best practices andwhat we can do for new hires.’ I drove the pension issue.” She launched acash-balance plan for managers in 2000 and for some unions in 2001 and 2002.

Of all the issues related to benefit cost increases at major companies,pension funding is now the most expensive and the most intractable. KeySpan’snew cash-balance plan will cut the company’s annual pension costs by 30percent for each new hire, but moving existing employees into the new plan is aslow process. “Two-thirds of our employees are unionized, so we attempt tonegotiate the cash-balance plan as various contracts come up, but ourdefined-benefit plan is still very dominant,” Weinstein says. Cash-balanceplans help control costs because final retirement benefits are notpredetermined, as is the case in traditional defined-benefit plans. Benefits arebased solely on the amount that accumulates in each employee’s account fromannual employer contributions, which are usually a percentage of salary, plusearned interest.

With a viable solution in place in the area of pensions, she is focusing onhealth-benefit costs. “We negotiate very aggressively with our health-benefitcarriers, and because of the pressures they face, we have been able to extractsome concessions,” she says. The company is also inching up employeecontributions for both union and nonunion workers. Management employees nowcontribute 23 percent of their premiums, up from 20 percent in 2002. KeySpanalso adopted a three-tier design for its prescription program and eliminatedmultiple vendors to reduce administrative costs. A new mandatory mail-orderprogram for recurring prescriptions has saved the company $1 million.

KeySpan’s limited ability to find sufficient immediate savings in benefitcosts has forced it to take a holistic, total-compensation approach to costcontrol. In February 2003, KeySpan froze all merit increases for 12 months formanagerial employees and for 24 months for executives. “This has beentraumatic for our company,” Weinstein says. “The decision came from the top,and the impact starts at the top.”

For some cost issues, top management approaches Weinstein with questions, andshe does the research and provides the information that the executive committeeneeds. “Then we discuss it and vote on it,” she says. In other cases, sheinitiates proposals for change. “There’s a lot of verbal noise about HRbeing a business partner, but you must bring to the table a knowledge of thebusiness or you can’t possibly play a partnership role. If you can’t dothat, then all the talk is just garbage. I understand the business, which is whyI can take an aggressive approach to defining the problems and proposingsolutions.”

Deep cuts without layoffs
    Human resources also took an aggressive approach at CUNA Mutual Group, whichprovides financial services to credit unions and their members. Vice presidentof compensation Teri Edman spent the better part of three months handling 80percent of the analysis, design, and approval process to cut $23.2 million fromthe company’s compensation and benefit costs for 2003. Like Weinstein, Edmanoperates in relatively tight spaces. Half of the company’s 5,000 employees areat corporate headquarters in Madison, Wisconsin, two thirds of them unionized.The company wanted cost improvements without significant staff reductions.

“Both our revenues and expenses have been dramatically affected by theeconomy, and the majority of our controllable expenses are staff-driven,”Edman says. Human resources developed proposals for the changes; top managementdiscussed them over a two-month period and gave final approval. Edman took atotal-compensation approach. A substantial $15 million in savings will come fromthe elimination of the 2003 salary-increase budget, with no merit or across-theboard increases for any employee group. The company also eliminated the annualholiday gift– $300 per employee–for both 2002 and 2003.

An additional $8.2 million in savings will come from health-care andvacation-benefit changes based on careful market analysis. “We targetedbenefit plans in which we were over market and obtained feedback from ouremployees about what types of changes were most acceptable to them,” Edmansays. To minimize the impact on recruitment and retention, “we modeled thecost savings of various alternatives and compared the proposed changes tomarket-competitive data and to our own experience in recruiting.”

Although many employers have eliminated HMO plans, which now register thehighest cost increases of all plan types, CUNA Mutual kept its HMO but addedco-pays for office visits. It also joined the significant employer shift to athree-tier prescription plan, increased drug co-pays, and obtained new networksfor its medical indemnity and dental plans. Edman anticipates saving $3 millionfrom the combined health-benefit changes.

The company will save $5.2 million from a new vacation-buyback program. “Wehad a very generous carryover provision that allowed employees to accumulate upto two years’worth of vacation earnings,” Edman says. “This unusedvacation had grown to an expense liability of $24 million. We needed to decreasethis expense, but because of our workload, we could not afford to have employeestaking larger than normal amounts of vacation.” Under the new program,employees can elect to give up earning new vacation for 2003, and in exchangecan sell for cash an equal number of days from their carryover. They also committo using an equal number of days from their carryover for time off this year.

CUNA Mutual carefully communicated the reasons for the changes to employees.”We illustrated the negative trend in our revenues and expenses over the pastfew years and our projections for 2003 and beyond,” Edman says. “Weexplained the environmental economic factors that are beyond our control, anddemonstrated our need to take action now to protect our future.” The companyhas not experienced higher turnover or a drop in benefit enrollments because ofthe cost-reduction measures, but Edman continues to monitor employee reaction.”We stay in touch with our employees through various feedback methods,including electronic communications, departmental meetings, staff forums withthe CEO, and culture surveys.”

KeySpan provides comprehensive information to its employees about its benefitchanges. “Our communication strategy is a cascading model,” Weinstein says.”After the executive committee approves the changes, we first present them tothe officers, who then present the information and explanations to theiremployee groups.” For the presentations, KeySpan uses a program called “StraightTalk,” which scripts the communications delivered by officers. The scripts forbenefit changes are “a way to assist employees in managing their expectationsabout employee contribution increases and to explain why changes are necessary,”she says. An employee-benefits newsletter, the company’s intranet, andopen-enrollment packages also explain benefit changes in detail. “By the timeemployees receive the open-enrollment packages, they have already heard themessage three or four times.”

Working in relatively restricted environments and with specific mandates tocontrol costs without jeopardizing employee relations, Weinstein and Edman havefound substantial long-term savings. KeySpan and CUNA Mutual are among a growingnumber of employers that are adjusting total compensation to address the crisisin benefit costs. Benefit cost increases have outpaced wage and salary costincreases for the past three years and will continue to do so for theforeseeable future. Almost one-fourth of employers have decreased or areconsidering decreasing 2003 salary-increase budgets to offset rising health-careand pension costs, according to a survey by Mercer Human Resource Consulting.The holistic approach to cost-cutting at KeySpan and CUNA Mutual erases the linecommonly drawn between salary and benefits budgets and allows executives fullrange of movement to tackle rising costs.

Most companies have already picked all the low-hanging fruit among benefitcost-cutting options without achieving sufficient results. Many continue toapproach cost-cutting on an ad hoc basis, without careful analysis of which cutswill yield the greatest long-term savings with the lowest impact on businessobjectives. Executives at companies with focused strategies can push their costsinto more acceptable territory, secure support from top management, and minimizethe impact on employees.

Workforce, March 2003, p. 36-42 — Subscribe Now!