The three most popular flexible benefits plans are modular plans, core-plus options plans, and flexible spending accounts.96

Modular plans consist of a series of different bundles of benefits or different levels of benefits coverage designed for different employee groups. For example, Module A might be the basic package paid for entirely by employer contributions. It would include only the most essential benefits and would be designed for single employees. Module B might include everything in Module A plus additional benefits such as family coverage under the health insurance plan, dental care, and child care. This module might be designed for married employees with young children and could require both employer and employee contributions.

Core-plus options plans consist of a core of essential benefits and a wide array of other benefits options that employees can add to the core. The core is designed to provide minimum economic security for employees, and usually includes basic health insurance, life insurance, long-term disability insurance, retirement benefits, and vacation days. Core-plus options plans give employees “benefits credits” that entitle them to “purchase” the additional benefits that they want. In most cases, all employees receive the same number of credits and may use them either to purchase higher levels of coverage in the core benefits package or to purchase additional benefits such as dental care or child care.

Flexible spending accounts are individual employee accounts funded by the employer, the employee (with pretax dollars), or both. Employees “pay” for the combination of benefits from their accounts. The result can be added take-home pay because employees do not pay taxes on the dollars that they have spent on benefits from their flexible spending accounts. Employee benefits administrators must design flexible spending accounts that conform to the rules specified in Section 125 of the Internal Revenue Code, which governs which benefits are exempt from taxes and which are not. For example, educational benefits and van pooling cannot be included in a flexible spending account because they are taxable benefits.

Flexible benefits offer employees the opportunity to tailor a benefits package that is meaningful to them at a reasonable cost to the company. However, they do pose some challenges to benefits administrators. These are:

• ▪ Adverse selection The adverse selection problem occurs when enough employees use a specific benefit more than the average employee does. Intensive use of a benefit can drive up the benefit’s cost and force the employer either to increase spending on benefits or reduce the amount of coverage it provides. For example, employees who know they will need expensive dental work may select a dental-care option instead of some other benefit. Or employees who know they have a high probability of an early death (due to a health condition such as high blood pressure or even a terminal condition such as cancer) may choose extra life insurance coverage. In both cases, the cost of the insurance coverage will eventually be driven up.

  Benefits administrators can deal with the adverse selection problem by placing restrictions on benefits that are likely to result in adverse selection problems. For instance, the company might require those applying for higher life insurance coverage to successfully pass a physical examination. They can also bundle a broad package of benefits together into modules to ensure a more balanced use of each benefit.97

• ▪ Employees who make poor choices Sometimes employees make a poor choice of benefits and later regret it. For example, an employee who selects additional vacation days instead of long-term disability insurance is likely to regret his choice if he experiences a long-term illness that exceeds his accumulated amount of sick leave. Benefits administrators can manage this problem by (1) establishing core benefits that minimize an employee’s risks and (2) communicating benefits choices effectively so that employees make appropriate choices.

• ▪ Administrative complexity A flexible benefits program is difficult to administer and control. Employees must be kept informed of changes in the cost of benefits, the coverage of benefits, and their utilization of benefits. They must also be given the opportunity to change their benefits selection periodically. In addition, the potential for errors in recordkeeping is high. Fortunately, computer software packages can help the HR department manage the recordkeeping aspect of benefits administration. Benefits consultants can assist HR staff in selecting and installing these software programs.