Overtime Pay Changes Will Affect Employee Benefits, Too Benefits cuts and pay compression will be on HR’s total rewards agenda

By Stephen Miller, CEBS  5/18/2016

The Department of Labor’s final rule revising the Fair Labor Standards Act overtime regulations, released May 18, will significantly alter employee pay structures. That should spur employers to evaluate their overall approach total rewards.

Under the final rule:

? The annual salary threshold for exempt positions will jump from $23,660 to $47,476 (or from $455 to $913 per week), and will be updated every three years. That’s more than double the old threshold. Employees who earn less than the threshold must to be paid for over 40 hours worked in a workweek—at a rate not less than time and one-half their regular hourly pay rate—even if they're classified as a manager or professional.

? There will be no change in the duties test used to determine whether employees earning more than the salary threshold must be classified as nonexempt from overtime, including the exemptions for executive, administrative and professional positions, among others.

? For highly compensated employees (HCEs), who may generally be considered exempt without regard to the duties test, the final rule raises the annual HCE salary threshold from $100,000 to $134,004.

 ? The new rule takes effect on Dec. 1, 2016. (See SHRM Online’s FLSA Overtime Rule Resources page.)

While the intent may be to raise workers’ earnings, empirical research suggests that “employers will lower base salaries to offset the anticipated cost of paying overtime,” said economist Liya Palagashvili, co-author of an April 2016 analysis of overtime pay. “It’s possible that employers will also respond by cutting some benefits or replacing a junior role in the firm and hiring another employee at a senior role who can justifiably be paid above the overtime regulation salary threshold. Salaried workers will be reclassified as hourly workers, and many will begin punching a time clock again,” at least figuratively

Even if newly nonexempt workers are treated as salaried—but precluded from working over 40 hours per week so as to avoid overtime—employers will now be responsible for tracking their hours. “Employers, especially those that operate outside the high cost-of-living areas in the Northeast and the West Coast, will need to overhaul the compensation system for a significant portion of their white-collar workforce, and also change the culture for employees who have never been required to record their time and are used to working until the job gets done,” said Nathan Oleson, a partner at Akin Gump in Washington, D.C.

“Some exempt employees enjoy additional benefits or perks that they will lose when reclassified as nonexempt,” said Jon Keselenko, chair of the Wage & Hour Defense Institute, a national organization of wage and hour attorneys from across the U.S., and a partner at law firm Foley Hoag in Boston. “To the extent that you reclassify people, their entitlement to benefits could change.”

First, Nondiscrimination Rules

Some perspective is called for to understand how benefits will, and won’t, be impacted.

“Because of Section 125 nondiscrimination rules, it’s been historically difficult to base eligibility for benefits such as medical, dental and vision—which flow through a Section 125 cafeteria plan—on hourly [nonexempt] or salaried [exempt] status,” said Zack Pace, senior vice president of benefits consulting at CBIZ Inc. in Columbia, Md.

For self-funded health plans subject to Section 105(h) nondiscrimination rules, it’s particularly difficult to alter eligibility terms between hourly and salaried employees, Pace said. “Meanwhile, the newer Affordable Care Act regulations have all but eliminated the option of varying medical benefits by hourly and salaried status,” he noted. In addition, qualified retirement plans are subject to stringent annual nondiscrimination testing to make sure they don’t reward highly compensated employees more than others.

Other Perks, Though, May Be Targeted

But other offerings can be richer for salaried workers, such as the number of vacation days and other paid time off (PTO) provided. Also, “within certain industries, including construction and retail, employer-paid group life and group disability benefits might only be offered to salaried employees,” Pace noted.

This isn’t trivial. “From a risk management standpoint, I would put long-term disability right after health insurance, arguably in a tie with life insurance,” Pace said. These are important benefits, “but not ones that all employers can afford to offer on an employer-paid basis.”

He sounded a cautious note, however, about grandfathering employees who are being reclassified to nonexempt status in order to keep benefits that they might otherwise lose. “You’d have to prove to the [disability or life] insurer that at one time the person was salaried and because of that, under the terms of the plan document, they’re still eligible because you grandfathered them,” he pointed out. “Grandfathering terms can be problematic and are probably unnecessary. Life and disability benefits are important, but whether it would cause someone to leave the employer if they lose those benefits, I’m not sure.”

As for PTO, it might be advisable to offer paid leave on the basis of tenure and job level instead of exempt or nonexempt status, benefit consultants say.

Revisiting the Rewards Mix

With overtime costs rising, benefits cuts across the board are also likely to be considered.

“Employers just went through major budget alignments with the Affordable Care Act, and now they’re being asked again to take a look at their budgets,” said Bobbi Kloss, HR director at Benefit Advisors Network (BAN), a consortium of health and welfare benefit brokers across the U.S. “Many small and midsize employers may not be expecting that.”

Higher overtime costs could make it more likely that dental, vision and disability coverage are turned into employee-paid voluntary benefits. “Employers will need to evaluate whether their current benefit mix continues to make sense, given their employee populations,” Kloss noted, especially in terms of ancillary benefits, asking themselves “Does it make sense for us to continue to provide this benefit? Should we shift those costs over to the employee, or should we even just eliminate it?”

In making those decisions, “a manufacturer may have greater reason to keep employer-paid disability benefits vs. an IT group,” Kloss pointed out.

“It’s easy for organizations to become quickly focused on the cost structure and the financial impact of expanded overtime pay, so their early instinct is to reduce some benefits or make some modifications to pay structures,” said Jennifer Donnelly, vice president and national practice leader for organizational effectiveness at Sibson Consulting in New York City. “But you have to balance that against the cost of reduced morale or turnover, and your loss of competitive advantage in recruiting and retaining top talent. That’s going to be the biggest long-term issue for organizations to balance when they’re thinking through how best to transition employees [into hourly/nonexempt status] and manage all the costs associated with the range of benefits.”

Organizations could also look at other ways to compensate for the loss of pay and benefits that don’t have an immediate high cost to them, Donnelly said, such as offering more types of flexible work arrangements or teleworking opportunities—but not over a proscribed number of tracked hours—along with employee recognition initiatives, “which aren’t considered in the traditional scope of benefits, but which can serve as a broader kind of safety net in the culture to compensate for some of those lost rewards.”

“To attract talent, employers may need to provide offerings that don’t impose the costs of traditional benefits,” Kloss concurred. “Younger workers, in particular, are looking for more flexibility in scheduling and work rotation.”

Coping with Compression

From a total rewards perspective, pay remains the central focus of the overtime rule changes. “Where you have people that are close to the pay threshold for exempt status, … employers may adjust their pay upward to meet the cutoff,” Keselenko said. But increasing employee pay to retain exempt status may be expensive, since the jump up for lower-level employees may lead to pay compression throughout the salary structure. “The ripple effect will mean making adjustments up the line, which could be huge,” he noted.

On the other hand, given that overtime pay comes out of overall compensation budgets, employers may adjust hourly rates lower for reclassified employees to take into account the need to pay them for overtime work. “There are online calculators where you plug in employees’ exempt salaries and how many hours a week they work, and it provides the hourly rate to pay them, to make them whole,” he noted.

But, Keselenko warned, “Say you take an employee making $45,000 a year and working 50 hours a week, and then bump them down to a wage rate that would be the equivalent when overtime pay is calculated in. But then, during the next round of budget tightening, the company cuts back on overtime. Suddenly, the employee is no longer whole and ends up losing money.”

Another likely scenario involves companies limiting overtime hours and instead hiring more part-time employees. “But part-time employees have their own problems in that they’re typically not covered by company benefits and their hours usually fall below the Affordable Care Act threshold level” for employer-provided coverage.

The result will be “fewer full-time employees receiving benefits and more part-time employees not receiving benefits,”