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Short-Term Disability: Plan Design Affects Behavior, Outcomes

July 9, 2009 | Stephen Miller, CEBS

NEW ORLEANS—By making simple plan design changes, employers can reduce costs from unnecessarily prolonged absences under their short-term disability (STD) programs, said Maria Henderson, a health and productivity principal with HDM-Solutions Inc. Henderson spoke on June 30 at the 2009 Society for Human Resource Management Annual Conference, during a session on "Short-Term Disability Plan Design: Effects on Employee Behavior and Outcomes."

"Put plan design on your radar screen," she advised, in order to understand and mitigate unintended effects on employee behavior.

Length of Full-Time Leave

The maximum length of benefits under STD plans ranges from 90 days to 52 weeks, and typically exhausts at 180 days or 26 weeks. Offering longer STD benefits might not be doing employees on leave a favor, since studies show that if employees are out for more than six months the odds that they will return to work on a regular basis drop dramatically.

In contrast, "employees are two times more likely to return to full-time work with transition work," Henderson said. So, for employees on leave who can't perform their normal duties (for example, because of the physical strain), she advised requiring participation in a return-to-work (RTW) program that provides some form of appropriate, physically lighter work that will bring these employees back into the worksite.

In the written disability plan, "do not include language that would result in employees being able to refuse a temporary or transitional assignment and continue to receive benefits when the company has identified productive work," she recommended. Use language to require employees to assume "any transitional assignment available."

Relapse/Recurrence Period

On the other hand, beware of allowing employees to run serial STD claims by returning to their normal duties briefly and then filing a new STD claim for what is essentially the same condition (they thus avoid shifting to long-term disability with lesser benefits). "Plans with a strong return-to-work focus and high productivity outcomes have a cycle of at least 30 days" back on the job before an employee can file a new STD claim, Henderson said. While many plans provide a standard 14 days, "if the recurrence period is too short, it's difficult to determine whether the person is able to sustain permanent employment" or just toughing it out until they can file an STD claim for a "new" condition, she observed.

Wage Replacement Rate

Wage replacement rates under STD programs range typically from 60 percent of salary to two-thirds (to be concurrent with workers' compensation), to 100 percent, often with tiered benefit structures (e.g., 100 percent of pre-disability earnings for the first 14 weeks, and 80 percent thereafter).

But Henderson cautioned that the "watershed level" for wage replacement is 70 percent. "Over 70 percent increases lost time," she said, because employees feel they can cut back on expenses and stay out. She noted that benchmarking studies (comparing leaves taken within the same industry, for the same type of work and the same conditions) show that leave duration periods "were at least 20 percent higher than normal when companies offered 100 percent income replacement," whereas "below 70 percent reduced lost time" because employees who were able to return to work had a financial incentive to do so and reclaim their full salary. In short, "70 percent-plus is an incentive not to come back to work," she said.

Leave durations "were at least 20 percent higher than normal when companies offered 100 percent income replacement."

Pre-Tax vs. After-Tax Benefits

"Employers can give their employees the opportunity to choose each year whether to pay short- and long-term disability premiums on a pre- or after-tax basis, without causing the plan to be treated as a contributory plan under applicable Treasury regulations," Henderson pointed out, referencing IRS Revenue Ruling 2004-55. "This is significant because it outlines a way employers can give their employees substantial flexibility to determine whether their short- or long-term disability benefits will be subject to tax," she noted. Employees can avoid taxes on their disability benefits by paying the premiums themselves with after-tax dollars or by including the value of employer-paid premiums in their income. "Would you rather have 60 percent of your pay taxed when you are on disability or receive your disability pay tax free?" she asked.

While after-tax premiums can be a benefit-enhancer for some employees — think of it as the disability income equivalent of a Roth 401(k) — Henderson commented that offering this option can complicate the annual election process and add complexity to open enrollment. Consequently, it increases the need for detailed communications from HR.

Elimination Period

Following the waiting period after which an employee becomes eligible for STD benefits (e.g., six months after the hire date), the elimination period is the amount of time an employee is away from work before STD leave begins. Usually, it runs concurrent with the period covered by sick leave or paid time off (PTO), which can be from day one of disability to after an elimination period of three, seven, 14 or 30 days. But the rules can get complex, such as offering STD after day one for hospitalization or accidents but requiring a seven-day wait for other triggers.

Henderson recounted that officials of one leading U.S. company (unidentified) couldn't understand why they were encountering substantially longer STD leaves and related expenses than their similarly situated competitors. Henderson said you had only to look at their plan to understand why: It provided that STD kicked in after 31 days, and at that time the plan reinstated all PTO and vacation time that the employee had used during the leave.

"Employees out for removal of a gall bladder, which usually takes three weeks for surgery and recovery, were asking their doctors to squeak their disability certification to, say, 35 days, so they could keep all their PTO and vacation days," Henderson said. Once the plan was redesigned to eliminate this incentive, recovery times reverted back to the benchmark, as did the company's STD costs.

Henderson's recommendation: the best practice is an elimination period of three to seven days with benefits starting day four or day eight after the medical disability, and a maximum benefit duration of 24 to 26 weeks (then shifting to long-term leave). "A main consideration is concurrency and centralization of FMLA [Family and Medical Leave Act] and STD administration," she added.

Offering a concluding tip, Henderson advised, "The key to reducing costs and absence duration is early intervention."

Stephen Miller is an online manager/editor for SHRM Online