Aligning Incentives: What do bonuses have to do with reducing absence? More than you might think. Entry 2 – 2008


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Five years ago, if a benefits manager told me he had a low rate of short-term disability at his company, I would have responded: “Great! What sorts of health improvement programs do you have?”

Today, that’s definitely not the question I would ask. What have I learned in the last few years?

Regular readers of this blog know we are great believers in the power of incentives. Other things being equal, a person will choose options that produce the greatest personal benefit.

Often, when we mention “incentives,” readers from human resources and health industries think we are referring to specific rewards for specific behaviors (e.g., being paid $100 for completing a health assessment). While this is certainly one type of economic incentive, our definition is much broader. Incentives can include anything of value (money, time, recognition, or opportunity) that a person has a chance to gain or lose.

The more someone stands to gain from an action, the more likely they are to act. And conversely, the more someone stands to lose from that action, the less likely they are to act. We each weigh gains and losses in all aspects of life. As gas prices increase, I may be less willing to take the same road trip I took when a gallon of gasoline was $1.00 cheaper. If my company cafeteria subsidizes the cost of the salad bar, I may be more likely to choose salad than when it is offered at the regular price. As cost (in every sense) changes, my likelihood of certain behaviors also changes.

In the health as human capital paradigm, we consider health to be an asset owned by the individual. Health, in addition to skills and motivation, make up the human capital package workers exchange for compensation in the labor market. The more valuable the rewards we are able to attain in exchange for our human capital, the more value we place on protecting and growing our own human capital. In other words, the more I can benefit personally from good health, the more it matters to me to be healthy.

In this blog, we will offer an example showing how the potential for greater gains and losses influences behaviors regarding employee health.

Variable pay and health-related absences

Today’s example demonstrates how variable pay (income potential above and beyond base salary) influences health-related benefits utilization. First, let’s look at the connection between pay and benefits use, and the underlying incentives involved. We have already seen that the amount of salary an employee is eligible to receive while absent influences the rate and duration of disability claims. The more you pay someone while gone, even if on sick or disability leave, the more likely they are to be gone.

Essentially, economic incentives influence behavior by changing the amount of income “loss” the individual will experience. When employees can only receive 60% pay during disability, an absence is less likely and will have a shorter duration than when employees can receive 100% of pay. In other words, a cost of work absence that equals a forfeiture of 40% of pay is much greater than if the worker forfeits nothing

Variable pay, sometimes called pay-for-performance, refers to a reward system where some portion of compensation is determined by a person’s achievement. From a human capital perspective, when a portion of my pay is determined by my work performance, my own ability to perform has greater value to me than if I receive the same pay (a set salary) regardless of performance. Thus, we would predict that the more a person’s compensation is based on performance, the more value they will place on being at work to earn the extra pay.

What we expect: the greater the portion of variable pay, the lower the likelihood of disability. And this is what we
see.

The graph at right shows the rate of short-term disability (STD) by the percent of variable pay the employee is eligible to receive. (click to enlarge) As seen, individuals who had higher variable pay were less likely to file a claim for STD. Note that pregnancy claims were excluded, and the analysis controlled for age and gender.

As some readers may recall, (in an earlier blog) there is an association between size of bonus and how much employees agree that good health is important to their success at work. The greater the bonus, the more they agree.

In today’s example, we take this even further. We see that when there is a greater alignment of rewards and risks—a measurable gain for being at work and a measurable loss for not being there—the less likely a person will be to have a long absence from work.

Those who still operate in a medical paradigm often interpret these findings negatively. If one assumes that all medical care is necessary, and that all disability claims are only influenced by medical needs, it’s easy to conclude that those receiving high bonus pay must be neglecting their health. In our world view, aligned economic incentives in the form of pay-for-performance actually increase the likelihood that people will engage in more health-protecting behaviors and lessen the likelihood of discretionary medical procedures. Thus, the phenomenon is one of better health and more appropriate healthcare utilization rather than a detrimental lack of necessary healthcare.

Today, when a benefits manager tells me he has a low rate of short-term disability at his company, how do I respond?

“Great! What is your policy on variable pay and what percentage of salary do you pay people who are absent on STD?”

Why this matters: Underlying incentives have a powerful influence on behavior. Often, companies overlook the unintended consequences that occur when benefits design and policies are misaligned with the desired outcome (such as attendance or high performance). This example illustrates how aligned incentives have the potential to reduce the use of health-related benefits not by discouraging necessary care, but by encouraging health protection and rewarding self responsibility.


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One Response to Aligning Incentives: What do bonuses have to do with reducing absence? More than you might think. Entry 2 – 2008

  1. >Thanks Wendy,

    Although I instinctively knew this was true, it’s nice to see a study that backs it up.

    I work in the health care industry which oddly has a high rate of absenteeism. I suspect a lot of it is not related to real illness.

    Every time a worker calls in, someone has to replace them either by working harder with less staff or by asking someone who is off that day to come in.

    I have long advocated a bonus program for those who consistently show up and work their shifts as scheduled… I think it should be substantial and scheduled to be paid the first week of December.

    Thanks,
    Rod

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