The Case for Portable Benefits, and How We Get There
It’s a buzzy time to be in the tech industry building for the Future of Work. We may not have quite the hype that blockchain did in 2017 or micromobility (scooters) did in 2019, but there’s undoubtedly a glow that comes from the phrase. Investors are eager to dive in to the large market, but few seem to agree on exactly what the category contains.
For some investors, it’s a new class of software, built for businesses but made to look and feel like slick consumer apps. For others, it’s updating infrastructure and streamlining workflows for the deskless workforce — the 80M Americans who aren’t staring at a screen all day. For some investors and entrepreneurs, too, it’s a phrase that brings a lot of attention and FOMO.
For Catch, when we talk about building solutions for the Future of Work, we’re focused on providing the financial products and services for a workforce that looks dramatically different than it did 75+ years ago when our existing benefits ecosystem came together.
The benefits system has been showing its age for years. Fierce debates about independent contractor classification have laid bare the holes in the safety net for “non-traditional” workers.
Then, with little warning, tens of millions of Americans lost their jobs because of a global pandemic. But they didn’t just lose their income. They lost access to the only decent financial support this country offers: employer-sponsored benefits.
Without health insurance, retirement contributions, paid time off, and more, millions of people have had to face the reality that there actually wasn’t a net under the trapeze at all.
If your protection against catastrophe is dependent on a tax form and your ability to earn “regular” wages, you don’t so much have a safety net as a finicky benefactor who will only catch you when market conditions are good. This isn’t just a problem for freelancers, gig workers, and 1099 contractors. It’s a problem for all of us.
The right solution, then, is not to force everyone onto a W2 tax form and hope employers will maintain employment rates and benefits contributions (news flash: they won’t). The solution is not to create more government programs and administration. The solution is not to rely on non-profit donations and grants. The solution is leverage technology and the private sector to undo the original sin of the American Safety Net and divorce benefits from employer whims.
In this piece, I’ll dive into where our existing benefits system came from, why it worked in the past, why it won’t work in the future, and how we can think about the role non-profits, the public sector, and the private sector can play to rebuild a system that is strong, flexible, and accessible.
Before we get into the history, I should note that I don’t explicitly intend to get political in this essay. In many ways, portable benefits are attractive to both parties: Democrats love the focus on serving the underserved and Republicans love a private sector solution that promotes independent ownership. However, that also means portable benefits are unattractive to both parties: Democrats are quick to point out that individual autonomy may drive employers to shirk responsibility to workers and Republicans are typically not on board with the suggestions of single-payer health systems. So… let’s just leave our political backpacks at the door and say there are things here you’ll like and things you won’t. Cool? Cool.
How did we get here?
The answer of how our benefits system was built is a lot like the answer to most things that took place over several decades: it was an accident. We’re here because a series of decisions and incentives and contextual historical events led us here. There is no grand order to the entirety of the employer-sponsored benefits world, and there is no master plan for how it’s supposed to work. Because of that, a bit of history can be really enlightening.
The W2 Tax Form
Taxes were first withheld in the U.S. as part of the Tariff Act of 1913, but the withholding was repealed with the Revenue Act of 1916 that was put in place to raise federal revenue to pay for World War I.
At this time, jobs were still migrating from agrarian to factory. The familiar understanding of a “company” didn’t really take hold until GM transformed from a holding company to a modern M-Corp in the 1920s. Income taxes were mostly paid directly by individuals, because earning income wasn’t aggregated by large employers.
By the 1940s, more Americans were earning a living from manufacturing than any other industry. Large companies had tens of thousands of employees and had built efficient systems for payroll and record keeping. The Current Tax Payment Act of 1943 (notably during World War II when revenue was again critically important for the government) mandated that employers withhold federal income tax from paychecks and send them to the government directly on the worker’s behalf.
The Act also established the W2, or the “Withholding Tax Statement” (now called the Wage and Tax Statement). The first W2 forms were provided to employees in 1944.
Many of the benefits that we now associate with the W2 form (unemployment insurance, etc.) had nothing to do with the form’s creation. The government simply uses a tax withholding form as a proxy for what it means to be employed. You probably can already see how this is a problem in today’s workforce.
Tax Credits for Health Insurance
In 1918 the Federal Government did another overhaul of the tax system. In a few sentences, the government made it tax exempt for employers to pay for “accident or health insurance or under workmen’s compensation acts, as compensation for personal injuries or sickness.”Nikhil Krishnan has a great piece where he points out this clause is in fact shorter than the section in the bill that talks about taxing circuses.
At the time, as Krishnan points out, health insurance was typically inexpensive because the care available was so much more limited. Chemotherapy, ventilators, organ transplants, and care for life-long illnesses like diabetes were not available. Not many employers paid attention.
A few decades later (again during WWII, see the pattern?), soldiers going overseas meant that there was fierce competition for labor here at home. President Roosevelt enacted an Executive Order to prevent factories from raising wages. The only problem was that insurance and pension benefits were excluded. The IRS reiterated the exclusion in 1943 by ruling that group health plans were “ordinary and necessary” business expenses and not compensation.
All of a sudden, employers found a way to offer something of value that wasn’t restricted by the wag caps. Employees got a huge benefit without it counting towards their taxable gross income. It was considered a win-win.
Pensions and 401(K)
In the early- and mid-twentieth century, pensions were the most common way to pay for retirement. In another hugely impactful tax bill called the Internal Revenue Act of 1921, contributions to employee pensions were declared free from federal corporate income tax.
By the 1940s, unions recognized the power of the pension and made it a cornerstone of negotiations. In 1960, about half of the workforce in the private sector had a pension. (To all my millennial friends — I KNOW, RIGHT?)
In 1978, though, The Revenue Act clause 401(K) made an allowance for employees to contribute their own money to a tax-advantaged retirement account.
The 401(K) and other vehicles were the beginning of the Defined Contribution Plan, a name so given because the amount of the contribution (by the employer) stays the same for each month the employee works. Pensions, on the other hand, were part of a Defined Benefit Plan, where the benefit (for the employee) stays the same for each month the payout is received. In 2011, 93% of those participating a retirement plan at work contributed to a Defined Contribution Plan like a 401(K).
Why was this system good?
It’s the 1960s. Hippies and Woodstock and Volkswagen vans. Americans are working in manufacturing, wholesale, and retail. Big companies were the norm and employers provided all of the things you needed for a stable and prosperous life in the middle class: a living wage, pensions, and health insurance. No wonder everyone was feeling groovy.
The system was working (a caveat: it was working for white men, who made up a majority of the workforce, but that’s another essay).
Average tenure at a job was just about ten years. Given how pension benefits were structured, it’s not a surprise that employees stayed for significantly longer. With that, the relationship an employer had with an employee often cycled through many life milestones: marriage, buying a house, having children. Employers were more paternalistic and less transactional.
It was also fairly cost prohibitive for banks and financial institutions to deliver financial products directly to consumers. With the technology of the day, existing channels for consumer adoption were department stores, grocery stores, and a bit of multi-level marketing with Tupperware parties and Mary Kay. Distribution for complex financial products was highly dependent on employer relationships.
The most important reason tenure was long and distribution was efficient, of course, is that government incentives made this system lucrative. Companies saved millions of dollars in taxes by offering health insurance and retirement. Employees got the promise of a stable retirement if they were willing to stay at a company for a longer time. Financial institutions could reach tens of thousands of accounts by working with a single employer. For the system as a whole, the upside far outweighed the costs of administration.
There are a few reasons why the system started to crumble. First, there’s a book and brilliant article on “The Great Risk Shift” by Jacob Hacker that details a key principal in what changed in our system: the transition of risk from the government to employers and employers to individuals. We have methodically moved pieces of financial risk: from losing a job, to getting sick, to living longer than you expected to sit squarely on each of us personally.
Incentives for companies to take on less overhead have also increased. Shareholder-mania means lower-cost 401(K) decimated investment in pensions. Companies constantly looked for ways to keep costs low, so employee incentives to stay for a long time completely evaporated. With the average tenure currently at 4.3 years — less than half of what it was in the 1960s — the administration costs of offering benefits are getting higher per person.
Finally, the proliferation of the internet has made it easier for people to find work with less friction any time, anywhere. More of our economy operates in the professional and managerial services sector. Tools make communication across distance instant. People have discovered that working when and how they want gives them freedom and flexibility that outweighs a tenuous wage, retirement plans with $0 employer contribution, and employer health insurance with a $2000 deductible.
It’s not so much that this generation of workers is fundamentally different than the ones before; it’s that the incentives have dramatically changed.
Why doesn’t the old system work now?
We’ve seen changes in our social construct and incentive structure that’s made the old system fall apart in the last twenty years.
More people are non-traditional employees
With new tools enabling new ways to work (remotely, on demand), the number of people who are no longer considered traditional employees is exploding. While traditional employee growth is flat at less than 2% per year, the growth of independent contractors has averaged between 5–10% each year since 2013. Some estimates report nearly 60 million people are currently working in independent engagements.
By our own estimates, nearly 80 million people are currently living without employer sponsored benefits (tax withholding, retirement, health insurance). This says nothing of the 36 million unemployed due to coronavirus who lost any coverage or benefits they may have had.
401(K) doesn’t replace a pension
Companies used to offer employees a lifetime guarantee so that they could plan, knowing what their income would be for as long as they lived. While medical and care costs at end of life are always unknowable, there was certainty on what income streams would be coming in. The move to the 401(K) didn’t just limit the amount of contribution employees received, it added two additional variables of uncertainty that make it difficult to plan for retirement.
First, the ownership of the funds in the account belong to an individual, not the company providing the account. That exposes the individual, personally, to market risk. If the market goes up in the 5 years before your retirement, great. If there’s a recession or a depression? That’s your problem. Pensions mitigated the market risk by having fund ownership that could smooth out the impact of fluctuations on those who retired in any specific year.
Second, the amount you contribute in a defined contribution plan is up to you. Sure there are calculators and matching percents from (some) employers, but ultimately how much you save is your choice. Because you don’t know how long you’re going to live, you don’t know how much you need to save. Even if you’re a great saver, you’re trying to hit a moving target in the dark. General guidance says you should have 10–20x of your income saved by the time you retire. Research shows we’re not doing a great job by ourselves.
Effectively, a pension is an insurance plan and a 401(K) is a personal investment account. Swapping one for the other means we are woefully unprepared for end of life care for future generations. A statistic to keep you up at night: 81% of current retirees are receiving some sort of a defined benefit (read: pension) plan. Only 24% of workers who are not retired have any defined benefit plan at all. Among millennials, only 6% are earning anything in a defined benefit plan.
Health insurance costs have skyrocketed
Because employers became the primary payer for health insurance even though they weren’t the recipient of the services, health insurance companies had a unique opportunity to inflate costs that consumers would not have been able to bear.
In the last 15 years, though, the costs have become too high for employers too. From 2009 to 2014, the number of employer-sponsored plans with a deductible above $1,000 jumped from 22% to 41%. The number of employers offering only high deductible plans more than tripled between 2012 and 2016 from 7% to 24%. More of the expense is being pushed back on to employees, even if the plan itself is still chosen and paid for by the employer.
Additionally, the system doesn’t make it easy to choose what type of health insurance you get. If you have access to employer sponsored health insurance, even if your employer pays nothing towards your premiums or costs, you may not be eligible for tax credits to purchase more affordable or comprehensive coverage through the independent marketplace.
Out of pocket costs for families have nearly quadrupled in twenty years, and while employers are covering much of the cost right now, the balance is shifting.
What system should we have instead?
The best way to think about solving the problem of an out-dated benefits system is to talk about the key players and the role they should (and should not) be playing in a solution.
Non-profits should buoy the most vulnerable
Non-profits play a critical role in serving those who can’t be reached with market-based solutions. We should tap non-profits to continue doing what they do best: infusing capital from donors to the lowest income segments, administering programs to educate and support complex social problems, and investing in explorations of solutions that could some day be deployed in the private sector with sustainable economics. Non-profits don’t need to solve for every person, nor should we be reliant on donors from the uber-wealthy to provide a safety net for large portions of the population.
The government should align incentives
The government should not build software. I’ll say it again. The government should not build software. It’s not a core competency (or even an ancillary one), and the basic methods of agility, user-centered design, and understandable communication are foreign to government bureaucrats.
What the government should do, though, is the hard stuff that no other group can do. Legislators should focus on incentivizing behavior through tax law that will promote the outcomes we need from a safety net. It should be easy for any person to save in a tax-advantaged way for their retirement (equally to what W2 employees do), not wrapped in a complicated multiple-employer plan (MEP) that makes people turn themselves into companies to participate. It should be easy to set aside for taxes, not independent quarterly returns based on receipts and excel sheets. We need independent payroll.
The government should also focus on other pre-tax insurance products that are incentivized for companies and offer the same incentives for individuals: life insurance, disability insurance, paid leave, etc. These products provide stability and safety and should be affordable through tax credits.
The government should also pay for healthcare. Individuals should get choice in where they get care, but the administration of costs should be managed through the federal government who can negotiate scale in a way that insurance carriers can’t. If you’ve learned anything in this essay, it should be that crises are the perfect time for complete revamping of the systems we think are unassailable.
The single greatest way to support independent work (ie, the future) is to remove the tie of health insurance from employment. This pandemic is when we can truly rethink what healthcare is all about, and not what the bloated insurance industry tells us it needs to survive. A unified system where all people can get the care they need to survive should be non-negotiable for the next Administration.
If we lack the political will to accomplish the truly massive overhaul we need, the next best solution is a robust public option and easing of the requirements to be a part of employer-sponsored coverage. If your company offers a crappy health plan, you should have an easy path to taking part in a federal plan. At a minimum, the federal government should clear regulatory hurdles with state by state regulation in insurance so that innovators are incentivized to build scalable products (similar to how the Web Brokers exemption from the SEC opened the door for Roboadvisors in the late 2000s and 2010s).
Only the government can make these things happen.
The private sector should make portable benefits
When I speak with experts in the portable benefits space, I’m alarmed how many come from non-profit, academia, or the government and how few come from the private sector. The private sector built the existing benefits infrastructure, and it worked pretty well for at least fifty years, maybe close to a century.
The administration of a “program” for portable benefits should not be run by non-profits or government agencies. True portability requires a deep understanding of technology, the ability to build high quality financial products, and a profit motive to create a sustainable and thriving business that meets customer needs. The private sector must build portable benefits and find efficient ways to distribute them.
So… how does the private sector do it?
Start by providing personal payroll
One of the biggest headaches in being self-employed is paying your taxes. There has historically been insurmountable complexity in managing multiple income streams, variable payments, and uncertain annual income. Most independent workers track their income weekly, figure out their tax withholding monthly, and have to pay the IRS quarterly. How many of you W2 workers want to do that? I don’t. It’s a waste of time, energy, and typically leads to a shock at tax day for new and seasoned independents alike.
Instead, we need a modern payroll system, built around the individual, not an organization. We need to make it easy to withhold for FICA, automatically, and send payments directly to the IRS on a quarterly basis. Existing payroll providers aren’t equipped to offer this because they serve companies and have difficulty managing the volatility and diversity of payment sources for an independent contractor. This was the first product we built at Catch.
Integrate deeply with infrastructure
Payroll is only powerful if its building blocks are connected to the benefits people need most. Retirement investment. Health insurance plans. The products most needed in portable benefits are difficult to build. But we’re long past the time where throwing up a landing page and linking out to some third party for a lead generation fee is the appropriate way to solve the problem.
This means tackling regulatory burden that crosses sectors: federal banking and ACH regulation, investment advisory regulation with the SEC, and state by state licensing requirements to broker health insurance. There is no cutting corners, but the potential upside then becomes the union (superset) of market size for insurance agents, banking transactions, and investment advisory fees. It is worth building correctly for a market of hundreds of billions of dollars.
To build the right integrations, we still have a long way to go bringing insurance APIs onto a level playing field with financial services. It’s critical that insurance and financial services products can operate together technically, because on a human level, the products are completely intertwined.
HSAs depend on high quality integrations and shared information between financial and insurance products (at least the good ones do). Long-term investment products that can address the gaps in the 401(K) as a primary retirement vehicle will need to blend investment and longevity insurance to stabilize end of life wealth. Student loans can be de-risked by bundling life insurance and investment accounts during refinancing. The future of financial services depends on these separate products working together, and portable benefits is the first step towards breaking down the rigid product lines at banks and behemoth financial institutions.
Once integrations are functioning, we stand in a unique position to allow portable benefits to leapfrog traditional benefits in one very important way: intelligence. Advancements in artificial intelligence and machine learning mean that we can leverage data in a way the benefits infrastructure of the twentieth century couldn’t.
Consumers no longer need to be financial experts or pay thousands to hire them. We should be able to use the information we have to innovate financial and insurance products in really exciting ways: automatic contribution adjustments, underwriting for volatility, and recommendations and enrollment based on human life events (having a baby, retirement, etc.). Creating aligned incentives between consumers and the private sector can unleash massive wealth creation.
The next ten years…
We are at a turning point. The system has been crumbling for years, and we’ve let the government and private institutions chip away at the stability of families in the name of protecting shareholder value. The coronavirus pandemic is a unique opportunity to completely rethink what we can create.
The technology is available. The need for a solution is at crisis level. The roadmap is here. At Catch, we’re sharing our thesis publicly because we believe this problem is too big to solve alone. To make the trillion-dollar impact we hope to achieve in the next decade, we’ll need partners, support, political will, and yes, more competitors racing to solve the problem alongside us.
Join us. Portable benefits by 2030 is a mission we can achieve, together.