Incentives in the Pandemic
By Michael R. Marino, Arthur H. Kohn, Michael Albano, Caroline F. Hayday, Howard Pianko, Ben Conley
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While much of the focus today is on restarting segments of the economy and developing action plans to reopen businesses, history outside of corporate America teaches us important lessons on how incentives can play a role in driving effective outcomes. It shows us that incentives, not just rules, may be the solution businesses need. Consider the British prisoner dilemma over two centuries ago as a powerful lesson in incentives and how these lessons can be applied to the current pandemic.
Back in the 1700s, the British government had a crisis arising from jail overcrowding. It responded by paying sea captains to take felons to Australia, mostly in the same ships that had been used in the slave trade. At first, not surprisingly, that didn't work so well. About a third of the felons on one particularly horrific voyage died. The rest arrived beaten, starved, and sick.
This was a scandal back in England, so the government tried to fix it with all different kinds of rules. Force the captains to bring a doctor along. Require them to bring lemons to prevent scurvy. Have inspections. Raise captains’ salaries. None of it worked. Even the clergy begged the captains, for humanity’s sake, to take better care of the prisoners. No dice.
Finally, an economist had an idea: instead of paying for each prisoner that walked on the ship in Great Britain, the government should only pay for each prisoner that walked off the ship in Australia. And in fact, this was the suggestion which in 1793 was adopted and implemented. And immediately, the survival rate shot up to 99%.1
As we consider numerous hard issues concerning reopening workplaces in the midst of the pandemic, it makes sense to reflect on the point that incentives matter, particularly when they can motivate individuals to deliver a desired outcome. In fact, they may sometimes work better than rules, as the British transport experience illustrates, particularly in an environment – such as the one that currently exists – in which there may be skepticism among a portion of the population about the efficacy or need for new rules and social dynamics that stigmatize compliance with rules and enforcement efforts. 2
Incentives are not a cure-all; they present challenges of their own. Two challenges in this context are i) how to pay for them and ii) how to design them to effectively encourage the desired conduct or outcome, while avoiding unintended consequences. But as we debate the steps that might assist businesses to operate more fully and safely in the current environment, it seems worth considering whether incentives, in addition to prescriptive rules, might contribute to a better outcome. Is there a potential funding source for COVID-19 safe conduct incentives and what kinds of incentives could companies adopt that would efficiently result in increased adoption by employees of practices that reduce the risks arising from COVID-19 contagion?
As to funding, consider that corporate savings on health and welfare benefits may provide part of the solution. Preliminary data indicate that health and welfare costs for 2020 for large self-insured employer plans could be down because of collateral impacts of the virus.3 Some of those costs may be deferred rather than eliminated, such as covered non-emergency procedures. Some of the costs, however, including for example one-time missing of routine appointments due to concerns about exposure to the virus at medical facilities, or closure of doctors’ offices, or covered elective surgeries that are postponed for the long-term, should give rise to permanent savings.
Additionally, reducing COVID-19 infections should reduce health costs for employers, potentially making a well-designed incentive self-funding.4 A recent study estimates that COVID-19 hospital admission costs for large-employer plans would range from a median of approximately $12,500 for short admissions not requiring ventilator support to a median of approximately $88,000 for admissions of longer than four days requiring ventilator support:5 Every infection avoided produces corresponding savings. COVID-19 absences also entail other costs, including productivity loss, impacts on employee morale and reputational risks. While the insurance industry has agreed to pick up the cost of COVID-19 testing as well as taken other steps in response to the crisis,6 the costs of treatment would be borne under current rules largely by employers.7 Can incentive programs be structured in which such savings, together perhaps with savings described in the preceding paragraph, are sufficient to fund meaningful incentives?
Such cost savings will not be spread evenly across all types of employers. For example, employers that can reduce health risk through work-from-home arrangements may have an effective approach that makes special incentives unnecessary. But other employers, including businesses that have been deemed essential and those that have not, might be able to generate a financial benefit from adopting new incentives while at the same time helping to protect the welfare and safety of its workforce, a good in and of itself. In addition, for some businesses, there may be a potential for creating positive employee morale and potentially positive reputational benefits among other stakeholders. Even employees who would comply with the rules without incentives might derive comfort from knowing that their colleagues who are not like-minded will have a financial incentive to moderate their conduct.
Assume that there are financial resources available to fund an incentive pool intended to reduce COVID-19 risk. Putting aside limits on the size of the pool to reflect the funding calculations, how should that bonus pool be designed?
First, employers should review their current incentives programs and the policies or procedures in place to support those incentives to determine if counterproductive incentives exist. It is not hard to identify historical cases of incentives creating unintended consequences. For example, incentives and supporting policies or procedures in the financial services industry may have contributed to the 2008/2009 financial crisis. Today, legal complaints have already been filed in connection with the COVID-19 pandemic that include allegations of inappropriate incentives,8 including specifically incentives for employees to come to work even if they may have symptoms or direct exposure to confirmed cases. These counterproductive incentives should be identified and eliminated.
Second, positive incentives should be kept simple and focused around workforce sustainability metrics with clear outcomes. Employers considering this approach should establish health and safety policies and procedures that can be objectively or subjectively measured at year-end, including for example social distancing policies (subjective), provisions for personal protective equipment (objective), back to work/remote work policies (subjective), testing (objective), COVID-19 employee medical costs (objective) or other indictors of workforce sustainability.
Third, employers should be cautious of anti-discrimination laws that may apply to “wellness” programs that incentivize healthy behaviors. Among others, the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) places limits on the level of incentives employers may use to incentivize healthy behavior or outcomes and may require that employers offer a reasonable alternative to employees who cannot reduce their health costs due to a medical condition. Further, the Americans with Disabilities Act only permits employers to offer incentives tied to medical exams/inquiries that are “voluntary”. These rules typically apply in the context of individual-level incentives as opposed to group incentives, so arguably these rules would not apply to a reward/incentive based on the health costs of an employee group. That said, a group incentive may be less motivational, as employees cannot control the health care costs of those around them.
Fourth, while this note is focused on health and safety incentives, consideration should be given to the impact of financial incentives on the overall situation. Financial incentives to positively address the pandemic can be structured in parallel with health and safety incentives. For example, employers should consider establishing objective and quantifiable metrics that measure enterprise-wide liquidity tied to daily operations, not just the ability to pay bondholders or to declare dividends to shareholders in the short-term (e.g., quarterly cash balance levels, possibly as a percentage of expected sales), but also working capital ratio, cash conversion cycle time, or other indicators of enterprise liquidity. Financial incentives should be reviewed from the perspective of consistency with health and safety imperatives, so that for example financial concerns do not unintentionally conflict with health and safety best practices.
Lastly, consideration should be given to the form of payment. Cash bonuses are the best alternative for short-term objectives, but cash-strapped companies may consider awards of common stock, restricted stock or restricted stock units, increased retirement savings or 401k matches, or other fringe benefits.
The suggestion that incentives might play a role in helping to manage COVID-19 risk is not novel. No two businesses are exactly alike, but many employers already include workplace safety metrics in their incentive programs9. Adopting those programs to the current circumstances should be done thoughtfully, of course, but there is reason to believe that they could play a positive role as businesses face the multiple challenges of operating in the pandemic environment.
1Pop Quiz: How Do You Stop Sea Captains From Killing Their Passengers?, at https://www.npr.org/sections/money/2010/09/09/129757852/pop-quiz-how-do-you-stop-sea-captains-from-killing-their-passengers.
2See, e.g., A Survey of Essential Workers Shows a Political Divide, at https://www.nytimes.com/2020/04/27/upshot/red-blue-workplace-differences-coronavirus.html (“Three out of four (73 percent) essential workers who affiliate with the Democratic Party say that they are very confident that social distancing saves lives, compared with 27 percent of essential workers who identify as Republicans. . . . These partisan differences are predictive of actual worker behavior, although with a more modest effect.”).
3https://www.vox.com/coronavirus-covid19/2020/4/1/21202148/health-insurance-premiums-coronavirus-covid-19 (“Health Insurance Premiums”) (“‘Many issuers are receiving significantly lower call volumes, which is considered a key predictor for future claims,’ Dillon says. ‘Therefore, it appears that 2020 Covid-19-related losses may be offset by reduced spending in other areas in the short term.’”).
4Health Insurance Premiums (“Analysts for California’s insurance marketplace recently projected insurers nationwide could end up spending as much as $251 billion to cover care for coronavirus patients.”).
5https://www.healthsystemtracker.org/brief/potential-costs-of-coronavirus-treatment-for-people-with-employer-coverage/ (“Employer Cost Study”)
6https://www.ahip.org/health-insurance-providers-respond-to-coronavirus-covid-19/.
7Employer Cost Study. (“To address concerns over costs associated with COVID-19, Vice President Pence met with a group of large private insurers, who agreed to waive copayments and deductibles for COVID-19 tests. However, America’s Health Insurance Plans (AHIP) clarified that the out-of-pocket costs for treatment – such as hospitalizations for more serious cases – would not be waived, meaning people with private insurance who face deductibles could be on the hook for large costs.”)
9See FW Cook – Annual Incentive Design Research, 2019 Top 250 Report
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Michael R. Marino is Managing Director and Head of the New York office of FW Cook. Arthur H. Kohn and Michael Albano are partners and Caroline F. Hayday is counsel at Cleary Gottlieb. Howard Pianko and Ben Conley are partners at Seyfarth.