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Small Business Employee Benefits and HR Blog

How to Calculate the ROI on Defined Contribution Health Benefits

Health benefits are the number one fringe benefit offered by employers, and are an important part of employee recruiting and retention strategies. Many employers look at health benefits as an investment in employees. And just like traditional health benefits, companies who implement defined contribution health benefits are looking to quantify their return on investment (ROI).

This article looks at one way to calculate the ROI on "pure" defined contribution health benefits - by comparing the cost of employee turnover with the cost of the defined contribution health benefits.

Note: This article is an excerpt from our new Health Benefits Planning Workbook eBook. Download the free PDF Workbook here.

How to Calculate the ROI on Defined Contribution Health Benefits

One way to calculate the ROI on defined contribution health benefits is to compare the cost of employee turnover with the cost of health benefits. This can be done at the start of the health benefits program (as a benchmark), and as an on-going exercise. To calculate ROI in this way, follow these two steps.

Step 1: Calculate Your Current Cost of Employee Turnover

The cost of losing an employee varies by industry and role at the company. Below are estimates of the cost of losing an employee based on a Center for American Progress study (see this article for a comprehensive overview of the cost of employee turnover).

  • <$30,000/year: 16% of annual salary

  • $30,000 - $75,000/year: 20% of annual salary

  • $75,000+/year: Up to 213% of annual salary (the most for highly-educated, highly paid, hard-to-replace CEOs)

cost_of_employee_turnover_chart

Using these example rates, you can calculate the cost of employee turnover by role or pay grade.

Example

Here's an example of how to calculate the cost of employee turnover using a 24 employee company.

In Q4 of 2013, the company had 4 employees leave the company:

  • 3 retail staff earning $10/hour, and

  • 1 manager earning $40,000/year

Using the example rates above, the cost of employee turnover can be estimated for this quarter as follows:

  • 3 retail staff: Take the annual salary ($20,800) and multiply by 16% = $3,328. This is the cost of losing one retail staff. Therefore, the total cost of losing three this quarter was $3,328 x 3 = $9,984.

  • 1 manager: Take the annual salary ($40,000) and multiply by 20% = $8,000. The cost of losing one manager this quarter was $8,000.

  • Total cost of employee turnover this quarter: $9,984 + $8,000 = $17,984

cost_of_employee_turnover_chart_example-1

Step 2: Calculate the ROI of Defined Contribution Health Benefits

To calculate the ROI of the defined contribution health benefits program, calculate your employee turnover costs before the health benefits were implemented, and after a time period, say one quarter.

ROI is calculated by this equation:

ROI = [(Payback - Investment)/ Investment)]*100

"Payback" is the amount you saved by implementing health benefits, and "Investment" is the cost of the health benefits program.

Example

Here's an example of how the same 24 employee company calculated ROI of a new defined contribution health benefits program.

  • The company had a goal of reducing the cost of employee turnover to under $10,000/year.

  • To do this, they focused on the managers, who are more expensive to lose. To help retain the managers they began offering their four managers a defined contribution healthcare allowance of $200/month (total monthly expense of up to $800, total quarterly expense of up to $2,400).

  • In the next quarter, they had turnover of 3 retail staff, but retained all managers.

  • The cost of turnover this period was $9,984 (compared to $17,984 last quarter).

  • The cost of health benefits (their "investment") this quarter was $2,400.

  • The total "cost" (turnover + benefits) was $12,384.

  • By offering defined contribution health benefits to the managers, they saved $5,600 (their "payback").

ROI = [(Payback - Investment)/ Investment)]*100

ROI = [($5,600-$2,400)/$2,400]*100 = 133%

Calculating the ROI on defined contribution health benefits provides companies with a quantified ROI measurement of the impact of health benefits. This is a valued measurement to present to board members, and to use as a key performance indicator for HR. 

Another way to measure ROI on health benefits is absenteeism and the associated cost. Track missed days before you start offering health benefits, and over time.

How are you tracking the ROI on health benefits? Leave a comment or question below.

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