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PTO Financial Analysis and Preliminary Design

March 1, 1996
After clarifying corporate objectives (Step 1), comes financial analysis and preliminary design (Steps 2 and 3). With financial analysis, you can better determine amount of employee paid time off (PTO). The following example will help illustrate critical planning steps and answer concerns raised by companies thinking about adopting a PTO policy.

Conduct financial analysis.
Assumptions about a hypothetical company's program are as follows:

  1. Current Annual Leave:
  2. Account

    New Employee

    5-Yr. Employee

    Vacation

    10 days

    15 days

    Sick

    10 days

    10 days

    Personal

    4 days

    4 days

    Total

    24 days

    29 days

  3. Average use of sick time is six days per employee.
  4. 1,000 eligible employees receive annual paid time off.
  5. Daily wage is $100.
  6. Direct sick time costs are $600,000. [1,000 employees x $100 (average daily wage) x 6 (average sick days per employee)]. Based on experience, other costs average 10% to 25% of direct costs. Therefore true unscheduled absentee costs range from $660,000 to $750,000.
  7. Company wants to lower sick time costs by two days per employee. The result is a minimum savings of $220,000 [1,000 employees x $100 daily wage x 2 days x 10% other costs].
  8. Proposed PTO Design:

Account

New Employee

5-Yr. Employee

PTO

18 days

23 days

CAT

6 days

6 days

Total

24 days

29 days

Create preliminary design.
The key features of the PTO program are as follows:

  1. Total paid days are the same (a new employee receives 24 days, while a fifth-year employee receives 29). What is different is the arrangement.
  2. PTO for a new employee is 18 days (10 vacation days, four personal days and four sick days).
  3. PTO for a fifth-year employee is 23 days (15 vacation days, four personal days and four sick days).
  4. Both employees now have two fewer sick days than the average of sick days used. This is how the company caps its sick time exposure. Now, if an employee needs more than four sick days, the employee uses what was vacation time. Therefore, the employee has an incentive not to abuse paid time off. Also, using vacation time for sick time reduces the company's future vacation payout liability.
  5. PTO rewards employees with good attendance. These employees gain up to four additional days for scheduled time off. Scheduled time off is key: Planned absences are easier to provide coverage for. With PTO, employees are encouraged to give advance notice and supervisors are more receptive to working things out with employees and granting the time off. Knowing the employee will be absent gives the manager time to make alternative plans to maintain productivity.
  6. CAT (catastrophic account) is six days for all employees.
  7. Combination of PTO and CAT is the same as under the traditional system. Both total 24 days (new employee) and 29 days (fifth-year employee).
  8. CAT provides coverage in the event an employee has a short-term illness (out for more than five consecutive work days). For example, if an employee was out because of an illness for two weeks (10 days), the first five days would be deducted from the PTO account, the balance (five days) would be deducted from the CAT account. An option is to credit PTO accounts with five days (taken from CAT accounts) because the absence was for an illness. The reason is that under a traditional system, sick time would have been used as payment. This presumes there's sufficient time in PTO and CAT accounts.
  9. Time credited to PTO and CAT is based on an accrual system. This means if an employee is paid bi-weekly, then the employee will receive 1/26 of annual PTO and CAT hours every pay period. In essence, you work and then get paid; you work and then receive paid time off. Payroll managers report ease in using the accrual system to account for time, and in complying with FMLA.
  10. Companies cap the amount of time accrued in both PTO and CAT. The PTO cap often is 125% to 150% of the annual allotment. If the annual amount is 24 days, then the cap would be 30 days (125%) to 36 days(150%). The CAP usually is equal to the waiting period for long-term disability. Caps motivate employees to take time, and give employees a way to accumulate time for planned long vacations. Caps also place a ceiling on the company's PTO payout liability.
  11. Unused, earned PTO time is paid out at time of termination. CAT time is not paid out.
  12. Many companies place unused, earned balance of PTO and CAT time on an employee's pay stub. This helps ensure accuracy of recordkeeping.

Personnel Journal, March 1996, Vol. 75, No. 3, p. 117.