GHDP 118-17: Issues to Consider in Self-funding Long Term Disability Insurance

Question 1

Introduction

1. Reasons why ERs Consider Self-funding
2. Serious Implications to Consider

Answer 1

1. Reasons why employers consider self-funding their long-term disability plan:
a. Improvement of cashflow
▪ Ability to use funds normally provided to the insurance company for reserves

b. Save costs
▪ Self-funded benefit payments and ASO admin fees are not subject to state premium tax
▪ Elimination of the insurance carrier’s risk charge

2. Serious implications to consider
a. The employer must evaluate whether it is financially advantageous to assume the risk

b. Weigh the advantages against adverse economic, tax, legal or EE relations consequences

Question 2

Implications of Self-Funding

1. Loss of Third Party Guarantee For EEs
2. Volatility in Claims
3. Economic Cycle
4. Employee Relations
5. Accounting Regulation
6. Tax Risks

Answer 2

1. Loss of Third Party Guarantee for Employees
a. If an employer self-funds their LTD plan, it is responsible for the entire LTD liability and the insureds could lose the advantage of having a third party to guarantee benefit payments

b. Under an insured program, state insurance regulators protect the insureds by requiring that insurers are solvent and have sufficient reserves

2. Volatility in Claims
a. Volatility due to fluctuations in claim incidence and severity are common in LTD

b. Employer faces the difficulty of budgeting for fluctuations in benefit payments

c. Employer assumes the risk that the overall claims liability could be larger than anticipated

3. Economic Cycles
a. LTD claim costs are tied to the general economy, as well as the economic state of the employer’s industry

b. LTD plans have higher incidence and longer duration of claims in periods of high unemployment and downsizing

c. Poor economic conditions and an alternative income source may curtail an employee’s desire to work

d. Often, claim costs will increase at the very time the company’s profit is suffering (when the employer can least afford additional expenditures)

4. Employee Relations
a. Under a self-funded arrangement, any claim suit is against the employer

b. The employer is responsible financially and otherwise, for defending the suit

c. In contrast, suits under an insured plan are generally against the insurance company
▪ The implication is that a suit could be viewed as employer versus EE rather than claimant versus contract

5. Accounting Regulations
a. Financial Accounting Standard Board (FASB) #112 requires that employers recognize a liability for self-funded LTD which keeps the beneficial cash flow of self-funding from dropping to the bottom line

b. By contrast, premiums paid for an insured plan are fully deductible by the employer

6. Tax Risks
a. With trusts, there is a tax risk when maintaining reserves for self-funded benefits

b. Contributions are limited to paid claims plus a reasonable reserve for incurred claims

c. There are also substantial penalties for making excess contributions to the trust
▪ The IRS will not permit a tax deduction for excessive amounts, any fund earnings attributable to the excessive amount would be taxable, and contributions to the fund in future years could be restricted

d. If employers do not set up a trust to pre-fund benefits and pay benefits from current revenues, they still need to recognize a liability on their balance sheet for accrued benefits

Question 2

Benefits of Insuring with a Carrier

1. Weigh the advantages against …

Answer 2

1. Any employer considering self-funding LTD benefits must weigh advantages against
a. The cost of additional management

b. Administrative and financial resources required

c. The loss of insuring long-term obligations with a financially regulated insurance company

d. Potential adverse employee reaction to benefits disputes

2. LTD is an excellent candidate for insurance because the premium expenditure for a fully insured plan is stable and budgetable

3. Any one company self-funding its LTD for its employees incurs increased risk due to the fluctuations inherent within any single long-term disability risk

4. The risks are increased when establishing a separate trust for funding any portion of this volatile coverage

5. Under the FASB 112 change, self-funded programs must recognize open claims liabilities either on the company’s books or under the accounting of a trust, if one exists
a. This change requires that companies post these liabilities on their balance sheets

b. This standard was prompted by the merger activity seen in the past decade

c. Many companies did not recognize these liabilities during merger proceedings,which left them with self-funded pensions, medical and disability programs in unbalanced positions