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ALTERNATIVE FUNDING METHODS

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Upon termination, employer is responsible for deferred premiums, so insurers are ... Employer is responsible for claims up to some level, such as 90 % of ... – PowerPoint PPT presentation

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Title: ALTERNATIVE FUNDING METHODS


1
ALTERNATIVE FUNDING METHODS
  • CHAPTER 14

2
Reasons for Alternative Funding
  • Cost savings
  • From lower retention Commissions, Premium
    taxes, Risk charges, Profits
  • From claims. Focus here is on not providing
    benefits mandated in insurance contracts.
  • Improved cash flow
  • Postpone payment of premiums
  • Release reserves to employer who can earn more on
    funds than insurer will credit

3
Premium-delay arrangements
  • Premium deferred for 60-90 days
  • Allows employer to have use of funds longer
  • Insurer must still maintain reserves so a charge
    is made for delay.
  • Upon termination, employer is responsible for
    deferred premiums, so insurers are concerned with
    financial responsibility of employer and may want
    some type of security.

4
Reserve-reduction arrangement
  • Employer allowed to retain an amount of premium
    equal to claim reserve
  • In other respects this is like a premium-delay
    arrangement.
  • A variation is a limited-liability arrangement
    for LT disability income coverages.
  • Insurer pays claims only for one year.
  • At renewal a premium is paid to continue
    disability payments for another year.
  • Problem for employees No security if employer
    fails to renew coverage

5
Minimum-premium plans
  • To reduce premium taxes, but may also improve
    cash flow
  • Employer is responsible for claims up to some
    level, such as 90 of expected claims.
  • Insurer administers all claims and pays employer
    portion as agent of employer. Balance is
    insurance for which premium was paid. Only
    insurance portion is subject to premium taxes.
  • Employer must maintain reserves and pay all
    claims.
  • Not used for life insurance because of 5,000 IRS
    limit on income-free benefits to beneficiaries

6
Cost-plus arrangements
  • Employer pays periodic premium that is equal to
    claims of prior period plus retention
  • Improves cash flow if experience better than
    average

7
Retrospective-rating arrangements
  • Employer pays less than justifiable premium.
  • Employer must pay additional premium if claims
    exceed a specified level. However, there is a
    maximum additional payment.
  • In other respects, this is like a traditional
    group insurance arrangement.

8
Self-funding used when
  • Predictable claims
  • Noncontributory plan.
  • Nonunion situation
  • Unions concerned about security
  • Unions may want a piece of any savings
  • Ability to handle claims effectively and
    efficiently
  • Ability to perform other administrative services
    normally provided by insurer.

9
Extent of use of self-funding
  • Little use for death benefits because of 5,000
    limit on income tax-free benefits
  • Frequently used for short-term disability income
    benefits
  • Long-term disability income is often self-funded
    by large employers. Catastrophic potential of
    claims makes its use difficult by small
    employers.
  • Medical expense benefits are more likely to be
    self-funded as the size of the employer
    increases. The problem is predicting average
    severity.

10
Stop-loss coverage
  • Enables self-funding to be used when level of
    claims is difficult to predict
  • Types Aggregate and Specific
  • (Next slides)

11
Aggregate Stop-loss
  • Insurer bears aggregate dollar amount of claims
    that exceed some percentage of expected claims.
    120-140 percent is common.
  • Improves cash flow
  • Premium taxes paid on stop-loss premium only

12
Specific Stop-loss
  • There is a large deductible, usually per person
    per year.
  • Insurer only responsible for claims in excess of
    deductible
  • Large employers often have deductibles of 5,000
    to 10,000. Small employers may have deductibles
    in the 500 to 1,000 range.

13
ASO contracts
  • Purchase administrative services from insurer or
    an independent TPA.
  • Any one service or several can be purchased.
  • Claims payment is most often purchased. No
    responsibility for paying claims if employer's
    funds are insufficient.
  • ASO contract is not an insurance contract and is
    not subject to premium taxes.
  • If ASO contract provider is an insurer, it (for a
    fee) may provide conversion policy to employees.

14
501(c)(9) trusts
  • Often called VEBAs or voluntary employees'
    beneficiary associations. It is a trust
    established by an employer to pay benefits.
  • Delete the rest of this chapter

15
Advantages of VEBAs
  • Employer can deduct payments to trust.
  • Trust assets free of taxation
  • More latitude for investing trust assets than if
    same funds held by insurer
  • Can be used if a plan is contributory
  • Latitude in funding. Employer can underfund in
    bad times and overfund in good times. However,
    no tax deduction is allowed if trust is
    overfunded.

16
Disadvantages of VEBAs
  • Expensive to establish and maintain
  • Possibility of trust depletion by excessive
    claims. However, stop-loss coverage can be
    purchased.

17
Requirements for VEBA establishment
  • Membership in the trust must be persons who share
    a common employment-related bond. Can
    discriminate in favor of highly compensated
    individuals.
  • Participation by employees must generally be
    voluntary.
  • The trust may only provide eligible benefits.
  • Death, medical, disability, legal, and
    unemployment benefits are acceptable.
  • Retirement benefits and deferred compensation are
    among prohibited benefits.
  • The sole purpose of trust must be to provide
    benefits to members.

18
The trust must be controlled by one of following
  • Its members
  • Independent trustees (for example, a bank)
  • Trustees or fiduciaries, some of whom are
    designed by, or on behalf of, its members

19
Limitations on contributions
  • Cannot exceed the sum of
  • The qualified direct cost of the benefits
    provided for the taxable year, and
  • Any permissible additions to a reserve. These
    are basically for claims that have been incurred
    but not paid.
  • There are limitations on the benefits for which
    deductions are allowed. For example life
    insurance benefits on retired employees cannot
    exceed what is tax-free under Sec. 79.
  • If an employer overfunds, excess contributions
    may be deductible in future years when
    contributions are below permissible limits.

20
Potential tax consequences
  • Earnings on reserve may be taxable if reserves
    are too high.
  • An excise tax is payable if improper benefits are
    provided.
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