Single employer welfare benefit plans can be used to fill a large void in employee benefit programs. This kind of benefit program is becoming popular as a way to provide life insurance and post-retirement medical reimbursement benefits.
People protect themselves against risks by using insurance to minimize the financial hardship that results from catastrophic events. For example, businesses offer health insurance and life insurance to full-time employees to help employees protect against the costs of medical expenses and loss of life; businesses and individuals contribute to qualified plans to plan for the loss of employment income when they retire; and finally, property/casualty insurance protects against the loss of such property as homes and automobiles.
Financial professionals who make their livings helping businesses and individuals assess risks and who offer products and services to mitigate these risks shouldn't miss an opportunity to help their clients.
What risk is so concerning to consumers? According to the "Risks of Retirement -- Key Findings and Issues," a summary of the "2003 Risks and Process of Retirement Survey" conducted by the Society of Actuaries, 79% of pre-retirees are concerned (49% very concerned, 30% somewhat concerned) that they may not have enough money to pay for good health care during retirement. In addition, pre-retirees are concerned about a spouse not being able to maintain the same standard of life when the pre-retiree dies. This summary points to the decreasing number of employers offering retiree health benefits and life benefits as a primary cause.
Given that Medicare covers most acute hospital care and physician services, and beginning in 2006 will cover a part of prescription drug costs, how large is this risk? Is this concern justified?
In the February 2003 Issues Brief, by the Employee Benefit Research Institute, written by Paul Fronstin and Dallas Salisbury, the authors attempt to measure this exposure. For someone age 65 in 2003 with employment-based health benefits in retirement to supplement Medicare, the amount of savings needed ranged from $37,000 to $750,000. For someone without access to employment-based health benefits who purchases Medigap coverage, the exposure increases to $47,000 to $1,458,000.
Before we discuss from where this money is going to come, let me clarify a few issues. First, this study does not include expenses for long-term care, which vary by location, but which the survey indicates usually cost $50,000 or more a year. Second, the cost estimates above are per person; a married couple can expect to incur roughly double the individual amount. Third, few employees are expected to be eligible for retiree health benefits in the future. These benefits traditionally have been offered primarily by large employers. Finally, this is occurring while Medicare and Medigap are providing limited benefits, meaning retirees should expect to pay a larger part of these expenses.
Policy makers have many ways to address these issues, including expanding Medicare; providing tax incentives to employers, active workers, and retirees to save for these expenses; mandating employers to make or maintain commitments to provide retiree health benefits; and undertaking public education campaigns to make people aware of health insurance costs.
A quick review of government policy indicates that policy makers do not want to expand welfare programs. The introduction of such programs as health savings accounts and the proposal for medical savings account and medical savings reimbursement accounts show the government wants to provide tax incentives for employers and individuals to address these issues themselves.
Single employer welfare benefit plans have provided a solution for these concerns for some time, but usually have not been promoted to small employers. The administration costs in many cases made small employer plans prohibitive. A relatively new development combines the principle of self-funding for a defined benefit approach (i.e., if a small employer accumulates a stated amount and the plan fits certain parameters, the contributions may be deductible).
There are several requirements for contributions to be deductible:
o Because the benefit program provides post-retirement benefits, it must be provided on a non-discriminatory basis. This means 70% of all eligible employees must be offered the benefit. Eligible employees are determined by a three-part eligibility test. They: 1) are age 25 or older; 2) have 36 months of service; and 3) work at least 35 hours a week.
o The benefits must be funded on a level basis over the employee's working life. This means that larger contributions will be made for older employees (their working life is shorter than a younger employee's).
o Although vesting is not required, the plan must have the same entitlement age and years of service requirement for all eligible participants.
o There are annual administration requirements such as filing the Form 5500, reviewing employee information for newly eligible employees, reviewing the projected liability relative to the assets accumulated to pay benefits, and so on.
If the welfare benefit trust is established as a taxable trust, the investment earnings result in taxable income to the trust. By using a tax-favored vehicle such as life insurance, the plan can avoid the added expense of this taxation on the earnings. The plan trust must be the owner and beneficiary of the life insurance policy.
To review how this concept can be used, let's look at an example:
Denny, an orthodontist, would like to provide life insurance and medical benefits for his employees and himself. He is willing to contribute $100,000 a year on a tax-deductible basis until he retires in five years.
By providing the benefit to employees and spouses, Denny can accumulate $304,000 that he can receive income tax-free if he uses the money to pay medical expenses he or his dependents incur (see the chart on pg. 30 of the February 2005 LIFE INSURANCE SELLING). Any policy loans or withdrawals will reduce cash values and death benefits, and may have tax consequences.
It is imperative that the plan use a specialized third party administrator (TPA) to make sure the plan operates in a compliant manner. The independent TPA is responsible for the plan documents, preparation of proposal material, and the annual calculations and IRS and ERISA reports.
