Protecting Canadians' Long Term Disability Benefits. CLHIA Policy Paper

Transcription

1 Protecting Canadians' Long Term Disability Benefits CLHIA Policy Paper September 2010

2

3 Introduction: Ensuring that all Canadian employees covered by long term disability 1 (LTD) plans continue to receive their benefits in the event of their plan sponsor s bankruptcy is an important public policy issue. How best to achieve this has been considered on a number of occasions over the years. These periodic deliberations have been renewed recently by the insolvency of a high profile plan sponsor that has again highlighted that LTD claimants can be at risk when their plan sponsor becomes insolvent. At the core, the concern relates to the different level of protection accorded disabled employees under insured and uninsured plans. While the use of uninsured plans provides another option for many plan sponsors, such plans do not offer the same level of benefit payment certainty to employees as insured plans. History has shown that when an employer becomes insolvent, and its LTD plan was uninsured, disabled employees can sometimes lose their benefits. This creates a severe financial and emotional burden for them, since they often have few, if any, prospects of returning to the work force in the future. The Canadian life and health insurance industry understands the critical importance of ensuring that employees on LTD are protected in the event of a plan sponsor's financial stress or insolvency. The life and health insurance industry has a longstanding role in providing safe and reliable long term benefit plans to Canadians. In this paper, we present our analysis and recommendations for addressing this important issue. Background: Currently, Canadian plan sponsors can provide disability income replacement benefits to employees on an insured basis or an uninsured basis. When a plan is insured, it is offered through an insurance contract with a regulated insurer. Uninsured plans have no insurance contract and are often administered by a third party - which is sometimes an insurer. Roughly nine out of ten employees with LTD benefits are covered under insured plans, which represent 82 per cent of actual coverage. For more details, see Appendix I. 1 Generally, benefits in duration of less than two years are called "short term" disability benefits (STD) and those in duration longer than two years are called "long term" disability benefits (LTD).

4 Although insured and uninsured plans may appear to provide employees with similar benefits, a key difference is who bears the financial risks and, consequently, the level of protection afforded to employees in the event of a plan sponsor insolvency. Insured Benefit Plans With insured plans, plan sponsors enter into a group insurance contract with a regulated insurer and pay premiums in exchange for transferring the risk and financial liabilities for providing the LTD benefits to the insurer. In order to meet expected future payment obligations, the insurer sets up a reserve fund that requires actuarial valuation and reporting, as required by federal and / or provincial prudential regulation. As an added level of protection, insurers are required to hold excess capital to provide a financial buffer that ensures that the insurer s obligations will be met. In the event that more workers than expected experience disabilities and reserves become inadequate, the insurer's required excess capital is drawn on to support the reserves. The insurance carrier s benefits payments under an insured plan are subject to the terms of the contract with the plan sponsor, as well as the requirements of the insurance legislation in each province, which subjects the insurer to significant market conduct regulation. The key point, though, is that the insurer's responsibility with respect to disability benefits continues even when the plan sponsor experiences financial difficulties or after the plan is terminated. Indeed, after a plan sponsor s bankruptcy, the insurer will continue benefits for disabilities that began while the group policy was in force. Government regulators monitor insurance companies to ensure they maintain sufficient assets to meet their liabilities. In the extremely unlikely event that a Canadian insurance company became insolvent, the relevant prudential regulator would step in to ensure an orderly windup or restructuring process with a minimum impact on policyholders. In such cases, the full asset base of the insurer is available to provide an additional measure of protection to disabled employees and in fact, disabled employees and other policyholders 2

5 rank ahead of other creditors in such situations. Should the assets of the insurer be insufficient to cover all claims, long term disabled employees would be covered by Assuris - which would continue to ensure that payments of up to $2,000 per month or 85% of the monthly benefit, whichever is greater, are made to such employees. 2 For more detail on the regulatory regime for insurers in Canada, refer to Appendix II. Uninsured Benefit Plans Uninsured plans, are also sometimes referred to as "Administrative Service Only" (ASO) plans. In these situations, a third party (e.g. an insurance company) only provides administrative services, such as adjudicating claims and administering payments, for the plan sponsor. An uninsured plan may also be entirely administered by the plan sponsor without the involvement of a professional administrator. In contrast to insured plans, the plan sponsor bears the full financial risk and there is no specific regulation to invoke if payments fail to be made due to the plan sponsor s financial difficulties. Plan sponsors with uninsured benefit plans are not required to set up a reserve to pay disabled employees and, as such, it is common for such benefits to be funded out of current cash flow. 3 These pay-as-you-go ASO plans rely on the plan sponsor being able to continue to generate adequate cash flow each year over the lifetime of the plan and for the duration of the benefit period of any disabled employees to pay benefits. Herein lies the risks of this type of approach - in times of financial stress it can be challenging for plan sponsors to continue to support their LTD commitments. In the event of a bankruptcy or insolvency, there are often no funds set aside to continue paying benefits into the future. Disability liabilities are unsecured debts in the wind up of a company. Although the term self-insured plan is sometimes used to describe ASO type arrangements, this terminology conveys a greater sense of protection than may be available in the event of 2 Assuris is a not for profit organization that protects Canadian policyholders in the event that their life insurance company should fail. More information on Assuris can be found at 3 From an accounting perspective, while there is often no reserving for the long term disability benefit payments, the value of liabilities is included in the plan sponsor s balance sheet. 3

6 a bankruptcy or insolvency. Indeed, for a plan to be insured, an insurance policy must have been issued to the plan sponsor by an insurance company authorized to provide insurance under provincial and/or federal insurance legislation and regulation. Cost differences of insured and uninsured plans One of the reasons why plan sponsors may choose to offer benefits to their employees on an uninsured basis is the perception that there are cost savings in doing so. This is largely a perception only, as over the entire lifetime of a benefit plan, insured and uninsured plans have similar costs. One reason for this perception is the timing of costs. While insured plans require that insurers set up reserves to cover the expected LTD costs in the future, uninsured plans do not. Rather, as mentioned above, uninsured plans commonly pay out benefits as they arise from current period cash flows which may give the perception of lower costs in any given year. However, over the entire life of the plan, including the run off of all claims, the reserve in an insured plan is an asset that is drawn on to make payments. The cost associated with establishing an adequate reserve will tend to be equal to the present value of future payments made under a pay-as-you-go ASO type plan, assuming that all benefits are actually paid. Some plan sponsors may also feel that they can earn a greater return by more aggressively investing their funds themselves, rather than turning them over to an insurer to fund a reserve. The life and health insurance industry invests its reserves prudently, to match assets and returns with expected liabilities, with an eye to capital preservation and in accordance with regulatory solvency requirements. Insurers' expertise in these areas significantly reduces the risk that assets will be insufficient to fund future liabilities while maximizing the return on the reserves. Due to this expertise and economies of scale, insurers are able to more efficiently manage assets than any single employer. Finally, in some provinces, the current tax regimes encourage ASO type plans by providing preferential tax treatment for such plans. These tax benefits may drive certain plan sponsors to choose ASO over the insured option. From our perspective, one of the changes 4

7 needed under the current regime is to amend the tax rules in certain provinces to create a more level playing field. Existing legislative framework Legislative responses relating to ASO plans in Canada have thus far focused on disclosure. The goal of these efforts is to help Canadians understand when their LTD plans are not insured, as well as the implications that this has for their financial security. In particular, Alberta and British Columbia have implemented disclosure requirements on plan sponsors in the case of ASO agreements. British Columbia provides that insurance licensing requirements do not apply to 'plan sponsors' (including a group of employers, unions, etc.) that provide uninsured employee benefits, on the condition that the plan sponsor discloses in writing to its employees that the employee benefits are not insured and that the plan sponsor is not subject to insurance licensing regulation. Alberta requires plan sponsors that provide employee benefit plans for income replacement to disclose to the plan participants, prior to or at the time that the benefits are offered, that the benefits are not underwritten by an insurer and are supported solely by the financial resources of the company. These disclosure requirements are helpful in clarifying the nature of the benefits being provided, but were not designed to protect those benefits in the event of the bankruptcy or insolvency of a plan sponsor. Assessment of potential policy solutions: As the life and health insurance industry assessed the range of possible policy solutions, our guiding principle was to ensure the maximum protection possible for employees on LTD. The policy options we considered, including a very brief discussion of each, are listed below in increasing order of protection for disabled employees. 5

8 1. Enhanced disclosure requirements: Enhanced disclosure rules on plan sponsors like those prescribed by Alberta and B.C., if harmonized and adopted by the various provincial and territorial jurisdictions, may help Canadians with uninsured plans better understand that their LTD plans are not insured, as well as the implications that this has for their financial security. However, expanding disclosure requirements is simply an extension of the current situation which has not addressed the issue of protecting the benefits of those Canadians. While the life and health insurance industry generally supports disclosure as a means to help protect consumers, it is important to note that in the case of LTD plans, disclosure does not address the fundamental issue of protecting LTD payments when plan sponsors become insolvent or bankrupt. 2. Increased priority status of disabled employees during bankruptcy: Some private members bills introduced at the federal level would raise the priority status of LTD claims in bankruptcy. Such an approach would increase the likelihood that disabled employees get access to any available funds in a bankruptcy proceeding. In this sense, it does somewhat improve the safety of LTD payments. However, it does not address the fundamental issue of protecting LTD payments, as it does not ensure that there are in fact funds available in the event of an employer's bankruptcy. As well, it should be noted that changing the established creditor rankings in bankruptcy would distort the credit and bond market in Canada and would likely increase capital funding and borrowing costs for plan sponsors with ASO plans. 3. Require plan sponsors to establish reserves under a separate disability fund: Requiring the plan sponsor to establish reserves under a separate disability fund with substantially the same actuarial requirements as insured plans would meaningfully improve 6

9 the protection of LTD payments over the status quo. To be effective, however, such a fund would need to be protected from other creditors of the plan sponsor. One implication of this approach is that it would require provinces to establish some form of substantive regulatory and supervisory framework for uninsured benefit plans - something that does not currently exist - in order to ensure proper compliance and the adequacy of reserves. This new framework might be somewhat similar to the current framework for defined benefit pension plans that already applies to insurers as well as to plan sponsors. It must be noted, however, that while this approach may be an improvement over the current situation, it will not fully protect LTD claimants in the event of a plan sponsor bankruptcy. As the Nortel experience demonstrates, in times of financial stress, benefit plans can become underfunded whether subject to a regulatory and compliance regime or not. 4. Require that LTD plans be offered on an insured basis: As discussed above, requiring that LTD plans be offered on an insured basis provides the maximum protection for disabled employees and ensures they are paid, regardless of their plan sponsor's financial status. Another benefit of this approach is that there is already a robust regulatory and supervisory framework in place that provides protection to LTD claimants even in the most unlikely scenario of an insurer's insolvency. Conclusion: Options three and four would provide meaningful improvement over the status quo. However, option three does not fully protect Canadians' LTD benefits. The most effective option to achieve the public policy objective of fully protecting individuals on LTD, with minimum administrative cost and complexity, is clearly to require that LTD plans be offered on an insured basis. 7

10 APPENDIX I: INCOME REPLACEMENT 2008 Group Long Term Disability Income Plans NUMBER OF PERSONS COVERED PREMIUMS or PREMIUM EQUIVALENTS ($M) Group Insured Plans 9.4 million 4,466.1 (1) Uninsured or Administrative Services only contracts (ASO) Life Insurers Administered Uninsured Plans ASO TPA Administered 1.06 million (2) N.A. 80 (3) (1) Direct premiums written (2) Premium equivalents (benefits payments + administration fees) (3) Premium equivalents (estimate) At the end of 2008, persons insured under group plans totalled 9.4 million with long term disability (LTD). Insurance companies also administer uninsured plans under which plan sponsors provide benefits to employees outside an insurance contract with nearly 1.1 million workers with long term disability income protection. Source: CLHIA 2008 Health Benefits results for Canada 8

11 APPENDIX II: Overview of Regulatory Regime for Canadian Life and Health Insurers All insurers in Canada are subject to comprehensive prudential regulation from either the federal government, through the Office of the Superintendent of Financial Institutions (OSFI), or one of the Provincial regulators. Life and health insurance companies are also subject to comprehensive provincial market conduct regulation by the provinces in which they carry on business. As well, insurance companies build up reserves by putting money safely aside for the purpose of paying future benefits. Because it is the insurer that bears the financial risk of not having sufficient funding to honour the disability benefits payments, there is strong supervision and detailed regulations governing the calculation of the actuarial liabilities, based on conservative estimates of future mortality and morbidity rates, investment returns, rates of policy termination and operating expenses and taxes. In this way regulators ensure that insurers are setting aside amounts sufficient to make expected future payments. In addition to the required funding of reserves for future benefit payments, insurers are required to hold additional capital to support the guarantees embedded in the insurance contracts. Minimum Continuing Capital and Surplus Requirements (MCCSR) are established by regulators, with an expectation that at least 150% of this value will be held by the insurer to protect benefit payments. This risk based capital assessment includes factors for mortality risk, morbidity risk and investment risk. In the highly unlikely event that the insurance company were to become bankrupt, insured benefits would continue to be protected by Assuris which provides income replacement benefits of up to $2 000 or 85% of monthly benefits, whichever is greater per month. Finally, the insurance industry regulatory framework provides consumers with recourse to ensure proper access to a claim review when needed. This is available through the Ombudservice for Life and Health Insurance (OLHI), a national independent complaint resolution and information service for consumers. Cumulatively, all of these factors ensure that LTD benefits are protected, regardless of plan sponsor or insurance company financial status where plan sponsors provide LTD benefits through an insured plan. None of the above protections apply where plan sponsors provide LTD benefits on an uninsured ASO basis. 9

12