Protecting Canadians'
Long Term Disability Benefits
CLHIA Policy Paper
September 2010
Introduction:
Ensuring that all Canadian employees covered by long term disability1 (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.
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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).
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
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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 www.assuris.ca
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.
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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
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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.
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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
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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.
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APPENDIX I:
INCOME REPLACEMENT 2008
Group Long Term Disability Income Plans
NUMBER OF
PERSONS
COVERED
PREMIUMS or
PREMIUM
EQUIVALENTS
($M)
Group – Insured Plans
Uninsured or
Administrative Services
only contracts (ASO)
9.4 million
4,466.1
1.06 million
725.2
N.A.
80
(1)
(2)
Life Insurers
Administered
Uninsured Plans – ASO
TPA Administered
(1)
(2)
(3)
(3)
Direct premiums written
Premium equivalents (benefits payments + administration fees)
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
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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.
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