Easy Simple Side Money

Government deficits are sometimes called deferred taxation. At some point, you have to pay for them somehow usually though increased taxes. The question is not “if” but “when” the taxation will occur. It appears that the private company equivalent of deferred taxation occurs, in part, by simply underfunding pension plans and employee benefit obligations. For some Nortel employees, they are finding the hard, and sad, way that their “insurance plan” actually wasn’t an insurance plan.

As the story indicates, Nortel’s long term disability benefits was funded by the company itself, through what are known in the insurance industry as health and welfare trusts. On a very simplistic basis, the company creates the trust with the named employees as beneficiaries of the trust. The employers and employees can contribute to the trust.  The administration of the trust is out-sourced to insurance companies who administer the payouts and report to the trustee (who, realistically, report to management of the company) the financial position of the trust.  A trust is used since it is creditor proof. In other words, it is self-insurance with a benefit to the company of the contributions being tax deductible.

But the trust is not an insurance company. It is administered by an insurance company as self-insurance. What is the difference? Primarily, insurance companies are regulated to maintain some minimum capital requirement to adequately fund payment to the policy-holders. Self-insurance has no such requirements. Additionally, a person holding a policy from a bankrupt insurer can typically apply to a government insurance program to maintain coverage for some set period of time. No such insurance exists for self-insurance program.

In other words, it has the sheen of being insurance without being insurance. In and of itself, it is a good struture- PROVIDED it is adequately funded. If the company cannot continue to fund the health and welfare trust fund adequately, the company ceases to fund, there’s a large run on claims or any combination of the three, the self-insurance tends to collapse eventually on to itself. As the recent past has showed us, companies run the same way as governments in that they are deferring their current costs by underfunding pension or employee benefits to make the books look good.

What are the practical implications for you and I? A Nortel situation is not common-place so most of us would not be denied coverage tomorrow by our employers. Instead, I would check to see whether your health benefits are actually insured by an insurance company or self-insured by the employer with the insurance company as administrator.

If it is self-insurance, it is, frankly, hard to tell whether there is adequate funding since you would have to know both the claims history of all the named employees in the trust plus the company’s funding history. This type of information is difficult to obtain unless you are in senior management. But at least you know the risk factors involved in claiming on your employee benefits.

On a more sober note, one tends to learn a lot about people and structures when times are bad. What we are seeing is that the concept of security is self-made rather than given by third parties who ultimately live in self-perservation rather than for your benefit. If there is one lesson reinforced by this recession, it is that the only person who you can rely on for your own security is yourself.