Finding a More Tax-Efficient Solution for Employee Benefits

In today's marketplace, employers face skyrocketing costs for employee benefits. On average, premiums are increasing by 15% per year-effectively doubling every five years. Insurance earners attribute this price hike to cutbacks in BC's provincial health care system and increasing prescription and dental fees-all of which, in turn, result in higher group insurance claims by employees.

To avoid paying the increasingly high premiums associated with traditional group insurance plans, employers should consider switching to health and welfare trusts.

"Insurance" Is a misnomer

When it comes down to it, half of the various benefits offered to employees-namely dental and extended health-aren't really insurance at all. In truth, dental and extended health benefits are really just an amortization of the premium. Yet upon closer examination we know that 65 - 70% of the overall premium is paid for these two benefits alone.

The average employee benefit plan has annual limits, co-insurance of 80/20% or 50/50%, deductibles, exclusions, and so on. Insurance carriers know how much the average single person or family of four will claim on an annual basis; they simply add their profit margin and average out the amount.

Take a look at your claims ratio

You can insist that your insurance carrier provide you with a "claims ratio," which is a comparison survey of the premiums paid by an employer versus the claims reimbursed to employees over the previous few years. Simple arithmetic will yield the difference between these two amounts. The important thing to remember is that this difference stays with the insurance carrier. In fact, most insurance carriers actuarially project a claims ratio of about 65%-in other words, for every $1.00 of premium paid out by an employer, the insurance carrier keeps at least $0.35.

And there's more. A year with higher than normal claims will result in substantially increased premiums at the next annual renewal-well beyond the 15% average increase for the employer (and if costs are shared, for the employees as well). This leaves employers with only two options: paying the increased costs or reducing the benefits offered. Right? Wrong.

Another option is available

Specifically, remove the two most expensive benefits (dental and extended health) and set up a health and welfare trust. Should you decide to keep some of the other benefits like life insurance and long-term disability, most insurers will offer them on a stand-alone basis. This scenario offers several advantages: Removing the insurance company from the picture creates an automatic increase of about 30 - 40% (depending on size), which can then be used to pay dental and extended health expenses claimed through the health and welfare trust. Moreover, employers enjoy immediate cost control and avoid future annual premium increases; they are now only obligated to contribute a fixed annual limit per employee, which is usually very similar to the previous cost of the group insurance. And when an employee doesn't max out their annual limit, the unused funds will simply be carried forward and used for the next year's claims. This gives employees a set annual spending limit with a dramatically increased list of redeemable expenses, and no co-insurance, exclusions, or deductibles. In fact, the list of redeemable expenses is 36 pages long (refer to the CRA's Interpretation Bulletin IT519R2).

What are the costs?

A health and welfare trust should run very smoothly once it's set up, with only a fraction of the cost and administration of a group insurance plan. Most trustees have a one-time set-up fee of $200 - $350. Claims are adjudicated for a 10% administration fee plus GST on the fee only-for instance: $1,000 claim + $100 fee + $7 GST= $1,107 total deducted from the trust account. Compare this with the 30 - 40% your insurance company retains as their profit margin on dental and extended health benefits, and you're already ahead.

Trustees provide a fairly detailed statement of account activity to the employer's administrator (note, however, that new privacy legislation only gives an employer access to the dollar amount on each employee claim, not specific details such as the type of drug or service).

Where the wheels fall off

If you already have a traditional plan in place, you'd be well advised to schedule a transition period of 60 days before cancelling the plan and switching to a health and welfare trust. Then, during this transition period, you should strongly encourage employees and their dependants to visit the dentist and address any extended health-care needs, and to claim these expenses from the group plan-this will prevent the health and welfare trust from being inundated with claims right off the bat.

Also, bear in mind that because health and welfare trusts are usually set up without spending limits for the owners or major shareholders, a large claim from either party could potentially exceed the amount of funds in the trust. However, this dilemma can be remedied by topping up the trust account to cover a large claim.

These cautions notwithstanding, a health and welfare trust offers immense flexibility because it basically lets employers set up all the rules and leaves them free to change the rules at any time in the future.

Why aren't health and welfare trusts more popular?

Professionals are slowly becoming aware of this vehicle, especially for their more progressive clients. Still, "slowly" is the operative word, and for three main reasons: First, group insurance brokers have not embraced the health and welfare trust option because it means getting rid of some or all of the insurance benefits-and when the insurance goes, so does the brokers compensation. Second, it takes a paradigm shift to transition from traditional group insurance to a health and welfare trust. As a result, many companies default to traditional group insurance because it's what they already know. Finally, health and welfare trusts have also been ignored because professionals simply don't know where to send their clients to get one.

The final analysis

With a little retooling, a business owner can achieve massive advantages for his company and employees by switching from a traditional group insurance plan to a health and welfare trust. Rules can be set up that reduce employee turnover, for instance, and give valued employees non-taxable raises, as claims reimbursed from a health and welfare trust are not considered taxable benefits to the employee. In the end, a health and welfare trust lets both the employer and employee win.

By John J. Robinson, CFP

John Robinson, CFP, is the senior advisor with the Robinson Group Inc. and a member of the Trusted Advisor(TM) Network in Vancouver. His practice specializes in tax-driven risk management tools for the business owner. A version of this article originally appeared on the company's website at www.trustedadvisor.ca, where you'll also find FAQs about health and welfare trusts and specific case studies.

Copyright Institute of Chartered Accountants of British Columbia Dec 2004
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