Final overview RMI 3011
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This 33 page Study Guide was uploaded by Melissa Ciruzzi on Sunday April 24, 2016. The Study Guide belongs to RMI 3011 at Florida State University taught by Lynn McChristian in Spring 2016. Since its upload, it has received 40 views. For similar materials see Risk Management and Insurance in Risk Management And Insurance at Florida State University.
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Chapter 10 Annuities and IRA An annuity is a periodic payment that continues for a fixed period or for the duration of a designated life or lives. ◦ The person who receives the payments is the annuitant. An annuity provides protection against the risk of excessive longevity. An annuity is the opposite of life insurance. ◦ additional retirement money; pays for living longer than you expected and outliving savings A fixed annuity pays periodic income payments that are guaranteed and fixed in amount. ◦ During the accumulation period prior to retirement, premiums are credited with interest. (Accumulate interest) ◦ The guaranteed rate is the minimum interest rate that will be credited to the fixed annuity. ◦ The current rate is based on current market conditions, and is guaranteed only for a limited period. ◦ A bonus annuity pays a higher interest rate initially. ◦ The liquidation period is the period in which funds are paid out, or annuitized. Payouts are a fixed amount. ◦ Downside of fixed annuity: Little or no protection against inflation. Fixed annuity income payments can be paid immediately, or at a future date: ◦ An immediate annuity is one where the first payment is due one payment interval from the date of purchase. ◦ A deferred annuity provides income payments at some future date. ◦ A deferred annuity purchase with a lump sum is called a single- premium deferred annuity. ◦ A flexible-premium annuity allows the owner to vary the premium payments. The fixed annuity owner has a choice of annuity settlement offers: ◦ Most annuities are not annuitized. ◦ Under the cash option, the funds can be withdrawn in a lump sum or in installments. ◦ A life annuity (no refund) option provides a life income to the annuitant only while the annuitant remains alive. ◦ A life annuity with guaranteed payments pays a life income to the annuitant with a certain number of guaranteed payments. ◦ An installment refund option pays a life income to the annuitant; after the annuitant’s death, payments continue to a beneficiary until they equal the purchase price. ◦ A cash refund option is similar, but pays the beneficiary a lump sum. ◦ A joint-and-survivor annuity pays benefits based on the lives of two or more annuitants. The annuity income is paid until the last annuitant dies. ◦ An inflation-indexed annuity option provides periodic payments that are adjusted for inflation. ◦ A variable annuity pays a lifetime income, but the income payments vary depending on common stock prices. ◦ The purpose is to provide an inflation hedge by maintaining the real purchasing power of the payments. ◦ Premiums are used to purchase accumulation units during the period prior to retirement. ◦ At retirement, the accumulation units are converted into annuity units. Annuity unit • It is an accumulation unit, a sub-account of the retiree's total accumulated annuity. These units represent a fixed share of ownership of the insurer's accounts portfolio. When an insured person changes from accumulating wealth to spending it, they draw on their saving. While saving, the insured party has made periodic payments to their life insurance company to purchase shares of ownership of a very large portfolio managed by the insurer. When the insured wants to start taking money out, they convert their total accumulated savings to start paying them an income. So, the insured person purchases annuity units with the money that was formerly being saved as accumulation units. Types of annuities A guaranteed death benefit protects the principal against loss due to market declines. Typically, if the annuitant dies before retirement, the amount paid to the beneficiary will be the higher of two amounts: the amount invested in the contract or the value of the account at the time of death. Variable annuities contain the fees and expenses that can be high: Investment management charge Administrative charge Mortality and expense risk charge Surrender charge-charge if the annuity is surrendered in the early years of the contract. It is usually a percent of the account value and declines over time Longevity insurance is a generic name for a single-premium deferred annuity that begins paying benefits only at an advanced age, typically age 85. They are low-cost annuities because there are no cash values or death benefits in the policy. Advantages: Monthly benefits kick in when other assets may be diminished. Low cost. Can be purchased with an inflation hedge. Disadvantages: Heirs lose money if the person dies during the deferral period, i.e., no death benefit. Once purchased, funds are locked up, so no access to emergency funds. Taxation of individual annuities An individual annuity purchased from a commercial insurer is a nonqualified annuity. ◦ It does not meet IRS code requirements. ◦ It does not qualify for most income tax benefits. ◦ Premiums are not income-tax deductible. ◦ Investment income is tax deferred. ◦ The net cost of annuity payments is recovered income-tax free over the payment period, but the amount that exceeds the net cost is taxable as ordinary income. An exclusion ratio is used to determine the taxable and nontaxable portions of the payments. Exclusion ratio=investment in the contract/expected return Annuities can be attractive to investors who have made maximum contributions to other tax-advantaged plans. Individual retirement account An individual retirement account (IRA) allows workers with taxable compensation to make annual contributions to a retirement plan up to certain limits and receive favorable income-tax treatment. Two basic types of IRAs are: ◦ Traditional IRA ◦ Roth IRA A traditional IRA allows workers to take a tax deduction for part or all of their IRA contributions ◦ The investment income accumulates income-tax free on a tax-deferred basis. ◦ Distributions are taxed as ordinary income. ◦ The participant must have earned income during the year, and must be under age 70½. ◦ For 2016, the maximum annual contribution is $5,500 or 100 percent of earned compensation, whichever is less. For those over 50, maximum contribution is $6,500. ◦ A full deduction for IRA contributions is allowed under certain circumstances. The full IRA tax deduction is gradually phased out as a person’s modified gross income increases. Taxpayers with incomes that exceed the phase-out limits can contribute to a nondeductible IRA. A spousal IRA allows a spouse who is not in the paid labor force, or a low- earning spouse to make a fully deductible contribution to a traditional IRA. Distributions from a traditional IRA before age 59½ are considered an early withdrawal, and subject to a 10% tax penalty unless certain conditions apply, e.g., death or disability Distributions from traditional IRAs are treated as ordinary income. ◦ Any nondeductible contributions are received income-tax free ◦ A formula is used to compute the taxable and nontaxable portions of each distribution ◦ For 2009, the required minimum distribution rules were temporarily waived Traditional IRAs can be established at a bank, mutual fund, stock brokerage firm, or insurer The IRA can be set up as either: ◦ An individual retirement account ◦ An individual retirement annuity IRA contributions can be invested in a variety of investments An IRA rollover is a tax-free distribution of cash or other property from one retirement plan, which is deposited into another retirement plan A Roth IRA is another type of IRA that provides substantial tax advantages. ◦ The annual contributions to a Roth IRA are not tax deductible ◦ The investment income accumulates income-tax free ◦ Qualified distributions are not taxable under certain conditions ◦ Contributions can be made after age 70½ ◦ Roth IRAs have generous income limits ◦ A traditional IRA can be converted to a Roth IRA Ch. 11 health Insurance The US health-care delivery system has 6 major problems: Problem 1: Rising Health-Care Expenditures Reasons for the increase in spending include: ◦ Increase in consumer demand ◦ Advances in technology ◦ Cost insulation because of third-party payers ◦ Employment-based health insurance ◦ State-mandated benefits ◦ Increased spending on prescription drugs ◦ Cost shifting by Medicare and Medicaid ◦ Higher administrative costs ◦ Rising prices in the health-care sector ◦ Defensive medicine Aging of the population is not a major factor Problem 2: Many people do not have health insurance coverage Groups with large number of uninsured include: Foreign born Hispanics, Blacks, and Asians Young adults Low income households ◦ Many people are uninsured because the coverage is not affordable ◦ Many low income people who are eligible for Medicaid are not aware they are eligible The consequences of being uninsured are severe: ◦ The uninsured often delay or skip needed medical care because of high costs ◦ When the uninsured receive medical care, they frequently pay more for that care ◦ Uninsured adults are less likely to have a regular source of medical care ◦ The uninsured often do not have access to regular screenings and preventive care ◦ The uninsured are sicker and die earlier than people with insurance Biggest achievement of ACA: 20 million people who were previously uninsured have health-care coverage. Problem 3: Uneven Quality of Medical Care ◦ The quality of medical care varies widely depending on geographic location, type of health insurance plan, and disease being treated Problem 4: Waste and Inefficiency ◦ Experts estimate that the present system wastes more than $800 billion each year Sources of wasteful spending include: ◦ Duplication of tests ◦ Medical errors that are largely preventable ◦ Unnecessary tests due to fear of lawsuits ◦ High administrative costs and excessive and redundant paperwork ◦ Readmissions into hospitals because of inadequate or ineffective initial treatment ◦ Hospitalizations for preventable conditions ◦ Overuse of expensive medical technology Problem 5: Defects in Financing Health Care ◦ Critics argue that the financing of the present system aggravates many of the problems Defects of the current system include: ◦ It is based on the ability to pay, not health needs ◦ The fee-for-service method encourages unnecessary tests and treatments ◦ Distortions in medical care which result from a limited supply of physicians in general practice and in rural areas Problem 6: Abusive Insurer Practices ◦ Some insurer practices are harmful to both policyholders and applicants for insurance Examples include: ◦ Exclusions for preexisting conditions ◦ Rescission of insurance contracts to limit benefits ◦ Lifetime or annual limits on benefits ALL forms of health coverage were affected by ACA, but operate independently from it. This is why half of Americans say they are unaffected by it. The Affordable Care Act: Extends health-care coverage to 30 million uninsured Americans Provides substantial subsidies to uninsured individuals and small businesses to make insurance more affordable Contains provisions to lower health-care costs in the long run Prohibits insurers from engaging in certain abusive practices Provisions Provisions that apply to health insurers include: ◦ Retention of coverage until age 26 ◦ Lifetime limits and annual limits prohibited. ◦ Preexisting conditions prohibited ◦ Rescission of insurance policies prohibited ◦ Guaranteed access to health insurance ◦ Grandfathered plans ◦ Minimum medical loss ratio ◦ Limited waiting periods The Act requires insurers to cover essential health benefits: ◦ Ambulatory patient services ◦ Emergency services ◦ Hospitalization ◦ Maternity and newborn care ◦ Mental health and substance use disorder services ◦ Prescription drugs ◦ Rehabilitative services and devices ◦ Laboratory services ◦ Preventive and wellness services and chronic disease management ◦ Pediatric services, including oral and vision care Each plan provides essential benefits ◦ Applicants will have a choice of four benefit categories: ◦ The bronze plan covers 60 percent of the benefit costs ◦ The silver plan covers 70 percent of the benefit costs ◦ The gold plan covers 80 percent of the benefit costs ◦ The platinum plan covers 90 percent of the benefit costs ◦ Each plan has annual out-of-pocket limits that limit the amount insureds must pay in the form of deductibles, coinsurance, copayments, etc. ◦ The new law creates an Affordable Insurance Exchange in each state The exchange is a new transparent and competitive insurance marketplace where individuals and small firms can purchase affordable and qualified health insurance plans Eligible small employers can receive significant tax credits under the new law ◦ Beginning in 2014, the tax credit for eligible small employers that purchase health insurance through a state exchange will be increased up to 50 percent of the employer’s contribution if the employee contributes at least 50 percent of the total premium costs. The new law contains many provisions that will improve the quality of health care and lower costs, including: ◦ New incentives to rebuild the primary care workforce ◦ A Prevention and Public Health Fund that will invest in programs designed to keep Americans healthy ◦ Establishing a patient-centered outcomes research institute ◦ Strengthening community health centers ◦ Enhanced screening procedures for health-care providers to eliminate fraud and abuse ◦ Incentives for physicians to join together to form “accountable care organizations” ◦ Standardization of billing and rules for secure electronic exchange of data ◦ Increasing Medicaid payments for primary care physicians ◦ Paying physicians based on value and not volume Individual health insurance coverages Major medical insurance is designed to pay a high percentage of covered medical expenses incurred by an insured who has a catastrophic illness or injury Most individual expense plans provide a broad range of benefits, including ◦ Inpatient hospital benefits ◦ Outpatient benefits ◦ Physician benefits ◦ Preventive services ◦ Outpatient prescription drugs Elemenets of a great health insurance plan A coverage limit high enough that it won’t likely be exhausted, even for catastrophic medical expenses. An annual dollar limit you can live with on the out-of-pocket maximum. No dollar limit on the types of expensed, such as dollar limits on daily room charges or dollar limits on the types of surgery. Freedom to see specialists without a referral. Worldwide coverage. Most plans don’t meet all of these. What’s the difference between coinsurance and copayment? A coinsurance provision states a percentage of the bill in excess of the deductible, which the insured must pay out-of-pocket up to some maximum annual dollar limit ◦ Purpose is to reduce premiums and prevent overutilization of plan benefits A copayment is a flat amount the insured must pay for certain benefits, such as an office visit or generic drug Medical expense policies contain a deductible provision ◦ The purpose of the deductible is to eliminate small claims and the high administrative cost of processing them ◦ A calendar-year deductible is an aggregate deductible that has to be satisfied only once during the calendar year Individual Medical Expense Insurance and Managed Care Plans Most individual medical expense plans sold today are managed care plans ◦ A managed care plan provides covered medical services to the members in a cost effective manner, with heavy emphasis on cost control. The most popular plan today is a preferred provider organization (PPO) ◦ A PPO contracts with physicians, hospitals, and other health-care providers to provide covered medical services to policyholders at discounted fees. Health savings account A health savings account (HSA) is a tax exempt account established exclusively for the purpose of paying qualified medical expenses ◦ The beneficiary must be covered under a high-deductible health plan to cover catastrophic medical bills. ◦ Contributions can be made by individuals, their employers, and family members. ◦ Contributions and annual out-of-pocket expenses are subject to maximum limits. Long term care insurance Long-term care insurance pays a daily or monthly benefit for medical or custodial care received in a nursing facility, in a hospital, or at home ◦ People who reach age 65 will likely have a 40% chance of entering a nursing home, and about 10% of them will stay there five years or more LTC Plans come in three main forms: ◦ A facility-only policy ◦ A home health care policy ◦ A comprehensive policy Most LTC plans have an elimination period, which is a waiting period during which time benefits are not paid. Some states have long-term care partnership programs designed to reduce Medicaid expenditures by eliminating or reducing incentives of some people to rely on Medicaid to pay for long-term care To encourage people to purchase private partnership policies, part or all of their assets are protected from the Medicaid spend-down requirements Disability income insurance The financial impact of total disability on present savings, assets, and ability to earn an income can be devastating Disability-income insurance provides income payments when the insured is unable to work because of sickness or injury ◦ Income payments are typically limited to 60-80% of gross earnings The most common definitions of total disability are: ◦ Inability to perform the material and substantial duties of your regular occupation ◦ Inability to perform the material and substantial duties of your occupation, and are not engaged in any other occupation ◦ Inability to perform the duties of any occupation for which you are reasonably fitted by education, training, and experience ◦ Inability to perform the duties of any gainful occupation ◦ Loss-of-income test, i.e., your income is reduced as a result of sickness or accident The benefit period is the length of time that disability payments are payable after the elimination period is met Individual policies normally contain an elimination period (waiting period), during which time benefits are not paid Most policies automatically include a waiver-of-premium provision ◦ If the insured is totally disabled for 90 days, future premiums will be waived as long as the insured remains disabled Policies typically include a rehabilitation provision Some policies pay accidental death, dismemberment and loss-of-sight benefits Optional benefits include: ◦ Under a cost-of-living rider, the insurer periodically adjust benefits for increases in the cost of living ◦ Some insurers provide an option to purchase additional insurance in the future ◦ A Social Security rider pays an additional amount if the policyholder is turned down for SS disability benefits ◦ A return of premiums rider refunds part or all of the premiums if the policyholder’s claim experience is favorable Individual Health Insurance Contractual Provisions A guaranteed renewable policy is one in which the insurer guarantees to renew the policy at each anniversary date ◦ Premiums can be increased for the underwriting class Under a noncancellable policy, the insurer cannot change, cancel, or refuse to renew the policy as long as premiums are paid on time ◦ The insurer cannot change the premiums or the rate structure specified in the policy The grace period is a 31-day period after the premium due date to pay an overdue premium The reinstatement provision permits the insured to reinstate a lapsed policy The time limit on certain defenses states that after the policy has been in force for two years, the insurer cannot void the policy or deny a claim on the basis of misstatements in the application, except for fraudulent misstatements Ch. 12 and 13 Employee benefits ◦ Employee benefits are employersponsored benefits, other than wages, which enhance the economic security of individuals and families and are partly or fully paid for by employers. These benefits include: ◦ Group life, medical and dental insurance ◦ Paid holidays, vacations, medical leave ◦ Educational assistance, employee discounts ◦ Employer contributions to Social Security and Medicare Group insurance differs from individual insurance in several ways: ◦ Many people are covered under one contract; a master contract is formed between the group and insurer. ◦ Coverage usually costs less than comparable insurance purchased individually. ◦ Individual evidence of insurability is usually not required. ◦ Experience rating is used. This is how you compare with similar organizations in your rating classification. Group insurers observe certain principles: ◦ The group should not be formed for the sole purpose of obtaining insurance. ◦ There should be a flow of persons through the group. ◦ Benefits should be automatically determined by a formula. ◦ A minimum percentage of eligible employees must participate. ◦ Individual members should not pay the entire cost. ◦ The plan should be easy to administer. Eligibility for group status depends on insurance company policy and state law ◦ Usually a minimum size is required. Employees must meet certain participation requirements: ◦ Be a full-time employee. ◦ Satisfy a probationary period. ◦ Apply for coverage during the eligibility period. ◦ Be actively at work when the coverage begins. Group Life insurance The most important form of group insurance is group term life insurance ◦ Provides low-cost protection to employees. ◦ Coverage is yearly renewable term. ◦ The amount of coverage can be based on the workers’ earnings, position, or it can be a flat amount for all. ◦ Coverage usually ends when the employee leaves the company. Many group life insurance plans also provide group accidental death and dismemberment (AD&D) insurance ◦ Pays additional benefits if the employee dies in an accident or incurs certain types of bodily injuries. ◦ The benefit is some multiple of the group life insurance benefit. ◦ Group universal life insurance is a voluntary life insurance product paid entirely by the employee through payroll deduction. ◦ In the single plan approach, the employee who wants only term insurance pays only the mortality and expense charges. ◦ In the two plan approach, the employee who wants only term insurance pays into the term insurance plan; the employee who wants universal life insurance must pay higher premiums to accumulate cash value. Group Medical Expense Insurance Group medical expense insurance is an employee benefit that pays the cost of hospital care, physicians’ and surgeons’ fees, and related medical expenses. Coverage is available through: ◦ Commercial insurers ◦ Blue Cross and Blue Shield Plans ◦ Managed Care organizations ◦ Self-insured employer plans ◦ A small number of health insurers dominate the market. ◦ In nearly half of the U.S. metropolitan areas, one insurer controls 50 percent or more of the commercial market (AMA, 2011) Managed care organizations are generally for-profit organizations that offer managed care to employers. ◦ Plans offer medical expense benefits in a cost effective manner. ◦ Plans emphasize cost control and carefully monitor the medical care provided by physicians. Many employers self-insure part or all of the benefits provided to their employees. ◦ Self insurance means the employer pays part or all of the cost of providing health insurance to the employees. ◦ Self insuring can save employers 10% to 25% on their healthcare costs. Why is it less costly? Because insurers build in higher profit margins to account for the actuarial risk of higher-than-expected healthcare costs AND the risk of being fully-insured upfront. Only about 26% of employers with between 100 and 499 employees self-insure, compared with more than 82% of employers with 500 or more employees, according to data from the U.S. Department of Health and Human Services. The risk level is simply too great for most small businesses. Only about 5% of businesses with fewer than 50 employees self insure. Why employers self-fund health plans Can customize to meet specific health-care needs of its workforce. Not one-size-fits-all. Employer maintains control of health plan reserves. They get the interest income, not an insurance carrier. Employer does not have to pre-pay for coverage, so improves cash flow. Avoids state health regulations because self-insured plans are regulated under federal law. Employer is not subject to state health insurance premium taxes, which are generally 2-3 percent of the premium dollar. Can contract with providers or provider network directly. Self-insured group plans ◦ Plans are usually established with stop-loss insurance whereby a commercial insurer will pay claims that exceed a certain limit. Large employers have reserves to pay unpredicted, high-cost medical claims. They buy stop-loss insurance to reimburse them for claims above a certain specified dollar amount. This is a contract between stop-loss insurance carrier and the employer, and it is not considered a health insurance policy covering individuals. ◦ Some employers have an administrative services only (ASO) contract with a commercial insurer. Employers can administer claims themselves or subcontract – to companies such as Aetna, BC/BS. Employer pays a fee to ASO companies to handle claims, organize provider networks and manage other logistics. ◦ Self-insured plans are exempt from state laws that require insured plans to offer certain state-mandated benefits Managed Care Plans Managed care is a generic name for medical expense plans that provide covered services in a cost-effective manner. ◦ An employee’s choice of physicians and hospitals may be limited. ◦ Cost control and cost reduction are heavily emphasized. Emphasis on preventive care and healthy lifestyle. ◦ Utilization review is done at all levels. ◦ The quality of care provided by physicians is monitored. ◦ Health care providers share in the financial results through risk-sharing techniques. ◦ Three types: Health Maintenance Organization (HMO), Preferred Provider Organization (PPO), Point-of-Service Plans (POS) A health maintenance organization (HMO) is an organized system of health care that provides comprehensive medical services to its members on a prepaid basis. The emphasis is on controlling costs. (option for managing paperwork and controlling costs for self-insured employers) ◦ HMOs negotiate rates and enter into agreements with hospitals and physicians to provide medical services ◦ Broad, comprehensive medical services are provided ◦ Choice of providers is limited. A gatekeeper physician is a primary care physician who determines whether medical care from a specialist is necessary. ◦ Cost sharing provisions are imposed A preferred provider organization (PPO) is a plan that contracts with health- care providers to provide certain medical services to members at discounted fees. ◦ PPO providers typically are paid on a fee-for-service basis. ◦ Patients are not required to use a preferred provider, but the deductible and co-payments are lower if they do. ◦ Most PPOs do not use a gatekeeper physician, and employees do not have to get permission from a primary care physician to see a specialist. A point-of-service plan (POS) is typically structured as an HMO, but members are allowed to go outside the network for medical care. ◦ If patients see providers who are in the network, they pay little or nothing out of pocket. ◦ Deductibles and co-payments are higher if patients see providers outside the network. Cafeteria plans A cafeteria plan allows employees to select those benefits that meet their specific needs. ◦ In many plans, the employer gives each employee a certain number of dollars or credits to spend on benefits, or take as cash. ◦ Many plans allow employees to make their premium contributions with before-tax dollars. ◦ Under a full choice, or full flex plan, employees select from a full range of benefits. Group Medical Expense Contractual Provisions The Health Insurance Portability and Accountability Act (1996) placed restrictions on the rights of insurers to limit coverage for preexisting conditions. ◦ Period is restricted to 12 months. ◦ The act also established the portability of insurance coverage, whereby insurers must give an employee credit for previous coverage. Employee Benefits: Retirement Plans Fundamentals of Private Retirement Plans Private retirement plans have an enormous social and economic impact. ◦ The Employee Retirement Income Security Act of 1974 (ERISA) established minimum standards. ◦ The Pension Protection Act of 2006 increases the funding obligation of employers. ◦ Employers’ contributions are deductible, to certain limits. ◦ Investment earnings on the plan assets accumulate on a tax-deferred basis. ◦ Private plans that meet certain requirements are called qualified plans and receive favorable income tax treatment. Most plans have a minimum age and service requirement that must be met. ◦ A qualified plan must benefit workers in general and not only highly compensated employees. ◦ All eligible employees who have attained age 21 and have completed one year of service must be allowed to participate in the plan. ◦ Normal retirement age is the age that a worker can retire and receive a full, unreduced pension benefit (usually 65 years). ◦ An early retirement age is the earliest age that workers can retire and receive a retirement benefit. ◦ The deferred retirement age is any age beyond the normal retirement age. ◦ Vesting refers to the employee’s right to the employer’s contributions or benefits attributable to the contributions if employment terminates prior to retirement. A qualified defined-benefit plan must meet a minimum vesting standard. ◦ Cliff vesting: The worker must be 100% vested after 5 years of service, i.e., they get nothing until Year 5. rd ◦ Graded vesting: The worker must be 20% vested by the 3 year of service, and the minimum vesting increases another 20% for each year until the worker is 100% vested at year 7. Funds withdrawn from a qualified plan before age 59½ are subject to a 10% early distribution penalty. ◦ There are some exceptions to this rule, for example if the distribution is made because the employee has a qualifying disability. Pension contributions cannot remain in the plan indefinitely. ◦ Distributions must start no later than April 1 of the calendar year following the year in which the individual attains age 70½. ◦ This rule does not apply to certain IRAs. Types of Qualified Retirement Plans A wide variety of qualified plans are available today to meet the specific needs of employers. The two basic types of plans are: ◦ Defined-benefit plans ◦ Defined-contribution plans Different rules apply to each type of plan. Defined-Benefit Plans In a defined-benefit plan, the retirement benefit is known, but the contributions will vary depending on the amount needed to fund the desired benefit. ◦ The amount can be based on career-average earnings or on a final average pay, which generally is an average of the last 3-5 years earnings. ◦ A firm may give an employee past-service credits for prior service. ◦ Assets of the plan are held in a pool, not an individual account for each employee. So, the employee has no voice in investment decisions. ◦ The employer assumes the risk of fluctuations in value. Retirement benefits in defined-benefit plans are based on formulas. ◦ Under a unit-benefit formula, both earnings and years of service are considered. ◦ Some plans pay a flat percentage of annual earnings, while some pay a flat amount for each year of service. ◦ Some plans pay a flat amount for each employee, regardless of earnings or years of service. Defined-Contribution Plans In a defined-contribution plan, the contribution rate is fixed but the actual retirement benefit is variable. ◦ For example, a money purchase plan is an arrangement in which each participant has an individual account, and the employer’s contribution is a fixed percentage of the participant’s compensation. ◦ Either the individual alone or employer & employee make contributions into the plan. Each participant has a separate account; risk of fluctuations in investment shifted to employee. Contributions to defined-contribution retirement plans are limited: ◦ For 2016, the maximum annual contribution to a defined-contribution plan is 100% of earnings or $53,000, whichever is lower. ◦ Workers age 50 or older can make an additional catch-up contribution of $6,000 per year. Most new qualified retirement plans are defined-contribution plans. ◦ Cost to employer is lower because they do not grant past-service credits. Disadvantages to the employee include: ◦ Employees can only estimate their retirement benefits. ◦ Investment losses are borne by the employee. ◦ Some employees do not understand the factors to consider in choosing investments. Section 401(k) Plans A Section 401(k) plan is a qualified cash or deferred arrangement (CODA) that allows eligible employees the option of putting money into the plan or receiving the funds as cash. ◦ Typically, both the employer and the employees contribute, and the employer matches part or all of the employee’s contributions. ◦ Most plans allow employees to determine how the funds are invested. ◦ Employees can voluntarily elect to have part of their salaries invested in the Section 401(k) plan through an elective deferral. ◦ Contributions to a 401(k) plan accumulate tax-free, and funds are taxed as ordinary income when withdrawals are made. For 2016, the maximum limit on elective deferrals is $18,000 for workers under age 50. If funds are withdrawn before age 59½, a 10% tax penalty applies, with some exceptions. The plan may permit the withdrawal of funds for a hardship: ◦ To pay certain unreimbursable medical expense. ◦ To purchase a primary residence. ◦ To pay post-secondary education expenses. ◦ To make payments to prevent eviction or foreclosure on your home. ◦ The 10% tax penalty applies, but plans typically have a loan provision that allows funds to be borrowed without a tax penalty. In a Roth 401(k) plan, you make contributions with after-tax dollars, and qualified distributions at retirement are received income-tax free. ◦ Investment earnings accumulate on a tax-free basis. ◦ Distributions from the plan are income-tax free is you are at least 59½ and the account is held for at least five years. Section 403(b) plans A Section 403(b) plan is a retirement plan designed for employees of public educational systems and tax-exempt organizations. ◦ Eligible employees voluntarily invest a fixed amount of their salaries in the plan. ◦ Employers may make a matching contribution. ◦ The plan can be funded by purchasing an annuity or by investing in mutual funds. ◦ The employer must purchase the annuity and it is nontransferable. ◦ In 2016, the maximum limit on elective deferrals for workers under age 50 is $18,000. ◦ Employees age 50 an older can make an additional catch-up contribution of $6,000. Employers have the option of allowing employees to invest in a Roth 403(b) plan. Profit-Sharing Plans A profit-sharing plan is a defined-contribution plan in which the employer’s contributions are typically based on the firm’s profits ◦ There is no requirement that the employer must actually earn a profit to contribute to the plan ◦ Funds are distributed to the employees at retirement, death, disability, or termination of employment (only the vested portion), or after a fixed number of years ◦ For 2016, the maximum employer tax-deductible contribution is limited to 25% of the employee’s compensation or $53,000, whichever is less. ◦ There is a 10% tax penalty for early withdrawal. Keogh Plans for the Self-Employed Retirement plans for the owners of unincorporated business firms are commonly called Keogh plans. ◦ Contributions to the plan are income-tax deductible, up to certain limits. ◦ Investment income accumulates on a tax-deferred basis. ◦ Amounts deposited and investment earnings are not taxed until the funds are distributed. Simplified Employee Pension A simplified employee pension (SEP) is a retirement plan in which the employer contributes to an IRA established for each eligible employee. ◦ Annual contribution limits are substantially higher. ◦ One type, called a SEP-IRA, must cover all workers who are at least age 21 and have worked for at least three of the past five years. ◦ There is full and immediate vesting of all employer contributions under the plan. ◦ Employees cannot contribute to the plan. SIMPLE Retirement Plans A Savings Incentive Match Plan for Employees (SIMPLE) plan is limited to employers that employ 100 or fewer employees and do not maintain another qualified plan. ◦ Smaller employers are exempt from most nondiscrimination and administrative rules that apply to qualified plans. They get an income tax deduction for any employee match. ◦ Can be structured as an IRA or 401(k) plan. The match must be offered equally to all employees. ◦ For 2016, eligible employees can elect to contribute up to 100% of compensation up to a maximum of $12,500. ◦ Employers can contribute in one of two ways: through a matching option or a nonelective contribution option. ◦ NOTE: If an employee does not sign up, the employer doesn’t have to put any money away for them. Problems and Issues in Tax-deferred Retirement Plans Several serious problems exist among current tax-deferred retirement plans. ◦ Inadequate 401(k) account balances ◦ Incomplete coverage of the labor force ◦ Lower benefits for women ◦ Limited protection against inflation ◦ Workers spending lump-sum pension distributions ◦ Investment mistakes by participants that jeopardize economic security Ch 14 Social Insurance Reasons for Social Insurance Why are they necessary? ◦ To help solve complex social problems. ◦ To provide coverage for perils that are difficult to insure privately. ◦ To provide a base of economic security to the population. Basic Characteristics of Social Insurance o Social insurance programs are distinct from other government insurance programs because: o Most programs are compulsory. o Programs are designed to provide a floor of income. o Programs pay benefits based on social adequacy rather than individual equity. ◦ Benefits are loosely related to earnings. ◦ Programs, benefits, and benefit formulas are prescribed by law. ◦ A formal means test is not required. ◦ Full funding of benefits is unnecessary. ◦ Programs are designed to be financially self-supporting. Old-Age, Survivors, and Disability Insurance (OASDI) Commonly known as Social Security, OASDI is the most important social insurance program in the US. ◦ Enacted in 1935, it covers more than 9 out of 10 workers Virtually all private-sector employees, and a majority of state and local government employees are covered under the Social Security Program A worker becomes eligible for benefits by attaining an insured status: ◦ To attain a fully insured status and be eligible for retirement and survivor benefits, you must have 40 credits. (you earn credits by earning a certain amount each year, and you can only earn up to 4 credits a year. The amount needed for 1 credit is $1,260) ◦ You are currently insured, and eligible for survivor benefits, if you have earned at least 6 credits in the past 13 calendar quarters. ◦ The number of credits required to receive disability benefits depends on your age when you become disabled. ◦ A duration of work test must be satisfied before receiving disability benefits. OASDI: Retirement Benefits ◦ For persons both in 1937 or earlier, full retirement age for unreduced benefits is age 65. ◦ The full retirement age will increase gradually to 67. ◦ Workers and their spouses can retire at age 62 with actuarially reduced benefits. ◦ Monthly retirement benefits can be paid to retired workers and their dependents. The monthly retirement benefit is based on the worker’s primary insurance amount (PIA). ◦ The PIA is based on the worker’s average indexed monthly earnings (AIME). ◦ The AIME is based on a weighted benefit formula which weights the benefits heavily in favor of low-income groups. ◦ Social Security actuaries calculate each year the indexing factors that are used to determine the worker’s average indexed monthly earnings. Each additional year of work adds another year of earnings to your Social Security earnings record. A delayed retirement credit is available if you delay receiving retirement benefits beyond the full retirement age. Cash benefits are automatically adjusted each year for changes in the cost of living. The program has an earnings test that can result in a reduction or loss of monthly benefits for workers with earned incomes above certain annual limits. OASDI: Survivor Benefits Survivor benefits can be paid to dependents of a deceased worker who is either fully or currently insured. Survivors include: ◦ Unmarried children younger than age 18 ◦ Unmarried disabled children ◦ Surviving spouse with children younger than age 16 ◦ Surviving spouse age 60 or older ◦ Disabled widow or widower, ages 50-59 ◦ Dependent parents The benefits provide a substantial amount of financial protection to families. OASDI: Disability Benefits Disability income benefits can be paid to disabled workers who meet certain eligibility requirements. ◦ The benefits provide protection against the loss of income during a long-term disability. ◦ The worker must meet a five-month waiting period, and satisfy the definition of disability. ◦ The worker must have a physical or mental condition that prevents him or her from doing any substantial gainful activity and is expected to last at least 12 months or is expected to result in death. Major groups eligible to receive OASDI disability income benefits include: ◦ A disabled worker under the full retirement age. ◦ The spouse of a disabled worker. ◦ Unmarried children of the disabled worker, if under age 18. ◦ Unmarried children age 18 or older who become severely disabled before age 22. Medicare Medicare covers the medical expenses of most persons age 65 and older. Beneficiaries can select among an array of plans including prescription drug plans and health care plans of private insurers. Under the original Medicare plan, ◦ Beneficiaries can elect any provider that accepts Medicare patients. ◦ Medicare pays its share of the bill, and the beneficiary pays the balance. Four parts: Part A – Hospital Insurance Part B – Medical Insurance Part C – Medicare Advantage Plans Part D – Prescription Drug Plans Hospital Insurance (Part A) provides coverage for inpatient hospital stays and other services including skilled nursing facility care, home health care, hospice care, and blood transfusions. Inpatient care is covered for up to 90 days for each benefit period. Inpatient care in a skilled nursing facility is covered up to a maximum of 100 days in a benefit period. Hospitals are reimbursed for inpatient services under a prospective payment system. A flat amount is paid for each service based on its diagnosis-related group (DRG). Medical Insurance (Part B) is a voluntary program that covers physicians’ fees and related medical services. Covered services include physician services, clinical laboratory services, home health care, outpatient hospital services, and blood. Beneficiaries must pay a monthly premium for the benefits. The beneficiary must meet an annual deductible. The program pays 80% of the Medicare-approved amount for most services. Medicare hospital insurance (Part A) is financed by a payroll tax paid by covered employees, employers, and the self-employed. Payroll tax is 1.45 percent on all covered earnings The program is subsidized by a small amount of general revenues Medical insurance (Part B) is financed by monthly premiums and the general revenues of the federal government. Medicare Advantage Plans (Part C) are private health plans that are part of the Medicare program. ◦ Medicare pays a set monthly amount to the plan. ◦ Most plans provide extra benefits and have lower co-payments than the original Medicare plan. Part C Plans include: ◦ Medicare PPOs ◦ Medicare HMOs ◦ Medicare Private Fee-for-service plans ◦ Medicare Medical Savings Account Plans ◦ Medicare Special Needs plans Medicare Prescription Drug Plans Medicare prescription drug coverage (Part D) is available to all beneficiaries. ◦ Beneficiaries in the original Medicare plan can add prescription drug coverage by joining a stand-alone plan. ◦ Monthly premiums depend on the plan chosen, and vary in the cost and types of drugs covered. ◦ Plans must provide at least standard coverage. ◦ Beneficiaries pay part of the cost of prescription drugs, and Medicare pays part of the cost. ◦ For 2012, the average monthly premium for the private plans is an estimated $30. The cost sharing provisions are complex. ◦ Beneficiaries must meet an annual deductible that cannot exceed $320 in any plan. ◦ After the deductible is met, beneficiaries must meet a copayment or coinsurance charge. ◦ Most plans have a coverage gap, or “donut hole”, which refers to drug costs that must be paid completely out of pocket, after an initial amount has been covered by the plan, and until the annual out-of- pocket limit. ◦ In 2012,once a beneficiary spends $4700 out-of-pocket for the year, the coverage gap ends, and catastrophic coverage, with a lower deductible, applies. Medigap Insurance Medicare beneficiaries can purchase a Medigap policy to cover part or all of medical expenses not paid by Medicare. ◦ The policies are sold by private insurers, and are strictly regulated by federal law. Impact of the Affordable Care Act on Medicare Some provisions of the Affordable Care Act will have significant impact on the Medicare program: ◦ Rebates for the Part D coverage gap (donut hole). ◦ Cracking down on health-care fraud. ◦ Providing free preventive care to seniors. ◦ Reducing overpayments to Medicare Advantage Plans. Other impacts: • Improving health-care quality and efficiency • Reducing unnecessary hospital readmissions • New innovations to hold down Medicare costs • Linking payments to quality outcomes • Bundling of payments OASDI: Problems and Issues he program is running an annual surplus, but the OASDI trust funds will soon experience serious financial problems. ◦ The combined OASDI trust funds will be exhausted in 2033. ◦ In 2033, non-interest income will be sufficient to pay only about 75 percent of scheduled benefits. ◦ To pay all scheduled benefits over the next 75 years, the trust funds require an additional $8.6 trillion in present value dollars. ◦ The Disability Income trust fund is projected to be exhausted in 2016. The deficit can be reduced or eliminated by: ◦ Increasing payroll taxes ◦ Decreasing benefits ◦ Using general revenues to pay benefits ◦ Some combination of these Recent proposed changes include: ◦ Using “progressive indexing” to determine benefits ◦ Increasing the Social Security payroll tax for both employers and employees ◦ Moving up scheduled increases in the full retirement age Recent Proposed Changes, continued ◦ Reducing benefits for future retirees across the board ◦ Increasing the OASDI taxable wage earnings base ◦ Subjecting all OASDI benefits to the federal income tax ◦ Extending OASDI coverage on a compulsory basis to all new state and local government employees ◦ Increasing the number of years used in calculating retirement benefits from 35 to 38 ◦ Investing part of the trust fund assets in private investments Medicare Financial Crisis Medicare Part A also has financial problems. ◦ The projected 75-year deficit in the Hospital Insurance Trust Fund is 13.35% of taxable payroll. ◦ The fund is projected to be exhausted by 2024. The poor financial condition is affected by: ◦ Higher prices for medical service. ◦ Increased volume and complexity of medical services. ◦ Aging of the population and increased enrollments. ◦ Overpayments to private insurers. ◦ Increased expenditures from prescription drugs. Efforts to hold down costs include: ◦ Reducing payments to hospitals and physicians. ◦ Limiting spending on specified services. ◦ Implementing a diagnosis-related group method for reimbursing hospitals. ◦ New provisions of the Affordable Care Act. Unemployment Insurance Unemployment insurance programs are federal-state programs that pay weekly cash benefits to workers who are involuntarily unemployed. Cash benefits are paid during periods of short-term involuntary unemployment. Applicants are encouraged through local employment offices to find jobs. Unemployment benefits help stabilize the economy during recessionary periods. Most jobs in private firms, state and local governments, and nonprofit organizations are covered for unemployment benefits. Private firms are subject to the federal unemployment tax. To be eligible, an unemployed worker must meet the following monetary eligibility requirements: Have qualifying wages and employment during the base year Be able and available for work Be actively seeking work Meet a one-week waiting period Regular state benefits depend on the worker’s past wages, within certain limits. Most states use a formula that pays weekly benefits based on a fraction of the worker’s high quarter wages. The maximum duration of regular benefits is limited to 26 weeks in most states. Under the extended-benefits program, an additional 13 weeks of benefits is paid during periods of high unemployment. Extended benefits are also available to workers to exhaust their regular benefits in states with high unemployment. Programs are financed largely by payroll taxes paid by employers on the covered wages of employees. For 2012, covered employers paid a federal payroll tax of 6.0% on the first $7000 of annual wages. To strengthen reserves and maintain fund solvency, most states have a taxable wage base that exceeds $7000. Experience rating is also used, by which firms with favorable employment records pay reduced tax rates. Problems with state unemployment compensation programs include: Programs do not cover all unemployed persons. State fund balances are inadequate. A high percentage of claimants are exhausting their regular state unemployment benefits. Workers Compensation Workers compensation is a social insurance program that provides medical care, cash benefits, and rehabilitation services to workers who are disabled from job-related accidents or disease. ◦ The benefits are important in reducing the economic uncertainty that may result from a job-related disability. Employer liability laws passed between 1885 and 1910 improved the legal position of injured workers. But, workers still had to sue their employers to collect for their injuries. Most states passed workers compensation laws by 1920. Coverage is based on the fundamental principle of liability without fault. Employees do not have to sue their employers. Under the common law of industrial accidents (1837), workers injured on the job had to sue their employers and prove negligence before they could collect damages. ◦ Under the contributory negligence doctrine, injured workers could not collect damages if they contributed in any way to the injury. ◦ Under the fellow-servant doctrine, the injured worker could not collect damages if the injury resulted from the negligence of a fellow worker. ◦ Under the assumption-of-risk doctrine, the injured worker could not collect if he or she had advanced knowledge of the dangers of the occupation. Objectives of state workers compensation laws include: ◦ Broad coverage of employees for job-related accidents and disease. ◦ Substantial protection against the loss of income. ◦ Sufficient medical care and rehabilitation services . ◦ Encouragement of safety. ◦ Reduction in litigation. Employers can comply with state law by: ◦ Purchasing a workers compensation policy ◦ Self-insuring, or ◦ Obtaining insurance from a monopoly or competitive state fund Most occupations are covered by workers compensation laws. ◦ Most states exclude or provide incomplete coverage for farm workers, domestic servants, and casual employees ◦ Some states exempt firms with few employees Two eligibility requirements must be met to receive benefits: ◦ The disabled person must work in a covered occupation ◦ The injury or disease must arise out of and in the course of employment Workers compensation laws provide four benefits: • Medical care generally is covered in full with no limitations. • Disability-income benefits can be paid after the disabled worker satisfies a waiting period. • Death benefits can be paid to eligible survivors if the worker dies as a result of a job-related accident or disease. • All states provide rehabilitation services to restore disabled workers to productive employment. • Problems with state workers compensation programs include: • Rising share of medical costs to total benefits. • Fraud and abuse. • Impact of an aging workforce on workers compensation costs.
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