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Sunday, April 07, 2013
Creative Insolvency: EUTF to Enter ‘Shadow Insurance Industry’?
By Andrew Walden @ 1:36 PM :: 6516 Views :: Health Care, Labor

by Andrew Walden

Quietly a multi-billion dollar scheme to rework Hawaii government employees pension and health insurance funding is made its way through the legislature.  Its vehicle is currently SB946 -- and formerly HB1459.   

SB964 is now set for Third Reading in the House as SB964HD1, with an amended version of the contents of HB1459 dumped into an amended version of SB964SDS1.  Earlier versions of SB964 would have garnished revenues from the Transient Accommodations Tax (TAT) and GE Tax.  In the current SB964HD1, an annual required contribution for the State, Counties, and all other government employers would be set by the Hawaii Employer-Union Trust Fund (EUTF) Board which also determines insurance benefits and premiums for all active Hawaii public employees.  This effectively makes pension payments the number one item in the State budget, subject only to the discretion of an unelected EUTF board.  EUTF would apparently take over some or all responsibilities of the Hawaii Employees Retirement System (ERS) Trustees. 

Rather than reducing pension abuses or cutting benefits the bill opts for creative insolvency and hides it in a ‘captive insurance’ structure.  The New York Times, May 8, 2011 describes captive insurance as part of “a shadow insurance industry….much like the shadow banking system that contributed to the financial crisis.”

But in Hawaii, the captive is a State property and its obligations are part of the State budget—so the coming bailout is implied in the text of SB946.  As Budget Director Kalbert Young explained to the Senate Committee on Judiciary and Labor February 20:

…the specified contribution levels and timetable is not affordable at the present time without drastic reductions in other areas of the State budget or significant measures to increase State general fund tax revenues.”

For example, EUTF’s July 1, 2012 actuarial valuation by Aon Hewitt determined that the State’s annual required contribution by FY 2012-13 is $994.9 million – $474.5 million for normal cost plus interest and $520.4 million for amortization  of unfunded actuarial accrued liability.  Using this amount as a benchmark for illustrative purposes, the State’s annual required contribution under this bill could be at least:

  • $200 million in FY 2014-15 (20% of $994.9)
  • $398 million in FY 2015-16 (40% of $994.9)
  • $597 million in FY 2014-15 (60% of $994.9)
  • $796 million in FY 2014-15 (80% of $994.9)
  • $995 million in FY 2014-15 (100% of $994.9)

Lowell Kalapa of the Hawaii Tax Foundation testifies at the same hearing:

Earmarking tax receipts, as this bill does, is an abdication of responsibility that, no doubt, will lead to pressure to raise additional revenues by raising taxes or enacting new revenue enhancements.

In the current SB964HD1 version of the bill, the EUTF trust is capped at $1.5 billion and the specifics are kicked to a Task Force due to report to the 2014 legislative session.

This built-in bailout rides in tandem with a loosening of already-lax transparency rules and easing of capitalization requirements.  Captive insurance rules would make it possible to run the EUTF under conditions which would place a non-captive insurer in default.

State Insurance Commissioner Gordon Ito, testifying before the House Committee on Labor and Consumer Protection February 6 asked that the bill be amended so that “it would not circumvent the Division’s regulatory authority” and explains how the bill legalizes an otherwise illegal taking of power from the EUTF beneficiaries:

Since the Captive would be formed as a reciprocal … (defined in HRS431:3-108 as) … ‘an unincorporated aggregation of subscribers operating individually and collectively through an attorney in fact common to all such persons to provide reciprocal insurance among themselves’ … all references to a Board of Trustees and an Administrator should be removed.  Instead the bill should provide for an organizational structure consisting of the Captive’s subscribers, the Subscribers Advisory Committee and the Attorney in Fact.”

Notably, the ERS Board, which would be partly or wholly displaced by the EUTF, includes four member-elected Trustees.  ERS Administrator Wesley Machida testified March 15:

(SB946’) involvement of the ERS’ investment program and services brings up many unanswered questions….particularly in areas which may affect the ERS’ tax-qualified status.

SB964HD1 establishes an EUTF board with no member-elected representatives.  All eleven members are to be appointed by the Governor with five selected from lists presented by union bosses. 

The New York Times explains that “state laws make the audited financial statements of the captives confidential.”  And in Insurance Commissioner Ito’s testimony on HB1459, he warns:

Insurance Code provisions dealing with Insurer Supervision, Rehabilitation, and Liquidation in article 15 have limited application to captive insurance companies.  We are concerned that the Captive, as envisioned in this bill would be exempt from (HRS Ch 431) Article 15.  Without the regulatory authority available under Article 15, there would be no clear statutory direction to dissolve or rehabilitate the Captive in case of insolvency.

HB1459 proposed regulations even looser than those denounced as insufficient in the Times, but SB946HD1 states: “All insurance plans provided by the captive insurance company shall comply with the provisions of chapters 431 and 432E."  That’s interesting.  Will the Captive EUTF itself have to comply?

Captive insurers were originally created as a way for companies to self-insure and thereby save money which would otherwise go to insurers commissions and profits.  But Hawaii’s duopoly insurers can rest easy.  The text of SB964HD1 throws away that potential advantage, stating:

“The captive insurance company will not compete with the private sector because it will only manage the administration and financing of the current and potential future employee health benefit obligations of the State and the counties.”

Under Obamacare, insurance rates are expected to skyrocket.  The Society of Actuaries reports that Hawaii health insurance rates will soar 12-21% in 2014.   The New York Times, February 17, 2013 warns that “companies with relatively young, healthy employees may opt out of the regular health insurance market to avoid the minimum coverage standards in President Obama’s sweeping law, a move that could drive up costs for workers at other companies.”

But instead of taking younger, healthier workers into a separate pool, Hawaii would be taking retirees burdened by the expensive diseases of old age.  Instead of lower rates, the captive EUTF would likely score higher rates—and still pay insurers’ commissions and profits.  Moreover, the Hawaii Health Exchange is calculating its rates on the basis of a statewide pool which includes the expensive retirees and then selling insurance to a Health Exchange pool made younger and healthier by the removal of those retirees to a separate captive insurer.

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