If your agency pays into a standard state unemployment insurance fund, it could be wasting money.
Nonprofits can opt out of a state’s unemployment tax by promising to reimburse the state the actual costs of unemployment payments to former employees. It may sound risky, but many youth-serving agencies do it with the help of companies that help them manage the financial risk.
Instead of paying unemployment taxes to the state, the agencies pay a monthly fee into a trust fund, which in turn pays the state for unemployment compensation claims made by former workers of those agencies. The fees can be considerably lower than the state taxes would be, and the trust fund invests the money, so that the investment grows.
“Not enough nonprofits know about this,” says Irv Katz, CEO of the National Human Services Assembly. “We are more focused on the mission aspects of our work than the administrative and operational aspects. However, there are ways to save money, which means more funds for mission purposes.”
Unemployment insurance has always been very different at nonprofits than at for-profits. Traditionally, nonprofits pay far less in unemployment claims than do for-profit businesses, which tend to have higher salaries and a tendency toward boom-and-bust employment waves.
Another factor might just be that nonprofits are nicer to their employees, says Ellen Johnson, a trust administrator for 501(c) Services, which manages three unemployment trusts.
“They’re in the business of helping people and they’re people-oriented,” Johnson says. “It’s not like working for a high-tech sales company where if you don’t hit your numbers, you’re out the door.”
Johnson estimates that nonprofits typically pay $2.20 in unemployment taxes for every $1 of benefits that are paid to their ex-employees. The disparity between nonprofit and for-profit unemployment rates is so wide that before 1972, charities didn’t have to pay unemployment taxes. But when nonprofits went broke, their employees were out of luck.
That changed in 1972, when an amendment to the Unemployment Insurance Act required nonprofits to provide unemployment benefits. The agencies had a choice, however: Join their state’s unemployment insurance system, or reimburse the state for claims as they arose.
The latter option struck many as too risky. If an agency had a rash of layoffs or bad employees who had to be let go, the cost could be devastating. State rates are high, but predictable.
“Nonprofits didn’t want to participate [in the state plans], but they didn’t want to have volatility of unemployment claims,” says Cheryl L. Jones, an account executive at Unemployment Services Trust (UST), the largest nationwide unemployment trust for nonprofits. “They could go for years with very little, and then have one year with $25,000 in claims.”
John Huckstadt tried to find a solution when he was executive director of the United Cerebral Palsy Association in Northern California in the 1970s. The answer finally hit him when he later went into the private insurance business: Nonprofits could set up their own insurance policies. He founded 501(c) Services to help them do just that.
That’s the basic idea behind today’s most popular alternatives for nonprofits to opt out of state unemployment systems.
How it Works
The two major unemployment trust services for nonprofits are 501(c) Services, based in Cupertino, Calif., and Unemployment Services Trust (UST), based in Santa Barbara, Calif. Both started in 1983 and are cooperatively owned.
501(c) Services invests aggressively, putting some of its the money into the stock market. UST takes a more cautious investing approach, but is aggressive in investigating the claims of former employees.
UST says it serves 2,200 nonprofit agencies. Its clients include the Washington-based Zero to Three, and members of the Child Welfare League of America and of the Council of Family and Child Caring Agencies.
Jones, the account executive at UST, says the fund’s clients pay 30 percent less to the trust than they would if they were in their state unemployment insurance programs. She says program costs amount to about 10 percent of an agency’s contributions.
Even when an agency leaves UST, it takes whatever money is has in the trust, including interest – something unheard of in the state systems.
The fund is managed by UBS, a global financial firm based in Switzerland, and the chief financial officers of the nonprofits. They follow a conservative investment strategy that uses short-term vehicles such as bonds. As a general rule in investing, the longer your time horizon, the more risky your investments can be and the higher return they will yield. Since UST is concerned that an employer could need all the money at any given moment, it acts as if the fund is a short-term investment and invests in low-risk, low-yield vehicles, such as bonds.
The amount in each employer’s reserve fund accumulates with payments and investment returns. UST calculates the rate each employer should pay, based on its past unemployment claims. The payment rates are evaluated after three years. Agencies that have more than enough money in reserve can get some of that money refunded.
Jones says UST cuts costs by hiring “aggressive” auditors to investigate unemployment compensation claims by former employees of its client agencies. “We are as aggressive as a particular agency will ask us to be,” Jones says.
In 2004, UST paid $41 million in unemployment claims, she says.
Jones acknowledges that some nonprofits with this kind of unemployment insurance have gone belly-up, leaving their former workers in the lurch because the unemployment fund wasn’t big enough to cover everyone. If an agency folds, UST will file a claim with other creditors in bankruptcy court.
501(c) Services runs a little differently. It manages three trusts: one for the Boy Scouts of America (the Boy Scouts Unemployment Plan), one for groups in the Pacific Northwest (Northwest Agencies’ Trust) and one for everyone else (Joint Agencies Trust, or JAT). Altogether, 501(c) Services says it serves about 1,400 nonprofit agencies.
The firm views its funds as long-term investments, so it invests in more risky vehicles, such as stocks. The result can be high returns on the investments. Last year, the trust returned 14 percent on its investments, an impressive result for a year in which the return on investments for the broad market, as gauged by the Standard & Poor’s 500 index, was 10.8 percent.
Because of that investment strategy, Johnson says, “a number of our members do not pay anything into the trust because investment income is paying for claims.”
JAT members include the YMCA, the YWCA, UNICEF and the Alliance for Children and Families. JAT also has co-branding and cooperative marketing arrangement with Katz’s Human Services Assembly.
The investment strategy carries a risk: Because stocks are more volatile, agencies might not have enough money in their trusts to pay claims if the stock market goes south.
JAT is less aggressive than UST in investigating unemployment compensation claims. “It’s not required that they contest claims if they don’t feel like they want to,” Johnson says of the member agencies.
Last year 501(c) Services paid out $30 million in claims, Johnson says.
For all the benefits of a trust, some agencies fare better in state programs. Johnson notes that an agency with a large seasonal staff or high turnover (such as Head Start) is probably subsidized by the state system and would lose money paying claims itself.
Because unemployment benefits and policies vary among states, nonprofits have to investigate what they pay now and compare that with the costs of joining a trust.