Associations must pay for unemployment benefits just like any business, but did you realize a federal exemption gives nonprofits unique flexibility in funding for their unemployment claims?

501(c)(3) nonprofits can opt to reimburse the state dollar for dollar as “reimbursable employers” for any unemployment claims paid out to their employees, instead of contributing to State Unemployment Insurance (SUI) programs by paying taxes.

The reality is that almost 86 percent of nonprofits are overpaying SUI taxes. Since many states have raised tax rates on unemployment funds, associations could be paying up to $2 in unemployment taxes for every $1 in employee claims.

Exploring alternative unemployment insurance options could help your association significantly trim costs, but don’t opt out of your SUI program without first considering the risks of doing so. At a minimum, nonprofits paying the state tax should compare that annualized cost against the actual amount of claims paid during that same period.

Becoming a reimbursable employer is a long-term strategy and every organization must carefully review their state requirements before making any decision. Knowing that, here is a closer look at the five risk transfer and service options available to nonprofits:

1. Grantor Trust.  Nonprofits that use a grantor trust contribute to an unemployment trust funded collaboratively with other nonprofit organizations. The amount contributed is based on an organization’s projected loss experience. The grantor trust essentially functions as a bank account to pay its participants’ unemployment benefits. Grantor trusts contract with claims administrators to handle claims for their clients. Since this option operates as a service provider, the grantor trust deals with all administrative duties, claims, and invoicing. This is a good option for nonprofits that tend to have high turnover rates and employ lower-level employees in multiple regions throughout the United States. The downside: expensive administrative fees and no insurance protection.
2. Full self-insurance program. Nonprofit can also opt to self-fund 100 percent of their unemployment costs. This option gives nonprofits total program control and, if needed, they can engage a third-party administrator (TPA) to manage claims. But there are downsides: This program provides no protection against large claims. As a result, nonprofits and their board members unable to pay state unemployment obligations could face severe repercussions, including liens against personal property.
3. Stop-loss insurance. Nonprofits that select stop-loss coverage self-fund their state obligations up to a set threshold, beyond which unemployment insurance kicks in up to the stop-loss policy limit. This option is best suited for groups with high payrolls and low turnover since it transfers the risk of catastrophic loss. The downside is that these policies have high self-insured retentions. In addition, nonprofits that opt for stop-loss insurance must manage state invoices, which can prove to be an administrative burden.
4. Bonded service. Associations that opt for this arrangement will contract with a service provider, and payment of state obligations by the service provider are guaranteed by a surety bond; the service provider selected pays the unemployment benefits up to a limit of insurance. The downside: Since bonded surety agreements are not regulated by state departments of insurance, the service provider can cancel the agreement mid-term. In addition, bonded service agreements typically have variable costs. Pricing is set at a minimum based on projected payroll but can increase if payroll grows during the contract term.
5. Commercial “first dollar” insurance. Groups that opt for commercial “first dollar” insurance pay an annual premium to a licensed, admitted commercial insurer that assumes 100 percent of the costs of unemployment benefits up to a limit of insurance. These programs include administration of state invoices and offer fixed pricing. The commercial insurer also handles all claims through a TPA. The downside: This coverage option can be expensive and policy premiums can vary.

While selecting the right unemployment risk financing mechanism can be overwhelming for organizations, a nonprofit risk advisor with a subspecialty in unemployment insurance can create and dissect the options, modeling different financial scenarios to identify the best solution.