Unemployment Insurance -- Financing -- Solvency Provisions

In deciding how to fund their unemployment insurance programs, states must choose between two primary funding strategies. The first is known as forward funding and relies upon a sizeable fund maintained by fixed taxes on employer payrolls. The second, often referred to as pay-as-you-go funding, involves fixed taxes as well. With pay-as-you-go funding, however, both the taxes and the balance of the fund are generally lower and rely on adjustments in times of high need.

The latter funding strategy relies on automatic or legislative adjustments each time the insurance fund falls below a certain threshold. States utilizing such a strategy must formulate a procedure for reacting to funding shortages. These procedures, which prevent the unemployment insurance program from running out of money, are known generally as solvency provisions.

Types of Solvency Provisions

States have variety of ways of ensuring the solvency of their unemployment insurance accounts. The first involves an increase in the amount of taxes paid by employers. Also known as a solvency tax provision, this method requires employers to contribute a larger percentage of their taxable wage base to the fund. This provision is by far the most common.

In addition to increasing employer taxes, a state may also rely on the implementation of an employee tax to maintain the unemployment fund. This practice increases the state income tax burden for all working individuals; the increased revenue is diverted to the unemployment insurance fund. This type of solvency provision is quite rare.

Also quite rare is the use of a flexible taxable wage base. Here, as in the solvency tax provision, employers are called upon to make a greater contribution to the insurance fund. Rather that increasing the percentage of payroll paid, however, a flexible taxable wage base means that the base salary upon which employers are taxed is increased. (The resulting difference of this type of provision is that employers of more highly paid workers pay more than those of lower paid employees.)

The fourth option states have (and the most commonly utilized after solvency taxes) is that of flexible benefits. With this type of provision, benefits paid to the unemployed are adjusted when the fund begins to run low. Some states decrease the wage replacement rate, the percentage of prior weekly earnings that an unemployed person is entitled to collect. Others decrease benefits to higher wage claimants.

Triggering Response

In states relying on flexible financing, adjustments made to the income and expenditures of the program are "as needed." Typically, this need is defined as a specific threshold for the fund. When the fund is depleted beyond a certain point, the solvency provisions are put into effect. Base on the type and number of provisions used by the state, one or more may be put into effect at one or more stages of fund depletion.

Usually, solvency provisions are automatic. That is, when the unemployment insurance fund is depleted, the provisions go into effect. Some states, however, enact provisions on an ad hoc basis. In these states, there are certain provisions in place, but they must be enacted by the state legislature each time there is a need. This allows the legislature to adjust the provisions as it sees fit to address each unique situation.

Copyright 2010 LexisNexis, a division of Reed Elsevier Inc.