California Voluntary Plans (SDI)

With the California Employment Development Department’s (EDD) decision to remove the cap on wages subject to the CA State Disability Insurance (SDI) tax—currently capped at $153,164 in annual wages—employees making over the cap are concerned about the increase of their contributions to the CA SDI program. This concern has led to increased interest in employers opting out of CA SDI, and in providing a Voluntary Plan that self-funds the claims under SDI/Paid Family Leave (PFL.) A Third-Party Administrator (TPA) can be engaged to manage the self-funded plan. The decision to initiate a Voluntary Plan has many moving parts, as there are approval steps, administrative requirements, and financial considerations that the employer should understand to make an informed decision.

Creating an approved Voluntary Plan (opting out of the state plan)

There are requirements to have an approved Voluntary Plan in the state of California. Here are the high-level points:

• The Voluntary Plan must provide the same level of benefits as the state plan, paying for benefits for medical leave (DI) and for family leave (PFL). It must also provide at least one benefit that is greater than the state plan. (One option to provide the “better benefit” is for the employer to cover some, or all, of the cost of employee contributions.)

• The employer must have the Voluntary Plan approved with the consent of a majority of employees.

• The plan must be approved by the state of California (application process).

• The plan must cover the majority of employees—individual employees are allowed to opt out of the Voluntary Plan and stay with the state-administered SDI.

• The employer may charge contributions to the employees to fund the plan—but contributions cannot exceed the contributions allowed under the state plan.

• The Voluntary Plan must stay in place for one year, or it can be subject to state penalties. The state can cancel a plan for non-compliance and impose penalties.

• The employer must provide and maintain a security deposit with the state.

Establishing and maintaining the security deposit

The deposit will be used to cover the potential liability of the Voluntary Plan, and to reimburse the EDD if the employer fails to pay claims or any assessments.

• This security deposit can be in the form of a(n):

  • Check deposited with the state; or

  • Irrevocable Line of Credit (LOC) from a U.S. financial institution submitted to the state by the financial institution; or

  • Guarantee Bond (GB) issued by an admitted surety insurer and submitted to the state.

• The security deposit is equal to 50% of the annual contributions to the state plan, for the covered employees. Please note, the security deposit will be figured[MS2] on the uncapped wages starting in 2024.

• The security deposit must be maintained and cannot be touched. Each year, the security deposit must be reviewed and adjusted for changes in wages for the covered population.

• If the Voluntary Plan is terminated in an approved manner, the security deposit can be refunded. However, premiums for any LOC or GB must be paid up until the security is released by the state.

• If the Voluntary Plan is terminated by the state for non-compliance, any unpaid liabilities will be recovered from the security deposit.

Establishing and maintaining a trust

Employers may establish a trust for the Voluntary Plan. It must be used solely to fund and maintain the Voluntary Plan, and cannot be diverted for use by the employer, or to the employer’s profit. The rules governing a trust include:

• Employers cannot charge more than the SDI contributions to fund the trust.

• If employee contributions cannot cover plan expenses, the employer will fund the Voluntary Plan by either making a gift or loan to the plan.

• Employers must accurately account for the trust funds, using a separate bank account, apart from all other operations of the employer.

• The trust can only be charged with paying benefits and allowable administrative costs incurred from managing the Voluntary Plan. Allowable costs include: medical exam fees to adjudicate claims, security deposit premiums, fees paid to a TPA, and other administrative expenses including salaries of employees that manage the Voluntary Plan.

• The interest and dividend income earned by the trust must be credited to the fund.

• An annual report of trust fund transactions must be reported to the EDD.

• The employer is allowed to use excess trust fund amounts for additional benefits, if approved by the EDD, as follows:

  • The distribution of excess funds must be commensurate with the employees’ contributions, or otherwise distributed in a fair and equitable manner.

  • Methods of distributing funds can include, but are not limited to:

    • Reducing or waiving payroll deductions for a period of time to dispose of the excess.

    • Refunding employees in an approved manner.

    • Increasing benefits under the Voluntary Plan either temporarily or permanently.

Maintaining an approved Voluntary Plan

There are administrative requirements to keep the Voluntary Plan compliant with the state, and in place from year to year. Here are the high-level elements. The employer must:

• Maintain the security deposit.

• Generate plan documents that illustrate the Voluntary Plan, in line with the state plan requirements (benefit percent, benefit maximum, etc.), submitted to and approved by the state. The employer must review any changes to the SDI plan, and the plan documents must be updated each time there are changes to the SDI program, or when the employer changes the Voluntary Plan.

• Pay all approved claims, and claims expenses. For example, the request for an Independent Medical Exam (IME) to verify disability.

• Submit each claim in a timely manner to the state upon opening and closing of the claim or denial of the claim. Appeals will be handled by the state.

• Comply with all reporting and audit requirements to maintain an approved plan which includes an annual report of self-insured Voluntary Plan transactions, security review worksheets, TPA authorizations, and plan document updates.

• If a Voluntary Plan is terminated, the employer is responsible for any claims incurred prior to the termination date.

Financial impact of a Voluntary Plan

Currently, employers do not contribute directly to the SDI plan. Employers collect employee contributions, and normal administrative expenses are involved. In moving to a Voluntary Plan, the employer needs to weigh the current level of expenses and administration versus the financial responsibility inherent in an approved Voluntary Plan.

First is a comparison of the impact to the uncapped wage contributions. There are two sample companies:

Sample Company #1—100-employee group, with 69 employees at or below the current wage cap of $153,164, and 31 employees over the cap.

Sample Company #2—478-employee group, with 4 employees over the wage cap.

Employee SDI Contributions (Annual)

Employer financial responsibility (first year of Voluntary Plan — 2024)*

The elements in the financial responsibility for administering a Voluntary Plan will include fees, claims, and the security deposit. Using the same two sample companies, claims are based on expected claims (DI and PFL) for the sample case population and wages, and the TPA fees (if applicable) are based on a PEPM of $4.00. The security deposit is based on the uncapped wages for this sample population, as required by the state.

*The financial analysis here does not account for any other administrative costs required to manage the Voluntary Plan. The analysis also assumes that all employees are covered by the Voluntary Plan. Employees are allowed to opt out of the Voluntary Plan and can remain covered by SDI.

**The total estimated claims amount does not include any claim administrative costs (paying for independent medical exams and similar expenses).

*** The security deposit shown is the full amount required by the state. The use of a LOC or GB for the deposit will be less than a check deposit, consisting of a percentage of the full amount, plus any ongoing premiums to maintain the LOC or GB.

• A Guarantee Bond (GB) may be based on 1 to 15% of the bond amount. A typical rate for a customer with good credit would be 3%. For example, the $59,504 security deposit for Company #1 could have estimated premiums of about $1,785 per year.

• A Line of Credit (LOC) would typically have a rate of 4% or higher (the average is about 6.5% for companies with good credit), and could have an origination fee of up to 2% of the loan amount, and a maintenance fee to keep the LOC open. A LOC will require collateral to obtain.

****Second year and beyond costs will include the ASO fees (if applicable), payable DI and PFL claims, and only changes to the security deposit (the original first year security deposit will remain in place, and only adjustments to the deposit would count as new expenses in the intervening years—if using GB or LOC options for the security deposit, cost will include continued premiums each year).

The employer may be able to fund claims with employee contributions, not to exceed the state-mandated limits. If the employer chooses this route, they may need to enhance some other benefit (example, increased maximum or increased maximum duration[MS3] ) to satisfy the requirement for an approved Voluntary Plan to exceed the state plan. Such an increase in benefit design can result in higher claim costs.

The employer utilizing a Voluntary Plan will also need to weigh the risk in claims performing as expected or better, versus the risk of poorer claims experience or “shock” claims exceeding budgeted or expected claims.

In conclusion, employers considering a Voluntary Plan must consider all the potential outcomes, from administrative to financial, in making a decision in the best interest of their employees, and their own financial outlook.