Delving into Unemployment Insurance Solvency in the US

The unemployment insurance (UI) system plays a critical role in ensuring that employees who are separated from a company through no fault of their own have access to benefits based on their eligibility. Yet that very system is plagued by challenges that threaten UI solvency, which can have negative consequences for employers and employees.  

This article looks at how the UI trust fund works and how UI solvency rates are trending across the US, especially in the wake of COVID-19.

A Flawed UI Trust Fund System 

Each state’s UI trust fund is the mechanism for paying unemployment benefits to eligible claimants. These accounts are funded through taxes paid by employers, including FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) rates. In several states, employees also contribute to the UI trust fund through an additional UI tax on their wages. Each state has some degree of control over how it generates revenue for the trust fund, through measures like determining the taxable wage and SUTA tax rate.  

The UI system was designed to collect more revenue than it pays out during periods of robust employment, in order to generate the reserves needed when claims rise during times of high unemployment, such as the Great Recession and the COVID-19 pandemic. While this forward-funding approach should work in principle, it doesn’t always work in reality. 

One reason is the fact that there are no federal requirements for a UI trust fund’s reserves—just a guideline that states should maintain a reserve of at least one year of projected benefit payments. In the absence of a true requirement, some states don’t maintain adequate funds to cover excessive claims during economic downturns. 

The COVID-19 pandemic shone a spotlight on this problem, as skyrocketing unemployment strained many states’ ability to cover their benefit payment liabilities. UI trust funds paid out far more in benefits during the pandemic than they have historically. Per the Tax Foundation, from February 2020 to January 2022 states paid approximately $187 billion in unemployment benefits, compared to a pre-pandemic annual average of $30 billion.  

How UI Solvency is Determined 

In the wake of the COVID-19 pandemic, the issue of UI trust fund solvency has taken center stage. A UI trust fund’s solvency is an indicator of its ability to pay unemployment benefits to eligible claimants and repay US government loans taken under Title XII, which allows states to borrow funds to help cover unemployment benefits.  

One measure used to evaluate a UI trust fund’s solvency is the average high cost multiple (ACHM). Here’s how ACHM is calculated: 

  • First, the fund’s reserve ratio is determined by dividing the trust fund balance by the state’s total annual wages.  
  • Then the ACHM is determined by comparing the reserve ratio to the average of the state’s three highest benefit cost rates over the previous 20 years.  

An ACHM value greater than 1.0 is considered the minimum solvency rate to be prepared for a recession.  

A State Unemployment Compensatory Advisory Program (SUCAP) report shared the status of state trust fund solvency in the US as of March 22, 2023, reviewing ACHM values and outstanding Title XII loan balances. According to the report, only 14 states had an ACHM of 1.0 or more at that time, while 14 states had an AHCM between 0.5 and 0.99. The remaining 22 states, plus Puerto Rico, had an AHCM below 0.49 or an outstanding Title XII loan balance.   

According to data from The Brookings Institution, 22 states took federal loans to help cover unemployment benefits in 2020. Though federal legislation granted states a temporary waiver on interest on these loans during the height of the COVID-19 pandemic, when the measure ended in September 2021 the interest accruals resumed. As of March 24, 2023, three states (California, Connecticut, and New York) plus the Virgin Islands still had outstanding loan balances, per SUCAP data. 

To understand how significantly an economic downturn can impact a state’s UI trust fund, consider this comparison based on US Department of Labor data: In early 2020, 31 states were considered to have met the federal government’s minimum solvency standard. As of January 1, 2024, only 19 states met the standard. And while outstanding Title XII loan balances were near zero in 2019, as of March 2024 those loan balances totaled $27 billion. That doesn’t include balances from private loans, which many states are eligible to obtain on an interest-free basis.  

If a state is unable to pay its Title XII loan balance in full within the grace period (a timespan of not quite three years), the federal government reduces the state’s FUTA tax credit. In effect, this increases the UI tax rate, driving up costs for all taxable employers in the state

How States Are Tackling the UI Solvency Dilemma 

In the aftermath of the massive unemployment fueled by the COVID-19 pandemic, and facing current economic volatility, some states are taking significant measures to improve their UI trust fund solvency.  

One example is Connecticut, which saw unemployment surge from 3.7% in January 2019 to 9.8% in June 2020. The Connecticut Department of Labor website characterized the pandemic’s effect on employment as “worse than any recession ever” and described its trust fund as “decimated.” 

The agency recently announced changes to improve the state’s UI solvency, including measures that impact both unemployment taxes and benefits. On the tax side, Connecticut’s taxable wage base was increased substantially and will now be indexed to inflation, while both the minimum and maximum UI tax rates are increasing. On the benefits side, the state’s maximum benefit rate will be frozen from October 2024 through October 2028, and some types of pay will be considered disqualifying income under certain circumstances.  

Many states also change their UI tax rate after periods of higher-than-usual unemployment to help bring their trust fund balance to an appropriate level. However, there is inevitably a lag between the economic cycle that sapped the trust fund and a change in the UI tax rate, in part because rate changes are based on a longer historical period than a single year. As the UI tax rate pendulum swings in response to economic cycles and trust fund fluctuations, employers are left to grapple with the resulting impacts.  

How UC Alternative Can Reduce Your UI Tax Rate  

No matter how your state’s UI solvency rate is trending or what happens next with the economy, it’s essential to take every measure possible to impact the portion of your UI tax rate that’s within your control. One of the best first steps is to partner with an experienced provider like UC Alternative.  

UC Alternative takes ownership of the unemployment claims function, applying our knowledge, expertise, and experience to capture more opportunities to reduce your UI tax rate and total claim costs. With a unique performance-based fee structure that ensures we’re rewarded for claims outcomes, we have a strong incentive to optimize your savings by achieving the lowest possible UI tax rate for your industry and state.  

Get a free unemployment claims projection and learn how we save employers up to 40% or more on their unemployment costs.