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Issue in Focus:

Will Utah Taxpayers be 'Enron'-ed

by the Legislature? The Half-Billion Dollar

Workman's Compensation Fund Sell-Out

by Utah State Auditor Auston Johnson

Summary: Concerned State Auditor Auston Johnson exposes the threat behind recent proposals to "privatize" Utah's Workman's Compensation Fund. Learn what the state's top CPA feels taxpayers should know.


1. Recent Proposals Shortchange Taxpayers

2. The History of WCF

3. WCF Cannot Have It Both Ways

4. Conclusion: Look Out for the Taxpayers


1. Recent Proposals Shortchange Taxpayers

Over the last few months, some legislators have proposed that the Utah’s Workers Compensation Fund (WCF) be morphed from a state agency into a private mutual insurance company — with assets of nearly one billion dollars. The proposed legislation would exempt this private company from state control, causing it to lose its tax exempt status. With this advantageous status lost, WCF would no longer be required to be the insurer of last resort for Utah workers injured on the job.

State officials — and WCF officials — agree the tax exemption is vital in order to maintain WCF service to injured workers. However, if WCF is privatized, that tax-exempt status will probably be revoked due to Federal tax law and complaints of unfair tax advantages from other states where the WCF desires to extend its services. Once that status is revoked, taxpayers will inevitably be pressured to cough up more hard-earned dollars to recreate a WCF-like entity to serve the less profitable businesses WCF was originally intended to serve.

The worst part of this proposed legislation is not privatization, but that current proposals do not fully reimburse taxpayers for the hundreds of millions of dollars they have forgone in the tax exemption WCF has enjoyed since it was created. Current proposals offer $50 million to the State, while the estimated tax advantage over just the last eight years is $98 million.

As state auditor, I oppose this move unless taxpayers are compensated for their significant investment. Given that the tax exemption would be lost in any case if privatized, WCF should be sold, much like the state of Michigan sold its Michigan insurance fund. The portion of the proceeds from the sale of that fund’s assets, monies, and surpluses went to the state — in spite of challenges by policyholders of the Michigan fund. Consultants have set the fair market value of WCF at between $480 and $550 million dollars if it were sold.



2. The History of WCF

How have we arrived here? In 1917, the legislature created a state agency to provide workers’ compensation insurance when no one else would. From 1917 to 1988, this state agency was administered as a department of state government. In 1988, the legislature created the Workers’ Compensation Fund of Utah as an independent state agency, and amended its statute in 1990 to change its status to a "nonprofit quasi-public corporation." This change in status, however, has not been clearly defined: the legislature gave no guidance as to how this status differed from state agencies or how they should be dissolved when no longer needed.

In 1997, the legislature allowed WCF to form or acquire subsidiaries to do business in other states, and also removed from the State Auditor the ability to audit WCF. In 1998 the legislature allowed WCF to enter into joint enterprises, in 2000 the Legislature removed "of Utah" from the name of WCF, in 2001 the legislature exempted WCF from the Open and Public Meetings Act, and in 2002 the legislature tried to amend the governor’s appointment powers so that he could no longer appoint WCF board members.

As a result of all these amendments, WCF is now an entity that provides workers’ compensation insurance and other products and services to Utah and non-Utah businesses. The final step in this progression was attempted, but failed in 2003: the privatization of WCF.

This gradual "secession" from the state has been rationalized as necessary to the ability of WCF to continue to provide for the "residual market": businesses that other insurance companies refuse to insure because they are, for one reason or another, not profitable. WCF is required by statute to provide insurance to these businesses. WCF has argued to the legislature many times over the past fifteen years that if it is to continue to serve the residual market, it must have the ability to subsidize that market — to sell to a larger and more profitable market that would include non-Utah businesses and Utah businesses with employees outside of Utah. This is the reason WCF received legislation allowing subsidiaries and joint ventures. This subsidization is in addition to the "quid pro quo" WCF already receives for providing for the residual market — a federal tax exemption worth $98 million over the last eight years.

The final step to privatization is motivated by the WCF’s desire to sell insurance in states other than Utah. Idaho has challenged the ability of WCF to be licensed in its state, asserting that the appointment by the governor of WCF board members is tantamount to the "voting control" which Idaho prohibits if held by a government. WCF is arguing to eliminate the governor’s appointment powers, and allow privatization, so that it can continue to sell insurance in Idaho to Utah and non-Utah businesses alike — thus subsidizing the less profitable Utah residual market.



3. WCF Cannot Have It Both Ways

Here, then, enters the conflict that turns this entire, complex issue on its head. In order to become licensed in Idaho, WCF must show that the State of Utah does not control it. In order to retain its tax exemption, WCF must show that the state does control it.
(Note: Internal Revenue Code section 501(c)(27) provides a tax exemption for an entity provided that, among other requirements, "the majority of the board of directors or oversight body of such organizations are appointed by the chief executive officer or other executive branch official of the State, by the State legislature, or by both.")

WCF is attempting to make both arguments, but as the Idaho hearing officer wrote:

"WCF’s argument is inconsistent in arguing on one hand 'that it should be independent from state control in the case under examination' but maintaining on the other hand that 'at least some degree of connection between it and the state for the purpose of the I.R.C. section 501(c) exemption [exists].'"

Admittedly, WCF is facing this apparent inconsistency head-on and is making highly technical legal arguments that it hopes will win the day both in Idaho and with the IRS.

In the 2003 legislative session, WCF unsuccessfully supported SB 170, which would have addressed the IRS provision requiring control by a "board of directors or oversight body of such organization," by providing for the creation of a Utah Residual Market Oversight Council, an entity separate from the WCF board of directors, whose members would be appointed by the governor. Even if WCF is able to convince the IRS, as it is attempting to do, that the "other oversight body" need not refer to a controlling board of WCF, I am concerned that the tax exemption granted will, nevertheless, be short-lived.

The bottom line is that other states are justifiably concerned about an entity with a tax exemption unfairly competing with taxpaying businesses in their states. Thus, there would almost certainly be some effort by other states to prohibit WCF from doing so. And though WCF has argued in legislative interim meetings that such additional legislation by the states would be unconstitutional, I have confidence that the states would have the skill and the incentive to word legislation in such a way as to avoid any legitimate constitutional questions.

Finally, even if WCF were successful in keeping its tax exemption in the short run, another provision of the federal law granting the exemption is almost certainly to come into play in the near future. Tax exempt status is also based on the requirement that the entity is "operated under state law exclusively to . . . provide workmen’s compensation insurance which is required by State law. . . ." While exclusively does not mean "exclusively" (go figure it), the incentive of a private business, whether a mutual organization or not, is on profitability. Therefore, the incentive of WCF will be to subsidize the residual market to a greater and greater extent, i.e., to sell to profitable non-Utah businesses. At some point, a line will be crossed beyond which WCF is no longer providing, exclusively, insurance required by Utah state law, and will then lose its tax exemption.

Accepting the position that there is a basic conflict between the motives of a tax-exempt entity and a private, for-profit entity, if privatized, there will come a time when WCF cannot have it both ways. That time may be now, or may be sometime in the future, but it will come to pass.



4. Conclusion: Look Out for the Taxpayers

For these reasons, I have supported the position that, in this case, WCF must not be privatized. However, if WCF is privatized the State of Utah should receive full compensation. Given that the tax exemption would be lost in any case if privatized, WCF should be sold, much like the Michigan insurance fund was sold, and the sales price should come to the state, as it did in Michigan.

Once WCF loses its tax-exempt status, it will no longer be required to be the insurer of last resort to the residual market. Therefore, the original "insurer of last resort" intent, which was started nearly a century ago and has worked well, would be lost. The state would be in the position to either recreate the mechanism — (again) at taxpayer expense — or to forgo the compensation business entirely.

It would simply be irresponsible of the state’s managers and policymakers to fail to maximize the return on WCF in the event of privatization, so that funds are available to continue to provide for the residual market. The more responsible course of action is to refuse to put the tax exemption at risk by going down the path of creative lawyering that will ultimately backfire on the taxpayers of Utah.

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Permission to reprint this article is hereby granted provided that the author and Accountability Utah are cited.  See the Taxes & Spending section of our Issues & Alerts page for more information on Utah taxes, including the poor performance of both parties on tax issues.  If you need help finding your legislator, visit our elected official contact page.




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