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PRB 03-41E
Kevin B. Kerr
Social Affairs Division
Revised 6 February 2009
PDF (126 Kb, 16 pages)
Implemented in 1996, the Employment Insurance Act (EIA) enacted a number of fundamental changes to Canada’s unemployment insurance system. One of these reforms was supposed to establish a new financing regime that would maintain relatively stable premium rates over the course of a business cycle. The 1996 premium rate-setting process was suspended in 2001, when an amendment to the EIA established that the Employment Insurance (EI) premium rate for 2002 and 2003 would be set by the Governor in Council on the recommendation of the ministers of Human Resources Development and Finance. During this period, a new premium rate-setting process was to be developed and implemented in order to address the concerns expressed by many about the growing so-called “reserve” in the Employment Insurance Account.(1)
As the government was not prepared to implement a new premium rate-setting process by the end of 2003, it announced in the February 2003 budget that the premium rate for 2004 would be set at $1.98 per $100 of insurable earnings. The government also announced that it would accept submissions from the public on a new premium rate-setting process until 30 June 2003. In the event that the new rate-setting legislation was not in place to set the rate for 2005, the government extended by one year its rate-setting authority in the March 2004 budget.
On 23 February 2005, the government introduced legislation to establish a new framework for setting the EI premium rate. Under this rate-setting initiative, the Canada Employment Insurance Commission sets the EI premium rate on a one-year, forward-looking basis so as to ensure that premium revenues in the coming year are sufficient to cover the costs of EI. However, this rate-setting process continues to allow excess EI premium revenues to be used as general revenue. As a consequence, Budget 2008 proposed several additional modifications to the EI rate-setting process. These modifications were expected to take effect in 2009, but will now be delayed until 2010 as a consequence of provisions in Budget 2009.
Prior to the 1996 EI reform, the premium rate was set (under the Unemployment Insurance Act, 1971) each year so as to cover the adjusted basic cost of unemployment insurance (UI). This amount was equal to the average basic cost of benefit plus (minus) any amount required to remove or reduce a deficit (surplus) in the Unemployment Insurance Account. The average basic cost of benefit was equal to a three-year average of UI costs.(2)
The biggest drawback associated with this approach was that premiums sometimes increased at the bottom of the business cycle, a time when employers are laying off workers and unemployment is rising. Hence, the pro-cyclical nature of this rate-setting process served to raise the cost of labour at a time when lower labour costs were needed to stimulate job growth and to reduce the unemployment rate.(3) This perverse result is evidenced by the data presented in Figure 1, which depicts percentage changes in both the unemployment rate and the premium rate from 1973 to 2007. Of particular interest here are the concurrent increases in these rates, as shown in quadrant “A.”
Figure 1 - Percentage Change in the UI/EI Premium Rate and the Unemployment Rate, 1973-2007
Source: Figure prepared by the author using data obtained from Human Resources and Skills Development Canada and Statistics Canada.
The UI premium rate’s heightened adverse impact on the demand for labour during the years 1976, 1981, 1983, 1990, 1991 and 1992 was further exacerbated by the fact that the tax base on which the premium rate was applied increased rapidly due to an indexation formula that grossly overstated the wage inflation of the late 1970s and early 1980s.(4) When this indexation formula was introduced in 1972, maximum weekly insurable earnings were comparable to average weekly earnings. Between 1983 and 1993, however, average weekly earnings (industrial composite) increased by 45.6%, whereas maximum weekly insurable earnings increased by 93.5%. In 2009, maximum weekly (annual) insurable earnings are $813 ($42,300), up 2.9% from 2008 as determined by the indexation formula that was introduced in 2001.(5)
In an effort to eliminate the ill effects of the pro-cyclical UI premium rate-setting process, section 66 of the EIA required the Employment Insurance Commission, subject to the approval of the Governor in Council on the recommendation of the ministers of Finance and Human Resources Development, to establish a premium rate each year. That rate was to ensure, to the extent possible, enough revenue to cover the Employment Insurance Account’s estimated liabilities over a business cycle and to maintain relatively stable premium rates throughout the same period. If premium rates are relatively fixed, the government is exposed to more fiscal uncertainty, as there is no mechanism within the Consolidated Revenue Fund (CRF) to establish a real separate reserve from which to draw to finance one or more year-end deficits in the Employment Insurance Account. Hence, the CRF must cover periods when EI expenditures exceed revenues. Depending on its extent, such a revenue shortfall could substantially undermine the fiscal position of the government.(6)
During 1996 to 2001, when section 66 of the EIA guided the premium rate setting process, a strong economy contributed to unprecedented year-end surpluses in the Employment Insurance Account. As illustrated in Figure 2, this gave rise to a cumulative surplus that, as previously mentioned, reached nearly $57 billion by the end of the 2007–2008 fiscal year. Throughout this period, many expressed growing concern about the size of the cumulative surplus in the Employment Insurance Account, as it became increasingly apparent that this reserve more than met the objectives of section 66 of the EIA. This opinion was premised largely on the Chief Actuary’s report on EI premium rates for 1998, in which he concluded that at the upper limit, a cumulative surplus of between $10 and $15 billion would be sufficient to cover program costs over a 15-year period as well as facilitate premium rate stability (at the time, this implied an average premium rate of between $1.95 and $2.10 per $100 of insurable earnings).(7) Despite this finding, the government continued to allow the cumulative surplus to grow, prompting the Auditor General of Canada to raise concerns about the government’s compliance with the EIA.(8)
Figure 2 -Status of the Employment Insurance Account, 1972 to 2007
Note: From 1996 on, data are reported on a fiscal-year basis. Data for 1996 relates to a 15-month period beginning January 1996.
Source: Figure prepared by the author using data obtained from Human Resources and Skills Development Canada and Public Accounts of Canada.
In 2001, the EIA was amended and a new section 66.1 allowed the Governor in Council, on the recommendation of the ministers of Human Resources Development and Finance, to set the EI premium rate for 2002 and 2003.(9) This change suspended the premium rate-setting process described above. The government also announced that during this period it would undertake research and conduct public consultations on the creation of a new premium rate-setting process, to be implemented by the end of 2003. As public consultations had not occurred by the February 2003 budget, the government set the premium rate in 2004 at $1.98 per $100 of insurable earnings and reiterated its intention to conduct consultations on a new premium rate-setting process. The budget also established five premium rate-setting principles to guide the consultations:
Although it was assumed that the new premium-rate setting framework would be in place by the beginning of 2005, the government extended its rate-setting authority by one year in the March 2004 budget. It was understood that the rate would be set in a manner consistent with the principles outlined above.
Interested parties were invited to participate in the EI premium rate-setting review consultation process between April and August 2003. Groups and individuals had until 30 June 2003 to make a submission. In addition, several roundtable meetings involving representatives of business and labour, experts and EI Commissioners were held during the summer of 2003.(11) As expected, a variety of views were expressed regarding the five premium rate-setting principles outlined above. The following provides a brief summary of the Overview Report that was posted on the Department of Finance’s Web site.(12)
This principle generated the most commentary from stakeholders. Labour representatives who participated in the consultations expressed the view that the EI Account should not be consolidated with the Accounts of Canada, and that EI funds should be managed by an independent arm’s-length organization. Most business groups also supported the notion of maintaining a separate, independently managed EI Account. Both business and labour supported a stronger, more independent EI Commission, with better representation among employers and employees. In the interest of greater transparency, many participants felt that the underlying information used to establish premium rates, including information provided by EI’s Chief Actuary, should be made public. Some groups also suggested that the government should repay the cumulative surplus in the EI Account over a period of time. Some business representatives maintained that the cost of special benefits should not be considered in the rate setting process. Many consultation participants did not support a “push-button” automatic premium rate calculation.
Consultation participants were in general agreement with this principle. Many felt that there was a continued role for EI’s Chief Actuary, mainly as an advisor to the Commission. In addition to the Chief Actuary, participants suggested that expert advice should also be sought from employers, employee groups, economic forecasters and other knowledgeable parties, including the Office of the Auditor General of Canada.
Although there was wide agreement that expected EI revenues should cover program costs over some specified period of time, such as a business cycle, many participants who commented on this principle identified the need for a reserve in order to mitigate pro cyclical movements in EI premium rates. However, it was noted that if the government continues to control the program, then EI should remain in the Accounts of Canada.
Some participants felt that the size of the reserve should be calculated as some proportion of program costs. Moreover, it was generally felt that the government should be very specific about the costs that EI revenues are supposed to cover. Expected program costs should also consider non-cyclical contingencies such as the effects of the September 2001 terrorist attacks and the Severe Acute Respiratory Syndrome (SARS) epidemic.
While many consultation participants agreed that rates should be set on a forward-looking basis, there was less agreement on whether the current cumulative surplus should be factored into future rates.
There was also some discussion of adopting experience-rated premiums (i.e., premium rates related to the lay-off behaviour of firms), as well as moving away from a specified purpose tax to a general payroll tax.(13)
There was a consensus among consultation participants that premiums should not be set pro-cyclically. Moreover, as previously noted, a majority of participants favoured a forward-looking rate-setting process. Once again, some participants called for the creation of a reserve to eliminate the need to raise EI premiums during a downturn. Another view called for the establishment of a long-term, low, and stable premium rate, with the government covering the increase in EI costs during periods of economic weakness. Some expert participants noted that by setting a break-even premium rate over the course of a business cycle (or at least a long time horizon), annual adjustments to the rate would probably be small. In terms of this approach, “bygones would be bygones” and the concept of a cumulative surplus would disappear. Although this approach does not entail any of the governance or accounting problems associated with establishing a real reserve, it was noted that most private-sector forecasters do not provide “business cycle” projections.
This principle produced the second-greatest amount of commentary, and all participants agreed that EI premium rates should be stable over time. While labour representatives suggested that the best way to achieve stability is through a reserve, there was no support for raising rates to establish a new reserve. Some business representatives also agreed that a reserve would allow for premium rate stability and that, given the existing cumulative surplus, rate stability in the future should be assured. With regard to future rate changes, some business representatives indicated that it would be helpful to have more time to adjust to a new rate and suggested that the EI rate for the coming year be set in September or October at the latest.
Some two years after announcing its intention to consult Canadians on a new premium rate-setting framework, the government revealed its proposal in the 23 February 2005 budget. The legislation for this initiative was contained in Part 19 of Bill C-43, an omnibus bill containing certain provisions to implement the budget. The new framework for setting EI premium rates received Royal Assent on 29 June 2005.
Bill C-43 restored the EI rate-setting responsibility of the Canada Employment Insurance Commission, which was suspended in 2001 under Bill C-2 (An Act to amend the Employment Insurance Act and the Employment Insurance (Fishing) Regulations). In setting the rate for a given year, the Commission is to take into account the principle that the premium rate should generate just enough revenue to cover estimated EI program costs (including the cost of administration) in that year (i.e., a break-even rate), as well as the report of the Commission’s Chief Actuary and any public input. If needed, the Commission may engage the services of persons with specialized knowledge in rate-setting matters.
This rate-setting objective is very different from its predecessor, as the rate is now set on a forward-looking basis and thus does not consider the notional reserve that has accrued in the Employment Insurance Account since the inception of the Employment Insurance Act. In other words, let bygones be bygones. Moreover, no rate adjustment is contemplated in the event that the revenue generated by the estimated break-even rate exceeds that actually required to cover program costs in any given year. Hence, even in the absence of notional interest payments on the cumulative surplus in the Employment Insurance Account, incremental growth in the Account’s substantial cumulative balance remains a possibility.(14) The Employment Insurance Account will continue to be used to track EI revenues and expenditures. As well, it will probably continue to track year-end and cumulative balances, the purpose of which is uncertain.
Under the 2005 rate-setting framework the Commission’s Chief Actuary is mandated to determine the break-even rate for the coming year based on information provided by the Minister of Finance by 30 September of each year.(15) The Chief Actuary is required, at the request of the Minister of Human Resources and Skills Development, to include in the calculation of the break-even rate for the coming year any program changes that can affect payments that have been announced by the Minister as of 14 October in the year prior to the coming year. The estimated break-even rate for the coming year must be provided to the Commission on or before 14 October of each year. The Commission must set the premium rate for the coming year on or before 14 November of each year. On a joint recommendation of the Minister of Human Resources and Skills Development and the Minister of Finance, the Governor in Council has until 30 November to set a different rate than that established by the Commission, if the Governor in Council considers that it is in the public interest to do so.
The principle of maintaining premium rate stability is loosely achieved by restricting the Commission to setting a premium rate in any given year that is no more than $0.15 per $100 of insurable earnings above or below the previous year’s rate.(16)
Since the advent of the 2005 EI premium rate-setting process, the Canada Employment Insurance Commission has set the premium rate four times. Its last and final rate was announced on 14 November 2008. As of 1 January 2009, the employee premium rate will be $1.73 per $100 of insurable earnings (maximum insurable earnings in 2009 are set at $42,300), unchanged from the previous year.(17) Since employers pay 1.4 times the employee rate, employers will pay $2.42 per $100 of insurable earnings. The 2009 premium rate for workers and employers in Quebec will be somewhat lower than in the rest of the country (i.e., $1.38/$1.93 per $100 of insurable earnings), because Quebec delivers its own parental benefits.(18)
Based on estimated insurable earnings of some $113.9 billion in Quebec and $352.4 billion in the rest of Canada, as presented in the Chief Actuary’s recent report to the Commission, the aforementioned premium rates are expected to generate roughly $18.4 billion in program revenues in 2009, slightly higher than estimated EI costs for the same year.(19)
Budget 2008 contained the announcement that the government would establish a Crown corporation called the Canada Employment Insurance Financing Board (CEIFB). The CEIFB will manage a separate $2 billion EI reserve (outside the EI Account) and set EI premium rates under a modified premium rate-setting process. These changes are contained in Part 7 of Bill C-50, Budget Implementation Act, 2008, which received Royal Assent on 18 June 2008.(20)
The CEIFB will be managed by a board of directors, composed of seven directors, including the chairperson. Directors will be appointed by the Governor in Council, on the recommendation of the minister of Human Resources and Skills Development.(21) After consulting with the minister, the board of directors will appoint a chief executive officer and a chief actuary.
The CEIFB is required to set the premium rate for the following year on or before 14 November of the current year. The premium rate must be set such that EI revenues are sufficient to cover EI costs in the coming year, repay advances made to the EI Account and ensure that the forecast fair market value of the board’s reserve is equal to the indexed value, beginning in 2009, of the initial $2 billion reserve.
The CEIFB must consider a great deal of information in setting the premium rate including, for example, information provided by the minister of Human Resources and Skills Development (e.g., forecast change in payments made under paragraphs 77(1)(a), (b) and (c) of the Employment Insurance Act as a consequence of changes announced by the minister on or before 30 September in a year and forecast costs related to EI administration), the minister of Finance (e.g., most current forecast values of economic variables that are relevant to the determination of the premium rate and the estimated amounts credited to the Employment Insurance Account under sections 73 to 75 of the Employment Insurance Act), the difference between amounts credited to and charged to the Employment Insurance Account after 31 December 2008, and the return on the reserve managed by the board.
The premium rate set in any given year may not be more than 15% (i.e., 15 cents per $100 of insurable earnings) above or below the rate in the previous year. However, according to subsections 66(8) and 66.3(1) of the Employment Insurance Act, the Governor in Council may substitute a premium rate which exceeds the allowed maximum change in the premium rate set by the board if it considers it in the public interest to do so (this is different from the current Act, which limits the rate set by the Governor in Council to the 15% maximum threshold).
Prior to Budget 2009, the CEIFB was expected to become operational in 2009 and set the premium rate for 2010 on or before 14 November 2009. However, according to the budget, the federal government will freeze the EI premium rate at $1.73 for the year 2010. The CEIFB is expected to set the rate for 2011 and beyond.
Following a prolonged period of what many, including the Auditor General of Canda, believed to be excessive EI premium rates, steps have been taken to modify the EI premium rate-setting process. The most recent modifications were adopted in June 2008. One of the weakest aspects of the new rate-setting framework and a point raised in a report tabled by the House of Commons Standing Committee on Human Resources, Social Development and the Status of Persons with Disabilities, relates to premium rate stability, both in terms of the size of the reserve and the rate-setting reference period. Furthermore, the temptation to set a premium rate “in the public interest” above the threshold of 15 cents (which itself does not necessarily constitute premium-rate stability) will probably grow as the Canadian economy weakens. In the event that this occurs, we will return to the days of pro-cyclical rate setting, the policy objective that the government was purportedly trying to avoid while amassing an unprecedented notional surplus in the Employment Insurance Account.
(2MB, 127 pages), 27 November 2008, p. 40.