Legal Issues Regarding Section 125 Plans

1
Legal Issues Regarding Section 125 Plans

• Patricia A. Butler, JD, DrPH
• SCI/NASHP/NGA Section 125 Plans Policy and
  Implementation Issues, Boston June 20, 2008

2
Presentation Outline

• Section 125 Plan requirements
• Application of other federal laws
• HIPAA
• COBRA
• ERISA
• State health policy implications

3
Section 125 Plan Requirements

• Internal Revenue Code Section 125
• The only way to exclude health insurance payments
  from employee income
• Allows employees to buy coverage in individual
  insurance market with pre-tax
• If health insurance is the only benefit, plan can
  be called premium only plan (POP)
• For purposes of tax code, these individual
  premium payments (salary reduction) are
  considered employer contributions

4
Section 125 Plan Requirements

• Revised proposed regulations published August
  2007
• Final regulations expected before the end of 2008
• Written plan document lists specific benefits and
  maximum amounts for which payroll deduction is
  allowed, employee eligibility, etc.
• In the case of individually purchased benefits,
  employers must verify that employee funds are
  used for qualified coverage (ie health insurance)
  reg proposes 3 ways
• Employee annual election irrevocable
• Applies only to employees (not self-employed,
  partners and certain small corporation
  shareholders)
• Failure to meet tax law requirements subjects
  employer and employees to tax liabilities

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Nondiscrimination Provisions

• Cafeteria plans cannot discriminate in favor of
  highly compensated individuals or key
  employees defined in the regs regarding
  eligibility for the plan or contributions and
  benefits (including actual use of a salary
  reduction)
• Favoring these employees doesnt disqualify plan
  but subjects them to the foregone taxes
• Employers need to assess plan at end of tax year

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Nondiscrimination Provisions Highly Compensated
Employees

• Eligibility if all employees are eligible for
  cafeteria plan, plan meets this test
• Contributions any employer contributions must be
  at same level for HCEs and non-HCEs
• Benefits actual use of caf. plan contribution or
  salary reduction cannot favor HCEs
• Ratio of aggregate amount of benefits elected by
  HCEs as a of total compensation cannot exceed
  aggregate amount of benefits elected by non-HCEs
  as of their total compensation
• Safe Harbor if POP plan meets eligibility test,
  but may not apply to salary reduction for
  purchasing individual insurance products

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Nondiscrimination Provisions Key Employees

• More than 25 of total tax-advantaged benefits
  cannot benefit key employees (if they do, Keys do
  not receive tax benefit)
• Safe Harbor if POP plan meets eligibility test,
  but may not apply to salary reduction for
  purchasing individual insurance products

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Application of other federal laws COBRA

• Because even employee-only premium payments are
  considered to be employer contributions, these
  cafeteria plans are considered group health
  plans under COBRA
• COBRA allows employees (of firms with 20 or more
  workers) leaving group coverage to stay in the
  group for 18 months (paying the full premium)
• This continuation authority is irrelevant to
  individually purchased health insurance, but
  would permit employees to use severance pay to
  buy coverage with pre-tax funds from former
  employer or to pay premium for the individual
  coverage under cafeteria plan of a new employer
  during insurance eligibility waiting period

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Application of other federal lawHIPAA

• Prescribes permissible pre-existing condition
  exclusion periods, special enrollment periods,
  portability and renewability for employer groups
  of 2
• Prohibits discrimination in health coverage
  eligibility and premiums based on health status,
  claims experience, etc.
• Applies to section 125 plans because HIPAA
  defines group health plans like COBRA
• Therefore, to avoid tax law penalties, employers
  must be sure that insurers selling individual
  plans to employees under a cafeteria plan meet
  HIPAA standards

10
Application of other federal lawHIPAA

• Some state individual insurance product laws do
  not meet HIPAA pre-ex standards
• Most do not prohibit health status discrimination
  in eligibility or premiums in individual market

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Application of other federal lawERISA

• Federal Employee Retirement Income Security Act
  regulates private-sector employer-sponsored
  health plans
• Clearly applies if employers contribute to
  employee insurance premiums
• Also applies if employers sponsor a plan to which
  they dont contribute

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Application of other federal lawERISA

• Relevant to Section 125 plan discussion if health
  coverage purchased individually through a 125
  plan is considered employer-sponsored
• US DOL has said cafeteria plans not ERISA plans
• If individual policies are considered
  employer-sponsored, employers must meet
  disclosure, reporting and fiduciary requirements
• Also, it could be argued that a state requirement
  for all employers to offer such cafeteria plans
  is an employer mandate preempted by ERISA

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Application of other federal lawERISA

• Whether health insurance purchased individually
  via a cafeteria plan is an ERISA plan depends on
  extent of employer endorsement of individually
  purchased products under DOL regulation
• Courts and DOL have defined employer endorsement
  to include selecting, creating, promoting, or
  administering employee insurance plans
• Objective is to avoid misleading employees to
  believe employers are responsible for a plan
• Some courts (in health plan damages law suits)
  have held that allowing insurance to be purchased
  individually via a cafeteria plan (among several
  other factors) constitutes endorsement

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Application of other federal lawERISA

• While not completely clear from written DOL
  policy or case law, it is possible to argue that
• Health insurance purchased individually through a
  cafeteria plan is not an ERISA plan if employers
  do nothing more than payroll deductions
• ERISA does not preempt a state requirement that
  employers offer cafeteria plans (DOL informally
  sanctioned the MA law)

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Primary Cafeteria Plan Issues for State Health
Policy Makers

• Uncertainty regarding application of
  nondiscrimination requirements regarding HCEs and
  Keys and safe harbor
• HIPAA compliance
• ERISA
• Whether individual policies become ERISA plans
• Preemption challenge potential

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State Policy Responses

• To assist employers to offer cafeteria plans,
  states could
• provide technical assistance and model cafeteria
  plan materials, including awareness of
  nondiscrimination rules
• Provide guidance on how to avoid the appearance
  that employers are endorsing insurance
  purchased individually through the cafeteria plan
  
• To assist employers to comply with HIPAA, states
  could
• evaluate their individual health insurance market
  standards for consistency with HIPAA and
• revise insurance standards and/or
• condition insurer participation in a state
  purchasing pool on complying with HIPAA

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State Policy Responses

• States could create a purchasing pool/exchange
  through which individuals may purchase health
  coverage
• Helps to distance employer from insurance
  products and minimize endorsement arguments and
  avoid ERISA requirements and preemption challenge
• Provides a way for employers to assure products
  bought under a cafeteria plan meet HIPAA
  requirements