Note: This is Part 2 of an article on medical loss ratios (MLR). See Part 1.
As a reminder, insurance carriers are required to satisfy certain medical loss ratio (“MLR”) thresholds. This generally means that for every dollar of premium a carrier collects with respect to a major medical plan, it should spend 85 cents in the large group market (80 cents in the small group market) on medical care and activities to improve health care quality.
If these thresholds are not satisfied, rebates are available to employers in the form of a premium credit or check.
If a rebate is available, carriers were required to distribute MLR checks to employers by September 30, 2019.
Importantly, employers must distribute any amounts attributed to employee contributions to employees and handle the tax consequences (if any).
This does not apply to self-funded plans.
The rules around rebates are complex and require careful review with ERISA counsel. Among other things, an employer receiving a rebate as a policy holder will need to determine:
• who receives a rebate (e.g., current participants v. former participants);
• the form of the rebate (e.g., premium reduction v. cash distribution);
• the tax impacts of any such rebate (on both the employer and participants receiving the rebate); and
• what, if any, communication to provide participants regarding the rebate.
The following questions and answers summarize information regarding what employer action may be necessary.
When Do Rebates Need to Be Made to Participants?
As soon as possible following receipt and, in all cases, within 3 months of receipt.
What is the Form of Rebate to Participants?
There is no one way to determine this, but guidance has been provided to aid employers.
Reductions in future premiums for current participants is probably the best method.
If proceeds are to be paid to participants in cash, the DOL is likely to require that payments go to those who participated in the plan at the time the proceeds were “generated,” which may include former employees. An option that may be easier to administer is to keep the proceeds in the plan and provide a “premium holiday” (suspension of required premiums) or a reduction in the amount of employee-paid premiums.
The interim final regulations for non-ERISA governmental plans require that rebates be used to reduce premiums for all health plan options for subscribers covered when the rebate is received, to reduce premiums for current subscribers to the option receiving the rebate, or as a cash refund to current subscribers in the option receiving the rebate. In each case, the regulations allow the rebate to be allocated evenly or in proportion to actual contributions to premiums. Note that the rebate is to be used to reduce premiums for (or pay refunds to) employees enrolled during the year in which the rebate is actually paid (rather than the MLR reporting year on which the rebate was calculated).
To recap, here are some options to consider:
• Reduce future premiums for current plan participants. This is administratively easy with limited tax issues with respect to participants.
• Cash payments to current participants. This is administratively burdensome and results in tax consequences to participants.
• Cash payments to former participants. This is administratively burdensome and results in tax consequences to former participants.
The employer could also consider, with counsel, whether providing benefit enhancements or payment of reasonable plan expenses would be considered permissible.
What are the Federal Tax Implications to Employees?
Pre-Tax Premium Payments
When employees pay their portion of the premiums for employer-sponsored health coverage on a pre-tax basis under a cafeteria plan, MLR rebates will be subject to federal income tax and wages. Briefly:
• For rebates that are distributed as a reduction in premium (thus reducing an individual’s pre-tax premium payment during the year), there is a corresponding increase to the employee’s taxable salary that is also wages taxable for employment tax purposes.
• Rebates that are distributed as cash will result in an increase in taxable income that is also wages subject to employment taxes.
The result is the same regardless of whether the MLR rebates are provided only to employees participating in the plan both in the year employees paid the premiums being rebated and the year in which the MLR rebates are paid, or to all employees participating in the plan during the year the MLR rebates are paid (even if some employees did not participate in the plan during the year to which the rebate applies.)
After-Tax Premium Payments
When employees pay their portion of the premiums on an after-tax basis, MLR rebates generally are not subject to federal income tax or employment taxes. This applies when the rebate is provided as a reduction in premiums or as a cash. The result is the same regardless of whether the MLR rebates are provided only to employees participating in the plan both in the year employees paid the premiums being rebated and the year in which the MLR rebates are paid, or to all employees participating in the plan during the year the MLR rebates are paid (even if some employees did not participate in the plan during the year to which the rebate applies.)
What are the Tax Implications to Employers?
Employers should review the tax implications of a rebate with tax advisors. Generally, amounts used for benefits (e.g., to pay premiums with respect to insured plans) should not be taxable.
When Employees Pay Premiums on a Pre-Tax Basis, Does Reducing a Participant’s Premiums Mid-Year Allow Them to Make Election Changes?
If employee contributions are paid on a pre-tax basis and there is a mid-year rate change, the cafeteria plan must determine whether such a change is permitted under the Section 125 rules.
If the plan incorporates the permitted election change rules, the relevant issue is whether this change in cost is permitted under the regulations.
• If there is an insignificant decrease, there can be an automatic adjustment.
• If there is a significant decrease, employees may make a corresponding change including commencing participation in the cafeteria plan for the first time for the option with a decrease in cost.
Generally, MLR rebates are expected to be fairly low dollar amounts and may not rise to the level of a significant change. Employers should consider either taking the position that the cost change is insignificant or that the cost change is significant and the “corresponding change” is to simply allow the reduction or increase. The cafeteria plan document should be consistent with the employer’s position.