Legal Issues Regarding Section 125 Plans Patricia A. Butler, JD, DrPH SCI/NASHP/NGA Cafeteria Plan Meeting, Denver, July18, 2008

Presentation Outline Section 125 Plan requirements Application of other federal laws: –HIPAA –COBRA –ERISA State health policy implications

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

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

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 doesn’t disqualify plan but subjects them to the foregone taxes –Employers need to assess plan at end of tax year

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

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

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) –Continuation authority is irrelevant to individually purchased health insurance, but would permit employees to pay premium for the individual coverage under cafeteria plan of a new employer during insurance eligibility waiting period Employers required to inform employees of COBRA rights

Application of other federal law: HIPAA 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

Application of other federal law: HIPAA 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

Application of other federal law: ERISA 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 don’t contribute

Application of other federal law: ERISA 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

Application of other federal law: ERISA 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

Application of other federal law: ERISA 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) –“Endorsement” issue not relevant to voluntary state programs

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

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

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