Large Companies and Medical Stop-Loss

Medical stop-loss coverage protects self-insured groups from catastrophic medical claims. Medical stop-loss has long been used as risk management tool by small- and medium-sized organisations to limit their exposure to medical claims above their desired retention levels. This strategy has been used by single parent programs as well as group captive programs.

The reason this strategy has been more popular in the mid-market is because of two primary reasons. First, businesses have wanted to insulate themselves from catastrophic claims risk, as one large claim could have a material impact on the financial sustainability of the program. Second, the relatively small size of the groups means greater variability from an actuarial perspective. In comparison, large companies have stronger balance sheets allowing them to take on a more aggressive risk management strategy and reduce third party spend with insurers.medical stop-loss captives

As I write this in April of 2020, there are a myriad of unprecedented challenges facing both small and large employers and medical stop-loss can help mitigate some of these concerns. Recently, we have seen a shift in the market where large employers are increasingly becoming interested in reviewing the possibility of leveraging a captive to provide medical stop-loss coverage. I anticipate this trend to continue. Here’s why:

  1. Hardening markets

This past renewal season, we saw that markets are starting to harden, and given the current Covid-19 pandemic and the financial and economic climate, this is bound to continue. A variety of factors have contributed to this including regulatory changes (ACA and healthcare reform) and many recent natural disasters (Hurricane Harvey, California wildfires, etc.). Insurers for a large part of the past decade have benefited from the favorable financial markets world over, thereby reducing their need to increase rates to continue to make their target earnings per share (EPS).

As we stare towards the possibility of a recession and reduced economic output, poor investment income will have an adverse impact on insurance company financials. Further, as markets tighten, access to inexpensive cash is becoming harder. Since most insurance companies are public, the increased pressure to keep their share prices buoyant is going to result in them wanting to beat their expected EPS – which requires higher profit margins. Finally, as reserves balances diminish due to market conditions, principles of conservatism are going to require them to shore up financials, and the easiest way to do this is by increasing premiums.

These factors coupled with the ongoing pandemic, which will likely result in an increase in aggregate claims, led me to believe hardening insurance markets are upon us. This is likely to result in an increase to reinsurance costs for employers who are currently self-insured. A well-structured medical stop-loss solution can help employers navigate these market conditions by providing them greater control over the program and creating an alternate avenue for reinsurance.

Hardening markets make captives more favorable, as they allow for customized coverage otherwise unavailable in the commercial market. Employers currently using captives have been provided an opportunity to leverage the captive program to fund for Covid-19-related expenses. For non-captive employers, this impact is felt directly on their financial statements.

  1. Cashflow volatility due to higher claims costs

Claims costs have been increasing at an aggressive pace. The US has long been criticized for poor population health management, with rising chronic conditions like diabetes that are expensive to treat. In addition, the pricey cost of medication has made extremely high cost claims a reality of healthcare. Claims in excess of $1m are becoming commonplace. For large employers, who are traditionally self-insured, such claims cause volatility from a cashflow perspective, making it harder for finance teams to budget and build expected proformas. Using a medical stop-loss program eliminates this volatility as claims above the self-insured retention level are funded in the captive, creating a level funded premium plan.

  1. Upwards healthcare trend

According to studies by , while medical cost trend has been flat for a couple years, it is expected to increase from 5.7% to 6% in 2020. This rise in healthcare costs is attributable to an increase in the utilization rates. Medical trend increases are outpacing those of inflation, which was 2.07% in 2018 and 1.55% in 2019.

As a result, employers have had to leverage solutions such as high deductible health plans and other forms of cost sharing to bend the healthcare cost curve. The crux of the issue is that now organisations are having to combat both rising medical trends as well as increasing claims costs, while still needing to retain talent and provide competitive benefits.

A well-crafted medical stop-loss solution can help ease the burden for employers and provide them a sustainable way to bend the healthcare cost curve. Development of a formal reserve mechanism is an efficient way for employers to set aside dollars to mitigate large cost increases in the future. While an employer cannot control what happens in the insurance and healthcare markets, they can make the decision to put themselves in a position to be able to navigate the landscape more efficiently. We are seeing an increasing number of CFOs drive conversations around better managing employee benefits spend as it is becoming one of the largest expense items for organisations.

  1. Control

By writing stop-loss into a captive, an employer can leverage captive savings to focus on initiatives most useful for its employee demographic. We have seen employers use the captive savings for wellbeing initiatives as well as cost control programs focused on disease management for conditions like diabetes or musculoskeletal problems. This kind of structure can then be tied with programs dedicated to population health management, wellness and health advocacy for a robust, employee-first package aimed at gradually reducing claims costs.

Using a captive provides employers access to data in a timely manner, allowing them to better analyse and review drivers of claims, in turn providing them an opportunity to implement measures that would focus on addressing those drivers. While this is possible without a captive, we have seen employers are more engaged when using a captive — meaning they are more likely to create a structured approach to claims and cost management leveraging the captive. In my view, this is because of lack of funds for such initiatives and the lack of a structured risk framework in some cases. Using a captive to underwrite medical stop-loss addresses both of these aspects.

Transparency is one of the core benefits of a captive. Once organisations begin to use a captive funding solution for its medical spend, they usually begin to expand their horizons for other cost reduction initiatives. One such initiative has been carving out drugs (Rx). Using a pharmacy benefit management (PBM) solution can generate additional savings ranging between 15% to 30% of Rx spend. These savings are in addition to those that an employer may recognize by restructuring their funding approach. Further, these savings have a multi layered benefit, reducing the overall medical trend and generating additional reserves for the program to offset possible cost increases in the future.

In general, large employers are more accustomed to customization and retaining control, so a captive program for medical stop-loss aligns with their needs and enhances their ability to control their healthcare programs. Better data analytics and understanding of claims also provides employers the ability to be more reactive and make necessary changes quickly, in a much more agile setup. A captive provides monthly and quarterly reports which are usually much more detailed and timelier than those provided by a commercial insurer. Finally, adding additional risk to the captive also helps the risk managers develop a more comprehensive understanding of enterprise risk at large.

Medical stop-loss coverage in a captive continues to be a prudent business strategy for companies of all types and sizes. It creates multi-layered protection. Large employers are beginning to realize the attractiveness of such a program, whose advantages have been especially highlighted lately due to market and global economic shifts and conditions.

Legal Alert: Carrier Premium Credits and ERISA Fiduciary Obligations

Due to COVID-19 and state and local stay-at-home orders, utilization of group medical and dental insurance benefits is down.  As a result, some carriers recently notified employers that they will be issued premium credits. When asking how these premium credits should be treated by the employer, we often compare then to the ACA’s medical loss ratio (MLR) rebates.  While these premium credits are not MLR rebates, a similar decision must be made to determine whether they, like MLR rebates, are ERISA plan assets.COVID-19 law

Background

As background, the Affordable Care Act’s MLR rule requires health insurers to spend a certain percentage of premium dollars on claims or activities that improve health care quality, otherwise they must provide a rebate to employers. At the same time the U.S. Department of Health and Human Services issued the MLR rule, the U.S. Department of Labor (DOL) issued Technical Release 2011-04 (TR 2011-04), which clarifies how rebates should be treated under ERISA.  Under ERISA, anyone who has control over plan assets, such as the plan sponsor, has fiduciary obligations and must act accordingly.

Clearly, the premium credits we are seeing are not subject to the MLR rule; however, a similar analysis applies.   TR 2011-04 clarified that insurers must provide any MLR rebates to the policyholder of an ERISA plan.  However, while the DOL’s analysis was focused on MLR rebates, it recognized that distributions from carriers can take a variety of forms, such as “refunds, dividends, excess surplus distributions, and premium rebates.”  Regardless of the form or how the carrier describes them, to the extent that a carrier credit, rebate, dividend, or distribution is provided to a plan governed by ERISA, then the employer must always consider whether it is a “plan asset” subject to Title I of ERISA.  If it is, then as the party with authority and control over the “plan assets,” the employer is a fiduciary subject to Section 404 of ERISA and bound by the prohibited transactions provisions of Section 406.  In other words, to the extent that a refund is a plan asset, it must be used for the exclusive benefit of plan participants, which may include using it to enhance plan benefits or returning it to employees in the form of a premium reduction or cash refund.

Treatment of Premium Credits to Employers

In situations where an employer uses a trust to hold the insurance policies, the DOL’s position is that the rebates are generally assets of the plan.  However, in situations where the employer is the policyholder, the employer may, under certain circumstances, retain some or all of a rebate, credit, refund, or dividend.  When considering whether a rebate is a plan asset, the terms of the plan should be reviewed.  As discussed below, some employers draft their plan documents in a manner that allows them to retain these types of refunds.  If the terms of the plan are ambiguous, the DOL recommends employers use “ordinary notions of property rights” as a guide.

When determining whether carrier credits, dividends, distributions or rebates are ERISA plan assets, the DOL will look to the terms of the documents governing the plan, including the insurance policy.  If these governing documents are silent on the issue or unclear, then the DOL will take into consideration the source of funding for the insurance premium payments.  In such situations, the amount of a premium credit that is not a plan asset (and that the employer may therefore retain) is generally proportional to the amount that the employer contributed to the cost of insurance coverage.  For example, if an employer and its employees each pay a fixed percentage of the cost, a percentage of the premium credit equal to the percentage of participants’ cost would be attributable to participant contributions.  In the event that there are multiple benefit options, a premium credit attributable to one benefit option cannot be used to benefit enrollees in another benefit option.

The Plan Document

Employers can draft their plans to make it clear that the employer retains all rebates, credits, distributions, etc. if the rebates, credits, distributions, etc. do not exceed the employer’s contribution towards the benefit.  If given this flexibility in the plan, the employer may not have to return a portion of the premium credit to employees or use the credit to provide a premium reduction.  While this gives employers more flexibility, employers should consider that carriers communicate some premium refunds, such as an MLR rebates, to both the policyholder and participants, therefore employees know the employer received money back from the carrier and they may expect something in return.   Therefore, there is the potential for employee relations issues with this approach.

If the plan document does not provide this flexibility to the employer, is silent with regard to the use of such funds, or is unclear about how such funds are allocated, then the employer should treat any premium credits like they are ERISA plan assets (to the extent they’re attributable to employee contributions) and allocate them accordingly.

Allocating the Employees’ Share of a Premium Credit

The portion of the premium credit that is considered a plan asset must be handled according to ERISA’s general standards of fiduciary conduct.  However, as long as the employer adheres to these standards, it has some discretion when allocating the premium credit.

If an ERISA plan is 100 percent employee paid, then the premium credit must be used for the benefit of employees. If the cost of the benefit is shared between the employer and participants, then the premium credit can be shared between the employer and plan participants.

There is some flexibility here.  For example, if the employer finds that the cost of distributing shares of a premium credit to former participants approximates the amount of the proceeds, the employer may decide to distribute the portion of a premium credit attributable to employee contributions to current participants using a “reasonable, fair, and objective” method of allocation.  Similarly, if distributing cash payments to participants is not cost-effective (for example, the payments would be de minimis amounts, or would have tax consequences for participants) the employer may apply the premium credit toward future premium payments or benefit enhancements.  An employer may also vary the premium credit so that employees who paid a larger share of the premium will receive a larger share of the premium credit.

Ultimately, many employers provide the employees’ share of the premium credit in the form of a premium reduction or discount to all employees participating in the plan at the time the premium credit is distributed.  Employers should review all relevant facts and circumstances when determining how such a credit will be distributed.

Regardless, to avoid ERISA’s trust requirement, the portion of a premium credit that is plan assets must be used within three months of receipt by the policyholder.

Conclusion

Employers that would like additional flexibility in how to treat carrier premium credits should work with counsel to update their plan documents. Even for plans with flexibility built into the terms, we encourage consultation with counsel to review the facts and circumstances surrounding any such premium credits to ensure compliance with ERISA.

 

About the Authors.  This alert was prepared for Alera Group by Marathas Barrow Weatherhead Lent LLP, a national law firm with recognized experts on the Affordable Care Act.  Contact Stacy Barrow or Nicole Quinn-Gato at sbarrow@marbarlaw.com or nquinngato@marbarlaw.com.

The information provided in this alert is not, is not intended to be, and shall not be construed to be, either the provision of legal advice or an offer to provide legal services, nor does it necessarily reflect the opinions of the agency, our lawyers or our clients.  This is not legal advice.  No client-lawyer relationship between you and our lawyers is or may be created by your use of this information.  Rather, the content is intended as a general overview of the subject matter covered.  This agency and Marathas Barrow Weatherhead Lent LLP are not obligated to provide updates on the information presented herein.  Those reading this alert are encouraged to seek direct counsel on legal questions.

© 2020 Marathas Barrow Weatherhead Lent LLP.  All Rights Reserved.

Legal Alert: Agencies Extend Deadline to Pay COBRA Premiums and Certain Other ERISA and Internal Revenue Codes Due to COVID-19

This legal alert was updated May 13, 2020.

A cafeteria plan, or Section 125 plan, sometimes referred to as a POP plan, allows employees to pay for certain expenses on a pretax basis. Employees choose between a taxable benefit (cash, typically distributed via payroll) and two or more pre-tax qualified benefits. Just like standing in line at a cafeteria and selecting a salad, a plate of meatloaf, and a carton of milk, employees can “stand in line” and select health insurance, vision insurance, and dental insurance – and more! The IRS limits the benefits that can be offered through a cafeteria plan.COVID-19 law

  • Coverage under an accident or health plan (traditional health insurance, self-insured reimbursement plans, dental, vision, etc.)
  • Health care expense reimbursement plans (FSAs)
  • Dependent care assistance benefits
  • Paid time off
  • Adoption assistance benefits
  • Health savings accounts (HSAs)
  • Group term life
  • 401(k) contributions

 

Employees can make elections and select which of the offered benefits they would like to enroll in. Employees can choose to cover other individuals, including spouses and dependents, if the employer’s plan allows. These elections are prospective, with an exception for birth, adoption and placement for adoption as well as new hires, when the employer’s plan does not impose a waiting period for new employees. The IRS considers pretax elections to generally be irrevocable unless a permitted event occurs or there is an exception. These events sometimes overlap and fall into three general categories, HIPAA special enrollment events, change in status events, and other triggering events.

A plan sponsor is not required to recognize any midyear changes to pretax elections. However, for practical purposes, because HIPAA requires group health plans to provide a special enrollment opportunity to an employee upon the occurrence of specific events (e.g. marriage, birth, adoption, etc.)¹ most plan sponsors at a minimum will design their plan to recognize HIPAA special enrollment events, permitting changes to pretax elections midyear. All of the events however are optional, and a plan sponsor must ensure their plan documents affirmatively indicate which of the events are recognized.

QUALIFYING EVENTS
Gain dependent(s) due to marriage Employee or dependent becomes entitled to Medicare or Medicaid Employee/dependent status change results in gaining eligibility under the plan (e.g., new job; part-time to full-time) Plan makes SIGNIFICANT cost change Plan makes automatics small cost change(s)
Lose spouse (e.g., divorce, legal separation, death of spouse) Employee or dependent becomes entitled to premium assistance subsidy for Medicaid or CHIP Employee/dependent employment change results in losing eligibility under employer plan (e.g., full to part-time; unpaid leave) Plan makes SIGNIFICANT curtailment in coverage Other employer’s plan increases/decreases/ceases coverage
Gain/lose child (e.g., birth adoption or placement for adoption/death) Employee or dependent loses entitlement for Medicare, Medicaid, or CHIP Employee hours of reduced to average less than 30 hours a week Plan eliminates/adds new benefit or coverage option Other employer’s plan offers open enrollment
Dependent loses/gains eligibility (e.g., child reaches age limit/becomes student after age 26) Change in residence triggers gain/loss eligibility (e.g., move in/out of a plan services area Employee becomes eligible to enroll in a QHP in the Marketplace Order requiring plan to add child(ren) to health plan coverage Order requiring another employer’s plan to add child(ren) to health plan coverage

 

The following situations are not cafeteria plan qualifying events:

  • Change in employee’s finances
  • Change in employee’s medical condition (worsens/heals)
  • Provider leaves network, unless it results in a significant reduction of coverage (e.g., the only gastroenterologist in the network leaves)
  • Legal separation, unless it causes the spouse to lose eligibility under the terms of the plan. (Many plans eligibility isn’t lost until divorce is final.)
  • Commencement of domestic partner relationship
  • Dependent or spouse leaves/returns from prison/jail, unless it causes the individual to lose HMO eligibility due to change in residence

On May 12, 2020, the IRS issued Notice 2020-29 which, among other things, allow employees to amend their cafeteria plans to permit employees to make mid-year changes for the following purposes:

  • For employer-sponsored health coverage:
    • Make a new, prospective election if the employee had previously declined coverage;
    • Revoke an existing election and make a new, prospective election to enroll in different health coverage sponsored by the employer; or
    • Prospectively revoke coverage if the employee attests in writing that they are enrolled in, or immediately enroll in, other health coverage not sponsored by the employer. The Notice provides a sample attestation employers can use and may rely on the written attestation unless the employer has actual knowledge the employee is not, or will not be, enrolled in other comprehensive health coverage.
  • For FSA coverage:
    • Prospectively revoke an election, make a new election, or decrease or increase an election to a health FSA (including a limited purpose health FSA) or DCAP.

Notice 2020-29 provides that employers may amend their plans to allow each eligible employee to make prospective election changes or an initial election regardless of whether the election change satisfies one of the permitted election changes under applicable Treasury regulations. The Notice is very clear that this is not a free-for-all. The employer has the discretion to impose parameters for these election changes, including the extent to which the election changes are permitted and applied, and they can limit the period during which election changes may be made.

The relief may be applied retroactively to January 1, 2020; however, as set forth above, all election changes must be prospective. The retroactive application of the relief is to cover any employer who may have allowed an election change that may not have been consistent with Section 125 (but would be consistent with one of the permitted election changes discussed above).

Finally, employers must ensure the election changes do not result in failure to comply with the nondiscrimination rules. The Notice provides strategies an employer may use to ensure there is no adverse selection of health coverage, such as limiting elections to circumstances in which an employee’s coverage will be increased or improved as a result of the election change (ex. switching from self-only to family coverage).

For more COVID-19 legal alerts, please visit our resource center at aleragroup.com/coronavirus/#legalalerts.

If you have any questions related to this alert, please reach out to your Alera Group advisor or email us at info@aleragroup.com to be connected with your local firm.

 

¹Special Enrollment rights are not required for “HIPAA-excepted benefits” which generally include stand-alone dental, vision and most health care FSAs.

 

The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such. Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice. This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc. Reviewed as of 05/13/2020.

Legal Alert: COVID-19 and Cafeteria Plan Considerations

This alert was updated on 04/29/20. 

A cafeteria plan, or Section 125 plan, sometimes referred to as a POP plan, allows employees to pay for certain expenses on a pretax basis. Employees choose between a taxable benefit (cash, typically distributed via payroll) and two or more pre-tax qualified benefits. Just like standing in line at a cafeteria and selecting a salad, a plate of meatloaf, and a carton of milk, employees can “stand in line” and select health insurance, vision insurance, and dental insurance – and more! The IRS limits the benefits that can be offered through a cafeteria plan.

  • Coverage under an accident or health plan (tCOVID-19 lawraditional health insurance, self-insured reimbursement plans, dental, vision, etc.)
  • Health care expense reimbursement plans (FSAs)
  • Dependent care assistance benefits
  • Paid time off
  • Adoption assistance benefits
  • Health savings accounts (HSAs)
  • Group term life
  • 401(k) contributions

Employees can make elections and select which of the offered benefits they would like to enroll in. Employees can choose to cover other individuals, including spouses and dependents, if the employer’s plan allows. These elections are prospective, with an exception for new hires. The IRS considers pre-tax elections to be irrevocable unless a permitted event occurs. These events sometimes overlap and fall into 3 general categories, HIPAA Special Enrollment Events, Change in Status Events, and Other Triggering Events.

The only events that a plan sponsor must recognize are HIPAA special enrollment events, as long as the plan is subject to HIPAA. Almost all plans are subject to HIPAA. All of the other events are optional, and a plan sponsor must ensure their plan documents affirmatively indicate which of the vents are recognized.

QUALIFYING EVENTS

Gain dependent(s) due to marriage Employee or dependent becomes entitled to Medicare or Medicaid Employee/dependent status change results in gaining eligibility under the plan (e.g., new job; part-time to full-time) Plan makes SIGNIFICANT cost change Plan makes automatics small cost change(s)
Lose spouse (e.g., divorce, legal separation, death of spouse) Employee or dependent becomes entitled to premium assistance subsidy for Medicaid or CHIP Employee/dependent employment change results in losing eligibility under employer plan (e.g., full to part-time; unpaid leave) Plan makes SIGNIFICANT curtailment in coverage Other employer’s plan increases/decreases/ceases coverage
Gain/lose child (e.g., birth adoption or placement for adoption/death) Employee or dependent loses entitlement for Medicare, Medicaid, or CHIP Employee hours of reduced to average less than 30 hours a week Plan eliminates/adds new benefit or coverage option Other employer’s plan offers open enrollment
Dependent loses/gains eligibility (e.g., child reaches age limit/becomes student after age 26) Change in residence triggers gain/loss eligibility (e.g., move in/out of a plan services area Employee becomes eligible to enroll in a QHP in the Marketplace Order requiring plan to add child(ren) to health plan coverage Order requiring another employer’s plan to add child(ren) to health plan coverage

The following situations are not cafeteria plan qualifying events:

  • Change in employee’s finances
  • Change in employee’s medical condition (worsens/heals)
  • Health insurance carrier permitting special open enrollment (for example, during COVID-19 pandemic)
  • Provider leaves network, unless it results in a significant reduction of coverage (e.g., only gastroenterologist in the network leaves)
  • Legal separation, unless it causes the spouse to lose eligibility
  • Commencement of domestic partner relationship
  • Dependent or spouse leaves/returns from prison/jail, unless it causes the individual to lose HMO eligibility due to change in residence

The IRS may be less likely to penalize plan sponsors that allow a special open enrollment given the unprecedented circumstances; however, employers need to be aware that there is still risk and provide it on a uniform and reasonable basis. As there is potential risk, an employer should strongly consider having contributions be post-tax as it can help reduce risk of allowing employees enroll in a plan without having a

qualifying event. If employers choose to allow a special open enrollment due to COVID-19 concerns, they may want to update their plan documents to reflect this period.

Employers who are considering allowing employees to come onto the plan due to a non-qualifying event (such as carrier’s open enrollment) should consider the following:
  • It is recommended the enrollment be done on a post-tax basis
  • If the plan’s ERISA plan documents identify the situations in which an employee is eligible to enroll in the plan, and it mirrors cafeteria plan language, the plan document should be amended to ensure the administrator is enrolling people in accordance with its governing documentation
  • The cafeteria plan document should be reviewed to ensure it indicates the special circumstanced relating to the pandemic time period

Dependent care accounts (DCAPs) and flexible spending arrangements (FSAs) also create unique issues due to the cafeteria plan regulations.

DEPENDENT CARE ASSISTANCE PROGRAMS

DCAPs, sometimes referred to as “dependent flex spending accounts” are an employer-sponsored plan to provide the exclusive benefit of dependent care assistance. Under the Internal Revenue Code (IRC) employees can exclude up to $5,000 annually from the gross income for dependent care. DCAPs are subject to flexible spending arrangement rules under the IRC. These arrangements can cause issues when employees are no longer working and not in need of childcare, or alternatively, an employee’s childcare program/center/provider has closed due to the pandemic.

GENERAL PRINCIPLES

Because of their tax favored status, DCAPs are subject to many regulations. Any common law employee can participate in a DCAP. In order to have dependent care expenses reimbursed by the program the following general requirements must be met:

  • The expense must enable the employee (and their spouse) to be gainfully employed
  • The expense must be for a qualifying individual (a child under the age of 13)
  • The expense must be for care, not education (daycare is acceptable, private school tuition is not)
  • The expense must be incurred in the coverage period (the plan year)
  • The expense must be substantiated

EXCLUSION FROM INCOME

An employee’s exclusion from income for payments under a DCAP in a calendar year is limited to the smallest of the following amounts:

  • $5,000 if the employee is married and filing a joint return or if the employee is a single parent ($2,500 if the employee is married but filing separately);
  • the employee’s “earned income” for the year; or
  • if the employee is married at the end of the taxable year, the spouse’s earned income

The spouse of a married employee is deemed to be gainfully employed and to have an earned income of not less than $250 per month if there is one qualifying individual, or $500 per month if there are two or more qualifying individuals in each month during which they are a full-time student, or is incapable of self-care and has the same principal place of abode as the employee for more than half the year.

LEAVE OF ABSENCE

If an employee takes a leave of absence they may no longer be considered “gainfully employed” and eligible for dependent care reimbursements during their leave. In general, this is determined on a daily basis, however, there is an exception to the “daily basis” rule for certain short, temporary absences (e.g. Emergency Paid Sick Leave) and part-time employment.

This exception is based on the IRS regulations establishing a “safe harbor” under which an absence of up to two consecutive calendar weeks is treated as a short, temporary absence. However, whether an absence for longer than 2 weeks qualifies as short and temporary is determined on the basis of facts and circumstances.

Likewise, when it comes to FMLA, the IRS does not agree that one’s entire absence under FMLA (which guarantees eligible employees up to 12 weeks of unpaid leave for certain purposes) is appropriate as a temporary absence safe harbor, noting that an absence of 12 weeks “is not a short, temporary absence” within the meaning of the regulations.

REIMBURSEMENTS

Reimbursements are subject to the same rules as flexible spending arrangements (FSAs). The period of coverage must be 12 months unless there is a short plan year. DCAPs that are underspent lead to forfeited money, unused contributions cannot carry over from year to year. DCAPs are not subject to COBRA and the participant has no right to coverage after their plan participation terminates. Employers can provide for a spend- down provision in their plan documents to allow former employees to receive reimbursement through the end of the plan year in which they terminated employment and coverage. If the plan document does not provide for this spend down, the funds are forfeited.

REIMBURSEMENTS DURING LEAVE OF ABSENCE

Although the employee may not be eligible to reimburse dependent care expenses while on leave, an employee on LOA may be able to continue to participate in (and make contributions to) a DCAP but any reimbursements from the DCAP will still be subject to the gainfully employed rule and would have to fall within the exception for short, temporary absences.

CHANGES TO ELECTIONS

Under the cafeteria plan regulations, elections are irrevocable unless a permitted event occurs. For DCAPs this is:

  • A change in status
  • A change in cost and coverage
  • FMLA (employees taking FMLA leave can revoke elections of non-health benefits and reinstate their benefits upon return from leave)

REMINDER: Although IRS rules govern dependent care assistance programs (DCAPs) also known as dependent care FSAs, including the requirement that elections are irrevocable except in the case of a “change event”, an employer is not required to recognize all the IRS permitted election changes when designing their FSA plan. Therefore, if an employee requests to change their dependent care FSA election, employers need to be mindful of:

  • FSA plan document language – must explicitly permit changes to elections due to a change in cost. If it does not, an employer may want to consider prospectively amending their plan to include this change event.
  • Following their plan’s rules to avoid plan disqualification
  • Refunds for dependent care FSA contributions already taken from an employee’s paycheck are not permissible.
Dependent Care Change in Status, or Cost & Coverage Events DCAP Election Change
A new childcare provider is available at a different cost than current provider. Includes someone (e.g. parent, older sibling) agreeing/able to watch the child for free. Employee may increase or decrease election amount consistent with change in qualified dependent care expenses.

Employee may cancel the election if child is now being cared for at no cost.

Enrolling child at a childcare provider closer to home or new work location. Employee may increase or decrease election amount consistent with change in cost.
An employee or their spouse has a new work schedule (including to or from part-time status), and a different number of hours of childcare are required. Employee may increase or decrease election amount consistent with change in cost.
A child who wasn’t previously enrolled in childcare now needs a childcare provider due to schools being closed. Employee may enroll in dependent care FSA. Or increase their election if they are enrolling an additional child not previously enrolled in childcare.
Child’s daycare closed Employee may decrease or cancel their election.

It is likely that many of the reasons an employee no longer needs childcare as the result of the COVID-19 pandemic would allow them to change their DCAP contributions, potentially reducing them to zero dollars, particularly if their child has been pulled from care (change in cost and coverage), or they are taking FMLA leave (including the newly created emergency FMLA leave under the new Families First Coronavirus Response Act).

Therefore, employers should be lenient and allow employees to change their DCAP contributions within the above scenarios. Employers with employees who are laid off (not expected to return to work) should consult with counsel to see if their plan documents allow for a spend down, or if that change can be made mid-plan year.

HEALTHCARE FLEXIBLE SPENDING ACCOUNT PROGRAMS (HCFSAS)

Similar to DCAPs, health FSA elections generally are irrevocable and the IRS only permits mid-year changes when an IRS approved qualifying status change has occurred. Any change in employment status of the employee, spouse or dependent that affects eligibility for the health FSA is a qualified status change and the change in the election must be on account of the qualified status change.

REMINDER: A health care FSA may (but is not required) to permit an employee to change their health FSA election for IRS permitted qualifying change in status events. Employers should refer to their FSA plan documents to determine which events their plan recognizes

 

Change in Status Events

 

Health FSA Election Change

Spouse (or dependent) loses health insurance coverage Employee may increase election amount
Employee changes from FT to PT Employee may revoke election if the change affects eligibility for the health FSA (Note: Employee may lose coverage automatically when hours change to PT.) COBRA paperwork may need to be provided if the account is underspent. (The health FSA balance

is equal to or more than the amount of FSA premiums charged for the remainder of the plan year.)

Employee is on layoff or furlough If the employee stops getting paid, the FSA technically ends. COBRA should be offered to continue the FSA. The employer may keep the FSA active by providing contributions for the employee, having the employee send payments into the employer, or catching up the contributions upon return.
Employee is on an unpaid, unprotected leave of absence (e.g. not FMLA) If eligibility is lost, employee may revoke election. COBRA paperwork may need to be provided if the account is underspent.
Employee is on FMLA or Emergency FMLA Extension under FFCRA Employee may revoke election for the period of coverage provided for under FMLA or EFMLEA (or the employer may allow the employee to continue coverage but discontinue contributions during the leave period.)
Termination of employment – employee Employee’s coverage ends. COBRA paperwork may need to be provided if the account is underspent.
Termination of employment for spouse, dependent who had health insurance or health FSA. Employee may enroll or increase election
Termination and Rehire Within 30 Days Employee’s elections in effect at termination are reinstated unless another event has occurred that allows a change.
Termination and Rehire After 30 Days Depending on the FSA plan design, the employee may reinstate elections in effect at termination or make a new election under the plan. It is possible, though for the FSA plan to prohibit an employee from re-enrolling in the plan during that plan year.

Section 125 Operational Failure Exposure

According to the regulations, a plan that fails to operate in accordance with its terms or otherwise fails to comply with the Code or regulations “is not a cafeteria plan,” and employees’ elections between taxable and nontaxable benefits result in gross income to employees.

Furthermore, the IRS could choose to treat the plan as if it did not exist. This would disqualify the plan and result in employer employment tax withholding liability and penalties for all employee pre-tax and elective employer contributions. Employees could also be required to pay employment and income taxes and penalties on their pre-tax and elective employer contributions.

Errors in violation of ERISA, COBRA, and HIPAA could also expose a sponsor to damages from private lawsuits as well as penalties.

• Cafeteria plan disqualification – the plan would no longer exist and neither the employer nor employee can enjoy tax-preferred status on their benefits
• Requiring the cafeteria plan to comply with Section 125 and its regulations, including reversing transactions that caused noncompliance. This could have tax filing implications to the employer and the employee(s)
• Imposing employment tax withholding liability and penalties on the employer regarding pre-tax salary reductions and elective employer contributions. This could have tax filing implications to the employer.
• Imposing employment and income tax liability and penalties on employees regarding pre-tax salary reductions and elective employer contributions. This could have tax filing implications to the employee.

The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such. Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice. This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc. Reviewed as of 4/29/2020.

Legal Alert: COVID-19 and DCAPs, FSAs, and Transit Benefit Concerns

This alert was updated on 5/13/2020.COVID-19 law

In the wake of the COVID-19 pandemic, many employers are dealing with how to handle employees requesting to make changes to their Section 125 or Cafeteria Plan elections. For instance, an employee’s Dependent Care Assistance Program (DCAP) election when they are no longer working and not in need of childcare, or alternatively, an employee’s childcare program/center/provider has closed due to the pandemic.

On May 12, 2020, the IRS issued Notice 2020-29, which, among other things, allows employers to amend their plan documents to permit employees to make mid-year changes prospectively for health flexible spending arrangements (health FSAs) and DCAPs.

This article looks at options for DCAPs, FSAs and transit benefit concerns. Charts showing common situations are included.

Dependent Care Assistance Programs

DCAPs, sometimes referred to as “dependent flex spending accounts,” are an employer-sponsored plan to provide the exclusive benefit of dependent care assistance. Under the Internal Revenue Code (IRC) employees can exclude up to $5,000 annually from the gross income for dependent care. DCAPs are subject to flexible spending arrangement rules under the IRC.

General Principles

Because of their tax favored status, DCAPs are subject to many regulations. Any common law employee can participate in a DCAP. To have dependent care expenses reimbursed by the program the following general requirements must be met:

  • The expense must enable the employee (and their spouse) to be gainfully employed
  • The expense must be for a qualifying individual (a child under the age of 13)
  • The expense must be for care, not education (daycare is acceptable, private school tuition is not)
  • The expense must be incurred in the coverage period (the plan year)
  • The expense must be substantiated

Exclusion from Income

An employee’s exclusion from income for payments under a DCAP in a calendar year is limited to the smallest of the following amounts:

  • $5,000 if the employee is married and filing a joint return or if the employee is a single parent ($2,500 if the employee is married but filing separately);
  • The employee’s “earned income” for the year; or
  • If the employee is married at the end of the taxable year, the spouse’s earned income

The spouse of a married employee is deemed to be gainfully employed and to have an earned income of not less than $250 per month if there is one qualifying individual, or $500 per month if there are two or more qualifying individuals in each month during which they are a full-time student, or is incapable of self-care and has the same principal place of abode as the employee for more than half the year.

Leave of Absence

If an employee takes a leave of absence they may no longer be considered “gainfully employed” and eligible for dependent care reimbursements during their leave. In general, this is determined daily, however, there is an exception to the “daily basis” rule for certain short, temporary absences (e.g. Emergency Paid Sick Leave) and part-time employment.

This exception is based on the IRS regulations establishing a “safe harbor” under which an absence of up to two consecutive calendar weeks is treated as a short, temporary absence. However, whether an absence for longer than two weeks qualifies as short and temporary is determined on the basis of facts and circumstances.

Likewise, when it comes to FMLA, the IRS does not agree that one’s entire absence under FMLA (which guarantees eligible employees up to 12 weeks of unpaid leave for certain purposes) is appropriate as a temporary absence safe harbor, noting that an absence of 12 weeks “is not a short, temporary absence” within the meaning of the regulations.

Reimbursements

Reimbursements are subject to the same rules as flexible spending arrangements (FSAs). The period of coverage must be 12 months unless there is a short plan year. DCAPs that are underspent lead to forfeited money, unused contributions cannot carry over from year to year. DCAPs are not subject to COBRA and the participant has no right to coverage after their plan participation terminates. Employers can provide for a spend-down provision in their plan documents to allow former employees to receive reimbursement through the end of the plan year in which they terminated employment and coverage. If the plan document does not provide for this spend down, the funds are forfeited.

Reimbursements During Leave of Absence

Although the employee may not be eligible to reimburse dependent care expenses while on leave, an employee on LOA may be able to continue to participate in (and make contributions to) a DCAP but any reimbursements from the DCAP will still be subject to the gainfully employed rule and would have to fall within the exception for short, temporary absences.

Changes to Elections

Under the cafeteria plan regulations, elections are irrevocable unless a permitted event occurs or there is an exception. For DCAPs this is:

  • A change in status
  • A change in cost and coverage
  • FMLA (employees taking FMLA leave can revoke elections of non-health benefits and reinstate their benefits upon return from leave)

Notice 2020-29 addresses an exception and allows cafeteria plans to be amended to permit employees to make mid-year election changes to prospectively revoke an election, make a new election, or decrease or increase an election to a health FSA (including a limited purpose health FSA) or DCAP.

IRS rules govern dependent care assistance programs (DCAPs) also known as dependent care FSAs, including the requirement that elections are generally irrevocable except in the case of a “change event”. However, an employer is not required to recognize all the IRS permitted election changes when designing their FSA plan. Therefore, if an employee requests to change their dependent care FSA election, employers need to be mindful of:
  • FSA plan document language – must explicitly permit changes to elections due to a change in cost. If it does not, an employer may want to consider prospectively amending their plan to include this change event.
  • Following their plan’s rules to avoid plan disqualification
  • Refunds for dependent care FSA contributions already taken from an employee’s paycheck are not permissible.
Dependent Care Event Election Change
A new childcare provider is available at a different cost than the current provider. Includes someone (e.g. parent, older sibling) agreeing/able to watch the child for free. Employee may increase or decrease election amount consistent with change in qualified dependent care expenses. Employee may cancel the election if child is now being cared for at no cost.
Enrolling child at a childcare provider closer to home or new work location. Employee may increase or decrease election amount consistent with change in cost.
An employee or their spouse has a new work schedule (including to or from part-time status), and a different number of hours of childcare are required. Employee may increase or decrease election amount consistent with change in cost.
A child who was not previously enrolled in childcare, now needs a childcare provider due to schools being closed. Employee may enroll in dependent care FSA. Or increase their election if they are enrolling an additional child not previously enrolled in childcare.
A child’s daycare closed. Employee may decrease or cancel their election.

 

It is likely that many of the reasons an employee no longer needs childcare as the result of the COVID-19 pandemic would allow them to change their DCAP contributions, potentially reducing them to zero dollars, particularly if their child has been pulled from care (change in cost and coverage), or they are taking FMLA leave (including the newly created FMLA leave under the new FFCRA).

Therefore, employers should be lenient and allow employees to change their DCAP contributions within the above scenarios. Employers with employees who are laid off (not expected to return to work) should consult with counsel to see if their plan documents allow for a spend down, or if that change can be made mid-plan year.

In addition, under the new guidance, an employer is also permitted to amend their plans retroactively to January 1, 2020 to permit an employee to revoke their DCAP election prospectively which in turn would give more latitude for permissible reasons for an employee to change their DCAP contributions mid-plan year.

Healthcare Flexible Spending Account Programs (HCFSAs)

REMINDER: A health care FSA may (but is not required to) permit an employee to change their health FSA election for IRS permitted qualifying change in status events.  Employers should refer to their FSA plan documents to determine which events their plan recognizes. Employers wishing to allow the new temporary exception due to the pandemic must amend their plans by 12/31/2021 but the change can be retroactive to 1/1/2020.

Similar to DCAPs, health FSA elections generally are irrevocable and the IRS only permits mid-year changes when an IRS approved qualifying status change has occurred. However, due to the pandemic, the IRS is now permitting employers to amend their plans to temporarily allow each eligible employee to make prospective election changes or an initial election for the 2020 calendar year, regardless of whether the election change satisfies one of the permitted election changes under applicable Treasury regulations. Any change in employment status of the employee, spouse or dependent that affects eligibility for the health FSA is a qualified status change and the change in the election must be on account of the qualified status change.

Commuter Benefit Programs

During this COVID-19 pandemic, employees may be staying at home with a child, working remotely or not working at all. The qualified transit or qualified parking elections previously made may no longer be needed now or perhaps for the foreseeable future.

If the employee is no longer in need of mass transit or parking costs, the employee may make a change to their elections, even down to $0. The materials provided at hire or during open enrollment should be reviewed to determine the frequency and timing of when employees may make changes to their election.  The employer can set the timing, for instance a change can be made at the next payroll period or perhaps the first of the month.

If no election change is made, the elections will automatically continue, and funds will continue to rollover monthly. If an election change is made, the funds available prior to the election change will continue to rollover to the next month and elections will be reduced.

Employers are encouraged to advise employees of their commuter benefit program options and a reminder of how to make the election change by paper, online through payroll, their benefits administration platform or another source.

Current monthly contributions levels are released annually by the IRS and can be found here.

 

For the latest updates from the Alera Group team regarding coronavirus (COVID-19), please visit our live dashboard at aleragroup.com/coronavirus

This document was authored by the Alera Group Compliance team. Alera Group based in Deerfield, IL serves thousands of clients nationally in employee benefits, property and casualty, risk management and wealth management. Alera Group is the 15th largest independent insurance agency in the country.

The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such.  Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice.  This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc.

Legal Alert: Tax Credits Under FFCRA: Qualified Leave Wages & Health Plan Expenses

This content was last reviewed on April 14, 2020.

Employers who are uncertain about how to calculate their qualified health plan expenses and qualified leave wages should consult with their legal counsel or financial adviser.COVID-19 law

The Families First Coronavirus Response Act (“FFCRA”) created two new refundable tax credits intended to reimburse employers for costs associated with their financial obligations to provide leave benefits created by the Act plus the cost of continuing health insurance for employees on FFCRA leave.

Employers with fewer than 500 employees (“eligible employers”) are entitled to receive a credit in the full amount of the qualified sick leave wages and qualified family leave wages, plus allocable qualified health plan expenses and the employer’s share of Medicare tax, paid for leave during the period beginning April 1, 2020, and ending December 31, 2020.

Determining what is meant by “costs associated” and to understand what is included in the tax credits, the DOL’s guidance references the Internal Revenue Code.

  • Qualified health plan expenses are amounts paid or incurred by an Eligible Employer to provide and maintain a group health plan (as defined in section 5000(b)(1) of the Internal Revenue Code) that are allocable to the employee’s qualified leave wages.
  • Qualified leave wages are wages as defined in section 3121(a) of the Internal Revenue Code for social security and Medicare tax purposes.

In general, the term “group health plan” as defined in Section 5000(b)(1) includes all plans that are subject to continuation coverage under COBRA, such as medical, dental, vision, health FSA and HRA.

  • (1) Group health plan the term ‘‘group health plan’’ means a plan (including a self-insured plan) of, or contributed to by, an employer (including a self-employed person) or employee organization to provide health care (directly or otherwise) to the employees, former employees, the employer, others associated or formerly associated with the employer in a business relationship, or their families

However, the provisions related to determining which contributions by an employer to these health plans are allowed to be included for purposes of claiming payroll tax credits and the extent these amounts are excluded from the gross income of employees under Section 106(a) of the Code is not black and white.

  • 26 CFR 1.106-1: Contributions by employer to accident and health plans indicates:
    (a) The gross income of an employee does not include the contributions that the employer makes to an accident or health plan for compensation (through insurance or otherwise) to the employee for personal injuries or sickness incurred by the employee, the employee’s spouse, the employee’s dependents (as defined in section 152 determined without regard to section 152(b)(1), (b)(2), or (d)(1)(B)), or any child (as defined in section 152(f)(1)) of the employee who as of the end of the taxable year has not attained age 27. The employer may contribute to an accident or health plan either by paying the premium (or a portion of the premium) on a policy of accident or health insurance covering one or more of his employees, or by contributing to a separate trust or fund (including a fund referred to in section 105(e)) which provides accident or health benefits directly or through insurance to one or more of his employees. However, if such insurance policy, trust, or fund provides other benefits in addition to accident or health benefits, section 106 applies only to the portion of the employer’s contribution which is allocable to accident or health benefits. See paragraph (d) of § 1.104-1 and §§ 1.105-1 through 1.105-5, inclusive, for regulations relating to exclusion from an employee’s gross income of amounts received through accident or health insurance and through accident or health plans. For the treatment of the payment of premiums for accident or health insurance from a qualified trust under section 401(a), see §§ 1.72-15 and 1.402(a)-1(e).

These are complicated issues and determining the deductible costs is not easy. Therefore, we recommend employers who are uncertain should reach out to their legal counsel or qualified accountant for guidance.

For more legal alerts and resources, please visit our live COVID-19 dashboard

 

The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such. Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice. This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc.