Beginning in 2011, the medical loss ratio (MLR) requirements of the Affordable Care Act require health insurers to spend at least 85% of premiums for large group policies on medical expenses and activities to improve health care quality. If an insurer does not meet this requirement, it must rebate to the employer a portion of the collected premiums. The employer, in turn, is responsible for determining whether and how to pass along the rebate to plan participants. By August 1, 2012, insurers in the large group market were expected to return $386 million in rebates to employers.
Employers must consider both the implications under ERISA and the Internal Revenue Code in determining how to use the rebates. Although employers are responsible for determining how to use the rebate, insurers are responsible for notifying employees (and their dependents) who participate in the plan that the employer has received the rebate. Accordingly, employers should expect questions from both current and former employees regarding their use of the rebate.
Can an Employer Keep Any of the Rebate?
An employer can keep any portion of the rebate that is not “plan assets” under ERISA. To determine the portion of the rebate that is plan assets, the employer must review the insurance contract or any plan provisions governing the use of amounts received from the insurer. If these documents are silent, the Department of Labor has issued guidance in the form of DOL Technical Release 2011-04 that provides some insights into how the rebate can be allocated between the employer and participants. Generally, the employer can keep the rebate if the employer paid the entire premium (i.e., if no portion of the premium was paid by participants or out of trust assets). If the employer did not pay any of the premium, the entire amount is a plan asset and must be used for the benefit of plan participants. If the employer paid some of the premium, the employer might be able to keep a portion of the rebate depending on the formula that the employer used to determine its share of the premium.
How Should the Rebate Be Used for the Benefit of Participants?
- If all or a portion of the rebate will be given to participants, it must be used only to benefit participants in the plan to which the rebate relates.
- The rebate should be used in accordance with the terms of the plan. If the plan is silent, generally the rebate:
- can be allocated to participants under any method that is reasonable, fair and objective, given the circumstances, which might include providing refund checks to participants, using the rebate to reduce future premiums, or using the rebate in some other way that would benefit plan participants (such as a wellness program); and
- can be used for current participants if the employer can show that the cost of identifying participants in the plan during 2011 and returning the rebate to them would use up too much of the rebate to make this effort worthwhile.
Ultimately, the decision regarding how to use the rebates for the benefit of participants is a fiduciary decision that must be made by the plan’s fiduciaries after considering all of the relevant circumstances.
What is the Deadline for Using the Rebate?
Any portion of the rebate that is “plan assets” must be used for the benefit of plan participants within three months after it is received or it must be held in trust.
The tax treatment of any refund of the rebate to employees depends on whether the employees pay for coverage on a pre-tax or after-tax basis. Internal Revenue Service (IRS) guidance on the tax treatment of the rebates is available in the form of Frequently Asked Questions.
Employees Who Pay for Coverage on a Pre-Tax Basis
Any refund of the rebate to employees who pay for coverage on a pre-tax basis (such as through a cafeteria plan), is subject to federal income and employment taxes. For this reason, it may be administratively less burdensome for an employer to provide the rebate in the form of a premium reduction (rather than cash). A premium reduction will cause the employee to use less pre-tax dollars to pay for coverage and, therefore, automatically receive a corresponding increase in taxable wages. If the rebate is returned in cash, the employer must remember to report the rebate as taxable wages for 2012.
Employees Who Pay for Coverage on an After-Tax Basis
Any refund of the rebate to employees who paid for the coverage on an after-tax basis will not be subject to federal income or employment taxes. However, if the employee previously deducted the premium on his or her tax return, the rebate is subject to federal income tax to the extent the employee received a tax benefit from the deduction.