Back in 2010, the ACA enacted a new rule prohibiting insured group health plans from “discriminating” (on the basis of eligibility or provision of benefits) in favor of highly compensated individuals (called “HCIs”). This rule generally became effective January 1, 2011 for calendar year plans; however, there is and has been an enforcement delay pending issuance of IRS regulations. We’ve heard through the grapevine that this is a “high priority” item for the Service, but to date we’ve seen nothing.
Once guidance is issued, we expect a flurry of changes in group health insurance plans and separation practices. The days of “one-off” arrangements for the benefit of separating executives (i.e., terminated exec can stay on active plan and/or receive contributions like an active employee) are likely going to be a thing of the past.
Unless a plan has and continues to have “grandfathered status” (as defined under the statute and governing regulations) and is, therefore, exempt from this requirement, the employer maintaining the plan will need to react to the issuance of these regulations, and get its plan and practices in conformance with the law. Query whether and how employers will revisit existing arrangements that turn out to be problematic under the forthcoming regulations.
Our recommendation is to be proactive now – this means adopting policies and practices that comply with the basic guidance we have to better position the organization to comply with the expected rules.
What does this look like ?
Well, pre-ACA, self-insured group health plans were already prohibited from discriminating in favor of HCIs – as far as eligibility to participate or benefits provided under the plan. For this purpose, HCIs include: (i) the top five highest-paid officers; (ii) any shareholder who owns more than 10% of the value of stock of the Company’s stock; and (iii) the highest-paid 25% of all Company employees (other than excludable employees who are not participants).
Enforcement of this law was historically lax and many employers adopted questionable practices that arguably violated the terms of the regulations. Nevertheless, these nondiscrimination regulations for self-insured plans provide a baseline of what we expect to see. While we expect (and sincerely hope) that the new rules have more clarity, flexibility and workability, we know that there is likely to be a prohibition in discriminating in favor of HCIs as far as eligibility to participate in the plan and in receipt of benefits/contributions under the plan.
Under the existing guidance, there is no blanket prohibition on providing coverage to any particular HCI (e.g., a terminated executive); however, the plan must meet one of three eligibility tests (which largely mirror the coverage test applicable for retirement plans under Internal Revenue Code (“Code”) Section 410(b)).
According to the IRS regulations, benefits received by a retired employee who was a HCI are discriminatory benefits unless the type, and the dollar limitations, of benefits provided retired employees who were HCIs are the same as for all other retired participants.
It is unclear how exactly the term “retiree” is defined (including whether it applies to any former employee or only those who meet specified retirement criteria) and how this special retiree rule applies, including whether the retiree rule implicates the eligibility test, benefits test, or both; whether former employees are tested separately from active employees; and, whether all former employees must be considered for testing purposes.
In response to practitioner questions, the IRS has informally indicated that an extension of eligibility to former employees who are HCIs would raise an eligibility discrimination issue, and all former employees should be considered in the test. See ABA Joint Committee on Employee Benefits, Meeting with IRS and Department of Treasury Officials (May 9, 2003), Q/A-6, available at http://www.abanet.org/jceb/2003/qa03irs.pdf (as visited December 15, 2014). Specifically, the informal guidance provided as follows:
It is not unusual for former employees to be allowed to continue to participate in their employer’s health plan for a limited period of time as if they were still active employees. Often this is done as part of a RIF or a termination agreement with a particular employee. If the plan is self-insured and some of the former employees were highly compensated individuals (“HCIs”), does this raise an eligibility discrimination issue, a benefits discrimination issue, both or neither under [Code] § 105(h)?
Proposed response: It raises an eligibility discrimination issue, not a benefits discrimination issue. Thus, § 105(h) does not prohibit such an extension of coverage as long as it does not cause the plan to violate § 105(h)(2)(A) (requirement that plan not discriminate in favor of HCIs as to eligibility to participate).
IRS response: The IRS agrees with the proposed answer, but notes that providing a benefit to former employees will require that all former employees must be considered in testing for eligibility.
If the IRS does not change its position when it issues new guidance, then we believe that all former employees will need to be aggregated and tested in a group distinct from active employees. Thus, if the group of former employees extended continued coverage benefits all or mostly HCIs, it will not pass the eligibility test.
What to do now?
In the absence of future guidance, employers may wish to discontinue the practice of entering into arrangements where HCIs are allowed to continue to participate in the active employee plan post-termination. Alternatively, employers might consider including a “reopener” and/or “claw-back” provision wherein the employer will revisit or terminate the practice, if future guidance from IRS indicates that it may be discriminatory. It is unclear whether paying for the COBRA coverage of terminated HCIs (either in full or in part) will violate the rules; however, this may be deemed discriminatory as well.
It may be prudent to avoid the issue of subsidizing health care coverage for terminated executives entirely. As outlined in our earlier post, the employer can simply increase the amount of severance pay payable to the executive so that the executive can use the funds to pay for COBRA or an individual insurance policy. In such an instance, the employer must not condition the receipt of such additional severance pay upon enrollment in COBRA or a policy, or otherwise reimburse the employee for the cost of insurance.
Why does it matter?
The consequences of an insured plan’s failure to comply with the nondiscrimination rules are different from the consequences for a plan that is self-insured. In fact, if an insured plan is determined to be discriminatory, the penalty for the employer would be much more severe than the penalty for a discriminatory self-funded plan. An insured plan that fails to comply with the nondiscrimination rules is subject to a civil action to compel it to provide nondiscriminatory benefits and, for each day that the plan fails to comply, the plan or plan sponsor is subject to excise taxes or civil money penalties of $100 per day per individual discriminated against. In this case, this penalty would presumably apply for each non-HCI who terminated employment and did not receive the same benefits provided to HCIs. In contrast, if a self-insured plan fails to comply with the rules, then amounts paid to HCIs that are considered to be “excess reimbursements” will be taxable to the HCI
As mentioned above, historically the IRS has not exerted much effort in identifying discriminatory self-insured plans; however, with the addition of the same nondiscrimination rules in the fully-insured context, we should almost certainly expect increased scrutiny sometime in the future. While we hope for a transition period after issuance of regulations before the IRS takes any aggressive enforcement actions, we believe that actions taken now to discontinue or curtail potentially discriminatory arrangements may protect employers from penalties in the future.