ERISA generally governs all pension and welfare benefit plans. In regulations, the Department of Labor (“DOL”) has exempted certain types of plans or practices from the definition of a welfare benefit plan under Title I of ERISA. One commonly used exemption is the “payroll practice” exemption. Exempt payroll practices include “payment of an employee’s normal compensation, out of the employer’s general assets, on account of periods of time during which the employee is physically or mentally unable to perform his or her duties, or is otherwise absent for medical reasons (such as pregnancy, a physical examination or psychiatric treatment).” 29 CFR § 2510.3-1(b)(2).
This regulation is used to exempt self-funded short-term disability (STD) plans and salary continuation plan from ERISA coverage. An exempt plan is not required to:
- maintain a plan document or an SPD;
- file Form 5500; or
- comply with ERISA claim procedures.
The Requirements for Payroll Practice Exemption
The exemption applies only if the benefits are paid from the employer’s general assets. An employer can use an insurer or other party as a third-party administrator and still have an exempt plan, but providing STD through an insurer will cause the plan to be covered by ERISA.
A self-funded STD plan can qualify as an exempt payroll practice if it provides either full or partial payment of wages during a disability leave. See, e.g., DOL Opinion Letter 93-02A.
If a short-term disability plan falls within the definition of a “payroll practice,” courts will generally treat the plan as a non-ERISA plan even if the employer has attempted to characterize it as an ERISA plan by providing an SPD, filing Form 5500, etc. See, e.g., Langley v. DaimlerChrysler Corp., 502 F.3d 475 (6th Cir. 2006).
The Benefits of ERISA Applicability
However, an exempt plan does not receive the benefits of ERISA preemption, so claim issues could be subject to state law, jury trial and consequential damages. A multistate employer may prefer the benefits of ERISA preemption.
Best Practice for Employers
We think it is a best practice to have a comprehensive plan document or written policy even if an STD plan is exempt from ERISA. It protects both the employer and employee by spelling out eligibility, the types of disabilities covered, how and when benefits are paid, and any exclusions, limitations or restrictions. We also recommend that the plan include a claim and appeal procedure, even though it does not need to be as formal and detailed as the ERISA claim procedures.
Employers should weigh not just the cost of coverage but also the pros and cons of ERISA coverage in determining whether to structure a short-term disability as a payroll practice or as an ERISA-governed plan.