- A welfare plan administrative services only (ASO) vendor breached fiduciary duty under ERISA when it failed to properly disclose fees.
- Lack of trust did not prohibit contributions from being characterized as plan assets in the vendor's hands.
Over the last several years, plan fiduciaries have been made painfully aware of the importance of the duty to monitor and disclose fees charged to 401(k) plans and participant accounts under the Employee Retirement Income Security Act of 1974, as amended (ERISA). Hi-Lex Controls, et. al. v. Blue Cross Blue Shield of Michigan, Nos. 13-1773/1859, 2014 serves as a reminder that plan fees are not just an issue for retirement plans, but also welfare plans.
ASO Fee Agreements Under Scrutiny
Hi-Lex Controls, Inc. is an automotive parts supplier with approximately 1,300 employees that maintains a self-insured health plan for which Blue Cross and Blue Shield of Michigan (BCBSM) acted as a third-party administrator under an "administrative services only" (ASO) agreement. Similar to most ASO arrangements, BCBSM processed claims for Hi-Lex's health plan (the "plan") and granted plan participants access to its provider networks. In return, BCBSM received a monthly administrative fee based on the number of employees enrolled in the plan. ASO arrangements typically provide two very important benefits, among others, to employers and plan participants:
- access to an established network of providers
- cost savings based on the economy of scale provided by the ASO's negotiating power with the provider networks
In 1993, BCBSM began a program called "Retention Reallocation" under which it marked-up hospital claims and passed the additional mark-up onto its ASO clients. The mark-up was in addition to – not in lieu of – the administrative fee. Additional fees at issue in Hi-Lex included:
- a provider network access fee
- reserve contingency risk fee
- "other than group" subsidy fee
- a retiree surcharge fee
Court Finds Administrative Compensation Fees Not Acceptable
Hi-Lex asserted it was unaware of the fees until 2011 when BCBSM disclosed the fees to Hi-Lex in a letter in which BCBSM referred to the fees as "administrative compensation." Hi-Lex brought suit in 2011 and the District Court found that BCBSM:
- was a fiduciary under ERISA
- had engaged in self-dealing prohibited transactions under Section 406(b) of ERISA
- breached its general fiduciary duty
The District Court also found that Hi-Lex's claims were not time-barred because of its concealment of its fee practices. The court awarded Hi-Lex more than $6 million in damages and pre-judgment interest. BCBSM appealed the court's findings.
On appeal, a three-judge panel for the Sixth Circuit found the following:
- BCBSM was in fact a fiduciary due to its ability to exercise discretion over the amount of fees charged to its ASO customers, including waiving fees in certain cases.
- Hi-Lex's contributions to a BCBSM managed account were "plan assets" in BCBSM's hands because BCBSM held the funds, had discretion to pay claims, had sole check writing authority over the plan's account, provided related data to Hi-Lex for disclosure on the plan's annual Form 5500 and, as a result, there was a reasonable expectation of a "beneficial ownership interest" in the funds.
- The applicable statute of limitations was six years from the date of discovery of the fee practices because of BCBSM's concealment and since BCBSM never properly disclosed the fees in question until 2007 at the earliest, had previously offered misleading statements such as the administrative fee was all-inclusive and that a "hypothetically reasonable diligent plaintiff" would not have discovered the facts until 2007.
- BCBSM engaged in self-dealing and prohibited transactions under Section 406(b) of ERISA for which there is no "reasonable compensation" exemption under Section 408(b) of ERISA.
- BCBSM breached its general fiduciary duty when it failed to act "solely in the interest of [plan] participants and beneficiaries."
The key to the Hi-Lex decision is the finding that the funds in the BCBSM managed account were ERISA plan assets since indentifying plan assets is a threshold question for fiduciary status and prohibited transactions under ERISA. The court's finding that the managed account funds were plan assets may not be adopted by other courts. Nonetheless, Hi-Lex makes it clear to welfare plan vendors that they need to be transparent about their fee practices and provide adequate disclosure of the fees. Concurrently, plan sponsors and administrators have a separate duty to monitor the fees being charged to the plans for which both the sponsors and administrators have oversight responsibility. Hi-Lex also makes it evident that while not subject to the same detailed regime that defined contribution plans are under, described in Section 408(b)(2) of ERISA, failure to properly disclose welfare plan fees can result in significant liabilities, particularly with large self-insured plans.
Action Items for Vendors and Plan Fiduciaries
In order to establish and maintain a best practices approach to plan management, the following are action items for vendors and plan fiduciaries:
- Vendors should develop a set of best practices focused specifically on transparency in order to remove any ambiguity over the amount and nature of the fees passed onto the plans for which they provide services.
- Vendor best practices should include disclosure to both plan administrators and plan participants on a regular basis depending on the type and regularity of a fee (e.g., at least annually, quarterly, when a change occurs, etc.).
- Plan fiduciaries (e.g., plan sponsors and administrators) need to review welfare plans fees as well, particularly with respect to self-insured plans where premiums are not set year-to-year by a regulated insurance market.
- Plan fiduciaries should be proactive in monitoring fees and request adequate disclosure from vendors. A failure to make reasonable inquiries, investigate and take remedial action, if necessary, may result in a breach of fiduciary duty by the plan fiduciary.