Last year, the Department of Labor and the Treasury Department/IRS (Departments) issued guidance on the application of certain of the Affordable Care Act’s insurance market reforms to health reimbursement arrangements (HRAs), certain health flexible spending arrangements (health FSAs) and certain other employer health care arrangements. For an explanation of this guidance, please see our client advisory dated September 25, 2013.  The Departments issued further clarifications in May of this year, which we covered in a previous post.  Collectively, these guidance items addressed plan designs in which employers attempt to subsidize the purchase of health insurance coverage (whether on a pre-tax or after-tax basis) in the individual market (whether or not under a qualified health plan offered through a public exchange).

In each of these pronouncements, the Departments clarified that arrangements of all stripes that seek to provide cash subsidies for the purchase of individual market coverage are themselves group health plans subject to the Act’s insurance market reforms and other requirements. As a consequence, schemes claiming that employers can comply with the Act by simply providing cash subsidies do not work as advertised.  Despite the Department’s efforts, a handful of promoters have consistently failed to get, or have purposely chosen to ignore, the proverbial memo. A recent set of FAQs makes short shrift of two arrangements—after tax subsidies and a pre-tax reimbursement arrangement—that are on solid regulatory ground. These arrangements are not now and never were (in our view) viable, and their promotion was both reckless and irresponsible. The Departments’ treatment of a third arrangement—giving employees with high claims risk a choice between group health plan enrollment or cash—is well-intentioned and may even be the “right” result. But it rests (again in our view) on less solid legally and regulatory ground.

Set out below are the FAQs’ questions together with our reaction:

Question 1: My employer offers employees cash to reimburse the purchase of an individual market policy. Does this arrangement comply with the market reforms?

Notice 2013-14 made it abundantly clear that certain pre-tax arrangements (i.e., health reimbursements accounts (HRAs) and health flexible spending accounts (health FSAs) used to fund the purchase of individual market health coverage—referred to generically as “employer payment plans”—run afoul of the Act’s bar on annual and lifetime limits and preventive services mandate. But an employer payment plan does not include an arrangement under which “an employee may choose either cash or an after-tax amount to be applied toward health coverage,” provided that the arrangement qualifies as a payroll practice. A “payroll practice” for this purpose is defined with reference to applicable Department of Labor regulations (29 C.F.R. §2510.3-1(j)).

An arrangement that qualifies as a payroll practice is not treated as a group health plan and thus is not subject to the ACA’s insurance market reforms. Some folks missed the implication of the “payroll practice” requirement, which permits an employer to provide a choice between unrestricted after-tax cash and health coverage. But an offer of after-tax cash that is conditioned on the purchase of health coverage is itself a group health plan that is itself subject to, and will run afoul of, certain of the ACA’s insurance market and other requirements.

Q2: My employer offers employees with high claims risk a choice between enrollment in its standard group health plan or cash. Does this comply with the market reforms?

Moving participants with expensive health conditions off of an employer’s group health plan and onto a public exchange or other individual market coverage has the potential to destabilize the insurance markets. Congress took no steps in the Affordable Care Act or elsewhere, however, to expressly ban this practice. In its 2006 health care reform law, the Massachusetts legislature took the opposite tact by expressly barring individuals with access to employer coverage from enrolling in coverage under the state’s public insurance marketplace. As a consequence, it seems to us that this is a problem for Congress to fix, not the Departments.

A legislative fix is impossible given the current political environment, particularly in light of the results of the 2014 mid-term elections. So the Departments have tackled the problem using existing law and regulations. The particular lever that the Departments choose for the task is ERISA § 702 and Code § 9802, which were originally added by the Health Insurance Portability and Accountability Act (HIPAA). These statutory provisions prohibit discrimination based on one or more health factors. According to the Departments, “offering, only to employees with a high claims risk, a choice between enrollment in the standard group health plan or cash,” constitutes such discrimination. The problem for the Departments is that their current regulations permit more favorable rules for eligibility or reduced premiums or contributions based on an adverse health factor (sometimes referred to as benign discrimination). So in the Q&As the Departments had to explain why this particular species of benign discrimination is discriminatory—for which they provide the following reasons:

1. The offer of a choice of additional cash or enrollment in the employer’s plan to a high-claims-risk employee does not reduce the amount charged to the employee with the adverse health factor. The offer instead effectively increases the premium or contribution the employer’s plan requires the employee to pay for coverage, because the high-claims-risk employee must accept the cost of forgoing the cash in order to elect plan coverage.

Seriously? The employee ends up with coverage through a public exchange or marketplace under a plan that covers all 10 essential health benefits (a requirement to which the employer’s plan is not subject). So the employee gets the better of one or the other. This choice might be particularly valued by an employee who requires a very high-cost specialty prescription drug not covered under the employer’s plan. Where, one might ask, is the increased cost to the employee?

2. The current regulations that permit benign discrimination allow for benefits enhancements but not cash. For example, a plan may have an eligibility provision that provides coverage to disabled dependent children beyond the age at which non-disabled dependent children become ineligible for coverage. But providing cash as an alternative to health coverage for individuals with adverse health factors is an eligibility rule that discourages participation in the group health plan.

And the problem with this is? Where coverage is preserved under either the employer’s plan or a public market place using an approach that Congress could have easily prevented but chose not to, why is it a problem that participation in the employer’s group health plan might be discouraged at the margins?

3. The Departments rightly point out that the choice between taxable cash and a tax-favored qualified benefit must take the form of an election under a Code section 125 cafeteria plan, which could, depending on the facts and circumstances, result in discrimination in favor of highly compensated individuals. So this practice may not be available to individuals in the prohibited group.

At bottom, it strikes us that this is a policy rather than a regulatory matter. Nevertheless, there is all likelihood sufficient statutory authority for the Departments to impose the rule that is asserted in this FAQ. The statute speaks in terms of “discrimination based on health status.” One can read “discrimination” narrowly to mean “to treat differently” such that benign discrimination is not permitted. But that is not how the regulators have historically treated discrimination.

Q3: A vendor markets a product to employers claiming that employers can cancel their group policies, set up a Code section 105 reimbursement plan that works with health insurance brokers or agents to help employees select individual insurance policies, and allow eligible employees to access the premium tax credits for Marketplace coverage. Is this permissible?

This compliance strategy is truly loopy. On its face, a “Code section 105 reimbursement plan” is clearly a group health plan, which is clearly subject to the Act’s insurance market and other reforms. As such, the prohibition on annual limits and the requirement to provide certain preventive services without cost sharing would apply. According to the Q&A, “[t]hese arrangements cannot be integrated with individual market policies to satisfy the market reforms and, therefore, will violate PHS Act sections 2711 and 2713, among other provisions, which can trigger penalties such as excise taxes under section 4980D of the Code.” In addition, employees participating in such arrangements are ineligible for premium tax credits (or cost-sharing reductions) for marketplace coverage.