On July 6, 2011, the Board of Directors of Blue Cross Blue Shield of Massachusetts (BCBSMA) announced1 that the company would credit customers some $4.26 million in the form of policy credits on individual and group health policies. The announcement came in response to a report by Massachusetts Attorney General Martha Coakley, which was critical of a severance benefit paid to former BCBSMA Chief Executive Officer Cleve Killingsworth in the same amount. To the extent that policy credits are being paid to group health plans that are subject to regulation under the Employee Retirement Income Security Act of 1974, as amended (ERISA), employers will need to exercise care. Based on long-standing Department of Labor (DOL) guidance, a portion of aggregate policy credits could constitute “plan assets,” which are subject to the ERISA fiduciary requirements.
This client alert explains the ERISA-related issues raised by the BCBSMA announcement and suggests ways that employers might choose either to sidestep the need to apportion, or to apportion, policy credits, as the case may be. While the policy credits in question relate to both individual and group health insurance policies, this alert covers only the issues relating to group health plans that are subject to ERISA—generally, private sector group health plans.
Whenever a vendor or service provider or entity returns money to an ERISA-covered group health plan, ERISA’s fiduciary standards must be considered. ERISA defines the term “fiduciary” functionally to include anyone with discretion or control over “plan assets.” Once it is determined that plan assets are involved, the myriad of fiduciary and other protections afforded by ERISA generally apply. In determining whether and how to allocate policy credits, employers that sponsor group health plans are exercising discretion in a manner that is at least potentially governed by ERISA’s fiduciary standards.
Guidance issued by the U.S. Department of Labor provides that participant contributions are plan assets. Specifically, DOL Reg. 2510.3-102 provides, in relevant part:
[T]he assets of the plan include amounts (other than union dues) that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution … to the plan …. 2
ERISA requires that “plan assets” be held in trust pursuant to a written trust agreement. There is, however, an exception where the assets consist of insurance contracts or policies issued by an insurance company, or where an insurance company holds the assets. The reason for the rule and its exceptions are not difficult to discern: state laws governing the insurance industry are deemed to provide sufficient protections so as to make the trust requirement unnecessary. But once the policy credits are distributed, the “insurance company” exception to the ERISA trust requirement is no longer available and the general rule applies.
Applicable Law and Guidance
There are at least three possible ways to analyze the BSBCMA policy credits:
Insurance Company Demutualization Proceeds
Some years ago, the DOL considered issues similar to those presented by BCBSMA’s policy credits in the context of the apportionment of insurance company demutualization proceeds. In two Advisory Opinions3 and an Information Letter4 issued in response to the demutualization of Prudential Insurance Company, the DOL provided relief to policyholders on the apportionment of demutualization awards where the underlying policy is held in the context of a pension and welfare benefit plan governed by ERISA. While recognizing that a trust would ordinarily be required in connection with the receipt of a demutualization award, the DOL determined that it would not assert a violation of the trust requirement if the following criteria were satisfied: 5
- The assets eligible for the exception to the trust requirement consisted solely of proceeds received by the policyholder in connection with the demutualization;
- Such assets, and earnings thereon, are placed in the name of the plan in an interest bearing account, in the case of cash, or a custodian account, in the case of stock, as soon as reasonable following receipt;
- Such proceeds are applied to the payment of participant premiums or applied to plan benefit enhancements, or distributed to plan participants as soon as reasonably possible but no later than 12 months following receipt;
- Such assets are subject to control by a designated plan fiduciary;
- The plan is not otherwise required to maintain a trust; and
- The designated fiduciary maintains such documents and records as are necessary under ERISA with respect to the foregoing.
The DOL also provided the following advice in the case of an ERISA welfare plan (e.g., an employer-sponsored group health plan) that is particularly relevant in this instance:
[I]n the case of an employee welfare benefit plan with respect to which participants pay a portion of the premiums, the appropriate plan fiduciary must treat as plan assets the portion of the demutualization proceeds attributable to participant contributions. In determining what portion of the proceeds are attributable to participant contributions, the plan fiduciary should give appropriate consideration to those facts and circumstances that the fiduciary knows or should know are relevant to the determination, including the documents and instruments governing the plan and the proportion of total participant contributions to the total premiums paid over an appropriate time period. 6
Proceeds from Late-Trading and Market-Timing Settlements
In the mid-2000s, the Securities and Exchange Commission (SEC) determined that several mutual funds had violated SEC rules by permitting trading in mutual funds after the markets had closed (“late trading”) and had engaged in other “market timing” activities. As part of the resolution of these violations, the SEC required restitution to the mutual fund holders and appointed an “independent distribution consultant” for each mutual fund involved that was responsible for developing and implementing the settlement funds’ distribution among affected parties. Allocating these settlements proved particularly vexing for ERISA-covered plans. In many cases, sufficient records to determine precise allocations were not available, or the cost of calculating allocations to individual accounts exceeded the amount provided by the settlement.
DOL Field Assistance Bulletin No. 2006-01,7 provided guidance to 401(k) plan fiduciaries on how to allocate settlements in connection with mutual fund late-trading and market-timing violations. The DOL determined that the settlement fund proceeds would not constitute plan assets prior to their distribution if certain requirements were satisfied. Specifically, settlement proceeds were required to be apportioned in relation to the impact the late-trading and market-timing activities may have had on the plan. In implementing this approach, allocations to participant accounts were required to be generally in proportion to losses. But the plan fiduciary was not required to use an allocation methodology that would cost more to implement than the plan participants would receive.
Pharmacy and Other Credits and Rebates
The issue of the extent to which a plan or carrier can retain all manner of credits and rebates has received a good deal of attention. While the issues are complex, the general rule is that, where a plan by its terms provides that discounts and rebates are retained by the plan (and assuming no enforceable state law to the contrary), the discount or rebate is the property of the plan and not the participants.
Employers, in their capacity as fiduciaries with respect to their employer-sponsored group health plans, should determine their obligations with respect to policy credits by taking the following steps:
1. Review plan documents.
Employers should first review their plan documents to determine whether the plan provides a manner of allocating credits. While this is not a common provision, it is possible for a plan to include language that would provide a rule in this instance. If the plan provides a rule (that is not otherwise contrary to ERISA), that rule should be followed.
2. Determine the cost of allocating to plan participants.
If the plan does not provide a rule, employers should next determine the cost of allocating the credit to participants. According to BCBSMA, the premium credit will be about $2.00 per “member” (aka participant). And since employer contributions are virtually always at least half of the premium cost, the “plan asset” amount is likely to be $1.00 or less per member. Taking a cue from DOL Field Assistance Bulletin No. 2006-01, a fiduciary might well conclude, after analyzing the relative costs, that no allocation is necessary, since the administrative costs of making correction exceed the amount of the allocation. The employer would then retain the full amount of the policy credit.
3. If appropriate, make the allocation.
If all else fails, plans with employee contributions will be obligated to apportion the credit. While both the demutualization guidance and the late-trading settlement guidance generally require apportionment, the former appears better suited to this issue. Since assets are being returned by way of a policy credit to the employer, there will be no separate check (as was the case with demutualization proceeds), so certain of the DOL prescribed procedures will not apply. But others will: for example, the process should be documented. Following the DOL’s admonition (i.e., that the fiduciary should consider the surrounding acts and circumstances, including “the proportion of total participant contributions to the total premiums paid over an appropriate time period”), a plan sponsor might simply apply a ratable portion of the award to an across-the-board reduction in employee premiums until the employee portion of the rebate is used up (which should be very quickly).