The IRS issued Notice 2011-1 delaying the application of nondiscrimination rules to insured health plans until plan years after further guidance is issued. At least for 2011, there is a "pass" for insured health plans. It could be longer if the IRS chooses to address in guidance all 13 items identified in the Notice for comment, including how the nondiscrimination rules will operate once the insurance exchanges and other health reform changes become effective for 2014.
What is non-discrimination for health plans?
For years, Code Section 105(h) has applied to self-insured group health plans, requiring that eligibility and benefits not favor highly compensated individuals. Health reform included new Public Health Services Act Section 2716 which provides that rules "similar" to Code Section 105(h) will apply to insured health plans.
For self-insured health plans, highly compensated individuals include the top paid 25% of all employees, plus 10% shareholders and officers. There is no "floor"; even small or moderately paid workforces will have highly compensated individuals.
For self-insured health plans, the eligibility test is similar to the 70% coverage test used for 401(k) plans under Code Section 410(b), requiring that a sufficient share of non-highly compensated individuals be eligible for health coverage.
For self-insured plans, the benefits test essentially requires that non-highly compensated individuals be provided the same benefits as any highly compensated individual.
For insured plans, the new law would apply the self-insured health plan rules to insured plans in a "similar" manner. Exactly what "similar" means is left to future guidance. Also, these rules would not apply to "grandfathered" insured plans (but have always applied to "grandfathered" self-insured plans).
When does health plan discrimination occur?
For self-insured plans, the principal problems have been executive medical plans and extended health coverage during severance. With the first, both eligibility (for example, coverage from date of hire rather than implementation of a waiting period) and benefits (for example lower premiums or no deductibles for a specified person or group) have been common ways to favor executives. With severance, extending active employee coverage until the end of a severance period has often affected more highly compensated individuals than non-highly compensated individuals. One common "workaround" has been to use insured health plans for these individuals and their benefits since insured plans, up to now, have not been subject to nondiscrimination testing. Another common "workaround" has been to have the executive or other employee pay the full cost of coverage, or impute the full cost as additional W-2 income. This takes the coverage out of Code Section 105 and its nondiscrimination rules. The employer has often given the employee a taxable cash allowance or other "gross-up" as part of the package.
With the new law, insured plans will be subject to discrimination rules. During the period of delay for the effective date, fully-insured plans may still be able to be used as a "workaround" if the insurer is willing to offer the plan and if the affected individual's need for the coverage does not exceed the extended delay period for the new rules."
For insured plans, it is not clear that the other "workaround", having the individual pay full cost, will work. That is one of the items the IRS has identified for comments by March 11, 2011 in Notice 2011-1. Because the insured plan rule is found in the Public Health Service law and not the Internal Revenue Code, many practitioners suggest that paying full cost to remove the benefit from Code Section 105 will not remove insured benefits from rules "similar" to Code Section 105(h).
What are the penalties?
Our prior Compensation and Benefits Brief (http://www.nelsonmullins.com/newsletters/health-plan-discrimination-ppaca-takes-it-to-a-new-level) explained the difference between the taxation of benefits to highly compensated individuals under self-insured plans and the daily excise tax on employers under insured plans.
How to prepare for the coming changes?
If you currently offer a self-insured plan, check for current compliance with the Code Section 105(h) nondiscrimination rules. In the short-term, insured plans may still be a "workaround" for executive plans or extended severance coverage.
If you currently offer an insured, non-grandfathered plan, check for differences in eligibility or benefits in your plan and consider where the line between your highly compensated individuals and non-highly compensated individuals occurs. Be prepared to use this information to understand the insured plan rules when they are issued.
If you currently offer an insured, grandfathered plan, stay alert to the grandfathered plan rules and what changes are required and what changes cannot be made to maintain grandfathered status.