Employers, often including those that are publicly traded, traditionally have used fully insured medical programs to provide coverage for certain current and former executive officers and other key employees under employment agreements, severance arrangements and similar programs established to provide non-uniform coverage for such selected individuals. Prior to the Patient Protection and Affordable Care Act, as amended (the “PPACA”), such insurance programs provided employers with a means to provide discriminatory health coverage to selected highly compensated employees and former employees without the unfavorable tax results associated with self-insured medical plans.
Section 105(h) of the Internal Revenue Code applies to self-insured group health plans and provides that if a highly compensated employee or former employee (for this purpose, a highly compensated employee is an employee in a group consisting of the highest 25 percent of all employees ranked by compensation) receives employer provided benefits under a self-insured group health plan that is not available to all non-highly compensated employees, the highly compensated employees generally are taxable on the reimbursements under the health plan. Such arrangements, to the extent they result in taxable benefits, also raise certain deferred compensation operational and document compliance issues under the deferred compensation rules contained in Section 409A of the Internal Revenue Code. Many employers have taken the position, without formal guidance from the Internal Revenue Service, that if highly compensated employees pay the full cost of the discriminatory coverage under a self-insured group health plan (generally determined based on the COBRA cost) on an after-tax basis, they should not be taxed on the reimbursements because the coverage paid for on that basis should not be considered employer-provided.
Similar non-discrimination tax rules have not existed under the federal tax laws with respect to group health benefits provided under fully insured health plans based, in part, on the theory that the underwriting considerations applicable to the issuance of insured products would eliminate any discrimination issues and potential coverage and design abuses. As a result, employers routinely have used fully-insured health programs to provide discriminatory health coverage required under the terms of employment, severance and other executive agreements. However, the use of such programs will change significantly under the PPACA, which imposes (through an amendment to the Public Health Service Act) nondiscrimination rules on fully insured group health plans that are not “grandfathered plans” under the PPACA. Under the new rules, failures to comply can result in an excise tax of $100 per day on employers maintaining such plans (rather than taxable income to highly compensated employees as in the case of a discriminatory self-insured group health plan) for the period of non-compliance with respect to each individual to whom the failure relates. The affected group to which the excise tax will be applied appears to include all individuals who are not entitled to the discriminatory benefit and, therefore, could result in a significant excise tax liability on large employers maintaining such coverage.
The new discrimination rules applicable to fully-insured group health plans was scheduled to become effective for plan years beginning after September 23, 2010 (January 1, 2011 for calendar year plans). However, based on a lack of guidance from the Internal Revenue Service regarding the new rules and confusion regarding the application of the new rules to existing insurance arrangements, the Internal Revenue Service issued Notice 2011-1 (PDF) requesting additional comments from the public and delaying the effective date until guidance can be issued as to the application of the new rules.
OUR TAKE: Given the significant potential excise tax, large employers and their compensation committees, if any, should review all existing arrangements, including employment agreements, severance agreements, change in control agreements and retention programs, under which special group health benefits are being provided (or may be provided in the future upon the occurrence of specified events) to selected executives or other highly compensated employees to determine what alternative arrangements or design changes could be implemented or revisions made in anticipation of the new rules or what changes can be made when the new rules become effective. Employers also should avoid establishing additional special group health plan coverage programs under new agreements until additional guidance has been issued by the Internal Revenue Service and other regulatory agencies.