This month the ability of employers to rely on ERISA preemption to implement a uniform health program was again called into question. In December 2007, a United States District Court held that the employer spending requirement in the San Francisco Health Care Security Ordinance (the “SFHCO”) was preempted by ERISA and could not be enforced. However, on January 9, 2008, the Ninth Circuit Court of Appeals unanimously ruled to stay the District Court’s ruling and granted the City of San Francisco’s (“City”) request for an expedited appeal. This will enable the City to immediately begin enforcing the SFHCO pending the appeal.

ERISA Preemption

In general, ERISA preempts all state laws that “relate to” an employee benefit plan, other than state insurance laws. In issuing the emergency stay, the three-judge panel of the Ninth Circuit found a “strong likelihood” that the City will prevail on appeal in showing the SFHCO is not preempted by ERISA. In issuing its ruling, the Ninth Circuit reviewed a number of ERISA preemption cases, most notably the Supreme Court cases of New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Insurance and District of Columbia v. Greater Washington Board of Trade.

In Travelers, a New York state law required hospitals to collect surcharges from patients covered by commercial insurance companies, including those administering ERISA plans. The Supreme Court recognized that the surcharge might have an influence on ERISA plans, but this influence was determined to be indirect and did not bind an ERISA plan administrator to any particular choice. The Ninth Circuit found that the SFHCO had an even more indirect influence than the surcharge. The Travelers surcharge changed the cost structure for ERISA plans, and thereby affected how the ERISA plans would be administered. However, the SFHCO does not regulate benefits or charges for benefits and its only influence is on an employer who chooses to make its required health care expenditures through its ERISA plan rather than by payments to the City.

In Greater Washington, an ordinance required employers to provide workers’ compensation health benefits at the same level as existing health care coverage provided by the employer. The Supreme Court held that this ordinance related to an ERISA plan and was therefore preempted. Although the District Court relied on Greater Washington in holding that the SFHCO was preempted, the Ninth Circuit distinguished this case by recognizing that the obligations in Greater Washington applied to the level of ERISA benefits, while the obligations in the SFHCO are measured by reference to the payments provided by the employer to an ERISA plan or to the City. Further, the SFHCO obligations are measured based on hours worked, rather than on the value of ERISA benefits.

In sum, the Ninth Circuit concluded that the SFHCO does not require any employer to adopt an ERISA plan or other health care plan because a covered employer can comply with the law by making the required payments directly to the City. Because this decision was unanimous and indicates a “strong” case, on appeal the Ninth Circuit is likely to hold that the SFHCO is not preempted by ERISA when the appeal is heard in the coming months.

The Health Care Security Ordinance

The SFHCO became effective on January 1, 2008 for all employers with 50 or more employees. On April 1, 2008, the SFHCO becomes effective for for-profit employers with 20 or more employees. In a nutshell, the SFHCO requires covered employers to make health care expenditures to or on behalf of covered employees in an amount that is based on the size of the employer. Health care expenditures may include paying health insurance premiums for covered employees, contributing to a health flexible spending account (“FSA”), health savings account (“HSA”) or health reimbursement arrangement (“HRA”) on behalf of covered employees or making payments to the City to fund its Healthy San Francisco Program. The salient details of the SFHCO are as follows:

Covered Employers. To be a covered employer, the employer must be engaged in business within the City or County of San Francisco and have at least 50 or more employees (effective April 1, 2008, 20 or more employees). In making this determination, all of the employer’s employees, on a controlled group basis, are considered, regardless of whether the employees work in San Francisco. In addition, all persons performing work are counted, including temporary, seasonal, part-time and leased employees.

Covered Employees. Covered employees are those who (1) work within the geographic boundaries of the City or County of San Francisco, (2) have been employed for at least 90 calendar days, and (3) work at least ten hours per week (eight hours, beginning January 1, 2009). However, certain classifications of employees are exempt from the SFHCO, including employees who are managers or supervisors earning more than $76,851 in 2008 (as adjusted in subsequent years), and employees who are covered by Medicare or TRICARE/CHAMPUS. In addition, employees who voluntarily sign a waiver for the year verifying that they receive health care coverage through another employer are also exempt from the health care expenditure requirement. This waiver must be made on a special form provided by the City and must be provided on an annual basis.

Amount of Health Care Expenditures. A covered employer must make health care expenditures on behalf of its covered employees. The amount of the health care expenditures is based on the size of the covered employer (taking into account all the employer’s employees on a controlled group basis regardless of whether those employees are “covered employees”) and is subject to adjustment by the City each year. The amounts for 2008 and 2009 are as follows: (to see table click here

The minimum health care expenditure for each covered employee is calculated by multiplying the total number of hours paid to that covered employee by the applicable hourly rate. Calculations must be performed on a quarterly basis, and expenditures must be made no later than 30 days after the end of the preceding quarter (that is, by April 30, 2008, for the first quarter of 2008). Special rules apply to self-funded plans to calculate whether the hourly rate is satisfied. These rules generally allow a self-funded employer to determine the hourly expenditure rate on an average basis by either using the total amount of health care expenditures made for only covered employees, or for all employees participating in the self-funded plan who receive the same type of coverage (e.g., PPO expenditures can be aggregated together, but HMO coverage cannot be aggregated with PPO coverage).

Type of Health Care Expenditures. Once a covered employer calculates the amount of health care expenditures for each of its covered employees, the covered employer can satisfy the requirement through any of the following: 

  • Paying premiums for medical, dental, vision, and prescription drug coverage on behalf of the covered employee; 
  • Making contributions to a health FSA, HRA or HSA on behalf of the covered employee; 
  • Reimbursing the covered employee’s health care expenses; or 
  • Making payments to the City to fund its Healthy San Francisco program.

Amounts paid on behalf of a covered employee for the benefit of his or her spouse/domestic partner, child or other dependent are included in determining whether a covered employer satisfies its required expenditure. However, amounts paid towards workers’ compensation will not satisfy the health care expenditure requirement. In addition, if an employee declines to participate in the employer’s health plan (and the employee does not sign a waiver as discussed above), the employer must satisfy the health care expenditure requirement some other way.

Reporting, Recordkeeping and Penalties. Employers must maintain records of health care expenditures and provide the information to the City on an annual basis. In addition, the SFHCO imposes penalties on employers that do not make the required health care expenditures or do not meet the reporting requirements. The fine for failure to make the required health care expenditure is up to 1.5 times the expenditure that should have been made plus up to 10% interest (the total fine is limited to $1,000 per employee, per week). Fines can also be incurred for failure to allow access to records ($25 per employee, per day), failure to make the required annual report ($500 per report), and taking retaliatory action against an employee related to the employee’s rights under the SFHCO ($100 per employee, per day). The City has the right to bring a civil action to recover any of these penalties, and the violating employer will be liable for the City’s enforcement costs and attorneys’ fees.

Looking Forward

Given the Ninth Circuit’s ruling and its signals regarding the ultimate outcome of the appeal, employers must give serious consideration to how they will respond to the SFHCO and must do so soon, because the SFHCO is currently effective and being enforced by the City. Further, with recent developments in Vermont, Massachusetts and now San Francisco, employers have wondered what has happened to ERISA preemption and their ability to institute a national and uniform health care plan. Because health care reform has been stalled at the Federal level for some time, states and local governments have started to become the incubators of health care reform.

For example, the Massachusetts health reform law requires an employer to establish a cafeteria plan and provide for pre-tax withholding for health coverage. It also requires an employer to make a “fair and reasonable contribution” to the health coverage costs of its employees, and if it fails that requirement, the employer must pay a tax to the Commonwealth of Massachusetts. In Vermont, the state requires employers to pay a tax based on employees who are not covered by the employer’s health coverage. Now, San Francisco has entered the arena with an employer health care spending requirement that does not require an employer to establish or modify an ERISA health plan. In each of these cases, the laws have been specifically designed to make an end-run around ERISA preemption by not requiring the establishment or modification of an ERISA employee benefit plan. Until the Supreme Court gives a more expansive reading to ERISA preemption or Congress revises the ERISA preemption rule, both of which appear unlikely in the near term, employers will continue to see more of these laws at the state and local level, thereby increasing the compliance and administrative costs with respect to employee health benefits.