New Health Care Non-Discrimination Rules for Fully Insured Plans

The Patient Protection and Affordable Care Act now requires fully insured health care plans to meet the same non-discrimination rules previously applied only to self-funded health care plans. IRC Sec 105(h)(2) requires that in order to receive tax exclusion treatment of self-funded health care benefits from the participants’ taxable income, plans may not discriminate in favor of highly compensated employees (HCE’s). Failure to meet these requirements results in any “excess reimbursement” being treated as taxable income for the highly compensated employees. A somewhat common practice among employers is to provide upper and senior management positions with a fully insured plan, which provides for higher rates of coverage while providing other employees with a “standard” self-insured plan. This technique allows employers to provide HCE’s with benefits at a higher level than non-HCE’s and possibly still meet the requirements of 105(h)(2). The Act now makes this technique more difficult, if not impossible to apply in the face of the Act’s new requirements.

Self-funded health care plans sponsored by employers are allowed to “classify” employees by various categories using guidelines under the pension related rules in IRC Sec 1.410(b)-4. Provided that these “classifications” did not discriminate in favor of HCE’s, employers could disaggregate their workforce into different groups for the purposes of providing different plan benefit designs for different groups. Thus, employees in a plant in California could feasibly have a different health care plan with different benefits as opposed to workers in a plant in Florida and still meet the requirements of non-discrimination. Typical allowable classifications include geographic locations, lines of business, salaried vs. non-salaried, union vs. non-union and any “bona fide business criteria”. As with any governmental regulations, advice and council should be sought from an appropriate legal and/or tax advisor before pursuing adoption of any plan design implementation or change.

My personal experience has demonstrated that non-discrimination issues could be avoided by excluding HCE’s from plan participation (carve-outs) and providing for a post-tax plan. However, it is unclear, at least to me, that this approach would eliminate the non-discrimination testing requirements under the Act. Another alternative that I have seen is to “gross-up” HCEs’ wages to accompodate for the “excess reimbursement” attributable to the failed test. Of course, this last technique has its own pitfalls and could create unforeseen consequences associated with wage based bonuses and other benefits. Clearly, if an employer wishes to provide HCE’s with a higher level of health care reimbursements, advice and council should be sought from the appropriate legal and/or tax advisor before pursuing any plan design change.

Clearly, one goal of the Patient Protection and Affordable Care Act is to provide for a level playing field among employees at all levels within an organization for the delivery of health care benefits. In other words, why should the level of health care reimbursements be related to the organizational level of the employee?