July 2012 Volume 8 Number 11

Planning for MLR Rebates to Group Health Plans

By Jason P. Lacey, Foulston Siefkin LLP, Wichita, Kansas

AuthorUnder Section 2718 of the Public Health Service Act,1 health insurers are required to spend a minimum percentage of insurance premiums (generally 85 percent in the large-group market and 80 percent in the small-group market) on medical care and quality improvement. This percentage is often referred to as the “medical loss ratio” or “MLR.” If the MLR minimum is not satisfied, premiums must be returned to the extent necessary to reach the required percentage.

The MLR rule applies for plan years beginning on or after January 1, 2011,2 and rebates relating to 2011 plan years are due out soon. A recent report by the Kaiser Family Foundation3 estimates that insurance carriers nationwide will be rebating as much as $1.3 billion in total premiums collected during 2011. Of that, employer-sponsored plans are expected to receive approximately $900 million, and rebates are expected in nearly every state. So rebates are likely to be floating through a number of fully insured group health plans in the near future.

But determining whether an MLR rebate must be paid is only part of the analysis. When a rebate is paid to a group health plan, additional issues must be addressed, such as what may or must be done with the rebate and whether there are tax consequences associated with the receipt and further disposition of the rebate.

MLR Rebates as “Plan Assets”

MLR rebates are paid to the policyholder. In the case of an individual insurance policy, this is simple enough to do. But if the policy is a group policy, the analysis is more complicated. Specifically, when a rebate is received with respect to a group policy that is part of an ERISA-covered plan, consideration must be given to whether some portion of the rebate is a “plan asset” and so must be used for the benefit of the plan participants and otherwise treated in a manner that complies with the ERISA fiduciary obligations applicable to handling plan assets.

The Department of Labor (“DOL”) provided some specific guidance on this issue in Technical Release 2011-04.4 As a threshold matter, policy ownership must be considered. If the policy is owned by the plan, then any MLR rebate is generally a plan asset. But if, as is more commonly the case, the policy is owned by the employer, then the terms of the plan (and any other relevant facts and circumstances) must be reviewed to see if there is some understanding about how premium rebates are to be allocated between the employer and the plan participants. The portion allocable to the participants generally is a plan asset and must either be returned to the participants or used exclusively for their benefit.

Many plans, of course, will be silent on this issue. Premium allocations are rarely addressed by the plan document. And when they are, the plan would typically describe only how the employer and the participants share the contributions to the premium, not how they would share any return of the premium, by rebate or otherwise.

Technical Release 2011-04 says that in the absence of more direct evidence (e.g., specific plan language),a rebate generally is to be allocated between the employer and the plan participants based on their relative contributions to the premiums paid. So, for example, if the employer paid 60 percent of the premium and the participants paid 40 percent, the rebate would be allocated between the employer and participants in those same percentages.

The DOL also has said that some rules of reason may be applied in allocating a rebate. For example, if the cost of distributing a rebate to former participants is not justified by the amount of the rebate, allocations may be limited to current participants, using any “reasonable, fair and objective allocation method.”5 And it is not necessary to distribute a rebate in cash if a plan fiduciary determines that the rebate is better used for other permissible plan purposes, such as reducing future premium payments or enhancing benefits.

In short, some latitude is available in determining what to do with an MLR rebate, so long as any portion of the rebate that is allocable to participants is used in a reasonable manner to benefit current or former participants.

Sponsors of church and governmental plans are effectively subject to similar requirements, even though they are not subject to ERISA. Regulations issued by the Department of Health and Human Services indirectly require church and governmental employers to use MLR rebates to benefit employees, to the extent the rebates are allocable to premiums paid by employees.6 Similar to ERISA plans, the regulations provide church and governmental plans with some latitude in deciding how the MLR rebates will be used to benefit employees.7

Timing of Disbursement and the ERISA Trust Requirement

In deciding what to do with an MLR rebate, employers should remember that, under ERISA, plan assets generally must be held in trust. But many employers do not utilize trusts in connection with their group health plans, relying instead on the non-enforcement policy described in DOL Technical Release 92-01.8 So what happens when a portion of an MLR rebate is determined to be a plan asset? Will the employer be required to establish a trust for that portion of the rebate?

The DOL provides at least a partial solution to this conundrum in Technical Release 2011-04. Employers that rely on Technical Release 92-01 may rely on the same non-enforcement policy for MLR rebates that are plan assets, so long as the MLR rebates are used within three months to either pay premiums or make refunds to participants. So it may not be necessary to establish a trust for the rebates, but it may be necessary to act quickly to use the rebates for the benefit of the participants.

Tax Considerations

Once it has been determined how an MLR rebate will be utilized, consideration should be given to the tax consequences associated with the rebate, which may affect an employer’s reporting and withholding obligations. Recent guidance from the IRS, in the form of FAQs posted to its website,9 illustrates these tax considerations through a series of examples. In general terms, whether a participant’s share of an MLR rebate is taxable depends on the tax character of the premium associated with the rebate. If the rebate relates to a premium that was paid on a pre-tax basis, the rebate generally is taxable. And if the rebate relates to a premium that was paid on an after-tax basis, the rebate generally is tax-free.

Although these general rules cover many common situations, the IRS’s guidance provides a more detailed framework for analysis. Relevant considerations include whether the rebate is treated as allocable to prior-year or current-year premiums; whether any tax benefit (e.g., deduction or exclusion) was received with respect to the premium to which the rebate relates; and whether the rebate will be used to reduce premiums or make cash payments.

After-Tax; Prior Year. In situations where the rebate relates to premiums paid on an after-tax basis and the rebate is only provided to participants who also were covered under the plan during the prior year, the rebate is treated as a purchase-price adjustment for the premium paid in the prior year, and the rebate will be tax-free, regardless of whether it is provided in cash or in the form of a premium reduction, unless the participant deducted the premium on the participant’s individual tax return.10 To the extent the participant claimed a tax deduction for the prior-year premium, the rebate will be taxable for income-tax purposes, but will not be subject to employment taxes, because the prior-year premium was paid out of after-tax income.11

After-Tax; Current Year. The result is largely the same in situations where a rebate relating to after-tax premiums is provided to all current-year participants, regardless of whether the participants also were covered during the prior year. Analytically, the rebate is treated as a purchase-price adjustment for the current-year premium, with the effect that the rebate is tax-free, whether provided in cash or in the form of a current-year premium reduction. The rebate also is not subject to employment taxes because the current-year premium is otherwise paid on an after-tax basis.12 But if the participant claims a deduction for current-year premiums on the participant’s individual tax return, the deduction must be reduced by the amount of any cash rebate received with respect to the current-year premium.13

Pre-Tax; Rebate Used to Reduce Premiums. In the case of participants who pay premiums on a pre-tax basis through a cafeteria plan, if the MLR rebate is used to reduce current-year premiums, the rebate is effectively taxable in the current year as additional wages.14 By reducing the pre-tax premium amount, the rebate increases the taxable wages paid to the participants and so is indirectly subject to both income and employment taxes in the current year.

Pre-Tax; Cash Rebate. Similarly, if participants are paying premiums on a pre-tax basis through a cafeteria plan and receive a cash rebate, the rebate is treated as an indirect return of a portion of the current-year amounts being withheld through the cafeteria plan. Thus, the rebate is treated as additional taxable wages for the current year and is subject to both income and employment taxes.15

Cafeteria Plan Election Changes

MLR rebates are likely to arrive in the middle of a plan year, and, for reasons described above, it may be necessary to quickly return them to participants, rather than holding them until the beginning of the next plan year. For example, an employer may decide to use the rebate to implement an immediate premium reduction. This raises the question whether a mid-year change may be made in a participant’s cafeteria-plan election to accommodate the reduced premium.

The IRS FAQs implicitly accept this, stating as a fact in several situations that participant cafeteria-plan elections are reduced by the amount of the premium reduction.16 And although the FAQs do not cite the legal basis for this, most election changes of this nature would be supported by the regulations allowing for mid-year changes that correspond to changes in the cost of coverage.17

Depending on the magnitude of a premium reduction, an employer may need to consider whether the change in cost is insignificant, thereby supporting an automatic change in the election,18 or whether the change is significant and may support re-opening participant elections on a broader basis.19 But in most cases it would seem unfavorable from the employer’s perspective to allow for broad-scale election changes in the middle of the plan year. So the preferred approach may be to either design any premium reductions to be insignificant or avoid the issue altogether by distributing the refunds in cash, rather than through premium reductions.

Summary

The receipt of an MLR rebate may be just the beginning of a series of important steps. Group health plans and their sponsors and advisors must carefully consider how the rebates will be handled to ensure compliance with these related obligations under ERISA and the Internal Revenue Code.


1

42 U.S.C.§ 300gg-18, as added by Sections 1001 and 10101 of the Patient Protection and Affordable Care Act (PPACA), Pub. L. 111-148.

242 U.S.C.§ 300gg-18(b)(1)(A).
3

The Henry J. Kaiser Family Foundation, Insurer Rebates under the Medical Loss Ratio: 2012 Estimates(Apr. 2012), http://www.kff.org/healthreform/upload/8305.pdf; see also News Release, Kaiser Analysis: Estimated Health Insurance Rebates Under The Health Reform Law Total $1.3 Billion Dollars In 2012 (Apr. 26, 2012), http://www.kff.org/healthreform/hr042612nr.cfm.

4

DOL Tech. Rel. 2011-04 (Dec. 2, 2011), available at http://www.dol.gov/ebsa/pdf/tr11-04.pdf.

5

Id. at p.3.

6

As to governmental plans, see 45 CFR § 158.242(b)(1) (interim final rule), 76 Fed. Reg. 76596, 76599 (Dec. 7, 2011), available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-07/pdf/2011-31291.pdf (“the policyholder must use the amount of the rebate that is proportionate to the total amount of premium paid by all subscribers under the policy, for the benefit of subscribers”). As to church plans, see45 CFR § 158.242(b)(3) (interim final rule), 76 Fed. Reg. 76596, 76600 (Dec. 7, 2011), available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-07/pdf/2011-31291.pdf(insurance carrier must obtain “a written assurance” from the policyholder that the rebates will be used in a manner similar to that required for governmental plans).

7

See, e.g., 45 CFR § 158.242(b)(1) (interim final rule), 76 Fed. Reg. 76596, 76599-76600 (Dec. 7, 2011), available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-07/pdf/2011-31291.pdf (allowing the rebate either to be distributed in cash or used to reduce future premiums and allowing allocation of the rebate among employees on either a per capita or pro rata basis).

8

DOL Tech. Rel. 92-01 (May 28, 1992), available at http://www.dol.gov/ebsa/newsroom/tr92-01.html; see also DOL Tech. Rel. 88-1 (Aug. 12, 1988). Under Technical Release 92-01, employers that withhold participant contributions through a cafeteria plan governed by Internal Revenue Code Section 125 are effectively exempt from the requirement to hold those amounts in trust. The DOL “will not assert a violation [of the ERISA trust requirement] in any enforcement proceeding solely because of a failure to hold participant contributions in trust.” DOL Tech. Rel. 92-01.In practice, this non-enforcement policy has been widely relied on to forego establishing a trust in connection with a group health plan funded in whole or in part by participant contributions, even though those amounts mightotherwise be characterized as “plan assets” once they have been withheld from participant wages.

9

IRS, Medical Loss Ratio (MLR) FAQs, http://www.irs.gov/newsroom/article/0,,id=256167,00.html [hereinafter “IRS MLR FAQs”]. Although not discussed specifically in this article, these FAQs also address 1099-reporting requirements for insurance companies and the tax consequences of rebates paid in the individual market.

10

See IRS MLR FAQs, Q/A-5, Q/A-6, and Q/A-7.

11See IRS MLR FAQs, Q/A-7.
12

See IRS MLR FAQs, Q/A-8 and Q/A-9.

13

See IRS MLR FAQs, Q/A-8.

14See IRS MLR FAQs, Q/A-10, Q/A-12 and Q/A-14. These Q/As also clarify that it makes no difference for this purpose whether the rebate is allocated to all current-year participants or only those participants who were covered during the prior year. The important fact is that the rebate reduces the current-year premiums paid through the cafeteria plan.
15

See IRS MLR FAQs, Q/A-11, Q/A-13 and Q/A-14. In these cases too it does not matter whether the rebate is allocated to all current-year participants or only those participants who were covered during the prior year.

16See, e.g., IRS MLR FAQs, Q/A-10, Q/A-12 and Q/A-14.
17

See Treas. Reg. § 1.125-4(f)(2).

18

See Treas. Reg. § 1.125-4(f)(2)(i).

19

See Treas. Reg. § 1.125-4(f)(2)(ii).


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