Comments Concerning Cafeteria Plan Regulations
Under Internal Revenue Code Section 125

III.  Comments

A.  Significant Cost or Coverage Changes

3. Health FSA Election Changes
    
4. 1. Explanation of New Rule

   2. If the cost of a benefits package option significantly increases during a period of coverage, a cafeteria plan may permit employees to either make a corresponding prospective increase in their payments, or to revoke their elections and, in lieu thereof, to receive on a prospective basis coverage under another benefits package option providing similar coverage. Prop. Treas. Reg. §1.125-4(f)(2)(ii).

   3. Concerns

   4. Many employers have expressed an interest in allowing mid-year changes in Health FSA elections due to a significant cost or coverage change. The large majority of these employers are small and medium-size companies. The reason for such interest is that many small employers have very few health options available to their employees. The cost of the available health care options to small employers is high because of the size of the small employers yet the coverage available to small employers is typically not as comprehensive as coverage offered by large employers. Therefore, many employees of small employers utilize Health FSAs in order to reduce the cost of their health care expenses.

      For example, if the cost of a health option significantly increases during the year, employees are permitted to drop that option, and if desired, elect another health option. However, many small employers have only one or two health options, and the cost increase may rise to the level that employees can no longer afford the coverage. In such a circumstance, since the increase in cost is beyond the control of the employees, they should be allowed to increase their coverage under the Health FSA if they do not want to elect (or cannot elect) another health option.

      In addition, if coverage is significantly curtailed or ceases under a health option, the plan may permit employees to revoke their elections and elect a new similar option. If a small employer’s health plan option eliminates vision coverage during a period of coverage, as an example, most often another similar option is not available. In such a circumstance, employees should be able to increase their Health FSA coverage during a period of coverage in order to make up for the loss in benefits.

   5. Recommendation

   6. We recommend that the significant cost or coverage change rules be extended to apply to Health FSAs. Allowing such a limited change should still allow the Health FSA to exhibit the risk-shifting and risk-distribution characteristics of insurance, while allowing employees to make a change on account of circumstances that are beyond their control. Further, since most employers annually limit Health FSA coverage (typically to no more than $5,000 or some lesser amount), the effect of allowing such a change would be nominal.