Alerts

What employers should consider when a rebate is received from an insurance issuer. 

Background

The Affordable Care Act established Medical Loss Ratio (MLR) requirements for health insurance issuers (the term federal guidance uses for insurance carriers). An MLR generally measures the percentage of premium revenue an issuer spends on medical claims and certain activities designed to improve health care quality. 

The federal MLR standard generally requires issuers to spend at least 85% of applicable premium revenue in the large group market and 80% in the small group and individual markets. If an issuer does not satisfy the applicable standard, it generally must provide a rebate. The calculation is based on the issuer's aggregated experience in the applicable market and state, rather than the claims experience of a particular employer group. 

Insurance carriers typically send required MLR rebate notices directly to covered individuals. Employers should consider following up with affected participants to explain how the rebate will be handled under the employer's specific plan, including how any participant portion of the rebate will be used. 

Scope

MLR rebates generally apply to fully insured medical coverage. They do not apply to self-funded medical plans. Stand-alone dental and vision coverage that qualifies as an excepted benefit generally is also outside the ACA MLR requirements. Level-funded arrangements generally are treated as self-funded for this purpose. Note that a surplus refund under a level-funded arrangement may raise separate ERISA plan-asset considerations. 

Step 1: Identify the Policy that Generated the Rebate

Employers should begin by reviewing the issuer's rebate notice to determine which insurance policy generated the rebate. This is particularly important when an employer offers multiple medical options or changed insurers during the relevant period. 

The employer should also review the governing plan documents and insurance contract to determine whether they address ownership or allocation of rebates or other distributions from the issuer. 

Step 2: Determine Whether the Rebate Includes Plan Assets

For an ERISA-covered plan, the employer should determine what portion, if any, of the rebate constitutes a plan asset. A plan asset is an amount in which the plan has a beneficial ownership interest. ERISA does not establish a single rule under which every MLR rebate automatically becomes a plan asset. 

When the employer is the policyholder, employers should first review the plan document, insurance contract, and other relevant evidence addressing ownership of rebates. If those materials do not resolve the issue, the source of the premiums generally becomes relevant.

Step 3: Determine Who Should Benefit

After determining the plan-asset portion, the plan fiduciary should identify the participant population that will benefit. In general, the allocation should be directed to the individuals whose participation resulted in the MLR. However, it does not necessarily need to recreate each participant's precise historical premium contributions. The fiduciary should consider the costs to the plan, the ultimate benefit to participants, and the competing interests of different participant groups. 

The resulting methodology should be reasonable, fair, and objective based on the facts and circumstances. Depending on the circumstances, an employer may determine that it is appropriate to allocate the rebate among participants who were enrolled during the period that generated the rebate, participants who were enrolled during that period and remain enrolled, or current participants. The guidance also recognizes that distributing very small rebate amounts may not be cost-effective. If the administrative cost of making individual payments would approximate or exceed the amount being distributed, the employer may have greater discretion to use the plan-asset portion for another permissible purpose that benefits plan participants, rather than making individual payments. 

Former Participants and COBRA Participants

Former participants should not automatically be excluded. However, if the cost of distributing a former participant's share approximates the amount that would otherwise be distributed, the fiduciary may determine that it is appropriate to allocate the rebate among current participants instead. There is no specific federal dollar threshold defining when an amount becomes de minimis for this purpose. 

COBRA participants also should not automatically be excluded from the analysis. Their treatment may depend on the participant population selected and the contributions associated with the policy that generated the rebate. 

Step 4: Determine How the Plan-Asset Portion Will Be Used

Depending on the circumstances, employers generally may consider several methods for using the portion of an MLR rebate determined to be a plan asset rather than directly passing through those amounts to the plan participants.

Benefit Enhancements Require Careful Review

Examples might include a flu-shot clinic, health-related educational programming, or another health-plan-related enhancement. Employers should not assume that any wellness activity, employee perk, or general employee expense qualifies merely because it has some connection to health or wellness. The proposed use should be evaluated as a permissible use of plan assets for the appropriate participant population.  

Timing: The Three-Month Rule Requires Precision

Employers should act promptly after receiving an MLR rebate. As a general rule, any portion of the rebate that constitutes a plan asset should be used for the benefit of plan participants within three months of receipt. 

The three-month period does not necessarily require the employer to issue individual refund checks. The plan-asset portion may be used through one of the permissible methods described above. 

Employers should document when the rebate was received and how and when the plan-asset portion was used. 

Tax Treatment

The tax consequences generally depend on how the participant originally paid the premiums associated with the rebate. 

Pre-Tax Contributions

If an employee paid the employee portion of the medical premium on a pre-tax basis through a Section 125 cafeteria plan, a cash rebate generally results in additional taxable income and wages subject to applicable employment taxes. Using the rebate to reduce the employee's current pre-tax premiums contribution generally does not eliminate the tax effect because the employee's pre-tax salary reduction is reduced. 

After-Tax Contributions

These situations are not common. However, if an employee paid the applicable premium contribution with after-tax dollars and did not claim a federal income tax deduction for that premium, a cash rebate or premium reduction generally is not taxable. Different treatment may apply if the employee previously received a tax benefit from deducting the premium. 

Tax Coordination

Employers should coordinate with payroll and their tax advisors before implementing a rebate distribution, particularly when participant circumstances vary. 

Special Situations

Terminated Plans

Termination of the plan does not necessarily eliminate the fiduciary considerations associated with a later rebate. The governing plan documents should be reviewed. If they do not resolve how the rebate should be handled, the fiduciary should determine an appropriate use of any plan-asset portion based on ERISA's fiduciary standards, including whether distribution to former participants is cost-effective. 

Church and Governmental Plans

Church plans and non-federal governmental plans generally are not subject to ERISA's Title I fiduciary requirements. However, separate federal MLR rules may govern how rebates are allocated and used under these arrangements. Although some of the practical considerations may be similar, employers sponsoring these plans should apply the rules to their specific plan type rather than the ERISA analysis described in this Alert. 

Recordkeeping

The most important aspect of the process is that the employer documents its determination. If the employer is able to demonstrate its process and how it arrived at its determination, it is unlikely to be challenged by any enforcement actions. Employers should maintain documentation supporting the treatment of an MLR rebate. 

Recommended Actions

• Identify the applicable policy. Review the issuer's notice to determine which policy generated the rebate. 
• Review the governing documents. Determine whether the plan document, insurance contract, or other governing materials address ownership of rebates. 
• Determine the plan-asset portion. If the documents do not resolve the issue, review the source and structure of employer and participant premium contributions. 
• Identify the participant population. Consider current participants, former participants, and COBRA participants, as applicable. 
• Select an allocation methodology. The methodology should be reasonable, fair, and objective under the circumstances. 
• Determine how the plan-asset portion will be used. Options may include direct payments, reductions in participant premiums, or an appropriate benefit enhancement. 
• Address timing. As a general rule, employers should use the plan-asset portion for the benefit of plan participants within three months after receiving the rebate. 
• Coordinate with payroll and tax advisors. The tax treatment may differ depending on whether the underlying employee contributions were made pre-tax or after-tax. 
• Document the analysis and decision. Maintain records explaining how the plan-asset amount, participant population, allocation methodology, and ultimate use were determined. 
• Consult benefits counsel when appropriate. Additional guidance may be appropriate for terminated plans, unusual contribution arrangements, uncertain plan-asset determinations, or other circumstances not clearly addressed by existing guidance. 

Conclusion

Receipt of an MLR rebate requires an employer to do more than determine how much money to return to employees. The employer should first identify the policy that generated the rebate and determine whether any portion constitutes a plan asset. The plan fiduciary should then determine the appropriate participant population and select a reasonable, fair, and objective method for using that amount. 

Because the appropriate treatment depends on the plan's governing documents, funding structure, and particular facts and circumstances, employers should document their analysis and seek benefits counsel or tax advice when necessary. 

This Alert is provided for general informational purposes only and does not constitute legal or tax advice. Employers should consult with qualified benefits counsel regarding the application of these requirements to their specific plans.