Thomas M. White

Most employers recognize that their self-insured health plans must not discriminate in favor of highly compensated employees if those benefits are to be provided on a tax free basis. However, these non-discrimination rules have not previously been applied to insured health care programs. Consequently, many employers have purchased health care policies only for key executives and some employers provide “preferential” insured health care benefits to former employees after their COBRA continuation period expires. Under new health care legislation, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, significant tax penalties may be imposed on many employers that provide “discriminatory” insured health benefits. These rules will apply, for example, to individual health care policies, certain COBRA continuation arrangements and to some longterm care contracts. The tax rules regarding discriminatory non-insured programs continue in effect.

Except as explained below, effective for plan years beginning after September 23, 2010, nondiscrimination rules apply to many insured group health plans. In general, employers with fewer than 50 employees are not subject to the new standards. For example, it would be discriminatory for an insured plan to provide benefits only to the president of the plan’s sponsor, to provide better (or less expensive) benefits to executives or other highly compensated employees, or to extend cost-free COBRA continuation coverage only to a handful of the most highly compensated employees.

Consistent with prior law, there are no adverse tax consequences to the highly compensated employee who benefits under a discriminatory insured health plan. Instead, the new law provides for a $100 per day per participant penalty on employers that establish discriminatory insured health plans. This penalty is draconian and in almost all cases will exceed the cost of the insurance premium.

For purposes of compliance, the group that may not receive discriminatory (i.e., preferential) benefits are (i) the employer’s five highest paid officers; (ii) individuals who are 10% or more shareholders of the employer; and (iii) the highest paid 25% of all employees.

There are different effective dates for complying with the new law.

• Employers that have provided benefits under insurance policies in effect on March 23, 2010 may continue to provide discriminatory benefits if these programs do not lose their “grandfathered” status. However, under recently issued guidance, grandfather status ends, for example, when the benefit is provided under a new insurance policy. Because many employers adopt new insurance contracts each year, the grandfather exemption might be of limited utility.

• Policies that are purchased after March 23, 2010 and before September 23, 2010 will be subject to the non-discrimination requirements beginning with the first “plan year” (typically, the contract year) commencing after September 23, 2010.

• Policies purchased on or after September 23, 2010 will be immediately subject to the new rules.

Employers should proceed now to determine whether they will be covered by the new nondiscrimination standards. Any new insurance and employment related contracts should
comply with the new rules. In the case of existing arrangements, if the new rules will apply, employers should identify the affected employment agreements and then notify those individuals who receive discriminatory benefits of the consequences of the new tax regime. Because in many cases, these agreements are still legally binding between the employer and employee, they may not be amended or terminated without the consent of each party. This means that negotiations will be necessary and employees may request an increase in the payments due them because the new bargained for consideration will be subject to income tax and, therefore, less valuable to the individual, while the old benefit was non-taxable to the employee.

There are aspects of the new health care tax rules which have yet to be clarified by
appropriate regulations. Of course, in a very complex and technical area such as this, legal
counsel and the employer’s insurance broker should be contacted as soon as possible in
order to identify the scope of any problems and possible solutions.

The DOL model notices contain information that COBRA qualified beneficiaries must receive about their eligibility to receive a subsidy toward payment of their COBRA premiums in different situations.  There are three model notice for use by employers, all of which can be found at http://www.dol.gov/ebsa/COBRAmodelnotice.html:

(1) a General Notice (full version) that can be used for all qualified beneficiaries in connection with any type of qualifying event that occurs at any time from September 1, 2008 through December 31, 2009.  This version contains the “regular” COBRA notice as well as the additional notifications required by ARRA;

(2)  a General Notice (abbreviated version) that can be provided to former employees who have experienced a qualifying event on or after September 1, 2008, who elected COBRA coverage, and who still maintain that COBRA coverage; this model can also be used in conjunction with a “regular” COBRA notice to update it for ARRA; and

(3)  a Notice in Connection with Extended Election Periods, which must be provided to any “assistance eligible individual” whose qualifying event occurred at any time from September 1, 2008, through February 16, 2009, and who either did not elect COBRA continuation coverage, or elected COBRA continuation but subsequently discontinued it. This is the Notice that must be provided by April 18, 2009.

Employers and COBRA administrators must tailor these COBRA model notices to comply with the administrative procedures and other requirements of their particular group health plans.