By Mark C. Blackwell
The medical loss ratio (“MLR”) rule under the Patient Protection and Affordable Care Act (the “ACA”) is now in effect and over the next few weeks many of our clients will be receiving rebate checks from their health insurers. These checks will “come out of the blue” for many clients and will surely raise questions – – for example, what is this for, what can I do with the money, does any go to employees, is it taxable? Guidance by the U.S. Department of Labor (DOL) and Internal Revenue Service (IRS) has been provided for employers, summarized below.
[Note that this summary applies primarily to private employers who provide health insurance to their employees through a policy with an insurer who is subject to the MLR Plans of governmental employers, churches and non-ERISA plans are not included in this summary.]
Generally, the MLR rule requires health insurers to issue “rebates” to policyholders if the insurer’s MLR ratio exceeds 85 percent for the large group market, and 80 percent for the small group and individual market. The MLR is basically the ratio of the insurer’s (i) claims and quality improvement expenses to (ii) total premium dollars earned (adjusted for certain taxes and fees).
An MLR rebate is required to be allocated by the sponsor of an applicable health care plan between the policyholder (usually the employer) and each enrollee covered by the policy insuring the employer health care plan (usually the employees participating in the plan) “in amounts proportionate to the amount of premium paid.” DOL recently issued Technical Release 2011-4 which provides guidance for how such rebates may be used by sponsors of ERISA-covered plans, and the IRS subsequently issued FAQ’s that provide information on the federal tax consequences of rebate payments.
How Can the Sponsor of an ERISA Group Health Plan Use the Rebate?
DOL guidance provides generally that if the employer pays the entire cost of insurance coverage, the rebate may be retained by the employer. If the employer and plan participants each contribute a portion of the premium, the employee share is treated as a plan asset and must be used within 3 months of receipt for a permitted purpose, which may include:
• Distribute rebate to participants;
• Enhance benefits provided by the applicable plan; or
• Reduce future participant premiums.
In deciding on how to apply the rebates to plan participants, the DOL guidance notes that a plan “may properly weigh the costs to the plan and the ultimate plan benefit as well as the competing interests of participants or classes of participants provided such method is reasonable, fair and objective.” For example, if the cost of distributing the rebate to former participants approximates the amount of proceeds, the employer may decide to allocate the proceeds to current participants using a reasonable, fair and objective allocation method. Or, again for example, if the payments would be de minimus in amount, the employer may use the rebate for other permissible purposes including applying the rebate to future participant premium payments or benefit enhancements.
For plans that are exempt from ERISA’s trust and annual audit rules (i.e., unfunded group health plans that are insured), MLR rebates normally remain exempt from ERISA’s trust, annual audit and reporting requirements.
Is a Rebate of Amounts Paid with Employee After-tax Dollars Taxable?
An employee is taxed on the rebate only to the extent the employee received a tax benefit from deducting the premiums. Thus, if the employee did not deduct the premiums on his or her tax return, the rebate is not taxable. And, regardless of any prior deduction of premiums, no taxable income results (although any deduction for current year premiums is reduced) if the employer provides the rebate to all current employees participating in the health plan, without regard to who participated in the year the rebate relates. In no event is the rebate allocated in this manner subject to employment taxes.
Is a Rebate on Amounts Paid with Employee Pre-Tax Dollars (e.g., 125 Plans) Taxable?
If the rebate is distributed as a premium reduction for the employee, then the amount paid for the coverage is less, resulting in increased taxable wages. If the rebate is distributed in cash, then the rebate is treated as taxable wages, subject to income and employment taxes.