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Insured Group Health Plans –Nondiscrimination in Favor of the Highly Compensated is a Ticking Time Bomb

The Patient Protection and Affordable Care Act (“ACA”) has been making big political waves since its enactment in March 2010.  Since then, the focus has switched to different provisions depending on effective dates and political winds.  One provision which has gained attention and will gain more is the prohibition against insured group health plans (plans where an employer pays a fixed monthly premium for employee coverage) from discriminating in favor of highly compensated individuals (“Nondiscrimination Rule”).  Self-insured plans (plans where an employer pays claims as they are incurred rather than a fixed premium) have been subject to a similar rule since 1980.  ACA expands most of the substantive rules for self-insured plans to insured group health plans.

Self-insured plans are subject to provision 105(h) of the Internal Revenue Code (“Code”) which prohibits discrimination in favor of “highly compensated individuals.”  The Code defines “highly compensated individual” as one who is 1) one of the 5 highest paid officers, 2) a shareholder who owns more than 10% in value of the stock of the employer, or 3) is among the highest paid 25% of all employees.  Under this definition, every company regardless of size employs highly compensated individuals.  The nondiscrimination prohibition includes both plan eligibility and plan benefits.  The Code contains complicated tests to determine if a plan discriminates in either eligibility or benefits, and specific rules excluding certain employees from those tests.  (Note: These provisions only apply where coverage is provided on a pre-tax basis which is most coverage.)

ACA extends this prohibition by amending the Public Health Service Act’s Section 2716 which subjects non-grandfathered insured group health plans to a similar Nondiscrimination Rule prohibiting discrimination in favor of highly compensated individuals.  The Nondiscrimination Rule will impact plans that offer coverage that discriminates in eligibility and/or benefits between groups of employees, such as between managers or professionals and staff.  For example, management-only coverage, reduced premium or added benefit coverage to management, and post-termination continuation of benefits to one group of employees and not another, will all likely be deemed discrimination under this provision.

Under this Nondiscrimination Rule, the plan or plan sponsor who is not in compliance will generally face an excise tax or civil money penalty of $100 for each day of noncompliance per employee who is discriminated against or a civil action compelling it to provide non-discriminatory benefits, absent some exception.  When enforced, these penalties will become significant quickly.

Although the Nondiscrimination Rule is effective now and has been effective since 2010, the IRS issued a notice (Notice 2011-1)  stating compliance will not be mandated nor will penalties be assessed until after regulations or other administrative guidance is issued.  Until that time, employers need not file the requisite paperwork under this section.  The notice also states the guidance will not apply until plan years beginning a specified period after issuance of the guidance.  Thus, once the rules are effective, employers will have some time to reach compliance.  Immediate compliance is not necessary – yet.

Although we are awaiting regulatory guidance on this provision, i.e., when the rules will be effective, the Nondiscrimination Rule is here to stay and employers with insured group health plans should be consulting legal counsel and their tax advisor now to evaluate possible compliance issues and potential coverage options.  Once the regulatory guidance is issued, there will be a finite amount of time to evaluate these issues and make necessary changes.

Brody and Associates regularly advises management on complying with the latest state and federal employment laws.  If we can be of assistance in this area, please contact us at info@brodyandassociates.com or 203.965.0560.