During this pandemic, many employers are having to curtail operations and are going through the difficult process of finding cost-saving measures because of the sudden reduction in revenue caused by the various COVID-19 related state and local government orders.
Many carriers are allowing, and some states are requiring insurance policies to remain in force even if premiums are not paid timely. In addition, some fully insured carriers, knowing employees have not been able to utilize their insurance due to non-emergency services being closed (e.g. dental exam), may be returning premiums paid to employers or giving a reduction in the monthly premium as a good faith gesture.
This payment grace period and refund of premiums may be a welcome relief to employers who are finding it challenging to meet their financial obligations. However, employers, should be aware of possible consequences before taking advantage of these carrier grace periods and also understand how they may utilize the premiums returned to them, if their plans are subject to ERISA (i.e. virtually all private-sector employers who establish or maintain a welfare benefit plan, fund or program for their employees).
Background – ERISA’s Fundamental Fiduciary Rules
ERISA sets minimum standards and requirements for welfare benefit plans (e.g. group health plan) including how plan assets must be handled by those administering or managing the plan (i.e. fiduciary responsibilities). Anyone who exercises any discretionary authority or control over a plan; exercises any authority or control over a plan’s assets; has any discretionary authority in administering a plan is deemed to function as a fiduciary under ERISA, even if not named as a fiduciary in the plan’s governing documents.
Fiduciaries have important responsibilities and are subject to standards of conduct because they act on behalf of group health plan participants and their beneficiaries. These responsibilities include:
- solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
- out their duties prudently;
- the plan documents (unless inconsistent with ERISA);
- plan assets (if the plan has any) in trust; and
- only reasonable plan expenses.
How Do These Responsibilities Affect the Operation of the Plan?
If a plan provides for salary reductions from employees’ paychecks for contribution to the plan or participants pay directly, such as the payment of COBRA premiums, then the employer must make plan insurance premium payments or deposit the contributions in a plan trust, in a timely manner.
The law requires that participant contributions (i.e. plan assets) be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than 90 days from the date when the employer withholds or receives them. If employers can reasonably deposit the contributions sooner, they must do so. For plans with fewer than 100 participants, salary reduction contributions deposited with the plan no later than the 7th business day following withholding by the employer will be considered contributed in compliance with the law.
For participant contributions to cafeteria plans (also referred to as Internal Revenue Code Section 125 plans), the Department will not assert a violation solely because participant contributions were not held in trust.
Other contributory health plan arrangements may get the same relief if the participant contributions are used to pay insurance premiums within 90 days of receipt.
If an employer withholds employee salary reductions but does not use the funds in a timely manner or misuses the funds (e.g. paying rent) this may be considered a “prohibited transaction” (i.e. what not to do with the Plan’s assets) and breach of fiduciary duty.
INSURANCE COMPANY REFUNDS
Distributions from insurance companies to employers for their employee benefit plans, take a variety of forms, including refunds, dividends, demutualization payments, rebates, and excess surplus distributions. To the extent that these distributions are considered to be plan assets, they become subject to fiduciary responsibility and prohibited transaction provisions of ERISA.
ERISA does not expressly define plan assets, however, there are regulations describing what constitutes plan assets with respect to participant contributions. In general, the portion of a refund that is attributable to participant contributions would be considered plan assets. Thus, if the employer paid the entire cost of the insurance coverage, then no part of the refund with respect to this particular policy would be attributable to participant contributions. However, if participants paid the entire cost of the insurance coverage, then the entire amount of the refund would be attributable to participant contributions and considered to be plan assets. If the participants and the employer each paid a fixed percentage of the cost, a percentage of the refund equal to the percentage of the cost paid by participants would be attributable to participant contributions. There are also rules on what may be done with plan assets to ensure they are used for the exclusive benefit of plan participants and beneficiaries.
AL Machine Shop offers Chopper Insurance dental plan to its full-time employees. The employees who elect coverage pay 100% the cost of coverage pretax via their S.125 plan. There are 100 employees enrolled in dental coverage. Chopper Insurance returned $1,000 of premium to AL Machine Shop due to employees not able to use their plan for two months. The employees contributed 100% of the premium, so 100% of the rebate would need to be used for the benefit of the employees. AL Machine Shop could decide to reduce each enrolled employee’s pretax contribution to the next pay period by $10.
Peanut’s Candy Store offers Ojo Insurance vision plan to its full-time employees. The employees who elect coverage contribute 50% of the premium on a post-tax basis. There are 15 employees enrolled in vision coverage. Ojo Insurance returned $750 of premium to Peanut’s Candy Store due to employees not able to use their plan for three months. 50% of $750 or $375 would need to be used for the benefit of plan participants. Peanut’s Candy Store could decide to provide a $25 refund to each employee via their next paycheck. The refund is a return of contributions originally withheld from the employee’s paycheck on a post-tax basis, therefore the refund provided to employees generally will not be subject to income taxes.
Due to lack of utilization during the pandemic, an insurance carrier may voluntarily return premiums to an employer. A portion or all of this refund may be considered a plan’s assets and how the refund is used may have restrictions.
Determining whether any part of the refund is a plan's asset, is based on factors such as the terms of the plan document and whether employees paid any portion of the premiums. If any part of the refund is a plan asset, the employer must decide, consistent with ERISA’s fiduciary rules, how to allocate the refund, such as distributing to participants, enhancing plan benefits or reducing future participant premiums. Guidance suggests this allocation must occur within three months of receipt, or the plan assets must be held in a trust.
Employers should keep in mind, when refunding premiums to employees the tax consequences depending on whether the salary reductions were made on a pre-tax basis through a Section 125 plan, or post-tax. If salary reductions were pretax, the refund generally will be taxable income subject to employment taxes.
CONSEQUENCES OF FAILURE TO FULFILL FIDUCIARY DUTIES
- liability to make plan whole –restore plan losses
- & IRS may assess civil penalties
- may be removed and barred from being a fiduciary
Note: Any person who is a decision-maker regarding a Plan, is an ERISA fiduciary. ERISA has a “functional” definition – it is not dependent on job title or documents. Many fiduciaries fail to understand that they can be held personally liable for a breach of fiduciary duty, even when the breach is unintentional.
Possible ERISA Consequences of Taking Advantage of a Carrier Grace Period
If the employer is delaying payment of the carrier invoice but due to unforeseen business circumstances is unable to catch up (e.g. bankruptcy) and the carrier due to nonpayment of premium, ends up canceling the insurance plan retroactively, any employee who saw a health care provider during the grace period may find themselves faced with denied claims, or receive bills from providers for health care visits previously paid which the carrier is recouping. Likewise, other benefits an employee thought they had available to them, (e.g. life insurance) an employee or beneficiary may discover that plan too was canceled and benefits not available. Consequently, an employee, dependent or beneficiary may sue if they were improperly denied benefits, coverage or reimbursement.
In addition to the plan fiduciary possibly being personally liable for the claims, they also may have additional consequences if during investigations into the plan’s activities by the Department of Labor it was discovered that employee’s salary reductions were never used for their intended purpose.
Possible ERISA & IRS Consequences of Improperly Using Carrier Refunds
There is no de minimis exception to ERISA's fiduciary rules for the use of plan assets. Nor is it permissible to use plan assets to pay for expenses that are for the benefit of the employer, (e.g. tax consulting fees). An employer, upon audit, may have to substantiate how they determined which portion of the carrier refund was a plan asset and how these assets were allocated. Or participants, upon learning about a refund, may inquire about the status and sue for breach of fiduciary duties.
Self-Funded Or Level-Funded Plan Considerations
If employers receive a surplus or refund, the terms of the plan should be reviewed before deciding a course of action. Any amounts that are attributable to participant contributions are plan assets. However, many plan documents will include plan language indicating that participant contributions are used to pay claims prior to using employer funds, therefore it is possible any surplus, refunds or other adjustments in fees belong to the employer. Employers who have based participant contributions off of maximum total costs and find themselves with lower expected costs, may want to consider reflecting the low utilization in their 2021 calculations.
Communication with Employees
If an employer has decided they will not be returning a portion of the refund directly to employees, they may want to consider proactively communicating with employees how they intend to use the plan asset portion of the refund for the employee’s benefit. This may help alleviate employee relations issues arising if employees learn about carriers providing refunds to employers.
Employer Options to Consider for Reducing ERISA Risks
A critical consideration is the viability of the business long term if the COVID-19 state of emergency continues and the employer’s ability to pay back the premiums owed in the future. If the possibility exists the employer may not be able to pay their debt, the employer should consider canceling the insurance coverage and providing honest and accurate information to employees about their benefits. If salary reductions have occurred that were not sent to the carrier, these should be returned to the employee. If carriers have provided a refund, employers may want to consider providing the employee’s share of the refund in the form of a future premium reduction, or cash (subject to appropriate tax treatment.) If a carrier provides a reduction in the monthly premium for a plan which is 100% paid by employee salary reductions (e.g. no employer contribution), employers should reduce the employees’ salary deduction accordingly.
Employers that wish to take advantage of the carrier’s grace period or receive a refund, to avoid missteps that could result in legal or tax liability, as well as mitigate any disastrous impact on their employees, should consult with their legal counsel to fully understand the administrative, tax or legal impediments to any contemplated action.