What are Medical Loss Ratios?
The Patient Protection and Affordable Care Act added a new Section 2718 to the Public Health Service Act that requires health insurance issuers to report how they spend premium dollars, and requires that insurers spend a minimum percentage of premiums on health care services and quality improvement activities. Insurers in the large group market must spend 85% of premiums on health care services and activities that improve health care quality, and insurers in the small group and individual markets must spend 80% on these items. These percentages (“medical loss ratio percentages”) are not specific to an employer group or an individual but are instead based on the insurer’s aggregate market data in each State. Insurers that do not meet medical loss ratio percentage requirements in a State must provide rebates (“MLR Rebate”) to enrollees in that State.
These rules became effective for plan years beginning on or after January 1, 2011. Insurers are required to notify policyholders by August 1st as to whether they met their medical loss ratio percentage. Our clients began receiving such notices in July of 2012, and for those who are receiving an MLR Rebate the checks are beginning to arrive. A preliminary list of the insurers who were required to provide MLR Rebates can be found at http://www.cciio.cms.gov/resources/files/mlr-issuer-rebates1.pdf.
This article will address the fiduciary and tax considerations that apply to employer group health plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) that receive an MLR Rebate. Plans that are not subject to ERISA, and individual insurance policies, are subject to different rules that will not be addressed by this article.
If an employer receives notice that it will be receiving an MLR Rebate, the employer must first determine whether some or all of the MLR Rebate will be considered plan assets under ERISA. Any portion of the MLR Rebate that is considered to be plan assets cannot be retained by the employer for its own use. On December 2, 2011, the Department of Labor (the “DOL”) issued Technical Release 2011-04, which explains how an employer may satisfy its ERISA fiduciary obligations when distributing an MLR Rebate. Employers who have previously dealt with insurance company demutualizations will find that the DOL guidance on MLR Rebates is similar to the prior DOL guidance on demutualizations. The decision on whether an MLR Rebate is plan assets must be made promptly, because the portion of an MLR Rebate that is considered plan assets must be used within 90 days. Otherwise, the employer may become subject to the general ERISA trust requirements. Generally, ERISA plan assets must be held in trust, but DOL Technical Release 92-01 provides an exemption from the trust requirement if:
- benefits are paid solely from the general assets of the employer;
- benefits are provided exclusively through insurance contracts or HMOs and the premiums are paid directly by the employer (or employee organization), provided that contributions by participants are forwarded to the insurance carrier or HMO by the employer (or employee organization) within three months of receipt; or
- benefits are provided partly from the general assets of the sponsor, and partly through insurance contracts or through a qualified HMO as described above.
Determining Who is Entitled to the MLR Rebate
To determine whether all or a portion of an MLR Rebate will be considered plan assets, the employer must start by determining who owns the insurance policy. If the plan or the plan’s trust is the policyholder, then the policy will be a plan asset. For multiemployer plans, MLR Rebates will usually be plan assets, because the policyholder is almost always the multiemployer trust. In this situation, all of the MLR Rebate must be used to benefit plan participants.
If the employer is the policyholder, then the employer must determine whether the plan language provides that some or all of the MLR Rebate belongs to the employer. If the plan document and insurance policy can fairly be read to provide that some or all of the MLR Rebate belongs to the employer, then the employer may retain that portion of the MLR Rebate. However, if the governing plan documents do not address the allocation of insurance rebates, or are If the employer is the policyholder, then the employer must determine whether the plan language provides that some or all of the MLR Rebate belongs to the employer. If the plan document and insurance policy can fairly be read to provide that some or all of the MLR Rebate belongs to the employer, then the employer may retain that portion of the MLR Rebate. However, if the governing plan documents do not address the allocation of insurance rebates, or are unclear, then the decision must be based on who paid the insurance premiums. DOL Technical Release 2011-04 provides as follows:
- If the employer paid the entire premium, then the employer can retain the entire MLR Rebate.
- If employees paid the entire premium, then the entire MLR Rebate is considered plan assets and none of the MLR Rebate can be retained by the employer.
- If the employer and employees each paid a fixed percentage of the premium (e.g., the employer pays 80% and employees pay 20%), then the percentage of the MLR Rebate equal to the percentage paid by employees would be plan assets. In this situation, the MLR Rebate would be divided based on the respective percentages paid by the employer and employees (e.g., the employer retains 80% and 20% is returned to employees in the manner discussed below).
- If the employer was required to pay a fixed dollar amount of the premium and employees were responsible for paying any remaining premium costs (e.g., the employer pays $250 per employee per month and employees pay the remainder), then the portion of the MLR Rebate that does not exceed the employees’ total amount of premium contributions during the relevant period would be considered plan assets. In this situation, the employees would be entitled to receive up to the total amount of premium contributions made by them during the relevant period. Any excess may be retained by the employer.
- If employees were required to pay a fixed dollar amount of the premium and the employer was responsible for paying any remaining premium costs (e.g., the employees pays $250 per month and the employer pays the remainder), then the employer would be entitled to retain the portion of the MLR Rebate that does not exceed the total amount of premium contributions made by the employer during the relevant period. Any excess must be returned to employees.
Methods for Distributing MLR Rebates
DOL Technical Release 2011-04 provides that MLR Rebates that constitute plan assets may be used in one of three ways. These are to:
- provide a cash rebate to plan participants;
- reduce plan participants’ future premium contributions;or
- provide benefit enhancements.
Provided that the method chosen is reasonable, fair, and objective, the plan fiduciaries have discretion in deciding which participants will receive an MLR Rebate and how it will be allocated. Factors that may be considered include the costs to the plan, the ultimate plan benefits, and competing interests of participants or classes of participants. For example, if the plan fiduciaries determine that the cost of distributing shares of an MLR Rebate to former participants approximates the amount of the proceeds, the fiduciaries may determine that it is reasonable to distribute MLR Rebates only to current plan participants (even if they did not participate in the plan during the year to which the MLR Rebate relates).
The DOL guidance also states that: “if distributing payments to any participants is not cost-effective (e.g., payments to participants are of de minimis amounts, or would give rise to tax consequences to participants or the plan), the fiduciary may utilize the rebate for other permissible plan purposes, including applying the rebate toward future participant premium payments or toward benefit enhancements.”
What if a Plan Provides Benefits under Multiple Insurance Policies?
Many employers have ERISA plans that provide several benefit options under multiple insurance policies. If a plan provides benefits under multiple policies, then the plan fiduciaries should allocate the MLR Rebate solely for the benefit of participants who are covered under the policy to which the MLR Rebate relates. An employer may not use an MLR Rebate generated by one plan option for the benefit of participants in another plan option. For example, if an employer’s ERISA plan provides two HMO options — HMO A and HMO B, and the employer receives an MLR Rebate from HMO A that constitutes plan assets, then it must use it for the benefit of participants in HMO A, and may not use it for participants in both HMO A and HMO B or for participants in HMO B.
What Happens if a Terminated Plan is Entitled to a Medical Loss Ratio Rebate?
Since MLR Rebates are paid in a year subsequent to the year in which the premiums were paid, employers may be receiving MLR Rebates for plans that have been terminated.
In the context of a merger or acquisition, employers will often have the target company terminate their health plan pre-close or sometimes the buyer will terminate the acquired company’s health plan post-close. In these situations, when an MLR Rebate is returned to the employer the ERISA fiduciary requirements for allocating the MLR Rebate apply, including looking to the plan document to determine how assets of the plan are to be allocated upon termination. If the plan document does not provide direction, the employer may need to allocate all of the MLR Rebate to former participants in the terminated plan.
In the event that a terminated plan is due an MLR Rebate, and the insurer cannot, despite reasonable efforts, locate the policyholder, the insurer must distribute the entire MLR Rebate directly to the subscribers of the terminated group health plan.
In addition to the ERISA considerations discussed above, there are potential tax implications with respect to MLR Rebates. In April 2012 the IRS issued FAQs addressing the tax treatment of MLR Rebates. These FAQs are available at: http://www.irs.gov/uac/Medical-Loss-Ratio-%28MLR%29-FAQs.
With respect to a group health plan, whether the MLR Rebate will be treated as taxable income to employees, and subject to employment taxes, will depend on whether the premiums for the insurance coverage were paid for on a pre-tax or post-tax basis as described below.1
Generally, if employees paid their premiums on a pre-tax basis through a Section 125 cafeteria plan, then any MLR Rebates received in the subsequent year will result in taxable income to the employee. If the MLR Rebate is distributed to the employees it will be treated as taxable income. If the MLR Rebate is used to reduce future premiums, then employees will have less salary reduction contributions to pay for their coverage in the current year, which will result in greater taxable income.
If employees paid their premiums on a post-tax basis, then any MLR Rebate will not be treated as taxable income in the year in which it is received. The Internal Revenue Service considers this a “purchase price adjustment.” Since the premiums were paid on a post-tax basis any MLR Rebate attributable to such premiums will not be treated as taxable income. This is true regardless of whether the MLR Rebate is distributed as cash to the employees or used to reduce future premiums.
An employer (or other plan sponsor) who receives an MLR Rebate must act quickly to determine who is entitled to the MLR Rebate and how the MLR Rebate will be used. If the MLR Rebate constitutes plan assets, then time is of the essence, since MLR Rebates must generally be used within 90 days of receipt. If you would like more information on how to handle MLR Rebates please contact Julie Burbank or the Trucker Huss attorney with whom you normally work.
1 The employee will have additional tax consequences if he or she made pre-tax contributions and then deducted any portion on his or her Federal income tax return.