Health Care Reform—Impact on Employers and Employer-Sponsored Health Plans

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By Lois Wagman Colbert, Esq., Martha L. Sewell, Esq., Mark L. Stember, Esq., Mark D. Wincek, Esq., and Karen D. Martinez, Esq.

Kilpatrick Stockton LLP, Charlotte, NC, Raleigh, NC, Washington, DC, and Atlanta, GA 

Litigation will likely continue for months and possibly years and both Health and Human Services (HHS) and the Internal Revenue Service (IRS) will need to issue hundreds of pieces of guidance.  However, one aspect of Health Care Reform is certain – not since the passage of ERISA itself has there been such a sweeping and comprehensive piece of legislation affecting employee benefits.

On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act, P.L. 111-148 (the PPACA), and a week later on March 30, 2010, President Obama signed the Health Care and Education Reconciliation Act of 2010, P.L. 111-152 (the HCERA), which amends certain provisions of the PPACA. (The PPACA and HCERA are referred to collectively as "Health Care Reform.")

The centerpieces of Health Care Reform are "individual responsibility" provisions, which generally require individuals to maintain health coverage (e.g., individual coverage purchased through an Exchange, as defined below, or group health coverage) or pay assessments, and the "employer responsibility" provisions, under which large employers must offer group health coverage to full-time employees, and contribute to the cost of coverage, or pay a penalty. In addition, there are many other aspects of Health Care Reform that will affect group health plans and their sponsors.

The employer responsibility provisions of Health Care Reform are designed to require employers to shoulder a large portion of the burden of providing group health coverage to their employees, either directly through subsidized employer sponsored coverage or by funding a portion of the cost of coverage provided through the Exchange. While most of the employer mandates affect only "large" employers (defined below), all group health plan sponsors will be impacted to some degree by these new mandates.

As a starting point, this commentary provides a basic overview of the new mandates for employers and individuals, new plan design and administrative requirements for group health plans, and the revenue and other provisions that affect employers and group health plans. Given the far-reaching changes to the health care system brought about by the new legislation, there are still many unanswered questions regarding its implementation and application to employer-sponsored health plans.

Employer Mandate

Large employers must provide "minimum essential coverage" to their full-time employees or pay a monthly penalty if a full-time employee obtains coverage through the Exchange and is eligible for a premium tax credit or cost sharing reduction (i.e., taxpayer-subsidized coverage). These provisions are effective January 1, 2014, except where otherwise noted.

Large Employer Status. A "large" employer is one that, during the prior year, had an average of 50 or more full-time employees, as determined on a controlled group basis.  Solely for purposes of determining "large" employer status, full-time equivalents must be included in the number of full-time employees. Full-time equivalents are calculated by adding the total hours worked in a month by employees, other than full-time employees, and dividing by 120. Seasonal workers may be excluded under certain circumstances.

Full-Time Employees. Full-time employees are employees who perform, on average, at least 30 hours of service per week.

Minimum Essential Coverage. Coverage under an eligible employer-sponsored group health plan satisfies the requirements for minimum essential coverage for purposes of the individual mandate (discussed below). However, for purposes of the employer mandate, employer-sponsored health coverage must satisfy certain additional requirements to qualify as minimum essential coverage. There are no standard benefits packages that must be offered, as there are for insurance policies offered through the Exchange. But there are many new substantive design and administrative requirements for group health plans, which are described below.

Penalty for Not Offering Health Coverage to Full-Time Employees. Large employers who do not offer any health coverage to their full-time employees are subject to a monthly penalty if any full-time employee enrolls in an insurance plan offered through the Exchange and qualifies for taxpayer-subsidized coverage for the month. The amount of the monthly penalty is $2,000 divided by 12, multiplied by the number of full-time employees employed during the applicable month, not counting the first 30 full-time employees.  Only full-time employees (not full-time equivalents) are counted for purposes of the penalty.

Penalty for "Under Subsidizing" Health Coverage for Full-Time Employees. Large employers who offer health coverage to full-time employees are also subject to a penalty if any full-time employee enrolls in an insurance plan offered through the Exchange and qualifies for taxpayer-subsidized coverage. 

Individuals may qualify for taxpayer-subsidized coverage if (a) their household income for the tax year is between 100% and 400% of the federal poverty line for a family of the size involved; and (b) they are not eligible to participate in an employer sponsored group health plan or they are eligible but the employer does not pay at least 60% of the allowed costs under the plan or the employee's required contribution for coverage is more than 9.5% of the employee's household income.

The amount of the monthly penalty is $3,000 divided by 12, for each full-time employee who is eligible for taxpayer-subsidized coverage for the month (employees who receive a free choice voucher are excluded). However, the penalty will not be greater than the penalty that would apply if the employer offered no coverage at all.

Free Choice Vouchers. All employers (not just large employers) who offer minimum essential coverage through a group health plan and pay any portion of the costs of coverage are required to provide vouchers to certain employees who opt out of coverage.  The vouchers can be used to purchase insurance through the Exchange and are not taxable to the employee, unless the amount of the voucher exceeds the cost of coverage through the Exchange in which case the difference will be paid to the employee as taxable compensation.  Employees who opt out of employer-sponsored coverage are entitled to vouchers if:

 The employee's share of the cost of coverage (whether paid on a pre-tax basis or otherwise) would be between 8% and 9.8% of household income for the taxable year; and

 The employee's household income does not exceed 400% of the federal poverty line for a family of the size involved.  

Automatic Enrollment. Employers who have more than 200 full-time employees must automatically enroll new employees in a coverage option, subject to any applicable waiting periods, and continue existing elections from year to year. Employees must also be given adequate notice regarding the auto-enrollment and the opportunity to opt out of any coverage in which they have been automatically enrolled.

Notice to Employees. Effective March 1, 2013, all employers (not just large employers) must notify existing and new employees of (a) their right to purchase insurance through the Exchange, (b) their potential eligibility for a premium tax credit and a cost sharing reduction if the employer covers less than 60% of the allowed costs under the plan and the employee elects to purchase insurance through the Exchange, and (c) their potential loss of the employer contribution if coverage is purchased through the Exchange (unless the employee receives a free choice voucher).

Retaliation. Employers are prohibited from discharging or discriminating against employees who receive taxpayer-subsidized coverage.

Individual Mandate

The individual responsibility provisions of Health Care Reform are intended to provide for universal coverage of individuals through employer-sponsored group health plans, individual-market policies and existing governmental programs. The following provisions are effective January 1, 2014.

Requirement to Maintain Minimum Essential Coverage. Individuals who do not maintain minimum essential coverage for themselves and their spouses and dependents will be assessed penalties. Individuals who cannot afford coverage (e.g., because the cost of coverage would exceed 8% of the individual's household income), who have only short gaps (less than three months) in coverage, or who have household incomes less than the threshold for filing a federal tax return are not subject to penalties. Additionally, members of certain religious groups, incarcerated individuals, and individuals not lawfully present in the United States are not required to maintain coverage.

Minimum Essential Coverage. Coverage under eligible employer-sponsored group health plans, individual-market insurance policies, or certain governmental programs (e.g., Medicare, Medicaid, the CHIP Program or TRICARE) constitute minimum essential coverage.

Exchange. States are required to establish an American Health Benefits Exchange (the "Exchange") that facilitates the purchase of individual or group health insurance plans. Insurance policies offered through the Exchange must offer certain essential health benefits packages established by PPACA, which may be supplemented by the state, and must meet certain cost-sharing requirements.

Taxpayer-Subsidized Coverage. Individuals with household incomes ranging from 100% to 400% of the federal poverty line for the size of the family involved who acquire coverage through the Exchange may be eligible for a subsidy in the form of a premium tax credit or reduced cost-sharing. The amount of any subsidy depends generally on the individual's household income and the cost of coverage provided through the Exchange. Additionally, as noted above, individuals whose employer covers at least 60% of the allowed costs under the plan and whose required contribution is less than 9.5% of household income are not eligible for taxpayer subsidies.

Reporting Requirements. Health insurance issuers or group health plans that provide minimum essential coverage to an individual are required to report the coverage to the IRS, including any portion of premium paid by the employer, and provide a statement to the individual. Large employers (i.e., employers with 50 or more full-time employees) and employers required to provide free choice vouchers (as described above) are subject to expanded reporting requirements.

Provisions Affecting Design or Administration of Group Health Plans

Health Care Reform adds many new benefit design and administrative requirements for group health plans. These new requirements are added to the Public Health Services Act (generally only applicable to insurers) and then incorporated by reference into ERISA and the Internal Revenue Code. The PPACA incorporates these provisions by adding them to ERISA Title I, Part 7 and Chapter 100 of the Code. The significance of this incorporation is that these sections are not generally applicable to separate ERISA retiree health plans, stand-alone dental or vision benefits or health FSAs. This means that those plans will be exempt from many Health Care Reform requirements. However, those sections (as well as the Health Care Reform requirements) are applicable to medical benefits, including employee assistance plans and HRAs and retiree medical benefits that are part of the same ERISA plan as active employee medical benefits. 

In addition, under the PPACA, group health plans that were in effect as of the date of enactment (Grandfathered Health Plans) would have been exempt from substantially all of the new requirements.  The HCERA substantially cut back the benefits of grandfathered status, but Grandfathered Health Plans remain exempt from many of the new requirements. The PPACA makes certain that new employees and family members can join Grandfathered Health Plans without the plan losing its grandfathered status. However, it is unclear whether substantial modifications or plan mergers would destroy grandfathered status.  Hopefully, this will be addressed in future regulatory guidance. 

Provisions Applicable to Grandfathered Health Plans

The following provisions are generally applicable to all group health plans, including Grandfathered Health Plans.  Unless a later effective date applies as set forth below, the following changes are effective for plan years beginning six months after enactment (or January 1, 2011 for calendar year plans).

Pre-Existing Conditions Exclusions for Children under Age 19. Group health plans may not impose any pre-existing condition exclusions with respect to children under age 19.

Lifetime Limits. Group health plans are not permitted to impose lifetime limits on the dollar value of benefits for participants or beneficiaries for "essential health benefits," which are generally those offered under the typical employer plan. Lifetime limits may apply to non-essential health benefits.

Restrictions on Annual Limits. Group health plans can only impose annual limits upon the coverage of participants and beneficiaries for essential health benefits in amounts determined by HHS. These restrictions do not apply to annual limits on non-essential health benefits.

Rescissions. Coverage under a group health plan cannot be rescinded except in the case of fraud or intentional misrepresentation of a material fact. Further, coverage cannot be cancelled except upon proper prior notice to the participant or beneficiary in the case of non-payment of premiums or termination of the plan. 

Adult Dependent Coverage. Group health plans that offer dependent coverage must offer coverage for adult children until age 26, regardless of whether the adult child is married. The HCERA amends the Code to provide that this coverage is not taxable. However, prior to January 1, 2014, coverage does not have to be offered to adult children who are eligible to enroll under another employer-sponsored health plan. Further, grandchildren are not required to be covered. Because group health plans will be required to cover adult children, the rules regarding dependent coverage of full-time students will be largely obsolete for medical benefits.  However, the full-time student rules could still be applied to stand-alone ERISA retiree medical plans and other benefits not subject to Health Care Reform (e.g., dental and vision benefits, life insurance, etc.).

Uniform Explanation of Coverage. HHS will develop uniform terms and formats for summaries of benefits and coverage for enrollees under a plan. Insurance issuers of insured plans and plan sponsors or administrators of self-insured plans are required to provide these summaries within 24 months of enactment and to enrollees at the time of enrollment. The penalties for noncompliance are $1,000 for each failure, applied separately for each enrollee.

Bringing Down the Cost of Health Coverage. Health insurance issuers for group health plans must report to HHS the percentage of premium revenue expended for reimbursement for clinical service provided to enrollees under the coverage, for activities that improve health care quality, and for all other non-claim costs, excluding state taxes and licensing or regulatory fees. Health insurance issuers will also have to provide rebates to participants to the extent they expend more than 20% of premium revenue on other non-claim costs (or a lower threshold, if determined by the state). This provision does not apply to self-insured health plans.

Pre-existing Conditions Exclusions for All Participants and Beneficiaries. Effective for plan years beginning on or after January 1, 2014, the prohibition on pre-existing conditions exclusions is extended to all participants and beneficiaries under a group health plan.

Excessive Waiting Periods. Effective for plan years beginning on or after January 1, 2014, group health plans are not permitted to impose a waiting period exceeding 90 days.

No Annual Limits. Effective for plan years beginning on or after January 1, 2014, no annual limits may be imposed on essential health benefits. Annual limits may apply to non-essential health benefits.

Expansion of Adult Dependent Coverage. Effective for plan years beginning on or after January 1, 2014, group health plans that offer dependent coverage must offer coverage for adult children until age 26, regardless of whether the adult child is eligible to enroll under another employer-sponsored health plan.

Provisions Not Applicable to Grandfathered Health Plans

The following amendments are applicable to group health plans other than Grandfathered Health Plans. Unless a later effective date applies as set forth below, the following changes are effective for plan years beginning six months after enactment (or January 1, 2011, for calendar year plans).

Coverage of Preventive Health Services. Group health plans must cover certain preventive services without any cost-sharing, including certain immunizations and screenings for infants, children and adolescents, and breast cancer screenings and mammography for women.

Patient Protections. Group health plans that provide for in-network coverage must permit each participant or beneficiary to designate any participating primary care provider who is available to accept that individual. Group health plans that cover emergency services cannot require advance authorization for emergency services and must cover expenses without regard to whether the provider is a participating provider.

Appeals Process. Group health plans are required to have in effect internal review processes and an external review process. The internal review process must, at minimum, initially incorporate the existing Department of Labor claims procedure regulations.  The external review process, at a minimum, includes the consumer protection requirements under the Uniform External Review Model Act. 

Nondiscrimination Rules for Insured Plans. Insured group health plans are prohibited from establishing eligibility rules that discriminate in favor of highly compensated individuals. These rules will be similar to the rules already applicable to self-insured group health plans under Code §105(h).

Transparency. Group health plans are required to submit to HHS and the state insurance commissioner, and to make available to the public information concerning claims payment policies and practices, financial disclosures, data on enrollment, disenrollment, claims denied and rating practices and information on cost sharing and payments for out-of-network coverage, enrollee and participant rights, as well as any other information required by HHS.

Ensuring Quality of Care. Within two years from the date of enactment, HHS will develop reporting requirements for use by group health plans designed to improve health outcomes, implement activities to prevent hospital discharge readmissions, implement activities to improve patient safety and reduce medical errors, and to implement and design wellness programs. Group health plans will also be required to submit reports to HHS annually describing their success in meeting these criteria.

The following provisions are applicable to group health plans, other than Grandfathered Health Plans, beginning with the first plan year on or after January 1, 2014.

No Discrimination Based on Health Status. Health Care Reform generally endorses the existing regulations relating to discrimination on the basis of health status and wellness plans under HIPAA. But Health Care Reform increases the limit of rewards or rebates under a wellness program for satisfying a standard related to a health status from 20% to 30% of the cost of coverage, which may be increased up to 50% by the Department of Labor, HHS and the IRS.

Cost-Sharing Limitations. Group health plans are prohibited from imposing cost-sharing provisions in excess of the limits for high-deductible health plans in 2014.  After 2014, the limits on cost-sharing provisions will automatically increase annually by formula.

Prohibition on Discrimination Against Providers. Group health plans are prohibited from discriminating with respect to participation under the plan against any health care provider who is acting within the scope of the provider's licenses or certification under applicable state law.

Revenue and Other Provisions

Health Care Reform imposes a number of tax and other provisions that will affect employers that sponsor group health plans. These provisions are summarized chronologically by their effective dates below.

Effective within 90 Days of Enactment

Reinsurance of Early Retiree Plans. HHS is charged with developing a reinsurance program for reimbursing employer-based plans with a portion of the cost of coverage for plans covering early retirees between the ages of age 55 and eligibility for Medicare.  Employers must apply for this reimbursement, and because funds are limited, employers should apply as soon as HHS announces the application procedures.

Effective January 1, 2011

W-2 Reporting. Employers will be required to report the aggregate cost of employer-sponsored coverage on Form W-2.

Reimbursements for Over-the-Counter Drugs. Reimbursements under a health FSA, HSA, HRA or Archer MSA for expenses for medicine or drugs will be limited to drugs for which a physician writes a prescription or insulin.

HSA Penalty Taxes. The penalty tax for HSA distributions not used for qualified medical expenses increases from 10% to 20%.

Effective January 1, 2013

Elimination of Deduction for Relating to Medicare Part D Subsidy Sponsors of retiree prescription drug plans will not be able to deduct amounts attributable to the Medicare Part D subsidy received from the federal government. This will substantially increase the costs of providing prescription drug coverage to retirees and may lead many employers to cut back retiree prescription drug coverage. Even though this is not effective until 2013, plan sponsors will likely need to reflect this change immediately in their financial statements.

Health FSAs. Employees cannot elect to have salary reduction contributions in excess of $2,500 annually, which will be indexed for inflation.

Medicare Taxes. An additional 0.9% Medicare tax is imposed on wages in excess of $250,000 for joint return filers or $200,000 for other filers. The additional tax applies to the employee portion only, but employers are responsible for withholding this tax from employees' wages. The HCERA also imposes a 3.8% tax on unearned income for joint return filers with modified adjusted gross income in excess of $250,000, or $200,000 for other taxpayers. 

Fees for Group Health Plans. Effective for years ending after September 30, 2012, there will be a fee assessed on issuers of insured plans and sponsors of self-insured plans in the amount of $1 per participant for the year ending in 2013, and $2 for each life covered under the plan or policy for the year ending in 2014, and indexed thereafter for increases in health care expenditures.  These fees are intended to be temporary and will not apply to plan years ending after September 30, 2019.

Effective January 1, 2018

High-Cost Plan Excise Tax. The Reconciliation Bill delayed the onset of the so-called "Cadillac plan tax" until 2018. This provision imposes a 40% excise tax on "excess health coverage."

Liability for Tax. The excise tax is imposed on health insurance issuers with respect to insured plans or the entity that administers the benefits with respect to self-insured plans.

Excess Health Coverage. Excess health coverage is the total cost of coverage (including the employee-paid portion) exceeding $10,200 for self-only or $27,500 for coverage other than self-only coverage for 2018.

Inflation Adjustments. The above dollar thresholds will increase with inflation and will automatically increase if the cost of the standard benefit option under the Federal Employees Health Benefits Plan for comparable coverage exceeds the applicable threshold. In making this determination, cost of the standard benefit option will be adjusted for the age and gender demographics of the employer's workforce.

High Risk Professions. Employees engaged in certain high-risk professions are subject to a higher threshold.

High Cost States. The HCERA eliminates a provision in the PPACA that would have provided a transition period in which higher cost states are subject to different thresholds.

Dental and Vision. The HCERA adds provisions that excludes stand-alone dental and vision benefits from the Cadillac tax. However, the wording of the exclusion suggests only insured benefits are excluded.

There are many provisions in the Health Care Reform legislation that will need to be examined and explained further by HHS and the IRS. Due to the staggered effective dates, hopefully both HHS and the IRS will have sufficient resources to address all of the provisions on a timely basis. However, it is clear that employers and plan administrators will be dealing with Health Care Reform for many years to come.

 For more information, in the Tax Management Portfolios, see Kenty, 389 T.M., Medical Plans — COBRA, HIPAA, HRAs, HSAs, and Disability,  and in Tax Practice Series, see ¶5920, Health and Disability Plans.