Tuesday, May 21, :00 p.m. 1:00 p.m. CST

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1 For audio participation, dial and enter Participant Passcode: The Benefits News You Need in 60 Minutes or Less Tuesday, May 21, :00 p.m. 1:00 p.m. CST 2

2 Housekeeping Issues Call for technology assistance Dial *0 (star/zero) for audio assistance If you have any questions following the Web conference, please contact your Foley attorney directly. Click on the Full Screen button located above the presentation slides to maximize the presentation for full screen viewing. Click on the Download Files button located to the right of the presentation slides to get a copy of the slides. Foley will apply for HRCI and CLE credit after the Web conference. If you did not supply your CLE information upon registration, please it to jpolson@foley.com. NOTE: Those seeking New York & New Jersey CLE credit are required to complete the Attorney Affirmation Form. A 5-digit code will be announced during the presentation. the code to jpolson@foley.com to get a copy of the form. Immediately fill it out and return it after the program. 3 Today s Speakers Gregg H. Dooge Joshua A. Agen Katherine L. Aizawa 4

3 Today s Topics PCORI Fees Due July 31 Are You Ready? Common Errors Under Code Section 409A Fiduciary Liability and Your Life Insurance Program 5 PCORI Fees Due July 31 st Are You Ready? 6

4 Patient Centered Outcomes Research Institute Research comparative effectiveness of medical treatments Findings will be made public Patients, health care providers, employers and policy makers to make informed health decisions 7 Funding for PCORI Insurance companies Sponsors of self-funded medical plans 8

5 Payment Deadline July 31 July 31 of the calendar year after end of plan year Same deadline for all plan years Similar to 5500 due date for calendar years, except NO extensions allowed 2012 through 2018 plan years, i.e., years ending before October 1, How to Pay Fees TPAs can NOT pay for sponsors Plan assets may NOT be used to pay fees Form 720 Quarterly Federal Excise Tax Return Form 720X for corrections No final decision as to the deductibility of the PCORI fees 10

6 Covered Employers Private and governmental Profit and non-profit Government and church employers are covered 11 Covered Plans Grandfathered and non-grandfathered are covered HRAs integrated with insured group health plan Retiree only plans 12

7 Plans Not Covered 6 Categories 1. Excepted Benefit Plan Health FSA is an excepted benefit if maximum benefit is not more than the (i) greater of 2 times the employee s pretax contributions, or the employee s pretax contributions plus $500, and (ii) FSA participants are eligible to participate in the medical plan 13 Plans Not Covered - continued Dental and vision plans are excepted benefits if (i) coverage may be declined, and (ii) employees who elect coverage must pay an additional contribution 2. EAPs, wellness or disease management programs if they do not provide significant medical care or treatment benefits. No guidance yet on what is significant. 14

8 Plans Not Covered - continued 3. Ex-Patriate Plans designed specifically to cover primarily employees who work and reside outside of the United States, which includes all U.S. territories: American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, the Virgin Islands, and any other possession of the United States 4. HRAs integrated with a self-insured plan 5. Stop loss policies what if attachment point is low? 15 Plans Not Covered - continued 6. Exempt Governmental Programs Medicare insurance programs Medicaid or Children s Health Insurance Program medical assistance programs Federally established plan for the care of members of the military and veterans Federally established plan for the care of members of Indian tribes 16

9 PCORI Fee Amount (Applicable Dollar Amount) times (average number of lives covered under the plan for the plan year) Applicable Dollar Amounts 2012: $1 2013: $ : indexed 17 Average Number of Lives Covered 2012 plan year (begins before 7/11/12 and ends on or after 10/1/12): Any reasonable method allowed Include individuals on Federal and State COBRA continuation periods Include retirees 18

10 Average Number of Lives Covered Aggregation Rule: Can combine self-insured plans with the same plan year Example: Employer maintains a self-insured medical plan, and a self-insured prescription drug benefit plan. If both have the same plan year, they can be treated as one plan and employee covered by both is only counted once. 19 How to Count Covered Lives 3 Methods 1. Snapshot Method Snapshot Factor Method Snapshot Count Method 2. Form 5500 Method 3. Actual Count Method 20

11 Consistency Requirements Must use the same method in calculating the average number of covered lives for the entirety of the plan year May use a different method from one plan year to the next 21 Snap Shot Method Step 1: Count total lives covered on a date each quarter Can use more than 1 date/quarter Dates in quarters must be within 3 days of the date(s) used in first quarter 30th and 31st of each month are treated as the last day of the month All dates must end in the same plan year 22

12 Snap Shot Method - continued Step 2: How to count lives Snapshot Count or Snapshot Factor Methods Snapshot Count: Number of actual lives covered Snapshot Factor: Number of employees with selfonly coverage on the date, plus the number with employees with other than self-only coverage times Snap Shot Method - continued Step 3: Determine average by adding totals for 4 quarters, and divide by 4. 24

13 Form 5500 Method Available only if Form 5500 is filed no later than July 31 after end of plan year. Dependents are not counted Plans with self-only coverage: Sum of total participant counts at beginning and end of year. Divide total by 2. Plans with self-only and family coverage: Sum of total participant count at beginning and end of year. 25 Actual Count Method Sum up the total lives actually covered for each day of the plan year Divide total by number of days in the plan year 26

14 Special Rules for Health FSAs and HRAs Employer offers a health FSA or HRA and a self-insured group health plan: Can aggregate and treat as a single plan. Applies only to the employees in the health FSA or HRA who do NOT participate in the group health plan. Count employees participating in both the health FSA or HRA and the selfinsured group health plan only once and for purposes of the self-insured plan Employees who participate in only the health FSA or HRA: Count only the employees and disregard dependents Employer offers only a health FSA or HRA, and no medical plan: Count only the employees covered by the FSA or HRA, and disregard dependents 27 Special Rules for Lives Covered Only by a Full-Insured Option When a Self-Insured Option Is Also Available Fully insured plan means any arrangement whereby a fixed premium is paid for the provision of health care, regardless of how much health care is provided, e.g., HMO If a self-insured plan offers a fully insured option, can disregard the lives covered solely under the fully insured option 28

15 Common Errors under Code Section 409A 29 Overview of Code Section 409A Applies to all deferred compensation Definition: a legally binding right in one year to compensation that is or may be payable in a later year Examples of arrangements that may be subject to 409A: Supplemental retirement plans Discounted stock options Restricted stock units Agreements providing for severance 30

16 Overview of Code Section 409A - Continued Basic idea of 409A is to limit control by service providers (and service recipients) over when income is recognized, taxed and/or deducted Limits take the form of strict rules on when the election to defer compensation must be made and when the compensation may be distributed Penalties for noncompliance are immediate recognition of income, extra tax of 20% on the compensation and interest penalties Additional penalties in some states (e.g., California) Gross-ups may add significantly to employer costs, if provided 31 The Many Challenges of 409A 409A is complex, formalistic, ambiguous and unforgiving Two voluntary correction programs: For plan errors IRS Notice , as modified by Notice For operational errors IRS Notice IRS is currently auditing 409A compliance Voluntary correction may not be available while service provider return is under audit 32

17 Error #1 Option Exercise Price at Less than Fair Market Value Nonqualified stock options and stock appreciation rights are exempt from 409A only if the exercise or grant price is at least equal to the fair market value of the underlying stock on the date of grant Other requirements: no additional deferral features, cannot be granted on the stock of a subsidiary, must relate to common stock Can 409A compliant discounted options, but they would need to meet all 409A requirements Potential audit target: determination of fair market value of the stock on the date of grant When is grant date? When all necessary corporate action to create the legally binding right has been taken 33 Error #1 Option Exercise Price at Less than Fair Market Value - Continued For publicly traded companies: value determined by any reasonable method using actual transactions on the market Examples include last sale before or first sale after grant, closing price on date of grant or day before, average price on day before or day of grant If using multi-day average, the averaging period must be irrevocably specified before the period begins 34

18 Error #1 Option Exercise Price at Less than Fair Market Value continued For private companies: value determined by the reasonable application of a reasonable valuation method Presumption of reasonableness for: Independent appraisal within the preceding 12 months Certain consistently applied valuation formulas Valuation of an illiquid start-up corporation (no material trade or business for 10 years or more) made by a qualified person 35 Error #1 Option Exercise Price at Less than Fair Market Value - Continued Sutardja v. United States demonstrates IRS focus on discount options under 409A Recommendation: document clearly the basis for determination of fair market value, the timing of option grant approvals and the timing of notification to award recipients 36

19 Error #2 Failure to Observe Six-Month Delay Requirement for Specified Employees Payment of deferred compensation to specified employees of publicly-traded companies upon their separation from service must be delayed until 6 months after separation from service Specified employee is defined in Code Section 416(i) and generally includes officers of the publicly-traded company and its controlled group members with compensation over $165,000 (limited to the top 50) 37 Error #2 Failure to Observe Six-Month Delay Requirement for Specified Employees - continued This is a plan document requirement Any deferred compensation arrangement that covers a specified employee must incorporate the 6-month delay if payments may be triggered by a separation from service Recommendations: Audit all deferred compensation arrangements to ensure the 6-month delay is incorporated Under Notice , a plan that does not include the 6-month delay may be eligible for correction if certain requirements are met One alternative to avoid complexity: apply the 6-month delay to all distributions upon an employee's separation from service 38

20 Error #2 Failure to Observe Six-Month Delay Requirement for Specified Employees - Continued Recommendations (continued): Establish a procedure (e.g., a checklist) that will identify any payments to specified employees on a separation from service Annually identify specified employees and maintain historical records 39 Error #3 Failed Short-Term Deferrals The short-term deferral rule provides that 409A does not apply to deferred compensation that is paid no later than the 15th day of the third month following the year in which the compensation is no longer subject to a substantial risk of forfeiture Examples of common short-term deferrals: Bonus or other incentive arrangements Restricted stock units that settle upon vesting 40

21 Error #3 Failed Short-Term Deferrals - Continued Potential audit targets: Is risk of forfeiture substantial? Could plan be read to permit payments to be made potentially later than the 2 ½ month deadline? Caution regarding multi-year performance periods in which some amount is essentially guaranteed after year 1 Retirement eligibility versus retirement 41 Error #3 Failed Short-Term Deferrals - Continued Are payments actually made by the 2 ½ month deadline? Caution regarding substantial risk of forfeiture that lapses at year end if payment is not made until audited financials are complete Recommendations: Document basis for reliance on short-term deferral rule Coordinate with payroll to ensure timing of payment meets deadline 42

22 Error #4 Mistaking the Separation from Service Date Employer may delay an employee s official termination date until the end of a severance period for some purposes In other cases, a terminated employee may continue to provide consulting services after the official termination date In either case, the timing of payments due on a separation from service under 409A must tie to the 409A definition of termination of employment, not to the termination date used for other purposes 43 Error #4 Mistaking the Separation from Service Date - Continued 409A termination of employment occurs when: Employer and employee reasonably anticipate that bona fide services that will be performed will permanently decrease to 20% or less of the average level over the preceding 36 months Recommendations: Establish a procedure (e.g., a checklist) in connection with employee terminations to determine the date of the 409A separation from service, regardless of when the termination occurs for other purposes Coordinate with payroll to ensure that payments are made on the 409A-required timeline 44

23 Error #5 Severance Conditioned on a Release Some severance arrangements require a release from the terminated employee and non-revocation as a condition of receiving payment If the employee s delay in providing the release can cause a delay in the timing of the payment, then the arrangement may not comply with the 409A requirement to specify the timing of distribution 45 Error #5 Severance Conditioned on a Release - Continued Plan may require a release without violating 409A by providing that, if the release is not returned and does not become irrevocable by the designated payment date, benefit will be forfeited Recommendation: Review all arrangements that may require a release If the timing of the release could affect the year of the payment, evaluate whether an amendment is required 46

24 Error #5 Severance Conditioned on a Release - Continued Notice sets parameters for corrective amendments: Must be made before the triggering event If the plan provides for payment within a designated period, then amendment must provide for payment only on the last day of the designated period Otherwise, the amendment must provide for payment only on a fixed date 60 or 90 days following the occurrence of the permissible payment event Must comply with notice and filing requirements 47 Error #6 Definition of Compensation for Elective Deferrals Elective deferred compensation plans define the types and amount of compensation a participant can defer under the plan If the plan document s definition of compensation and the operation of the plan do not match, a 409A operational error may result As an example: Plan may specify that the percentage of compensation deferred is calculated based on compensation paid before any deferrals to the 401(k) plan Payroll instead calculates the deferrals based on compensation paid after the applicable 401(k) deferrals Result is an ongoing operational error because too little is deferred under the plan 48

25 Error #6 Definition of Compensation for Elective Deferrals - Continued Recommendations: Verify that implementation of deferred compensation calculations matches the definitions in the plan Calculate expected deferrals in advance of a payroll run based on terms of plan and compare to actual deferrals that result Correct any errors as soon as possible using voluntary correction program 49 Fiduciary Liability and Your Life Insurance Program 50

26 ERISA s Fiduciary Duty Requirements Fiduciary must discharge duties with care, skill, prudence and diligence Court cases have determined that fiduciary duties: Include a requirement not to misrepresent a participant s benefits or the terms and conditions under which the benefits are available. May include a requirement to affirmatively provide information (even if the participant does not ask) if the fiduciary knows or should know that the information is important. 51 Fiduciary Duty Rules in Life Insurance Plans Life Insurance seems like a (relatively) low cost benefit Premium cost of group term life insurance not as expensive to employer as cost of providing other benefits. Supplemental (voluntary) group term life is employee-paid. However, in terms of fiduciary risk, life insurance disputes may result in substantial employer exposure. Dispute only arises when a death has occurred, so argument is not about premium cost, but rather the entire death benefit amount. A typical fact pattern is that participant is not eligible for or not enrolled in coverage under the insurance contract (so insurance company is not responsible), but the heirs make claim alleging that employer misrepresented eligibility rules or that the employer is responsible for enrollment failure (fiduciary breach claim). 52

27 Two Recent Cases Two life insurance cases: (1) Bicknell and (2) Weaver. The Bicknell case: Participant enrolled son in dependent life insurance program using online enrollment program. Maximum age for dependent coverage was 25. Employer withheld premiums from participant s paycheck and remitted premiums to insurance carrier through date of death, i.e., employer s actions might have suggested continuing coverage. Participant s son died at age 27. Insurance carrier denied coverage. Participant sued for death benefit. Participant claim included argument that employer breached its fiduciary duty by failing to notify participant of right to convert to individual insurance policy when dependent s group coverage terminated upon attainment of maximum age. 53 The Bicknell Case Other Facts Documentation provided to employee clearly stated the eligibility rules. On-line system contained conspicuous disclaimer: Claims will only be paid for dependents you have enrolled who meet the eligibility requirements for those plans. You are responsible for maintaining accurate information on the eligible dependents you want to cover. Result: Employer wins. 54

28 The Weaver Case The Weaver case: Participant ceased active employment due to long-term disability (cancer). Under terms of plan, life insurance coverage ceased one year after participant stopped active work. Participant passed away after the one year period. Heirs brought suit against employer for death benefits. Claim against employer for breach of fiduciary duty. Fiduciary breach claims included assertions based on material misrepresentation and failure to notify participant of right to convert to an individual policy of insurance. 55 The Weaver Case continued Employer apparently told participant that life insurance coverage would continue as though the participant were an active employee. Result: Heirs of the participant win. 56

29 Bicknell and Weaver: Explaining the Results Explaining the Bicknell and Weaver results Weaver involved a fact pattern in which the employer knew or should have known that continued life insurance coverage would be important. This created fiduciary duty to provide notice of conversion option. When a plan administrator fails to provide information when it knows that its failure to do so might cause harm, the plan administrator has breached its fiduciary duty to individual plan participants and beneficiaries. 57 Bicknell and Weaver: Explaining the Results continued Weaver involved a plausible misrepresentation claim. In Bicknell, no evidence of misrepresentation (other than continued collection of premiums). The employer on-line enrollment system in Bicknell included a conspicuous notice/disclaimer that enrollment on the on-line system was not a determination of eligibility. 58

30 Protecting the Employer How can an employer protect itself? Establish a process for notifying of right to convert to an individual policy of insurance. Almost every life insurance case involves a claim that the conversion notice was not provided. Notice of conversion rights will be an issue, either because the insurance law/contract seeks to place this obligation on the employer or because of the possibility that the employer is responsible as a matter of ERISA s fiduciary duty rules. Make certain that the SPD describes the conversion process. 59 Protecting the Employer continued Appropriately communicate (in writing) coverage end dates in disability situations. The alleged misrepresentation in Weaver likely involved a statement that was correct for the first year (coverage continues as if the participant were still active). However, it seems that the one-year end date was either not communicated or not understood. 60

31 Protecting the Employer continued Add appropriate disclaimer to documents and on-line enrollment systems. Disclaimer must be conspicuous, e.g., on the first page of the on-line system so that the participant sees it every time they log in. A disclaimer is unlikely to offer protection against a employer misrepresentation or failure to provide a conversion notice. However, an appropriate disclaimer/statement of responsibility can (a) clarify that enrollment will be effective only if it meets all plan rules, and (b) help combat the argument that employer accepted the employee s enrollment actions by continuing to take premiums/contributions on behalf of an ineligible person. 61 Contact Information Gregg H. Dooge gdooge@foley.com Katherine L. Aizawa kaizawa@foley.com Joshua A. Agen jagen@foley.com 62

32 Thank You A copy of the PowerPoint presentation and a multimedia recording will be available on Foley s website within 24 to 48 hours: We welcome your feedback. Please take a few moments before you leave the web conference today to provide us with your feedback. 63