IRS Issues New Proposed Cafeteria Plan Regulations

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1 FOCUS on Benefits September 2007 In This Issue IRS Issues New Proposed Cafeteria Plan Regulations Washington Update: Wellness Bill Introduced in Senate Rhode Island Cafeteria Plan DOL Reports on FMLA Comments Back to the Future? Study Attests to Effectiveness of Traditional Diabetes Meds Media Adds to VEBA Confusion Medicaid Programs Affected by Doctor Shortage Spotlight On... High Cost of Maternity in a High-Deductible Health Plan IRS Issues New Proposed Cafeteria Plan Regulations On August 3, the Internal Revenue Service published new cafeteria plan regulations in the Federal Register. The new rules are proposed regulations (meaning that they are not legally binding). Employee benefits professionals have been awaiting new cafeteria plan guidance for years. The new proposed regulations will govern the operation of all types of cafeteria plans, including plans that: Are simple and allow health plan and other contributions to be deducted pre-tax Provide cash payments to employees that decline coverage under an employer s medical plan Provide health flexible spending arrangements that allow employees to reduce their pay in order to receive nontaxable reimbursement of health care expenses Provide dependent care flexible spending arrangements that provide similar opportunities for dependent care expenses Provide flex credits that employees can use to pay for benefits available under the plan Provide for employees to make pre-tax contributions to health savings accounts Even though the new rules are only proposed, they represent an important step toward the IRS providing meaningful cafeteria plan guidance. Existing cafeteria plan guidance on matters other than election changes consists largely of a 23-year-old set of proposed regulations that has been revised piecemeal over the years, resulting in confusing and sometimes conflicting guidance. The result has been that employee benefits professionals have relied on informal, non-binding statements from IRS representatives to determine how to structure and operate cafeteria plans. Willis Employee Benefits 09/07

2 The new proposed rules replace the previous proposed rules and include provisions explaining: The benefits that can be offered through cafeteria plans Requirements for valid cafeteria plan elections Operation of flexible spending arrangements Requirements that must be met in order for expenses to be paid on a pre-tax basis through a cafeteria plan Nondiscrimination requirements for cafeteria plans Guidance on this last topic nondiscrimination is particularly welcome, because the IRS has not previously issued any official guidance in any form on the topic. Willis Legal & Research Group will be studying the new proposed regulations and reporting on them in future editions of FOCUS on Benefits. healthcare costs and keeping our population healthy. The bill s sponsors note that businesses are increasingly bearing the costs of diet-related chronic disease and obesity through employer-provided healthcare plans and, indirectly, through higher rates of absenteeism. Specifically, S would provide a tax credit of up to $200 per employee for the first 200 employees and up to $100 per employee thereafter to businesses that provide comprehensive wellness programs for up to ten years. To be eligible for the tax credit, the program must contain three of the following provisions. Health awareness programs that include education and health risk assessments Behavioral change programs that encourage employees to lead a healthy lifestyle through counseling, seminars or online programs, including classes on nutrition, stress management or smoking cessation A supportive environment to encourage employee participation in workplace wellness programs, which could include a meaningful incentive to participating employees, such as a reduction in health insurance premiums An employee engagement committee, which would tailor the wellness program to the needs of the workforce at a particular company Washington Update: Wellness Bill Introduced in Senate In July, Senators Tom Harkin (D-IA) and Gordon Smith (R-OR) introduced the Healthy Workforce Act (S. 1753). The Act would provide tax incentives to businesses that offer wellness programs designed to encourage employees to lead healthier lives and help prevent many chronic illnesses. Much of the cost borne by our healthcare system is from preventable chronic illnesses as a result of poor diet and lack of exercise, Smith said in a press statement. By encouraging businesses to educate and motivate their employees to take their health seriously, we can take a significant step toward lowering Once again, the government arrives late to the party. For almost a decade, a growing number of employers have found that expanding workplace wellness programs and incentives for individuals to lead healthier, more active lifestyles, is a key strategy in addressing rising healthcare costs. 2 Willis Employee Benefits 09/07

3 Rhode Island Cafeteria Plan The state of Rhode Island recently enacted legislation requiring employers with more than 25 employees to establish and maintain a Section 125 cafeteria plan so that employees may purchase health insurance on a pre-tax basis. The law does not require employers to pay for or make any contribution toward the cost of health insurance purchased through the cafeteria plan. Employers must comply with this requirement on or before July 1, As most organizations well understand, a Section 125 cafeteria plan is a program that allows employees to choose between receiving cash (their normal wages) and certain non-taxable benefits, which can generally be purchased on a pre-tax basis. It is not yet clear how the new Rhode Island law will affect employers who do not currently offer any benefits to employees or who exclude certain employees from participating in employersponsored benefits. Additional guidance is sorely needed. Presumably, though, the state wants employers to allow employees to access the cafeteria plan to purchase health insurance, even if the employer is not directly sponsoring the health insurance benefits. (An interesting legal argument might arise, as federal law likely deems that any benefit made available pursuant to a cafeteria plan would constitute a program subject to ERISA.) Benefit professionals will immediately note the difficult and complicated issues that result from allowing employees to pay for individual health insurance with pre-tax amounts elected under a cafeteria plan. In such circumstances an employer could easily be deemed to sponsor any or all of the individual policies, which would result in a variety of compliance obligations, including ERISA, COBRA and HIPAA. Would ERISA preempt the Rhode Island requirement compelling employers to sponsor a Section 125 plan? Although a Section 125 plan is not directly subject to ERISA, we believe there are strong legal arguments supporting the position that such a mandate is preempted. Massachusetts did include a similar requirement in its Health Care Reform Act, and it has not yet been challenged. (For additional information about the Massachusetts Health Care Reform Act, see Willis Employee Benefits Alert, Issue 110, The Massachusetts Health Care Reform Act: What s an Employer to Do?.) DOL Reports on FMLA Comments The Family Medical Leave Act (FMLA) became effective for most covered employees in The law provides eligible employees up to 12 weeks of unpaid, job-protected leave per year to care for a newborn baby or for a child placed in the employee s home through adoption or for foster care; to care for a spouse, parent or child with a serious health condition; or when the employee is unable to work due to the employee s own serious health condition. Since inception, the administration of the FMLA has been difficult and confusing. Last December, the Department of Labor (DOL) undertook to obtain comments from the public about their experiences with the FMLA. More than 15,000 responses were received from workers, family members, employers, unions, academics and other interested parties. These responses were analyzed and published in a report available at The DOL categorizes the comments into three primary areas. Gratitude from employees who have used family and medical leave Desire for additional benefits, such as more time off, paid leave, or expanding the leave to cover additional family members Frustration by employers in maintaining necessary staffing levels and controlling attendance problems, particularly as a result of unscheduled intermittent leave 3 Willis Employee Benefits 09/07

4 In fact, the DOL states that intermittent leave is the area of greatest friction between employers and employees relative to the FMLA. Although individuals have the right to intermittent leave, the DOL acknowledges that it is particularly difficult for certain industries with time-sensitive components (such as transportation, telecommunications, healthcare, public safety and manufacturing) to compensate adequately for unscheduled leave. Employers reported that intermittent FMLA leave can result in missed holidays and vacation, lower morale and added stress for other employees. The medical certification process is another area of concern. None of the parties involved is satisfied with the current system. The lack of meaningful information, the costs associated with obtaining the certification, and the difficulty in predicting health problems all contribute to the dissatisfaction. The report includes comments on other FMLA topics such as the definition of a serious health condition, employee rights and responsibilities, the interplay between the FMLA and the ADA, and substitution of paid leave for unpaid FMLA leave. Back to the Future? Study Attests to Effectiveness of Traditional Diabetes Meds The Wall Street Journal (June 18, 2007) reports a new government study s findings that widely available and far less expensive diabetes drugs are as safe and effective as newer diabetes drugs. The findings are good news for diabetics and group medical plans, but may hurt some pharmaceutical companies. In recent years, diabetes has reached epidemic proportions. Current reports suggest that the condition affects about 20 million people (about seven percent of the US population). Most have Type 2, which occurs when the body under-produces insulin or is unable to use what it does produce. Being overweight increases the risk. The federal Agency for Healthcare Research and Quality (AHRQ) first commissioned the analysis of diabetes drugs in AHRQ is the nation s leading federal agency for research on healthcare quality, costs, outcomes and patient safety. It is also the health services research arm of the US Department of Health and Human Services (HHS), complementing the biomedical research mission of its sister agency, the National Institutes of Health. AHRQ s stated goal was to undertake the first in-depth comparison of oral medications that have come out in the last decade, as well as older ones, such as sulfonylureas, that have been sold for 50 years. For more information about the AHRQ and details about the study, visit: The DOL emphasizes that this report is not necessarily a prelude to new proposed regulations, but rather, a unique step in expanding the discussion. Others, however, believe that issues raised here and in prior court decisions need clarification, and new regulations may eventually be proposed. 4 Willis Employee Benefits 09/07

5 Media Adds to VEBA Confusion The New York Times (July 18, 2007) reports that a tough road lies ahead for the United Auto Workers (UAW), as the union and auto manufacturers begin a new round of contract negotiations late this month. The article notes that UAW worker healthcare obligations total about $12 billion annually, and those costs are expected to grow as union members age. Car manufacturers are eager to restructure their firms and regain profitability, but even with layoffs, the medical costs related to current and retired workers will rise. General Motors, Ford and others claim it costs them $1,000 per car to offer workers healthcare and pension benefits which is far more than the several hundred dollars (or less) foreign competitors spend on similar benefits. UAW leaders have stated that the union has already compromised on benefits and is unlikely to budge on previous contract gains. The Times indicates that the union may push for establishment of a VEBA (voluntary employees beneficiary association) trust to meet the cost of future retiree health expenses. As envisioned by the union, the trust would be funded up front with cash to account for all the manufacturers liabilities, equal to about $100 billion, but it is unclear if the manufacturers have the funds to establish the trust with cash. VEBA trusts have been put in place by organizations such as Goodyear and are reported in the popular press as permitting the unionized employers to off-load their retiree medical liability. This may appear to be an appealing way for any employer to either dump current retiree medical liability or to offer a retiree medical plan and avoid the FAS 106 costs associated with such plans. Unfortunately, that result is not in the offing for most employers. If an employer has or sets up a retiree medical plan, the accounting rules under FAS 106 require the employer to include the future expected liability on their financial statements, and any growth in that liability will reduce current income. A VEBA is a funding vehicle, but using a VEBA will not change the result. Although those assets may offset the liability to some extent, so do any other assets the employer has. The growth in the assets is unlikely to match the growth in the liability, either in size or even in direction. Therefore, a VEBA will just not be effective in offsetting the FAS 106 liability, but it will tie up those assets in a trust that cannot be used for any other purpose. So, why is the auto industry looking at VEBAs, and why did Goodyear use one? Union retiree medical benefits are the subject of collective bargaining. Such benefit obligations cannot be changed except as a result of good faith bargaining. Non-unionized employers could, generally (if they retained the right to do so in the plans), simply terminate retiree medical benefits. Terminating such benefits eliminates the FAS 106 liability because there is no more obligation to provide the benefit (retaining the benefit but using a VEBA does not change that result). However, the unionized employers bargained for the termination of the plan, which would also eliminate the FAS 106 liability. In brokering this deal, the Goodyear unions demanded a cash payment into the VEBA trust. However, that transfer ended the employer s obligation. It is not clear what, if any, obligation Goodyear would have to make up a shortfall; however, in this case, Goodyear was able to wipe the obligation off its books, because the union took over that obligation. Unfortunately, non-unionized employers do not have that same option. [VEBAs] may appear to be an appealing way for any employer to either dump current retiree medical liability or to offer a retiree medical plan and avoid the FAS 106 costs associated with such plans. Unfortunately, that result is not in the offing for most employers. 5 Willis Employee Benefits 09/07

6 Medicaid Programs Affected by Doctor Shortage On July 25, 2007 the Wall Street Journal reported an interesting phenomenon developing around Medicaid coverage: patient difficulty in accessing coverage because fewer and fewer doctors are accepting Medicaid. Much of the problem stems from Medicaid s low reimbursement levels, which are generally lower than Medicare reimbursement and significantly lower than private insurer reimbursements for identical procedures. The article notes that the problem appears to be especially acute in states such as Massachusetts, where Medicaid is being used as a cornerstone for plans to provide health coverage to the uninsured. In Massachusetts, many policyholders find it difficult to even get an appointment with a primary care physician, and if they are able to set up an appointment, it could be up to seven weeks away. The Massachusetts Medical Society recently reported a 57 percent increase over last year in terms of the waiting period between calls for appointments and actual visits to the doctor s office, and about 50 percent of internists are not accepting new patients. The Massachusetts universal healthcare plan is expected to provide coverage for more than 500,000 uninsured state residents, but primary care physicians are concerned that they will be unable to accommodate additional patients, even if they do have insurance coverage. Much of the problem stems from Medicaid s low reimbursement levels, which are generally lower than Medicare reimbursement and significantly lower than private insurer reimbursements for identical procedures. Medicaid Patients Doctor Availability The number of internists interested in primary care practices has also declined, leaving the already strained sector scrambling for providers. Policyholders under the state s new health insurance plan, dubbed Commonwealth Care, cannot visit a specialist without a referral from a primary care physician. The practical result: with timely appointments with primary care physicians difficult or impossible to obtain, these once uninsured residents will still not get the healthcare they need. Community healthcare centers in the state are the hardest hit by the new insurance program, because they do not have enough primary care physicians to meet the demand in low-income neighborhoods. Spotlight On... High Cost of Maternity in a High- Deductible Health Plan A new study suggests that families typically pay much more out of pocket for maternity care when covered by a high-deductible health plan (HDHP) paired with a health savings account (HSA). Although not always the case, this increased cost can be significant when considering the cost of a complicated pregnancy or one that requires a longer hospital stay. The Georgetown University/Kaiser Family Foundation study compared a traditional health plan for federal employees (with a $500 annual deductible and $20 co-payment for office visits), a HDHP for federal employees and a HDHP offered through small business. The out-of-pocket costs for an uncomplicated delivery in the traditional plan was $1,455, but $3,000 for the federal HDHP, and $7,000 in the small business HDHP. Out-of-pocket costs for a Caesarean delivery (longer hospital stay, otherwise uncomplicated pregnancy) were $2,244 under the traditional plan, $3,545 under the federal HDHP, and $7,688 under the small business HDHP. For a more complicated delivery (treatment for gestational diabetes and hospitalization for pre-term 6 Willis Employee Benefits 09/07

7 labor), however, the traditional plan out-of-pocket costs were $8,770, and $14,000 in the small business HDHP, but only $6,000 in the HDHP for federal employees. When multiple-plan options are available, the report emphasized the need to look at total cost premium, deductible and the out-of-pocket limits to determine which plan best meets an individual s needs. We have recently seen plenty of mainstream media effort devoted to discrediting consumer-directed programs and generally presenting HDHPs in a bad light. Those articles typically reflect the non-employer perspective. Note that the appearance of such articles is a good indication of the effectiveness of such programs in controlling plan costs historically borne by employers. Of course, Willis continued focus is on plan design options from an employer s cost-control perspective. A copy of the survey report can be found on Kaiser s web site 7 Willis Employee Benefits 09/07

8 Key Contacts US Benefits Office Locations Atlanta, GA Farmington, CT Minneapolis, MN San Diego, CA Austin, TX Florham Park, NJ Mobile, AL San Francisco, CA Baltimore, MD Ft. Worth, TX Naples, FL San Jose, CA Birmingham, AL Grand Rapids, MI Nashville,TN San Juan, PR Boston, MA Greenville, SC New Orleans, LA Seattle, WA Cary, NC Houston, TX New York, NY Tampa, FL Charlotte, NC Jacksonville, FL Omaha, NE Washington, DC Chicago, IL Knoxville, TN Orange County,CA Wilmington, DE Cincinnati, OH Cleveland, OH Columbus, OH Las Vegas, NV Long Island, NY Los Angeles, CA Orlando,FL Philadelphia, PA Phoenix, AZ FOCUS on Benefits is produced by Willis Legal & Research Group. The information contained in this publication is not intended to represent legal advice and has been prepared solely for educational purposes. You may wish to consult your attorney regarding issues raised in this publication. Dallas, TX Louisville, KY Pittsburgh, PA Denver, CO Memphis, TN Portland, OR Detroit, Ml Miami, FL Roswell, NM Eugene, OR Milwaukee, WI St. Louis, MO Willis Employee Benefits 09/07