written by Kevin Hogan
The Patient Protection and Affordable Act (“PPA Act”) now requires health insurance carriers to spend at least 85% (80% for smaller employers) of policyholder’s premium dollars on medical claims and health care quality improvement activities, as opposed to administrative and marketing expenses. This is known as the Medical Loss Ratio (“MLR”) standard. Insurance carriers that spend premiums below the MLR standard must refund the balance back to policyholder’s as a rebate, in the form of cash, or a reduction of future health insurance premiums. The MLR rebate check employers have begun to receive this year is a refund of premiums paid to insurance carriers in 2011.
The health plan sponsor must decide how to allocate the MLR rebate between the employer and current and/or former participants and how to use the money for the benefit of participants and beneficiaries (e.g., whether to pay rebates, reduce premiums or fund enhanced benefits). Since the MLR rebate would be considered a “plan asset” in most situations under ERISA, the plan fiduciary must use the MLR rebate solely for the benefit of plan participants and beneficiaries.
In deciding on an allocation method of the MLR rebate, the plan fiduciary may properly weigh the costs to the plan and the ultimate plan benefit as well as the competing interests of participants, provided such method is reasonable, fair and objective. If the plan sponsor is the policyholder (which is usually the case), the plan fiduciary must first review plan or policy language to determine what portion of the MLR rebate is considered plan assets.
If the documents are silent or unclear, the determination will likely be based on what percentage of total premiums were paid by the employer and participants in the prior year. For example, if the plan sponsor paid 60% of total premiums in 2011 and participants paid 40%, then 60% of the MLR rebate for 2012 would belong to the plan sponsor and 40% would be plan assets that must be used for plan participants.
MLR rebates should be paid back to participants within three months of the date the MLR check is received from the insurer. However, if the MLR cash rebate amounts to be paid back to participants are de minimis or would result in tax consequences to participants, the plan fiduciary may use the MLR rebate for other permissible plan purposes, including applying it toward future participant premium payments or toward benefit enhancements.
The IRS has issued a set of Frequently Asked Questions (“FAQ”) explaining the tax treatment to participants who receive an MLR rebate in the form of either a premium reduction or cash refund. The FAQ’s follow the premise of basic tax law that requires participants to be taxed on any portion of the MLR rebate in which they previously received a tax benefit. For instance, if participants paid their share of the premium on a pre-tax basis in 2011 through a cafeteria plan, then any 2012 MLR rebate will be subject to income and employment taxes in the year the rebate is received, whether the participant receives a check or current year premiums are reduced (effectively increasing taxable income to the participant).
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