One of the provisions in the new health care law states that a health insurance provider must spend less than 20% of the premiums they receive on administrative expenses. This is known as the 80/20 medical loss ratio. For this reason many insurance companies have started issuing rebates to their policyholders. This rebate may be in the form of a check from the insurance company or a reduction of your current premiums. Policyholders (employers) may need to return some of this money to their current and former employee participants.
There are a number of different ways to reimburse the participants. Those ways are contingent upon the amount of the premiums that are paid by the employer versus the participants. The regulations indicate that while the sponsor (employer) must act in a fiduciary capacity, factors such as administrative costs can also be considered. Therefore, if the fiduciary finds that the cost of distributing a portion of the rebate to former participants approximates the amount of the proceeds, the fiduciary may properly decide to allocate the proceeds to current participants based upon a reasonable, fair and objective method. There also is a question as to whether the rebate is taxable or not. The following items discuss these issues:
- If the employer paid the entire cost of the insurance coverage, then no part of the rebate would be attributable to the participant.
- If participants paid the entire cost of the insurance coverage, then the entire rebate would be attributable to the participants (such as COBRA payments).
- If the participants and the employer each paid a fixed percentage of the cost, the rebate would be allocated based upon that percentage.
- If the employer pays a fixed amount of the premium and the participants are responsible for paying the additional costs, then the rebate would go entirely to the participants as long as the rebate did not exceed the amount of premiums previously paid by the participants.
- If the participants paid a fixed amount of the premium and the employer was responsible for paying the additional costs, then the rebate can go entirely to the employer as long as the rebate does not exceed the amount of premiums previously paid by the employer.
- If the employee premiums are paid on an after-tax basis then any rebate, whether paid in cash or as a reduction in premiums, would not be subject to any employment taxes. The rebate may be taxable to the employee on their personal return, to the extent that they received a tax benefit if they took a deduction on their previous return.
- If the employee premiums are paid on a pre-tax basis then any rebate, whether paid in cash or as a reduction in premiums, are fully taxable. Since the premiums were previously subtracted from the employee’s salary under the employer’s cafeteria plan any rebate now received must be added to the employee’s wages as additional compensation subject to all employment taxes including FICA and Medicare taxes.
The allocation of the employee’s portion of the rebate can be dealt with in a number of different ways, including:
- Direct cash refund to employees who participated in the 2011 year based upon their ratio of premiums.
- Reduction in the 2012 employee premiums for employees who participated both in 2011 and 2012.
- Reduction in the 2012 employee paid premiums for employees who were participants in 2012 if the cost of distribution versus the allocation to 2011 participants is prohibitive.
The allocation need not be exact to each 2011 employee in the ratio of their premiums paid, since items a and b above will miss some 2011 participants who have left employment in 2011 or 2012, as long as the allocation is fair and equitable.
Each employer must also consult the written plan to be sure that the text itself does not provide direction regarding the allocation.
For more information, please contact us.