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Legal Alert: Employee Benefit Nondiscrimination Basics

There are four main regulations that employers should consider when they are ensuring their employee benefit plans are not discriminatory in design, participation, or in operation.

Regulation: HIPAA

General Rule:

Prohibits group health plans and health insurers from discriminating with regard to eligibility and health status-related factors.

Who does this apply to?

All employer-sponsored group health plans subject to HIPAA (practically speaking, all employer plans are subject to HIPAA).

Test:

No specific test.

Definitions:

Under HIPAA, health factors are:

  • Health status
  • Medical condition (physical and mental)
  • Claims experience
  • Receipt of health care
  • Medical history
  • Genetic Information
  • Evidence of Insurability
  • Disability

Practical Impact:

Employers cannot exclude individuals who participate in dangerous activities, who have a history of high health claims, or hinge eligibility of enrollees on evidence of insurability or “passing” a physical exam.

Employers cannot exclude individuals from the plan for refusing to receive vaccinations or receive their annual physicals/exams.

Employers cannot exclude coverage related to specific disease treatments for individuals who are non-compliant with known therapies or who decline vaccinations for specific diseases.

Employers cannot charge individuals different premiums based on the existence or absence of health factors, unless it is done in conjunction with a bona fide wellness program that meets all regulatory requirements. For example, you cannot charge tobacco users (a health factor) more in premiums unless you have a proper tobacco cessation wellness program in place

Clauses limiting coverage to those who are “actively at work” at the time their waiting period ends are not permissible.

Employers cannot keep high claimants off the plan and in turn pay for a “better” or comparable plan in the individual market.

Penalties

Violating HIPAA nondiscrimination requirements can trigger numerous potential penalties, including an ACA-related excise tax penalty of $100 a day per affected plan participant.


Regulation: ACA (Section 1557)

General Rule:

ACA Section 1557 provides that individuals shall not be excluded from participation, denied the benefits of, or be subjected to discrimination under any health program or activity which receives federal financial assistance from HHS, based on race, color, national origin, sex, age, or disability. Consistent with the Supreme Court’s decision in Bostock and Title IX, beginning May 10, 2021, the Office of Civil Rights (OCR) will interpret and enforce Section 1557’s prohibition on discrimination on the basis of sex to include: (1) discrimination on the basis of sexual orientation; and (2) discrimination on the basis of gender identity.

Who does this apply to?

The rule applies to any program administered by HHS or any health program or activity administered by an entity established under Title I of the ACA, which are considered covered entities. The rule also applies to any health program or activity which receives federal financial assistance from HHS, which will include all fully insured plans. Some self-funded plans will also be considered a covered entity by the nature of their business. Because health insurance carriers are covered entities, all fully insured plans are subject to these rules.

Test:

No specific test.

Definitions:

Covered entities include, but are not limited to:

  • Hospitals
  • Nursing homes
  • Home health agencies
  • Laboratories
  • Community health centers
  • Therapy service providers (physical, speech, etc.)
  • Physicians’ groups
  • Health insurers
  • Ambulatory surgical centers
  • End-stage renal dialysis centers
  • Dental practices
  • Schools or universities with health programs receiving federal financial assistance through grant awards

Practical Impact:

Blanket, categorical or automatic exclusions for coverage of care associated with gender dysphoria or associated with gender transition is prohibited.

The regulations do not preclude neutral standards that govern the circumstances under which coverage will be offered.

Medical examinations (such as pelvic, prostate, or breast exams) cannot be denied based on a person’s sex assigned at birth, gender identity, or recorded gender, if they are medically appropriate.

Penalties:

Section 1557 rules are being litigated in various courts across the country. Anticipate additional guidance from HHS in the coming months and years. Employers should seek guidance from legal counsel on these regulations, particularly if they are a covered entity. Risks of categorical exclusions for treatment of gender dysphoria include regulatory oversight and civil lawsuits brought by plan participants.


Regulation: Internal Revenue Code, Section 125

General Rule:

Section 125 prevents employers from favoring or disproportionately offering pre-tax benefits to certain groups of highly paid or key employees. This prohibition relates to both the plan design and operation of the plan, as well as the actual utilization of the plan. Furthermore, certain components of 125 plans- notably health flexible spending accounts and dependent care flexible spending accounts- have additional nondiscrimination tests that must be run in addition to the general 125 tests.

Who does this apply to?

Any employer offering benefits on a pre-tax basis must do so through a 125 plan, that plan must undergo annual testing, and if the plan fails, the failure must be corrected.

Test:

A cafeteria plan must pass the following three tests unless a safe harbor applies:

  • Eligibility test
  • Contributions and benefits test
  • Concentration test
  • Definitions

Highly-compensated individuals are defined as:

  • Officers
  • 5 percent shareholders
  • Highly compensated employees (HCEs)
  • Spouses or dependents of any of the preceding individuals

Highly compensated means any individual or participant who – for the prior plan year or the current plan year in the case of the first year of employment – had annual compensation from the employer more than the compensation amount specified in the Internal Revenue Code and, if elected by the employer, was also in the top-paid group of employees for the year.

For 2021, the applicable compensation amount is $130,000.

A key employee is a participant who, at any time during the plan year, is one of the following:

  • An officer with annual compensation greater than an indexed amount ($185,000 for 2021)
  • A five percent owner of the employer
  • A one percent owner having compensation in excess of $150,000

Practical Impact:

Cafeteria plans must be open to all similarly situated eligible employees and must give each similarly situated participant a uniform opportunity to elect qualified benefits.  Highly compensated participants must not disproportionately elect qualified benefits. The plan cannot provide more than 25 percent of its nontaxable benefits to key employees.

Executive plans cannot be provided on a pre-tax basis, because they cannot be run through a 125 plan and pass the testing by the nature of their plan design.

Penalties:

A highly compensated participant or key employee in a discriminatory cafeteria plan must include the value of the taxable benefit (with the greatest value that the employee could have elected to receive) in their gross income. This requires both the employer and the affected employees to amend past tax filings to account for undeclared gross income, unpaid Social Security, FICA, FUCA, etc. There is no impact on participants that are not highly compensated or key employees.


Regulation: Internal Revenue Code Section 105(h)

General Rule:

A self-insured medical reimbursement plan must pass two nondiscrimination tests to ensure the plan does not favor highly compensated individuals.

Who does this apply to?

Any self-insured medical reimbursement plan, which includes self-funded major medical plans, health reimbursement arrangements (HRAs) and medical expense reimbursement plans (MERPs).

All plan sponsors should note that the ACA provided for section 105(h) to become applicable to fully insured plans, however, regulations have yet to be proposed on this topic.

Test:

The eligibility test determines whether there are enough regular employees benefitting from the plan. Section 105(h) has three methods of passing the eligibility test:

The 70% Test – 70 percent or more of all employees benefit under the plan.

The 70% / 80% Test – At least 70% of employees are eligible under the plan and at least 80% or more of those eligible employees participate in the plan.

The nondiscriminatory classification test – Employees qualify for the plan under a classification set up by the employer that is found by the IRS not to be discriminatory in favor of highly compensated individuals.

The benefits test determines whether all participants are eligible for the same benefits.

Definitions:

A highly-compensated individual (HCI) is an individual who is:

  • One of the five highest-paid officers
  • A shareholder who owns more than 10 percent of the value of stock of the employer’s stock
  • Among the highest-paid 25 percent of all employees (other than excludable employees who are not participants)

The following employees may be excluded from the highest-paid 25 percent of all employees unless they are eligible to participate in the plan:

  • Employees who have less than three years of service
  • Employees who are not 25 years old
  • Part-time employees (defined as customary weekly employment of less than 35 hours) or seasonal employees (defined as customary annual employment of less than 9 months)
  • Collectively bargained employees
  • Nonresident aliens who receive no earned income from U.S. sources

Practical Impact:

Self-funded plan sponsors should be cautious of plan designs that create separate plans for different employee groups or that do not cover all employees, or base employer contributions or benefits on employees’ years of service or compensation level.

Penalties:

If the plan fails the nondiscrimination tests, then highly compensated individuals’ excess reimbursements will be taxable. Amounts that are excess reimbursement are includable in a highly compensated individual’s income; the excess reimbursement calculation varies based on whether the benefits were paid to highly compensated individuals due to either discriminatory coverage for failing to meet the eligibility test, or discriminatory benefits for failing to meet the benefits test.

The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such. Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice. This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc. Updated as of 09/28/2021.

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