Paying Employees to Opt Out of Health Insurance or Other Benefits: Problems and Potential Solutions

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Employers attempting to reduce the costs associated with their employee benefits may seek to implement an opt-out arrangement, whereby employees who decline coverage under the employer’s group health plan and/or its other benefits receive some kind of financial incentive for doing so (usually in the form of additional taxable compensation). There are several potential compliance issues with implementing such arrangements, particularly with respect to group health plan opt-outs. Employers that have implemented, or may seek to implement, such arrangements should be aware of these issues and potential strategies for now to mitigate the risks associated with these issues.

Effect of Health Plan Opt-Out Payments on ACA Affordability

If an employer offers additional compensation to employees who decline coverage under the employer’s health plan, then the amount of the opt-out payment generally is added to the employee’s required premium contribution when determining whether the plan meets the ACA’s affordability standards, regardless of whether the employee actually declines coverage and receives the opt-out payment. The reason why the IRS takes this position is that the IRS views opt-out payments as additional amounts of compensation an employee must forgo in order to participate in the plan, and thus, the IRS views opt-out payments as being economically equivalent to the salary reductions employees must elect in order to pay for their required premium contributions. Because of this IRS’s position, it is likely that health plan opt-out payments will cause a plan to no longer be considered “affordable” for ACA Employer Mandate purposes, which then may cause the employer to incur “subsection (b) penalties” if one or more employees receive subsidized health insurance coverage through the Marketplace/Exchange.

The IRS’s proposed regulations issued in July 2016 included an exception to this rule for “eligible opt-out arrangements.” Eligible opt‐out arrangements are arrangements under which opt-out payments are conditioned upon the employees providing reasonable evidence that they and their “expected tax family” have or will have minimum essential coverage (“MEC”) other than individual market coverage during the plan year or other period covered by the opt-out arrangement. For example, the other coverage could be through a spouse’s employer’s plan.

The “reasonable evidence” of other coverage can include the employee’s attestation (i.e., self-certification) of such other non-individual market coverage for the relevant period; however, employers must not make the opt-out payments if they know or have reason to know that the employee or his/her tax family do not, or will not, have such other coverage. Reasonable evidence of the other coverage must be provided (a) no less frequently than every plan year to which the arrangement applies, and (b) no earlier than a reasonable period of time before the period of coverage begins. An attestation obtained as part of open enrollment that occurs within a few months before the commencement of the next plan year will meet this requirement.

Potential Medicare Secondary Payer and Nondiscrimination Issues

It is generally best to offer opt-out arranagements to all eligible employees, since offering an opt-out arrangement only to certain employees or groups of employees could violate various federal laws (depending on the employees/groups that are included in and excluded from such arrangements). For example, the Medicare Secondary Payer (“MSP”) rules prohibit a plan sponsor from offering a “financial or other incentive” for an individual entitled to Medicare “not to enroll (or to terminate enrollment) under” a group health plan that would otherwise be the individual’s primary health coverage. HHS representatives have informally indicated that no MSP violation occurs if employees entitled to Medicare have the same opt-out payment rights as employees who are not entitled to Medicare. However, offering an opt-out arrangement to all eligible employees, while a much safer approach, is still subject to some risk if any of those employees are Medicare eligible, since there is no formal guidance confirming the HHS representatives’ aforementioned statements. As a better approach, employers attempting to meet the requirements applicable to “eligible opt-out arrangements” for ACA purposes (as described above) should restrict opt-out payments not only to those who have MEC that is not individual market coverage, but also to those who have MEC that is not Medicare coverage. In addition to the potential MSP issue, if an opt-out arrangement is limited to a specific group of employees or is otherwise designed in such a way that, directly or indirectly, targets high claims individuals, then the opt-out arrangement could be considered as violating HIPAA’s prohibition against discriminatory treatment based on a health factor.

Other Considerations

Opt-out arrangements should be offered under a Code Section 125 cafeteria plan. This is because opt-out arrangements offer employees an option between employer contributions toward their health insurance coverage (a non-taxable benefit under Code Section 106) and additional cash compensation (a taxable benefit). Therefore, if an opt-out arrangement is not offered under a cafeteria plan, then pursuant to the “constructive receipt doctrine” under tax law, the arrangement could result in immediate taxation of the opt-out payment amounts to eligible employees, even for those who choose to enroll in the health plan and, thus, do not receive any opt-out payments. Additionally, employers should be aware that Federal or state wage laws may treat opt-out incentives as wages for purposes of calculating overtime payments. FLSA guidance and regional court opinions should be consistently reviewed to confirm legal developments on this issue.