From the Hotline: Medical Loss Ratio Rebates

Question:  How do we handle the employee distributions from the carriers for Medical Loss Ratio (MLR) rebates?

Answer: The Medical Loss Ratio (MLR) is the percentage of premium that the insurance carrier spends on health care. Generally, the MLR is the amount spent on medical care (claims, clinical services and quality-improvement activities) divided by the amount of net premium (premium after subtracting certain license fees and taxes).

Starting with 2011 policy years, carriers must demonstrate that their MLRs meet the new minimum standards: 85% in the large group market or 80% in the small group market (or individual insurance market). The MLR standards apply only to insurance plans based on the carrier’s total policies in each market segment in each state. There is no MLR requirement for self-funded plans. “Mini-med” plans and expatriate plans also are exempt.

Under the Affordable Care Act, carriers that fail to meet the MLR standard must notify their policyholders and refund the excess portion of premium by August 1, 2012. HHS has issued a separate rule stating that issuers that do not owe rebates for 2011 are required to provide a notice to their policyholders and subscribers that they have met or exceeded the MLR standards. The notice is required for the 2011 MLR reporting year only and must be provided with the first plan document that the issuer provides to enrollees on or after July 1, 2012.

If rebates are due, it is important to note that these rebates are based upon aggregated market data in each state and not upon a particular group health plan’s experience.

In order to reduce burdens on issuers and to minimize the tax impacts on participants in and sponsors of group health plans, the final rule directs issuers to pay to the policyholder (usually the employer) any rebates owed to persons covered under a group health plan, through lower premiums or in other ways that are not taxable. According to Technical Release 2011-04, any portion of a rebate constituting plan assets must be handled in accordance with the fiduciary responsibility provisions of ERISA, if the plan is an ERISA-qualified plan.

Tips and information for handling the rebates:

ERISA health plans: Employers that sponsor an ERISA health plan must handle any carrier rebate they receive in accordance with Department of Labor guidance regarding plan assets. If employees make contributions (payroll deductions) to the plan, then a portion of the rebate must be treated as a plan asset since it is attributable to contributions made by the employees. The ERISA rules require that plan assets must be used exclusively for the benefit of the plan participants and beneficiaries.

In determining how to allocate the rebate, first determine who paid the premiums for the health insurance policy.

  • If the premiums were paid from a trust, the rebate should be deposited in the trust and used in accordance with the trust agreement.
  •  If the premiums were paid 100% by the employer, the employer can retain 100% of the rebate.
  •  If the premiums were paid 100% by the employees, the employees should receive 100% of the rebate.
  •  If the premiums were paid partly by the employer and partly by the employees, the rebate must be split between the employer and the employees. We recommend using a proportional share of premiums paid by the employees. For example, if the premium cost share between employees is 25% employee-paid and 75% employer-paid and the rebate received is $10,000, then $2500 should be rebated back to the participants and the employer could retain $7500.

Rebate Options: Employers may use the entire rebate to reduce employee contributions (or provide additional benefits). Cash refunds may create additional taxes to employees. The recent IRS guidance states that a cash refund to an employee would create a taxable event (unless the worker had previously contributed the funds on an after-tax basis). However, with a premium reduction, the amount employees pay for premiums that are subtracted from salary on a pre-tax basis under the employer’s cafeteria plan will be smaller which will increase the employee’s taxable wage base (but the taxable amount will be less than with a cash rebate).

After determining the portion of the rebate that is attributable to employee contributions, the employer will need to decide how to apply the rebates as follows:

  1. The rebate can be paid to the participants, under a fair and equitable allocation method. For example, the employer could “weight” the rebate so that an employee with family coverage who paid a larger share of premiums would get a larger share of the rebate. The employer may conclude that only current participants are allowed to share in the rebate. Each employee who received a share of the rebate would recognize additional taxable income.
  2. The employer can apply the rebate toward future participant premium payments.
  3. The employer could use the rebate to provide enhanced benefits for the participants.

The DOL suggests in the Technical Release that the second and third options be used if distributing payments to participants is not cost-effective, such as if the payments to participants are minimal or if they would give rise to tax consequences to the participants. In addition, the DOL guidelines suggest that the distribution, premium credit or benefit enhancement be made within three months after receipt of the rebate so that a trust to hold the rebate will not need to be established.

If the employer is receiving rebates from multiple policies, then the employer should allocate the rebates related to each policy to those plan participants who were covered by the policy. According to the DOL, using the rebate generated by one plan to benefit the participants of another plan is a “breach of the duty of loyalty” to a plan’s participants.

Plan documents for all ERISA health plans should include, or be amended to include, language allowing for rebates and describing how they will be treated.

NOTE: With the new W-2 benefits cost reporting requirement under the PPACA, the IRS’ FAQs do not indicate whether the employer has any obligation to report the MLR rebate on Form W-2.

We encourage you to work with your tax advisor and insurance broker on this issue.