Inevitably, anything as massive as health care reform will have unanticipated consequences. One of those appears to be a renewed demand for welfare benefit trust funds. This demand arises in a specific context: self-insured, stand-alone retiree health plans. To understand this recent phenomenon, some history is in order.
Those who have been in the benefits field for twenty or more years can remember a time when most self-insured, employer health plans were funded through trusts. These were designed to comply with ERISA’s requirement that “plan assets” (such as participant contributions) be held in trust, for the exclusive benefit of plan participants and their beneficiaries. Most of these trusts were also designed to be exempt from federal income tax under Section 501(c)(9) of the Tax Code, thereby constituting “voluntary employees’ beneficiary associations” (or “VEBAs”).
Then something happened that drove VEBAs into near extinction. This was the Department of Labor’s 1988 announcement (in its Technical Release 88-01) that it would not enforce ERISA’s trust requirement with respect to participant contributions to welfare plans if those contributions were made through a Code Section 125 “cafeteria plan.” Four years later (in Technical Release 92-01), the DOL confirmed that this “trust nonenforcement policy” applies for annual reporting purposes, as well.
This was an important clarification. Both then and now, an unfunded welfare plan (i.e., one with no “plan assets”) is exempt from ERISA’s requirement to file an Annual Report (Form 5500) if it has fewer than 100 participants. And although larger plans must file an Annual Report, they are exempt from the related audit requirement if they are unfunded. Technical Release 92-01 made clear that any welfare plan that was excused from holding participant contributions in trust could also take the position that it was “unfunded” for purpose of these annual reporting requirements.
As a way of avoiding these additional reporting requirements, sponsors of self-insured health plans began rushing to terminate their VEBAs. This approach carried the additional advantage of relieving the VEBA, itself, from the obligation of filing a tax return (on Form 990) with the IRS each year. About the only exceptions to this VEBA-termination trend were collectively bargained plans, where trusts were required under collective bargaining agreements (and, in the case of multiemployer plans, compliance with the Taft-Hartley Act).
So what has now changed to stem this anti-VEBA tide? Oddly enough, it is health care reform. More specifically, it is the desire on the part of many sponsors of self-insured health plans to avoid having to comply with the health care reform mandates in the context of their retiree health coverage. By splitting a health plan into two separate plans — one for active employees and one for retirees — the sponsoring employer can achieve this goal.
The retiree-only plan will be exempt from all of the health care reform mandates, and not just those from which “grandfathered” plans are exempt. Thus, for instance, a retiree-only plan may continue to apply lifetime limits on essential health benefits, low annual limits on such benefits, preexisting conditions limitations or exclusions on individuals under age nineteen, and a maximum dependent age of less than twenty-six.
How can that be? It is because the health care reform mandates do not apply to any plan that is exempt from the requirements of the Health Insurance Portability and Accountability Act (“HIPAA”). One such HIPAA exemption applies to “certain small group health plans.” These are defined in DOL regulations as any plan that, “on the first day of the plan year, has fewer than two participants who are current employees.” Although initially viewed as an exemption for single-employee plans, the preamble to regulations interpreting the health care reform mandates concedes that this exemption applies to “retiree-only” plans, as well.
As a result, many sponsors of health plans that had covered both active and retired employees have elected to spin off their retirees into a separate plan. To ensure that the agencies charged with administering health care reform do not view the retirees as continuing to participate in the same plan as the active employees (which would undermine the retiree plan’s exemption from the health care reform mandates), most of these employers have taken pains to characterize the retiree-only plan as a separate ERISA “plan.” This requires the drafting of a separate plan document and summary plan description, the assignment of a separate plan number, and (when the time comes) the filing of a separate Annual Report.
So far, so good. So what exactly is the problem? Well, it has to do with the precise scope of the DOL’s trust nonenforcement policy.
On its face, Technical Release 92-01 applies only to participant contributions that are made through a cafeteria plan. (Although the nonenforcement policy also applies to participant contributions that are forwarded to a plan’s insurer within 90 days of their receipt by the employer, this aspect of the policy has no application to a self-insured plan.) Typically, only active employees are allowed to participate in a cafeteria plan. This is because they are the only participants who have any salary that can be recharacterized as an employer contribution. For this reason, the DOL was asked to extend its trust nonenforcement policy to welfare plans under which retirees or COBRA beneficiaries make their contributions on an after-tax basis.
Responding to a question raised during a 1996 American Bar Association committee meeting, a DOL representative stated that the trust nonenforcement policy would apply to all participant contributions — so long as any contributions made by active employees are made through a cafeteria plan. Thanks to this clarification, plans covering both active and retired employees have been able to rely on this trust nonenforcement policy with respect to all of their participants.
In responding to this same 1996 question, however, the DOL representative cautioned that the trust nonenforcement policy would not apply to either retiree or COBRA contributions if Technical Release 92-01 is not otherwise applicable to the plan. This would appear to be the case for a self-insured, retiree-only plan. IRS regulations specifically bar a cafeteria plan from being “established or maintained predominantly for the benefit of former employees.” And while it is permissible for some cafeteria plan participants to be former employees, there is a significant risk that characterizing retirees as participants in the same cafeteria plan as active employees would undermine the degree of “separateness” required to bring the retiree-only plan within the scope of the HIPAA exemption.
As a result, any self-insured, retiree-only health plan sponsored by an employer to whom ERISA applies (i.e., not a governmental or church plan) should hold any retiree contributions in trust. This, in turn, would cause the plan to be “funded” for purposes of the annual reporting requirements So what are the practical implications of this conclusion? Among other things, any sponsor of a self-insured, retiree-only health plan should take the following steps to remain in compliance with both ERISA and the Tax Code:
1. Draft a trust agreement sufficient to create a trust for the holding of retiree contributions.
2. Identify and appoint one or more trustees of that trust. This could be either a financial institution or one or more employees of the plan’s sponsoring employer.
3. Coordinate the proper flow of funds with any third-party administrator or other parties involved in collecting retiree premiums. The only legal requirement is that retiree contributions be deposited into the trust as soon as they can reasonably be segregated from the sponsoring employer’s general assets. To keep the trust assets at a bare minimum, however — thereby avoiding the question of how those assets should be invested — the contributions should probably be sent to the third-party administrator on a frequent basis. Remember that those assets can be used to pay claims incurred only by retirees and their dependents (i.e., participants in the retiree-only plan).
4. File an Annual Report each year on behalf of the retiree-only plan. This is due within 7 months following the close of each plan year (subject to an automatic 2½-month extension).
5. For any plan year during which the retiree-only plan covers more than 100 participants, commission an independent audit of the plan and then attach that audit to the plan’s Annual Report.
6. Although not required to comply with ERISA, the plan’s sponsor will likely also want to apply to the IRS for tax-exempt status on behalf of the VEBA. This must be done by completing and filing an IRS Form 1024 within 15 months following the VEBA’s effective date.
7. Assuming the trust is intended to be a VEBA, an IRS Form 990 should be filed with the IRS within 4½ months following the close of each fiscal year. If the VEBA has any “unrelated business taxable income,” this should be reported on an IRS Form 990-T. (If an employer elects not to obtain tax-exempt status for the trust, other tax-reporting rules would apply.)
Of course, this new VEBA boomlet could be brought to an end if the DOL chooses to expand its trust nonenforcement policy to apply to retiree-only plans. Although it is hard to see any policy basis for doing so, the DOL did not bother to justify its existing policy, so anything is certainly possible.