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The Ins and Outs of Opt-out Incentives

As annual open enrollment season approaches, many employers may be evaluating ways in which to control rising health plan costs. One strategy frequently considered is a financial incentive for employees to waive or opt out of the employer-sponsored group health coverage. Although such “cash-in-lieu” or “opt-out” arrangements have long been common, they raise potential problems under the Affordable Care Act (“ACA”), as well as a number of other federal laws.

ACA “Employer Payment Plan” Issue

Often, opt-out payments are conditioned on an employee’s proof of other health coverage. The first ACA issue arises if such arrangements are structured as premium reimbursements for individual health insurance, whether purchased on the open market or through a public exchange. This is because the regulators have said that, by paying or reimbursing employees’ individual health insurance premiums, an employer establishes an “employer payment plan.” And by its terms, such a plan violates the ACA. This is because it does not comply with the ACA rules prohibiting lifetime or annual limits on essential health benefits and mandating coverage for specified preventive-care services.

Thus, if an employer specifically wants an opt-out payment to be conditioned on proof of other health coverage, the option should be limited to after-tax reimbursements for those who provide proof of other “integrated” group coverage (e.g., through a spouse’s employer). The other coverage should probably not be Medicare, because paying an employee to opt out of the employer’s plan in favor of Medicare may be viewed as a violation of the Medicare Secondary Payer (“MSP”) rules.

As explained in our December 19, 2016, article, there is a limited exception to this ACA prohibition. This exception permits certain small employers to reimburse individual health insurance premiums under a “qualified small employer health reimbursement arrangement” (or “QSEHRA”). However, this QSEHRA option is available only to employers who offer no other type of health coverage. For that reason, it could not be used in connection with opt-out payments.

Alternatively, according to the agency guidance, an employer would not be deemed to establish an “employer payment plan” if it foregoes any documentation requirement and simply offers additional cash – on a taxable basis – to employees who waive coverage under the employer’s plan. Again, as noted above, the opt-out payment should probably not be made available to Medicare-eligible employees (or those with Medicare-eligible spouses), due to the MSP prohibition on offering financial incentives to waive coverage. Furthermore, as explained below, this “unconditional cash” option raises a second potential ACA issue for larger employers.

ACA “Affordability” Issue

Any employer that is subject to the ACA’s “shared responsibility” provision (because the employer is part of a group with 50 or more employees) faces another ACA issue if it chooses to offer opt-out payments. This is the possibility that the amount of any opt-out payment might have to be included – along with the nominal employee premium – when determining whether the employer’s health coverage is “affordable” under the ACA. (Offering affordable coverage may allow an employer to avoid an ACA penalty.) The IRS has said that an opt-out payment conditioned solely on waiving coverage under the employer’s health plan (with no requirement to substantiate other coverage) must be added to the nominal employee premium when determining whether the employer’s coverage is affordable for those who actually elect it. This is because those employees are not only paying the premium, but also forfeiting their right to the opt-out payment.

By contrast, if an opt-out payment is “conditional” (as defined below), it will not affect the affordability analysis. In order to qualify as a “conditional” payment under an “eligible opt-out arrangement,” the following two requirements must be met:

  • The employee must decline enrollment in employer-sponsored coverage; and
  • At least annually, the employee must provide reasonable substantiation that he/she and his/her “tax dependents” have minimal essential coverage from a source other than the individual marketplace (or Medicare).

Reasonable evidence of alternative coverage includes an employee’s attestation that the employee and all other members of the employee’s expected tax family, if any, have or will have minimum essential coverage (other than coverage in the individual market). The arrangement must also provide that any opt-out payment will not be made (and the payment must not in fact be made) if the employer knows or has reason to know that the employee or any other member of the employee’s expected tax family does not have (or will not have) the required alternative coverage.

An eligible opt-out arrangement must also require that the evidence of coverage be provided no less frequently than every plan year to which the eligible opt-out arrangement applies, and that the evidence be provided no earlier than a reasonable period before the commencement of the period of coverage to which the eligible opt-out arrangement applies. Obtaining the reasonable evidence (such as an attestation) as part of the regular annual open enrollment period that occurs within a few months before the commencement of the next plan year of employer-sponsored coverage meets this “reasonable period” requirement.

Conclusion and Other Considerations

This all boils down to the following general rules:

  • If an employer is small (under 50 employees), it may offer either (1) an unconditional opt-out payment (cash), or (2) after-tax reimbursement upon proof of other group coverage (but not individual insurance).
  • A large employer (50 or more employees) has the same two options. However, if the employer chooses the unconditional opt-out payment (cash), it must add the amount of that payment to the nominal employee premium for ACA affordability purposes.

Aside from the two ACA issues discussed above, opt-out payments can create issues under the Code Section 125 cafeteria plan election rules, the Medicare Secondary Payer rules (as mentioned above), and even the Code Section 105(h) nondiscrimination rules for self-funded plans (if a disproportionate number of non-highly compensated employees opt out, thereby causing the health plan to cover a disproportionately highly compensated group of employees). All of these issues should be analyzed on a case-by-case basis by any employer that has – or is considering – an opt-out program.

This blog post was drafted by Julia Vander Weele, an attorney in the Spencer Fane LLP Kansas City, MO office. For more information, visit spencerfane.com.