As we previously reported, on June 13, the Departments of Health and Human Services, Labor, and the Treasury (collectively, the “Departments”) issued a coordinated set of final regulations (“final rules”) permitting employers to, among other things, make individual coverage health reimbursement arrangements (ICHRAs) available to their employees for the purposes of purchasing individual market health insurance coverage. The final rules address how an employer determines whether coverage provided under an ICHRA is “affordable” for purposes of complying with the Affordable Care Act’s (ACA’s) employer shared responsibility standards, which are codified in section 4980H of the Internal Revenue Code. In recently issued proposed regulations (the “proposed affordability rule”), which are the subject of this post, the Internal Revenue Service (IRS) addresses how employers might determine whether coverage under an ICHRA is affordable.

Background

Prior Law

Prior law generally barred employers from making health reimbursement arrangements (HRAs) available to enable employees to purchase health insurance of their choice in the individual health insurance market. These arrangements, which were generically referred to as “stand-alone” HRAs, were deemed under prior guidance to fail to satisfy the following requirements added by the ACA:

• Public Health Service Act section 2711, which generally bars group health plans from imposing annual or lifetime limits on the dollar amount of benefits (the “annual dollar limit prohibition”); and

• Public Health Service Act section 2713, which requires non-grandfathered group health plans to provide preventive services without imposing any cost-sharing requirements (the “preventive services requirement”).

In a 2017 executive order, President Trump directed the Departments of Labor, Health and Human Services and the Treasury to review regulations issued under the ACA to, among other things: 

Create rules that allow employees to use health reimbursement arrangement (HRA) funds to pay health care premiums for plans employees purchase on the individual market, such as through the ACA's Marketplace exchanges

The Final Rules

The final rules, which are in response to the President’s order, enable ICHRAs to be applied to the purchase of health insurance in the individual market. The final rules leave certain issues unaddressed, however, most notably with respect to the determination of the circumstances under which an ICHRA offered by an applicable large employer (ALE) is affordable. ALEs (generally, those employers with, on average, 50 or more full-time and full-time equivalent employees in the previous calendar year) are exposed to excise tax penalties if at least one employee qualifies for and receives a premium tax credit from the state exchange or marketplace, and:

• The employer either does not offer minimum essential coverage to substantially all (i.e., at least 95 percent) of its full-time employees and their dependents; or

• The employer offers such coverage, but the coverage is either unaffordable or fails to provide minimum value. (Minimum value coverage is, essentially, major medical coverage that includes physician and inpatient hospital services.)

Under the final rule, an employee who is offered coverage under an ICHRA that is affordable is barred from receiving premium tax credits. (The individual market coverage that an employee accesses with his or her ICHRA is deemed to provide minimum value.) Thus, an employer that offers an individual coverage to substantially all its full-time employees and their dependents is not subject to excise tax penalties. Coverage is “affordable” for this purpose if the employee’s contribution towards self-only coverage does not exceed the required contribution percentage of their household income. In addition, an employee who enrolls in an ICHRA HRA and purchases the required individual coverage is not eligible for premium tax credits, even if the ICHRA is not affordable.

The Affordability Conundrum

In the preamble to the 2012 final regulation implementing the ACA employer shared responsibility rules, the Treasury Department and the IRS acknowledged that employers would not generally know an employee’s household income. The regulation therefore established three affordability safe harbors that employers may use as proxies when fulfilling the ACA information reporting and filing requirements: The W-2 safe harbor, the rate of pay safe harbor, and the Federal Poverty Line safe harbor. These safe harbors are available to employers when determining the affordability of ICHRAs. The proposed affordability rules collectively refer to these as “household income safe harbors” or “HHI safe harbors.”

Most employer-sponsored group health plans charge a single, composite rate to all eligible employees, despite that the coverage provided to older workers tends to be more expensive than similar coverage provided to younger workers. The result is that younger workers tend to subsidize the coverage of their older counterparts. Under the final regulations, an ICHRA is affordable for an employee for a month if the required HRA contribution does not exceed 1/12 of the product of the employee’s household income and the required contribution percentage. The required HRA contribution is the excess of:

(i)         The monthly premium for the lowest cost silver plan for the employee for self-only coverage offered by the ACA exchange or marketplace for the rating area in which the employee resides (the proposed regulations refer to this plan as the “HRA affordability plan”); over

(ii)        The self-only amount the employer makes available to the employee under the ICHRA for the month.

Thus, in the absence of relief, affordability would be determined employee-by-employee considering each employee’s age and the rating in which he or she resides. Notice 2018-88 suggested and invited comments on ways to simplify ICHRA affordability determinations. In particular, the notice proposed a “location” safe harbor under which an employer would be permitted to determine affordability for an individual-coverage HRA using only the lowest-cost silver plan where its primary site of employment is located. The notice also invited comments on “any administrative burdens that may arise due to the need to separately determine the employee’s required contribution for each individual employee based on the employee’s age.”

Concerned that “employers generally determine the health benefits they will offer for an upcoming plan year well in advance of the start of the plan year,” the notice also offered two safe harbors (one for calendar year plans and the other for non-calendar year plans), under which an employer would be permitted to determine ICHRA affordability based on the cost of the individual market coverage in the prior year. Each of these safe harbors could be used in addition to the location safe harbor.

Coordination with the Code § 105(h) Non-discrimination rules

As self-insured medical plans, ICHRAs are subject to the Code section 105(h) non-discrimination rules, which bars discrimination in favor of highly compensated individuals with respect to plan eligibility or benefits. These rules do not apply to fully insured group health plans. The ACA imposed similar nondiscrimination rules on fully insured arrangements, but the application of these rules was delayed indefinitely by IRS Notice 2011-1 pending the issuance of formal guidance—which is not expected any time soon. 

According to Notice 2018-88, an ICHRA that reimburses employees only for premiums paid to purchase health insurance policies is not subject to Code Section 105(h). But an ICHRA that pays or reimburses medical expenses and premiums used to purchase individual health insurance policies is subject to Code Section 105(h) if it covers one or more highly compensated individuals. Notice 2018-88 refers to these latter HRAs as “covered HRAs.”

The current Code 105(h) regulations require the maximum limit attributable to employer contributions to be uniform for all participants. Here is the relevant portion of the rule [Treas. Reg. § § 1.105-11(c)(3)(i)]:

However, any maximum limit attributable to employer contributions must be uniform for all participants and for all dependents of employees who are participants and may not be modified by reason of a participant's age or years of service. (Emphasis added).

Thus, as currently constituted, this regulation does not permit employers to vary ICHRA contribution amounts in the case of covered HRAs. Notice 2018-88 proposes that a covered HRA could be treated as not failing to meet the requirements of the Code Section 105(h) regulations (i.e., that any maximum limit attributable to employer contributions must be uniform for all participants, if the covered HRA provides—

• The same maximum dollar amount to all employees who are members of a particular class of employees; and/or

• The maximum dollar amount made available to an employee for any plan year increases as the age of the employee increases.

To qualify for this relief, an employer would be required to ensure that the covered HRA provides that the maximum dollar amount made available to employees who are members of a class increases in accordance with the increases in the price of an individual health insurance coverage policy in the “relevant individual insurance market” based on the ages of the employees who are members of that class of employees. The “relevant individual insurance market” means an individual insurance market in which at least one employee who is a member of the class of employees is able to purchase individual health insurance coverage.

The Proposed Affordability Rule

The proposed affordability rule largely tracks Notice 2018-88. 

Affordability safe harbors

The proposed affordability rules reiterate that an employer that offers minimum essential coverage providing minimum value may apply the affordability safe harbors—i.e., the W-2, rate-of-pay, and Federal Poverty Line safe harbors. Thus, there might be instances in which an employer’s coverage is deemed affordable for purposes of Code section 4980H(b) despite that an employee may still qualify for a premium tax credit or a cost-sharing reduction. This would occur where the employee’s actual household income differs from the safe harbor amount.

An employer is deemed to satisfy the W-2 safe harbor with respect to an offer of an ICHRA to an employee for a calendar year (or a part thereof) if the ICHRA is affordable under the Form W-2 safe harbor based on the employee’s required contribution. Similar rules apply in the case of the rate of pay and Federal Poverty Line safe harbors. In each case, affordability is determined based on the employee’s required HRA contribution, applying one or both (or neither) of the following newly proposed affordability safe harbors:

Look-back month safe harbor

Under the Look-back month safe harbor, when determining an employee’s required ICHRA contribution for a calendar month, an employer would be allowed to use the monthly premium for the applicable lowest cost silver plan for a previous as opposed to the current month. Under the rules governing premium tax credits, affordability is determined, in part, based on the cost of the individual market coverage commencing with the current policy year, typically the calendar year. But, exchange premium information for a calendar year generally is not available until shortly before the beginning of the open enrollment period for that calendar year, which generally begins on November 1 of the prior calendar year. While this time frame may work for individuals, it would not work for employers seeking to offer an ICHRA, since employers generally determine their health benefit offerings well in advance of the start of the plan year.

The proposal adopts the approach set out in Notice 2018-88, with some modifications. In the case of a calendar year plan, an employer would be allowed to use the monthly premium for the applicable lowest cost silver plan for January of the prior calendar year. For a non-calendar year plan, an employer is allowed to use the monthly premium for the applicable lowest cost silver plan for January of the current calendar year. In general, employers may use the applicable lowest cost silver plan for the applicable look-back month for all calendar months of the plan year, other than in the case of a change in the employee’s location. Where there is a change of location, the employer may continue to determine the monthly premium for up to an additional two months.

The location safe harbor

The proposed rule also carries over the location safe harbor first described in Notice 2018-88, again, with some modifications. Under the general rule, an employer is allowed to determine its required HRA contribution for a calendar month based on the cost of the applicable lowest cost silver plan for the location of the employee’s primary site of employment. An employee’s primary site of employment for this purpose is generally the location at which the employer reasonably expects the employee to perform services. An employee’s primary site of employment is treated as changing, however, if the location at which the employee performs services changes and the employer expects the change to be permanent or indefinite. Where a change occurs, the employee’s primary site of employment is treated as changing no later than the first day of the second calendar month after the employee has begun performing services at the new location. Where an employer first offers an ICHRA, and the change in location occurs before the ICHRA’s initial plan year, the employee’s primary site of employment is treated as changing no later than the later of the first day of the plan year or the first day of the second calendar month after the employee has begun performing services at the new location.

The proposal also includes a special rule for “remote workers.” A remote worker for this purpose is defined to mean:

“an employee who regularly performs services from home or another location that is not on the applicable large employer member’s premises, but who may be required by his or her employer to work at, or report to, a particular location, such as a teleworker with an assigned office space or available workspace at a particular location to which he or she may be required to report."

The location to which the employee would report to provide services if requested is the primary site of employment. But in the case of an employee who works remotely from home or at another location that is not on the employer’s premises and who otherwise does not have an assigned office space or a particular location to which to report, the employee’s residence is the primary site of employment.

Proposed Regulations under Section 105(h)

The proposed affordability rules adopt the position first advanced by Notice 2018-88 to covered HRAs. According to the proposal, ICHRAs that are covered HRAs will not be treated as failing to satisfy the requirements to provide nondiscriminatory benefits solely due to the variation based on age. The proposal also provides that if the maximum dollar amount made available varies for participants within a class of employees, or varies between classes of employees, then with respect to that variance, the ICHRA will not run afoul of the regulations under Code section 105(h) if within each class of employees, the maximum dollar amount only varies in accordance with the same terms requirement and, with respect to differences in the maximum dollar amount made available for different classes of employees permitted under the final rule.

The preamble to the proposed affordability rules caution that “satisfying the terms of the safe harbors under the proposed regulations does not automatically satisfy the prohibition on nondiscriminatory operation under §1.105-11(c)(3)(ii).” Thus, for example, if a disproportionate number of highly compensated individuals utilize the maximum HRA amount allowed under the same terms requirement based on age in comparison to the number of non-highly compensated individuals who qualify for and use lower HRA amounts based on age, the ICHRA may be found to be discriminatory.

Conclusion

What the proposed rules did not do is perhaps more important that what they did do. Notice 2018-88 raised the issue of an age-based safe harbor. Traditionally, employer-sponsored group health plans use the cost of a single plan (i.e., the lowest cost plan providing minimum value that the employer offers to the employees), which does not vary by employee. This is referred to as composite rating. In contrast, the affordability test for ICHRAs is based on the cost of the applicable lowest cost silver plan for each employee, which will vary by employee, based on an individual’s residence and age. This means that coverage for older workers will be more expensive than coverage for their younger counterparts (up to three times as much). The preamble to the proposed rules reports on various proposal that might modify this result, which the regulators rejected.

The move away from composite rating strikes us a fundamental restructuring to the bargain that employees, particularly older employees, have come to expect. This is not to say the subsidy of older workers by younger workers where health benefits are concerned is good thing, or not. We will leave that call to the economists and the policy makers. We wonder whether employers are willing to take this step. The safe harbors and other refinements contained in the proposed affordability rules are certainly welcome, and they should materially ease the administrative burdens of establishing and maintaining ICHRAs. What remains to be seen is whether they are sufficient to encourage the widespread adoption of these programs.