The Medical Loss Ratio (MLR) provisions of the Affordable Care Act require insurers to spend at least a specified percentage of employees’ premium dollars on clinical care, rather than on administrative expenses such as executive salaries, overhead, marketing and profit. If an insurer does not spend enough on patient care to satisfy the MLR provisions, the insurer must make financial adjustments and provide rebates to customers. Health care reform sets the minimum MLR level at 85 percent for the large group market (policies covering over 50 employees) and 80 percent for the small group market. This means that administrative and other non-clinical costs can be no more than 15 or 20 percent of the insurer’s revenue. If an insurer fails to meet these standards, the insurer will be required to provide a rebate to customers beginning this year.
Rebates from insurers will differ depending on if the rebate is to a group health plan policyholder or an individual policyholder. See below for a chart of rebate dollars per state. For group health plans, the policyholder is usually (but not always) the employer sponsoring the plan. Insurer rebates to employer policyholders can be paid either in cash or in form of reduced premiums.
Application of Rebates
The U.S. Department of Health and Human Services, along with the Department of Labor and the Internal Revenue Service, have issued guidance on how policyholders must apply the rebates, which for group health plans involves an allocation of the rebates for the benefit of employees.
MLR rebates to group health plans may be considered plan assets. If this is the case and if the policyholder's (employer's) plan is subject to ERISA, the policyholder is required to comply with ERISA's fiduciary provisions with respect to handling the rebates. Determining the plan sponsor's portion of the rebate as compared to the plan participants' portion of the rebate may depend on the terms of the plan and how the plan sponsor and participants have shared the cost of the coverage.
If the employer paid the entire cost of the insurance coverage, then no part of the rebate with respect to the policy would be attributable to participant contributions and the employer could retain the entire cash rebate or premium reduction. However, if participants paid the entire cost of the insurance coverage, then the entire amount of the rebate would be attributable to participant contributions and considered to be plan assets, due back to the participants. If participants and the employer each paid a fixed percentage of the cost, a percentage of the rebate equal to the percentage of the cost paid by participants would be attributable to participant contributions, with the remainder attributable to the employer. The Department of Labor has instructed that in general, rebates will have to be applied to appropriate uses within three months of receipt.
The allocation of the MLR rebate must be reasonable, fair and objective. There is no standard requirement for allocating rebate dollars. The plan sponsor will have to determine if the rebate will be allocated to only active employees, to former employees, and/or to COBRA participants. The plan sponsor is permitted to factor in the cost (and benefit) it would incur in allocating the rebate to former participants. If costs for sharing the rebate with former participants would exceed the amount of the rebate, the allocation can be limited to current plan participants. Moreover, if it is not cost-effective to distribute cash payments to plan participants (for example, if the rebate amount is small), then the rebate may be used for other permissible plan purposes, such as benefit enhancements or premium reductions.
Tax Treatment of Rebates
The tax implication of a rebate (both a cash rebate and a premium reduction) will depend on how the cost of health insurance coverage was paid, whether it is an individual or group policy, and how the rebate is delivered.
Payment of Insurance Premiums With Pre-Tax Dollars
Employees who participate in an employer's cafeteria plan and pay for insurance coverage on a pre-tax basis will be subject to tax on any rebates received (cash rebate or premium reduction).
Premium Reduction. If the MLR rebate is distributed as a premium reduction, the amount the employee will pay for premiums through a salary reduction contribution will be decreased by the amount of the rebate. Consequently, there will be a corresponding increase of the dollar amount of the rebate in the employee's taxable salary that will be wages subject to employment tax.
Cash Rebate. If the MLR rebate is paid to an employee in cash, the employee with have an increase in taxable income equal to the dollar amount of the rebate. Since the amount paid for health insurance premiums was subtracted from the employee's salary on a pre-tax basis, the rebate is a return of part of that untaxed compensation that is no longer being used to pay for health insurance. Therefore, the amount of the MLR rebate received is an increase in taxable income that is wages subject to employment taxes.
Payment of Insurance Premiums With After-Tax Dollars
If an employee pays his share of the cost of insurance coverage with after-tax dollars, any rebate the employer passes onto the employee (cash rebate or premium reduction) will not be subject to tax.
The logic for no taxation is that the rebate is being received due to participation in the group health plan. The rebate is considered a purchase price adjustment. The employee purchased the insurance with after-tax dollars. Any amount given back to the employee is basically a refund of amounts already paid. Since the amounts already paid were subject to tax before payment was made, the refund does not have to be taxed again when given back to the employee.
Individual Policies
The tax treatment of a MLR rebate under an individual health insurance policy will depend on whether the individual took a deduction on his or her tax return for the amount of the health insurance premiums. If the individual claimed the standard deduction, the rebate will not be subject to tax. If the individual itemized the cost of health insurance premiums, the rebate will be taxable income to the individual.
Employer Action
Employers should be considering the action they will take with respect to MLR rebates, be it in the form of a premium reduction or a cash payment. Payroll systems should be prepared to apply the correct tax treatment to rebates, and employers should start to gather census data on covered employees and contributions toward coverage for purposes of allocating those rebates. For more information on how BAS can help with the census data gathering, please contact sales@BASusa.com.
