United States: Proposed Regs Clarify Opt-Out Payments And Plan Affordability

Last Updated: October 14 2016
Article by Ron M. Present, CALA, CNHA, LNHA, FACHCA

Recently proposed IRS regulations clarify the interaction between employer opt-out payments and the Affordable Care Act's (ACA's) affordability standards. The regulations, which are scheduled to take effect January 1, 2017 (except for certain collective bargaining agreements), elaborate on guidance the IRS offered last year in Notice 2015-87.

Opt-out payments are cash inducements for employees to not participate in their employers' health care plans. Such payments fall into two categories: conditional and unconditional. The IRS isn't raising an issue with conditional opt-out payments, but it's actively discouraging unconditional ones.

No Strings, Potential Problems

An unconditional opt-out payment is one an employee may accept with no strings attached. The problem is that employees can simply pocket the cash and then leave their employers' plans without ever proving they've secured health care coverage elsewhere.

To discourage unconditional opt-out payments, the IRS treats the incentive forgone by employees who stay in your plan as an added cost that those employees have to pay to participate in the plan. More specifically, the agency considers that those who decline the opt-out payment are having their compensation reduced by the amount of the money they could have received. This could cause your plan to flunk the ACA's affordability test — assuming you're an applicable large employer (ALE) subject to the ACA's penalties. Under that test, for 2016, the cost of single-only coverage is deemed "affordable" if it doesn't exceed 9.66% of the employee's annual household income. (Because of inflation-indexing, this threshold rises slightly in 2017, to 9.69%.)

Assume the employee's share of single-only coverage amounts to $3,000 a year (whether or not the employee buys single-only or some other form of coverage, such as for an entire family), and the employee's household income is $32,000. The plan would pass the affordability test because $3,000 is 9.38% of $32,000. (Note: The IRS provides safe harbor formulas that allow employers to safely estimate employees' household income.)

Further suppose you offer a $500 unconditional opt-out payment to employees who agree not to participate in the plan. This would cause your plan to fail the affordability test for that employee. This is due to the $500 added to the calculation of the employee's share of single coverage ($500 plus $3,000), the new higher total, $3,500, is 10.94% of the employee's household income — in other words, more than 9.66%.

Failing the affordability test could trigger a penalty for an ALE if just one employee buys a health plan via a Health Insurance Marketplace on the public exchange and receives a tax subsidy because his or her employer's plan is deemed unaffordable. (For details, see "Calculating the 'Unaffordability' Penalty.")

Eligible Payments

As mentioned, there is an alternative to unconditional opt-out payments: conditional ones. This is the approach favored by the IRS. As long as your conditional opt-out payments qualify as "eligible," the value of the incentive isn't added to the employee's share of the plan cost. Therefore, your risk of flunking the ACA's affordability test is diminished (again, assuming you're an ALE).

Adding detail to the definition of conditional opt-out payments is a focus of the proposed IRS regulations. For instance, to obtain eligibility, two conditions must be met. An employee taking the opt-out payment must:

  1. Decline enrollment in your own plan, and
  2. Provide "reasonable evidence," at least once a year, that he or she, and anyone else claimed as a dependent, will secure minimum essential coverage (as defined under the ACA) — but not through a Health Insurance Marketplace.

What constitutes reasonable evidence? One kind is a formal attestation from the employee during your enrollment period that he or she is indeed securing coverage anywhere other than a Health Insurance Marketplace. You can also require and secure evidence of the employee's new coverage, once he or she obtains it.

The proposed regulations describing eligible, conditional opt-out payments offer considerable flexibility. For example, the agreement doesn't need to require a reduction in the incentive payment if the employee who opted out loses the alternative coverage during the employer's plan year. However, the regulations do clarify that employers can't bar an employee who accepts an opt-out from re-enrolling in the employer's plan after a year of being out of the plan.

Strategic Decision

Incenting employees to forgo coverage under your plan — even when your opt-out agreement satisfies IRS eligibility standards for conditional payments — is a strategic decision. Say your plan successfully keeps covered employees and their dependents as healthy as possible through proactive medical treatment and ample health education. The value of these results may well exceed the money you'd save by encouraging employees to move to other plans.

That's an important consideration if you suspect that the alternative plans in which "opt-outers" might enroll are less effective than yours. After all, controlling costs and maintaining a healthy, productive workforce is your primary objective.

Calculating the "Unaffordability" Penalty

For applicable large employers the penalty calculation for having a plan that doesn't meet the Affordable Care Act's affordability standard may be affected by whether the plan also violates the ACA's minimum essential coverage requirement. However, let's focus on when the plan's only deficiency is failing the affordability test.

In this case, the penalty is $3,240 per year (inflation-adjusted annually), paid pro rata on a monthly basis, per employee who receives coverage subsidies via a Health Insurance Marketplace. Suppose you have 130 full-time employees, and 15 of them received tax subsidies via a Health Insurance Marketplace on affordability grounds. Your annualized penalty would be 15 × $3,240 = $48,600.

However, the ACA puts a ceiling on the penalty. To calculate it, you take your total number of full-time employees, subtract 30, and multiply the result by $2,160 (also inflation-adjusted). Going back to our example, the calculation would be 130 ‒ 30 = 100 × $2,160 = $216,000. Thus, the $48,600 penalty noted above would be way below the $216,000 ceiling.

If you have questions about opt-out payments, please contact Ron Present, Partner and Health Care Industry Group Leader, at rpresent@bswllc.com or 314.983.1358.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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