Connector Issues Emergency Rule Implementing Cafeteria Plan Requirement under Massachusetts Health Care Reform Act

The Massachusetts health care reform act—Chapter 58 of the Acts of 2006, An Act Providing Access to Affordable, Quality, Accountable Health Care (the "Act")¹—imposed new health care requirements on individuals, insurers and employers. The Act’s mandates include a requirement that employers adopt a cafeteria plan to permit employees to pay their employee premiums with pre-tax dollars. The Act’s cafeteria plan requirement takes effect July 1, 2007.

The Act directs the Commonwealth Health Insurance Connector Authority (the "Connector")—the quasi-governmental agency established under the Act to provide access to affordable group health insurance products—to issue rules implementing the cafeteria plan requirement. On March 20, 2007, the Connector issued an emergency cafeteria plan regulation, 956 CMR 4.00. This client advisory explains the key features of this new regulation and what steps employers need to do to comply.

Internal Revenue Code § 125 permits employees to make pre-tax contributions toward health insurance under so-called "cafeteria" plans, which allow employees to choose between taxable benefits (e.g., cash compensation) and non-taxable or "qualified" benefits (e.g., health insurance) without being taxed if they choose the latter. This provision is necessary since, in its absence, the choice between a taxable and a non-taxable benefit would result in the imposition of a tax under general tax law principles governing the constructive receipt of income.

In their most basic form (often referred to as a "premium-only" plan or arrangement), cafeteria plans allow employees to make contributions toward the costs of employer-provided coverage with pre-tax dollars. Cafeteria plans can also include medical and dependent care flexible spending accounts, among other non-taxable benefits. The regulation makes clear that the plan need only contain a premium-only feature. An employer is free to add other features, such as flexible spending accounts and adoption assistance, but these are not required.

The Act’s basic cafeteria plan requirement is set out in Act § 48 (adding M.G.L. c. 151F), under which employers with more than 10 employees in the Commonwealth must "adopt and maintain a cafeteria plan" and file a copy of the plan with the Connector. Act § 101 (adding M.G.L. c. 176Q) further requires small groups that choose to designate the Connector as their group health plan to establish a cafeteria plan to permit employees to get the benefit of pre-tax treatment for their health benefit plan premium payments.

Compliance with the cafeteria plan requirement is important because it protects employers from exposure under the Act’s surcharge for state-funded health costs (aka the "free rider surcharge"). This surcharge is another of the Act’s employer mandates, under which "non-providing" employers may be liable for a portion of the Commonwealth’s cost of providing health benefits to the employers’ uninsured employees. Compliance with the cafeteria plan requirement insulates an employer from free-rider liability even if the employer offers no health coverage of its own.

Under the regulation, employers in the Commonwealth with 11 or more full-time equivalent employees are subject to the cafeteria plan requirement. (The regulation refers to employers that are subject to the rule as "151F Employers.") Full-time equivalency is based on 2000 payroll hours per year, which include regular, vacation, sick, FMLA absence, short-term disability, long-term disability, overtime and holiday payroll hours. Multi-state employers need only count Massachusetts payroll hours. The cafeteria plan rule applies regardless of whether medical care coverage is offered on an insured or self-insured basis, purchased on an individual or group basis, or provided through the Connector or through any other distribution channel.

Under a special rule, an employer that maintains a fully contributory (i.e., employer-pay-all) plan is not subject to the cafeteria plan requirement. To fit within this exception, the employer must provide medical coverage to all its employees. The determination as to whether the employer covers all employees is made on a monthly basis.

Whether an employer has 11 or more full-time employees is tested on the basis of a "determination period." The initial determination period is the 12 consecutive month period beginning April 1, 2006 and ending March 31, 2007. Employers with 11 or more full-time equivalent employees during that period are subject to the cafeteria plan rule on July 1, 2007. The regulation includes a grace period, however, that effectively delays an employer’s obligations to September 1, 2007. Subsequent determination periods are based on a fiscal year beginning each July 1st and ending the following June 30th. Employers with 11 or more full-time equivalent employees during any subsequent determination period become subject to the cafeteria plan requirement on the following October 1st.

The regulation requires each 151F Employer to adopt and maintain a cafeteria plan in accordance with the rules and regulations promulgated by the Connector. The plan must be in writing, and it must include the following provisions:

• a specific description of each of the benefits available under the plan, including the periods during which the benefits are provided. (The benefit description need not be self-contained. Benefits described in other separate written plans may be incorporated by reference into the plan document.);

• the plan’s eligibility rules regarding participation;

• the procedures governing participant elections under the plan, including the period during which elections may be made, the extent to which elections are irrevocable and the periods with respect to which the elections are effective;

• the manner in which employer contributions may be made to the plan, such as by salary reduction agreement between the participant and employer or by non-elective employer contributions to the plan;

• the maximum amount of elective employer contributions available to any participant under the plan either by stating the maximum dollar amount or maximum percentage of compensation that a participant may contribute, or by stating the method for determining the maximum amount or percentage; and

• the plan year on which the cafeteria plan operates.

The cafeteria plan document may be a separate stand-alone document or combined/consolidated with other employer-provided plans. Employers are free to adopt more than one cafeteria plan document, including a "Connector-only plan" document. A single plan may cover employees of two or more related employers (in which case the plan document must clearly identify all participating employers). Employers must take such actions as they deem "necessary or appropriate" to adopt their cafeteria plan (or plans) in accordance with their own internal governance procedures and with applicable law.

To satisfy the cafeteria plan regulation, the plan must, at a minimum, provide access to one or more "medical care coverage options" in lieu of regular cash compensation. The term "medical care coverage option" is not defined. The Connector can be expected to establish a definition once it determines what constitutes "minimum creditable coverage" for purposes of the Act’s individual mandate. For example, the Connector might define the term "medical care coverage option" to mean any option that furnishes "minimum creditable coverage." (A proposed regulation governing "minimum creditable coverage" was also issued on March 20, 2007.)

Certain employees can be excluded from cafeteria plan participation. These include:

• employees who are less than 18 years of age;

• temporary employees;

• part-time employees working, on average, fewer than 64 hours per month for an employer;

• employees who are considered wait staff, service employees or service bartenders (as defined in M.G.L. c. 149 § 152A) and who earn, on average, less than $400 in monthly payroll wages;

• student employees who are employed as interns or as cooperative education student workers; and

• seasonal employees who are international workers with either a U.S. J-1 student visa, or a U.S. H2B visa and who are also enrolled in travel health insurance.

151F Employers are generally required to file a copy of their cafeteria plans with the Connector. A cafeteria plan maintained by a 151F Employer that is not available to any employees employed at a Massachusetts location is not subject to the filing requirement. The manner of submission will be in "the form and manner specified by the Connector and shall include such other documentation . . . as the Connector may from time to time require."

The cafeteria plan regulation establishes a special rule that applies to "employee leasing companies." The term "employee leasing company" refers to entities that provide workers to a "client company" but "retain . . . a substantial portion of personnel management functions, such as payroll, direction and control of workers, and the right to hire and fire workers." Leasing companies that provide "temporary help services during seasonal or unusual conditions" are not employee leasing companies for purposes of this rule.

The term "client company" is defined to mean an entity "that is a co-Employer of workers provided by an Employee Leasing Company pursuant to a contract." This definition would appear to limit the special leasing company rule to "professional employer organizations" or PEOs, which claim co-employment status for their workers, despite that the concept of "co-employment" is not recognized for benefits and income tax purposes. Traditional staffing firms, in contrast, usually treat workers placed with client companies as employees of the staffing firm.

Under the special rule, where there is a co-employment arrangement between a client company and an employee leasing company, the client company is the 151F Employer as to the co-employees covered under the arrangement. The client company may contractually allocate to the employee leasing company its cafeteria plan obligations, but the employee leasing company remains contingently liable. So if the employee leasing company agrees to comply with the cafeteria plan but fails to do so, the client company remains subject to the free rider surcharge.

The Connector issued the cafeteria plan regulation in emergency form to give it the force of law. This will allow employers to get their compliance efforts underway, secure in the knowledge that they are operating under reliable guidance. Nevertheless, it’s clear, at least with respect to the definition of "medical care coverage option," that changes will be necessary. Given the express language of the Act, employers should assume that the rule will ultimately apply to Connector plans and employer-sponsored group health plans that provide comprehensive major medical coverage. Less likely, but still possible, is that the rule would require cafeteria plan access to limited scope benefits (e.g., dental and vision) or disease-specific policies (e.g., cancer).

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.