Some employers that sponsor insured group health plans will receive rebates this year from insurers due to the medical loss ratio limits imposed on insurers under the Patient Protection and Affordable Care Act of 2010 (as amended by the Health Care and Education Reconciliation Act of 2010, together “Health Care Reform”). Under applicable Health Care Reform regulations, affected insurers must issue the 2011 rebates by August 1, 2012. 

Prior to enactment of Health Care Reform, many states already imposed medical loss ratio limits on insurers and, if those limits are higher than the limit imposed under Health Care Reform, they continue to apply. Medical loss ratio limits require insurers to spend at least a minimum percentage (e.g., 85%) of premiums collected on claim payments for those covered under the plan. 

If an insurer fails to meet the minimum medical loss ratio threshold with respect to a covered group, it must issue a rebate to the policyholder. In most cases involving group health plans, the policyholder that receives the rebate is the employer that sponsors the plan. 

If the plan is covered by the Employee Retirement Income Security Act of 1974 (“ERISA”), as most employer-sponsored group health plans are, the rebate amount generally will be considered a plan asset to the extent it is attributable to participant contributions. Therefore, such an employer must handle the rebate in accordance with ERISA’s fiduciary rules respecting plan assets. The US Department of Labor (“DOL”) issued Technical Release 2011-04 describing its position with respect to when the medical loss ratio rebates will be considered plan assets and how the rebates should be handled.

Most group health plans are funded by the general assets of the sponsoring employer, including amounts paid by employees with pre-tax payroll deductions. In such a case, according to the DOL guidance and in the absence of specific plan or policy provisions addressing the allocation, the employer generally must allocate any medical loss ratio rebate for a given year among the participants in proportion to their contributions for that year. If the cost to allocate the rebate among former participants approximately offsets the rebate, however, the employer can limit allocation to current participants. The allocation may be made in the form of a cash payment, premium reduction, or benefit enhancement, as appropriate under the circumstances.

According to IRS guidance, where covered individuals made their contributions on a pre-tax basis for a given year, any rebate allocation for that year will be taxable. Perhaps surprising to some, this tax treatment includes a rebate allocated by the employer in the form of a premium reduction. On the other hand, if covered individuals made their contributions on an after-tax basis for the year for which a rebate is issued, the rebated amount (whether cash or premium reduction) will not be taxable.