Question: What are the main employer considerations when responding to employee requests to make a mid-year enrollment exception outside of a permitted election change event?
Short Answer: The overriding concerns are 1) the Section 125 cafeteria plan irrevocable election rules, 2) insurance carrier or stop-loss provider limitations prohibiting the enrollment, and 3) the scope of the ERISA plan precedent created by permitting the enrollment.
Note: This is the first in a multi-part series addressing employee health plan exception requests.
Eligibility Exceptions: Mid-Year Enrollment Requests Outside of Permitted Election Change Event
There are three main issues for employers to consider upon receiving a request to enroll an employee or dependent mid-year outside of a permitted election change event or after the end of the (typically 30-day) window upon experiencing the event.
The three main issues are:
- The Section 125 Cafeteria Plan Rules;
- The Insurance Carrier Limitations; and
- The ERISA Plan Precedent.
Issue 1: The Section 125 Cafeteria Plan Rules
Employees’ elections to pay the employee-share of the premium for health plan coverage on a pre-tax basis are governed by Section 125 of the Internal Revenue Code. The Section 125 cafeteria plan rules are very strict when it comes to the irrevocability of employees’ elections.
That general rule under Section 125 is that all elections (including an affirmative or default election not to participate) must be:
a) made prior to the start of the plan year (or within 30 days of becoming eligible mid-year), and
b) irrevocable for the plan year unless the employee experiences a permitted election change event.
The permitted election change events are set forth in Treas. Reg. §1.125-4 (e.g., marriage, divorce, birth, adoption, change in employment status affecting eligibility).
If an employer’s cafeteria plan were to permit employees to make any mid-year (i.e., after the start of the plan year) election changes without experiencing a permitted election change event, or after the close of the plan’s election change timing window (typically 30 days), the plan would violate the irrevocable election rule described above.
In this scenario, the Section 125 rules provide that the IRS could cause the entire cafeteria plan to lose its tax-advantaged status (i.e., lose the safe harbor from constructive receipt) if discovered on audit. That could result in all elections becoming taxable for all employees.
How to address the issue: The employer could require the employee to pay the employee-share of the premium on an after-tax basis outside of the cafeteria plan for the remainder of the plan year (or, if earlier, until experiencing a mid-year permitted election change event). The employer-share of the premium would remain non-taxable under §106. However, the employer would still need to carefully consider issues #2 and #3 below before proceeding with the exception.
Issue 2: The Insurance Carrier Limitations
Insurance carriers (and stop-loss providers for self-insured plans) generally will pay claims only for employees and dependents who are eligible and properly enrolled pursuant to the terms of the applicable insurance policy. Carriers will in most cases permit employees to enroll only at open enrollment, upon new hire/newly eligible status, or upon the employee experiencing a permitted election change event and making an election within the required timeframe (typically 30 days). These restrictions are crucial to (among other reasons) avoid significant adverse selection issues for the carrier.
If an insurance carrier or stop-loss provider were to discover that the employer made an exception to permit an employee or dependent to enroll in any other situation, the carrier would be within its right to deny paying all claims for that employee/dependent. That would ultimately likely make the employer responsible for self-funding all claims incurred during the period at issue—which is the worst-case scenario of potentially unlimited liability that employers must avoid.
Note that even in the rare situations where the insurance carrier approves the exception, the carrier does not have the same concerns as the employer regarding the need to take the employee-share of the premium on an after-tax basis (issue #1 above) and consider the scope of the ERISA plan precedent (issue #3 below) because the carrier is not responsible for either of those issues. Employers will often incorrectly assume that the green light from the carrier absolves them of those additional concerns as the cafeteria and health plan sponsor and administrator.
How to address the issue: It is crucial that employers considering a mid-year enrollment exception first ensure that the insurance carrier (or stop-loss provider) agree to the exception. The carrier is well within its right to (and typically will) deny the exception request. As a practical matter, employers cannot permit the exception without carrier approval. Even if the carrier does approve, the employer would still need to carefully consider issues #1 and #3 before proceeding with the exception.
Issue #3: The ERISA Plan Precedent
ERISA requires that employers administer and maintain the plan pursuant to its written terms. The health plan terms will not permit employees to enroll or otherwise make election changes unless they experience a permitted election change event (and make the election within the required timeframe, typically 30 days).
Within this framework, employers do not make “exceptions” because doing so would be a breach of fiduciary duty. Rather, employers exercise their discretionary authority to interpret plan terms. Employers that permit enrollment in these situations have therefore interpreted the plan’s terms to be flexible enough to accommodate the enrollment in that situation.
A broad interpretation of the plan’s terms beyond their standard denotation to permit the enrollment effectively acts in the same manner as a plan amendment because the employer must apply that approach consistently for all similar situated employees. For example, an employer permitting an employee to enroll mid-year without experiencing a permitted election change event (or outside of the typical 30-day window to enroll after experiencing an event) because of the hardship it would cause to the employee to bear the uninsured medical expenses or state individual mandate tax penalty would generally have to accommodate the same requests from all other eligible employees making the same types of requests.
In other words, mid-year health plan enrollment “exceptions” create an ERISA plan precedent requiring the plan to permit the mid-year enrollment for all employees in similar circumstances. An employee denied the ability to change his or her election in similar circumstances would have a potential claim for ERISA breach of fiduciary duty or claim for benefits.
How to address the issue: Unfortunately, there is no good way to solve for the unavoidable establishment of an ERISA plan precedent. The only mitigating factor could be an argument as to the scope of the precedent. How broadly or narrowly the precedent applies in practice is a matter of interpretation based on the specific facts and circumstances of the exception. Employers should keep in mind that an aggressive argument as to the narrowness of the precedent’s scope could always be challenged by the DOL or a participant lawsuit if it were unreasonable.
Accordingly, the plan precedent derived from permitting a mid-year enrollment exception will always be a thorny concern that is difficult to manage. It is perhaps the most persuasive of the three issues arguing against permitting the enrollment exception.
For the reasons outlined above, employers should generally avoid making mid-year enrollment exceptions outside of a permitted election change event. The issues associated with making an exception in most cases far outweigh the typical hardship case presented by the employee requesting the late enrollment.
Nonetheless, there may be some very rare situations where employers consider making a mid-year enrollment exception despite the inherent plan risks. In these situations, employers will need to take employee contributions on an after-tax basis, ensure the insurance carrier (or stop-loss provider) approves the enrollment, and understand they must apply the exception consistently for similarly situated employees based on the applicable scope of the ERISA plan precedent.
Prop. Treas. Reg. §1.125-1(c)(7):
(7) Operational failure.
(i) In general. If the cafeteria plan fails to operate according to its written plan or otherwise fails to operate in compliance with section 125 and the regulations, the plan is not a cafeteria plan and employees' elections between taxable and nontaxable benefits result in gross income to the employees.
(ii) Failure to operate according to written cafeteria plan or section 125. Examples of failures resulting in section 125 not applying to a plan include the following—
(A) Paying or reimbursing expenses for qualified benefits incurred before the later of the adoption date or effective date of the cafeteria plan, before the beginning of a period of coverage or before the later of the date of adoption or effective date of a plan amendment adding a new benefit;
(B) Offering benefits other than permitted taxable benefits and qualified benefits;
(C) Operating to defer compensation (except as permitted in paragraph (o) of this section);
(D) Failing to comply with the uniform coverage rule in paragraph (d) in §1.125-5;
(E) Failing to comply with the use-or-lose rule in paragraph (c) in §1.125-5;
(F) Allowing employees to revoke elections or make new elections, except as provided in §1.125-4 and paragraph (a) in §1.125-2;
(G) Failing to comply with the substantiation requirements of § 1.125-6;
(H) Paying or reimbursing expenses in an FSA other than expenses expressly permitted in paragraph (h) in §1.125-5;
(I) Allocating experience gains other than as expressly permitted in paragraph (o) in §1.125-5;
(J) Failing to comply with the grace period rules in paragraph (e) of this section; or
(K) Failing to comply with the qualified HSA distribution rules in paragraph (n) in §1.125-5.
Prop. Treas. Reg. §1.125-2(a):
(a) Rules relating to making and revoking elections.
(1) Elections in general. A plan is not a cafeteria plan unless the plan provides in writing that employees are permitted to make elections among the permitted taxable benefits and qualified benefits offered through the plan for the plan year (and grace period, if applicable). All elections must be irrevocable by the date described in paragraph (a)(2) of this section except as provided in paragraph (a)(4) of this section. An election is not irrevocable if, after the earlier of the dates specified in paragraph (a)(2) of this section, employees have the right to revoke their elections of qualified benefits and instead receive the taxable benefits for such period, without regard to whether the employees actually revoke their elections.
(2) Timing of elections. In order for employees to exclude qualified benefits from employees' gross income, benefit elections in a cafeteria plan must be made before the earlier of—
(i) The date when taxable benefits are currently available; or
(ii) The first day of the plan year (or other coverage period).
(4) Exceptions to rule on making and revoking elections. If a cafeteria plan incorporates the change in status rules in §1.125-4, to the extent provided in those rules, an employee who experiences a change in status (as defined in §1.125-4) is permitted to revoke an existing election and to make a new election with respect to the remaining portion of the period of coverage, but only with respect to cash or other taxable benefits that are not yet currently available. See paragraph (c)(1) of this section for a special rule for changing elections prospectively for HSA contributions and paragraph (r)(4) in §1.125-1 for section 401(k) elections. Also, only an employee of the employer sponsoring a cafeteria plan is allowed to make, revoke or change elections in the employer's cafeteria plan. The employee's spouse, dependent or any other individual other than the employee may not make, revoke or change elections under the plan.
(1) Every employee benefit plan shall be established and maintained pursuant to a written instrument. Such instrument shall provide for one or more named fiduciaries who jointly or severally shall have authority to control and manage the operation and administration of the plan.
(1) Subject to sections 403(c) and (d), 4042, and 4044, a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and—
(D) in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this title and title IV.
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