Question: Why are employer-sponsored health plans typically not funded by a trust, and how could the J&J class action lawsuit turn on this issue?

Short Answer: Although ERISA requires that plan assets (including employee contributions) be held in trust, the DOL has a longstanding nonenforcement policy that applies to most health and welfare plans. Pursuant to Technical Release 92-01, the DOL does not enforce the trust requirement for employee contributions to health and welfare plans that are made through a Section 125 cafeteria plan. This issue may end up being a key aspect of the recently filed J&J class action lawsuit, which involves a health plan funded by a trust.

The J&J Case: ERISA Fundamentals Revisited

In light of the recent class action lawsuit filed against Johnson & Johnson (“J&J”) as employer-plan sponsor of its group health plan (Lewandowski v. Johnson & Johnson, et. al., D.N.J., No. 1:24-cv-00671 (Feb. 5, 2024)), we are reviewing the ERISA basics that may both affect the outcome of the case and offer employers as interested observers the opportunity to revisit best practices to better avoid such potential liability.

The plaintiffs in the J&J case principally allege that the company breached its fiduciary duty by mismanaging the health plan’s prescription drug benefit program, costing their ERISA plans and their employees millions of dollars in the form of higher payments for prescription drugs, higher premiums, higher deductibles, higher coinsurance, higher copays, and lower wages or limited wage growth.

The complaint argues that J&J breached its fiduciary duty by failing to engage in a prudent and reasoned decision-making process that would have drastically lowered the cost of prescription drugs in general and generic-specialty drugs in particular, and would have resulted in other cost savings for the plan. The allegation is that a fiduciarily prudent approach would have saved the plan and employees millions of dollars.

One key point of the case from an ERISA perspective is that the complaint states J&J relied on a trust to fund its group health plan. This may prove to be a pivotal aspect of the case because the plaintiff can establish a clear connection between the core fiduciary duties imposed upon employers as the ERISA plan administrator and all trust funds as plan assets. The connection would be far more extenuated if plan benefits were paid from J&J’s general assets, as is more typical for employers sponsoring self-insured health plans.

There are several significant advantages for employers to avoiding use of a trust to pay for health plan benefits. However, as the J&J case develops, and as the industry adjusts and adapts to its eventual holdings, it may turn out that there is no more significant driver of potential liability in this evolving area than the funding mechanism for the plan. This post looks to the ERISA trust requirements, why they typically are not enforced for health plans, and the potential pitfalls for employers to be aware of in this context.

• Newfront Note: The J&J case is merely at the initial complaint stage. Before considering radical changes to plan governance that may be costly, time consuming, and of indeterminable benefit, our recommendation is that employers return to the basic ERISA principles that have proven effective at avoiding potential liability. This series is intended to focus on those concepts—while maintaining an eye to the horizon for how this case (and potentially others) develops in litigation. The outcomes will drive best practices, including whether new approaches and processes might be warranted.

The ERISA Trust Requirement: Applies to “Plan Assets”

The basic rule is quite simple: ERISA requires that plan assets be held in trust unless an exception applies.

Although ERISA itself does not specifically define “plan assets,” DOL guidance is clear that employee contributions to the plan are treated as plan assets as soon as they can reasonably be segregated from the employer’s general assets. In the health plan context—notwithstanding the nonenforcement policy discussed below—this includes standard employee salary reduction contribution amounts for the employee-share of the health plan cost of coverage.

Employers that are not careful can also inadvertently cause other employer funding (e.g., amounts held in a separate account) to be treated as plan assets, depending on how the funds are held and documented. Furthermore, rebate amounts attributable to employee contributions (e.g., MLR rebates) are plan assets that must be handled appropriately and timely to avoid application of the trust requirements.

Why Employers Typically Want to Avoid the ERISA Trust Requirements for Health Plans

Establishing and maintaining a trust for the health plan can require additional documentation (trust agreement), procedural policies (trustee processes), fiduciary duties (assets must be held in trust for the exclusive benefit of participants and beneficiaries), administrative burdens (deadlines to deposit employee contributions into trust), and accounting and reporting obligations (loss of the small plan Form 5500 exemption and the requirement for an independent qualified public account’s opinion reported in Schedule H of the Form 5500).

• For more details: Newfront ERISA for Employers Guide

While employers are generally accustomed to these burdens on the retirement side—where no similar trust nonenforcement policy applies—the industry norm has developed around standard single-employer health and welfare plans being unfunded and operating without a trust pursuant to the DOL’s nonenforcement policy.

• The J&J Connection: The plan in the J&J case was funded by a voluntary employees’ benefit association (VEBA) trust. In some situations, typically limited to very large employers, companies choose to fund their health plan through a trust to address accounting and other similar considerations.

The DOL Health Plan Trust Nonenforcement Policy: Pre-Tax Contributions Through the Cafeteria Plan

The oft-mentioned “cafeteria plan exception” to the ERISA requirements stems from DOL Technical Release 92-01, which remains the seminal guidance in this area more than thirty years later. The key part of the guidance provides as follows:

“In the case of a cafeteria plan described in section 125 of the Internal Revenue Code, the Department will not assert a violation in any enforcement proceeding solely because of a failure to hold participant contributions in trust.”

To summarize: The DOL does not enforce the trust requirement for plan assets derived from employee health and welfare plan contributions where those contributions are made through a Section 125 cafeteria plan.

Employee contributions for the employee-share of the cost of coverage are almost always taken by employers on a pre-tax basis through a Section 125 cafeteria plan salary reduction contribution election. The Section 125 cafeteria plan is the exclusive means by which an employer can offer employees an election between taxable income and nontaxable health and welfare benefits on a tax-advantaged basis (i.e., without application of the doctrine of constructive receipt).

For more details:

• Newfront Section 125 Cafeteria Plan Guide

• The Section 125 Safe Harbor from Constructive Receipt

Technical Release 92-01 thereby captures virtually all employee health plan contributions with its policy not to enforce the trust requirement on health plan assets attributable to contributions made through the Section 125 cafeteria plan.

What About After-Tax Contributions to the Health Plan?

There are some situations where employers will take after-tax contributions for a health and welfare plan benefit. For example, employers will take after-tax COBRA premiums from terminated employees, and after-tax premium payments for employees on unpaid leave who are contributing by the pay-as-you-go approach. Furthermore, multiple forms of welfare benefits are often taken on an after-tax basis, such as group term life, disability, AD&D, fixed indemnity, and specified illness coverage.

The DOL has stated that “COBRA contributions or other after-tax participant contributions…would not by itself affect the availability of the relief provided for cafeteria plans in the technical release.” Accordingly, as long as the employer utilizes a Section 125 cafeteria plan to facilitate pre-tax employee contributions generally, the outlier situations that involve after-tax employee health and welfare plan contributions enjoy the same trust nonenforcement policy.

Additional Basis for DOL Health Plan Trust Nonenforcement: Fully Insured Plans

In the vast majority of situations, employers can rely on the cafeteria plan-linked nonenforcement policy to avoid the need to hold employee contributions in trust. However, even if that relief were not available (e.g., the highly unusual situation where the employer did not sponsor a cafeteria plan to facilitate employee pre-tax contributions), Technical Release 92-01 provides a separate basis for the trust nonenforcement policy that applies to employee contributions for fully insured plans.

Specifically, the relief applies for “any other contributory welfare plan with respect to which participant contributions are applied only to the payment of premiums in a manner consistent with §§2520.104-20(b)(2)(ii) or (iii) and 2520.104-44(b)(1)(ii) or (iii), as applicable….”

Those regulations cited refer to the small plan Form 5500 reporting exemption for health and welfare plans covering fewer than 100 participants on the first day of the plan year that are unfunded, fully insured, or a combination of unfunded and fully insured. The rules require the employer satisfy the following conditions with respect to employee contributions for the employee-share of the premium for a fully insured plan:

1. The benefits are provided exclusively through insurance policies (including HMOs) with a state licensed carrier;

2. The employer pays the premiums directly to the insurance carrier from its general assets and employee contributions; and

3. The employer forwards the employee contributions to the carrier for payment of such premiums within three months of receipt.

What About Self-Insured Plans?

The fully insured plan component of the Technical Release 92-01 nonenforcement policy is simply an additional alternative avenue of relief to avoid the trust requirement. Employers sponsoring a self-insured plan can still take advantage of the trust relief by taking employee contributions on a pre-tax basis through the cafeteria plan pursuant to the first exception described above.

Given that virtually all employers with employee health plan contributions utilize a Section 125 cafeteria plan to take those contributions on pre-tax basis, the cafeteria plan exception will be sufficient to provide the DOL’s trust nonenforcement imprimatur for both fully insured and self-insured plans in nearly all situations.

• The J&J Connection: Even though the J&J health plan is self-insured, there was nothing preventing the company from paying health plan benefits from general assets pursuant to “cafeteria plan exception” aspect of the relief described above. The company chose to fund the plan through a trust—which generally only very large employers consider.

ERISA Does Not Require That Health Plans Have Segregated Funding

The DOL has made clear that “ERISA does not impose funding requirements or standards with respect to welfare plans.” It has further clarified that “an employer sponsor of a welfare plan may maintain such plan without identifiable plan assets by paying plan benefits exclusively from the general assets of the employer.”

This means that nothing in ERISA requires that employers establish a segregated funding arrangement for health and welfare plans. Employers are often surprised by this laissez-faire landscape for health plan funding, particularly when moving to a self-insured arrangement for the first time.

In fact, the guidance makes clear that employers should generally avoid establishing any separate account because doing so—without being very careful—can cause the plan to lose the Technical Release 92-01 trust nonenforcement relief. Losing that relief has the consequence of being required to fund the plan with a trust, which would be a significant (and unnecessary) administrative burden that generally no employer would choose to embrace if given the option.

• The J&J Connection: In addition to the administrative burden concerns, avoiding the inadvertent loss of the DOL’s trust enforcement policy could end up as a key liability consideration derived from the J&J case. The J&J plan’s trust-funded status may prove to be one of the primary reasons the plan was targeted as the test case in this area, as well as a potential factor in the court’s analysis of the class plaintiff’s breach of fiduciary duty allegations.

Employers paying for health and welfare plan premiums and/or benefits through any arrangement other than standard general assets will therefore need to proceed with tremendous caution to avoid inadvertently having the arrangement deemed ERISA plan assets that must be held in trust.

Our series exploring the J&J case practical considerations continues next week with Part 2 of the ERISA Trust Rules for Health Plans.

Relevant Cites:

ERISA §403(a):

(a) Benefit plan assets to be held in trust; authority of trustees.Except as provided in subsection (b), all assets of an employee benefit plan shall be held in trust by one or more trustees. Such trustee or trustees shall be either named in the trust instrument or in the plan instrument described in section 402(a) or appointed by a person who is a named fiduciary, and upon acceptance of being named or appointed, the trustee or trustees shall have exclusive authority and discretion to manage and control the assets of the plan…

29 CFR §2510.3-102(a)(1):

(1)  General rule.For purposes of subtitle A and parts 1 and 4 of subtitle B of title I of ERISA and section 4975 of the Internal Revenue Code only (but without any implication for and may not be relied upon to bar criminal prosecutions under 18 U.S.C. 664), the assets of the plan include amounts (other than union dues) that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution or repayment of a participant loan to the plan, as of the earliest date on which such contributions or repayments can reasonably be segregated from the employer's general assets.

DOL Technical Release 92-01:

In the case of a cafeteria plan described in section 125 of the Internal Revenue Code, the Department will not assert a violation in any enforcement proceeding solely because of a failure to hold participant contributions in trust. Nor, in the absence of a trust, will the Department assert a violation in any enforcement proceeding or assess a civil penalty with respect to a cafeteria plan because of a failure to meet the reporting requirements by reason of not coming within the exemptions set forth in §§2520.104-20 and 2520.104-44 solely as a result of using participant contributions to pay plan benefits or expenses attendant to the provision of benefits.

In the case of any other contributory welfare plan with respect to which participant contributions are applied only to the payment of premiums in a manner consistent with §§2520.104-20(b)(2)(ii) or (iii) and 2520.104-44(b)(1)(ii) or (iii), as applicable, the Department will not assert a violation in any enforcement proceeding or assess a civil penalty solely because of a failure to hold participant contributions in trust.

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).