Cash in Lieu of Health Insurance Coverage for Employees Who Opt Out

A recent trend in the health care industry is employers offering additional (taxable) wages or other financial incentives in exchange for an employee declining coverage under the employer-sponsored group health plan.  Regardless of the (often well-meaning) reason for offering these types of “cash in lieu” arrangements, employers must consider the potential implications of the “opt out” payments on the group health plan’s affordability calculation under the Patient Protection and Affordable Care Act (“ACA”). 

As background, applicable large employers that are subject to the ACA’s employer shared responsibility provisions must offer minimum essential health coverage that is “affordable” to avoid potential penalties.  In calculating affordability, the IRS has stated that unless an opt-out arrangement satisfies the rules for an “eligible” opt-out arrangement, the amount of cash that an employee may receive in lieu of electing coverage must be included in the affordability calculation, making it more difficult to satisfy the ACA’s affordability requirement.  For example, assume that under an employer’s group health plan, the employee cost for self-only coverage is $100 per month.  Alternatively, the employee can elect to receive $250 per month as additional wages if they decline coverage.  For ACA affordability calculation purposes, the IRS would consider the total cost to the employee as $350 per month ($100 + $250).

However, if the opt-out arrangement is an “eligible” opt-out arrangement, the amount of the opt-out payment does not have to be included in the ACA affordability calculation.  “Eligible” opt-out arrangements must meet the following requirements:

1. The opt-out arrangement must be offered as an electable benefit option under the employer’s Section 125 cafeteria plan;
2. The arrangement must only be available to employees who decline employer-sponsored minimum essential coverage; and
3. “Opting-out” employees must attest that they and their dependents have or will have minimum essential coverage under a group health plan (that is, it cannot be individual market coverage) during the plan year. If the employer knows or has reason to know that an employee’s attestation is false, payment cannot be made.

Eligible opt-out arrangements should generally be offered to all eligible employees under the employer’s cafeteria plan to avoid violating other federal laws.  For example, the Medicare Secondary Payer (“MSP”) rules prohibit an employer from offering any “financial or other incentive” for an individual entitled to Medicare “not to enroll (or to terminate enrollment) under” a group health plan.  But representatives of the Department of Health and Human Services have informally indicated that no MSP violation would occur, if the same opt-out payment rights are available to employees broadly.

Relatedly, if the opt-out arrangement is limited to a specific group of employees or is otherwise designed in such a way that targets high-claim individuals, the arrangement could violate HIPAA’s prohibition against discrimination based on a health factor.  Finally, we note that Federal or state wage laws may treat opt-out payments as wages for purposes of calculating overtime under the Fair Labor Standards Act (“FLSA”).

While in theory, opt-out arrangements may seem like an attractive and simple option for employees who do not want health coverage, employers need to be careful about implementing these types of arrangements in light of the potential legal compliance issues.  Even an “eligible” opt-out arrangement could run into compliance issues and may not ultimately be practical if many of the employees who opt-out of coverage intend to purchase minimum essential coverage through the individual marketplace.  When considering offering an opt-out arrangement, consult with your benefits counsel to make sure you’re avoiding these potential traps.