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Updated: Apr 11, 2021

In the year 2000, the now world-renowned economist, Hernando De Soto published a must-read entitled “The Mystery of Capital – Why Capitalism Triumphs in the West and Fails Everywhere Else.” He meticulously outlines the economic vagaries of the working poor in Peru (his birthplace) as well as other 3rd world countries, caused (in part) by hapless bureaucratic behemoths that make it nearly impossible to own and operate a business legally, hence, forcing many into the extra-legal sector. In one instance, he cites the daily hours spent acquiring the necessary certifications to open a small garment shop in Lima. In total, it required 289 6-hour days of commute and wait times at government agencies on top of a $1231 price tag which at that time was “thirty-one times the monthly minimum wage.” While the book primarily focuses on the need for property rights and simplifying the entry point by which the working poor can access the intangible realm of working capital to create assets and other forms of tangible wealth, I could not help but underscore the similarities between an overly burdensome bureaucracy inherent in our countries healthcare system to that of the worlds destitute weaving their way through the endless fog of paperwork. Imagine navigating 77 bureaucratic procedures and 31 agencies over the course of 10 to 14 years just to register a lot on state-owned land in Egypt! Our health policies in many ways have created their own behemoth of paperwork for payer, employers, employees, and physicians alike.

At the forefront of Consumer-Driven Healthcare in the early to mid- 2000, many brokers were enthusiastically embracing higher deductible health plans and encouraging small employers to consider HSA (Health Savings Account) compatible policies – even going so far as to set up “mini” self-insured plans via a newcomer on the scene: the HRA (Health Reimbursement Arrangement). An HRA effectively allows a small employer to pay for portions of a deductible for its employee population that has elected to participate in a group health plan via a set-aside fund financed by the corporation only. It is not to be confused with an FSA, which is typically funded with employee “before tax” contributions and subject to a “use it or lose it” provision.

Let’s assume that Murphy’s Tire Shop employs 20 full-time employees. The owner of this S-Corp business offers small group health insurance and has elected a high deductible health plan with a $5000 deductible with 80/20 co-insurance to an additional $10,000 before the plan finally pays 100% of the qualified medical claims. A savvy broker, at that time,* has convinced the owner to move away from a $500-dollar deductible plan to the higher deductible plan to realize upwards of 40 - 45% in premium savings. With the additional savings, the employer could set aside money via the HRA to cover let’s say half the deductible for its employees. By doing so they are setting up a self-insured vehicle subject to documentation and reporting requirements that can make one’s head spin.

By way of a very simplified introduction to health insurance, self-insured plans historically have only been associated with large corporations. Those that employ at minimum 5000 employees (some brokers may differ on the entry point). They pay for health claims out of their plan assets – a set-aside from the overall revenue of the firm. In other words, they do not purchase an insurance product from Aetna or Humana (although they may employ them to administer the plan). It is simply far more fiscally advantageous for large companies to cover the risk associated with insuring employees themselves.

Companies that employ less but more than 200 – 400 employees are often partially self-funded and will purchase stop-loss insurance to cover deficits associated with claims that exceed $25,000 to $100,000 (depending on the size of the company). Aggregate insurance is also often purchased and covers loss incurred by a corporation’s insured population as a whole or in “aggregate.” Companies under 200 are typically fully insured – meaning they purchase a group policy from UHC, Cigna, BCBS, etc. In exchange for a monthly premium – the insurance company takes on all the risk of paying beneficiary claims.

ERISA is the governing law that oversees these “qualified welfare benefit plans,” although, under PPACA, its reach now extends to virtually all plans (except church and government-issued health plans). As one can appreciate, the DOL and the IRS have numerous regulations that govern plan design, claims procedures, and more. Self-insured policies via section 105 of the U.S. Treasury code must pass certain eligibility and benefit tests which are designed to deter plan designs that would discriminate in favor of what is termed a “prohibited group,” i.e., highly compensated individuals (HCI’s).

This is where the fun begins.

First, we shall define an HCI. Code Section 105(h)(5) defines “highly compensated individuals” as an individual who is a) one of the five highest-paid officers; b) a more than 10% shareholder; or c) among the highest-paid 25% of all employees (other than excludable employees who are not participants). Under the benefits test, the benefits provided to HCI’s under the plan must also be provided to all other plan participants. There are two components of the benefits test that determine discrimination on the “face of the plan,” as well as in actual operation. Essentially, the plan must offer the same benefits, waiting periods, contribution levels, and the maximum benefit level cannot vary based upon age, years of service, or compensation. Discrimination in the operation of the plan is established by a “facts and circumstances” determination and typically involves an analysis of the duration of a particular benefit. An example would be offering fertility treatment, of which the owner’s spouse undergoes as a covered benefit, but soon after the birth of their child, the plan is amended to exclude such procedures. This would likely be deemed discriminatory.

The eligibility test under Section 105 determines whether the plan favor’s HCI’s as to plan eligibility. In other words, the plan cannot only cover the top wage earners. A plan must pass one of four tests to satisfy eligibility criteria: 1) the plan covers 70% or more of all non-excludible employees; 2) the plan covers 80% or more of all non-excludable employees who are eligible to benefit if 70% or more of all non-excludable employees are covered under the plan; 3) the plan benefits a nondiscriminatory classification of employees which requires a bona fide business classification for any exclusion and a sufficient ratio of benefiting non-HCI’s to benefiting HCI’s; 4) the plan benefits employees in a fair cross-section of employees.

The problem with non-discrimination testing as it applies to HRA’s is that qualified employees that have waived coverage and elected to be covered under their spouses plan, for example, must still be counted in the numerator (and denominator depending on which test utilized). Additionally, a small employer may not be able to pass the testing since the owners cannot by law participate in the HRA (2% or greater shareholders in an S—Corp are excluded), yet they must be included in the test. It is not hard to imagine an insured pool of 20 (including say 4 owners) downsizing to 7 due to a downturn in the economy. If the owners remained, the plan would fail both the 70% test and the 70%/80% test.

No worries though, we can likely get the plan to meet the stipulations of the reasonable classification test. A reasonable classification refers to an objective business criterion that identifies a legitimate category of employees who benefit under the plan, such as job categories, hourly wage earners, geographic location, or some other bona fide criteria. Can the plan sponsor use legality as a business class? Since the owners and their spouses cannot legally participate in the HRA in the example provided above – can the plan sponsor simply list legally qualified employees as a class? Well if uncertain, one can always reach out to a qualified benefit attorney or alternately, they could simply move on to the safe harbor test (which is part of the nondiscriminatory classification test). Basically, the plan’s “ratio percentage” is first calculated. This is derived by dividing the percentage of non-HCI’s who benefit under the plan by the percentage of HCI’s that also benefit under the plan. To calculate the percentage of non-HCI’s covered under the plan one divides the pool of non-HCI’s who benefit by total non-HCI’s in the controlled group. This number then becomes the numerator to a fraction that consists of the HCI benefiting percentage (which is calculated by dividing the number of HCI’s who benefit by the total HCI’s in the controlled group).

We are not done. Next, the administrator needs to calculate the non-HCI concentration percentage, which for sanities sake I will not detail. The employer then determines whether the plan’s ratio percentage (step 1) is equal to or greater than the safe harbor percentages according to a table that incorporates the concentration percentage (step 2 above).

My head hurts and I have yet to discuss the fair cross-section test. BTW, it should be noted that “to benefit” under the plan has not been clearly defined. Does the fact that someone is eligible to participate in the plan, yet opts out, qualify? Or, does it only refer to individuals that have elected the plan? Many administrators consider eligibility alone when considering who benefits under the plan as it makes it easier to pass the non-discrimination testing (e.g., if more than 70% of all employees are eligible, but only 30% participate, the first test would pass).

I have not even touched on the non-discrimination testing that also must be done for the cafeteria plan (section 125) and the dependent care FSA (section 129).

Not only are employers of all sizes mired in procedures that could be trimmed back or eliminated altogether, but a vast majority of small employers are not in compliance. It is not uncommon to run across a small group plan that either lacks an SPD if in fact an HRA has been established (and the accompanying SBC for the HRA) or has failed altogether to perform non-discrimination testing. Fully insured small group health plans must also ensure that an ERISA wrap document is incorporated as well. This document is designed to wrap together disparate information that ultimately discloses to the employee what is covered under the plan, and in the case of Murphy’s Tire Shop would include the actual insurance benefit booklet and SBC in addition to specific notices required by the law (e.g., Michelle’s Law, GINA, HIPAA, FMLA, USERRA, etc.), because some insurance companies do not provide all of the proper notices and requirements per the onerous IRS and DOL regulations. I would venture to guess that upwards of 90 % of small group health plans lack an ERISA wrap.

In other words, we have gone extra-legal.

The price tag for going extra-legal is intimidating. For insured plans, each day that the plan fails to comply, the plan or plans sponsor is subject to excise taxes or civil money penalties of $100 per day per individual discriminated against. For self-insured policies, non-compliance turns amounts paid out to HCI as taxable excess reimbursements.

What inevitably ends up happening with the sheer volume of information is a futile attempt to summarize the technical arcana of benefit law and benefits “just in general” which leads to even more benefit lingo that provides little to no valuable information. An employee of Murphy’s Tire Shop would end up with all of the insurance collateral, including the SBC (which when first authored oftentimes actually misrepresented the underlying policy), the benefit booklet, an entirely separate SPD for the HRA (and SBC for the HRA) and a wrap document if the plan sponsor is truly covering all of their bases.

Case in point – let’s assume, for argument sake, that you, the employee, are trying to determine if a particular procedure or service under mental health (for example) is covered by your company's health plan. You read your wrap document and run across language that reads “your plan may or may not cover certain benefits associated with mental health – please refer to the plan for specific information….” You then decide to read through the HRA document and the accompanying HRA SBC and you read:

What expenses are considered covered medical care expenses?

Covered medical care expenses means:

Those expenses that would be reimbursed by the employer’s insured group medical Plan, but for the deductible.

Undeterred, you then decide to read the BCBS SBC which may contain equally vague language. No wonder plan beneficiaries are disgruntled. I have not even touched upon the new reporting requirements ushered in under ACA pertaining to applicable large employer groups and the complete nonsense associated with MEC (minimal essential coverage) and bronze, silver, and gold plans – all of which have become so unaffordable to the masses without access to government subsidies. In fact, Kaiser Foundation has reported an exodus of over 4 million Americans who have dropped coverage since 2015 due to cost and according to the Society for Resource Management - there has been a decrease in the number of small employers offering health insurance and many formerly “self-insured” individuals are now simply opting out of the system and going without coverage.

As we move forward with ideas to address reform, my hope is that we can all be courageous enough to examine the need to trim the bureaucratic fat.

*As of today, we have largely lost the financial incentive for small to medium-sized employers to consider an HRA. Moreover, some carriers began “penalizing” plans pre-ACA for incorporating them by charging the plan a surcharge equivalent to a lower deductible policy.

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