Flex Plan Rules Expand Mid-year Election Options

From The Flex Plan Handbook, ©Thompson Publishing Group, Inc.

Under new IRS regulations issued Jan. 10, 2001, flex plan participants may take advantage of liberalized rules governing mid-year changes in their health plans, dependent care and health flexible spending accounts, adoption assistance plans, group term life insurance and disability insurance benefits.

In March 2000, the IRS issued final rules on mid-year election changes under a flex plan. At that time, the IRS also proposed (1) extending the rules to cover dependent care and adoption assistance programs; and (2) extending the scope of permissible health care and other benefits changes due to significant cost or coverage changes.

The new rules issued Jan. 10 amend the March 2000 final rules and finalize the March 2000 proposed rules. Generally, the modifications to the final rules give more flexibility to flex plans and offer more opportunities for participants to make mid-year election changes. The modifications clarify when election changes relating to special enrollment rights are available on a retroactive basis, when mid-year election changes may be made on account of cost reductions in benefit plans and when coverage may be dropped.

In adopting the proposed rules as final rules, the IRS also has made some changes, including an expansion of permissible mid-year election changes due to reductions in the cost of benefits. Another change allows participants to drop coverage altogether in certain situations.

The changes to the final rules generally are effective immediately. The changes to the March 2000 proposed rules that now are made final generally take effect with plan years beginning after Dec. 31, 2001, although plan sponsors may choose to follow the modified rules regarding cost and coverage changes prior to that deadline.

Changes to the Final Rules

The IRS made four key changes to the final rules of March 2000.

Status changes.
The final rules specified that an employee could increase or decrease group term life or disability coverage on account of a change in marital status or employment status. The new amendments to the final rules extend that choice, adding birth, adoption, placement for adoption or death. The scope of these rules also has been extended to include plans that provide coverage for permanent loss of the use of a member or function of the body.

Prospective application of HIPAA special enrollment rules.
The final rules clarify the application of the flex plan rules in the context of special enrollment under the Health Insurance Portability and Accountability Act (HIPAA), including the right of employees to change their flex plan elections corresponding to special enrollment. In the event of birth, adoption or placement for adoption, proper enrollment operates retrospectively to the date of the event. Contributions to pay for coverage may be through pre-tax salary reduction retroactively to the event. However, with marriage as the special enrollment event, the new rules clarify that while coverage per plan terms may be retroactive to the date of marriage, pre-tax salary contribution may be done prospectively only from the date the plan receives the enrollment request.

Consistency rule.
The March 2000 final rules allowed a flex plan participant to terminate or reduce benefits in mid-year if the participant became eligible for coverage under a spouse's or a dependent's plan due to a change in either marital status or employment status. However, that reduction or termination is available only if the employee actually obtains coverage under the spouse's or dependent's plan. The new rules clarify that an employee's certification that he or she either has the other coverage or will obtain it is sufficient proof for the employer to allow the employee to reduce or terminate coverage.

Legal order.
The March 2000 final rules allowed an employee to change his or her election if a judgment, decree or order resulting from a divorce, legal separation, annulment or change in legal custody requires someone else to provide coverage for the employee's child. A provision in the new rules clarifies that the employee may make the mid-year election change only if the other person subject to the order actually covers the child. This modification to the final rules applies for plan years beginning after Dec. 31, 2001. Until that time, plans may either follow the March 2000 final rules or the new final rules as modified.

Changes to the Proposed Rules
In finalizing the rules proposed in March 2000, the IRS made some key changes. Those rules proposed extending mid-year election changes to dependent care and adoption assistance programs, and to significant cost or coverage changes.

Cost and coverage changes
In a rule particularly significant to self-funded plans, mid-year election changes were proposed for significant cost increases, or significant reductions in coverage. The final regulations clarify that a cost increase will be considered to have occurred if either the employee's salary reduction payment is being increased (for example, by having to pay a larger share of the entire cost of the coverage), or if the total cost of the benefit plan increases. While such changes had been permitted under insured plans, availability of the election changes was extended to self-funded plans under the final rules.

It is important to note that medical flexible spending accounts (FSAs) are excepted from this rule. Therefore, the medical FSA election may not be changed mid-year in the event of a cost increase even though the health plan election may be changed. On the other hand, dependent care FSA mid-year election changes are permitted on account of a significant cost increase, but only if that cost increase is imposed by a dependent care provider who is not a relative of the employee. Also, a dependent care coverage change has occurred if the employee's dependent no longer qualifies as a dependent under Code Section 129 (meaning the dependent is over age 13), or if the care provider's hours of service change.

If there is a significant decrease in the cost of coverage of a qualified benefit, a participant may make a mid-year election to participate with respect to that benefit. Or, if an employee was not a participant, he or she could make a mid-year election to commence participation. Similarly, if there is a significant improvement in coverage under a qualified benefit option or if a new qualified benefit option is added, mid-year election changes are permitted to allow employees to commence participation.

Example
Costs for health coverage under ABC Co.'s flex plan are reduced. ABC passes on the cost reductions to employees by lowering required contributions. Phil, an employee, initially elected to not participate. The contribution reduction is passed on mid-year. Phil may elect to participate in mid-year.

The decision by Phil not to participate was an election. The reduced cost may now make the coverage affordable to him. If so, Phil's decision to participate on account of the cost reduction is a mid-year election, and thus is permissible under the new clarification.

By the same token, if there is a significant cost increase for coverage, or a reduction in coverage regarding a qualified benefit, a participant may be allowed to drop the coverage completely if there is no other similar coverage available, or to drop from family to single coverage.

For an individual to drop coverage, though, the significant curtailment in coverage must constitute a loss of coverage. For accident and health plans, curtailments that result in a complete loss of coverage include:

1. elimination of a benefits package;
   
2. an HMO ceases to be available in an area where an individual resides; and
   
3. an employee or covered family member loses all coverage under a benefit package option by reason of reaching a lifetime or annual limit.

The third event is not likely to sit well with plan sponsors or insurers due to its adverse selection implications. For example, an employee could have a medical condition that has reached the annual limit. Coverage could be dropped for the remainder of the year, enabling the individual to avoid premiums and contributions. At the beginning of the next flex plan year, the individual could again elect coverage.

Plan sponsors should note that while the regulations permit mid-year election changes, the rules do not require plans to allow mid-year election changes. Plan sponsors should consider carefully the implications of allowing various types of mid-year election changes and the circumstances under which those changes will be permitted. Also, the underlying plan, in this case a health plan, may not allow annual elections. The flex plan, however, as the funding mechanism, would have annual elections. Limiting late or open enrollment in the health plan could avoid the adverse selection scenario described above.

In addition to the regulatory list of curtailments that constitute loss of coverage, flex plans have discretion to treat the following as losses of coverage:

• a substantial decrease in medical providers available under the option—for example, a hospital ceasing to be a member of a preferred provider organization (PPO), or a substantial number of physicians dropping out of the PPO (a single physician dropping out of a network would not be a significant curtailment);
  
• a reduction in benefits for a specific type of medical condition or treatment (if the plan participant is undergoing a current course of treatment for that medical condition when benefits are reduced); and
  
• any similar fundamental loss of coverage.

The exclusion from the definition of curtailment of the loss of a single physician from a network could become an issue for rural plans that have limited physician pools to draw from for participation in a network. For employees living and working in rural areas, there may only be one or two physicians available. A plan could argue under the provision giving discretion to flex plans that in such a situation the loss of a single physician is a fundamental loss of coverage if there is little or no viable alternative for a participant.

The appropriateness of allowing other events to be treated as significant will be determined on a facts-and-circumstances basis. Plan sponsors should take care to avoid having such events discriminate in favor of highly compensated employees or violate HIPAA's nondiscrimination rules.

Conclusion
With the immediate effective date for the changes in the final rules and the option of immediately applying part of the newly finalized rules, some plan sponsors may want to view the rules as an opportunity to enhance their benefits packages.

On the other hand, some of the new mid-year election changes could create unwanted burdens. While the new regulations are mostly beneficial to employees, some of them may be difficult to administer. Moreover, any mid-year election changes allowed under the new rules should be examined carefully for adverse selection implications. For example, the effective loss of coverage basis for mid-year election changes is a case in point. Flexibility can help both the plan sponsor and the participant, but adverse selection should not be the ultimate result.

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