Return to Sender | What to do with Insurance Premium Refunds and Discounts

September 7, 2021

What to do with Insurance Premium Refunds and Discounts

Insurance carriers will soon issue 2020 Medical Loss Ratio (MLR) rebates mandated by the Affordable Care Act (ACA). Although many insurance carriers gave advanced premium refunds and/or discounts in 2020 – due to lower-than-expected claims experience[1] – in the hopes of offsetting their eventual 2020 MLR rebates, the Kaiser Family Foundation is projecting this year’s rebate total to be the second highest since the requirement went into effect in 2012. We are not aware of any similar COVID-driven wave of refunds or discounts for 2021.

While money back is always useful for employers, there are rules governing what employers may be able to do with it. This Alert distinguishes between premium refunds and discounts, and it addresses what employers can do with them. We will also briefly discuss how the rules differ for self-insured group health plans.

Background

Medical Loss Ratio Rebates

The ACA’s MLR standards require health insurance carriers to spend a minimum percentage of premiums on health care services and activities that can improve the quality of care. If a carrier does not meet the MLR standards (85% in the large group market; 80% in the small group market), it must provide rebates to the policyholders – the employer in the group market and individuals in the individual market.

Each year, insurance carriers calculate their MLR across their market segment books of business and issue rebates to policyholders if the money spent on health care and quality care activities is less than the required MLR standard. A report containing those calculations is due to CMS by July 31st of the following year (e.g. July 31, 2021 for 2020) and rebates must be paid to policyholders by September 30th each year.

An MLR rebate is a premium refund. If participants pay all or a portion of the insurance premiums (known as a “contributory plan”), the same proportion of the MLR rebate is considered a “plan asset” and should be distributed to plan participants or otherwise used for their benefit.

Other Insurance Premium Refunds or Discounts

As mentioned earlier, insurance carriers may offer employers premium refunds or discounts on fully insured health coverage due to lower-than-expected claims experience for a given year. For 2020, this was almost entirely COVID-19 related. Insurance carriers tend to position this relief as a goodwill gesture to employers, although carriers who do not provide relief for medical coverage in the current year may owe large MLR rebates the following year. Most dental and vision coverage is not subject to the MLR standards, so relief provided by dental and vision carriers is more an act of goodwill on their part (unless a state standard similar to the MLR rules applies).

Unlike MLR rebates, insurance carriers have some flexibility to determine how to provide other premium relief and seem to favor providing relief in the form of a discount to a future premium invoice.

What’s in a Name? Refunds versus Discounts

The label used by an insurance carrier may not be that helpful. When we use the terms “refund” or “discount” in this Alert, we mean the following:

  • Refund – A refund is a return of premiums already paid for a prior period. All refunds are subject to plan asset rules and employers should generally treat them like an MLR rebate.
  • Discount – A discount is a reduction of a future premium. Since discounts are reductions to premiums not already paid, they are not subject to the plan asset rules. Employers can generally keep discounts but cannot charge employee more than actual premium for coverage.

“Disguised” Refunds: A future credit based upon premiums already paid in a prior period is really a refund. For example, a credit on the August invoice equal to 50% of the premiums paid in April is really a 50% refund of April premiums and not an August discount.

What about Self-Insured Health Coverage?

The situation is different when we are talking about self-insured coverage. First, MLR rebates do not apply to self-insured coverage. Second, an employer usually pays plan benefits from its own general assets. An employer may feel some pressure to return employee contributions if they exceed actual paid claims, but the employer usually has no legal obligation to do so.[2] The excess contributions theoretically remain in the employer’s general assets and are available to pay future claims. If a third party administrator refunds fees that were included in the plan’s premium equivalent rates, a proportion of the refund is a plan asset, but it can also theoretically remain in the employer’s general assets to pay future claims.

If the plan pays benefits through a trust, an employer may want to consider reducing excess contributions to avoid overfunding for tax reasons, particularly if the trust is a VEBA trust.

Who Gets the Money?

Determining who gets the money can be challenging. The Employee Retirement Income Security Act of 1974 (ERISA) requires that any amounts attributable to “plan assets,” such as employee contributions, be returned or used for the exclusive benefit of participants. Similar state-level rules apply to prevent the misuse of funds attributable to participant contributions for non-ERISA plans.

If the premium relief provided by an insurance carrier involves plan assets, some of the relief may belong to the plan participants and the employer cannot simply keep all of the money. Determining whether plan assets are involved and what amount may belong to plan participants is a multi-step analysis described below.

Multiple Employer Plans: This Alert focuses on single employer plans. Multiple employer plans may maintain their own rules for the distribution of plan assets and likely require additional analysis to determine plan participant proportional shares.

Step 1

Employers must first determine whether the premium relief is a refund or just a discount. If the premium relief is a discount, please skip to Dealing with Discounts. If an insurance carrier issues the employer a check or wire transfer, as is the case with MLR rebates, it is easy to classify the payment as a refund. If the premium relief is a refund, please proceed to Step 2.

Step 2

The employer needs to determine if any portion of the refund/rebate is a “plan asset.” Plan assets belong to the participants and may not be kept by the employer or used to pay its expenses. The relevant plan documents should indicate the source of the premiums paid to the insurance carrier and might describe the ownership interest in rebates or refunds of premiums received by the plan.

In most instances, the plan documents will not resolve ownership interests, and the employer will need to rely on the sources and relative ratios of paid premiums in order to determine what portion of the refund is a plan asset. Please proceed to Step 3.

Step 3

Assuming the plan documents do not resolve ownership interests (and they likely do not), the employer needs to determine what portion of the refund is a plan asset.

How Premiums are Paid

Plan Asset

Who Receives the Refund

100% from the plan’s trust assets

Yes

100% belongs to the trust as a plan asset and must be used for the benefit of participants

100% by participants

Yes

100% belongs to the participants

100% by employer

No

100% belongs to the employer and may be used for any purpose

 

How Premiums are Paid

Plan Asset

Who Receives the Refund

Employer and participants each pay a fixed % of the premium

(Example: Employer pays 70% and participants pay 30%)

Yes, partially

A % of the refund belongs to the participants equal to the % of the total premium paid by the participants.[3]

The remainder of the refund belongs to the employer and may be used for any purpose

Employer pays a fixed dollar amount toward coverage and the participants pay the rest

(Example: The employer pays up to

$5,000/year toward any tier of coverage and the participants pay the balance)

Yes

The amount of the refund up to the participant contributions is plan assets

Any portion of the refund that exceeds the participant contributions belongs to the employer and may be used for any purpose

Participants pay a fixed dollar amount toward coverage and the employer pays the rest

(Example: The participants pay up to

$5,000/year toward any tier of coverage and the employer pays the balance)

Possibly

The amount of the refund up to the employer’s contributions belongs to the employer and may be used for any purpose

Any portion of the refund that exceeds the employer’s contributions is plan assets

Step 4

Finally, employers must determine how to use the portion of the refund allocated to plan participants, addressed below under Dealing with Refunds.

Dealing with Refunds

Employers have a few considerations when dealing with refunds.

  1. Plan Participants – The employer may determine it is reasonable to use the refund for current plan year participants and not the exact participants from the plan year for which the rebate applies.[4] This includes current COBRA participants. Factors used to make this determination can include the cost and administrative difficulty of locating former employees and/or whether a large number of the same individuals are participants in both plan years.

    The available guidance prefers using the refund for participants in the same insurance policy (or policies) that generated it, but it should be reasonable to share the refund with participants in the employer’s other medical coverage depending upon the facts and circumstances.5 For example, if the employer replaced the plan option that generated the refund, it should be reasonable to use those funds for participants in the plan option(s) that replaced it.

  2. Preferred Methods – The most common approaches are to pay the refund in cash, use it to reduce future premiums in the current year (a full or partial "premium holiday"), or apply it to enhance benefits. Enhanced benefits might include HSA contributions or additional wellness benefits. For small refunds or small remainders of larger refunds, an employer could use the funds to pay for flu shots, educational presentations, or other similar expenses.

  3. Tax Consequences – If the participants pay premiums on a pre-tax basis through an Internal Revenue Code Section 125 cafeteria plan, a refund returned as cash or as a cash equivalent is taxable income. There is a myth that premium holidays provide participants with a “tax-free” benefit while cash refunds are taxable, but the net tax effect to employees is actually the same. The employee’s taxable take-home pay will increase because the amount withheld from the employee’s paycheck will decrease as demonstrated below.
  4. Timing – The employer must generally distribute or use the participant’s portion of the refund within three months of receipt.

$50 Refund as Taxable Cash

Step

$50 Refund as Premium Discount

$3,000

Monthly Base

Compensation

$3,000

$50

Cash Refund

-

$3,050

Subtotal

$3,000

($100)

Less Monthly Premium

($50)

$2,950

Taxable Compensation

$2,950

$885

Tax @ 30%

$885

Dealing with Discounts

Since the plan asset rules do not apply, employers are not generally required to share discounts with covered employees. While this frequently allows employers to keep the value of the discount for their own benefit, there are a few things for employers to consider.

  1. Employee deductions vs. premium amounts – Employers cannot charge employees more than the actual premium paid to the insurance carrier. If the plan is 100% employee paid and the insurer gives a temporary premium discount, employers must pass the discount through to the participating employees.

  2. COBRA – A temporary reduction in the overall premium for a fully insured plan during the plan year is also a good argument to reduce the corresponding COBRA premium (even though the reduction is only temporary).

  3. ACA grandfathered status – If an insurance carrier provides a premium discount on an ACA “grandfathered” medical plan option, not sharing the discount means the participant contribution percentage toward one or more tiers of coverage increases. This may cause a loss of grandfathered status even though the contribution percentage increase is only temporary. Once grandfathered status is lost, it cannot be restored.

  4. Future refunds (including MLR rebates) – Not sharing the discount with participants means their share of overall premium contributions increases. This can affect the participants’ share of a future refund of paid premiums for that plan year such as an MLR rebate. In other words, not sharing the discount today means the participants’ share of a potential future return of plan assets should be larger.

  5. Contractual obligations – Although rare, there may be instances where a client is contractually obligated to provide a certain percentage toward contributions or some similar obligation. For example, this might exist in a collective bargaining agreement.

  6. Participant noise – It is also worth a mention that not sharing the premium discount with participants may generate some “noise” if they learn about it.

[1] Although a pandemic lowering expected claims experience sounds counterintuitive, this was a result of limited access to health care providers due to office and facility closures, individuals staying away from providers out of fear of exposure to COVID-19, postponements and cancellations of elective procedures, and reduced covered participation under health coverage because of layoffs.

[2] This assumes the self-insured plan premium equivalent rates were set using sound actuarial principles. The employer must also consider the plan year’s claims experience when determining the premium equivalent rates for the next plan year.

[3] If the fixed percentage of premiums paid vary by tier of coverage, an employer could choose to use a single average percentage rate for all tiers or determine a weighted average percentage rate for each tier.

[4] HHS guidance expressly permits non-federal governmental plans to limit refunds to current plan participants.

The information contained herein is for general informational purposes only and does not constitute legal or tax advice regarding any specific situation. Any statements made are based solely on our experience as consultants. Marsh & McLennan Agency LLC shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. The information provided in this alert is not intended to be, and shall not be construed to be, either the provision of legal advice or an offer to provide legal services, nor does it necessarily reflect the opinions of the agency, our lawyers or our clients. This is not legal advice. No client-lawyer relationship between you and our lawyers is or may be created by your use of this information. Rather, the content is intended as a general overview of the subject matter covered. This agency is not obligated to provide updates on the information presented herein. Those reading this alert are encouraged to seek direct counsel on legal questions. © 2021 Marsh & McLennan Agency LLC. All Rights Reserved.