Nov./Dec Vol. 29/No. 6

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IRS TO BEGIN COMPLIANCE CHECKS OF NON-GOVERNMENTAL SECTION 457(B) PLANS 5

Mary K. Samsa, McDermott Will & Emery LLP

The Internal Revenue Code of 1986, as amended (the ‘‘Code’’) permits governmental and exempt entities to sponsor tax-advantaged retirement plans meeting the requirements of Code Section 457(b) (‘‘Section 457(b) Plans’’). Although governmental Section 457(b) Plans primarily operate and act like Code Section 401(k) plans and Code Section 403(b) Plans (i.e. a ‘‘qualied’’ retirement plan), Section 457(b) plans maintained by tax-exempt entities must be ‘‘top-hat’’ plans, thereby limiting participation to a select group of highly-compensated individuals and management employees. Numerous non-prots sponsor Section 457(b) Plans as a means of providing additional nonqualied deferral opportunities for their highly-compensated executives. The Internal Rev-enue Service (‘‘IRS’’) has decided to take a closer look at these arrangements, announcing recently that it would begin conducting ‘‘compliance checks’’ of Section 457(b) Plans maintained by non-governmental entities (e.g., health systems, educational institu-tions, museums, etc.). Though the compliance checks are not full audits, plan sponsors can expect the IRS to request extensive in-formation regarding written and operational plan compliance.

RISING HEALTHCARE COSTS-CHALLENGES AND OPTIONS FOR BUSINESSES 19

Robert Trumble and Priyadarshini Pattath

Healthcare costs in the U.S. are among the highest in the world and they keep on rising. Managing benets costs is one of the big-gest challenges facing the human resource manager in the current economy. HR managers have to determine the best benet plan for their workforce to ensure employee satisfaction and reduce healthcare spending. Numerous types of healthcare coverage includ-ing consumer driven, group insurance, dened benets, dened contribution, exible benet plans like cafeteria plans and exible spending accounts are some of the options. Also in the face of rising healthcare costs, there is a growing recognition that prevent-ing disease and the maintenance of good health for the workforce not only boosts morale but also increases productivity, thereby reducing the healthcare costs of the employer.

UNDERSTANDING HEALTH BENEFIT EXCHANGES: A FRAMEWORK FOR DECISION

MAKING 28

Randall K. Abbott

The emergence of health benet exchanges has stimulated considerable interest on the part of employers who are intrigued with the possibility of an exchange as a potential delivery channel for employee health benets. This article examines the concept of health benet exchanges and provides a contemporary framework for determining if—and when—a health exchange could make sense for an employer. The author examines this topic from the perspective of the larger employer that is typically covering em-ployees and retirees under a traditional self-funded benet arrangement. This article updates and expands on the author’s recent article in the May/June 2013 issue of this Journal.

EMPLOYEE BENEFITS TOOLS AND STRATEGIES TO PREPARE FOR BUY-SIDE M&A

ACTIVITY 33

Perry C. Papantonis, Human Capital, Ernst & Young LLP

This article highlights several best practices and lessons learned related to employee benets programs in buy-side corporate transactions. These lessons learned and best practices will assist any organization as they prepare for buy-side M&A activity and are focused on the assisting buyers with developing there employee benets negotiating and integration strategies and facilitating the eective integration of acquired entities. These strategies are gleaned from work with highly acquisitive organizations over the course of hundreds of transactions.

Managing Editor’s View Michael B. Snyder, J.D. 3

The Excellent Fiduciary Ronald E. Hagan 13

Reward Strategy and Practice Bob Russell 41

Real World Benets M. Scott Mahood 48

Nov./Dec. 2013 Vol. 29/No. 6

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Are Dened Contribution Health Plans

Destined to Replace Traditional

Models?

Bob Russell

* This article will examine the

past evolution and current state of dened contribution health plan models. The mandated 2014 implementation of the public health exchanges, coupled with the rapid emer-gence of competing private ex-changes has brought dened contribution health insurance to the forefront. The author be-lieves that exible benet pro-grams utilizing exible benet credits are becoming a viable alternative for plan sponsors to consider.

As key Aordable Care Act (ACA) requirements come into eect starting in 2014, includ-ing the public health exchanges, the xed subsidy approach is

attracting more attention of employers who currently oer health coverage to employees, especially in light of the increas-ing availability of private health exchanges in the market. Even though the Obama administra-tion recently extended the deadline for complying with the employer shared responsibility (“pay or play”) mandate from 2014 to 2015, other compliance issues must still be addressed. Many employers are still explor-ing their pay or play options and rening their business strate-gies to minimize penalties and health plan costs in the era of ACA. This might involve a com-bination of changes to plan designs, expanding or reducing

the number of plans being of-fered, or changing the way that premium costs are shared with employees.

This article will examine the past evolution and current state of dened contribution health plan models and why they are expected to become more prev-alent in the future. We will dis-cuss and compare three dier-ent approaches to dened contribution that are in exis-tence today:

E High Deductible Plans with Employee and/or Em-ployer Contributions E Private Health Exchanges

with Employer Subsidies *_{BOB RUSSELL, ASA, MAAA, FCA, is a senior benets consultant in the Dallas oce of Hay Group. He advises public and}

private sector employers in the design, funding, and accounting for health and welfare benet programs.

The dened contribution (DC) concept in employer health plans has been around for a number of years but the “pure DC” approach, in which an employer allocates a xed subsidy to employees to apply toward the purchase of health insurance, has not been prevalent except in certain labor sectors, such as county governments and public school districts.

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E Flexible Benet Plans with Flex Credits

GROWTH OF HIGH

DEDUCTIBLE HEALTH PLANS

High deductible health plans (HDHPs) with either health reim-bursement accounts (HRAs) or health savings accounts (HSAs) have become increasingly prev-alent as an eective means to control healthcare costs through a combination of higher medical plan deductibles and through the use of employer contributions to medical “ac-counts” within the plan struc-ture to mitigate some, but not all, of the employee's annual deductible and other out of pocket costs.

HSA's and HRA's were intro-duced in the early 2000's as a means of increasing employees' awareness of the true costs of health care, coupled with the idea that employees would make dierent health spending decisions if they had control over their own personal health accounts. Experience over the past decade has shown that the level of health spending in these plans is signicantly less than in traditional plans designs, and most employers typically oer a high deductible HRA or HSA plan as an option to employees, along with other more traditional plan options. Less frequently, HDHP plan have become the only type of option oered by some employers.

The market prevalence of HDHP plans oered by employ-ers has risen from 4% in 2005 to 31% in 2012, according to the Kaiser Family Foundation's 2012 Employer Health Benets Survey. HSA qualied plans are far more prevalent than HRA plans (26% of employers versus 5% of employers).

HSA accounts, when at-tached to an IRS-qualied high deductible plan, are designed to be a pre-tax savings vehicle for employees to manage and re-imburse themselves for out-of-pocket expenses such as de-ductibles, co-pays, and coinsurance. Under IRS rules, employees can carry over un-used balances (unlike Flexible Spending Accounts) and may retain ownership of the ac-counts upon leaving employment. Employers are also allowed to contribute to employees' HSA accounts (sub-ject to combined IRS limits), and typically they do contribute a discretionary amount to encour-age employees to enroll in these plans. According to the 2012 Kaiser survey, 72% of employ-ers oering an HSA plan made an annual contribution to em-ployees' accounts, with an av-erage of annual contribution of $609 to employees with single coverage and $1,070 to em-ployees who have family cover-age under the plan.

In contrast with HSA

ac-counts, HRA's are “notional” accounts to which only an em-ployer can contribute, and the account is usually an integral part of the medical plan's design. Unlike an HSA account, the actual money isn't moved into an employee's account until money is needed to pay claims as incurred, and whether any remaining balance at the end of the year is carried over or for-feited is a employer's plan de-sign choice. HRA plan dede-signs have gained less popularity with employees than HSA designs, even though the entire account comes from employer contributions. This is probably due to the lack of a carryover feature and employees feel that they have less “ownership” in the account.

RECENT EMERGENCE OF PRIVATE HEALTH

EXCHANGES

As the ACA mandated public health exchanges go into eect on January 1, 2014, privately owned health exchanges are rapidly growing in the market-place as an alternative to the public health exchanges. In the private exchange model, the employer contractswith a pri-vate company and chooses the health plan options that will be made available to its employees through the online market. It is up to the employer to determine the method for determining the subsidy it will provide to each

Journal of Compensation and Benets

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eligible employee to be used as an oset to the premiums the employee will pay for the bene-t package he or she elecbene-ts on the exchange.

The exchanges promise to take over many of the adminis-trative responsibilities and deci-sions that the employer's HR and payroll departments would typically handle in a traditional environment. However, partici-pating in a private health ex-change doesn't mean the em-ployer no longer has to comply with ERISA, the ACA, and other applicable laws and regulations

A few key questions for em-ployers to consider early in the process when evaluating whether to send their employ-ees to a private exchange for health coverage:

E How many and what type of health plan options will be oered to your em-ployee population? Do you also want ancillary benets such as dental, life and disability to be oered? E Which segment of the

em-ployee population will be given access to the ex-change? Full time employ-ees? Pre-65 and Post-65

retirees? Part-time and seasonal workers?

E How will the billing system work, and what employer interfaces with payroll will be necessary?

E What wellness and health management programs will be available?

E What type of reports will be provided and how of-ten?

E Who will be the ongoing point of contact for the employer?

E How will annual renewals be handled — will premium cost increases be negotia-ble by employers?

E What type of online tools and call centers will be used to assist individual employees in enrolling in plans?

SECTION 125 CAFETERIA PLANS

Most employers today take advantage of IRS Section 125 Cafeteria Plan rules to allow employees to make their re-quired contributions toward health plans on a pre-tax basis through reduction in salary through payroll deductions. This

is a tremendous benet for both employees and employers from a tax standpoint, since the pay that is deducted and converted to certain allowed benets is not subject to federal income tax, FICA or FUTA. The applica-tion of state and local taxes under cafeteria plans depends on individual state laws.

The rules for cafeteria plans are lengthy and complex, and we will not discuss a great many of them here, but to un-derstand the basic construct of cafeteria plans, employees may elect to reduce their otherwise taxable compensation in order to contribute toward the cost of certain “qualied” benets that are allowed to be part of a caf-eteria plan under IRS regulations. Because a cafete-ria plan by law must oer at least one qualied taxable ben-et (or cash compensation) as a choice, employers often in-clude qualied benets that may be paid for by employees on an after-tax basis as part of the cafeteria plan.

Table 1 below lists examples of qualied cafeteria plan ben-ets, and benets that IRS regu-lations specically exclude from being part of a cafeteria plan (but may still be oered outside of a cafeteria plan).

Table 1

Qualied Cafeteria Plan Benets Nonqualied Benets

Medical Long Term Care Insurance

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Qualied Cafeteria Plan Benets Nonqualied Benets

Vision Educational Assistance Programs

Group Disability Employer Provided Meals and Lodging Group Term Life and Accident Insurance Health Reimbursement Accounts Health Flexible Spending Account (FSA) Fringe Benets

Dependent Care Spending Account (DCA) Deferred Compensation other than 401(k) contribu-tions

Adoption Assistance plan Dependent life insurance Health Savings Account (HSA)

401(k) plan contributions Buying/Selling of paid time o

Employer ex credits to purchase qualied benets

FLEXIBLE BENEFIT PLANS WITH FLEX CREDITS VERSUS TRADITIONAL COST-SHARING

Cafeteria plans are also widely known as Flexible Bene-t plans, because Bene-they allow employees a great deal of ex-ibility in choosing from a “menu” of benets the employer oers, in order to best t their particu-lar wants and needs. During an-nual enrollment, employees can also make decisions on contrib-uting to exible spending counts or dependent care ac-counts, and 401(k) plans, and may be able to purchase volun-tary benets such as supple-mental life policies or long term care insurance.

Starting in the 1980's and 1990's the concept of providing each employee a dened “ex credit” (xed subsidy) that could be used to select among

available exible benet options gained a certain amount of popularity, and many such plans still exist. The ex credit ap-proach to health care is a true dened contribution method in that the employer denes a xed amount designated for benets spending per em-ployee, and employees must decide how they will make their selections using their ex credit as a budget. As previously men-tioned, the ex credit concept did not evolve as the standard method for sharing premium costs between employers and employees. The most common cost-sharing method that em-ployers use today is setting a target percentage of total costs it wishes to subsidize, such as splitting the premium costs 80% paid by employer, 20% paid by employee.

While the current method may seem fair and

understand-able to employees if well com-municated, a ex credit ap-proach makes the employer dollars paid per employee very transparent, and might cause employees to choose dierently when presented data in this way.

Let's illustrate this dierence with a simple example contrast-ing the two cost-sharcontrast-ing meth-ods for a typical employee, us-ing illustrative numbers:

An employer oers a choice between a “core” health plan with a $500 per person deduct-ible ($1,000 family) and a HSA qualied plan with a $1,500 de-ductible for single coverage and $3,000 for family coverage.

The Monthly employee con-tribution costs, representing one-third (33%) of the total premium costs for the two plans, are as follows:

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Employee Monthly Contribution Rates

Core $500 Deductible Plan $1,500 Deductible Plan

Employee only $100 Employee only $80

Employee plus Spouse $200 Employee plus Spouse $160 Employee plus Family $350 Employee plus Family $280

The employer has many dif-ferent ways to go about setting the amount of the ex credit, but let's say the credit is com-municated to be $700 per month.

Employee A is a 30 year old male, with a non-working spouse and one child.

Under the “old” cost-sharing method he has a choice of two medical plans, costing either $350 per month or $280 per

month for family coverage. He is also aware that if he decides to take the high deductible op-tion, the $70 dierence in monthly premium could be put into an HSA account, which would accumulate to $840 the rst year. However, the $840 HSA account would only par-tially oset the cost of paying the family deductible of $3,000, should the family have signi-cant medical expenses during the plan year.

Alternatively, under the “ex credit” cost-sharing method, Employee A would be pre-sented with a choice of the same plans, but working with an entirely dierent set of numbers, communicating the plans' total “price tags” instead of net em-ployee contributions. Remember that in this hypothetical ex-ample, the original employee contribution rates were set to be 33% of the total premium costs.

Monthly Price Tags

Core $500 Deductible Plan $1,500 Deductible Plan

Employee only $300 Employee only $240

Employee plus Spouse $600 Employee plus Spouse $480 Employee plus Family $1,050 Employee plus Family $840

Under the employer's “new” ex credit method, Employee A has a $700 monthly ex credit to use toward purchasing health coverage. He can easily see (by subtracting the monthly credit from the price tags) that his net cost will be either $350 for the core plan, or $140 for the high deductible plan.

Under this scenario, Em-ployee A could pay $350 (coin-cidentally the same amount he would have paid for family cov-erage under the old method) or $140 per month for a high

de-ductible plan — a signicant savings for this employee. If he elects the high deductible plan, he would then have several choices for the $210 he saved, depending on what choices the plan document actually allows:

i) Re-direct cash into an HSA, FSA, or DCA ac-count on a pre-tax basis ii) Contribute to 401(k) plan iii) Purchase other qualied cafeteria benets such as group life or disability

iv) Receive in paycheck as taxable income

Before leaving this example, suppose a dierent employee (employee B) is single or she has a working spouse who is electing health coverage from his own employer.

Assuming that the employer grants the same $700 ex credit to single employees as married employees, Employee B would have even more choices: She could elect single coverage under the health plan

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and have an “excess ex credit” of either $400 or $460 per month. The excess credit could then be used to purchase a combination of any of the other benet plans as shown above, or if the written plan al-lows, receive the excess credit (or a percentage of it) as tax-able compensation.

This is only an illustrative example, and does not repre-sent any employer's actual design. There is a very wide range of examples possible depending on the number and type of plans oered and how the ex credits and price tags are determined.

WHAT SHOULD EMPLOYERS THINK ABOUT BEFORE TRANSITIONING TO A FLEX CREDIT PROGRAM?

Employers who are consider-ing a dened contribution ex credit approach have a number of design and administration is-sues to examine, and decisions to make before moving forward with implementation of the nec-essary changes. Below are listed a few of these key issues: E Should the same amount of ex credits be given to every employee, regard-less of family status, or would you give additional ex credits to employees with a spouse or depen-dents?

E What credits should be

given to part time employ-ees?

E What credits should em-ployees who decline medi-cal coverage receive? E Does the exible benets

program have to stay cost-neutral to the current benets program, or is there a willingness to make an investment to minimize disruption?

E For what types of benets will ex credits be allo-cated? For example:

†Medical only at dol-lar credit

†Medical plus Dental at dollar credits †Medical plus Dental

plus Vision at dollar credits, plus pay-related credits for pay-related benets such as disability and life insurance?

E Is it acceptable for one plan to subsidize other plans in order to keep the employee premiums “rea-sonable” under all options? E Should ex credits be given (or taken away) de-pending on wellness pro-gram participation, to-bacco usage, etc.

E Should buying and/or sell-ing vacation or PTO be

part of exible benets program?

E Are current administrative systems fully capable of tracking employees' usage of ex credits, withholding taxes correctly, and han-dling online enrollments?

FLEX PRICING CONSIDERATIONS

One of the most critical steps involved in implementing a xed credit exible benets program (or alternatively transitioning employees to a health insur-ance exchange) is taking an an-alytical and thoughtful under-writing approach to determining the price tags and ex credits, and how these amounts will be adjusted from one year to the next, as health costs increase with ination.

For the initial determination of the ex credits, one approach would be to calculate the aver-age dollar cost per employee that the employer is now con-tributing to the current plans. This approach is easy to com-municate, and it may generate a net savings to the organiza-tion if a signicant number of employees migrate to the higher deductible, less costly medical plans in the rst year. This favorable result would give the employer more exibility in set-ting the ex credit the second year.

A dierent approach would

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be to initially set the ex credits somewhat lower than current average costs, in anticipation of employees migrating to the lower cost plan options. How-ever, caution should be exer-cised in designing the range of plans to be oered, and in set-ting the relative “price tags” that employees will pay for the dierent plan options, to ac-count for the possibility of verse selection. In short, ad-verse selection means that if any employees perceive that one plan option or feature is a “very good deal”, then they will likely select and over-utilize that plan or feature and thus drive up the plan's costs more than anticipated.

There are many other ways to set the ex credits, and since both the credits and price tags are highly visible to employees, methods should be used that are not overly complicated and which can be logically explained to all employees and other in-terested parties in layman's terms. At the same time, the employer should involve an un-derwriter or health actuary in the technical analysis phase.

CONCLUSION

Pure dened contribution ap-proaches to health insurance will become more prevalent in the future, the author believes. The mandated 2014 implemen-tation of the public health ex-changes, coupled with the rapid

emergence of competing private exchanges, which have enjoyed success in the retiree health in-surance market, has brought dened contribution health in-surance to the forefront.

Health plan sponsors of course have the option to main-tain complete control over their own health and welfare benet program design. Private health exchanges, which are relatively new, may not be the right t for many employers for a variety of reasons. Flexible benet pro-grams utilizing ex credits, such as described above in this ar-ticle may be a more attractive dened contribution alternative for an employer to consider for its employees.