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Regulators play vital role in health care funding


WASHINGTON—While federal lawmakers have played a crucial role in passing bills that affect the funding of health care and other employee benefits, the role of regulators also has been a vital one.

Perhaps the best example of their critical role in setting benefit funding rules involves the use of captive insurance companies to fund benefit risks.

Until 1979, the only guidance in that area was embedded in the Employee Retirement Income Security Act. When ERISA, which is primarily a pension law, was being put together, lawmakers first wanted to ban the use of captives to fund benefit risks because of the potential for self-dealing.

However, lobbying by then-Sears Roebuck & Co., which for years had been using its Allstate Insurance Co. unit to provide various benefit programs to Sears' employees, convinced lawmakers to modify the provision. Under the modification, employers could continue to use their insurance subsidiaries to fund employee benefit plan risks as long as no more than 5% of the subsidiary's business was third-party—a test Allstate could easily meet.

But other employers such as Deere & Co., with big insurance subsidiaries that had lots of but still not quite enough unrelated business to meet the 5% test, urged the Labor Department to ease the rule.

Their efforts were successful when the Labor Department in 1979 bumped up the 5% test to 50%. That change enabled Deere and other organizations whose captives did a lot of outside business to use their captives to fund corporate benefit risks.

But the liberalization of the outside business test was of no use to the overwhelming majority of employers whose captives had very little, if any, unrelated business.

It took more than two decades and many discussions with captive attorneys and consultants, but in 2000, the Labor Department offered an alternative to the 50% test.

Under that alternative, the 50% test could be disregarded as long as certain conditions were met including the use of an independent fiduciary, using top-rated fronting insurers, and enhancing the benefits of participants affected by the arrangement.

More than two dozen employers, including such household names as Alcoa Inc., H.J. Heinz Co. and Microsoft Corp., won Labor Department approval to fund benefit risks—typically, long-term disability and life insurance—under the alternative to the 50% test.

And one employer—soft beverages giant The Coca-Cola Co.—in 2010 became the first company to win Labor Department approval to fund retiree health care benefits through its South Carolina captive. That complex arrangement, which also involves the use of a special trust, is under review by the Internal Revenue Service concerning certain tax aspects.

The Labor Department's captive benefit funding rules are just one of many examples of how regulatory actions have affected the funding of benefits.

“We have seen an accelerating expansion of a body of regulations that have impacted benefit plans,” said Andy Anderson, a partner with the law firm Morgan Lewis & Bockius L.L.P. in Chicago.


Another example of the regulatory impact on benefit plans involves flexible spending accounts, a tax-favored method employers have tapped to make it easier to shift more health care costs to employees.

Under an FSA, employees make pretax contributions to pay for uncovered health care expenses, like costs that fall under a health care plan's deductible. That tax break reduces an employee's true cost in paying for a service.

But the rules involving the operation of FSAs have changed over the years. The most significant change was in 1984, when IRS regulators said account balances had to be forfeited at the end of a plan year.

Then in 1995, IRS regulators modified the rules again, allowing employers to redesign their FSAs so employees could carry over unused FSA balances to pay for expenses incurred during the first two and a half months of the succeeding plan year.

“It is a quid pro quo. If you want the tax advantages of FSAs, there is an arc of regulations to follow in offering and administering the plans,” Mr. Anderson said.

Regulators also have modified rules affecting health reimbursement arrangements, which typically are coupled with high-deductible health plans. In 2002, the IRS gave its blessing to the arrangements, but attached certain conditions to its approval. Among other things, the arrangements must be funded solely by employers and used only for substantiated medical expenses.

If those conditions are met, the arrangements can be structured so that unused employer contributions can be rolled over to pay employees' expenses in succeeding years, the IRS said in a 2002 ruling.

And the 2010 health care reform law has given rise to numerous regulations affecting funding of health care benefits.

For example, regulators gave a temporary reprieve—through the end of 2013—that has enabled employers to offer mini-med plans. Such plans, without a special exemption, would flunk a basic health care reform law test than bans annual lifetime dollar limits.

And plenty of rules lie ahead. For example, the law imposes a special tax on insurers and—in the case of employers that self-fund their health care plans—on third-party claims administrators for plans whose costs exceed certain amounts.

Regulatory guidance is needed, though, in how the tax is to be calculated and allocated in situations where employers offer multiple plans with varying costs, said Tracey Giddings, a director with PricewaterhouseCoopers L.L.P. in Tampa.