Guest Article

New Change-in-Election Rules Provide Greater Flexibility

(From the May 2000 supplement to the Flex Plan Handbook, Thompson Publishing Group, Inc.)

Summary: New IRS rules issued in March allow employers and employees more flexibility and additional opportunities for making mid-year changes to benefits elections under flex plans. The rules apply to plan years beginning on or after Jan. 1, 2001, but they may be relied on immediately, according to the IRS.

(May 3, 2000) In the wake of new IRS rules addressing mid-year elections in a flex plan, employers and employees have more flexibility and additional opportunities for making mid-year changes to benefits elections.

The rules were issued March 23 in two sets--one in final form and one in proposed form. The final rules are similar to the 1997 temporary rules on mid-year election changes, with a few key changes. The proposed rules issued with the final rules represent more significant changes, and are more plan- and employee-friendly--particularly to self-funded plans. For example, the rules allow automatic employee-contribution changes in mid-year in the event of significant cost changes (either up or down). This should create the potential for many plan sponsors to reduce plan costs.

The final rules apply to health, disability and group-term life benefits, replacing the temporary rules issued in November 1997. The proposed rules would extend the basic principles of the final rules to dependent care and adoption assistance plans. The proposed rules also expand mid-year election options for health, accident and group-life benefits, for significant cost and coverage changes.

The rules apply to plan years beginning on or after Jan. 1, 2001, but they may be relied on immediately, according to the IRS. The proposed rules also may be relied on now, but plan sponsors have the option to continue to rely on the old proposed rules.

In addition to making some key changes from the temporary rules, the new final rules formalize interpretations applied in the industry based on informal guidance from the regulators. Key changes in the new final rules include increased flexibility with respect to election changes:

Also, the final rules allow pre-existing dependents to be added to coverage under a flex plan if the employee experiences a HIPAA event that would entitle the employee, spouse or dependent to special enrollment rights. Similarly, in the event of a status change involving a new spouse or dependent, the final rules allow that if there is such a status change entitling the employee to change to family coverage, other family members may be covered as well as the individual experiencing the status change. The regulations stress that these provisions do not attempt to interpret (or alter) the HIPAA special enrollment rules.

In addition, the new final rules extend the scope of election changes related to coverage changes under Medicare and Medicaid. Under the 1997 rules, if a person became covered under Medicare or Medicaid, such an event was treated as a status change. The rules did not clarify if loss of either of those coverages also constituted a status change. The new rules clarify that loss of either also is a status change.

The proposed rules issued with the new final rules have more sweeping impact in that they would extend the status change rules to dependent care assistance and adoption assistance. They also provide guidance on election changes on account of changes in cost or coverage with respect to dependent care assistance, adoption assistance, disability, health and group-term life insurance coverage.

The Final Rules

In defining what is a status change, the final rules incorporate a bit more flexibility than the 1997 rules, but nowhere near the flexibility of the 1989 proposed rules.

As with the 1997 rules, the final rules provide for mid-year election changes to coincide with HIPAA special enrollment events--marriage, birth, adoption, placement for adoption, and loss of other coverage. The final rules permit mid-year election changes for the following status changes.

• Legal marital status. Changes include marriage, death of spouse, divorce, legal separation and annulment.

• Number of dependents. Events that qualify include birth, death, adoption and placement for adoption.

• Employment status. Events that qualify are those that change the employment status of the employee or the employee's spouse or dependent, including the start or end of employment, a strike or lockout, commencement of or return from an unpaid leave of absence and a change in work site. Also, any change in employment status that affects eligibility in a flex plan or other benefit plan of the employer of the employee, spouse or dependent such that the individual would become or cease to be eligible, constitutes a status change. For example, if a plan covers only salaried employees, and the individual switches from salaried to hourly-paid--causing the individual to lose eligibility--that is a change in employment status.

The provisions extending status change qualification to strikes and lockouts, and commencement of or return from an unpaid leave of absence are expansions from the 1997 rules. Similarly, the change in employment status affecting eligibility under a cafeteria plan or employee benefit plan is an extension from the 1997 rules.

The provisions retain the temporary rule regarding an employee who terminates and returns within 30 days. If the cafeteria plan provides that the employee's election is automatically reinstated, the employer is not required to determine whether a bona fide change in status has occurred with respect to termination of employment. However, if there is an election change and the employee is rehired within 30 days, the status change must be bona fide under the rules. Also, the flex plan may permit an employee who resumes employment more than 30 days after termination to be automatically reinstated to the prior election or to make a new election. On the other hand, the employee may be prohibited from participating in the plan for that plan year upon reemployment.

• Dependent satisfies or ceases to satisfy eligibility requirements. Qualifying changes include those that cause a dependent to gain or lose eligibility upon attainment of age, student status or any similar circumstance. Thus, if a dependent becomes eligible for coverage under the plan as a result of an amendment to the plan during the year, that is a change in status event and the cafeteria plan may permit an election change by the employee to cover the dependent.

• Residence. The residence change that qualifies as a status change may be that of the employee, spouse or dependent.

Consistency Requirement

The final regulations retain the consistency requirement of the temporary rules. For a mid-year election change to be permitted, it must be consistent with the status change. To be consistent with the status change, the election change must be on account of and correspond with a change in status that affects eligibility under the employer's plan.

For example, reduction of health coverage from family to employee-only coverage would be consistent with the loss of the spouse. The spouse as a result of divorce typically loses eligibility (other than for COBRA). Dropping dependent health coverage for a child who lives with the employee would not necessarily be consistent with dropping coverage due to the spouse's divorce. The dependent would not necessarily lose eligibility due to the divorce with respect to that employer plan. Similarly, if a dependent ceases to satisfy the eligibility requirements for coverage, the employee's election to cancel accident or health coverage for any other dependent, for the employee, or for the employee's spouse fails to correspond with that change in status.

If the change in status is a change in the employee's marital status or a change in the employment status of the spouse or dependents, then an election to increase, or to decrease, group-term life or disability income coverage corresponds with that change in status.

The consistency rules are extended from the 1997 rules in certain of these circumstances to give more flexibility. The 1997 regulations allowed group-term life coverage to be reduced but not increased in the case of divorce, legal separation, annulment or death of a spouse or dependent. On the other hand, in event of an individual's beginning work, marriage, birth, adoption or placement for adoption of a child, the employee could increase but not decrease coverage. Under the final rules, upon the event of the employee's change in marital status, or the change in employment status of the employee's spouse or dependent, an employee may elect to increase or decrease group-term life insurance. A similar rule has been added that applies to election changes made with respect to disability income coverage that is not for medical care or for the loss of a limb, etc.

Comments to regulators on the temporary rules suggested that the time period for changing mid-year elections should be limited following a status change. The final rules do not adopt such a rule. The regulators want to give employers and other plan sponsors more flexibility in determining whether and for how long after a status change a benefit election change will be allowed. However, a flex plan may impose a time limit for making an election change.

Entitlement to Medicare, Medicaid

If an employee, spouse or dependent who is covered under a cafeteria plan becomes covered under Medicare or Medicaid, the plan may allow the employee to reduce or drop coverage of that employee, spouse, or dependent. Similarly, if the employee, spouse or dependent lost such coverage, the plan may allow the employee, spouse or dependent to elect to begin or increase coverage under the plan. The proposed rules clarify, however, that changes in eligibility for other government programs, such as the children's health insurance program, or CHIP, do not qualify as status changes.

COBRA Coverage as Change in Status Event

According to the final regulations, if a qualifying event occurs, an employee or ex-employee may change an existing cafeteria plan election affecting the group health plan to pay an increased amount for COBRA coverage. This rule had been included in the 1997 flex plan regulations.

One implication of this regulation is that employees may pay for COBRA coverage on a pre-tax basis. In applying this rule, however, it is important to note that the new cafeteria plan rule has a somewhat limited application. For example, if an employee loses coverage due to a termination of employment (a qualifying event), the qualifying event allows the employee to revoke his or her flex plan election. This means that no more pre-tax deductions will be taken; however, the employee presumably is also not receiving any more pay.

On the other hand, if the ex-employee will receive severance pay, it may be possible to arrange for pre-tax COBRA premium deductions out of the severance pay. In most instances, though, there is little practical meaning to the idea that the employee could increase cafeteria plan deductions to pay for COBRA premiums upon a termination of employment.

Similarly, if an employee is divorced and the employee's spouse loses coverage, it is not clear that the employee could continue pre-tax deductions to pay for COBRA premiums for the ex-spouse. General tax rules do not allow pre-tax deductions for non-spouses or those who fail to qualify as dependents under the tax code.

An instance where the new rule could help is in a reduction in hours of employment. For example, an employee might lose group health coverage due to a change from full- to part-time status. In that case, the employee could (if the cafeteria plan allows) increase pre-tax deductions to pay for COBRA coverage consistent with the new regulations.

Another area where the new cafeteria plan rule might have some practical application is for a child who ceases to be a dependent. In such a case, if the child continues to be a qualified dependent of an employee (that is, the employee provides more than one-half of the child's support), the employee could pay for the child's COBRA premiums through pre-tax payroll deductions.

Family and Medical Leave Act (FMLA)

An individual taking FMLA leave may change his or her group health coverage election for the remaining period of coverage under the plan as allowed under the FMLA.

The Proposed Rules

The proposed rules supplement the final rules to allow for mid-year election changes under a cafeteria plan for dependent care assistance and adoption assistance. Generally, the new proposed rules apply to these benefits the same standards that apply to group health, accident and group-term life benefits under the final rules, with clarifications that relate specifically to these benefits.

Furthermore, the proposed rules permit cafeteria plans to provide for mid-year election changes for all the qualified cafeteria plan benefits on account of cost or coverage changes. The rules extend the application of the cost and coverage provisions to self-funded plans, as well. And the proposed rules allow employees to make mid-year election changes on a pre-tax basis if:

• a new benefit package option is offered;

• a benefit package is eliminated; or

• a coverage change is made under a plan of the employer of the spouse or dependent.

While the proposed rules generally apply the status change and consistency standards of the final rules to adoption assistance and dependent care assistance plans, they also make other changes. For example, a change in the number of qualifying individuals (rather than a change in the number of dependents as with other benefits) is a status change for dependent care purposes. Also, commencement or termination of an adoption proceeding is a status change for adoption assistance plans. And there are certain consistency provisions specific to both adoption and dependent care assistance plans.

Change in Cost or Coverage

The old proposed rules allow limited mid-year elections changes to reflect significant cost or coverage changes. The new proposed rules extend the authority to all qualified benefits under the cafeteria plan--except medical FSAs.

Addressing a situation that occurs frequently, the proposed rules provide that if a plan adds a new option, such as an HMO option within a health care plan, affected participants may prospectively elect that option and make a corresponding election change with respect to other benefit package options.

The new rules also extend the cost-or-coverage provisions to self-funded accident or health plans. For example, if the self-funded plan's accident or health plan costs increase, the plan may automatically make a corresponding change in the salary reduction charge to contributing employees--on a pre-tax basis.

Also, a change of dependent care provider is treated similarly to the addition of a new HMO option under an accident plan. A corresponding election change can be made when one dependent care provider is replaced by another, even if the care provider is related to the employee with respect to coverage changes. However, for cost changes under the status change provisions, the care provider cannot be a relative.

In another significant change from the old proposed rules, mid-year election changes may be permitted by a cafeteria plan to accommodate families where both parents work but their respective employers have different plan years. The new proposed rules treat the election of an employee's spouse during open enrollment as a status change. For example, assume Barney's employer has a plan year based on a calendar year. Barney's spouse, Betty, works for an employer whose plan year begins September 1. Assume Betty had elected employee-only coverage under an HMO option. Betty's employer offered a new HMO option during open enrollment more to Barney's and Betty's liking because of the network of physicians and geographic service area. If Betty elects family coverage under the new HMO option, Barney has a status change for his employer's plan purposes and, although it is the middle of his employer's plan year, Barney can elect to drop his employer's coverage with Betty's family coverage election. Still, the consistency requirements have to be met. In this situation, Barney's reason for dropping coverage is on account of and corresponds with Betty's choice of family coverage.

Significant cost or coverage increases or decreases. If a cafeteria plan has terms automatically increasing or decreasing contributions in event of significant cost increases or decreases, the plan may treat the changes as status changes. For example, if the cost of an indemnity option for health coverage significantly increases during the plan year, covered employees may make a corresponding prospective increase in payments or instead elect to revoke their election and, instead, elect an HMO option. This applies to dependent care as well, but only if the cost change is imposed by a dependent care provider who is not a relative of the employee.

To illustrate how the rules work, a cafeteria plan offers on a calendar-year basis indemnity health care coverage and a medical FSA as agreed to through collective bargaining. Following mid-year negotiations, indemnity premiums and co-payments are reduced and an HMO option is added. The premium reduction is a cost reduction, thus the plan may automatically decrease the amount of salary reduction of affected participants by an amount that corresponds to the premium change. However, the plan may not allow changes to health FSA elections reflected by the lower co-payments. With the addition of the HMO option, participants may change elections to move to the HMO option. Again, the plan may not permit changes to FSA elections to reflect differences in co-payments under the HMO option.

Administrative Implications

Since plan sponsors have the option to follow the new final and proposed rules now, there are certain administrative and compliance issues that should be addressed.

• To permit the new mid-year election changes, plan documents (including SPDs) should be changed first to spell out which changes the plan wishes to adopt. Any changes adopted must be applied prospectively only and no earlier than from the date of adoption.

• There will be administrative challenges in making such changes prior to the beginning of a new plan year. There will be need for in-house training on the new final and proposed rules. And once the changes are adopted, new employee communications material must be prepared explaining the new provisions.

• There could be significant numbers of election change requests--a factor that plan sponsors should evaluate before making any mid-year plan document changes.

• Carriers--insurance and stop-loss--may not be willing to go along with the new rules at this time.

• The consistency rules will have to be examined closely to ensure that proposed mid-year election changes are on account of status changes. Changes in medical FSAs will have to be evaluated independently and scrutinized since the new rules on health plans versus medical FSAs differ slightly.

• Sponsors of self-funded plans should consider relying on the new proposed rules as a cost-saving mechanism and incorporate the automatic contribution change in the event of significant cost increases. While the contribution change anticipates health care cost increases, there also could be favorable experience.

Excerpted from the May 2000 supplement to the Flex Plan Handbook. Copyright 2000, Thompson Publishing Group, Inc. All rights reserved.

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