Offering Medical Opt-Out Payments

Some employers offer eligible employees a cash incentive, commonly called an “opt-out payment” or “cash in lieu of benefits”, for waiving group health plan coverage. While these arrangements can reduce employer premium costs, they carry real legal exposure across tax, ACA, HIPAA, Medicare and wage-and-hour rules. This article explains the key compliance considerations from the source guidance so brokers can quickly identify risk areas and know what to flag with clients before an opt-out program is rolled out or amended.

Offering Medical Opt-Out Payments – Overview

• Opt-out payments (“cash in lieu of benefits”) are cash incentives paid to employees who waive employer group health coverage, typically because they have coverage through another source (e.g., a spouse’s plan)
• The employer avoids its share of health plan premiums; the employee receives extra taxable compensation — usually less than the employer would have spent on premiums
• Payments are typically spread over the year (rather than paid in a lump sum) to limit employer losses if the employee leaves
• These arrangements are generally permissible but must be designed to comply with the ACA and HIPAA, among other laws
• Before offering a cash-out option under an insured plan, confirm it will not violate minimum participation requirements or other insurance contract terms
• Employers should involve their advisors before launching a cash-out option

Federal Tax Issues

• Opt-out payments are taxable compensation to the employee, unlike group health coverage itself (which is generally nontaxable)
• Employers must include opt-out payments in the employee’s gross income on Form W-2
• Payments are subject to federal income tax withholding and standard employment tax withholding (FICA and FUTA)
• Opt-out payments must be offered through a Section 125 cafeteria plan (Internal Revenue Code)
• Offering an opt-out payment outside a valid cafeteria plan risks triggering the IRS’s constructive receipt doctrine — taxing employees who elect health coverage

ACA Compliance

Proof of Other Coverage

• A common design requires employees to certify or prove they have coverage from another source (e.g., a spouse’s employer plan) to receive the payment
• Conditioning the incentive on an employee’s purchase of an individual insurance policy will likely create an employer payment plan that violates the ACA’s market reforms — which can trigger excise taxes of $100/day per affected employee
• The ACA’s pay-or-play rules require certain applicable large employers (ALEs) to give employees an effective opportunity to decline coverage — this applies when the employer’s coverage does not meet ACA affordability/minimum value standards
• Employers may require proof of other coverage to pay the cash-out, but ALEs that don’t offer affordable, minimum value coverage cannot require that proof as a condition of declining the ALE’s coverage

Affordability Calculation

• ALEs must offer affordable, minimum value coverage to substantially all full-time employees to avoid pay-or-play penalties; affordability generally turns on whether the employee’s required self-only contribution exceeds a set percentage of household income
• Guidance: IRS Notice 2015-87 and related proposed regulations address how opt-out payments affect the affordability calculation
• Opt-out arrangements adopted before December 16, 2015 generally will not increase the cost of coverage for affordability purposes (until final rules issue). Arrangements adopted after that date depend on structure, split into two categories:
  • Unconditional opt-out payments — conditioned solely on declining coverage, with no proof-of-other-coverage requirement. Per Notice 2015-87, these generally increase the employee’s required contribution beyond any salary reduction amount (e.g., a $200/month contribution plus a $100/month opt-out payment = $300/month required contribution for affordability purposes)
  • Conditional opt-out payments — conditioned on declining coverage AND providing proof of other coverage. Under the proposed regulations, these increase the required contribution unless the arrangement is an “eligible opt-out arrangement” (payments available only to employees who decline coverage and provide reasonable evidence that they and their tax dependents have/will have minimum essential coverage other than individual market coverage). Eligible arrangements won’t be treated as increasing required contributions until the proposed rules are finalized

Other Legal Concerns

HIPAA Special Enrollment Rights

• HIPAA special enrollment rights let eligible individuals enroll outside open enrollment after certain life events (marriage, birth, loss of other coverage)
• Employees who take the opt-out payment may still be able to enroll mid-year if a HIPAA special enrollment event occurs
• Employers may consider asking employees to waive special enrollment rights as a condition of the payment, but enforceability of such a waiver is uncertain
• Alternatively, employers could amend plan eligibility rules to exclude opt-out electors from participation for the year — though this approach’s durability under legal challenge is also unclear

Nondiscrimination

• HIPAA bars group health plans from discriminating on eligibility, premiums, or coverage based on a health-status-related factor
• Per Departments’ FAQs (DOL, HHS, Treasury), offering opt-out incentives only to employees with a history of high health claims violates HIPAA’s nondiscrimination rules
• “Benign discrimination” (more favorable eligibility/premium terms based on an adverse health factor) is permissible in some contexts, but the Departments do not view claims-based, cash-or-coverage arrangements as qualifying
• Depending on eligibility design, other laws — such as the ADA or Age Discrimination in Employment Act — could also be implicated

Medicare Secondary Payer (MSP) Rules

• Employers with 20+ employees generally cannot offer any “financial or other incentive” to Medicare-entitled individuals not to enroll in (or to terminate enrollment in) a group health plan
• An opt-out incentive aimed at Medicare-entitled employees would violate this prohibition, with penalties up to $11,823 per violation (inflation-adjusted)
• CMS has informally indicated no violation occurs if Medicare-entitled employees have the same opt-out rights as other employees under a Section 125 cafeteria plan — but this guidance has not been formalized

Fair Labor Standards Act (FLSA)

• The FLSA requires at least federal minimum wage for all hours worked and overtime at 1.5x the regular rate for hours over 40/week
• DOL regulations explain how employer benefit-plan contributions factor into the overtime calculation
• Under this guidance, opt-out incentives are generally included in an employee’s regular rate of pay when calculating overtime

To-Do’s for Benefit Consultants

• Confirm any client considering or currently offering opt-out payments is running them through a Section 125 cafeteria plan; flag exposure if not
• Review whether the opt-out payment is conditional (proof of other coverage required) or unconditional and confirm the affordability calculation reflects the correct treatment per Notice 2015-87 and the proposed regulations
• For ALE clients, verify opt-out design doesn’t undermine pay-or-play compliance or create an impermissible employer payment plan
• Check that opt-out eligibility criteria are not tied to employee health status or claims history — refer to the nondiscrimination FAQs if a client’s design looks claims-based
• Ask whether any Medicare-entitled employees are eligible for the opt-out incentive, and confirm the arrangement mirrors the terms offered to all other employees under the cafeteria plan (MSP Rules).
• Confirm payroll/finance is including opt-out payments in employees’ regular rate of pay for overtime calculations, per DOL guidance
• Flag the HIPAA special enrollment question with clients — decide (with counsel) whether to pursue a waiver of special enrollment rights or a plan amendment excluding opt-out electors, and document the choice.
• For insured clients, verify with the carrier that the opt-out design doesn’t violate minimum participation requirements or other policy terms
• Recommend the client loop in ERISA/benefits counsel before rolling out or materially changing an opt-out program — this summary is not a substitute for legal advice

Resources

• Amwins Compliance Brief - Opt-Out Incentives (Cash-in-Lieu of Benefits)

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