Beware! Fixed Indemnity Plans Under Increased Scrutiny

If it sounds too good to be true, it usually is when talking about saving a bunch of money.

The health insurance space is seeing many products that claim to provide cash back to employees paychecks and a tax savings to the bottom line for employers. Many of these products are designed with the following features:

Supplemental overlay plan to an existing medical Plan
An employee-only contribution to the product taken on a pretax basis, offering a tax savings
Employees earn cash back by completing certain wellness activities
Employees earn a payout for a medical event, regardless of how much the event actually cost the employee (fixed indemnity)
First dollar coverage (no copay) for virtual primary care and telemedicine

See the previous Leavitt Group article Short-Term Disability Plans and Fixed Indemnity Insurance See Proposed Rules Tightening Regulatory Grip.

Proposed Rules released this year would further clarify the stance of regulators as to the compliance of these products. These Proposed Rules would:

Permit “excepted benefit” status only when indemnity is paid on per time-period basis without regard to costs incurred
Prohibit coordination with health plan
Clarify taxation status of fixed indemnity plans regardless of medical expenses incurred (i.e., where pretax premiums require taxation at payout of indemnity policies)
Short-Term Limited Duration Insurance (STLDI) limited to 3-month contracts rather than the current 12-month

IRS Guidance

On June 8, 2023, the Internal Revenue Service (IRS) released Chief Counsel Advice 202323006 (CAA) addressing the tax treatment of these wellness indemnity payments. While the CAA is not as binding as the Proposed Rules will be, it is a good look into the position the IRS is taking on these Plans. At issue is:

Whether wellness indemnity payments under an employer-funded, fixed indemnity insurance policy (including where the premium for the coverage is paid by employee salary reduction through a cafeteria plan under section 125 of the Internal Revenue Code (Code)) are includible in the gross income of the employee if the employee has no unreimbursed medical expenses related to the payment.
Whether the wellness indemnity benefits that are includible in gross income (taxable wellness indemnity benefits) are wages for purposes of Federal Insurance Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) taxes, and federal income tax withholding (FITW) (collectively, “employment taxes”) with respect to the payments of benefits in the situation

Example Plans in Question

An Employer provides comprehensive health coverage for its employees through a group health insurance policy. The comprehensive health coverage provides preventive care benefits, such as reimbursements for the cost of flu shots and other vaccinations, without any cost sharing for covered individuals. In addition to the health coverage, the Employer provides all employees, regardless of enrollment in other comprehensive health coverage, with the ability to enroll in coverage under a fixed-indemnity health insurance policy that would qualify as an accident and health plan under Internal Revenue Code (IRC) § 106. Employees pay monthly $1,200 premiums for the fixed-indemnity health insurance policy by salary reduction through an IRC § 125 cafeteria plan. The only payments that the insurance company receives with respect to the insurance provided to the employees are the premium payments. In other words, the Employer has no liability for any costs incurred by the insurance company that may exceed the premiums paid by its employees.

The Employer’s fixed-indemnity health insurance policy is a voluntary program primarily intended to supplement its employees’ other health coverage through the provision of wellness benefits. The first type of wellness benefit provided by the fixed indemnity health insurance policy is a payment of $1,000 if an employee participates in certain health or wellness activities. This benefit is limited to one payment per month. Use of preventive care, such as vaccinations, under a comprehensive health plan in which an employee is enrolled, qualifies the employee for the payment for the month. The fixed-indemnity health insurance policy provides wellness counseling, nutrition counseling, and telehealth benefits at no additional cost. The employee is responsible for any costs associated with receiving any health-related activity, although in many cases all or part of the cost of the health-related activity will be provided at no cost or is covered by other insurance. The fixed-indemnity health insurance policy also provides a benefit for each day that the employee is hospitalized. Under the fixed-indemnity health insurance policy, the wellness benefits are paid from the insurance company to the Employer, which then pays out the wellness benefit to employees via the Employer’s payroll system.

What is “Wrong” with this Product/Plan?

Employment taxes is the issue. Or, the lack of. Regulations Sections 3101 and 3111 impose FICA taxes (comprised of social security tax and Medicare tax) on “wages” as that term is defined in section 3121(a). Section 3121(a) defines wages as all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash, with certain specific exceptions. Section 3301 imposes federal unemployment (FUTA) tax on “wages” as that term is defined in § 3306(b). Section 3306(b) defines wages as all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash, with certain specific exceptions.

The taxable wellness indemnity benefits are provided by employers to employees as remuneration for employment under benefit plans funded by employers and, thus, fit within the basic definition of wages under § 3121(a). To the extent the taxable wellness
indemnity benefits are not paid under a worker’s compensation law, they do not qualify for the exception from wages provided by § 3121(a)(2)(A). Although the payments are made on account of sickness or accident disability, the parenthetical in § 3121(a)(2)(A)
removes the payments from the exclusion because they are not received under a workers’ compensation law. Moreover, the taxable wellness indemnity benefits cannot qualify for the § 3121(a)(2)(B) exception because the payments are not made on account of medical or hospitalization expenses in connection with sickness or accident disability.

Wellness indemnity payments under an employer-funded, fixed-indemnity insurance policy (including where the premium for the coverage is paid by employee salary reduction through a cafeteria plan under section 125 of the Internal Revenue Code (Code)) are includible in the gross income of the employee if the employee has no unreimbursed medical expenses related to the payment.

The exclusion under Internal Revenue Code (IRC) § 105(b) is limited to amounts paid solely to reimburse expenses incurred for medical care and does not apply to amounts which the taxpayer would be entitled to receive irrespective of whether expenses for medical care are incurred. The exclusion from income in IRC § 105(b) does not apply to payments when the employee has no unreimbursed medical expense either because the activity that triggers the payment does not cost the employee anything or because the cost of the activity is reimbursed by other coverage. The fixed indemnity health insurance policy pays $1,000 per month without regard to whether the employee has any unreimbursed health insurance expenses. Thus, the payment is included in the employee’s gross income.

Compliance Considerations

Health Savings Account / High Deductible Health Plan First-Dollar Coverage

These products often provide medical care access (often via telehealth access to mental health or primary care) at no out-of-pocket costs at the time of service, violating the HDHP/HSA rules.

“No first-dollar coverage” rule states that in order qualify for HSA contributions, the HDHP member cannot receive any coverage without applying the minimum deductible (except for preventive care). See prior Leavitt Group article.
- See below for a new exemption to this rule.
- Normal cost-sharing can still be imposed for telehealth, e.g., copays plan requires after deductible is paid.
If spouse/dependent has an HSA, their spouse may not be able to use benefit, AND, if the employee is enrolled on the spouse’s or another non-Leavitt Group plan, this may also impact the employee’s ability to contribute to their own or their spouse’s HSA.

Spouse HSA Disclaimer Language

“Beginning January 1, 2024, your eligibility for pre-tax Health Savings Account (HSA) contributions may be impacted by the Company offering of a fixed indemnity plan that offers additional wellness or telehealth benefits at no cost. Those employees, dependents and spouses able to utilize this offering may be impacted even if enrolled in the spouse/dependent’s own High Deductible Health Plan (HDHP). To address this issue, in lieu of pro-rata monthly contributions, spouses/dependents may contribute the annual HSA maximum contribution in the last month of the calendar year before the telehealth HSA exemption rule expires. Failure to stop pretax HSA contributions on January 1, 2023 for the duration of the telehealth offering will result in additional taxation on those contributions made after 12/31/23 when reporting on your individual tax returns the following tax year.”

Or, prohibit spouse/dependents not enrolled on health plan from participating in the Behavioral Health telehealth plan (if they are selling this as a telehealth plan and not an indemnity plan).
- “Eligibility for Behavioral Health Telehealth plan is limited to employees/spouses/dependents enrolled in a Company health plan or in a non-Company health plan that does not include a High Deductible Health Plan with a Health Savings Account.”
- Include the above language in the plan documents and recommend to include on enrollment platform as alert prior to enrolling in a Company plan and as a take-home, email or first-class mail notice of this available benefit (consider an opt-out form, if this is an option with the provider of the benefit).
- Useful language to pull for use in defining eligibility could be under “Qualifying for HSA Contributions”.

Telehealth Exemption to First-Dollar Coverage Rule

If the product operates as telehealth only, there is a limited time exception to the rule against no first dollar coverage. For plan years beginning before January 1, 2022, an employer can sponsor an HDHP and simultaneously offer a telemedicine service without disqualifying an employee from making or receiving tax-advantaged HSA contributions.

Legislation passed in 2022 (Consolidated Appropriations Act of 2022) temporarily exempts telehealth coverage from restrictions impacting HSA-eligibility. The 2021 CARES Act (section 3701) provided this same exception to facilitate telehealth during the COVID-19 pandemic.
- The new legislation amends two key provisions in the Internal Revenue Code § 223 rules for HSAs.
  1. Telehealth and other remote care services will be considered disregarded coverage—and thus will not cause a loss of HSA eligibility—during the months beginning after March 31, 2022, and before January 1, 2023. This has been extended through 2024.
  2. During that nine-month period, plans may provide coverage for telehealth and other remote care services before the HDHP minimum deductible is satisfied without losing their HDHP status.
- Beginning January 1, 2025, the minimum deductible will then begin to.
  1. HDHPs are not required to waive their minimum deductible for telehealth and other remote services during the additional relief period, so some plan sponsors may conclude that a midyear change to take advantage of the restored exceptions is too difficult to communicate and administer, and not worth the effort.
- Plans wishing to use the exemption must update plan documents to reflect this exemption. It is recommended such an amendment include the end date. Otherwise, plan documents will need to be updated and notice to participants provided within 60 days of this change being discontinued.

ERISA Compliance

Health plans cannot rely on the ERISA exemption for excepted benefits if the plan provides more than minor treatment or medical care or where it is offered to those not also on the group health plan(s).

The DOL found that ERISA applied even to an employer sponsored Employee Assistance Program (EAP) under which employees, spouses, and dependents could obtain “assistance with dealing with major personal problems affecting mental or physical health” through a third-party vendor whose employees, trained in psychology and social work, counseled employees by phone and made referrals to additional resources as appropriate.

ERISA will require –

Offering COBRA (this can be burdensome as it is required for all eligible and not just those on the health plan(s) -where the EAP COBRA is essentially tied to the offer of COBRA for the health plan.
From 5500 reporting
HIPAA
Plan documents, including Summary of Benefits and Coverage. “Best effort rule” will apply as the SBC template will not mesh with the EAP offering exactly.

Conclusion

Aside from an IRS Section 125 pre-tax contribution loophole, it is hard to see any true overall health care cost savings, risk reduction, or health improvement over other health and wellness benefit plans. These fixed-indemnity plans are complicated, costly to enroll and administer, disqualify HSA contributions, and are uncoordinated with employees’ primary health plan. When seeking products to help reduce health care spending, work with a trusted advisor like Leavitt Group in order to find true cost savings.