Employee Benefits Compliance, Large Employers, Small Employers

Opt-Out Arrangements: 2018 and Beyond

insurance opt outs

Quick Read: 

All employers who offer or are contemplating offering an “opt-out” payment to employees who decline group health coverage should consider the ramifications of such an offering.  For large employers, ALL payments under opt-out arrangements count as employee contributions in the ACA “affordability” calculation unless the arrangement is an “eligible opt-out arrangement” (defined below).  The affordability issue does not apply for small employers (defined as employers with fewer than 50 full-time employees or “full-time equivalent” employees).  However, other issues (detailed later in this article) apply for both small and large employers:

  • Opt-out payments will result in taxable income unless offered through a Cafeteria Plan.
  • An opt-out arrangement may violate the Medicare Secondary Payer rules unless properly structured (if some employees are Medicare-eligible).
  • The decision of which employees should be offered an opt-out option should not be based on health status factors or claims, as this would likely violate HIPAA nondiscrimination rules or HIPAA Privacy rules.
  • A 2016 Ninth circuit Court decision held that in some cases opt-out payments must be included as “wages” for purposes of overtime payments under the FLSA.
  • The option should not be provided to enable an employee to purchase an individual policy, whether in or outside the marketplace/exchange.

Opt-out Arrangements and “Affordability” under the ACA

It is lawful to offer an “opt-out” arrangement, but such payments are taxable to employees and they may make it more difficult for an ALE to meet the “affordability” test under the Employer Shared Responsibility (ESR) provisions of the Affordable Care Act (ACA).  The rule stated in IRS proposed regulations (issued July 8, 2016) modifies the prior guidance in IRS Notice 2015-87 and continues to apply in 2018 and 2019.  This rule is:

As of the first day of the 2017 plan year, all opt-out arrangements that do NOT qualify as “eligible opt-out arrangements” do count as employee contributions under the ACA Affordability test, even if the arrangement was adopted on or before December 16, 2015. This includes all unconditional opt-out arrangements, as well as conditional arrangements that do not meet specific criteria (listed below).

  • Practical Tip: Large employers who adopted an opt-out arrangement before December 16, 2015 and have continued it on the same terms should review this article and determine if they need to modify the opt-out program to meet the affordability test.   The prior rule (Notice 2015-87) applied a more lenient test in 2016.

Three Types of Opt-out Arrangements

An opt-out arrangement is an arrangement under which an employer offers a financial incentive to employees who decline employer group coverage.  There are three types of opt-out arrangements.  The third one below was added by the 2018 proposed regulations.

  • An unconditional” opt-out arrangement is one under which the employer pays an employee taxable cash if the employee declines employer group health plan coverage, and the employee does not have to provide any evidence of or attest to having other group health coverage.  The employee can decline to enroll for any reason, even if the employee does not have other coverage.   (There are no “conditions” attached to receiving the opt-out payment.)
  • A “conditional” opt out arrangement is one under which the employer pays an employee taxable cash only if the employee declines employer group health plan coverage AND satisfies some other meaningful requirement related to having health coverage, usually that the employee must provide proof of other group health coverage (e.g., provided by a spouse’s employer).
  • An “eligible opt-out arrangement”is a “conditional arrangement that also meets the following criteria (specified in the July 2016 proposed regulations):
    1. The employee must provide “reasonable evidence” that the employee and all members of the employee’s tax family (dependents on his/her tax return) have or are expected to have minimum essential coverage (MEC) for the relevant period (the plan year for which the opt-out payment is offered).
    2. The MEC cannot be coverage in the individual market, either on or off the exchange; but it can be government coverage such as Medicare Part A, most Medicaid, CHIP and most TRICARE programs.
    3. The arrangement must provide that the employer cannot make opt-out payments (and the employer in fact must not) if the employer knows or has reason to know that the employee or family member does not or will not have MEC.
    4. The following rules apply regarding “reasonable evidence”:
      1. “Reasonable evidence” may be the employee’s attestation.
      2. Reasonable evidence/attestation must be provided at least annually.
      3. Reasonable evidence must be provided no earlier than a reasonable period of time before coverage starts (e.g., at open enrollment), and the employer can allow employees to provide it after the plan year starts.


Under the ACA employer shared responsibility provisions, an ALE may be subject to penalties under Code section 4980H(b) if coverage offered to a full-time employee is not affordable or does not provide at least minimum value, and if that full-time employee qualifies for a subsidy and buys health insurance in an exchange.

Prior IRS guidance provides that the employee cost for self-only coverage includes both direct employee contributions for coverage and also includes certain opt-out payments employees could have received for declining coverage.  The proposed regulations and Notice 2015-87 clarify which opt-out payments must be counted as employee contributions for coverage.

Details on Affordability: Coverage is deemed affordable for an employee if the employee’s required contribution for the lowest-cost self-only coverage does not exceed 9.5% (indexed for inflation to 9.56% in 2018) of the employee’s household income or of one of three safe harbor amounts:  W-2 box 1, the “rate of pay” test, or 100% of Federal Poverty Line (FPL) for one.  If coverage is not affordable for a full-time employee, the ALE will be subject to a penalty of $290 per month for each such employee ($3,480 for all 12 months of 2018).  For 2018, the affordability threshold under the FPL test is $96.08 per month. The other two safe harbors usually result in higher thresholds.


 Example: The total cost for self-only coverage is $400 per month, of which the employer pays $310 and the employee pays $90.  The employer also offers all eligible employees $75 per month if they decline coverage.  If the $75 opt-out payment must be counted (because it is unconditional or is conditional but does not meet requirements to be an “eligible opt-out arrangement”), the employee cost for self-only coverage will be $165 per month ($90 +$75).  In contrast, if the opt-out payment meets the criteria to be an “eligible” opt-out arrangement, it does not have to be counted, the employee cost for self-only coverage will be $90 per month, which is less than the FPL safe harbor of $96.08 per month for 2018.

Two Important Notes on Affordability:

  • If an opt-out payment must be counted in the affordability calculations, it will be counted for ALL full-time employees, both those who enroll in the employer group health plan and those who decline coverage and receive the opt-out payment instead. The affordability calculation will be apparent on the Form 1095-C, part II, line 15.
  • Even if an opt-out payment must be counted in the affordability calculations, no penalty applies if the employee enrolls in coverage, even if the coverage does not meet affordability. This is because employees who enroll in employer coverage are not eligible for a subsidy. The penalty only applies if the coverage is not affordable and the employee enrolls in exchange coverage and qualifies for a subsidy.

Other Considerations for both Large & Small Employers

  • Taxability.  Opt-out payments will be taxable unless offered under a cafeteria plan.  The “Doctrine of Constructive Receipt” applies unless the opt-out payment is offered under a cafeteria plan.  Under this doctrine, an individual is in “constructive receipt” of funds he or she could have received but elected not to.  Thus, even employees who decline the opt-out payment and elect to have an employer contribution toward (otherwise nontaxable) health coverage could be required to include in taxable income the amount that they could have elected to take as a taxable opt-out payment.
  • The Medicare Secondary Payer (MSP) rules prohibit employers from offering financial incentives to Medicare-eligible employees to get them or Medicare-eligible dependents to enroll in Medicare and decline coverage in the employer group health plan.  The MSP rules apply to ERISA plans and also to church and government plans that are exempt from ERISA.   The Centers for Medicare & Medicaid Services (CMS) has informally said that it is not a violation of the MSP rules when employees who are entitled to Medicare have the same cash-out rights as employees who are not entitled to Medicare, under a bona fide cafeteria plan that meets the requirements of Code section 125.  Thus, offering an opt-out payment is offered through a bona fide cafeteria plan to all employees (including those who are eligible for Medicare) might result in such offering not being a violation of the MSP rules.  However, EBIA notes that the language in the CMS enforcement manual “appears to walk back these informal comments a bit, at least for employees without primary coverage other than Medicare.”
  • HIPAA Nondiscrimination Rules.  It would violate HIPAA nondiscrimination rules and also HIPAA Privacy rules if an employer uses claims data from the group health plan to decide who to offer opt-out payments to.  Employers who offer opt-out payments should not offer them only to employees who the employer believes will have high-cost medical expenses (or who have family members who will) such as those with pre-existing conditions, chronic diseases or expensive medical diagnoses.  An employer should extend the opt-out offer to all employees who are eligible for group health plan coverage.
  • Opt-out Payment as “wages.”  Under a 2016 California case, Flores v City of San Gabriel, the Ninth Circuit court held that taxable opt-out payments must be included in the rate of pay used to calculate overtime pay under the Fair labor Standards Act (FLSA), unless certain exemptions apply.  One exemption is if opt-out payments are an incidental portion of the benefits received.  In this case the court said the payments were far more than incidental and held that the amounts were taxable compensation “even though not directly tied to specific hours of work.”   Flores involved a public sector employer that offered a cash opt-out payment to police officers, but nothing in the FLSA or the Court’s opinion limits the determination to public sector employers.  Employers who pay overtime amounts under the FLSA should get advice from their legal counsel before offering taxable opt-out payments to hourly employees.
  • No Individual Policies.  The option should not be provided to enable employees to purchase individual policies, whether in or outside the marketplace/ exchange.

Action Steps for Employers Who Offer or are Contemplating Offering Opt-Out Arrangements  

1- Offer the opt-out arrangement through a Section 125 Cafeteria Plan, to ensure the amount offered is not taxable to employees who decline it, and to help your argument that the arrangement does not violate the MSP rules if you have any Medicare-eligible employees.

2- Offer the opt-out payment to all employees who are eligible for the group health plan, not to specific employees based on their (or their dependents) health status or prior claims.

3- If you pay overtime, are subject to FLSA and are in the Ninth Circuit, talk with your attorney regarding the Flores v City of San Gabriel case and whether the opt-out amount would be considered incidental under FLSA, and what actions you should take to ensure the payments are not considered “wages” for overtime purposes.  

4- If you are an ALE, you should verify whether the opt-out amount counts in the ACA affordability calculation. Since the first day of the 2017 plan year, applicable large employers must count all opt-out payments in the affordability calculation for all full-time employees unless the program meets the criteria above for an “eligible opt-out program.”  Even if you must count the payment in the affordability calculation, you still might meet the affordability test.  This will depend on:  1) the amount employees must pay for self-only coverage, 2) the amount of the opt-out payment, 3) the applicable affordability safe harbor, and 4) the particular employee’s compensation level or hourly rate (unless the “100% of FPL” safe harbor is used).

  • Example:  If, as of January 1, 2018, a large employer pays 100% of the employee premium for self-only coverage, offers an UNconditional opt-out arrangement, and the opt-out amount is less than $96.08 per month, the employer will meet the “100% of FPL” affordability rest, regardless of the employee’s compensation level. This result applies even though the opt-out amount will count in the affordability determination, because the affordability amount for all full-time employees will be only the employer opt-out amount that is offered ($96.08 or less). This applies for those employees who enroll and do not take the opt-out amount, as well as for those who decline to enroll and elect the opt-out payment instead.

5- An applicable large employer who wants to make sure that the amount it offers as an opt-out payment will not count in the affordability calculation must offer an opt-out program that qualifies as an “eligible opt out program” and meets the four criteria listed earlier in this article.

6- Small employers are not subject to the affordability requirements; however, the affordability calculation may affect whether an employee (at a large or small employer) is eligible for a subsidy to buy coverage in the Marketplace.  For 2018 it also affects whether such employee is exempt from the individual mandate tax if s/he does not have medical coverage, but as of January 1, 2019 that tax is reduced to zero.



  1. Do you have any idea where I can find further direction regarding “opt-out” and its relationship to Tricare? My employer wants me to attest that I do not have health insurance through a government-sponsored health plan. Can you direct me to the reference in your section”eligible opt-out arrangement” section 2 stating …it can be government coverage such as …and most TRICARE programs.

  2. We are an ALE with a self-funded health insurance plan. Does the affordability calculation work the same with our premiums, which have both a fixed cost and a claims funding component?

  3. I am part of a very small non-profit, but will be growing. I want to offer an “opt out” option for employees who want to remain on their spouses insurance. Is there a traditional or standard dollar amount to offer? Or how can I find more information on what we, as a company, should allocate as our opt out option.