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When employers purchase fully insured health coverage, they expect premium dollars to be used primarily for employee health care, not excessive administrative costs or insurer profits. One of the Affordable Care Act’s (ACA) lesser-known consumer protection provisions helps ensure that happens through the Medical Loss Ratio (MLR) requirements.
The ACA established a nationwide minimum standard governing the amount of premium revenue insurers had to spend on medical care. The goal was to increase transparency while encouraging insurers to devote more premium dollars to patient care rather than overhead.
Although MLR rebates make headlines each fall, employers may be uncertain about what MLR measures, how rebates are calculated, and what obligations arise if a rebate is received. Understanding these rules can help employers properly manage plan assets, communicate with employees, and remain compliant with ERISA and federal insurance requirements.
The Medical Loss Ratio is the percentage of health insurance premium dollars that an insurance company spends on medical claims paid on behalf of covered individuals and activities that improve health care quality. The remaining premium dollars may be used for:
- Administrative expenses
- Customer service
- Marketing
- Broker commissions
- Taxes and regulatory fees (subject to federal adjustments)
- Insurer profit
Small group insurers must spend at least 80% of premium on medical care, and large group insurers must spend at least 85%. If an insurer spends less than the required percentage on medical care and quality improvement, it must return the difference as a rebate.
The Centers for Medicare & Medicaid Services (CMS) determines compliance using a rolling average of three years of MLR experience. This helps avoid unusually large rebates resulting from one exceptionally favorable or unfavorable claims year.
All fully insured plans are subject to the MLR.
Plans that are generally excluded are:
- Self-funded employer health plans
- Level-funded arrangements
- Excepted benefits, such as standalone dental or vision plans
Insurers owing rebates typically distribute them by September 30 following the reporting period. Although the insurance company sends the rebate to the employer as the policyholder, the employer is not always entitled to keep the entire amount.
In general:
- If the employer paid 100% of the premiums, the employer may keep the entire rebate.
- If employees paid part of the premiums, employees are entitled to a proportional share of the rebate.
For most ERISA-covered plans, the portion attributable to employee contributions is considered a plan asset and must be used for the benefit of plan participants. Employers should review the plan document and follow Department of Labor fiduciary rules when determining ownership.
Options for Using the Employee Portion of the Rebate
When employees are entitled to a share of the rebate, employers generally have several options.
1. Reduce Future Premiums. This is the most common approach. The employee share of the rebate is applied toward future health insurance premiums, reducing what employees pay for coverage. This method is often the simplest to administer because it automatically benefits current participants.
2. Provide Cash Payments. Employers may distribute each eligible employee’s share as a cash payment. Cash payments are generally appropriate when reducing future premiums is impractical, such as when coverage has ended or only a small group of employees remains enrolled.
3. Improve Plan Benefits. Using the employee portion to enhance plan benefits may be appropriate if is consistent with ERISA fiduciary requirements.
Tax Treatment Depends on How Premiums Were Paid
The tax consequences depend on whether employees paid their premiums on a pre-tax or after-tax basis.
- If premiums are paid pre-tax through a Section 125 cafeteria plan, the rebate is subject to payroll taxes because it represents previously untaxed compensation.
- If premiums are paid as after-tax payroll deductions, the rebate is generally not taxable because it is considered a return of amounts the employee already paid with taxed dollars.
If the rebate is used to reduce future pre-tax premium deductions, employees will simply have smaller pre-tax deductions, resulting in slightly higher taxable wages during the period the premium reduction is applied.
Timing Matters
For ERISA plans, employers should distribute or apply the employee portion of the rebate within approximately three months after receiving it. Holding employee funds longer than necessary may create ERISA fiduciary concerns.
Employer Action Items
When an MLR rebate is received:
- Determine how much of the premium was paid by the employer versus employees.
- Review the plan document to determine whether it addresses ownership of MLR rebates.
- Decide whether the employee portion will be returned through premium reductions, cash payments, or another permissible method that benefits participants.
- Coordinate with payroll to ensure the rebate is taxed correctly based on whether premiums were paid on a pre-tax or after-tax basis.
- Document the decision-making process and retain records showing how the rebate was allocated and distributed.
Although many MLR rebates are relatively small, employers should treat them carefully. Following ERISA fiduciary rules and the applicable tax guidance helps ensure that both the employer and employees receive the appropriate benefit from the rebate.
This information has been prepared by UBA. It is general information and provided for educational purposes only. It is not intended to provide legal advice. You should not act on this information without consulting legal counsel or other knowledgeable advisors.
