Incenting workers to opt out of health coverage may carry unintended consequences

As the economy continues to suffer, employers are reviewing alternatives to reduce health care costs and to shift more costs to employees. As part of this process, it is common for employers to consider opt-out payments for medical coverage.

For example, if an employer typically pays for 80% of the cost of family coverage, the cost of such benefits may be approximately $8,000 per employee on a $10,000 annual benefit, with the employee paying $2,000 of the cost with pretax dollars under a premium-only cafeteria plan.

Since dual-income families are common today, an employee's spouse may have coverage available through the spouse's employer.

An employer may determine that, if the employee drops from family to single coverage, the employer may save $4,000.

Thus, the employer may offer to pay the employee up to $2,000 to waive coverage, thus sharing the savings with the employee.

The employee obtains additional income, and the employee's spouse may elect coverage through the spouse's employer.

Most employers can anticipate that several employees, at a minimum, will elect opt-out payments when they are offered.

Obviously, opt-out payments should not be made unless employees can prove the existence of other medical coverage. This approach ensures that workers (particularly young workers) do not go uninsured when they are wooed with the opportunity to receive additional cash compensation.

Using opt-out payments may increase as employers continue to try to reduce their total health care spending.

Although opt-out payments are a valuable tool in an employer's arsenal of combating increasing medical costs, the savings do come at a price.

An issue frequently overlooked by employers is that opt-out payments must be considered when determining an employee's wages for purposes of overtime, often identified by the Department of Labor when conducting payroll audits.

For example, for an employee with a base pay of $10 per hour and an annual salary of $20,800, the normal overtime rate is 1 ½ times base salary, or $15 per hour.

If this employee elects to receive a $1,000 opt-out payment, the payment increases the employee's base pay by 48 cents (or $1,000 ÷ 2,080 hours).

The employee now has a base rate of pay equal to $10.48. With time and a half, the employee has an overtime rate equal to $15.72.

One would anticipate that payroll companies would automatically alert employers with opt-out payments to these basic rules.

However, most payroll companies, regardless of the size, rely upon the employer instructions and frequently do not provide any consulting services with regard to basic payroll matters, except at times when additional fees and/or projects are undertaken.

Most employers are encouraged to input the correct overtime rate into their payroll systems at the beginning of each year to properly calculate overtime.

Alternatively, if significant overtime is not worked, an employer may make adjustments on a monthly, quarterly or other basis.

If an employer does not properly compute an employee's base pay for several years, the amount of additional benefits and penalties, multiplied by the number of employees receiving opt-out payments, can become very expensive.

Whether an employer has already implemented opt-out payments or is anticipating using this approach in the future, attention to the relevant payroll issues is important.

Beware of making exceptions to Section 125 rules

During open enrollment, employers surely received employee requests for cafeteria plan changes.

Prior to the beginning of each plan year, workers must elect the benefits they wish to receive for the calendar year and may only change their benefit elections in the event that there is a valid "change in status," such as the birth of a child, marriage, divorce and other similar events.

Inevitably, however, employers receive requests from some employees during the first few weeks of each calendar year to make exceptions to the basic rule.

This happens for a number of reasons.

Many employers are switching to an online enrollment process, which can be overwhelming and confusing to some employees.

Other employers remain with paper submissions, which can also result in errors.

Under the Section 125 rules, however, once an election is made, it cannot be changed.

Minor, infrequent errors sometimes can be corrected.

For example, where an employee with no dependents erroneously elects to make contributions to a dependent care account, rather than a medical flexible spending account, employers may use their business judgment in making corrections within the first week or two of the new year.

However, employers are discouraged from allowing any exceptions, since they can be perceived as violating the Section 125 rules.

Further, once an exception is made for one employee, it is difficult to deny changes for other employees, whether based upon similar or different fact patterns.

Most importantly, after the Section 125 final regulations are issued in 2009, authorities are expected to give greater scrutiny to employee elections and employer administration of Section 125 plans.

Accordingly, caution should be exercised, and professional counsel may be needed before permitting changes for individuals.


Contributing Editor Frank Palmieri is an employee benefits attorney with Palmieri & Eisenberg in Princeton, N.J., and a fellow of the American College of Employee Benefits Counsel.

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