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Cafeteria Plan Developments: Mid-Year Election Changes

By: David LeFevre, ERISA Attorney + Chief ERISA Geek, ERISAfire Benefits Compliance Solutions

This post examines the recent mid-year election change regulatory and legislative developments from the IRS. For other analyses, see this post on a temporary relaxation of grace period rules, this post on an increase in the maximum healthcare FSA carryover, this post on the repeal of the prescription requirement for over-the-counter items, this post on HSA implications of recent telemedicine developments, and this post on cafeteria plan implications of DOL’s black hole ERISA deadline extension.

Much as it did when it created a mid-year election change event allowing employees to drop employer-sponsored coverage to enroll in state or federal exchange coverage, IRS created five new mid-year election change opportunities out of thin air—meaning they are not found anywhere in Code Section 125. These new mid-year election change events are permissive, not mandatory, so an employer can choose whether and to what extent to allow them.

Current Rule

Ordinarily, Code Section 125 limits mid-year elections to certain events: marriage or divorce, birth or adoption, change of employment, loss of eligibility, change in residence, a change in cost of coverage, improvement in benefits, and entitlement to Medicaid or Medicare, to name a few. Without one of these events occurring (which, in some cases must affect eligibility under the plan), an employee cannot change an existing election until open enrollment for the following year’s elections.

New Rule

IRS Notice 2020-29 gives employers the option of effectively waiving the mid-year election change requirements for five types of prospective election changes. This relaxation of mid-year election change rules, if adopted by an employer, only applies to election changes made during calendar year 2020. The election changes that an employer allows must be prospective, meaning that this guidance does not permit retroactive mid-year election changes, but it can be used to ratify prospective election changes that were technically not permitted but that an employer allowed before the guidance was issued. This ratification effect can only go as far back as January 1, 2020.

New Election Types and Considerations for Each

Add Major Medical

Under the guidance, for the 2020 calendar year, an employer can choose to allow its employees to enroll mid-year in the employer’s major medical plan* when the employee had previously waived such coverage, no questions asked. No reason like loss of other coverage is necessary.

Allowing enrollment in the medical plan when it was waived previously invites adverse selection—that is, employees dropping other coverage that is not as good (or regretting the decision to go naked) in favor of the employer’s richer benefits. For self-insured employers and for claims-credible insured employers, this could have real implications for current claims costs of self-insured plans and for next year’s renewal of insured plans and stop-loss policies, respectively.

In addition, this type of mid-year election change is something that the carrier (be it the stop-loss carrier or health insurance carrier) will likely have to approve before it is implemented. Most policies refer to the Section 125 rules for mid-year election changes, and as mentioned above, this new mid-year election change opportunity is not in Code Section 125.

Finally, the guidance places no limit on the number of times an employee can add major medical coverage using this new mid-year election change event. Conceivably an employee could add medical, drop it under a different election change event and re-add it. Employers are not required to implement this election change at all, and even if an employer does, it can place restrictions on it by, for example, opening a limited window of time.

Change Major Medical Option or Coverage Tier

Under the guidance, for the 2020 calendar year, an employer can choose to allow its employees to change to a different major medical coverage tier, to a different major medical option mid-year, or both, no questions asked. So, for example, an employer could allow an employee to change from employee-only to family or from family to employee-only coverage in a particular major medical option. Similarly, an employer could allow an employee to change from a low-deductible PPO to a high-deductible health plan (HDHP) or HMO. An employer could also allow an employee to change both medical options and coverage tiers.

Allowing employees who are already enrolled to change coverage tiers or coverage options (or both) presents less adverse selection risk than allowing them to add medical coverage that had previously been waived, but it is not void of adverse selection risk. Also, presumably in most cases this will result in employees downgrading to less expensive medical options or tiers, so self-insured employers will wind up collecting less in employee contributions for the same claims risk.

Both stop-loss carriers and health insurance carriers will feel the effects as well, and so the carrier will likely have to approve this election change opportunity before it is implemented. Most policies refer to the Section 125 rules for mid-year election changes, and as mentioned above, this new mid-year election change opportunity is not in Code Section 125.

Finally, the guidance places no limit on the number of times an employee can change medical coverage tiers or options. Employers choosing to implement this election change would be well-advised to put some type of restriction in place—i.e., opening a limited window of time to make a change and/or a limit on the number of times it can be used.

Limited Opportunity to Drop Major Medical

Under the guidance, for the 2020 calendar year, an employer can choose to allow its employees to drop major medical coverage mid-year if the employee provides a written attestation that he/she is enrolled or will immediately enroll in other major medical coverage. The other coverage can be that of another employer or from the Exchange or Medicare/Medicaid or an individual policy.

The attestation requirement adds administrative complexity for employers, and much like the other major medical mid-year election change opportunities it presents some adverse selection risk: healthier employees willing to run the risk may take the opportunity to go naked, providing the insurer or self-insured employer less in premiums from people who present less risk, leaving a marginally riskier population in the plan. Insurers, both stop-loss carriers and health insurance carriers, will likely have to approve this election change opportunity before it is implemented.

This mid-year election change opportunity may be useful as a way to speed up an existing, broader strategy of driving employees to government-sponsored programs or the individual market.

Any Change to DCAP/Dependent Care FSA

Under the guidance, for the 2020 calendar year, an employer can choose to allow its employees to add, drop, increase or decrease their dependent care FSA (dependent care assistance program, or DCAP) elections mid-year, or any combination of those, no questions asked.

Keep in mind that with this guidance IRS is expanding what employers may allow. Employers don’t have to go all-in and can instead choose to only allow election changes under certain circumstances. Allowing employees to change their dependent care FSA/DCAP elections should be narrowly tailored. If, for example, an employer finds it desirable to let people reduce their elections, the permitted reduction should have a floor equal to the amount of reimbursements already made (or that are pending), so that experience losses are kept to a minimum.

Any dependent care FSA/DCAP election changes that an employer decides are worthwhile should first be confirmed with its third-party administrator to ensure it has the capability to implement the change and, if so, confirm the timing of any system changes.

Any Change to Healthcare FSA

Under the guidance, for the 2020 calendar year, an employer can choose to allow its employees to add, drop, increase or decrease their healthcare FSA elections mid-year, or any combination of those, no questions asked. This applies to both limited-purpose and general-purpose healthcare FSAs.

As with the similar mid-year election change opportunity for dependent care FSAs/DCAPs, employers should narrowly tailor the rules to prevent unlimited, perpetual changes. If an employer finds it desirable to let people reduce their healthcare FSA elections, the permitted reduction should have a floor equal to the amount of reimbursements already made (or that are pending), so that experience losses are kept to a minimum.

Any healthcare FSA election changes that an employer decides are worthwhile should first be confirmed with its third-party administrator to ensure it has the capability to implement the change and, if so, confirm the timing of any system changes.

Unaffected Elections

IRS Notice 2020-29 does not impact elections for employer-sponsored coverages of the following types:**

1. Vision
2. Dental
3. Life/Accidental Death & Dismemberment
4. Disability

Plan Amendment Requirements

Even if the cafeteria or premium-only plan includes a broad cross-reference to Code Section 125 (e.g., “all mid-year election changes permitted under Code Section 125”), an amendment to the cafeteria plan will be required because these election changes are not actually permitted under Code Section 125. The amendment must be applied prospectively, except to the extent the employer has already permitted prospective election changes that, prior to the notice, were not allowed by Code Section 125.

Footnotes

* The Notice uses the term, “health coverage,” which is not ordinarily the term used to describe any tax-qualified welfare benefits. Rather, the Code and Treasury Regulations typically use “group health,” “accident and health,” “excepted benefits” or some other term. Because the Notice introduces a new term, it is unclear whether “health coverage” includes dental and vision or if it refers only to major medical. In light of the Notice’s reference to “comprehensive health coverage,” we are taking the conservative approach that “health coverage” means major medical coverage and not dental or vision.

** Our inclusion of vision in this list is based on our interpretation of the term, “health coverage,” that is used in the Notice.

About ERISAfire

ERISAfire LLC is an employee benefits compliance services firm, specializing in health and welfare benefits. ERISAfire has reimagined benefits compliance to help agencies and employers manage compliance risks and make the process easier. By leveraging custom-built technology to automate transactional tasks and provide a hyper-customized compliance calendar, its ERISA geeks can focus on complex analysis and experienced ERISA attorneys can scrutinize even the most mundane compliance tasks. Learn more at www.erisafire.com.

by allpointewp