Non-Discrimination Rules in a Post-PPACA World October 19, 2011 Stacy H. Barrow © 2011 Proskauer. All Rights Reserved.

2 Today’s agenda Update and current developments with PPACA Review of Code Section 105(h) and its proposed application to fully insured plans under PPACA Review of Cafeteria Plan nondiscrimination rules Review of Group Term Life Insurance nondiscrimination rules Discussion of “Simple” Cafeteria Plans under PPACA Note: Materials are up-to-date as of October 17, 2011 © 2011 Proskauer. All Rights Reserved.

Legislative Update  Is it going away?  HR 2: “An Act to repeal the job-killing health care law”  HR 9: “Instructing certain committees to report legislation replacing the job-killing health care law”  Enacted Legislation  Repeal of Vouchers  1099 Correction  Other Areas Being Considered  Elimination of OTC Prescription Drug Requirement  Elimination of CLASS Act  Medical Loss Ratio Changes © 2011 Proskauer. All Rights Reserved.

Legislative Update  Budget Control Act of 2011  Passed August 2, 2011  Increased the federal debt limit  Created Joint Select Congressional Committee charged with developing a plan to cut deficit by $1.5 trillion  Failure to do so will result in automatic budget sequestration in 2013  Sequestration is an across-the-board cut in federal spending  Likely cut spending for the Exchanges and subsidies © 2011 Proskauer. All Rights Reserved.

Judicial Update  Is it legal? Many constitutional challenges  Suits filed in most states; five federal court decisions:  Thomas More Law Center v. Barack Obama, et al. (MI)  Liberty University v. Timothy Geithner (VA)  Mead v. Holder (DC)  Commonwealth of Virginia v. Sebelius (VA)  Goudy-Bachman v. Sebelius (PA)  Florida v. Dept. of Health and Human Services (FL)  22 Attorneys General, 4 Governors © 2011 Proskauer. All Rights Reserved.

Judicial Update  On June 29 th, the 6th Circuit Court in Thomas More Law Center v. Obama ruled that the individual mandate is a valid exercise of congressional authority under the Commerce Clause  On August 12 th, the 11th Circuit Court in Florida v. Dept. of Health and Human Services ruled that the individual mandate exceeds Congress’ power under the Commerce Clause  On September 8 th, the 4 th Circuit Court in ruled that the ACA prohibited the Liberty case from going forward and also ruled that the Attorney General lacked standing to pursue the Commonwealth of Virginia case © 2011 Proskauer. All Rights Reserved.

Regulatory Update Proposed Regulations on Operation of Affordable Insurance Exchanges – July 15 th Proposed Regulations on Exchange Eligibility Determinations – August 17 th Proposed Regulations on Health Insurance Tax Credit and Premium Subsidies – August 17 th Proposed Regulations on Summary of Benefits and Coverage – August 22 nd HHS guidance on Annual Limit Restriction Waiver for HRAs – August 19 th IRS Requests Comments on Pay or Play Safe Harbor— September 13 (Notice ) © 2011 Proskauer. All Rights Reserved.

8 Nondiscrimination for Insured Plans Determined Under IRC 105(h) ­ Applies later of (i) first plan year beginning on or after September 23, 2010 or (ii) when plan loses its grandfathered status ­ Already applies to self-funded plans ­ For insured plans, however, the penalty is $100/day with respect to each individual to whom the failure relates, not taxation of benefit payment ­ With respect to fully insured plans, this requirement has been indefinitely delayed until further regulatory guidance is available © 2011 Proskauer. All Rights Reserved.

9 Nondiscrimination for Insured Plans Determined Under IRC 105(h) Under Code §105(h): ­ a plan cannot discriminate in favor of highly compensated individuals (“HCEs”) as to eligibility to participate (referred to as the “Eligibility Test”); and ­ the benefits provided under the plan cannot discriminate in favor of participants who are HCEs (referred to as the “Benefits Test”) An individual is an HCE if he or she is: ­ One of the five highest paid officers; ­ A shareholder who owns more than 10 percent of the employer’s stock; or ­ Among the highest paid 25 percent of all employees (other than excludable employees who do not participate in any plan sponsored by the employer) Assessment of HCE and Testing Performed on a Controlled Group Basis ­ Look for subsidiaries, brother-sister controlled group, affiliated service groups ­ Note: ­ Note: Don’t believe the myth—separate EIN is meaningless © 2011 Proskauer. All Rights Reserved.

10 Nondiscrimination for Insured Plans Determined Under IRC 105(h) ELIGIBILITY TEST ­ Three alternative tests: ­ the 70% test; ­ the 70%/80% test; or ­ a nondiscriminatory reasonable classification test ­ For testing, employers may exclude employees who: ­ Have less than three years of service; ­ Are under age 25; ­ Are “part-time” or “seasonal employees”; and ­ Belong to a union or who are nonresident aliens ­ Note: Part-time employees for this purpose are those whose customary weekly employment is less than 35 hours, if other employees have substantially more hours; provided, however, that any employee whose customary weekly employment is less than 25 hours may be considered as a part-time employee. © 2011 Proskauer. All Rights Reserved.

11 Nondiscrimination for Insured Plans Determined Under IRC 105(h) ELIGIBILITY TEST ­ The 70% test: ­ The plan benefits 70% or more of all non-excludable employees ­ e.g., 100 non-excludable employees, at least 70 must be covered ­ The 70%/80% test: ­ The plan “benefits” 80% or more of all non-excludable employees who are eligible to benefit under the plan and 70% or more of all non-excludable employees are eligible to benefit under the plan ­ e.g., 100 non-excludable employees, at least 70 must be eligible for coverage and at least 80% of those employees (56) are covered ­ Reasonable Classification test: ­ The plan benefits a classification of employees set up by the employer which is found by the Internal Revenue Service not to be discriminatory in favor of HCEs ­ In general, made based upon the facts and circumstances of each case, applying the same standards as are applied under section 410(b)(1)(B) © 2011 Proskauer. All Rights Reserved.

12 Nondiscrimination for Insured Plans Determined Under IRC 105(h) Example ­ Employer sponsors a self-insured HMO in which its rank and file participate ­ Employer establishes an executive-only fully insured plan which is a POS plan and in which only the executives of the Company may participate ­ There are 100 employees; only 10 executives are eligible to participate ­ Result: ­ Once executive plan loses its grandfathered status, this arrangement will fail the Eligibility Test, as only 10% of the workforce is eligible to participate. ­ Penalty of $100 per day will apply © 2011 Proskauer. All Rights Reserved.

13 Nondiscrimination for Insured Plans Determined Under IRC 105(h) BENEFITS TEST ­ All benefits provided to any one HCE are provided to all non-HCES on the same basis; and ­ The plan must also not discriminate in favor of HCEs in actual operation ­ Essentially, if any benefit is provided to an HCE that any non-HCEs do not receive, the plan will fail the benefits test ­ Myth Buster ­ Myth Buster: Benefits are not only those benefits included in the plan—IRS has ruled that benefits include any premium contribution that is greater for HCEs, shorter waiting periods, longer COBRA, etc. are all benefits © 2011 Proskauer. All Rights Reserved.

14 Nondiscrimination for Insured Plans Determined Under IRC 105(h) BENEFITS TEST ­ Example: ­ If an employer pays a greater percentage of premium for any of its HCEs than for all of its non-HCEs, the plan will fail the Benefits Test ­ Similarly, if an employer extends the post-termination COBRA or other coverage for an HCE and does not provide the same extension to all non- HCEs, the plan will fail this test © 2011 Proskauer. All Rights Reserved.

15 Nondiscrimination for Insured Plans Determined Under IRC 105(h) Observations ­ Are executive insurance products dead? ­ Under 50 exclusion from penalty ­ Potential work arounds for other practices © 2011 Proskauer. All Rights Reserved.

16 Nondiscrimination Rules for Cafeteria Plans ­ The proposed cafeteria plan regulations released in 2007 reinforce that nondiscrimination testing must be performed annually for all cafeteria plans. ­ Testing must be performed as of the last day of the plan year and must take into account all non-excludable employees (and former employees) who were employed on any day during the plan year. © 2011 Proskauer. All Rights Reserved.

17 Nondiscrimination Rules for Cafeteria Plans There are three cafeteria plan nondiscrimination tests ­ 1. Key Employee Test ­ If a plan provides nontaxable benefits to key employees (as defined under Code section 416(i)(1)) in excess of 25% of the aggregate nontaxable benefits provided to all employees through the cafeteria plan, key employees will be taxed on the amounts that have been deducted from their pay on a pre-tax basis © 2011 Proskauer. All Rights Reserved.

18 Nondiscrimination Rules for Cafeteria Plans There are three cafeteria plan nondiscrimination tests ­ 2. Eligibility Test ­ A cafeteria plan must not discriminate in favor of HCEs as to eligibility to participate. An HCE is any employee who, for the prior year (or current year if a new employee) is an officer, 5% shareholder, or an employee who received compensation greater than $110,000 in 2010 (indexed for inflation) and is among the top 20% of the employees ranked by compensation. ­ Note: ­ Note: This is a different definition of HCE than is used for purposes of 105(h) © 2011 Proskauer. All Rights Reserved.

19 Nondiscrimination Rules for Cafeteria Plans There are three cafeteria plan nondiscrimination tests ­ 3. Contributions and Benefits Test ­ A cafeteria plan must not discriminate in favor of HCEs as to contributions and benefits. This means that a plan must: ­ give each similarly situated participant a uniform opportunity to elect qualified benefits, and the actual election of qualified benefits through the plan must not be disproportionate by HCEs; and ­ give each similarly situated participant a uniform election with respect to employer contributions, and the actual election with respect to employer contributions for qualified benefits through the plan must not be disproportionate by HCEs © 2011 Proskauer. All Rights Reserved.

20 Nondiscrimination Rules for Cafeteria Plans Nondiscrimination in Actual Operation ­ In addition to not discriminating as to either benefit availability or utilization, a cafeteria plan cannot discriminate in favor of HCEs in actual operation ­ For example, a particular nontaxable benefit offered through the plan for a period during which only HCEs would utilize the plan or benefit © 2011 Proskauer. All Rights Reserved.

21 Nondiscrimination Rules for Cafeteria Plans “Safe Harbor” for Cafeteria Plans providing health benefits ­ A safe harbor test is available for plans that provide health benefits (excluding health care FSA coverage) ­ The safe harbor from the contribution and benefits test exists if contributions for each participant include an amount that either: ­ equals 100% of the cost of the benefits selected by the majority of similarly situated HCEs; or ­ is at least 75% of the cost of the highest cost benefits selected by any similarly situated participants ­ Note that any contributions above the safe harbor must be proportionate to participants’ compensation © 2011 Proskauer. All Rights Reserved.

22 Nondiscrimination Rules for Cafeteria Plans “Safe Harbor” for premium-only plans ­ A cafeteria plan that offers the same benefits at the same cost to all HCEs and non-HCEs is deemed to meet the nondiscrimination requirements ­ This safe harbor is not available for plans offering a health care FSA © 2011 Proskauer. All Rights Reserved.

23 Nondiscrimination Rules for Cafeteria Plans Anti-abuse rule for cafeteria plan nondiscrimination testing ­ A plan will not be treated as satisfying the applicable nondiscrimination requirements if there are repeated changes to testing procedures or plan provisions that have the effect of manipulating the nondiscrimination testing requirements “if a principal purpose of the changes was to achieve this result” © 2011 Proskauer. All Rights Reserved.

24 Nondiscrimination Rules for Group Term Life Insurance Plans Nondiscrimination for Group Term Life (GTL) Plans ­ If employer-provided group term life insurance is discriminatory, key employees lose the exclusion from income for the first $50,000 of coverage. ­ Additionally, the key employees’ coverage will be taxed at the greater of the “table value” (i.e., the value determined using the Table I rates) or the actual cost © 2011 Proskauer. All Rights Reserved.

25 Nondiscrimination Rules for Group Term Life Insurance Plans Group Term Life Insurance Eligibility Test ­ Employer-provided group term life insurance cannot discriminate in favor of key employees as to eligibility to participate. ­ This test is passed by meeting one of four alternative tests: 1.the Cafeteria Plan Piggyback Test; 2.the 70% Test; 3.the 85% Test; or 4.the Reasonable Classification Test © 2011 Proskauer. All Rights Reserved.

26 Nondiscrimination Rules for Group Term Life Insurance Plans Group Term Life Insurance Eligibility Test 1.the Cafeteria Plan Piggyback Test ­ A group term life insurance plan does not discriminate as to eligibility if it is part of a cafeteria plan that meets the requirements of Code §125 ­ This provision simplifies nondiscrimination testing for employers that offer group term life insurance coverage through their cafeteria plans, because only one eligibility test (the cafeteria plan eligibility test) must be run © 2011 Proskauer. All Rights Reserved.

27 Nondiscrimination Rules for Group Term Life Insurance Plans Group Term Life Insurance Eligibility Test 2.the 70% Test ­ A group term life insurance plan does not discriminate as to eligibility if the plan benefits 70% or more of all employees of the employer, including employees of controlled group members and leased employees © 2011 Proskauer. All Rights Reserved.

28 Nondiscrimination Rules for Group Term Life Insurance Plans Group Term Life Insurance Eligibility Test 3.the 85% Test ­ A group term life insurance plan does not discriminate as to eligibility if at least 85% of all employees who are participants under the plan are non-key employees. ­ There is some data collection involved in this test, and a mathematical comparison between the number of key employees and non-key employees participating is required, but this is a relatively simple test to run © 2011 Proskauer. All Rights Reserved.

29 Nondiscrimination Rules for Group Term Life Insurance Plans Group Term Life Insurance Eligibility Test 4.the Reasonable Classification Test ­ A group term life insurance plan does not discriminate as to eligibility if it benefits a classification of employees set up by the employer which is found by the Internal Revenue Service not to be discriminatory in favor of HCEs © 2011 Proskauer. All Rights Reserved.

30 “Simple” Cafeteria Plans under PPACA Simple Cafeteria Plans ­ Effective January 1, 2011, PPACA provides eligible small employers with a safe harbor from the nondiscrimination requirements for cafeteria plans, group term life insurance, and health care and dependent care FSAs ­ Under the safe harbor, the plan will be treated as meeting the specified nondiscrimination requirements if the cafeteria plan satisfies minimum eligibility and participation requirements and minimum contribution requirements © 2011 Proskauer. All Rights Reserved.

31 “Simple” Cafeteria Plans under PPACA Simple Cafeteria Plans – Eligible Employer ­ An eligible employer is an employer who employed an average of 100 or fewer employees on business days during either of the two preceding years. ­ If an employer was an eligible employer for any given year, then the employer remains an eligible employer until the employer employs an average of 200 or more employees during any year preceding any such subsequent year. ­ Tax-controlled group rules apply © 2011 Proskauer. All Rights Reserved.

32 “Simple” Cafeteria Plans under PPACA Simple Cafeteria Plans – Eligibility Requirement ­ The eligibility requirement is met only if all employees (other than excludable employees) are eligible to participate, and each employee eligible to participate can elect any benefit available under the plan ­ Excludable employees for purposes of a simple cafeteria plan are those who: ­ have not attained age 21 before the end of the plan year; ­ have fewer than 1,000 hours of service in the preceding year; ­ have not completed one year of service as of any day during the plan year; or ­ are covered under a CBA or are nonresident aliens © 2011 Proskauer. All Rights Reserved.

33 “Simple” Cafeteria Plans under PPACA Simple Cafeteria Plans – Minimum Contribution ­ The minimum contribution requirement is met if the employer provides a minimum contribution for each non-HCE in addition to any salary reduction contributions made by the employee ­ The minimum must be able to be applied toward the cost of any qualified benefit (other than a taxable benefit) offered under the plan ­ The contribution must be equal to: ­ A uniform percentage (not less than 2%) of the employee’s compensation for the plan year, or ­ An amount which is not less than the lesser of: ­ 6% of the employee’s compensation for the year, or ­ 2x the amount of employees’ salary reductions © 2011 Proskauer. All Rights Reserved.

34 Questions? October 19, 2011 Stacy H. Barrow © 2011 Proskauer. All Rights Reserved.