Proposed Rules Target Short-term, Limited-Duration and Fixed Indemnity Insurance Options

Executive Summary 

On July 7, the Departments of Labor, Treasury, and Health and Human Services (the “Departments”) published a long-anticipated proposed rule (“Proposed Rule”) that: 

• Reinterprets short-term, limited-duration insurance (“STLDI”)
• Changes the requirements for fixed indemnity and hospital indemnity excepted benefits
• Solicits comments on requirements for specified disease or illness excepted benefits
• Solicits information about the use of level-funded premium plans in the small group market
• Clarifies the tax treatment under Code section 105 of fixed amounts received through employment-based accident or health insurance that are paid regardless of the amount of medical expenses incurred

The result of the Proposed Rule, if adopted would make STLDI and fixed indemnity and hospital indemnity excepted benefits less available in the small and individual markets and would potentially cause fixed amounts from employment-based accident or health insurance to be taxable. 

Proposed Rule

On July 7, 2023, the Departments released a proposed rule to restrict options for consumers for certain types of health coverage that are not subject to the Affordable Care Act’s (ACA) consumer protections, including short-term, limited-duration insurance (STLDI) and fixed indemnity coverage. In addition, the proposed rules would potentially tax amounts received under fixed indemnity plans provided by employers, if the amounts are not directly tied to the amount of the medical costs incurred.  

The Departments solicited comments regarding the treatment of specified illness coverage (such as cancer coverage) as an excepted benefit and the treatment of level-funded medical plans with stop-loss coverage at “low” attachment points – the concern being that such coverage might be used to avoid the state regulation of insured plans in the small group market. Depending on what the Departments learn and propose from those comments, the ability of small employers to self-fund their group medical plans could be materially limited. Written comments are due by September 11, 2023.

STLDI 

STLDI is a type of health insurance coverage designed to fill temporary gaps in coverage when an individual is transitioning from one plan or coverage to another plan or coverage. STLDI is specifically exempt from the definition of “individual health insurance coverage” and, therefore, is not subject to the ACA’s requirements for comprehensive coverage. Final rules from 2018 currently define STLDI as coverage with an initial contract period of less than 12 months and a maximum total duration of up to 36 months, including renewals and extensions.

Effective for policies sold on or after the effective date of any final rule, the Proposed Rule would limit the length of the initial contract period to no more than three months and the maximum coverage period to no more than four months, taking into account any renewals or extensions. In addition, the Proposed Rule would 

• Prohibit a practice known as stacking, where the same insurer issues multiple STLDI policies to the same policyholder within a 12-month period
• Amend the consumer notice requirement to further clarify the differences between STLDI and comprehensive coverage and identify options for consumers to obtain comprehensive coverage.

The Proposed Rule includes a reminder that any health insurance sold in connection with employment is group health insurance coverage that must comply with the federal consumer protections in the group market, even if it purports to be STLDI.

The Departments noted that the STLDI plans do not include consumer protections such as the prohibition of discrimination based on health status, the prohibition of preexisting condition exclusions, and the prohibition of lifetime and annual dollar limits on essential health benefits. The Proposed Rule would also clarify the tax treatment of certain benefit payments in fixed amounts received under employer-provided accident and health plans. In addition, the proposal solicits comments regarding specified disease excepted benefits coverage and level-funded health plans to help the Departments determine if additional guidance or rulemaking is needed in these areas.

Fixed Indemnity Benefits

The Departments’ Proposed Rule would:

• Require that fixed indemnity excepted benefits coverage in the individual market pay fixed benefits only on a per-period basis (and remove the current option for such coverage to pay fixed benefits on a per-service basis)
• Create new standards related to the payment of benefits under fixed indemnity excepted benefits coverage in the group market, including adding a new example to address the prohibition on coordination between fixed indemnity excepted benefits coverage and any group health plan maintained by the same plan sponsor
• Require a consumer notice to be provided when offering fixed indemnity excepted benefits coverage in the group market
  
  

Some commentators have noted that the market for STLDI and fixed indemnity plans is selling “junk” insurance and cite concerns about aggressive and deceptive marketing. The STLDI policies do not come with the full component of consumer protections contained in the ACA-mandated coverage options. However, they are also much less expensive and accessible to some consumers. Being less expensive, there has been a concern that they will convince some younger, healthier consumers to choose these options rather than the more expensive Exchange-based coverage options. Therefore, the Biden Administration is proposing changes to STLDI that will overturn Trump Administration (which in turn modified the Obama Administration rule) changes that made STLDI more flexible for consumers. The proposed rules also would change some fixed indemnity coverage, which will make those options less attractive as well. The Departments state that the changes will help consumers distinguish these options from comprehensive health coverage and increase consumer awareness of coverage options that fully meet the ACA requirements. Taken together, employers may potentially see increased demand for their major medical plans. If the increased enrollment is from younger, healthier employees and their dependents, perhaps the experience of the employer plans will improve. Still, with increased enrollment, there will likely be increased costs even if the experience of the group is less costly. 

Tax Treatment of Fixed Indemnity Health Plans

The Proposed Rule would clarify (or change from a different perspective) that payments from employer-provided fixed indemnity health insurance plans (and other similar plans) are not excluded from a taxpayer’s gross income if the amounts are paid without regard to the actual amount of any incurred medical expenses and where the premiums or contributions for the coverage are paid on a pre-tax basis. Additionally, the Proposed Rule would clarify that the taxpayer must meet substantiation requirements for reimbursements for qualified medical expenses from any employer-provided accident and health plan to be excluded from the taxpayer’s gross income.

Fixed Indemnity Excepted Benefits Coverage Certain is in a category of coverage referred to as “excepted benefits” that are not subject to certain federal consumer protections, including the ACA’s requirement for comprehensive coverage. Fixed indemnity coverage is exempt from these protections because it is designed to provide a source of income replacement rather than full medical coverage. The Proposed Rule would create additional requirements for fixed indemnity excepted benefits coverage to ensure that consumers can distinguish between this coverage and comprehensive medical coverage.  

The Proposed Rule seeks to reinstate a requirement that Fixed Indemnity coverage provide benefits in the individual market for a fixed period and not permit benefits to be paid on a per-service basis and require Fixed Indemnity coverage to pay benefits without regard to services or items received, actual or estimated amount of expenses incurred, the severity of the illness or injury, or other characteristics particular to a course of treatment. It would also include a new notice requirement for plans and issuers that the Departments see as similar to that already required in the individual market and seeks comments regarding the specific information and burdens associated with that notice. 

Highlights

The proposed changes are intended to help consumers differentiate between comprehensive health coverage and certain types of coverage that are not subject to the ACA’s consumer protections. These changes would:

• Amend the federal definition of STLDI to reduce the initial contract period to no more than three months

• Clarify that fixed indemnity excepted benefits coverage must be offered as independent, noncoordinated coverage

Level-Funded Plans   

Level-funded plans are a type of self-funded medical plan that many employers find to be an attractive alternative to fully insured plans. They provide more flexibility for the employers that adopt them since they are not subject to all the same mandates that might apply to fully insured plans. The Proposed Rule cites concerns raised by “interested parties” that make that point. The Proposed Rules note that level-funded plans are not required to comply with federal or state consumer protection and insurance regulations (such as certain essential health benefit mandates) and see that as an abuse if the arrangement uses “stop-loss coverage that has low attachment points.”

The Departments noted the interested parties’ concern regarding the mingling of different plan sponsors’ contributions if held by a single service provider and whether the service provider “might inadvertently be establishing multiple employer welfare arrangements,” thereby subjecting the plans to state insurance regulation and additional ERISA obligations. It is not clear that the issue is truly a concern for the federal regulators since state insurance regulations already deal with self-funded Multiple Employer Welfare Arrangements (MEWAs), but the Departments noted this as a potential concern. 

The Departments are hinting their concerns that plan sponsors might be using level funding to provide lower-value benefits to their employees: 

• How prevalent are level-funded plans among private or public employers and how many individuals are covered by such plans?
• What factors are leading an increasing number of plan sponsors, particularly small employers, to utilize level-funded plans?
• What types of benefits are commonly offered or not offered by level-funded plans, and do they differ from fully-insured plans?
• Are additional safeguards needed with respect to level-funded arrangements to ensure that individuals and/or small employers are not subjected to unexpected costs resulting from the stop-loss coverage failing to comply with Federal group health plan requirements?
• How, and by whom, is the attachment point for stop-loss coverage determined and what factors are considered in setting the attachment point?
• What is the impact, if any, of level funding for plans offered by small employers have on the insured small group market?
• How do plan sponsors of level-funded arrangements account for compliance with the consumer protections and mandated benefits that would apply to health benefits provided by a plan sponsor through a level-funded arrangement that is reimbursed through stop-loss insurance?

Tax Treatment of Fixed Hospital and Indemnity Insurance 

This Proposed Rule seeks to “clarify” the tax treatment of fixed hospital and indemnity insurance and, therefore, will be effective the later of final publication or January 1, 2024. However, it goes much further and makes substantive changes to the tax rules that have governed these policies for several decades.

IRC Section 105(b) states that amounts received from an employer plan that reimburse the employee’s expenses for medical care (as defined in Code Section 213(d)) are excluded from taxable income. The exclusion does not apply to amounts the employee would be entitled to receive, irrespective of whether the employee incurs expenses for medical care or to the extent that such amounts exceed the actual expenses for such medical care. 

The Proposed Rule states that the current language has confused taxpayers about how the Code section 105(b) exclusion applies when the benefits are not directly related to a medical expense incurred by an employee. However, that confusion appears to only apply to certain promoters of a type of plan seeking to distort the rules to attain larger tax benefits than those provided by the exclusion. See the World article on one such promotion here. 

To clarify the issue, the Proposed Rule provides that amounts received under a fixed indemnity plan treated as an excepted benefit that pays regardless of the amount of medical expenses actually incurred, are not payments for medical care under section 105(b) and are included in the employee’s gross income under section 105(a). That might be sufficient to end the abuses, but the rule goes further. The preamble states that “even if a benefit payment under [an] arrangement is used to reimburse an employee’s medical expenses if the amount of the payment is not tied to the amount of the expense incurred and the employee is entitled to keep any amounts by which the benefit payment exceeds the incurred expenses, that would indicate that the benefit is not actually a reimbursement for medical expenses.”  So, it seems as though the position of the Proposed Rule is that even if the benefits paid under the fixed indemnity plan are substantiated, if the plan is an excepted benefit, the expenses cannot be paid for on a pre-tax basis.

 Conclusion

These Proposed Rules could be effective as early as January 1, 2024. Employers will need to be aware of some significant changes regarding their benefit plans and react accordingly if the Proposed Rules are finalized.