What is a health insurance opt-out?

A health insurance opt-out arrangement is a financial incentive some employers offer employees to decline group health coverage. Such arrangements are used by employers to reduce benefit costs by paying less for the incentive than they would for their share of the benefit premium.

While opt-out arrangements are lawful, there are some caveats to consider.

Opt-out arrangements should be offered under a Section 125 cafeteria plan to avoid unfavorable employee taxation. Under the "constructive receipt" rule, when an employee is offered the choice between nontaxable benefits and taxable benefits (in this case group health plan participation or cash), even if the employee chooses the nontaxable benefits, the IRS could take the position that the employee had constructive receipt of the cash (as it was hers or his for the taking), and it must then be included in the employee's income for the year, even though he or she elected not to actually receive the cash. Offering the opt-out under a cafeteria plan avoids this tax consequence.

The Affordable Care Act will consider certain opt-out payments as part of the employee's premium for determining affordability under the act. Applicable large employers must offer affordable premiums to eligible employees or face a potential tax under the shared responsibility provisions. In determining affordability, since an employee could take the cash incentive OR give it up and enroll in coverage, the amount of the incentive is considered part of the premium the employee must pay for coverage. There are exceptions, based upon the type of arrangement:

• Unconditional opt-out: Simply put, there are no conditions other than declining to enroll in the group health plan. In this scenario, the amount of the opt-out incentive must be included in the cost of coverage for affordability calculations.
• Conditional opt-out: In this arrangement, the employer will provide the incentive only if the employee satisfies some established condition related to having health care coverage, such as enrollment in another group health plan (from a spouse or parent's plan, for example). Any cash incentive offered in such an arrangement would be included in the affordability calculations unless it also met the criteria of an eligible opt-out arrangement.
• Eligible opt-out: As defined in the IRS's Premium Tax Credit Notice of Proposed Rulemaking VI (REG-109086-15), cash incentives under this type of arrangement would not need to be included in the affordability calculations. These arrangements must condition an employee's right to receive the opt-out payment on the following, according to the notice:

• • "the employee declining to enroll in the employer-sponsored coverage and,
  • "the employee providing reasonable evidence that the employee and all other individuals for whom the employee reasonably expects to claim a personal exemption deduction for the taxable year or years that begin or end in or with the employer's plan year to which the opt-out arrangement applies (employee's expected tax family) have or will have minimum essential coverage (other than coverage in the individual market, whether or not obtained through the Marketplace) during the period of coverage to which the opt-out arrangement applies." 

These regulations also establish that opt-out arrangements used to incentivize employees to get individual coverage rather than group coverage will not be excludable from the affordability calculations. The IRS has indicated that these proposed rules can be relied upon until final rules are published.

Opt-out incentives should be offered to all eligible employees. If they are not, an employer can risk unlawful discrimination if such incentives are offered to only certain groups; violation of the Medicare secondary payor rules if the incentives are meant to incentivize only Medicare-eligible employees to decline coverage; violation of the prohibition on offering incentives to Tricare-eligible employees to not enroll in group coverage; or violation of Health Insurance Portability and Accountability Act (HIPAA) nondiscrimination rules if the incentive offerings are based on health factors or claims.

Federal and state law may consider opt-out incentives to be wages for overtime pay. In a 2016 California case, the 9th Circuit Court found in Flores v. City of San Gabriel that taxable opt-out incentives must be included in the regular rate of pay when calculating overtime pay. As this ruling was based upon the Fair Labor Standards Act's definition of the regular rate used to calculate overtime, this is a concern for all employers. Consistent review of developing laws and regional court decisions should be established to ensure compliance.

Lump-sum payments may create issues. If the full payment is made at the start of the plan year, the employee could quit his or her job midyear and keep the payment, or the employee could have a HIPAA special-enrollment situation and join the plan midyear. It is unclear whether employees could waive their special-enrollment rights when accepting the opt-out. Most employers therefore choose to spread the incentive payments over the plan year.