How should employers disburse medical loss ratio (MLR) rebates from insurance carriers?

According to the U.S. Department of Labor’s Technical Release No. 2011-04, the employer’s responsibility for distributing the rebate to participants is dependent on who paid for the insurance coverage. If the employer paid the entire cost of the insurance coverage, then no part of the rebate would be attributable to participant contributions. However, if participants paid the entire cost of the insurance coverage, then the entire amount of the rebate would be attributable to participant contributions and would be considered to be plan assets. If the participants and the employer each paid a fixed percentage of the cost, a percentage of the rebate equal to the percentage of the cost paid by participants would be attributable to participant contributions.

The DOL guidance provides employers with the following three options for disbursing rebates:

• To reduce subscribers’ portion of the annual premium for the subsequent policy year for all subscribers covered under any group health policy offered by the plan.
• To reduce subscribers’ portion of the annual premium for the subsequent policy year for only those subscribers covered by the group health policy on which the rebate was based.
• To provide a cash refund only to subscribers who were covered by the group health policy on which the rebate is based.

These options allow for employers to distribute rebates only to subscribers (employees) who were enrolled during the year in which the rebate was paid rather than the reporting year on which the rebate was calculated. This option allows employers to avoid the burden of tracking down previous participants who may no longer be employed with the company. However, current COBRA participants must be included, as COBRA coverage must be the same coverage as available to active employees. On average, the per participant rebate will most likely be fairly small. Rather than having the administrative task of cutting relatively small checks to each participant, many employers are choosing to apply the rebate to current employee contributions, reducing the employee’s payroll deduction.

Federal tax treatment of MLR rebates paid to employees will depend on whether the employee’s payroll deductions for insurance premiums were made pre- or post-tax. Employees who pay for their insurance premiums post-tax have already paid employment taxes on the deduction for insurance premiums, and the rebate will not result in any further tax liability unless the employee deducted the premium payments on his or her annual tax return. However, many employers maintain a Section 125 cafeteria plan that allows employees to pay their insurance premiums on a pre-tax basis. This means that taxes were not initially paid on the premiums and that the rebate is a return to the employee that is no longer being used to pay for health insurance premiums. Therefore, the amount of the rebate will result in an increase in taxable income subject to employment taxes. See IRS Medical Loss Ratio FAQs.