New law significantly alters health insurance in Massachusetts

The new Massachusetts Health Care Reform Law, which took effect July 1, significantly changes the landscape of health insurance in Massachusetts.
The law is designed to increase access to health insurance both for individuals and for employers by: (1) providing subsidies to the low-income uninsured; (2) requiring individuals 18 and older to have health insurance; (3) requiring employers with 11 or more full-time employees to either offer health insurance or make a “fair share contribution”; and (4) reforming the small and non-group health insurance markets.
In addition, employers with more than 10 employees, regardless of whether they offer health insurance, must adopt a Section 125 plan (“125 plan”) that meets the regulations of the Commonwealth Connector, the state agency charged with administering the Health Care Reform Law.
Employers failing to offer a 125 plan will be hit with the “free rider” surcharge for state-funded health services incurred by the employer’s employees and their dependents.
The explanatory material issued by the Commonwealth Connector emphasizes that an employer’s 125 plan must comply with the Massachusetts regulations. However, a 125 plan is also subject to extensive federal regulations as well. In fact, a 125 plan (also known as a cafeteria plan) derives its name from Internal Revenue Code Section 125, which governs the plan’s terms and administration.

How it works
Under a 125 plan, an employee can choose a reduced salary in return for certain types of “qualified” benefits. For example, an employee may reduce her salary by $100 a month, which the employer will apply tax-free to the cost of a qualified benefit. The net effect is that the employee is funding the benefit with pre-tax dollars.
Dental, disability or group life insurance also can be offered through a 125 plan. A plan also can be used to fund flexible spending accounts that allow payment of medical out-of-pocket and dependent care expenses. The requirements of the Commonwealth Connector, however, are limited to the payment of health insurance premiums through the plan.
In addition to making benefits more affordable, a 125 plan can create tax savings by lowering taxable income for employees.

Administrative challenges
These advantages come at a price, however, since operating a 125 plan poses some administrative challenges. As an initial matter, appropriate recordkeeping and tax reporting mechanisms must be put in place. In addition, elections can only be made prospectively and cannot apply retroactively.
More significantly, an election under a 125 plan is generally irrevocable for the plan year. A participant who reduces income by $100 a month cannot decide later in the year that she would rather have the cash.
In the same vein, an employee who chooses not to participate in the 125 plan cannot elect participation in the middle of the plan year. An employee can only elect to participate in the plan during the designated annual open enrollment period, within a specified time of initial hire or within a specified time of initial eligibility for the plan.
IRS regulations do allow a change in the salary reduction election under certain specified circumstances, referred to as “change in status” situations. A plan is permitted to allow these changes in election but is not required to do so, and the IRS rules are complex and detailed.
In addition, special mid-year enrollment rights are provided under HIPAA. As an example, a plan may allow participants to change elections in the event the participant has a change in marital status or has a child. The change in the election, however, must always be consistent with the change in status. If a participant has a child, the participant may be allowed to elect dependent health coverage, but the participant may not elect disability coverage until the next open enrollment.
As is evident, a 125 plan involves more than simply executing a plan document, and it makes sense for all employers to understand the implications of a Section 125 plan when analyzing options under the Massachusetts Health Care Reform law.
If an employer concludes establishing a 125 plan is the appropriate course of action, it can expand the plan to provide for the pre-tax funding of other benefits in addition to health insurance.
Rosalie A. Beith, of counsel with Fetcher Tilton & Whipple, P.C., concentrates her practice in ERISA and employee benefits, including compensation plans and arrangements, as well as public company equity compensation matters and Sarbanes-Oxley. Ms. Beith is a former corporate counsel to a nationally known financial services company, where she worked on all aspects of the establishment and administration of pension, welfare, compensation, and stock compensation plans. She can be reached at [email protected] or 508.532.3500.