Alston & Bird LLP and Aflac
If finalized, recently proposed rules targeted primarily at STLDI would also impact supplemental benefits that have been an important option to help provide additional financial protection in the event of a covered accident or illness. For now, there is no change and these proposals might not be finalized or, if they are, may be revised.
New federal limits on the maximum permitted period for short-term limited duration insurance (STLDI) have been expected for some time. A proposed rule published by federal regulators on July 12, 2023 would cut back the current 36-month limit on STLDI. However, the proposed rule would also impose new restrictions on certain supplemental fixed indemnity health benefits. In particular, it would impose significant limitations on the structure of hospital indemnity and other fixed indemnity supplemental benefits. It also proposes to change the tax treatment of benefits under all health indemnity plans (fixed indemnity as well as benefits under specified disease plans like cancer or critical illness plans). Additionally, the proposed rule also requests comments on other issues.
Although federal regulators give various reasons for proposing these changes, a primary concern is that consumers may not fully understand the difference between the comprehensive major medical coverage provided through an ACA-compliant policy and the more limited coverage provided through supplemental benefits (or STLDI). The proposals, however, are very broad, and would essentially reduce and even eliminate the types of supplemental products available today.
No major medical policy, no matter how robust, covers all the expenses associated with an accident or illness. Major medical plans generally have deductibles and co-payments as well as other exclusions and limits on benefits. Further, there are many expenses associated with an accident or illness that major medical is not intended to cover, such as medical-related travel, childcare needed when going to the doctor, or other expenses. Supplemental products are not major medical coverage or a substitute for major medical coverage, rather they are intended to provide additional financial protection when a covered accident or illness occurs. There are various types of supplemental coverage, including accident, disability, cancer or critical illness, and hospital and other medical fixed indemnity products. These products are also referred to as “excepted benefits” because by law they are “excepted” from the ACA and certain other federal health coverage mandates, provided certain requirements are met. Like other types of insurance, supplemental benefits are subject to regulation under state law.
Proposed changes to hospital indemnity or other fixed indemnity supplemental coverage
Hospital indemnity and other fixed indemnity is one type of supplemental or “excepted” benefit. These plans typically pay a cash benefit directly to the insured (unless otherwise assigned) based on a medical trigger, which may be used for any purpose at the discretion of the insured. The policy sets forth covered medical events (e.g., hospitalization, visit to a doctor, x-ray) and the fixed payment applicable to that medical event. The proposed rule, if adopted, would significantly impact the way that benefits under these plans are structured.
If finalized, the proposed rules would eliminate the ability to vary the amount of benefits by the services or items received, severity of illness or injury, or any other characteristics particular to a course of treatment. This change would apply in both the individual and group markets. Currently, individual market regulations allow benefits to vary on a per service and/or per period basis. The group market regulations are different but still allow the ability to pay benefits that include a per p eriod limitation and also vary the fixed payment by the specific triggering event. Benefits structured in this way reflect the fact that different health events present different risks of financial loss and varying needs for additional financial protection. States have regularly approved products structured in this way because of the value they provide to consumers.
If finalized, the proposed rules would reinterpret and expand the meaning of “noncoordinated” benefits in group and individual markets.
If finalized, proposed rules would impose new notice requirements. A core purpose of the proposed rules is to reduce possible confusion and help employees and individuals understand the nature of the coverage they buy. New notice requirements go directly to this purpose. There is already a notice requirement in the individual market, that notice would be revised and a new notice requirement would apply in the group market. In general, the notice is designed to make it clear that the supplemental coverage is not comprehensive coverage and is not required to include most federal consumer protections. The details of the notice can be found in the proposed rule.
Proposed changes to the tax treatment of supplemental health benefits
The proposed rule would make major changes to the tax treatment of supplemental health benefits that pay on a fixed indemnity basis (i.e., a set cash amount), including both specified disease plans (e.g., cancer only or critical illness) and hospital indemnity or other fixed indemnity plans. Although described as a “clarification” the proposed rule is actually a significant change and will result in increased income taxes on employees, as well as increased FICA and FUTA taxes on employees and employers.
Currently, the tax treatment of benefits paid under fixed indemnity health plans is well established and depends on whether the premium was paid on an after-tax or pretax basis.
Under the proposal, if premiums are paid on a pretax basis (either by the employer or by employee pretax salary reduction), then the entire amount of the benefit would be taxable income regardless of the amount of the employee’s unreimbursed medical expenses. In other words, currently only the “excess benefit” is subject to tax. Under the proposal, the entire benefit would be subject to tax.
The explanation of the proposed rule also indicates that when the premium is paid on a pretax basis, then the benefits are also subject to employment taxes, although there is no clear mechanism for determining or withholding such taxes.
If the proposal is finalized, then many employers may prefer to offer the benefits on an after-tax basis, in which case the benefit will be tax free.
Proposed changes to the permitted length of STLDI
Unlike supplemental excepted benefit coverage discussed above, STLDI is considered a form of primary medical coverage, generally intended to fill temporary gaps in coverage, for example, between jobs or between school and a job. STLDI is available in the individual market only. Because STLDI is intended to be temporary in nature, it is exempt from the ACA and other federal health coverage mandates. The identifying feature of STLDI is that it must be “short-term”. Federal regulations have varied over time as to what time period is considered to be “short-term”. Initially, in 1997, STLDI was generally limited to a coverage period of less than 12 months. Regulations adopted in 2016 further restricted STLDI to less than 3 months. The current regulations, adopted in 2018, provide for an initial coverage period of less-than 12 months and, with renewals, a total coverage period of 36 months.
Under the new proposed rules, the initial coverage period for STLDI would be limited to no more than 3 months, and the total coverage period could be no more than 4 months (including any extensions or renewals).
These proposed changes do not prevent an individual from obtaining a new STLDI plan from a different issuer once a current plan expires; however, there are limitations that would prevent an individual from “stacking” policies from the same issuer. This means that an individual could not obtain a new STLDI plan from the same issuer within 12 months from the effective date of a previous STDLI plan from the same issuer. An individual could purchase another STDLI plan from an issuer that has not provided the individual with STLDI coverage within the previous 12-month period.
The proposed rule would also modify the existing notice requirement for STLDI.
Request for comments
Although not proposing any changes to the structure of specified disease plans, the regulators asked for comments on such plans and list some specific issue areas of interest. This request for comments indicates that they may be considering additional restrictions on such plans, including potentially restrictions similar to those proposed for hospital indemnity and other fixed indemnity supplemental excepted benefits.
Federal regulators are also gathering information on level-funded plan arrangements. In general terms, a level-funded arrangement is a type of self-funded plan in which the plan makes monthly payments to a service provider to cover estimated claims costs and premiums for stop-loss insurance coverage for claims above a certain level (referred to as the attachment point). It is common practice for sponsors of self-funded plans to purchase stop-loss coverage as protection against catastrophic or unpredictable claims. For small employers, self-funded plans may be of interest because certain of the ACA requirements in the small group market do not apply to self-funded plans (e.g., the requirement to offer essential health benefits does not apply to self-funded plans).
In the case of a level-funded arrangement, the self-funded plan is subject to all applicable federal health care mandates. However, the stop-loss coverage is not health coverage, but is regulated at the state level. Different states have different requirements for stop-loss coverage, including the attachment point. The concern of federal regulators with level-funded arrangements centers on small employers that self-fund their health plans using stop-loss insurance at low attachment points. Some of the main concerns expressed by the regulators is that small employers may not fully understand the arrangements (and their obligations) and that increasing use of such arrangements might adversely impact the ACA small employer market.
Next steps and effective dates
The proposed changes are undergoing a comment period, which lasts through September 11, 2023. Federal regulators will review comments and as they consider whether to adopt the rules as proposed, make changes, or only finalize part of the rules. There is no set date for when regulations could become final.
The effective date for the proposed changes varies, but in general are tied to when the rules are finalized. Many of the changes apply to both new and existing plans, but with a later effective date for existing policies. Note that many impacted plans are guaranteed renewable, which could create a conflict between the plan (and state law requirements) and new federal rules.
Proposed effective date
Changes to requirements for hospital indemnity and other fixed indemnity excepted benefit plans
General effective date: Plans sold or issued starting 75 days after a final rule is published.
For plans sold or issued before the general effective date, plan years (coverage periods in the individual market) beginning on or after Jan. 1, 2027. However, the notice requirement would apply starting 75 days after a final rule is published.
Changes to tax treatment
The later of the date of publication of the final rule or Jan. 1 , 2024.
Changes to the requirements for STLDI
General effective date: Plans sold or issued starting 75 days after a final rule is published.
For plans sold or issued before the general effective date, existing plans, the current rules regarding duration would apply, subject to any state law limitations. The notice requirement would apply starting 75 days after publication of a final rule.
If finalized, the proposed changes will have a significant negative impact on the supplemental coverage market, specifically with respect to hospital indemnity and other fixed indemnity coverage and, with respect to the tax changes, specified disease polices as well. The proposals, if finalized, will restrict and could eliminate popular products that have long been available for employers to offer to their employees and for individuals to use to provide an additional layer of financial protection. This advisory has provided a high-level overview of the proposed changes. Employers and others should consult their own advisors as to how they would be impacted if these proposed changes are finalized.