Self-funders have a keen interest in state regulatory activities because of (a) mandated benefits, (b) state registration and/or regulation of vendors, (c) ERISA preemption being not global, (d) ebb and flow of state-federal power, (e) considerable number of non-ERISA self-funded plans, (g) MEWAs, and (h) role of 24-hour coverage. It is known that states have enacted many statutes, most of which are NAIC-promulgated models. We also know that considerable legislation has dealt with vendor state licenses. Increasing activities at the federal level to tinker with ERISA are being seen, along with substantial pressure by the NAIC, and others, to amend ERISA. State attempts to effect significant health care reform to solve their Medicaid problems will probably be unsuccessful without ERISA modifications.
For the most part, the applicability of taxes to fully insured and to self-funded plans are the same. Examples include IRC §§104, 105, 106, 213, 4976, and 5000. However, there are some areas in which self-funders do face distinctions:
Self-Funded Death Benefits. IRC §101(b) does not apply to self-funded death benefits except where done under a VEBA.
Self-Funded Discriminatory Benefits. IRC §105(h) places tax-consequences on discriminatory self-funded medical benefits.
IRC §§419 and 419A make clear what the self-funder may deduct for tax purposes. A simple example may help.
Given for plan year/fiscal year, the following:
- Claim Reserves at beginning of year
- Approved for payment$100
- Other (reported or not$1,000
- Claim Reserves at end of year
- Approved for payment $150
- Other (reported or not)$1,200
- Paid claims for year $6,000
Consider two employers:
Employer A (general asset plan funded)
Deduction is: (100) + 6,000 + 150 or 6,050
Employer B (trusteed)
Deduction is: (1,100) + 6,000 + 1,350 or 6,250
The claim reserve must be within 35% of the paid claims to be in the safe harbor and, if audited, actuarially supportable as well. The funding vehicle for the reserves need not be a trust; a non-profit corporation would also be acceptable.
ERISA § 401(b) requires that any self-funded plan not only have a funding policy, but that such policy be stated in the plan document. The setting of this funding policy involves numerous decisions or considerations by the employer. For example:
General asset v. trusteed plan?
How may plan assets be unknowingly created with general asset plans?
Contributory v. non-contributory?
If trusteed, should such trust be qualified or not qualified?
How are fixed costs to be handled?
What is reasonable compensation to vendors?
What of dilatory claim funding payments?
How large may advance payments be to a trust account?
Will computer conduit accounts create plan assets?
When does stop-loss become a plan asset?
Who should be trustees?
When should commissions be disclosed?
What about incentive-related compensation?
What are constructive trusts?
What is the role of the cafeteria plan in plan funding?
These issues are discussed in great detail in the Self-funding of Health Care Benefits text. Secondary issues with employers involve retiree health care benefits and non-trusteed funding vehicles.
By using a Voluntary Employees Beneficiary Association (VEBA) as the governing vehicle of the health care plan, the plan sponsor will fund the plan using a qualified trust. The statute and regulations are extensive but essentially provide for the following:
Approval of the plan and trust by means of the IRS Form 1024.
Tax advantages in that (a) advance contributions (within the IRC §419A limits) are deductible and (b) investment income is tax-exempt.
Discrimination rules set forth in IRC §505 must be followed.
Annual tax return on behalf of the trust is filed on IRS Form 990.
Because of the extensive and burdensome rules and also the limited available deductions, the popularity of the qualified trust has diminished in recent years. Except for large plans, or where otherwise required by law, using a qualified trust, as opposed to a non-qualified trust, is questionable as a “solution for which there is no problem.” The non-qualified trust (a) avoids the IRS-approvals, (b) has the same tax deduction as the qualified trust, (c) avoids the discrimination rules of IRC §505 but (d) has its investment income fully taxable.