IRS clarification of cafeteria plans raises concerns

WASHINGTON – A U.S. Treasury Department regulation released in August has clarified tax provisions that allow employees to make contributions toward the cost of individual health plans and pay for healthcare services with pre-tax dollars through a flexible spending account if their employer has a cafeteria plan.

The clarification of Section 125 of the Internal Revenue Service Code, however, does not protect employees, employers, brokers, insurance carriers or other third-party administrators from HIPAA and state regulations.

Currently, the individual market does not have to comply with group market guaranteed issue coverage, said Ashley Gillihan, ERISA attorney for Alston + Bird. “Group plans cannot underwrite what individual health plan(s) do,” he said. That includes preexisting conditions.

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Three dozen states, including Texas, will regulate individual health plans as if they are a part of group coverage, said John Hickman, partner and head of health benefits practice at Alston + Bird.

Individual plans in which premiums are paid with pre-tax dollars will be subject to group coverage requirements. “This may mean adverse compliance for brokers and carriers,” he said, given that HIPAA nondiscriminatory rules regarding health status eligibility would go into effect.

Roy Ramthun, an independent consultant and visiting fellow at the Council for Affordable Health Insurance, said the Section 125 clarification allows employers to treat all employees equally by providing equal contributions toward the cost of insurance.

Additionally, if employees leave work and become self-employed, the individual health plan is portable and renewable at that rate.

“If you go freelance, HIPAA rules say insurers can’t deny you coverage based on health history, but they can charge you at a higher rate,” Ramthun said.

Some states are attempting to address this issue. Missouri passed a law this year allowing employees under individual plans to take advantage of the tax benefits. And Massachusetts is enabling individually purchased coverage for small businesses and the self-employed through its Connector infrastructure.

“The small business community is running out of options to offer affordable healthcare,” said Ramthun. Reconciling state regulations and HIPAA rules with Section 125 is one way to help.