The Internal Revenue Service ("IRS") has issued new guidance, in the form of temporary regulations, concerning the rules under which employees may change their elections for certain cafeteria plan benefits during the applicable coverage period (sometimes referred to in this bulletin as a "mid-year change"). Supplanting prior proposed regulations, the new guidance provides that a cafeteria plan may allow a mid-year change to be made for health, accident and life insurance benefits when:

• the employee becomes eligible to enroll in his/her employer’s health plan as a result of the Health Insurance Portability and Accountability Act ("HIPAA");
• the employee or the employee’s spouse or dependent experiences a "change in status" (which includes such events as having a child, getting married or terminating employment);
• a "qualified" medical child support order ("QMCSO") has been issued for the child of an employee; or
• the employee, or the employee’s spouse or dependent, becomes entitled to Medicare or Medicaid coverage.

Background

Under a so-called section 125 "cafeteria" plan, employees can elect certain benefits (such as health care, dependent care and group-term life insurance benefits) and pay the required employee premium for such benefits with pre-tax dollars. As a general rule, employees must elect these pre-tax benefits before the applicable coverage period (typically, the plan year) begins, or, in the case of newly eligible employees, upon first becoming eligible for the benefits. These elections are ordinarily irrevocable and may not be changed until the next coverage period begins. Although the existing cafeteria plan rules (which are contained in long-standing proposed regulations) permit mid-year election changes for "changes in family status", employers and plan administrators have struggled to understand and apply these rules. HIPAA’s enactment has added to the uncertainties surrounding this exception.

The new regulations are intended to conform the old rules with HIPAA’s requirements and provide more definitive guidance on when cafeteria plans may allow mid-year election changes for other events. Some of the more significant aspects of these new rules are discussed below.

The new regulations only apply to mid-year changes for health, accident and group-term life insurance coverage. All other cafeteria plan benefits (such as disability and dependent care benefits) will continue to be subject to the "change in family status" rules contained in the prior proposed regulations.

Generally, HIPAA requires that a group health plan allow employees to elect or add to existing health care coverage in certain situations (for example, when an employee has a new spouse or child or he/she loses other health coverage prior to the next open enrollment period). Under the new regulations, cafeteria plans can offer employees the opportunity to make a corresponding mid-year election change to conform with any HIPAA election. In some circumstances, this mid-year election of health coverage can be made retroactive to the date of the event giving rise to the HIPAA election.

Similar to the prior "change in family status" rules, the new regulations permit an employee to make a mid-year election change for certain "changes in status" so long as the change is "consistent" with the event involved. However, the new regulations apply these rules somewhat differently.

Qualifying Changes in Status – The new regulations provide that only changes in the following qualify as a "change in status":

• Marital Status – such as marriage, divorce or legal separation
• Number of Dependents – such as an increase or decrease in such due to the birth, death or adoption of a child
• Employment Status – generally, the termination or commencement of employment by an employee or the employee’s spouse or dependent
• Work Schedule – such as an increase or decrease in work hours, a strike or lock-out, or taking of (or return from) an unpaid leave of absence
• Dependent Status – events which cause a dependent to satisfy, or cease to satisfy, the requirements for health coverage (such as the attainment of a certain age or full-time student status) under the applicable group health plan
• Residence or Worksite – generally, a change in the place of residence or work of the employee or the employee’s spouse or dependents

However, unlike the prior proposed regulations, the new regulations do not appear to permit any other events, whether or not analogous to the covered events listed above, to qualify as a "change in status."

Consistency Requirement – As mentioned above, the new regulations continue the requirement that a mid-year election change must be consistent with the change in status. Unfortunately, the new rules take a much narrower approach to this requirement than what was generally thought to have been permissible under the prior proposed regulations.

• the affected individual gains or loses coverage (be it all coverage or just a particular coverage option) on account of the event, and
• the election change corresponds with the gain or loss of coverage.

A cafeteria plan can permit an employee to make a mid-year election change in response to a QMCSO that requires health coverage to be provided to a child of the employee. This election can be to increase contributions where the employee is required to provide health coverage for a child, or to decrease contributions where another party (such as the employee’s former spouse) is required to provide the child’s health coverage.

If an employee, or the employee’s spouse or dependent, enrolls for coverage under Medicare or Medicaid, a cafeteria plan may permit an employee to make a corresponding election change to the employee’s then existing cafeteria elections. For example, this would include situations where an employee’s spouse becomes entitled to Medicare coverage and the employee wishes to switch from family health coverage to single coverage.

Effective Date of the Temporary Regulations

In general, the new regulations become effective for plan years beginning after December 31, 1998. The regulations also give employers the option to apply the new rules beforehand. However, to use these rules, an employer must amend its cafeteria plan documents to reflect the new election rules it wishes to apply. While the regulations are scheduled to expire in the year 2000 (as temporary regulations automatically lapse, by law, three years after their issuance), the IRS hopes to release further guidance and finalize the regulations before their expiration.

While the new cafeteria plan regulations provide plan sponsors with valuable guidance as to permissible mid-year election changes, the application of the "change in status" rules appears to be unduly restrictive in several respects as described above. In addition, there are a number of issues that are not addressed in the regulations. For example, the guidance does not address such matters as:

• the circumstances, if any, in which a mid-year election change may be permitted when an employer offers a new health coverage option during a plan year,
• the use of default or "negative" election procedures through which an employee’s existing election is continued in the absence of an affirmative election change made during open enrollment, and
• whether bona fide mistakes in making elections can be corrected during the year.

The new regulations also left untouched a number of matters addressed under the prior proposed regulations, such as the rules concerning permissible mid-year changes due to (a) a change in coverage obtained through the employee’s spouse, (b) a significant change in either employee cost or coverage and (c) an employee’s failure to pay premiums. For these matters, employers and plan administrators can continue to rely on the rules contained in the prior proposed regulations.