Your employee benefit plan might be hiding a problem. The payments made by your employees for optional insurance benefits might – without your knowledge – be used to subsidize or reduce your cost for other insurance benefits. If this problem is found during an audit by the Department of Labor (“DOL”), monetary penalties could be significant. DOL investigations are focused on fiduciary breaches and issues affecting the fair treatment of participants in the plans. Last year, about 65% of DOL investigations resulted in a monetary fine or other corrective action.
Many employers offer group life and disability insurance to their employees. Typically, there are two types or “lines” of coverage provided by the same life insurance company. “Basic Life” coverage is paid for entirely by the employer. “Optional Life” coverage is usually offered to employees and is paid entirely by employees through payroll deduction. Each of these lines should be priced separately by the insurance carrier and each type should be financially self-supporting. If these two lines are not priced appropriately, the plan fiduciary – usually the employer – could be responsible for violations of ERISA’s fiduciary and prohibited transactions rules.
These lines can be priced inappropriately and you may not be aware until a DOL audit reveals the problem. Here’s how it could happen. When you and your insurance broker are shopping to replace or renew your insurance coverage, the insurance companies reviewing your plan will look at the financial performance of each line. That is, premium received compared to claims paid. If the Basic Life incurs higher claims than expected, a premium increase would be justified. On the other hand, if the Optional Life coverage is running better than expected, a premium decrease would be called for. However, the broker and insurance company know that you – the employer – are making the decision of who to select to provide the coverage and they know that you are paying the entire cost of the Basic Life. On the other hand, the cost of the Optional Life insurance is spread out among all of your employees. To make their product more attractive, the broker and insurance company may look to reduce the cost of the poor-performing Basic Life by subsidizing it with the excess premium in the Optional Life. This is commonly called “cost shifting,” subsidization, or “whole case underwriting.” By reducing the cost of the Basic Life, the broker and insurance company know that you are more likely to select them to provide the coverage.
The problem with this scenario is that your employees pay for the Optional Life coverage and their premium payments are being used to reduce your cost for the Basic Life coverage. This violates ERISA’s “Exclusive Benefit” and “Solely in the Interest” rules. The “Exclusive Benefit” rule requires that plan assets must be used for the “exclusive purpose” of providing benefits and paying expenses. The “Solely in the Interest” rule requires that the plan fiduciary carry out its duties prudently and “solely in the interest” of plan participants. An employer is acting as a fiduciary when it negotiates rates and selects an insurance carrier. If an employer chooses a carrier that uses employee money to reduce its cost for other benefits, it is violating its fiduciary duty. An employer could also be violating ERISA rules against self-dealing and receiving kickbacks. There could also be implications for how these benefits are taxed to employees.
It is crucial that employers make benefit plan decisions with awareness of this potential problem. You could have problems in a DOL audit even if you were unaware that employee money was shifted to reduce your cost. If you believe that this occurred in your benefit plan or if you are concerned that it might have, give us a call.