Crackdown on Fixed Indemnity Health Plans Alters Tax Treatment

The Biden administration is trying to crack down on perceived abuses by employers that offer fixed indemnity coverage with characteristics of comprehensive medical coverage, but its proposal looks headed for a fight with the insurance industry.

The proposed rule—issued by the Internal Revenue Service, and the Departments of Health and Human Services and Labor—would also restrict sales of short-term, limited-duration insurance, and would clarify the tax treatment of fixed benefit payments under employer-provided accident and health plans. Comments are due by Sept. 11.

The proposal is “trying to prohibit employers from trying to cobble together fixed indemnity coverage with some other minimum coverage” that doesn’t have to comply with Affordable Care Act mandates, Julia Zuckerman, vice president and senior consultant of employee benefits consulting firm Segal’s compliance practice, said in an interview.

The proposal would prevent employers from pairing fixed indemnity coverage with minimum essential, or “bare bones” plans such as preventive care-only plans, Zuckerman said.

Traditional fixed indemnity insurance pays a specific amount of cash, such as $100 per day for a hospital stay. The coverage is considered an excepted benefit—one not subject to Affordable Care Act mandates such as preventive care coverage requirements and prohibitions on lifetime and annual limits on essential health benefits. That’s because it’s paid without regard to the cost of the services, Zuckerman said.

The proposal appears aimed at stopping employers from offering fixed indemnity coverage that mimics comprehensive medical coverage by paying benefits based on services received but that doesn’t comply with ACA mandates, she said.

“The agencies have been seeing coverages that are characterized as fixed indemnity, but then pay on the basis of a doctor’s visit or lab work,” Zuckerman said.

The proposal would clarify that “if you’re offering fixed indemnity coverage, it has to be a fixed payment. It can’t be on a per-term or per-service basis,” she said. “That’s what medical coverage is. That’s not fixed indemnity coverage.”

Excepted Benefit Status

Plans that violate the terms of fixed indemnity plans would lose their classification as excepted benefits, Zuckerman said. Plans that lose excepted benefit classification would then be required to comply with group health plans requirements of the ACA, she said.

The proposal would also change the tax treatment of employer-provided fixed indemnity benefits, Christa Bierma, a principal in professional services organization EY’s national tax practice, said in an interview.

Sellers of fixed indemnity medical insurance are likely to oppose the proposal, which would would increase taxes on employment-based fixed indemnity coverage, Bierma said.

Taxpayers have relied on a 1969 IRS Revenue Ruling (69-154) that only payments that exceed their medical expenses are excluded from income for tax purposes, Bierma said.

Revenue rulings, which aren’t subject to notice and comment, don’t have the advantage of judicial deference in courts in the same manner that regulations traditionally have been accorded, she said.

“The point of contention is what if the amount that you’re getting doesn’t happen to be more than the expense, or you have an amount that is more than the expense. Do you lose the whole thing in terms of tax exclusion?” Bierma said.

If a policyholder was reimbursed more than the cost of a hospital stay, the question is whether they would be taxed on the full amount or would they only be taxed on the amount exceeding medical expenses, she said.

Full Reimbursement Would Be Taxable

The IRS is proposing that the full amount is taxable to employees “because it’s not a reimbursement” that’s excluded from employee income by section 105(b) of the tax code, Bierma said. “You would get the $100 either way,” she said.

“There will be a lack of consensus” on how fixed indemnity payments should be treated for tax purposes, Bierma said. “It is not going to be well taken.”

Aflac, a leading provider of fixed indemnity plans, said it is studying the proposal and isn’t in a position to comment on it yet.

American Council of Life Insurers president and CEO Susan Neely said in a statement that “Noncoordinated excepted benefits coverage, such as hospital or other fixed indemnity and specified disease insurance, supports household budgets when people face out-of-pocket expenses from illnesses or injuries that are not covered by traditional major medical insurance. These supplemental benefits are not a form of limited medical coverage and are therefore distinct from the other products, such as short-term limited duration insurance, discussed in the President’s proposal.”

Supplemental benefits “are highly valued by Americans who will demand that access to these products be maintained and supported,” Neely said.

The IRS issued chief counsel advice dated May 9 but released in June making similar clarifications to the tax treatment of wellness indemnity plan payments from employer-funded plans.