Benefits & Compensation Law Alert: Sample Article

Final Cafeteria Plan FMLA Regulations Include a Few Surprises
© By Sharon Cohen, Esq. (Watson Wyatt Worldwide), Ashley Gillihan, Esq., and John R. Hickman, Esq. (Alston & Bird, LLP). Excerpted from Benefits & Compensation Law Alert

About the Authors

Sharon Cohen is Health Care Counsel for Watson Wyatt Worldwide, an international benefits consulting firm. Advisory Board members John R. Hickman and Ashley Gillihan are attorneys with the Employee Benefits Practice Group of Alston & Bird, LLP, an Atlanta, New York, Charlotte, and Washington, D.C. law firm.

On October 17, the IRS issued final regulations regarding the effect of leaves of absence under the Family and Medical Leave Act of 1993 (FMLA) on cafeteria plan elections. The final regulations, which are effective for plan years beginning on or after January 1, 2002, replace the current proposed regulations that were issued in 1995. They also supplement the final change in status and cost or coverage change regulations recently issued.

Overview of the Final Regulations

The final regulations clarify and expand on the special FMLA election change rules set forth in the 1995 proposed cafeteria plan regulations. The final regulations provide employers with much needed clarification as well as more administrative flexibility when a participant in a cafeteria plan (including health flexible spending account (FSA) benefits) takes an FMLA leave of absence. Among other things, the final regulations confirm that employers can require reinstatement of coverage upon return from FMLA leave and require coverage continuation during a paid leave.

The final regulations do not amend or interpret the Department of Labor (DOL) FMLA regulations. Nevertheless, the preamble to the final regulations states that the final regulations are the result, at least in part, of discussions with the DOL. Thus, plan sponsors should take comfort in administering cafeteria plan benefits in accordance with the final regulations.

What's New in a Nutshell?

• Employer can continue coverage (but allow employees to discontinue contributions) for FMLA employees and recoup the employees' share of contributions upon return.
• Continuation may be required by employer during paid FMLA leave if required for paid non-FMLA leave.
• Employer can force returning FMLA employees to resume coverage (including health FSA coverage) if reinstatement is required for non-FMLA employees.
• Two options exist for health FSA coverage upon return from FMLA leave: reinstatement or pro-ration of coverage level.
• Open enrollment rights must be extended to FMLA employees.

Basic FMLA Requirements

FMLA has two basic requirements. First, employees taking an unpaid FMLA leave of absence are entitled to continue group health coverage (medical, dental, vision, and health FSAs) under the same terms and conditions as before the leave. If an employee continues coverage, the employer must continue to pay the employer's share of the required contribution and the employee must continue to pay the employee's share. Other (non-group health) benefits need not be continued unless they are continued for employees on non-FMLA leave. Second, employees whose coverage terminated during the leave (either for loss of eligibility, failure to pay premiums, or revocation) are entitled to have benefits reinstated upon return from the FMLA leave without restrictions.

In order to align the DOL's FMLA regulations and the cafeteria plan rules, the IRS issued proposed regulations in 1995. The 1995 proposed regulations entitle employees to revoke their group health coverage and to have it reinstated upon return from leave. Employees on FMLA leave can revoke non-health benefits to the same extent employees on non-FMLA leave can revoke non-health benefits under the cafeteria plan. If, however, benefits are continued during an unpaid leave, the final regulations (and the proposed regulations) permit the cafeteria plan to offer the following payment options during the unpaid FMLA leave (payments made during a paid leave must be made in the same manner as active employees, e.g., payroll deduction):

• Pre-pay. A cafeteria plan may allow employees to pay, on a pre-tax or after-tax basis, their share of the contributions required for coverage during the leave before the leave begins. The pre-pay method may not be mandated and it may not be the sole option offered to employees. However, employees on FMLA leave may be offered this method of payment even if this option is not offered to employees on non-FMLA unpaid leave. The proposed and final regulations clarify that an employee who chooses the pre-pay option may only pre-pay on a pre-tax basis through the end of the plan year in which the leave began. The employee must either pre-pay contributions due for coverage in another plan year on an after-tax basis or elect another option (either at the time the leave begins or during the open enrollment period).
• Pay-as-you-go. Employees may pay their share of the premiums on the same schedule as payments would be made if the employee was not on FMLA leave, or any other schedule permitted by the DOL's FMLA regulations (i.e., COBRA's schedule, employer's existing schedule for employees on unpaid leave, or a schedule agreed to voluntarily by the employer and employee). Generally, these contributions are made on an after-tax basis, but they may be made on a pre-tax basis from any taxable compensation received by the employee during the leave period. According to the DOL regulations, if an employee fails to pay during the leave, the employer is not obligated to continue coverage. As discussed below, under the final regulations, if the employer continues and pays for the coverage during leave, the employer may recoup the employee's share of those payments. Employers cannot offer only a choice between pre-pay and catch-up to the FMLA leave-takers.
• Catch-up. Under this option, the employer continues the coverage and pays the entire contribution (both employer and employee portion) during the leave. The employer recoups the employee's share of the contributions when the employee returns from leave on either an after-tax or pre-tax basis (the employer may, under certain circumstances, recoup the entire amount of health contributions if the employee fails to return to work at the end of the FMLA leave). Where an employee actively elects this option, the employer and the employee must agree that (1) the employee elects to continue health coverage while on unpaid FMLA leave; (2) the employer assumes responsibility for advancing payment of the premiums on the employee's behalf during the leave; and (3) the advanced amounts must be paid by the employee upon return from leave. The catch-up option can be the only payment option for employees on FMLA leave, if it is the only option for employees on non-FMLA unpaid leave. As discussed below, if an employee fails to make the required premium payment while on FMLA leave, the employer is permitted to use this catch-up option to recoup the employee's share of the premium when the employee returns even without prior agreement by the employee.

Key Changes in the Final Regulations

Conceptually, the final regulations are very similar to the proposed regulations with respect to scope of election changes and payment methods. There are, however, several significant changes and clarifications. While the rules discussed below literally apply only to group health coverage, we see no reason why similar concepts (relating to coverage continuation for a paid leave and required reinstatement) should not also apply to other benefits if required for employees on non-FMLA leave. Employers should review the employer's established policy or treatment of non-health benefits during non-FMLA leaves with legal counsel to determine the appropriate treatment during FMLA leave.

Employer can continue coverage (but allow employees to discontinue contributions) for FMLA employees and recoup payments. As we stated above, employees taking FMLA leave are entitled to continuation of health coverage (and non-health coverage if continued during non-FMLA leave). Prior to the final regulations, employees taking FMLA could revoke their coverage in lieu of continuing coverage. With regard to coverage revocation, the final regulations clarify and expand the options an employer must allow upon commencement of an unpaid FMLA leave. As an initial matter, employers must enable employees on FMLA leave to make the same election changes as employees on non-FMLA leave. Also, employers must allow one of the following options:

• Option 1: Revoke Coverage. Under this option, employees may choose to revoke health coverage instead of continuing their coverage. If the FMLA employee elects to revoke coverage, coverage can cease (subject to the FMLA reinstatement right). For those that continue coverage, the final regulations provide basically the same payment options for someone who continues coverage that the proposed regulations provide (i.e., pre-pay, pay-as-you-go, and catch-up options as summarized above).
• Option 2: The employer may require that health coverage continue but allow the employee to discontinue contributions. If the employer requires that coverage continue, but the FMLA employee elects to discontinue contributions, the employer can continue coverage by paying the employer and the employee's share of the contributions. The employer may recoup the employee's share of contributions when the participant returns from leave. The significance of this option is that it confirms that employers may continue coverage and subsequently recoup the employee's contributions upon return from leave. For non-health benefits similar rules presumably apply to FMLA leave if required for non-FMLA leave.

Continuation of coverage may be required by employer during paid FMLA leave if required for other leaves. The final regulations clarify that employers may require employees taking a paid FMLA leave to continue benefits during the leave. This would also apply to employees who are taking paid leave concurrently with their FMLA leave. In the preamble, the IRS further clarifies that the employer may force continuation of coverage during paid FMLA leave if and only if the employer requires continuation of benefits during a comparable non-FMLA paid leave. This is an important clarification for plan sponsors that refuse to allow election changes during a paid leave.

Practical Tip: Employers should review their paid non-FMLA leave policies to determine how employees on paid FMLA leave may be treated.

Returning FMLA employees can be forced to resume coverage if required for non-FMLA employees. The final regulations reverse the IRS position in the proposed regulations and provide that an employer may mandate reinstatement of coverage upon return from an FMLA leave but only if the employer requires reinstatement of coverage upon return from a non-FMLA leave of absence.

Practical Tip: Many plans only reinstate a participant's cafeteria plan election if the employee returns from a non-FMLA leave within 30 days after the leave began and allow employees to make new elections if they return more than 30 days after the non-FMLA leave began. Thus, a plan with the same rules could not forcibly reinstate a participant's cafeteria plan election if the employee returned more than 30 days after the FMLA leave began.

Two options exist for health FSA coverage upon return from FMLA leave: reinstatement or pro-ration of coverage level. If a health FSA participant revokes coverage or chooses the "pay-as-you-go" option and then fails to pay a required contribution, what is the coverage level upon return? Under the final regulation, the health FSA participant now has two coverage options upon return from FMLA leave: pro-rated coverage based on the missed contributions (as under the proposed regulation); and reinstatement of the original coverage level.

• Option 1: Proration. The employee may elect to reinstate a level of coverage that is reduced by the amount of contributions missed during the leave, at the original contribution amount. For example, assume that Employee A elected $1,200 for the plan year and paid $100 for such coverage. On April 1, after submitting no claims for reimbursement, Employee A begins a three-month FMLA leave of absence. Employee A does not elect to continue coverage and the employer does not continue it on Employee A's behalf. When Employee A returns July 1, the employee may elect to have $900 reinstated ($1,200-$300 in missed contributions) at a cost of $100 per month for the remainder of the year.
• Option 2: Reinstatement. The employee may elect to reinstate the level of coverage in effect when the leave began provided that the employee pays the missed contributions. Assume the same facts described in Option 1; however, Employee A elects this Option 2. Under Option 2, Employee A would have $1,200 in annual reimbursement at a cost of $150 per month ($100 original premium plus the $300 prorated over the remaining months).

Under either option, it appears that there is a single period of coverage (with an aggregate coverage limit before and after the leave). However, under either option (and notwithstanding the ability to continue the level of coverage in effect at the time the leave began under Option 2), expenses incurred during the period that the health FSA was not in force are not eligible for reimbursement.

"Catch-up" principles may be invoked for failure to make contributions. If an employee chooses the "pay-as-you-go" option and then fails to pay a required contribution, the employer may continue such coverage on behalf of the employee and then recoup the missed contributions when the employee returns from leave. Previously, the catch-up option was conditioned on an advance agreement between the employer and employee.

Annual enrollment privileges. The final regulations clarify that employees on FMLA leave must be able to participate in annual enrollment if active employees are permitted to participate in annual enrollment.

Practical Tip: Plan administrators should provide employees and participants on FMLA leave with enrollment materials and permit employees to enroll provided they would otherwise be eligible.

What Employers Should Do Before January 1, 2002

Employers/plan sponsors should compare the terms of their cafeteria and health FSA plans to the changes and clarifications set forth in the final regulations. Employers/plan sponsors should also identify the terms of their unpaid and paid non-FMLA leave policies so that they can determine their rights and responsibilities under the cafeteria plan when an employee takes FMLA leave. Amendments changing the terms of the cafeteria plan to comply with the final regulations should be completed prior to the first plan year beginning on or after January 1, 2002.

Note: This article is provided as general guidance on the subjects covered and is not provided as legal advice. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation.

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This article is an excerpt from Benefits & Compensation Law Alert. Benefits and Compensation Law Alert is designed to provide accurate and authoritative information in regard to the subject matter covered. It is published with the understanding that neither the author(s) nor its publisher is engaged in rendering legal, accounting, or other professional services through its pages. If legal advice or other expert assistance is required, the services of a competent professional should be sought. (From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a committee of Publishers and Associations.)