An opt-out arrangement offered as part of a group health plan can provide significant advantages to employers. Through such an arrangement, employees who have alternative sources of coverage are incentivized to forego participation in the employer plan. In exchange for the waiver, the employee receives a (taxable) payment. However, recent developments – both regulatory and judicial – may undermine the effectiveness of opt-out arrangements in certain circumstances.

Affordability Determinations under the Affordable Care Act (ACA)

In July 2016, the IRS released proposed regulations that discuss the impact an employer’s opt-out arrangement can have on the affordability of the coverage offered under the plan. In sum, Applicable Large Employers (ALEs) are subject to the ACA’s employer mandate. The mandate requires employers to offer full-time employees coverage that meets its definition of affordability. While the determination of affordability generally includes only the monthly cost to the employee for coverage, the IRS will require the inclusion of certain opt-out payments made available, whether or not actually paid to any particular employee.

In order to avoid the inclusion of the amount of the opt-out payment, ALEs must ensure the following with respect to any opt-out arrangement offered:

  • The availability of the opt-out payment must be conditioned upon the employee providing reasonable evidence that he/she, along with any dependents, will have minimum essential coverage for the duration of the plan year;
  • The minimum essential coverage cannot be coverage obtained through the individual market;
  • The employee’s own attestation may be accepted as reasonable evidence;
  • Reasonable evidence of other coverage must be requested and provided by the employee on an annual basis; and
  • The failure to timely submit reasonable evidence of other coverage will result in no payment made to the employee under the opt-out arrangement.

Overtime Pay Calculations

Last year, the Ninth Circuit Court of Appeals issued a decision in Flores v. City of San Gabriel that requires employers to include the amount of opt-out payments actually received by an employee when calculating the employee’s regular rate of pay for purposes of overtime compensation. The Court’s decision was appealed to the U.S. Supreme Court, but review was not granted. Thus, the Ninth Circuit’s decision stands and applies to employers within its district, including California.

As a result of the Court’s decision, California employers that provide opt-out payments to non-exempt employees must factor in those payments when calculating the overtime pay due to the employee. Failure to include these payments could result in claims for back-pay. However, unlike the guidance on ACA affordability determinations, this decision applies only to employees who receive the opt-out payment, not merely those to whom it is offered.

Next Steps

Opt-out arrangements will continue to be an important feature of group health plans, but employers affected by these most recent developments should carefully review the benefits of any arrangement offered now or in the future. ALEs should amend the operation of their opt-out arrangement to comply with the criteria outlined by the IRS. Alternatively, an ALE that does not comply with the criteria should confirm that the coverage offered under its group plan remains affordable even after taking into account the monthly amounts available under the opt-out program. Finally, an employer that provides opt-out payments to any exempt employee needs to include payments actually provided when calculating overtime pay.