September 1997 Vol. II, No.1
ERISA, EMPLOYEE BENEFITS AND EXECUTIVE COMPENSATION NEWSLETTER

This past year has been busy indeed with respect to numerous legal changes brought about by recently enacted legislation such as the Health Insurance Portability an Accountability Act of 1996 and the Taxpayer Relief Act of 1997 and pronouncements by both the Internal Revenue Service and the Department of Labor. For the benefit of our clients and business associates, this newsletter summarizes the highlights of these important changes in the employee benefits area. The newsletter is not intended, and cannot be considered to constitute, specific legal advice, as each individual circumstance is unique. However, we are prepared to assist our clients and business associates in reviewing their employee benefit programs and in making any necessary or desirable revisions to take into account changes in the law. It should be noted that many of the new rules will require amendments to tax-qualified plans.

In the event you desire legal advice or consultation or wish to discuss the appropriate timing of necessary plan amendments, please feel free to contact Attorney Marcia S. Wagner.

TABLE OF CONTENTS

 I. INVESTMENT ADVICE

II. TAXPAYER RELIEF ACT OF 1997

A. Plan Amendments

B. Qualified Plans

C. 401(k) Plans

D. Defined Benefit Plans

E. ESOPs

F. Permanent Exemption from Nondiscrimination Rules for State and local Governments

G. Annuities from Contributory Plans

H. Other Provisions

I. Individual Retirement Accounts ("IRAs")

III. BALANCED BUDGET ACT OF 1997

IV. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY OF 1996

A. Summary

B. Background

C. Preexisting Condition Limitations

D. Creditable Coverage

E. HMO Affiliation Periods

F. Certification Requirements

G. Special Enrollment Periods

H. Nondiscrimination Rules

I. Good Faith Compliance

J. Guaranteed Availability and Renewability    Provisions

K. Disclosure Requirements

L. Mental Health Parity Act

M. Newborns' and Mothers' Health Protection Act

 V. MISCELLANEOUS

A. Plan Amendments Required by Small Business Job Protection Act of 1996 ("SBJPA")

B. Plan Amendments for Tax-Exempt Organizations for Tax Reform Act of 1986

C. PBGC Expands Premium Audit Program

D. Qualified Medical Child Support Orders

E. Microsoft Case

F. IRS Rules on Exempt Hospital Physician Recruitment Agreement

G. Mandatory Age 70-1/2 Distributions

H. DOL Issues Opinions on Mutual Fund     Alliances

 

"Very frivolous. Do You know the penalty for being frivolous?"

Wall Street Journal
   

I. INVESTMENT ADVICE

Marcia S. Wagner, Esq. & Associates, P.C. is pleased to announce that it has been instrumental in developing a revolutionary product for Trust Company of the West ("TCW"), whereby investment advice will be rendered to 401(k) plan participants for purposes of determining in which commingled trusts (comprised of TCW's Galileo mutual funds) plan participants should invest. This investment advice is intended to take into account a participant's risk tolerance, time horizon, savings, etc. TCW will receive fees from its management of the Galileo funds, but expects to avoid the ERISA rules prohibiting self-dealing, which could result from recommending its own funds and receiving fees from managing those funds, by hiring independent financial experts to render the investment advice. It is expected that an exemption from the prohibited transaction rules will be issued in the near future by the Department of Labor in favor of TCW.

The implications of the arrangement are significant and far reaching: plan participants will receive the investment advice they so desperately need in order to select appropriate investments for retirement. Studies have shown that merely "educating" participants concerning their investment options is of limited value, with most plan participants selecting overly-conservative investments, thereby minimizing their retirement nest egg in an era in which Social Security benefits may be significantly limited. Moreover, with TCW affirmatively placing itself in the position of a fiduciary with respect to investment advice, the fiduciary liability of plan sponsors is, in effect, transferred to TCW, thereby limiting the plan sponsor's liability or exposure.

The TCW arrangement has generated significant interest in the ERISA industry, and favorable articles from the Wall Street Journal and Pensions & Investment Age are included below.

II. TAXPAYER RELIEF ACT OF 1997

A package of tax and pension changes, referred to as the Taxpayer Relief Act of 1997 (the "Act"), was signed by President Clinton on August 5. The Act, which consists of the tax provisions of the budget reconciliation package, is the result of months of negotiation between Congress and the White House.

Overall, the pension provisions of the Act are positive. In particular, the elimination of the 15% excise tax on excess distributions, the permanent moratorium on nondiscrimination testing for governmental plans, and the matching contribution provision for self-employed persons, benefit a broad range of employers and participants. Many of the other provisions of the Act case or simplify current administration of pension plans.

A. Plan Amendments

Plan amendments required by the Act must be made by the first day of the first plan year beginning on or after January 1, 1999 (January 1, 2001 for governmental plans)

B.Qualified Plans

1. Cash-Out of Accrued Benefits - Currently, employers may distribute a terminated employee's vested accrued pension benefit without the employee's consent if the present value of the employce's accrued benefit does not exceed $3,500. Effective for plan years beginning after August 5, 1997, the Act raises the limit for involuntarily cashing out accrued benefits to $5,000 (this amount is not indexed for inflation).

2. Repeal of Excess Distribution Tax - A 15% excise tax has been imposed on excess distributions from tax-favored plans (eg., qualified pension plans, 403(b) plans, IRAs) as well as a 15% additional estate tax on the excess accumulations in these plans remaining at death. The Small Business Job Protection Act of 1996 suspended the 15% excise tax for excess distributions received in 1997, 1998, and 1999. The Act repeals the 15% excise tax altogether, effective for payments received after December 31, 1996 and repeals the 15% additional estate tax on excess accumulations, effective for decedents dying after December 31, 1996.

Comment: We applaud the elimination of the perverse 15% "success tax" on excess pension distributions that exceed arbitrary limits, as we have always viewed this tax as a trap for unsuspecting middle-income retirees who have managed to save and invest successfully for retirement.

Recommendation: Individuals who tailored their financial and estate plans with a goal of minimizing the effect of these two taxes should reexamine their plans. For example, a spouse may have been named as beneficiary so that, following the death of the owner of the retirement benefits, the spouse could make a special election to defer the taxes. If you are in this situation, you may wish to consider designating one or more children as beneficiaries, thereby potentially lengthening the period of tax deferral for the entire family.

3. Plans Accepting Rollover Contributions - Current Treasury regulations protect a qualified retirement plan from disqualification for accepting invalid rollover contributions if the plan administrator reasonably concludes that the rollover is valid. The Act requires the Treasury Department to clarify that it is not necessary for a distributing plan to have a deten-nination letter in order for the plan administrator of the receiving plan to reasonably conclude that the contribution is a valid rollover. This provision is effective for rollover contributions made after December 31, 1997,

4. Assignment or Alienation of Benefits - Under ERISA, benefits payable from a qualified retirement plan are generally not assignable except in very limited circumstances (eg., to satisfy an IRS lien or a qualified domestic relations order). The Act permits a participant's benefit to be reduced to satisfy the liabilities of the participant to the participant's plan due to: (i) the participant's conviction for a crime involving the plan; (ii) a civil judgment (or consent order or decree) entered by a court in an action brought against the participant in connection with a violation of the fiduciary provisions of ERISA; or (iii) a settlement agreement between the Department of Labor or the Pension Benefit Guaranty Corporation and the participant in connection with a violation of the fiduciary provisions of ERISA.

However, if the participant is married, spousal consent would be required for the offset, unless (1) the spouse is also liable to the plan, or (ii) the order, judgment, or decree provides for a 50% survivor annuity.

This provision is effective for judgments, orders, decrees or settlement agreements issued on or after August 5, 1997.

5. Increase in Tax on Prohibited Transactions - A two-tier excise tax is imposed on certain prohibited transactions (such as self-dealing) between pension plans and related parties. The initial level tax is equal to 10% of the amount involved. Effective for prohibited transactions occurring after August 5, 1997, the initial level tax is increased to 15%. No other changes are made to the prohibited transaction rules; therefore, the 100% excise tax continues to apply if the prohibited transaction is not corrected within the specified time limit.

6. Summary Plan Descriptions - Effective August 5, 1997, employers no longer are required to file Summary Plan Descriptions and Summary of Material Modifications with the Department of Labor. These documents now must be fumished to the Department of Labor only upon request, subject to a penalty of $100 per day (maximum $1,000 per request) for failure to comply with such a request.

7. New Technologies in Retirement Plans - The Act requires the Treasury Department and the Department of Labor to issue guidance on the use of new technology (e.g., voice response systems, computers, e-mail) for various retirement plan purposes, such as notification, election consent, recordkeeping, and disclosure requirements. This guidance, which is to be issued by December 31, 1998, must clarify the extent to which paperless transactions may be permitted.

Recommendation: Until such guidance is issued, it is our recommendation that significant plan administration events, such as hardship withdrawals, loan applications, distribution requests, be undertaken pursuant to written instruments.

C. 401(k) Plans

1. Diversification of 401(k) Investments - The Act amends ERISA to prohibit the mandatory investment of more than 10 percent of an employee's elective pre-tax section 401(k) deferrals in employer securities or employer real estate. There are a number of exceptions, such as investments made voluntarily by the employee, employee stock ownership plans ("ESOPs") and companies whose defined contribution plans are clearly not their main retirement plans (i.e., where the value of the individual account plan assets is less than 10 percent of the value of the defined benefit plan assets). This change is effective for plan years beginning after 1998. This change does not affect the investment of employer matching contributions.

2. Matching Contributions for Self-Employed - The Act provides that matching contributions to a 401(k) plan for a self-employed individual (eg., a partner or sole proprietor) are to be treated in the same manner as matching contributions made by an employer for an employee. Therefore, matching contributions made for self-employed individuals are not to be treated as elective contributions and are not subject to the $9,500 elective contribution limit. This provision is effective for years beginning after December 31, 1997 (December 31, 1996 for SIMPLE plans).

3. Modification of 10% Tax on Nondeductible Contributions - A 10% nondeductible excise tax is imposed on qualified plan contributions that exceed the deduction limits. This excise tax does not apply to nondeductible defined contribution plan contributions that do not exceed 6% of compensation in the year for which the contri 'bution is made. The Act adds an additional exception to the 10% excise tax on nondeductible contributions. The 10% excise tax does not apply to nondeductible defined contribution plan contributions to the extent they do not exceed the amount of the employer's matching contributions plus the elective deferral contributions to a 401(k) plan.

D. Defined Benefit Plans

The full funding limit for defined benefit plans (the lesser of the plan's accrued liability based on projected benefits or 150% of the plan's current accrued benefit liability) is liberalized in stages for plan years beginning after 1998. The 150% limit is increased to 155% for plan years beginning in 1999 or 2000; 160%, for 2001 or 2002; 165%, for 2003 or 2004; and 170% thereafter.

Amounts that cannot be contributed due to the current liability full funding limitation are to be amortized over 20 years, up from the current 10 years. In addition, amounts that could not be contributed because of the current liability full funding limitation and that have not been amortized as of the last day of the 1998 plan year are to be amortized over a period of 20 years less the number of years since the amortization base had been established. These changes to the full funding rules are effective for plan years beginning after December 31, 1998.

E. ESOPs

The Act provides that in computing unrelated business taxable income, an ESOP of an S corporation will not count items of income or loss with respect to employer securities held by the ESOP, effective for tax years beginning after 1997.

Also, for tax years beginning after 1997, the Act allows an ESOP sponsored by an S corporation to distribute cash rather than stock to plan participants. The Act also provides exceptions to the prohibited transaction rules to permit an ESOP sponsored by an S corporation to purchase stock from shareholder-employees.

F. Permanent Exemption from Nondiscrimination Rules for State and Local Governments

The Act provides that state and local governmental pension plans are exempt from nondiscrimination and minimum participation rules. This exemption is effective for taxable years beginning on or after August 5, 1997. Also, governmental plans are treated as satisfying the coverage and nondiscrimination rules for taxable years beginning before August 5, 1997.

G.Annuities from Contributory Plans

A provision added to Internal Revenue Code Section 72 by the Small Business Job Protection Act of 1996 specified how to determine the taxable portion of a monthly pension that is funded in part from after-tax employee contributions. The Act adds another table, to be used when pension payments will continue to a beneficiary (including a surviving spouse) after the retiree's death. This will ordinarily spread the non-taxable portion of the benefit over a longer period, resulting in higher income taxes on each monthly payment. The change is effective for pensions with annuity starting dates after December 31, 1997.

H. Other Provisions

I . Stock Based Compensation Plans - The Act reduces the capital gains tax rate to 20% for shares held more than 18 months and to 18% for shares acquired (or marked to market) in 2001 and held for more than five years. The current maximum capital gains tax rate of 28% will continue to apply to shares held more than one year but not more than 18 months.

Recommendation: Many employers will want to establish or redesign their stock based compensation plans (eg., ISO, NQSO, Section 423 plans) to enable employees to take advantage of these changes.

2. Educational Assistance Programs - The Act reinstates and extends the $5,250 exclusion for employer-provided educational reimbursements for expenses paid for courses beginning before June 1, 2000. However, the law does not reinstate the exclusion for graduate-level courses, which expired on May 31, 1997.

3. Employer-Provided Parking - The Act removes the stipulation in Internal Revenue Code Section 132 that amounts are excludable from an employee's income on account of qualified employer-provided parking only if the parking is provided in addition to, and not in lieu of, the employee's compensation. Therefore, if cash is offered in lieu of parking, the amount is included in income only if the employee chooses to receive the cash. This provision is effective for taxable years beginning after December 31, 1997.

4. Loss of Tax-Exempt Status for TIAA-CREF and Mutual of America - The Tax Refon-n Act of 1986 provided that organizations under Code Section 501(c)(3) or (4) would retain their tax-exempt status only if no substantial part of their activities consisted of providing commercial-type insurance. However, a grandfather provision was included in the law which allowed TIAA-CREF and Mutual of America to retain their tax-exempt status with respect to their pension business. Effective for taxable years after December 31, 1997, the new law eliminates the grandfather provision. Although no change to the tax treatment of individuals covered by Section 403(b) programs will occur, the earnings credited to those annuities and custodial accounts will be expected to decrease.

I. Individual Retirement Accounts ("IRAs")

I . Deductible IRAs - Certain individuals may deduct up to $2,000 of contributions to an IRA in a tax year. However, if the individual or his or her spouse is an active participant in a tax-qualified plan, the $2,000 is phased out for adjusted gross income ("AGI") above certain levels. The Act makes several changes to the rules concerning the phase-out or loss of deductibility.

The Act increases the AGI phase-out ranges for making deductible contributions to IRAs by active participants in an employer-sponsored retirement plan. In 1998, the phase-out range is $30,000 to $40,000 if the individual is single (up from $25,000 to $35,000 under the old rules), and $50,000 to $60,000 for joint filers (up from $40,000 to $50,000). In later years, the phase-out ranges are increased further.

In addition, an individual is no longer treated as an active participant in an employer-sponsored retirement plan merely because his or her spouse is a participant. However, the non-active-participant-spouse's IRA deduction begins to phase out at $150,000 of AGI and is lost completely at $160,000 of AGI.

2. Nondeductible ("Roth") IRAs - The Act adds a new nondeductible tax-free IRA, commonly referred to as the "Roth IRA". Qualified distributions (including earnings) from these IRAs are tax-free. A qualified distribution generally is a distribution made at least five years after the contribution was made, and that is made due to one of the following: (i) the individual's attainment of age 59.5; (11) the death of the individual; (11) the disability of the individual; or (iv) first-time homebuyer expenses for the individual.

There is an annual limit on contributions made to a Roth IRA of $2,000, which phases out for individual tax filers with AGI between $95,000 and $1 1 0,000 and joint filers with AGI between $150,000 and $160,000. The overall annual limit on contributions made to all IRAs (deductible and nondeductible) for a year may not exceed $2,000, excluding rollover contributions.

Contributions are permitted to be made to a Roth IRA for all individuals, including those who are age 70-1/2 or older. Also, the minimum required distribution rules of Internal Revenue Code Section 401(a)(9) do not apply to Roth IRAs.

An existing IRA can be converted (rolled over) to a Roth IRA for taxpayers with AGI of less than $100,000 (not counting this conversion amount). However, a conversion is unavailable for a married individual filing a separate return. If a conversion is made before January 1, 1999, the amounts that would have been included in income upon withdrawal (i.e., the earnings on the principal contribution(s) are included in income ratably over four years. The 10% early withdrawal tax will not apply to these conversions.

Recommendation: If an individual made nondeductible contributions to a pre- or non-Roth IRA, he or she should consider, if eligible and dependent upon his or her tax bracket, rolling the amount in the non-Roth IRA over to a Roth IRA. If the individual does so, he or she will be taxed only on amounts earned in the non-Roth IRA ratably over four years, and not on the amount of the nondeductible contributions. Eventual distributions (both earnings and principal) from the Roth IRA will be tax-free.

3. Exemption from Early Withdrawal Tax - The Act provides that withdrawals from any type of IRA before age 59.5 that are used for first-time homebuyer expenses or for qualified higher education expenses are exempt from the 10% early withdrawal tax.

4. Effective Date - These provisions relating to IRAs are effective for taxable years beginning after December 31, 1997.

III. BALANCED BUDGET ACT OF 1997

The Balanced Budget Act of 1997 made three significant changes in the rules for coordinating coverage under employer-funded health plans with Medicare (Medicare Secondary Payor - MSP) for people who have overlapping coverage.

First, when Medicare has paid first on a claim for which the plan should have been primary, the government has up to 30 months to ask for reimbursement from the plan. This extended deadline applies to payments for health care provided on or after August 5, 1997; for claims incurred before that date, the deadline for Medicare is the same as the deadline set by the plan for claims filed by participants and beneficiaries.

Second, the period during which employer plans are primary for people with end stage renal disease ("ESRD") is extended from 18 to 30 months. This extension applies to people with ESRD who are already in their first 18 month of Medicare eligibility, but only with regard to care provided on or after August 5, 1997.

Third, the Act makes clear that, when Medicare makes primary payment on claims for which it should have been secondary, it can collect the overpayments from the employee benefit plan's third-party administrator, unless the employer or plan is bankrupt or the third-party administrator is no longer providing services to the employer or plan. This applies to claims incurred on or after August 5, 1997.

IV. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996

A. Summary

Regulations to implement the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") were issued April 1 by the Departments of Health and Human Services, Labor and Treasury. Although not comprehensive, the regulations provide useful guidance on the new limitations on pre-existing condition limitations, certification requirements, nondiscrimination provisions, and guaranteed availability and renewability provisions. They also provide plan sponsors with the opportunity to furnish certain ERISA health plan documents to participants electronically.

B. Background

On August 21, 1996, President Clinton signed HIPAA into law. HIPAA provides for increased health coverage portability through restrictions on preexisting condition limitations, certification requirements for prior health coverage and special enrollment periods. It also provides rules for insurers with regard to guaranteed availability and renewability of health coverage. HIPAA also provides new disclosure requirements for health plans. The Departments of Health and Human Services, Labor and Treasury, which have joint responsibility for enforcing many of the HIPAA provisions, issued a set of interim final regulations on these provisions. These sets of regulations, which are substantially similar to one another, focus on the portability requirements.

A separate set of regulations issued by the Department of Labor provide guidance on complying with HIPAA's disclosure requirements, including disclosures for minimum maternity stay rights. Importantly, these regulations allow health plan sponsors under certain circumstances to make disclosures electronically.

C. Preexisting Condition Limitations

The regulations primarily deal with HIPAA provisions for which the Departments of Health and Human Services, Labor and Treasury have concurrent jurisdiction. These provisions deal primarily with preexisting condition limitations, special enrollment rights and the prohibition of discrimination based on health status, and are generally effective for plan years beginning after June 30, 1997.

HIPAA prohibits employer-sponsored health plans from imposing preexisting condition limitations that last more than 12 months from the enrollment date (18 months in the case of late enrollees). The regulations define the enrollment date as the first day of coverage or, if there is a waiting period, the first day of the waiting period.

The regulations also provide the requirements that a plan must meet in order to impose a preexisting condition limitation on a participant or beneficiary. A preexisting condition limitation may be imposed only with respect to a condition that was treated or diagnosed within the 6-month period that ends on the enrollment date and a preexisting condition limitation period must be reduced by any creditable coverage under a group health plan.

The regulations provide examples of the 12/18-month look-forward rule, the 6-month look-back rule, and what is meant by enrollment and late enrollment. They also discuss the inapplicability of the preexisting condition limitation rules for newborns and adopted children and for pregnancy.

The regulations further provide that no preexisting condition limitation may be imposed prior to notifying the participant or beneficiary of the terms and existence of the preexisting condition limitation. The notice must provide an explanation of the rights of the individual to demonstrate creditable coverage, including the right to request a certificate from a prior plan, and an offer of assistance in obtaining a certificate.

Recommendation: Plans with preexisting condition limitations should be reviewed to determine if any modifications are necessary to meet HIPAA requirements. Plan sponsors may also want to assess the effectiveness of preexisting condition limitations and consider modifying or eliminating these provisions in light of the new HIPAA requirements, particularly the rules for counting creditable coverage, discussed below.

D. Creditable Coverage

Under HIPAA, the plan sponsor maintaining a preexisting condition limitation revision must determine a new employ ee's creditable coverage in order to ascertain the length of the preexisting condition limitation period, if any, it may impose. Creditable coverage includes coverage under any prior group plan, individual health insurance policy, or other specified plan or arrangement (eg., state health benefits risk pool, Medicare).

The regulations provide that coverage consisting solely of specified coverages (e.g., accidental death and dismemberment, disability income, and workers' compensation) is not creditable coverage. Also excluded is "limited-scope" dental or vision coverage, which is defined as provided under a separate policy or contract and limited in scope to a narrow range or type of benefits that are generally excluded from hospital/medical/surgical benefit packages. The regulations provide two methods for counting creditable coverage.

Under the standard method, creditable coverage is determined by counting all days of coverage under a plan (or other creditable arrangement). Any days in a waiting period are not counted, nor are days before a significant break in coverage (i.e., a period of 63 consecutive days during which there is no creditable health coverage). For break in coverage purposes, the regulations specify that any days in a waiting period or affiliation period (i.e., for an HMO) are not counted.

Under the alternative method, the plan can determine creditable coverage based on categories of benefits specified in the regulations (eg., mental health, substance abuse treatment, prescription drug, dental and vision). Coverage under a medical flexible spending account does not count as coverage under any specific category. The use of the alternative method must also be stated prominently in the plan, as well as communicated to each enrollee at the time of enrollment. Under the alternative method, the plan counts all days of coverage within the categorv during the period of up to 365 days (546 days for a late enrollee) prior to enrollment (disregarding any significant break in coverage) and reduces the preexisting condition limitation applicable to that category by that number of days.

Recommendation: Plan sponsors that want to continue to use preexisting condition limitations should weigh the benefits of their use against the burdens of administering them. In particular, a plan sponsor attempting to use the alternative method will likely find that the certifications of creditable coverage it receives from other plans do not delineate coverage information by category. Thus, additional information would have to be requested, for which the other plan may charge a fee.

E. HMO Affiliation Periods

As an alternative to a preexisting condition limitation, an HMO may impose an affiliation period (waiting period) before coverage is provided. The regulations provide that an affiliation period may be used by an HMO only if. (i) no preexisting condition limitation is imposed; (ii) no premium is charged during the affiliation period; (iii) the affiliation period is applied uniformly; (iv) the affiliation period begins on the enrollment date and runs concurrently with any plan waiting period; and (v) the affiliation period does not exceed two months (three months for a late enrollee).

F. Certification Requirements

Under HIPAA, certifications of creditable coverage must be provided by a group health plan and/or issuer (eg., insurer) when an individual's coverage ends, the individual becomes eligible for COBRA, COBRA coverage ends or upon request by the individual within 24 months after coverage ends.

The regulations specify that duplicate certificates are not required; therefore, if the plan provides the certificate, the health insurance issuer is not so required, and vice versa. Also, if there is an agreement between the plan and the issuer that the issuer is to supply the certification, the plan will not be in violation of the certification requirements if the issuer falls to provide the proper certification.

Recommendation: Establishing procedures for issuing certificates is a compliance issue for all plan sponsors and will be one of the more difficult administrative aspects of HIPAA. Plan sponsors should consider whether to use the plan administrator, insurer or COBRA administrator for issuing certificates. The regulations provide that the certification generally must be in written form. However, under certain conditions (eg., at the request of the individual and by agreement with the receiving plan ) the certification may be provided in an alternate form (eg., by telephone).

The certificate must include the following information: (i) date of certificate; (11) name of plan; (iii) name, address and telephone number of issuer; (iv) name of employee and dependent and other identifying information; (v) telephone number for further information; (vi) statement of 18 months of coverage or beginning dates for waiting period and coverage; and (vii) date coverage ended. The regulations provide a model certificate that satisfies the HIPAA requirements.

The regulations provide examples of conditions under which an individual may provide certification (eg., when the plan/issuer has failed to timely do so). In this case, the individual must attest to the period of coverage, provide corroborating evidence of the coverage and cooperate with the plan's or issuer's efforts to verify the coverage.

The regulations require that a plan make reasonable efforts to determine information needed for a certification of dependent coverage. However, the plan or issuer is not required to issue the certificate until the plan or issuer knows (or should know) of the cessation of dependent coverage. Also, the regulations allow plan sponsors to collect data once a year to satisfy the dependent data collection requirements. There is a transition rule for certifying dependent coverage. Under the transition rule, a health plan that cannot provide dependents' names may, through June 30, 1998, provide a certificate using the participant's name and the type of coverage (e.g. employee only, family). The regulations also specify that an individual may certify dependent coverage by attesting to a period of such coverage, providing corroborating evidence and cooperating with the plan's or issuer's efforts to verify the dependent coverage.

Recommendation: Plan sponsors should start to implement procedures that will allow them to collect dependent coverage information once a year (e.g., during the annual open enrollment).

G. Special Enrollment Periods

Effective for plan years beginning after June 30, 1997, HIPAA mandates new enrollment rights under group health plans for employees and dependents in two situations. First, a plan must provide a special enrollment period to an individual who declined coverage when initially offered because he or she had other coverage and subsequently losses that coverage. Second, a plan must offer special enrollment rights when an individual becomes a dependent of an employee through marriage, birth or adoption.

A notice describing the special enrollment rights must be provided to anyone who declines coverage. The regulations provide a model notice to meet this requirement.

The regulations specify the requirements for individuals to be eligible for special enrollment upon the loss of other coverage. The individual must be otherwise eligible for the plan and must have declined coverage because of other coverage (COBRA or otherwise). COBRA coverage must be exhausted before a special enrollment may be requested. Special enrollment must be requested within 30 days of the individual's losing other coverage.

In the case of special enrollment on account of a new dependent (eg., birth or adoption of a child), the regulations clarify that all dependents, as well as the employee, are eligible for enrollment. For example, upon the birth of a child, the spouse is eligible for enrollment (and the employee, if not already enrolled) as well as the child. The special enrollment must be requested within 30 days of the event.

Recommendation: The special enrollment requirements mandate enrollment rights which most employers do not currently provide. Health benefit provisions in cafeteria and other Section 125 plan documents should be reviewed and updated to reflect the new requirements for plan years beginning after June 30, 1997.

H. Nondiscrimination Rules

The regulations provide guidance on the HIPAA prohibition of discrimination against participants and beneficiaries based on a health status related factor. For example, the regulations specify that there would be discrimination in eligibility if a plan provides that individuals who do not enroll during the first 30 days of eligibility would need a physical examination to later enroll.

The regulations provide that bona fide wellness programs (i.e., for health promotion and disease prevention) are not discriminatory. For example, a program that provides a discount for cholesterol management would be allowable. On the other hand, a program under which a discount will be granted to those who pass a cholesterol screening test is not a bona fide wellness program because it provides benefits on the basis of a health-related factor.

Recommendation: Plans that require evidence of insurability will likely have to be amended. Plans that include an actively-at-work requirement or wellness program should be reviewed to ensure that they comply with the HIPAA requirements.

I. Good Faith Compliance

Any violation of the group market provisions can subject the health plan or issuer to a fine of $100 per day per individual affected. Under HIPAA, employers that operate in good faith compliance will not be penalized for any violations before January 1, 1998. Operation in accordance with the regulations is deemed to constitute good faith compliance.

J. Guaranteed Availability and Renewability Provisions

The regulations issued by the Department of Health and Human Services also provided guidance on the availability and renewability provisions that apply to issuers of individual and small group coverage. Insurers must make available individual coverage with no preexisting condition limitations to eligible individuals. Eligible individuals are defined under the regulations as those with at least 18 months of creditable coverage (most recently under a group health plan), not eligible for other coverage (e.g.Medicare), and not covered under other insurance. Also, to be eligible, an individual must have elected and exhausted COBRA (or similar state law) coverage. Many states are expected to enact rules that exceed these federal minimums.

Recommendation: Plan sponsors should communicate information on these rights to individual coverage to plan participants. In particular, individuals should be informed that taking conversion coverage upon termination may negate their status as an "eligible individual" under the guaranteed availability rules for individual insurance.

K. Disclosure Requirements

The Department of Labor ("DOL") separately issued interim regulations that provide guidance on the HIPAA modifications to the ERISA disclosure requirements for group health plans. These changes relate to the content and timing of summary plan descriptions ("SPDs") and summary of material modifications ("SMMs"). The regulations also address the use of electronic media to fumish SPDs and SMMS.

1. SPDs - HIPAA amended ERISA to require that health plan SPDs include information on whether a health insurance issuer is responsible for the financing or administration of the plan. The interim DOL regulations provide that where this is the case, the SPD must include the name and address of the issuer, whether and to what extent benefits under the plan are guaranteed under a contract or policy of insurance issued by the issuer, and the nature of any service (i.e., payment of claims) provided by the issuer.

The regulations require SPDs to include the office of the DOL through which participants can seek assistance on their rights under HIPAA, and they amend the model statement of ERISA rights to include language to this effect. The regulations also contain a statement that should be added to SPDs to inform participants of their rights to minimum maternity stay coverage.

2. SMMs - The interim regulations include guidance for implementing the HIPAA change requiring a group health plan to furnish a SMM no later than 60 days after the adoption of a material reduction in covered services or benefits provided under a health plan, or at regular intervals of not more than 90 days. For example, the regulations provided that a SMM would not have to be provided in the case where a plan administrator regularly communicates to participants with regard to benefits through a company publication, union newspaper, etc., if furnished at least every 90 days.

The DOL indicates that whether a modification is material will depend on the facts and circumstances. The regulations specify that a material reduction is a modification that would be considered by the average plan participant to be an important reduction in covered services or benefits under the plan. Examples in the regulations include modifications that eliminate benefits, increase deductibles or copayments or reduce service areas under an HMO.

3 . Electronic Media - The regulations provide that health plans may provide SPDs and SMMs electronically if. (i) the administrator takes steps to ensure that the documents are received (eg., return receipts); (ii) the electronic documents have a style, form and content consistent with current DOL regulations; (iii) each participant receives notice apprising the participant of the document being transmitted electronically, the significance of the document and the participant's right to receive a paper copy; and (iv) the administrator provides a paper copy free of charge, on request. The regulations specify further that documents may be transmitted electronically only to participants who actually have the ability to access them and print them on paper.

4. Effective Dates - The new requirements for SPDs and SMMs are effective for plan years beginning after June 30, 1997. The required disclosures with regard to minimum maternity stays are effective for plan years beginning after December 31, 1997. Electronic disclosures may be made beginning June 1, 1997.

L. Mental Health Parity Act of 1996

The Mental Health Parity Act of 1996 amended ERISA to prohibit a group health plan (or coverage offered in connection with the plan) that provides both medical and surgical benefits and mental health benefits from imposing either aggregate lifetime limits or annual limits on mental health benefits unless the plan also imposes the limits on substantially all medical and surgical benefits. The law is effective for health plan years beginning on or after January 1, 1998, and thereafter for services furnished through September 29, 2001. If a plan does include such limits on medical and surgical benefits, it must either: (i) apply the same lifetime limit both to the medical and surgical benefits and to the mental health benefits and make no distinction between them; or (ii) not impose any lesser aggregate lifetime limit on mental health benefits. Small employer plans (50 or less employees) are exempted.

A plan is not required, however, either to (i) provide mental health benefits, or (ii) chan ge the terms and conditions (e.g., cost-sharing, limits oil days of coverage, or requirements regarding medical necessity) regarding the amount, duration, or scope of the benefits, except as required by the provisions concerning aggregate lifetime and annual limits.

Comment: If desired, a plan may counteract the effect of these new limits by increasing limits on outpatient visits and inpatient hospital days.

M. Newborns' and Mothers' Health Protection Act

Effective for group health plan years beginning on or after January 1, 1998, the Newborns' and Mothers' Health Protection Act of 1996 provides that no group health plan or health insurer offering hospitalization benefits in connection with childbirth may restrict the period of hospitalization after birth to less than 48 hours for a vaginal delivery and 96 hours for a cesarean delivery. There is an exception if the attending health care provider, in consultation with the mother, decides that an earlier discharge is appropriate. The Maternity Act also provides an assortment of restrictions on health plans and insurers designed to prevent them from circumventing the requirement, including prohibitions against: (i) denying the mother or child the right to enroll in or renew coverage under a plan, solely to avoid compliance; (ii) providing any monetary inducement to either mothers or health care providers to encourage acceptance of shorter hospital stays, or (iii) penalizing or limiting the reimbursement of a health care provider for complying with the requirements.

Group health plans and insurers are not restricted from imposing deductibles, copayments, or other cost sharing methods in connection with inpatient postpartum care.

The changes required by the Mental Health Parity Act and the Maternity Act must be reflected in all plan documents as of January 1, 1998.

V. MISCELLANEOUS

A. Plan Amendments Required By Small Business Job Protection Act of 1996 In our September 1996 Newsletter (Vol. 1, No. 1), we discussed the provisions of the Small Business Job Protection Act of 1996 that necessitate plan amendments. For additional copies of this Newsletter, please feel free to contact us. Initially, employers had only to the end of the 1997 plan year to make the requisite plan amendments. However, the IRS has recently announced that employers have until the end of the 1999 plan year to amend their plans for changes made by the Small Business Job Protection Act of 1996, the Retirement Protection Act of 1994, and the Uniformed Services Employment and Reemployment Rights Act of 1994.

While the IRS provides relief for allowing sponsors to amend their plans for changes made by these three laws, it does not change the time in which the plans must be in operational compliance with such laws.

B. Plan Amendments for Tax-Exempt Organizations for Tax Reform Act of 1986

The IRS has extended the date for application of certain nondiscrimination rules to qualified plans maintained by organizations that are tax-exempt under Section 501(a) of the Internal Revenue Code, such as 501 (c)(3) organizations. Specifically, the IRS extends the date for applying certain nondiscrimination regulations to qualified plans maintained by tax-exempt organizations until the end of the first plan year beginning on or after October 1, 1997. For plan years prior to the extended effective date, such plans must be operated in accordance with a reasonable, good faith interpretation of these regulations. The nondiscrimination rules contained in these regulations were originally enacted as part of the Tax Reform Act of 1986.

Thus, in the case of a plan maintained by a tax-exempt organization with a plan year commencing October I and ending September 30, amendments required to comply with the nondiscrimination regulations must now be made by September 30, 1998. In the case of a plan with a calendar plan year, these regulations are first effective for the 1998 plan year, and any amendments required to comply with these regulations for that year must be made by December 31, 1998.

C. PBGC Expands Premium Audit Program

In 1995, the Pension Benefit Guaranty Corporation ("PBGC") instituted a premium audit pilot program in which it audited the premiums paid by single employer defined benefit plans located in the eastern United States. Based on the success of that pi 'lot program, the PBGC is now expanding its premium audit program to include a nationwide selection of single employer defined benefit plans.

Under the premium audit program, the PBGC reviews premium filings, actuarial assumptions, and other information to determine whether the correct premiums have been paid for the past six plan years. Plans that have underpaid are billed for the unpaid amount along with interest and penalty charges.

Recommendation: Employers should be aware that the PBGC is stepping up its efforts to collect additional income through its premium audit program. Plans that are audited will have their premium filings scrutinized and, if found inaccurate, will face the possibility of owing substantial penalties.

D. Qualified Medical Child Support Orders

Employers should also be aware of one particular aspect of the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 ("Welfare Act"). Since 1993, administrators of group health plans have been required to honor qualified medical child support orders ("QMCSOs") issued by courts of competent jurisdiction. A QMCSO is a court judgment, decree or order, including a court approved settlement, that, in general, provides health benefits for a child of a group health plan participant. The Welfare Act amended ERISA to include as qualified medical child support orders, such orders issued through an administrative process established under state law that has the force and effect of law under applicable state law. Thus, plan administrators are required to honor QMCSOs issued by authorized state agencies, not just courts of competent jurisdiction.

E. Microsoft Case

The Ninth Circuit upheld an en banc court decision that workers classified by Microsoft as "freelancers" or "independent contractors" are entitled to participate in the company's 401 (k) plan and its employee stock purchase plan.

The employees signed employment contracts as "Independent contractors" even though they worked at Microsoft for years and performed the same work, for the same managers, as permanent employees. The Court rejected Microsoft's distinction between those freelancers paid by the accounts payable department, and regular employees paid by the payroll department as determining eligibility for employee benefits, because the court concluded that the only reason for paying the freelancers out of the accounts payable department was their mistaken classification as independent contractors rather than as common law employees. The contractual terms under which the freelancers waived employee benefits were, according to the Court, "simply results which hinge on the status determination itself," rather than separate freestanding agreements. Therefore, the workers did not give up or waive their rights to be treated like all other employees.

Comment: High-tech companies, which typically use large numbers of "independent contractors" in code and software design, will be particularly affected by the Microsoft case.

F. IRS Rules on Tax-Exempt Hospital Physician Recruitment Arrangements.

The IRS issued a revenue ruling illustrating four situations in which recruiting incentives offered to physicians by tax-exempt hospitals to join their staffs and provide medical services in the community do not violate the institutions' tax-exempt status. The ruling also illustrates a situation in which a hospital's tax-exempt status was compromised by a criminal violation of the Medicaid anti-kickback statute.

The first four situations, in which the recruitment incentives were found to be consistent with the hospital's tax-exempt status, involved a variety of incentives such as payment of moving expenses, signing bonuses, income guarantees, and payment of malpractice insurance. The common denominator of the first four situations is a need for physicians. The first three situations involve rural or inner-city physician-shortage areas. In the fourth situation, although the hospital was not located in an area with a shortage of physicians, it needed a radiologist to provide coverage for its radiology department. The IRS, in ruling that these recruitment incentives did not compromise the hospital's tax-exempt status, emphasized they were reasonably related to the need for physician services in the hospitals and community.

Comment: The IRS ruling emphasizes that the incentives were offered in accordance with guidelines established by the hospitals' boards of directors and approved by the board committee responsible for staff contracts.

In the fifth situation, the IRS ruled that a hospital's recruitment practices that involved knowing and willful substantial criminal violations of the Medicaid anti-kickback laws, were inconsistent with tax-exempt status. The recruitment practices violated the statute because the incentives constituted payments for referrals. The IRS held that if a recruitment practice is unlawful, it is inconsistent with charitable purposes.

G.Mandatory Age 70-1/2 Distributions

The Small Business Job Protection Act of 1996 amended Internal Revenue Code Section 401(a)(9) to eliminate the requirement that pension payouts commence by the April I" date after the year in which a participant attains age 70-1/2, even if the participant is still working. However, there has been substantial confusion over how this provision works in practice. In earlier guidance, the IRS had pointed out that the law provides plan sponsors with two choices: (i) continue paying benefits to all participants who attain age 70-1/2, or (ii) give those who are still working at that age a choice of whether or not to wait for retirement before beginning to receive a pension. The IRS did not, however, authorize plan sponsors to eliminate pre-retirement benefit payments across the board, since the IRS views the right of an employee to receive benefits without retiring as a protected payment option, and eliminating that option would violate the anti-cutback rule.

However, under the Internal Revenue Code, IRS may, by regulation, allow plans to delete payment options when the IRS determines that it is appropriate. In a recently proposed regulation, the IRS is offering to use that power to give plan sponsors the control over benefit payments for older employees that was not included in the law itself The proposal seeks to balance plan sponsors' concerns about administrative complexity against the concerns for older employees who may have been expecting to receive both their pensions and their pay for continued work, by protecting employees now nearing age 70-1/2 but allowing plan sponsors to adopt simpler procedures in the future.

Under the proposed regulation, plan amendments eliminating in-service retirement payments for older employees would be allowed, if the following conditions are met: (1) the right to receive a distribution at the required beginning date must be preserved for employees who attain age 70-1/2 by December 31, 1998; (ii) a plan amendment must be adopted by the last day of the 1999 plan year; and (iii) participants who retire after age 70-1/2 must be offered all of the choices among benefit payment forms that would have been available if they had retired at age 70-1/2. However, an example in the proposed regulation indicates that a plan could drop special payment forms that it had provided only for participants who were compelled to begin distributions before retirement.

In addition to the proposal for prospective relief for plan sponsors, the IRS provides a correction procedure for plans that changed their distribution rules prematurely. Recognizing that some plans may already have stopped making distributions to participants working past age 70-1/2, the IRS allows them to remedy that without penalty, either by reinstituting automatic payouts at the required beginning date or by offering affected participants a choice between current or delayed payments. In either case the correction must be retroactive and the payout must be made, or the election offered, by December 31, 1997.

Comment: It is important to note that age 70-1/2 distributions are still required for 5 percent owners and for terminated vested participants.

Recommendation: Before deciding to amend a plan to eliminate in-service distributions to employees over age 70-1/2, the plan sponsor should consider all of the ramifications. In particular, for defined benefit plans, the postponement of payments until an older employee retires may be complicated by the requirement that benefits be actuarially increased to compensate for the delay.

H. DOL Issues Opinions on Mutual Fund Alliances

The Department of Labor ("DOL") issued two advisory opinions regarding the receipt of fees by a financial institution from unrelated mutual funds in connection with investments in the mutual funds by pension plan clients of the financial institution.

Under ERISA, the "anti-kickback rule" provides that a fiduciary of a plan may not receive payments from any party dealing with that plan's assets in connection with a transaction involving the plan's assets.

Certain financial institutions have established "turn-key" arrangements for plan sponsors. Under this type of arrangement, financial institutions provide an array of (i) services, including trusteeship, custody and recordkeeping, and (ii) investment options, including mutual funds.

In addition to the receipt of fees from the plan sponsor, the financial institution sponsoring the arrangement will receive fees from the participating mutual funds. If the financial institution is a fiduciary of the client's plan, such as a trustee, the receipt of the fees from the mutual fund could be deemed a prohibited transaction in violation of the anti-kickback rule.

In the first DOL opinion, the receipt of fees by a bank trustee did not violate the anti-kickback rule where there was full disclosure of the terms of the bank's arrangements with the mutual funds and the fees received were used either to offset, dollar for dollar, the fees otherwise payable by the plan to the bank or were credited back to the plan by the bank. The DOL did not distinguish between situations in which the bank acted as a "full" trustee or as a "directed" trustee.

In the second DOL opinion, a life insurance company sponsored the arrangement. The insurer did not provide trustee services itself nor through a related entity; rather, custodial services were provided by an unrelated bank. In all other respects, the services are the same as in the first opinion. All fees payable to the insurer by the mutual funds were disclosed both in the mutual fund prospectuses and in the insurer's marketing materials. However, unlike the first opinion, the insurer retains all fees received from the mutual funds. The DOL ruled that in this type of relationship, the insurer's power to add or eliminate mutual funds would not cause the insurer to become a plan fiduciary, if the plan has the authority to accept or reject the changes after advance notice of any fee changes and a reasonable time to secure a new service provider if the plan so desires. Thus, since the insurer is not a fiduciary under these circumstances, the receipt of fees from the mutual funds is not a prohibited transaction.