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Rebate from Medical Loss Ratios

Getting a Rebate from Medical Loss Ratios

Rebate from Medical Loss RatiosUsually, health insurance premiums are a one-way street; you pay them to the insurance company. But the insurance company may pay you—because of the rule on medical loss ratios (MLRs). It’s estimated that rebates paid to group health plan sponsors in 2021 disbursed in the Fall for the 2020 policy year are about $618 million. Additional amounts totaling $1.5 billion are payable to those enrolled in the individual market. Depending upon what you paid, the rebate may represent a nice infusion of cash for your business.

What is the medical loss ratio rule and how do you treat any rebate you receive from a tax perspective?

Medical loss ratios

The Affordable Care Act (ACA) requires health insurance companies to pay out 80% of their premiums in the small group market only for medical claims and expenses that improve health care quality (e.g., activities to reduce medical errors). The balance may be used for administrative costs and profits. If less than 80% is spent on allowable items, a portion of premiums must be rebated. These rebates result from the medical loss ratios (MLR).

Rebates paid in 2021 to plan sponsors with group health plans in 2020 are figured on the average loss ratio for the 3 prior years (2020, 2019, and 2018). Experts say that during 2020, with the pandemic, there was a significant drop in the utilization of health services. Elective surgeries were suspended for some time in various locations, people didn’t get usual (non-COVID-19) vaccinations, and many just didn’t go to doctors for complaints for which they usually would seek medical advice. These factors combined to boost rebates.

The DOL has guidance detailing general information about rebates from medical loss ratios. This guidance dictates whether employers are required to disburse the rebates to employees. For example, if an employer paid 100% of the premiums, the rebate may be retained by the employer. If employees paid all the premiums, the entire rebate is a plan asset which must be handled accordingly (i.e., distributed to employees, used to reduce their premiums, etc.). This must be done within 3 months of receipt.

Tax treatment of rebates

The IRS has FAQs on how to treat rebates from a tax perspective. They detail how an employer should handle rebates, which depends on whether and to what extent premiums were paid by the employer or the employee (on a pre-tax or after-tax basis). The following examples adapted from the FAQs explain how to treat the rebates for tax purposes.

Example 1

In 2020, an employee in his employer’s group health plan pays 40% of the premiums on an after-tax basis; the employer pays 60%. In 2021, the employer receives a rebate in the form of a reduction in premiums for the current year. Here, 40% of the rebate reduces the employee’s premiums for 2021 while 60% reduces the employer’s premiums. The employee’s rebate is not taxable; it’s treated as a purchase price reduction. From the employer perspective, the rebate is not subject to employment taxes. The employer reports its share of the rebate as taxable income (the premium was deducted in the prior year).

Example 2

Same as above except the rebate is paid in cash. The results are the same. There’s no income to the employee and the rebate is not subject to employment taxes. The employer reports its share of the rebate as taxable income (the premium was deducted in the prior year).

Example 3

Same as Examples 1 and 2 except the employee paid his share of premiums on a pre-tax basis (e.g., through a company cafeteria plan). In this instance, the rebate is treated as additional compensation to the employee reported on Form W-2 and is subject to employment taxes. The employer reports its share of the rebate as taxable income (remember, the premium was deducted in the prior year).

Final thought

The MLR may seem to come out of the blue and could be a cash break for employers. But following the rules from the DOL and IRS are essential so that you properly handle any rebates received this year. If you’re curious about MLRs, the National Association of Insurance Commissioners (NAIC) has more details.