Many insurance companies spend a substantial portion of consumers’ premium dollars on administrative costs and profits, including executive salaries, overhead, and marketing.

The Affordable Care Act requires health insurance issuers to submit data on the proportion of premium revenues spent on clinical services and quality improvement, also known as the Medical Loss Ratio (MLR). It also requires them to issue rebates to enrollees if this percentage does not meet minimum standards. The Affordable Care Act requires insurance companies to spend at least 80% or 85% of premium dollars on medical care, with the rate review provisions imposing tighter limits on health insurance rate increases. If an issuer fails to meet the applicable MLR standard in any given year, as of 2012, the issuer is required to provide a rebate to its customers.

The checks (rebates) typically raise many questions for employers from management and from rank and file such as:

  • How much (if any at all) of the MLR rebate check must be divided among plan members?
  • How soon must I distribute the employee’s who participates share?
  • What ways can we distribute the member’s share?
  • Are there tax consequences for funds received?

How much of the rebate must be distributed to plan members:

  • Plan sponsors must first determine total participant contributions for the year used to calculate the MLR rebate. Current rebates are based on premiums paid to the carrier for calendar year 2013.
  • The plan sponsor should then calculate the percentage of total plan premiums paid to the carrier due to participant contributions. This includes employee payroll deductions, COBRA premiums paid by participants, premiums paid by participants during an FMLA leave, and any other premium payment made by a participant. The resulting ratio is then applied to the rebate to determine the portion of the rebate that must be distributed to plan participants.


  • Total group health plan premiums paid to a carrier for a plan with 100 covered employees during 2013 = $1,000,000.
  • Total employee payroll deductions during 2013 plus COBRA premium payments received by the employer = $250,000 (i.e. participants paid 25% of the total plan premiums for the year).
  • The employer receives a $15,000 rebate from the carrier.
  • In this example, a total of $3,750 must be returned to participants (25% of the $15,000).
  • The participant portion of the rebate, in this case, would amount to an average of $37.50 per employee.

How quickly must I distribute the participant’s share?

As established above, ERISA plan assets must generally be held in trust; however, due to DOL guidance released a number of years ago, most employer-sponsored group health plans are not required to maintain trusts. Fortunately, according to DOL guidance, employers are not required to hold the rebates in trust as long as they are distributed to participants within three months of receipt by the plan sponsor.

What options do we have in distributing the employees’ share of the MLR rebate?

As Employers (plan sponsors) develop an allocation method, lots of questions are sure to arise. Should participants who are not required to contribute to the plan (e.g., employer-provided, employee-only coverage) share in the rebate? Should participants with family coverage receive a larger rebate than participants with employee-only coverage? Should participants in a high option receive more than participants who elected the low option?

Fortunately, the distribution allocation method is not required to exactly reflect the premium activity of individual plan participants.  DOL guidance states, “In deciding on an allocation method, the plan fiduciary may properly weigh the costs to the plan and the ultimate plan benefit as well as the competing interests of participants or classes of participants provided such method is reasonable, fair and objective.”

As a result, in many situations, the fairest, reasonable and objective method of allocation may be as easy as dividing the rebate evenly over all current participants in the plan, even if those participants made different employee contributions to the plan.

Once the allocation method is determined, the next step is to decide exactly how the rebate is to be distributed. There are, of course, tax implications for all three alternatives, as will be addressed in the next section. The three most obvious methods of distributing the participants’ share of the rebate are:

  1. To return the rebate to the participant as a cash payment,
  2. To apply the rebate as a reduction of future participant contributions (a so-called “premium holiday”), or
  3. To apply the rebate toward the cost of benefit enhancements.

Each option has its own advantages and disadvantages, but the third option (benefit enhancement) is viewed by many as being the least favorable due to the complexity of making a benefit change (for what will normally be a very small “per participant” amount), and the increased cost to the plan in future years when a rebate may not be available.

Based on the historic response of plan sponsors a number of years ago when rebates were provided during the process of insurance company demutualization, it is expected that premium holidays and return of the rebate through a bonus or compensation adjustment will be the most common distribution methodologies.

What are the tax consequences of the various distribution options that are available?

The Internal Revenue Service (IRS) published a set of Frequently Asked Questions (FAQs) related to the tax treatment of various forms of MLR rebate distribution. According to the IRS guidance, if participant contributions were made on a pre-tax basis, the rebate portion returned to the participant as cash or a premium holiday must be treated as taxable income. On the other hand, for contributions made on an after-tax basis, the rebate will not be taxable.

Pre-Tax Participant Contributions (Rebate limited to individuals who participated in the plan in both the current and the prior year):

  • If the rebate is distributed as cash, it will be taxable due to the participants’ income increasing by the amount of the rebate.
  • If the rebate is distributed as a reduction in current-year contributions, it will be “effectively” taxable; since the amount of the participants’ pre-tax contribution toward current year benefits will decrease, their taxable income will increase by a like amount.

Pre-Tax Participant Contributions (Rebate distributed to all current-year participants even if they did not participate in the prior year):

  • For that segment of the current year, covered population who were participants in the prior year, the rebate is taxable for the same reasons as described immediately above.
  • For employees who were not participants in the prior year, if the rebate is distributed as cash, it will be taxable due to an increase in the participants’ income.
  • For employees who were not participants in the prior year, if the rebate is distributed as a reduction in current year contributions, it will be “effectively” taxable by virtue of the fact that current year pre-tax contributions will decrease, thereby leaving more of the participants’ income as taxable.


Employers should be aware that while employers are not required to send a specific notice regarding the rebate to employees, insurance carriers are required to send notices of rebates to participants. The notices sent by carriers will not include the amount of the rebate but will state that the rebate was sent to the employer and that a portion may be distributed to participants.  This in itself raises the issue of members coming to the Employer asking for their share – so employer need be ready to answer the above (How much? How soon?  How will I get it?)  

Employers receiving a rebate may want to consider sending an employee communication that clarifies whether, and how, employees can expect to receive their portion of the rebate. Employers may also want to point out that the rebates are typically relatively small amount on a per-participant basis. Employees may (in most cases) incorrectly assume that they will be receiving a significant rebate based on only the information included in the carrier notices.

While every effort has been taken in compiling this information to ensure that its contents are totally accurate, neither the publisher nor the author can accept liability for any inaccuracies or changed circumstances of any information herein or for the consequences of any reliance placed upon it. This publication is distributed on the understanding that the publisher is not engaged in rendering legal, accounting advice or services. 

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