Advisory Opinion 1977-92

Dear :

This is in response to your letters in which you inquire whether the payment of premiums for health insurance coverage pursuant to a certain arrangement between (named) Insurance Company (the Insurance Company) and an employer/policyholder (employer) would involve a prohibited transaction under the Employee Retirement Income Security Act of 1974 (the Act). We regret the delay in responding to your request.

You represent that under normal group health insurance funding methods, a claim reserve for incurred but unpaid claims is accumulated by an insurance company from premium payments made by the employer. This reserve, which normally amounts to 20 percent to 30 percent of the annual premium of the particular group health insurance plan, is carried as a liability on the balance sheet of the insurance company insuring the group and is subject to audit and review by state insurance departments.

An alternative to this conventional manner of paying premiums is a method under which the Insurance Company accepts a demand promissory note, secured by an irrevocable letter of credit purchased from a major commercial bank, in lieu of cash for that part of the first year premium payment that is equal to the amount of the claim reserve. As a result, the employer can retain the cash representing the claim reserve for use in his business.

This alternative means of paying premiums is available only to single employers and employers who may have the employees of one or more subsidiaries insured under the same policy. It is not offered to multiemployer plans as defined in section 3(37) of the Act. In about 50 percent of the cases eligible for this arrangement, the employer pays the entire premium cost; in the remaining cases, employee contributions represent from 20 to 30 percent of the premium cost. This arrangement does not alter the terms of the group health insurance policy or the obligations of the insurer under such policy, and has no effect upon the types of health insurance benefits the Insurance Company offers to employers for their employees. Regardless of the method of premium payment used by an employer, each such employer is eligible to purchase the same benefits as any other employer for a group comprised of the same type of underwriting risk. If the employer defaults on the payment of premiums, any claim for benefits incurred while the policy was in force would be honored by the Insurance Company.

On the basis of the information provided, it is our opinion that in those cases where an employer makes premium payments for a health insurance policy for its employees solely with employer contributions from the general assets of the employer, the premium payments by the employer would not be considered plan assets. As a result, a method of paying part of such payments with a demand promissory note secured by an irrevocable letter of credit, as described in your letters, would not constitute a prohibited transaction under section 406 of the Act.

However, where premium payments include employee contributions, a funded welfare plan with plan assets may exist. See proposed regulation, 29 CFR 2550.403b-1 (formerly 29 CFR 2552.1, 39 FR 44456, December 24, 1974). In the absence of permanent regulations in this area, we are unable to respond to your interpretive request as it relates to the above described premium paying arrangement to the extent that it involves employee contributions. After the issuance of permanent regulations, you may wish to submit a request for a ruling at that time if you believe further clarification is necessary.