Smoking Surcharges Under Fire: ERISA Compliance Risks in Wellness Programs

by Matthew P. Suzor and Cameron Smith

A recent Employee Retirement Income Security Act (“ERISA”) case has placed employer wellness program surcharges under scrutiny, alleging that penalties imposed on health plans for employees using tobacco products violate federal benefits laws. The decision highlights growing wellness program compliance risks under ERISA for employers that use financial incentives or penalties tied to employee health habits.

What are Surcharges, and How do Employers Use Them?

Smoking and Wellness Surcharges in Health Plans

A tobacco surcharge is an extra fee on health insurance premiums for employees using tobacco products, typically designed as a financial incentive to encourage quitting. The Affordable Care Act (“ACA”) and the Health Insurance Portability and Accountability Act (“HIPAA”) impose nondiscrimination rules prohibiting group health plans from charging similarly situated individuals different premiums or contributions or from imposing different deductibles based on a health factor. Both of these Acts significantly affect ERISA-covered health plans. However, there is an exception that allows group health plans to implement surcharges based on participation or health outcomes for voluntary wellness programs. Some employers may offer a smoking cessation program to help their employees stop smoking and refrain from using tobacco products.

There are two types of wellness programs defined under the ACA: participatory and health contingent. Participatory programs are programs where incentives are earned by simply joining the program. An example may be a program that provides a reward to employees for attending a no-cost health education seminar. Health-contingent programs are programs that are goal-oriented, meaning a participant must either perform or complete an activity related to a health factor or attain/maintain a specific health outcome.

What Fiduciary Duties Apply to Employer-Administered Wellness Programs?

Tobacco surcharge programs fall under health-contingent programs as rewards are based on a health outcome–smoking tobacco or not. All health-contingent programs must meet five requirements under the ADA and HIPAA, and, as such, ERISA: :

1. The reward for the wellness program, together with the reward for other health-contingent programs, must not exceed 30 percent of the total cost of employee-only coverage under the plan, or 50 percent to the extent the program is designed to prevent or reduce tobacco use.
2. The wellness program shall be reasonably designed to promote health and prevent disease.
3. The health care plan shall give individuals eligible for the program the opportunity to qualify for the reward under the program at least once each year.
4. The wellness program must allow for a reasonably alternative standard to individuals for whom it is either unreasonably difficult due to a medical condition to satisfy the otherwise applicably standard or medically inadvisable to attempt to satisfy the otherwise applicable standard.
5. Employers must disclose in all plan materials the availability of a reasonable alternative standard and the terms surrounding the alternative standard.

In 2013, the Department of Labor (“DOL”), the Internal Revenue Service (“IRS”), the Department of the Treasury, the Employee Benefits Security Administration, the Centers for Medicare & Medicaid Services, and the Department of Health and Human Services jointly issued a regulation that added that the plan or issuer must disclose in all plan materials describing the terms of an outcome-based wellness program, the availability of a reasonable alternative standard to qualify for the reward, including contact information for obtaining the reasonable alternative standard and a statement that recommendations of an individual’s personal physician will be accommodated.

A Case that Could Challenge the Legality of a Tobacco-use Surcharge

In the Tennessee federal court case, Bailey v. Sedgwick, Sedgwick employee Korine Bailey, sued on behalf of current and former employee health plan participants alleging that a tobacco surcharge breached employers’ fiduciary duties and caused ERISA-prohibited transactions. Sedgwick offers a health insurance plan and imposes a tobacco surcharge on employees who are tobacco users and receive health insurance through the plan. Each year during enrollment, employees attest whether they use tobacco or not, and if they do, Sedgwick charged those users a surcharge in the amount of $50 per pay period or $1,300 per year.

Sedgwick offers a tobacco cessation program called “Quit for Life” where if an employee completely Quit for Life by June 30th of a calendar year, then Sedwick stops charging the surcharge for the rest of the year and refunds the surcharges paid earlier in the year. Bailey alleged that Sedgwick breached its fiduciary duties by administering a plan that does not conform with ERISA anti-discrimination provisions, collecting the tobacco surcharge, retaining and commingling the monies collected with other assets, and failing to communicate information to Plan participants.

The court denied dismissal of certain ERISA claims, finding that Bailey adequately alleged that Plan materials fail to notify participants that a physician’s recommendation will be accommodated, as mandated by the DOL and ERISA.

Miller Shah Can Guide Employers on ERISA Wellness Program Compliance

Workplace wellness programs must comply with HIPAA, ADA, ERISA, and DOL regulations. There are multiple steps employers can take to ensure ERISA wellness program compliance in wellness plan design. Employers should review regulation guidance by the DOL for a comprehensive overview of all compliance requirements. The DOL describes in detail the compliance of recommendations for frequency, size of reward, design, and reasonable alternative standards.

Employers must also stay up to date on courts’ interpretation of the laws and regulations. The Miller Shah team has extensive experience with guiding employers in wellness program compliance and fiduciary risk. If you have any questions surrounding wellness program compliance or fiduciary duties under ERISA, contact Miller Shah online or call 866-540-5505 to arrange a consultation.