What options do employers have when employees experience pay shortages, where employee wages don’t cover the health insurance premium?

Employers are often faced with situations that result in employees’ inability to pay insurance premiums. Whether the employee has experienced a reduction in hours, is on unpaid leave, is a tipped employee or must be offered coverage due to being in a stability period under the employer mandate, there are different times that the employee’s wages may not be enough to cover their health insurance premiums.

Unfortunately, the IRS hasn’t provided specific guidance regarding situations where there’s a pay shortage due to employees working fewer hours during certain periods of the year. However, we believe that we can look to the regulations that address how to finance employees’ benefits during FMLA leave for guidance on pay shortages.

These regulations provide three options for handling the contribution obligations of employees who continue group health coverage during an unpaid FMLA leave:

  1. Prepayment with a special salary reduction
  2. Pay-as-you-go on an after-tax basis
  3. Catch-up salary reductions (or after-tax payment) upon return from the leave

Thus, the IRS has indicated that salary reduction elections for group health coverage, at least in the context of FMLA leave, can be accelerated, deferred or paid on an after-tax basis when there is no pay. It seems reasonable to apply similar concepts in the non-FMLA context, as well. Moreover, there’s no requirement that salary reduction contributions be made in equal amounts every pay period. Keep in mind, though, that the plan document should contain language flexible enough to accommodate the employer's method for handling pay shortages.

The first option under the FMLA regulations – prepayment by acceleration of the salary reduction – isn’t likely to be useful unless the pay shortage is predicted, perhaps as in the event of a planned leave or an annual slow time for a commissions-only salesperson. It’s worth noting, however, that the FMLA regulations don’t allow prepayment to be the sole option made available to employees on FMLA leave. Further, the prepayment option cannot be used to pay for benefits in a subsequent plan year.

The second option – pay-as-you-go on an after-tax basis – will only be useful for participants that have additional resources to pay the amount out-of-pocket (like a workers’ comp or disability policy). The employer will also need to notify any such participants of how they will pay the premiums while out. For example, will they direct payment to the employer or the insurer?

The third option – catch-up salary reductions – is most likely to work when the pay shortage is unexpected. This option allows the employer and employee to agree that the employer will advance payment of the premiums and that the employee will pay the employer back upon their return. If it seemed that a given employee was going to go back to working full-time hours, then the catch-up salary reductions may be an option.

However, the risk in allowing catch-up salary reductions is that the employer may not be able to recoup the deferred salary reductions. So an employer permitting this option might consider establishing an outside limit for the deferral (e.g., 30 or 60 days) and then stopping or reducing coverage at the end of the time period if the catch-up salary reduction isn’t made or is insufficient to cover the amount due.

Note that there’s added risk in using this method under a health FSA, because the uniform coverage requirement isn’t suspended.

So, although there’s no specific guidance on what to do when an employee’s paycheck doesn’t cover the health premiums, the employer could explore the options provided for unpaid FMLA leave, as long as the plan document reflects the method that’s chosen. The employer ultimately may also want to seek outside legal counsel on this issue, since the IRS hasn’t provided specific guidance.