WHO WILL PAY FOR THE PLAN? | Plan Qualification Requirements

Most qualified pension plans are funded entirely by the employer. Pension plans requiring contributions by employees, referred to as contributory plans, were once popular but are currently of diminishing importance. There are two reasons for this. First, employee contributions to a qualified plan other than "salary reductions" (see below) are after-tax contributions—the employee receives no tax deduction or exclusion for the contribution. Also, employee contributions involve administrative complications such as Code Section 401(m).

Many employers believe that retirement plan benefits are appreciated more by employees if the employees themselves contribute (or feel that they are contributing) toward their cost. In most cases, of course, most of an employee's income comes in the form of compensation from the employer, so there is some degree of illusion in this approach. Some employers may also believe that a contributory approach lowers plan costs, but this is not actually true. To the extent that a contributory approach results in the loss of tax benefits (in effect, losing a contribution to the plan by the U.S. Treasury), a contributory plan actually costs the employer more for the same level of benefits. A better justification for contributory plans is that they give the employee some degree of choice in allocating his or her compensation between cash and deferred benefits.

Currently, the most favorable contributory plan design is to use salary reductions in a plan that is permitted to use salary reductions—a Section 401(k) plan, a Section 403(b) plan, a Section 457 plan, or a SIMPLE plan. Qualified pension plans cannot use salary reductions, except for some older plans that were "grandfathered" (permitted to use older law) when current law was enacted. Salary reductions are subject to FICA and FUTA (Social Security and federal unemployment) taxes but not to federal income tax. Thus, the tax benefits of qualified plans are not completely lost to the employee if the salary reduction approach is used.

Determination of Benefits Payable: A Simple Example

The actual mechanics of the previously described COB provision are demonstrated in the following example, which assumes that a person has coverage under the plans of two employers:

Plan A has PPO coverage that pays allowable expenses in full as long as network preferred providers are used. If nonnetwork providers are used, there is (1) a $500 annual deductible, (2) 80 percent coinsurance subject to a $3,000 out-of-pocket limit and (3) a $1 million lifetime maximum.

Plan B has traditional comprehensive major medical expense coverage with (1) a $200 calendar-year deductible, (2) 80 percent coinsurance subject to a $1,000 out-of-pocket limit and (3) a $2 million lifetime maximum.

Assume also that this person incurs the following expenses for a surgical procedure:

Semiprivate room for 5 days at $800 per day
$4,000

Other hospital charges
3,500

Surgeon's fees
3,000

Total expenses
$10,500

Assume that (1) neither plan contains a COB provision, (2) plan A is primary, and (3) network providers were used. In this case, plan A would pay the full $10,500, and plan B would pay $9,300 after deductions for the $200 deductible and the $1,000 out-of-pocket limit that applies to the coinsurance provision. Consequently, the insured would collect a total of $19,800, or $9,300 in excess of his or actual expenses.

If the example is changed so that plan B is primary and nonnetwork providers are used for plan A, plan B will still pay $9,300. However, plan A only will pay $8,000, which is 80 percent of the expenses above the nonnetwork deductible. In this case, the insured would collect $17,300, still significantly more than his or her actual expenses.

Before the COB provision is used, it must first be determined whether the provision applies to a given claim. It applies only if the sum of the benefits under the plans involved (assuming there is no provision) exceeds an individual's allowable expenses. Allowable expenses are defined as any necessary, reasonable, and customary items of expense, all or a portion of which are covered under at least one of the plans that provides benefits to the person for whom the claim is made. However, under a primary plan, the amount of any benefit reductions resulting from a covered person's failure to comply with the plan's provisions (such as second opinions or precertification) is not considered an allowable expense. In addition, the difference between the cost of a private hospital room and the cost of a semiprivate hospital room is not considered an allowable expense unless the patient's stay in a private room is medically necessary. When the allowable expenses are determined, any deductibles, percentage participation from coinsurance, and plan maximum are ignored.

In the previous example, the entire $10,500 is considered allowable expenses. Because the sum of the benefits otherwise payable under the two plans (either $19,800 or $17,300, depending on which plan is primary) exceeds this amount, the COB provision applies. If the sum of the benefits did not exceed the allowable expenses, the COB provision would not apply and each plan would pay its benefits as if it were the only existing plan.

When the COB provision applies, a person receives benefits equal to 100 percent of his or her allowable expenses and no more. The primary plan pays its benefits as if no other coverage exists, and the secondary plan (or plans) pays the remaining benefits. If plan A in this example is primary, it will pay $10,500, and plan B will pay nothing because 100 percent of the insured expenses have been paid. If plan B is primary, it will pay $9,300 and plan A will pay the remaining $2,200 of the insured's expenses.