The Regulation Of Insurance

Both individual state governments and the federal government regulate insurance. The states regulate rates, financial examination, formation of the company, qualification of officers, licensing, and taxing. The federal government provides for regulation as noted above, in addition to the activity of the Federal Insurance Administrator, the Interstate Commerce Commission, and the Federal Trade Commission.

A growing concern exists over which level of government is the most appropriate for the regulation of insurance. Many contend that there should be greater federal involvement. Advocates of federal regulation argue that state regulation lacks uniformity and that multiple state regulation is more costly than federal regulation, that the state insurance commissioners are unqualified, and that the states cannot effectively regulate interstate companies. Those who favor state regulation argue that the states are more responsive to local conditions and needs, that state regulation encourages innovation and experimentation, and that the decentralization of power is advantageous.

At present there exists an ongoing disagreement between the states and the federal government over the extent to which state laws are preempted by ERISA. The federal government believes it could move toward greater regulation without legal difficulty. This is based upon the federal ability to regulate interstate commerce, to provide for the general welfare, and to tax. Section 514(a) of ERISA states that it shall supersede any and all state laws insofar as they may now or later relate to any employee benefit plan. The preemption does not apply to any state law that regulates insurance. But a question remains: To what extent does ERISA preempt laws enacted under the insurance codes of the states, when such laws are designed specifically to apply to the insurance-type functions of employee benefit plans?

The Department of Labor advocated a broad interpretation of Section 514, which would preempt most state statutes even if the laws deal with areas not explicitly covered by ERISA, such as the content of health benefit plans. The federal courts have not been so consistent in their interpretation of the statute. In one case, Fleck v. Spannaus, the court decided ERISA does not preempt causes of action occurring before January 1, 1975. But in another case, Azzaro v. Harnett, the court held that Congress intended absolute preemption in the field of employee benefits. Even the insurance exception found in Section 514 is subject to limitations: "No employee benefit plan shall be deemed to be an insurance company or engaged in the business of insurance for the purpose of any law of any state purporting to regulate an insurance company."

In general, the courts, including the Supreme Court, have tended to preempt state regulation that relates to employee pension and retirement plans. This stems from the broad-based protections incorporated in ERISA for pension plan participants. The courts are less inclined to preempt state laws that apply to employee health and insurance plans. ERISA has had a more limited application to welfare plans and a more narrow view of the preemptive effect in the health and welfare plan area. When health insurance benefits are mandated in traditional insurance contracts, rather than through comprehensive health care legislation, claims of federal preemption will not hold. However, when an employer's prepaid health care plan satisfies the ERISA definition, state regulation is preempted.

Where the line will eventually be drawn between state and federal regulation of health and welfare plans continues to be uncertain. The debate centers on the degree to which arrangements have insurance versus noninsurance characteristics, with states arguing that even stop-loss coverage makes the underlying plan "insured," and thus subject to state regulation. The courts continue to be heavily involved but are increasingly reaching decisions that reinforce the strength and breadth of ERISA preemption.

The ongoing debate over national health policy will ensure legislative consideration of where the state-federal regulatory line should be drawn. The more limited the future federal role, the more likely ERISA will be modified. The debate surrounding patient's protection initiatives has continued to highlight differences between insured and ERISA plans.

The U.S. Department of Labor issued significant health benefits claim regulations in late 2000, and the U.S. Department of Health and Human Services has issued significant regulations on health data privacy and confidentiality in later years.

NONTAX FEDERAL REGULATION AFFECTING QUALIFIED PLANS

The tax-law requirements for qualified plans include numerous provisions to prevent discrimination in favor of highly compensated employees. Other federal statutes also have some impact on qualified plan benefit and contribution formulas:

• The Civil Rights Act of 1964 prohibits employers from discriminating on the basis of race, color, religion, sex, or national origin. Sex discrimination, as discussed below, is the only issue under this law that has a significant practical impact on pension benefit design.

• The Age Discrimination in Employment Act (Title 29 USC) prohibits discrimination by employers on the basis of age; the major implications of this provisions are also discussed below.

• The Americans with Disabilities Act (Title 42 USC) prohibits discrimination against disabled employees. This would prohibit special pension provisions applicable only to disabled employees and might also require general pension provisions to be changed to accommodate disabled employees. The law is broadly written and its full implications, including its effect on retirement plans, are not yet entirely apparent.

• The Family and Medical Leave Act of 1993 (Title 29 USC Sees. 2601 et seq.) generally requires employers with 50 or more employees to provide 12 weeks per year of unpaid leave for childbirth, adoption, health condition or care for a sick family member. When the employee returns, all accrued pension and other employee benefits must be restored, but the employer is not required to provide accrual of benefits during the period of the leave.

Sex Discrimination
Of the issues arising under these nontax federal statutes, sex discrimination is the one issue that has the most direct relevance to pension plan design.

Sex discrimination as it relates to qualified plans, annuities, and life insurance is a subject that is not yet completely resolved, but some clear rules for qualified plan design have emerged. The issue arises from the statistical fact that women, as a group, live longer than men. This means that if actuaries make separate calculations for men and women, the same periodic annuity costs more for women than for men of the same age. Or, for a given annuity premium, the periodic annuity amount is lower for women than for men.

The Civil Rights Act of 1964, like its predecessor, the Equal Pay Act of 1963, provides that it is an unlawful employment practice for an employer

to discriminate against any individual with respect to his compensation, terms, conditions or privileges of employment, because of such individual's race, color, religion, sex or national origin [Section 2000e-2(a), Civil Rights Act of 1964].

It is clear that qualified plan benefits are part of an employee's compensation; it was not originally clear, however, what constituted sex discrimination in a qualified plan.

• Must the plan provide the same periodic benefit for both men and women employees?

• Must the plan provide only the same employer contribution to the plan?

Early federal administrative guidelines under the Equal Pay Act of 1963 indicated that an employer satisfied the nondiscrimination requirement if it provided either equal periodic benefits or equal contributions. However, in 1972, the Equal Employment Opportunities Commission (EEOC) issued a revised sex discrimination guideline under the Civil Rights Act of 1964: To avoid sex discrimination in retirement plans, the employer must provide equal periodic benefits to men and women employees in all circumstances. Employers originally resisted this guideline, but recent court cases clearly point in this direction. The first significant case went to the United States Supreme Court, Los Angeles Department of Water and Power v. Manhart, 435 US 702 (1978). That case involved a contributory pension plan of a municipality. The Supreme Court held that the plan could not require women to pay higher contributions than men to receive equal periodic benefits upon retirement. Subsequently, the Supreme Court held in Arizona Governing Committee v. Norris, 103 S.Ct. 3492 (1983), that a municipal retirement plan could not provide sex-based annuity choices at retirement. No employer contributions were involved—only employee contributions.

Although technically the Manhart and Norris cases did not completely establish that the Civil Rights Act requires equal periodic benefits for men and women in an employer-provided retirement plan under all circumstances, the trend of the cases favors an equal-benefit approach and virtually all planners assume this to be the law.

Most qualified plans already avoid obvious sex discrimination problems. Most defined-benefit plans provide the same normal retirement benefit for men and women employees; most defined-contribution plans provide the same employer contribution for men and women employees. Discrimination problems arise when a qualified plan (either defined-benefit or defined-contribution) offers participants a choice of benefits including a retirement annuity. Most plan designers advise using only unisex annuities (those providing the same annuity rate for both men and women) for this purpose. Similarly, if a qualified plan offers life insurance as an incidental benefit, the life insurance cost to the employee must be determined on a unisex basis. However, in determining the annual deposit to a defined benefit plan, the sex of covered employees may be taken into account, because it affects only the employer's costs and not the ultimate benefit that the employee will receive.

The sex discrimination issue is complicated by the fact that the Civil Rights Act does not govern the pricing of insurance products; private insurance companies, therefore, currently are allowed to use sex as a factor in determining life insurance and annuity rates. The argument has been made that when a qualified plan uses a group pension contract for funding, sex-based annuity options should be allowed under the group contract. However, it is the employer, not the insurance company, that provides the pension as part of an employee's compensation. In view of this and the trend of the court cases, insurance companies no longer offer sex-based annuities as part of a group pension contract.

Even if employers remove any conceivable sex discrimination from qualified plan documents, if the plan is designed so that participants can withdraw their benefits at retirement, effective sex discrimination will still be possible so long as sex-based annuities are available from insurance companies. In that situation, men can withdraw their benefits and purchase an annuity from an insurance company providing greater periodic payments than women would be able to purchase for the same amount (or payments greater than those available under the plan if the plan provides a unisex annuity). Because of this and other related problems, the law may at some point reconsider the question whether insurance companies should be allowed to determine annuity and life insurance premiums on the basis of sex.

There is no doubt that sex is a relevant actuarial classification, as is any ascertainable factor affecting life expectancy, which could conceivably include such things as race, religion, or national origin. Insurance companies do not commonly use race or other potentially offensive actuarial factors, regardless of their relevance as predictors of life expectancy. However, they are strongly attached to the use of sex classifications and have vigorously opposed restrictions proposed in Congress.

Both sides of the controversy view the issue as one of fairness. Advocates of sex classification argue that unisex annuity rates are unfair to men, who should be allowed to purchase annuities reflecting their group's life expectancy. Opponents argue that it is unfair to attribute to an individual the characteristics of a group to which that individual belongs, regardless of whether the individual actually possesses those characteristics. Ultimately, Congress may have to determine the appropriate social policy in connection with insurance company practices.

Age Discrimination
The federal Age Discrimination in Employment Act,[3] as amended in 1978, 1986, and 1989, has an impact on qualified plans. The Age Discrimination Act applies to workers and managers of any business that engages in interstate transactions (a very broad category) and employs at least 20 persons during the year. Certain hazardous occupations are excluded as well as executive employees who would be entitled, upon retirement, to an annual pension of $44,000 or more over and above Social Security benefits.

The main provision of the Age Discrimination Act that affects qualified plans is that which prohibits involuntary retirement at any age. A qualified plan must not in any way require mandatory retirement.

In addition, Code Sections 411(b)(1)(H) and 411(b)(2) deal specifically with benefits for older workers. In general, older workers must be treated the same as younger workers with regard to plan contributions (for a defined-contribution plan) and benefit accruals (for a defined-benefit plan). However, for a defined-benefit plan, the benefit formula can provide that benefits are fully accrued not at a specified age but after a specified number of years of service, such as 25. This will cut off further benefit accrual for many older employees, but it is permitted. If a plan provides for normal retirement at 65 with actuarial increases for later retirement, the actuarial increases are credited toward any requirement of benefit accrual that applies. For example, if a plan provides a benefit of $1,000 per month beginning at age 65 or an actuarially adjusted $1,100 per month beginning at age 66, the extra $100 is counted as an additional benefit accrual.