States Start Mandating ‘Cafeteria’ Health Plans

August 15, 2007
As states try to expand the number of workers with health insurance, several recently have taken a minimalist approach: They are requiring businesses to implement “cafeteria” plans, which let employees get more bang for their buck by paying for health coverage with pretax dollars.

Cafeteria plans are administrative arrangements under which workers can have a portion of their pay set aside before taxes to pay for qualified benefits, like health insurance, or to contribute to a flexible spending account or health savings account.

A cafeteria plan requirement was just one part of Massachusetts’ ambitious health care reform package, which went into effect July 1. But in the past couple of months, three other states have taken a cafeteria plan requirement and enacted it separately.

In June, Rhode Island passed a law that requires companies with more than 25 workers to offer a cafeteria plan, whether or not they offer health coverage. Connecticut’s requirement, enacted in July, is triggered if workers have to contribute toward health coverage provided by their employer. Missouri’s measure, signed into law in June, kicks in if employers contribute toward workers’ health coverage.

“This is about reform and reducing health care costs for individuals,” says Kaye Pestaina, VP and senior health compliance specialist in the Washington office of the Segal Co.

The Massachusetts Health Connector, the agency set up to implement the state’s health insurance reforms, estimates that on average, Massachusetts workers who buy health insurance with pretax dollars save about 41 percent.

Richard Cauchi, health program director for the National Council of State Legislatures, cited growing interest at the state level in using cafeteria plans as part of health policy.

“What’s interesting is that it’s designed to be a less intrusive approach in terms of impact on employers,” Cauchi says.

Although there are costs involved in setting up the administrative framework for a cafeteria plan, companies should also see offsetting savings because employees’ use of pretax dollars to pay for health coverage reduces their total taxable income, which in turn reduces companies’ payroll taxes.

Of course, many companies already have cafeteria plans in place. The Society for Human Resource Management’s 2007 benefits survey showed that 48 percent of companies provide a cafeteria plan, including 54 percent of companies with 100 to 499 employees and 44 percent of companies with 500 or more employees.

Section 125 of the Internal Revenue Code governs cafeteria plans, and earlier this month the IRS issued a comprehensive set of regulations for such plans, replacing a hodgepodge of previously issued rules. The new regulations resolve one possible problem by making it clear that workers who buy health insurance in the individual market can use a cafeteria plan to pay for that insurance with pretax dollars, Pestaina says. “There was some question as to whether you could do that because the plans were set up to deal with group coverage.”

She says the cafeteria plan requirements could face challenges on the grounds that they are inconsistent with ERISA, the federal law governing employee health and retirement benefits. A couple of laws that required companies to put money toward employee health benefits, including Maryland’s “fair share” law, have been invalidated by courts on that basis.

But Pestaina noted that the laws requiring cafeteria plans are less burdensome than fair share laws. “You’re not really requiring the employer to provide coverage; you’re just requiring them to set up an administrative vehicle for pretax savings,” she says. “This isn’t as controversial as fair share.”

Filed by Susan Kelly of Financial Week, a sister publication of Workforce Management. To comment, e-mail