Question: Why are employer-sponsored health plans typically not funded by a trust, and how could the J&J class action lawsuit turn on this issue?

Short Answer: Although ERISA requires that plan assets (including employee contributions) be held in trust, the DOL has a longstanding nonenforcement policy that applies to most health and welfare plans. Pursuant to Technical Release 92-01, the DOL does not enforce the trust requirement for employee contributions to health and welfare plans that are made through a Section 125 cafeteria plan. This issue may end up being a key aspect of the recently filed J&J class action lawsuit, which involves a health plan funded by a trust.

Note: This is part of our series addressing practical considerations for employers related to the J&J case.

• J&J Case Practical Considerations: The ERISA Trust Rules for Health Plans (Part 1)

The J&J Case: ERISA Fundamentals Revisited

In light of the recent class action lawsuit filed against Johnson & Johnson (“J&J”) as employer-plan sponsor of its group health plan (Lewandowski v. Johnson & Johnson, et. al., D.N.J., No. 1:24-cv-00671 (Feb. 5, 2024)), we are reviewing the ERISA basics that may both affect the outcome of the case and offer employers as interested observers the opportunity to revisit best practices to better avoid such potential liability.

The plaintiffs in the J&J case principally allege that the company breached its fiduciary duty by mismanaging the health plan’s prescription drug benefit program, costing their ERISA plans and their employees millions of dollars in the form of higher payments for prescription drugs, higher premiums, higher deductibles, higher coinsurance, higher copays, and lower wages or limited wage growth.

The complaint argues that J&J breached its fiduciary duty by failing to engage in a prudent and reasoned decision-making process that would have drastically lowered the cost of prescription drugs in general and generic-specialty drugs in particular, and would have resulted in other cost savings for the plan. The allegation is that a fiduciarily prudent approach would have saved the plan and employees millions of dollars.

One key point of the case from an ERISA perspective is that the complaint states J&J relied on a trust to fund its group health plan. This may prove to be a pivotal aspect of the case because the plaintiff can establish a clear connection between the core fiduciary duties imposed upon employers as the ERISA plan administrator and all trust funds as plan assets. The connection would be far more extenuated if plan benefits were paid from J&J’s general assets, as is more typical for employers sponsoring self-insured health plans.

There are several significant advantages for employers to avoiding use of a trust to pay for health plan benefits. However, as the J&J case develops, and as the industry adjusts and adapts to its eventual holdings, it may turn out that there is no more significant driver of potential liability in this evolving area than the funding mechanism for the plan. This post looks to the ERISA trust requirements, why they typically are not enforced for health plans, and the potential pitfalls for employers to be aware of in this context.

• Newfront Note: The J&J case is merely at the initial complaint stage. Before considering radical changes to plan governance that may be costly, time consuming, and of indeterminable benefit, our recommendation is that employers return to the basic ERISA principles that have proven effective at avoiding potential liability. This series is intended to focus on those concepts—while maintaining an eye to the horizon for how this case (and potentially others) develops in litigation. The outcomes will drive best practices, including whether new approaches and processes might be warranted.

How Employers Could Inadvertently Lose Technical Release 92-01 Trust Relief: Separate Accounts

DOL guidance provides as a general principle that “assets of an employee benefit plan generally are to be identified on the basis of ordinary notions of property rights.” In addressing when an employer could create plan assets through use of a separate account, the DOL states that such amounts will become plan assets if the steps taken by the employer “cause the plan to gain a beneficial interest in particular assets.”

Outside of intentionally establishing a formal trust, steps that would meet this standard include where the employer “sets up a separate account with a bank or third party in the name of the plan, or specifically indicates in the plan document or instruments that separately maintained funds belong to the plan.” (emphasis added)

• Key Point: An account established in the plan’s name will create plan assets, and thereby require that account be operated as a trust.

On the other hand, using a separate account that is not in the plan’s name (e.g., in the employer plan sponsor’s name) would not necessarily cause the funds to be treated as plan assets. DOL guidance provides that “the mere segregation of employer funds to facilitate administration of the plan would not in itself demonstrate an intent to create a beneficial interest in those assets on behalf of the plan.”

Accordingly, the employer could carefully create a separate account in its name whereby there is an “absence of any other actions or representations which would manifest an intent to contribute assets to a welfare plan,” and thereby avoid creation of plan assets in maintaining that separate account.

• Key Point: The DOL states if employers are careful not to cause the plan to gain a beneficial interest in a separate account, “the mere establishment of an account in the name of the employer to be used exclusively in administering the plan would not create a beneficial interest in the plan.” (emphasis added)

Ultimately, this is a facts and circumstances analysis. As the DOL summarizes, “whether a plan acquires a beneficial interest in definable assets depends, largely, on whether the plan sponsor expresses an intent to grant such a beneficial interest or has acted or made representations sufficient to lead participants and beneficiaries of the plan to reasonably believe that such funds separately secure the promised benefits or are otherwise plan assets.”

• Key Point: Employers can avoid this complicated analysis of whether a separate account potentially jeopardizes the DOL’s trust nonenforcement relief by simply paying premiums and benefits from the employer’s general assets.

Common Arrangements That Generally Meet the 92-01 Relief to Avoid the ERISA Trust Requirement

• No Trust Required: Premiums/benefits paid from the employer’s general assets checking account.

• Facts and Circumstances: Premiums/benefits paid from a separate account in the employer’s name where the employer expresses no intent and makes no representations to lead employees to believe the funds in the account are plan assets.

In either case, the employer could provide the third-party administrator (TPA) with check-writing authority over the account to ameliorate administrative burdens.

Arrangements That Often Do Not Qualify for the 92-01 Relief (Subject to the ERISA Trust Requirement)

• Trust Required: A separate checking account held in the name of the health plan (even if maintained with a zero-balance approach to immediately pay premiums/benefits upon receipt).

• Facts and Circumstances: Zero-balance account maintained in the name of the TPA whereby the TPA periodically has the employer transfer funds in the exact amount of aggregate adjudicated claims to the fund the account and release approved benefit distributions to participants and beneficiaries.

With respect to the TPA account zero-balance approach, the DOL has cautioned that “drawing benefit checks on a TPA account, as opposed to an employer account, may suggest to participants that there is an independent source of funds securing payment of their benefits under the plan,” which could create ERISA plan assets that must be held in trust.

• The J&J Connection: Avoiding the inadvertent loss of the DOL’s trust enforcement policy could end up as a key liability consideration derived from the J&J case. The J&J plan’s trust-funded status may prove to be one of the primary reasons the plan was targeted as the test case in this area, as well as a potential factor in the court’s analysis of the class plaintiff’s breach of fiduciary duty allegations.

How Employers Could Inadvertently Lose Technical Release 92-01 Trust Relief: MLR Rebates

The DOL’s guidance for how to address the medical loss ratio (MLR) rebates required by the ACA provides that the portion of a rebate received by the employer that is attributable to employee contributions is considered ERISA plan assets. Those plan assets must be held in trust for the exclusive benefit of participants and beneficiaries, unless an exception applies.

The DOL piggybacks on the Technical Release 92-01 relief in its MLR guidance by providing that employers can avoid the trust requirement for such plan assets (i.e., the portion of the rebate attributable to employee contributions) provided those assets are spent within three months of receipt on refunds to participants, premium reductions, or benefit enhancements. Failure to expend the plan assets on one of those purposes within three months of receipt would cause the employer to lose the ERISA trust relief.

• For more details: How to Address MLR Rebates

How Employers Could Inadvertently Lose Technical Release 92-01 Trust Relief: Independent Contractors

A multiple employer welfare arrangement (MEWA) is an arrangement used to provide employee welfare benefits to employees of two or more employers that are not part of the same §414 controlled group. In some cases, employers will offer health plan coverage to an independent contractor such as gig workers or board members without an appreciation for the concerns that raises. Offering coverage under the health plan to any properly classified non-employee (i.e., not a Form W-2 common law employee), including any independent contractor reported via Form 1099, likely creates a MEWA.

Among multiple other issues caused by inadvertent creation of a MEWA, DOL guidance provides that MEWAs generally cannot take advantage of the trust nonenforcement policy that applies to most single employer plans. The DOL states that “the assets of the MEWA generally are considered to include the assets of the plan.” Accordingly, offering coverage to independent contractors likely causes the plan to lose the ERISA trust relief.

• For more details: Addressing Exception Requests to Offer Coverage to Independent Contractors and Other Non-Employees

Enforcement of ERISA Trust Requirements

Failure to hold health plan assets in trust where no exception applies could lead to a breach of fiduciary duty DOL enforcement action or participant lawsuits for failure to apply such assets exclusively for the benefits of participants and beneficiaries. ERISA §502(l) provides that the DOL can assess a 20% penalty for breach of fiduciary duty based on the amount recovered in a DOL settlement agreement or court order.

• The J&J Connection: An emerging aspect of potential liability on the health and welfare plan side is class action lawsuits alleging a breach of fiduciary duty caused by excessive plan costs. The J&J case involves a plan funded by a trust, where it is clear that all funds in the trust are ERISA plan assets subject to fiduciary obligations. Although employee contributions are still plan assets for health plans that are not funded by a trust (the vast majority), it will be interesting to see if plaintiffs bar finds that to be a sufficient basis to bring a similar claim against any employers that pay plan benefits from general assets.

Reminder: Trust Nonenforcement Policy Does Not Extend to Retirement Plans

Although employers enjoy broad nonenforcement relief from the trust requirements for health and welfare plans, retirement plans must hold plan assets in trust. The Technical Release 92-01 guidance does not apply to 401(k) or other retirement plans, which (except in very limited situations) must hold plan contributions in a trust to satisfy both ERISA and Internal Revenue Code requirements.

• The J&J Connection: Class action lawsuits alleging excessive fees that were not prudently monitored on the retirement side for 401(k) plans (and other defined contribution plans) have been a staple of the litigation landscape for decades now. These claims have been easier to make for 401(k) plans because they are always funded by a trust, and therefore it is clear that ERISA plan assets are involved. It is likely no coincidence that the first target of a similar class action approach on the health and welfare side was an employer (J&J) that funded its health plan through a trust.

Summary

DOL Technical Release 92-01 (and its related offshoots) has stood the test of time for over three decades as the primary basis for employers to avoid the need to fund their health and welfare benefits with a trust. Even though employee contributions are plan assets, the guidance provides relief in virtually all standard employer arrangements for employers to avoid the need to hold such assets in trust through use of a cafeteria plan.

Nonetheless, employers should be aware that the relief is not a blanket exemption from the trust requirements. Mistakes such as holding amounts in a separate account not in the employer’s name for use in paying plan premiums or benefits, retaining MLR rebates beyond three months before distributing the amount attributable to employee contributions, or inadvertent creation of a MEWA are examples of potential pitfalls that employers should exercise caution to avoid to safely circumvent the need to establish a trust for the health plan.

• The J&J Connection: Maintaining an unfunded health plan is likely to gain renewed and heightened importance as the J&J case—and potentially others modeled after its approach—plays out in litigation. This process will take years to fully develop the body of law. In the interim, employers in the far more common situation of having an unfunded health plan should a) reinforce their practices designed to ensure they are avoiding the requirements establish a trust, and b) keep an eye on the J&J case results to glean whether similar claims could be extended in the future to the vast majority of health plans that are not funded by a trust.

Our series exploring the J&J case practical considerations continues next time with an overview of the ERISA fiduciary responsibilities for employers with respect to their health and welfare plan benefits.

Relevant Cites:

ERISA §403(a):

(a) Benefit plan assets to be held in trust; authority of trustees. Except as provided in subsection (b), all assets of an employee benefit plan shall be held in trust by one or more trustees. Such trustee or trustees shall be either named in the trust instrument or in the plan instrument described in section 402(a) or appointed by a person who is a named fiduciary, and upon acceptance of being named or appointed, the trustee or trustees shall have exclusive authority and discretion to manage and control the assets of the plan…

29 CFR §2510.3-102(a)(1):

(1) General rule. For purposes of subtitle A and parts 1 and 4 of subtitle B of title I of ERISA and section 4975 of the Internal Revenue Code only (but without any implication for and may not be relied upon to bar criminal prosecutions under 18 U.S.C. 664), the assets of the plan include amounts (other than union dues) that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution or repayment of a participant loan to the plan, as of the earliest date on which such contributions or repayments can reasonably be segregated from the employer's general assets.

DOL Technical Release 92-01:

In the case of a cafeteria plan described in section 125 of the Internal Revenue Code, the Department will not assert a violation in any enforcement proceeding solely because of a failure to hold participant contributions in trust. Nor, in the absence of a trust, will the Department assert a violation in any enforcement proceeding or assess a civil penalty with respect to a cafeteria plan because of a failure to meet the reporting requirements by reason of not coming within the exemptions set forth in §§2520.104-20 and 2520.104-44 solely as a result of using participant contributions to pay plan benefits or expenses attendant to the provision of benefits.

In the case of any other contributory welfare plan with respect to which participant contributions are applied only to the payment of premiums in a manner consistent with §§2520.104-20(b)(2)(ii) or (iii) and 2520.104-44(b)(1)(ii) or (iii), as applicable, the Department will not assert a violation in any enforcement proceeding or assess a civil penalty solely because of a failure to hold participant contributions in trust.

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).