The discrimination rules for self-insured plans prohibit discrimination in favour of highly compensated individuals with respect to eligibility and benefits. (Generally, a highly compensated individual is either a 10% shareholder or one of the five highest paid officers or highest paid 25% of all employees.) Whether a plan discriminates as to eligibility is determined either by:

Whether a plan discriminates as to benefits depends on whether the plan provides benefits to highly compensated individuals that it does not provide to all other participants. To comply with the benefits test under the current rule, the plan document must not permit discrimination in benefits in favour of highly compensated individuals and the plan must not actually discriminate in favour of such individuals in operation. While the regulations implementing the rule for self-insured plans do not define the term "benefits", they suggest that the term is to be broadly construed. In the case of both the eligibility and benefits tests, the regulations for self-insured plans raise a number of questions and issues concerning the application of the discrimination rule that are yet unresolved.

If a self-insured plan does not satisfy the discrimination requirements, the value of the discriminatory benefit is taxable to the highly compensated individuals. In contrast, under the Act, if an insured plan does not comply with the comparable discrimination rule, the sponsoring employer may be subject to monetary penalties of up to US$100 per day per employee discriminated against (capped at the lesser of US$500,000 and the amount paid for the plan by the employer in the preceding year). In addition, under the Act, employees may also have a private right of action to enforce the rule. It would appear that a participant who is not a highly compensated individual in an insured plan would have the right to file a lawsuit under the US Employee Retirement Income Security Act (ERISA) to compel the sponsoring employer to provide non-discriminatory benefits.

The Act potentially excludes two types of medical arrangements from the new rule, although it is likely that the scope of these exceptions will be clarified by future regulation:

Where one of the limited exceptions under the Act is not available for an insured plan, the sponsoring employer will need to consider if the plan complies with the new discrimination requirements and, if it does not, how to achieve compliance with the Act's requirements. As potential discrimination issues frequently arise in connection with employment agreements or other executive severance arrangements, a first step to identifying potentially non-compliant arrangements is to review executive severance arrangements that provide for post-employment medical benefits to highly compensated individuals. Where benefits are found in an employment agreement or severance agreement with a highly compensated individual, the nature of the agreement may require the individual’s consent to any change. For this reason, even in advance of the effective date of the new rule, employers should give special attention to new arrangements or renewals of existing arrangements to ensure that they do not introduce or preserve discriminatory benefits that may require correction at a later date.

In addition, requirements affecting the taxation of deferred compensation plans under the US Internal Revenue Code may, in certain instances, limit an employer's ability to amend existing arrangements. In particular, where an employer intends to replace a potentially discriminatory benefit with one that complies with the discrimination rules, the employer will need to consider if the replacement is an acceleration or deferral of the payment of deferred compensation that would not be permitted under the Code.

For more information about the discrimination rule and deferred compensation requirements under the Code, please see our memorandum entitled Shearman & Sterling: Post-employment medical benefits for executives after health care reform.