Misrepresentation of Health FSA Costs Employer

May 13, 2008

It happens more often than we would care to admit. A new hire arrives and is given a quick overview of the employer's benefit package. The expectation is that enrollment must occur right away, before the end of the first pay period. In the process, the employee makes certain incorrect assumptions. Who is to blame?

In one recent case, it was the employer.

The case of O'Meara v. The CIT Group involved an August 2005 new hire, who received a Health FSA enrollment guide and summary plan description (SPD). The SPD clearly stated that expense reimbursement was permissible only for expenses incurred during the plan year. The difficulty lay in the fact that neither document defined what "incurred" meant. Instead, the documents referred to IRS Publication 502 (Medical and Dental Expenses), which states that "[y]ou can include . . . the medical and dental expenses you paid this year, regardless of when the services were provided."

Based on that language, the employee signed up to contribute $3,000 for the remainder of 2005, began orthodontic treatment, and paid $4,878 in 2005 (treatment continued in 2006). She submitted a reimbursement claim for 2005 for $3,000 but received only $623, the proportional share of orthodontic services incurred in 2005. She sued for breach of fiduciary duty, claiming she was misled.

The court agreed with the employee that "adequate disclosure to employees is one of ERISA's major purposes." If the employer wanted a different meaning of the word "incurred," it should have provided one. Its failure constituted a breach of fiduciary duty, the court said.

Back in 2005, IRS regulations prohibited the employer from paying the full amount in the plan year that the orthodontia expenses were paid. The Proposed Cafeteria Plan Regulations issued in 2007 now allow expense reimbursement on an as-paid – instead of as-incurred – basis.

However, the bigger mistake of the employer should not be overlooked. There are dangers to referring participants to Publication 502 as a resource for what is reimbursable. This publication is primarily used as a guide for the medical expense tax deduction. Some expenses are allowed in Publication 502 for the tax deduction (e.g., insurance premiums) but not under a Health FSA. Conversely, some expenses are allowed under a Health FSA (e.g., over-the-counter drugs) but not for the tax deduction.

Finally, this case points out the benefits of an enrollment benefits discussion. Once the employer representative received the enrollment forms, it would have been prudent to confirm the plan's rules regarding reimbursement, especially since the year was more than half over. Of course, asking the participant directly about health conditions would be inappropriate under HIPAA.