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Cafeteria Plans, the Affordable Care Act, and Continued Compliance with the Massachusetts Free-Rider Surcharge Requirement—New Advice from the Massachusetts Health Insurance Connector

Established as a part of the comprehensive 2006 Massachusetts health care reform law, the Massachusetts Health Insurance Connector (a/k/a the “Connector”) served as a model for the American Health Benefit Exchanges that are a central feature of the Patient Protection and Affordable Care Act. (The U.S. Department of Health and Human Services now refers to these exchanges as “insurance marketplaces.”) Both the Massachusetts Connector and insurance marketplaces serve as point-of-sale portals that enable individuals and small businesses to compare health insurance product offerings and that facilitate the purchase of coverage. There are, however, some important differences:

  • Under the Massachusetts statutory scheme, employees of Massachusetts employers with 11 or more full-time and full-time equivalent employees who are ineligible for employer-sponsored group health plan coverage (e.g., because they are part-time or fall into some other ineligible class) must be offered access to individual market coverage using pre-tax contributions under their employer’s Internal Revenue Code (“Code”) section 125 cafeteria plan1;
  • Under the Affordable Care Act, beginning in 2014, employees are generally barred from using pre-tax contributions to purchase insurance marketplace coverage.

Employers that have failed to adopt a cafeteria plan that conforms to the requirements of both the Code and Massachusetts law are subject to a free-rider surcharge. The surcharge is equal to a portion of the Commonwealth’s cost of providing health benefits to employees.

In addition, employees working at Massachusetts locations who have access to health insurance coverage through an employer are generally not eligible to purchase Connector coverage.2 Beginning in 2014, as a result of the Affordable Care Act, however, employees will be eligible to purchase coverage on the Connector even if employer coverage is available. As a result, Massachusetts law must yield on this score.

While Massachusetts has taken some additional steps to accommodate the Affordable Care Act, e.g., by repealing the “fair share contribution requirement” (click here for a copy of our July 18, 2013 client advisory), the free-rider surcharge and the cafeteria plan requirement have not been repealed or otherwise amended. Thus the federal and state laws are on a collision course. In a recent letter to employers, the Connector has addressed this conundrum.


Under Massachusetts law, employers with 11 or more full-time equivalent employees in the Commonwealth must “adopt and maintain a cafeteria plan that satisfies 26 U.S.C. 125 and the rules and regulations promulgated by the connector.”3 In addition, small groups that choose to designate the Connector as their group health plan must adopt a cafeteria plan to facilitate pre-tax premium contributions. Regulations implementing the cafeteria plan requirement specify that the cafeteria plan “must, at a minimum, be a premium only plan offering access to one or more medical care coverage options in lieu of regular cash compensation.”4 In both cases, the cafeteria plan requirement is limited to so-called “premium-only” arrangements. Employers are not required to adopt a medical or dependent care flexible spending account. The purpose of these requirements is to permit employees to purchase health care with pre-tax dollars.

The Affordable Care Act takes the opposite approach: insurance purchased through an insurance marketplace may not be funded through a cafeteria plan other than in limited instances that apply only to small groups that elect marketplace coverage. Thus, individual health insurance offered through an insurance marketplace must be purchased with after-tax dollars.

The Connector’s July 2013 letter

The Connector refers to arrangements under which employees purchase pre-tax Connector coverage as “voluntary plans.” Voluntary plan coverage is issued under Commonwealth Choice, which is one of the Connector’s two major product portals. In its recent letter, the Connector advises that the voluntary plan program will cease as of January 1, 2014. According to the letter:

If your company has 11 or more full-time equivalent employees, you must provide a way for your employees to use a Section 125 plan (also known as a “cafeteria plan”) to pay for health insurance on a pre-tax basis, even if they are not eligible for a company-sponsored insurance plan. . . .


Nothing would prevent employees from accessing Commonwealth Choice coverage from and after January 1, 2014 if an employer wishes to allow it, but premium contributions paid by the employee must be on an after-tax basis. Because the free rider surcharge remains, however, employers must find an alternative way to comply. Some of the options available to employers include the following:

  • Make coverage available to previously ineligible employees under an employer-sponsored plan (this would, at a minimum, require a plan amendment or the adoption of a new plan).
  • Permit employees to purchase coverage in the individual market outside the Connector.
  • Access coverage under a soon-to-be announced private exchange that is intended to mimic the Commonwealth Choice product offerings.

Employers should also review their plan documents, including health insurance and cafeteria plan documents, to ensure that they align with the employer’s free-rider solution. Some cafeteria plans adopted in response to the free-rider surcharge limit elections to either the employer’s plan or Commonwealth Choice. While this design has the benefit of ensuring that the employer would need to deal only with its vendors and the Connector, it will expose an employer to free rider penalties beginning in 2014.



1 In addition to the Code Section 125 cafeteria plan requirements, the plan must also comply with the Connector’s regulations found at 956 C.M.R. 4.00. These Connector regulations contain rules regarding, inter alia, maximum waiting periods for participation and the classes of employees that may be excluded from participation.

2 Although there are some exceptions, e.g., if the employee is subject to a waiting period or the employer’s coverage does not provide “minimum creditable coverage” as defined in 956 C.M.R. 5.00.

3 See Mass. Gen. Laws chapter 151F.

4 956 C.M.R. 4.07(3).



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Patricia Moran