February 25, 2025
This article introduces our new Observations section, which combines compliance information with commentary and practical insights from our Corporate Benefits Compliance team.
Wellness programs have become a cornerstone of employer-provided group health plans, aiming to foster healthier lifestyles and reduce healthcare costs. Among these initiatives, tobacco surcharges have emerged as a common strategy for wellness programs. These surcharges, which impose higher premiums on employees who use tobacco products, are designed to offset the elevated healthcare expenses associated with tobacco use and incentivize cessation. Endorsed by the ACA and regulated through HIPAA (as well as the ADA, tax code, and in some cases, state law), the legal landscape surrounding these programs is complex. These laws ensure that wellness programs are nondiscriminatory and reasonably designed to promote health. A recent uptick in litigation involving tobacco surcharges should prompt employers to take a closer look at their wellness programs.
Wellness Programs and Tobacco Surcharges
HIPAA generally prohibits group health plans from discriminating based on health factors, including tobacco use, which is considered a health status due to nicotine addiction. However, HIPAA provides an exception for wellness programs that meet specific criteria. These programs can offer rewards such as reduced premium contributions (in other words, avoiding a premium surcharge) or reduced cost-sharing. While HIPAA permits health plans to charge tobacco users up to 50% more for their premiums, the Kaiser Family Foundation reports that the median surcharge is about 10%, with most plans charging far less than the maximum. Still, a 10% surcharge can be significant, potentially costing employees hundreds or even thousands of dollars annually. Despite these financial incentives, the effectiveness of surcharges in reducing tobacco use remains debated. Lately, they have become the focus of numerous employee class action lawsuits, along with ongoing lawsuits against employers brought by the DOL.
Growing Litigation Risk Under HIPAA’s Wellness Rules
In recent months, more than a dozen employee class action lawsuits challenging tobacco surcharges have been filed against large employers, alleging failures to fulfill ERISA fiduciary duties and satisfy HIPAA nondiscrimination requirements for wellness programs. The requirements are meant to ensure that such programs are “not merely a subterfuge for cost-shifting" to employees with higher health risks, which would be unlawful discrimination. These outcome-based programs must:
Variations on a Common Theme
The recent lawsuits target three common shortcomings:
First, after satisfaction of the RAS, many of the challenged wellness programs only provide the lower tobacco-free premium prospectively. Under the HIPAA nondiscrimination rules, individuals given an RAS must be able to earn the same reward as those meeting the initial standard, even if it takes longer. When an individual has satisfied the RAS, the employer is required to refund or otherwise “credit back” any surcharges (meaning, making the employee whole — as if the surcharge had not been charged or the incentive had been received).
Our Observation:
Once the RAS is met, the plan has the flexibility to determine how to provide the reward – such as retroactive lump sum or pro rata payments for the remainder of the year – as long as the method is reasonable and the individual is made whole (meaning, receiving the full amount of the reward). If the alternative standard is met at the end of the plan year, the plan should make a retroactive payment within a reasonable time (for example, the first month of the new plan year) and should not spread the payment out over that subsequent year. Alternatively, the plan can waive the standard and provide the reward directly.
A midyear incentive award might trigger a change of election under IRC cafeteria plan regulations. For instance, the plan can allow a change in pretax election amounts to accommodate a midyear premium reduction reward. If the wellness incentive significantly lowers the cost of comprehensive medical coverage for all options offered by the employer, regulations permit employees to change their elections among the coverage options (note, this is a matter of plan design). Perhaps a more practical approach is to limit election changes and apply an automatic adjustment to the employee’s share of the coverage cost in which they are enrolled.
Second, the lawsuits frequently allege failure to clearly communicate the wellness program terms by not including a full description of the RAS, including retroactive removal of surcharges, in all wellness program materials and plan documents.
The HIPAA rules clearly require wellness plan disclosure of the availability of the RAS to qualify for the reward in all plan materials describing the program. For ERISA plans, wellness program terms should be disclosed in the summary plan description (SPD) and plan documents. Any benefit guides or open enrollment materials that describe the wellness program should similarly communicate the availability of the RAS, including the crediting of the reward. It’s important for employers to confirm that the wellness program is fully disclosed in all these materials.
Third, some of the lawsuits challenge wellness programs that require tobacco-free status without offering any RAS.
Wellness programs with a smoking surcharge often include a cotinine screening, a common biomarker for tobacco exposure. Alternatively, the surcharge may be based on a health risk assessment response to tobacco use. Regulations require the plan to offer an RAS to any individual who does not meet the initial healthy standard, regardless of their medical condition or health status. This ensures the initial standard is not a subterfuge for discrimination or underwriting based on a health factor. The plan cannot mandate a medical outcome, such as quitting smoking, nor can it cease to provide an RAS. Although RAS options may change annually (for example, smoking cessation programs, physician treatment plans, or new nicotine replacement therapies), they must remain available.
Other Laws
While the recent lawsuits focus on HIPAA’s nondiscrimination rule, wellness programs are subject to several other laws. For example, under the ADA, tobacco surcharges may be subject to restrictions if they consist of a disability-related inquiry or medical examination (such as a biometric screening or other medical exam to test for the presence of cotinine). However, a program that merely asks employees about their tobacco use through an attestation is not subject to the ADA limitations.
In addition, even though federal law permits tobacco surcharges under a compliant wellness program, some states have laws that limit or outright prohibit tobacco surcharges.
These laws vary widely. There are often state insurance laws that apply to carriers issuing fully insured group health plans and not self-insured plans. But some states have smoker protection laws that prohibit employment discrimination based on tobacco use and arguably extend to tobacco surcharges. Employers should review the application of state law with their legal counsel.
Federal Enforcement Outlook
Like the recent class actions brought by employees, over the past decade the DOL has similarly sued several employers for applying tobacco surcharges that fail to satisfy HIPAA’s nondiscrimination rules, specifically, the failure to offer a compliant RAS. It is unclear what enforcement position the second Trump administration will take on tobacco surcharges.
These DOL lawsuits were filed and pursued under both the first Trump and Biden administrations. However, many policies from the first Trump administration that were continued by the Biden administration are currently being reexamined and reversed.
Further, in one ongoing DOL lawsuit, Secretary of Labor v. Macy’s, Inc., the court is considering how the Supreme Court’s recent Loper Bright decision overruling long-standing precedent that required deference to a federal agency’s rulemaking interpretation of a Congressional statute impacts the validity of the HIPAA nondiscrimination rules. The defendants are arguing that the HIPAA nondiscrimination rules, which require a premium refund upon completion of an RAS even if the participant continues to use tobacco, are inconsistent with HIPAA’s statutory language, which requires “adherence to programs of health promotion and disease prevention.” Specifically, the defendants’ argument is that “adherence” must mean quitting smoking or using other tobacco products.
The HIPAA regulatory requirements of offering an RAS were adopted into the law via the ACA. The defendants’ argument under the Loper case is questionable given that the RAS language is in the actual ACA statute and is not necessarily an agency interpretation. While the Loper case diminishes a court’s deference to an agency’s interpretation of ambiguity in a statute, a court independently interpreting the law may find that the statute itself clearly mandates the provision of an RAS each year, without any ambiguity.
For now, it remains to be seen whether the defendants’ challenge to the HIPAA nondiscrimination rules in the Macy’s case will prevail.
Final Thoughts
While it will take years for these lawsuits to play out in court, they indicate a tendency for some employers to take a more aggressive stance on tobacco surcharges, which can be quite risky. Noncompliant tobacco surcharges expose employers to costly litigation and court orders or settlements to refund surcharges spanning multiple plan years, potentially with additional penalties.
Employers applying tobacco surcharges should take this opportunity to pause and review their wellness program compliance with legal counsel. Employers interested in taking a more aggressive approach should do so with open eyes and the advice of legal counsel. A careful assessment now may save significant legal fees, reputational damage, and employee relations issues down the road.
PPI Benefit Solutions does not provide legal or tax advice. Compliance, regulatory and related content is for general informational purposes and is not guaranteed to be accurate or complete. You should consult an attorney or tax professional regarding the application or potential implications of laws, regulations or policies to your specific circumstances.
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