Mark A. Hall
Amy B. Monahan
Paying for Individual
When employees without group health insurance buy individual coverage, they do so
using after-tax income—costing them from 20% to 50% more than others pay for
equivalent coverage. Prior to the passage of the Patient Protection and Affordable Care
Act (PPACA), several states promoted a potential solution that would allow employees
to buy individual insurance through tax-sheltered payroll deduction. This technical but
creative approach would allow insurers to combine what is known as ‘‘list-billing’’ with a
Section 125 ‘‘cafeteria plan.’’ However, these state-level reform attempts have failed to
gain significant traction because state small-group reform laws and federal restrictions
on medical underwriting cloud the legality of tax-sheltered list-billing. Several
authorities have taken the position that insurance paid for through a cafeteria plan must
meet the nondiscrimination requirements of the Health Insurance Portability and
Accountability Act with respect to eligibility, premiums, and benefits. The recently
enacted Patient Protection and Affordable Care Act addresses some of the legal
uncertainty in this area, but much remains. For health reform to have its greatest effect,
federal regulators must clarify whether individual health insurance can be purchased on
a pre-tax basis through a cafeteria plan.
It is a conspicuous anomaly in the United
States that premiums for most private health
insurance are excluded from taxable income,
but not for the fairly small percentage of
people who buy individual coverage outside
the workplace. This differential tax treatment
effectively increases the cost of individual
coverage 20% to 50% or more. The Patient
Protection and Affordable Care Act of 2010
(PPACA) changes much about the way health
insurance is bought and paid for, but this
differential tax treatment remains. Neverthe-
less, making insurance more affordable is one
of PPACA’s central aims and is critical to the
success of its individual mandate.
One possible way for people with individual
coverage to obtain the same tax benefits as
employees is to pay for individual insurance
through payroll deduction using a ‘‘cafeteria
plan.’’ Authorized by Section 125 of the
Internal Revenue Code, cafeteria plans permit
employers to offer voluntary benefits on a pre-
tax basis. Many of us are familiar with flexible
spending accounts that reimburse out-of-
pocket medical costs with pre-tax dollars.
Section 125 plans also may be used to pay
Mark A. Hall, J.D., is a professor of law and public health at Wake Forest University Medical School. Amy B.
Monahan, J.D., is an associate professor at the University of Minnesota Law School. Work on this article was funded
by the Robert Wood Johnson Foundation’s State Health Access Reform Evaluation (SHARE) program, administered
by the University of Minnesota’s State Health Access Data Assistance Center. Address correspondence to Prof. Hall at
Wake Forest University Medical School, Division of Public Health Sciences, 2000 W. 1st St., Winston-Salem, NC
27157-1063. Email: firstname.lastname@example.org
Inquiry 47: 252–261 (Fall 2010). ’ 2010 Excellus Health Plan, Inc.
ISSN 0046-9580 10.5034/inquiryjrnl_47.03.252
health insurance premiums. This is what
allows employed individuals to pay their share
of group premiums on a pre-tax basis.
Usually only larger employers offer cafete-
ria plans with a full menu of benefits, but
Section 125 cafeteria plans can also be set up
for a single purpose such as paying health
insurance premiums. These ‘‘premium-only
cafeteria plans’’ are relatively simple to create
and administer. Therefore, they are fairly
ubiquitous as an adjunct to employer-spon-
sored group health insurance. Less common
is their use solely as a pre-tax mechanism to
pay for individual insurance without employ-
Prior to PPACA, several states sought to
capitalize on the tax advantages of Section
125 plans by requiring or encouraging all
employers to offer a cafeteria plan for the
pre-tax payment of health insurance premi-
ums, even if the employer did not sponsor a
group health plan (Hall, Hager, and Orentli-
cher 2010). For reasons discussed later, these
state efforts involved significant legal uncer-
tainty. Specifically, there was concern that
paying for health insurance through a cafete-
ria plan creates a ‘‘group health plan’’ for
purposes of the Health Insurance Portability
and Accountability Act of 1996 (HIPAA).
Group health plans are prohibited under
HIPAA from using health status to determine
eligibility, premiums, or benefits. Therefore,
it was legally unclear whether cafeteria plans
could be used to fund medically underwritten
health insurance without violating HIPAA.
PPACA will significantly
landscape by offering another option for
purchasing insurance—through government-
supervised exchanges that provide public
subsidies for low- and moderate-income
individuals. PPACA states that Section 125
plans may not be used for individual insur-
ance purchased through exchanges, but it is
silent about individual insurance purchased
outside an exchange. Working Americans
whose employers do not offer insurance will
continue to face substantial affordability
problems, especially if they do not qualify
for public subsidies. For them, the ability to
pay premiums on a pre-tax basis may be a
significant factor in whether they obtain
insurance coverage. Therefore, this article
explores the legal issues involved in paying
for individual health insurance on a pre-tax
basis, how PPACA will impact this area of
the law, and what questions remain.
This analysis draws in part from 64 interviews
conducted in the period 2008–2009 with
regulators (12), insurers (11), agents and
benefits advisers (22), employer groups (7),
and benefits administrators (12). These sourc-
es were spread fairly uniformly (14 to 18
each) nationally and among three states with
relevant laws—Indiana, Massachusetts, and
Missouri. These states were selected because
they were the first to adopt laws requiring or
encouraging employers to establish Section
125 plans and because each takes a different
legal approach (Table 1). Informants were
selected for interviews based on their known
or reported experience through a ‘‘snowball’’
process in which initial contacts in each
category recommended others; leads were
followed until reaching saturation—that is,
until no major new information or points of
view were encountered.
The first author conducted all interviews
except for four conducted by the second
author. Interviews were done in person or by
phone, following a guide that covered each
informant’s category; however, responses
were open-ended and lines of questioning
flexible. Interview notes were coded and
entered into QSR NVivo for retrieval and
systematic analysis. Relevant descriptive da-
ta, legal rulings, operating instructions, mar-
keting materials, and other documents were
collected and analyzed (primarily by the first
individual health insurance
Facilitating cafeteria plans for
State law approachExamples
Require employers (with exceptions)
to set up Section 125 plans for
Provide employers tax credits for
setting up Section 125 plans for
Allow insurers to sell individual
coverage through payroll
Individual Health Insurance
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