Buried deep in the Patient Protection and Affordable Care Act (PPACA) – the health care overhaul bill signed into law in March – are provisions governing the health insurance industry that could greatly impact how insurers pay their sales employees. Section 2718 – Bringing Down the Cost of Health Care Coverage – stipulates that on or after January 1, 2011, a health insurance issuer offering group or individual health insurance coverage (including a grandfathered health plan) must, for each plan year, provide an annual rebate to each health plan enrollee on a pro rata basis unless at least 85 percent of the premium revenue it receives in the large group market – or 80 percent in the small group or individual markets – is used to pay out medical claims, provide services, or make quality improvements. The ratio of premium revenue to pay out such claims in proportion to the premium revenue used to pay other expenses such as administration, advertising, or salaries, is commonly referred to as the insurer’s medical loss ratio. The difficulty for many health insurers – especially those catering to the individual and small markets – is that payment of commissions to their sales personnel can make up a large portion of their administrative expenses, thus lowering their medical cost rations below the 80 percent threshold.

The new medical loss ratio requirements could put downward pressure on commissions paid to insurance agents and brokers, particularly in the small group and individual markets. Insurers may be compelled to revise their commission plans and agreements in order to achieve the minimum target ratio and avoid the statutory rebate obligation. For most employers with sales staff selling health insurance on a commission basis, the January 1, 2011 effective date will allow a change to be made without the additional complications which can arise from changes made in the middle of a contract or plan year. However, insurers with commission plans not based on the calendar year who want to make mid-term revisions to their commission plans will need to consider whether the plan language permits them to do so.

Insurers who want to reduce commissions may consider reduced commission rates, higher quotas, targets or thresholds, caps on commission, flat fees or conversion to a salary and bonus system. Whatever course may be taken, these changes present both motivational and legal challenges. Following are guidelines employers can consider to minimize legal risks and issues related to commission plans:

• Put it in writing. Oral promises may be binding and are almost always problematic; oral revisions to existing terms are often ineffective. Absence of a written plan or agreement may mean that the “procuring cause” doctrine applies, giving employees a vehicle to claim a commission based on producing a willing and able purchaser. Some states, such as New York, require written plans, or the employees’ interpretation will be credited.
• Avoid ambiguity. Many commission plans are historical compilations that were originally written by sales managers and have been revised in fragments over the years, without careful attention to clarity or internal consistency. Some are complex groups of cross-referenced general policies, business unit plans, and individual quotas and commission statements. Such plans and policies are often treated as contracts by the courts and any ambiguity will be construed against the drafter, i.e., the employer. The same is true of bonus plans, for employers who choose to convert from a commission based system to a salary plus bonus system.
• Provide discretion to the employer. Consider including language that allows the employer to discontinue or modify the commission plan at any time, with the caveat, discussed below, of avoiding an unlawful forfeiture.
• Avoid unlawful forfeitures or charge backs. State wage payment laws generally apply to commissions, but differ widely on whether an employer may effect a forfeiture of commissions that are deemed to have been earned, or impose a chargeback that is not directly tied to the costs or the cancellation of a specific sale. And many state laws include statutory penalty provisions for failure to pay earned wages, up to treble damages and attorneys’ fees. Most problems arise when an employee is terminated after the “sale” but before the payment date, but similar issues can arise with the implementation of a new plan under which commissions on a sale would be reduced or eliminated. Some states have invalidated provisions requiring “continued employment” up to the payout date as a precondition of receiving commission payments.
• Limit commissions. It may be possible to pay substantial commissions to motivate sales representatives, but still have a ceiling on earnings to preclude the occurrence of an unexpected rebate obligation in the event of commission windfalls. However, these must be carefully drafted to conform to state law.
• Clarify draws and advances. Specify when reconciliation will occur and how they will be calculated (certain expenses, cancellations, returns, etc.). These are common points of confusion that can lead to pay claims and, again, may be subject to varying treatment under state law. Handled correctly draws and advances can protect the employer against payment of excess commissions.
• Consider payment timing rules. Most states require commissions (as “wages”) to be paid within one to four weeks of when they are earned. Thus, the requirements for “earning” a commission are key, but there are cases finding arbitrary requirements invalid as against public policy.
• Pay attention to overtime exemption laws. As we reported previously, there have been two class action suits filed by HMO and health insurance marketing representatives in federal court in New York, challenging their classification by their employers as exempt from overtime under the Fair Labor Standards Act (FLSA) and state wage laws. While inside sales representatives are rarely exempt from overtime, there is an exemption for outside sales representatives. Qualification for these exemptions may be different under state laws, which may impose stricter standards than the FLSA. For non-exempt sales representatives, commissions must be factored into the computation of overtime pay.

This entry was written by Thomas Flaherty and Ilyse Schuman.

Photo credit: DigitalZombie