[Federal Register Volume 67, Number 133 (Thursday, July 11, 2002)]
[Proposed Rules]
[Pages 45933-45945]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-17469]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-165868-01]
RIN 1545-BA47


10 or More Employer Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance regarding whether a welfare benefit fund is part of a 10 or 
more employer plan. The regulations reflect changes to the law made by 
the Deficit Reduction Act of 1984. The regulations will affect certain 
employers that provide welfare benefits to employees through a plan to 
which more than one employer contributes. This document also provides 
notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by October 9, 
2002. Requests to speak and outlines of topics to be discussed at the 
public hearing scheduled for Tuesday, November 5, 2002, must be 
received by Tuesday, October 15, 2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG-165868-01), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered between the hours of 8 a.m. 
and 5 p.m. to CC:ITA:RU (REG-165868-01), Courier's Desk, Internal 
Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. 
Alternatively, taxpayers may submit comments to the IRS Internet site 
at www.irs.gov/regs. The public hearing will be held in Room 4718, 
Internal Revenue Service Building, 1111 Constitution Avenue, NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Betty J. Clary, (202) 622-6080; concerning submissions of comments, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, Regulations Unit Paralegal (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collections of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of

[[Page 45934]]

Information and Regulatory Affairs, Washington, DC 20503, with copies 
to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, 
W:CAR:MP:FP:S Washington, DC 20224. Comments on the collections of 
information should be received by September 9, 2002. Comments are 
specifically requested concerning:
    Whether the proposed collections of information are necessary for 
the proper performance of the functions of the Internal Revenue 
Service, including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collections of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collections of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    The collections of information in this proposed regulation are in 
Sec. 1.419A(f)(6)-1(a)(2) and Sec. 1.419A(f)(6)-1(e). These collections 
of information are authorized by section 419A(i) of the Internal 
Revenue Code. This information will be required by the Commissioner and 
by employers participating in a plan that is intended to be a 10 or 
more employer plan described in section 419A(f)(6) to verify the plan's 
compliance with section 419A(f)(6). This information will be used by 
the Commissioner and by the employers to determine whether the 
provisions of sections 419 and 419A, concerning the deductibility of 
employer contributions to a welfare benefit fund, are applicable to the 
employers participating in the plan. The respondents are administrators 
of plans that include certain taxable or tax-exempt welfare benefit 
funds.
    Estimated total annual reporting and/or recordkeeping burden: 2500 
hours.
    Estimated average annual burden hours per respondent and/or 
recordkeeper: 25 hours.
    Estimated number of respondents and/or recordkeepers: 100.
    Estimated annual frequency of responses: On occasion.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains proposed amendments to the Income Tax 
Regulations under section 419A of the Internal Revenue Code. Sections 
419 and 419A, which were added to the Code by section 511 of the 
Deficit Reduction Act of 1984, Public Law 98-369 (98 Stat. 494), set 
forth special rules for the deduction of contributions to a welfare 
benefit fund that would otherwise be deductible, including limitations 
on the amount of the deduction. Pursuant to section 419A(f)(6), the 
rules of sections 419 and 419A do not apply in the case of a welfare 
benefit fund that is part of a plan to which more than one employer 
contributes and to which no employer normally contributes more than 10 
percent of the contributions of all employers under the plan. However, 
this exception for 10 or more employer plans does not apply to any plan 
that maintains experience-rating arrangements with respect to 
individual employers.
    Section 419A(i) of the Code provides that the Secretary shall 
prescribe regulations as may be appropriate to carry out the purposes 
of sections 419 and 419A. Section 419A(i) further provides that the 
regulations may provide that the plan administrator of any welfare 
benefit fund to which more than one employer contributes shall submit 
such information to the employers contributing to the fund as may be 
necessary to enable the employers to comply with the provisions of 
section 419A.
    The legislative history of sections 419 and 419A of the Code 
explains that the principal purpose of the deduction limits for 
contributions to welfare benefit funds ``is to prevent employers from 
taking premature deductions, for expenses which have not yet been 
incurred, by interposing an intermediary organization which holds 
assets which are used to provide benefits to the employees of the 
employer.'' H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1155 (1984), 
1984-3 C.B. (Vol. 2) 1, 409. The section 419(e)(3) definition of fund 
includes taxable trusts and organizations described in section 
501(c)(9) and includes regulatory authority to encompass ``any account 
held for an employer by any person.'' The legislative history indicates 
that the regulatory definition of fund should be broad and should 
encompass situations ``in which an employer may, in some cases, pay an 
insurance company more in a year than the benefit costs incurred in 
that year and the employer has an unconditional right in a later year 
to a refund or credit of the excess of payments over benefit costs.'' 
H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1155 (1984), 1984-3 C.B. 
(Vol. 2) 1, 409.\1\
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    \1\ Section 1851 of the Tax Reform Act of 1986, Public Law 99-
514 (100 Stat. 2085), modified the definition of ``fund'' in section 
419(e) to exclude amounts held pursuant to a specific type of 
insurance contract. While section 419(e)(4), as amended, clarifies 
that assets held by an insurance company under certain experience-
rated contracts do not constitute a fund (so that premiums under 
those contracts are not subject to the deduction limitations of 
section 419), this amendment has no relevance in determining whether 
a plan intended to be described in section 419A(f)(6) has an 
experience-rating arrangement with respect to individual employers. 
Any insurance contracts purchased under a 10 or more employer plan 
are investments of the fund and are not the fund itself.
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    The legislative history of section 419A(f)(6) of the Code explains 
that the reason the deduction limits of sections 419 and 419A do not 
generally apply to a fund that is part of a 10 or more employer plan is 
that ``the relationship of a participating employer to [such a] plan 
often is similar to the relationship of an insured to an insurer.'' 
H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1159 (1984), 1984-3 C.B. 
(Vol. 2) 1, 413. Thus, the premise underlying the exception is that no 
special limitation on deductions is necessary in situations where a 
payment by an employer in excess of the minimum necessary to currently 
provide for the benefits under the plan is effectively lost to that 
employer, because the economics of the plan will discourage excessive 
contributions.
    The exception to the deduction limitation does not apply, however, 
where the plan maintains experience-rating arrangements with respect to 
individual employers. The reason for excluding these plans from the 
exception is that an experience-rating arrangement with respect to an 
individual employer changes the economics of the plan and allows an 
employer to contribute an amount in excess of the minimum amount 
necessary to provide for the current benefits with the confidence that 
the excess will inure to the benefit of that employer or its employees. 
The legislative history notes that making the exception to the 
deduction limits unavailable to plans that determine contributions on 
the basis of experience rating is consistent with the general

[[Page 45935]]

rules relating to the definition of fund because ``the employer's 
interest with respect to such a plan is more similar to the 
relationship of an employer to a fund than an insured to an insurer.'' 
H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1159 (1984), 1984-3 C.B. 
(Vol. 2) 1, 413.
    In Notice 95-34, 1995-1 C.B. 309, the IRS identified certain types 
of arrangements that do not satisfy the requirements of section 
419A(f)(6). Those arrangements typically require large employer 
contributions relative to the cost of the coverage for the benefits to 
be provided under the plan. The plans identified in the Notice often 
maintain separate accounting of the assets attributable to the 
contributions made by each participating employer.\2\ In some cases an 
employer's contributions are related to the claims experience of its 
employees, while in other cases benefits are reduced if assets derived 
from an employer's contributions are insufficient to fund the benefits 
to that employer's employees. Thus, a particular employer's 
contributions or its employees' benefits may be determined in a way 
that insulates the employer to a significant extent from the experience 
of other participating employers.
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    \2\ See Booth v. Commissioner, 108 T.C. 524 (1997), for an 
arrangement using a separate accounting system that does not qualify 
under the 10 or more employer plan exception.
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    The arrangements described in Notice 95-34 and similar arrangements 
do not satisfy the requirements of section 419A(f)(6) of the Code and 
do not provide the tax deductions claimed by their promoters for any of 
several reasons. For example, such an arrangement may be providing 
deferred compensation; the arrangement may be separate plans maintained 
for each employer; or the plan may be maintaining, in form or in 
operation, experience-rating arrangements with respect to individual 
employers (e.g., where the employers have reason to expect that, at 
least for the most part, their contributions will benefit only their 
own employees). The Notice also states that even if an arrangement 
satisfies the requirements of section 419A(f)(6), so that the deduction 
limits of sections 419 and 419A do not apply to the arrangement, the 
employer contributions may represent expenses that are not deductible 
under other sections of the Code.
    In Notice 2000-15, 2000-1 C.B. 826 (supplemented and superseded by 
Notice 2001-51, 2001-34 I.R.B. 190), the Service identified 
transactions that are the same as or substantially similar to the 
transactions described in Notice 95-34 as listed transactions for 
purposes of Sec. 1.6011-4T(b)(2) of the Temporary Income Tax 
Regulations and Sec. 301.6111-2T(b)(2) of the Temporary Procedure and 
Administration Regulations. Independent of their classification as 
``listed transactions'' for purposes of Secs. 1.6011-4T(b)(2) and 
301.6111-2T(b)(2), such transactions may also be subject to the 
disclosure requirements of section 6011, the tax shelter registration 
requirements of section 6111, or the list maintenance requirements of 
section 6112 under the regulations issued in February 2000 
(Secs. 1.6011-4T, 301.6111-2T and 301.6112-1T, A-4), as well as the 
regulations issued in 1984 and amended in 1986 (Secs. 301.6111-1T and 
301.6112-1T, A-3). Persons required to register these tax shelters who 
have failed to register the shelters may be subject to the penalty 
under section 6707(a), and to the penalty under section 6708(a) if the 
requirements of section 6112 are not satisfied.

Explanation of Provisions

    These proposed regulations provide guidance under section 
419A(f)(6) of the Code regarding the requirements that a welfare 
benefit fund must satisfy in order for an employer's contribution to 
the fund to be excepted from the rules of sections 419 and 419A. These 
regulations are consistent with the IRS's analysis of the arrangements 
described in Notice 95-34, discussed above and reproduced below.
    Section 419A(f)(6) of the Code provides that sections 419 and 419A 
do not apply in the case of a welfare benefit fund that is part of a 10 
or more employer plan that does not maintain experience-rating 
arrangements with respect to individual employers. A 10 or more 
employer plan is a plan to which more than one employer contributes and 
to which no employer normally contributes more than 10 percent of the 
total contributions contributed under the plan by all employers.
    Pursuant to the authority set forth in section 419A(i), the 
proposed regulations provide a special rule to assist participating 
employers and the Commissioner in verifying that the arrangement 
satisfies the section 419A(f)(6) requirements. Under that rule, an 
arrangement satisfies the requirements of section 419A(f)(6) and the 
regulations only if the plan is maintained pursuant to a written 
document that (1) requires the plan administrator to maintain records 
sufficient for the Commissioner or any participating employer to 
readily verify the plan's compliance with section 419A(f)(6) and (2) 
provides the Commissioner and each participating employer with the 
right to inspect and copy all such records.
    In addition, the proposed regulations make clear that in order to 
be eligible for the exception from the deduction limits of sections 419 
and 419A, a plan must satisfy the requirements of section 419A(f)(6) 
and these regulations both in form and operation. For purposes of these 
regulations, the term plan means the totality of the arrangement and 
all related facts and circumstances, including any related insurance 
contracts. Thus, all agreements and understandings (including 
promotional materials and policy illustrations) will be taken into 
account in determining whether the requirements of section 419A(f)(6) 
are satisfied in form and in operation. For example, if promotional 
materials indicate that an employer or its employees will receive a 
future benefit based on the employer's accumulated contributions, the 
plan will be treated as maintaining experience-rating arrangements with 
respect to individual employers, even if the formal plan does not 
specifically provide for experience rating.
    The proposed regulations clarify the situations in which a plan 
maintains experience-rating arrangements with respect to individual 
employers for purposes of section 419A(f)(6). A plan maintains an 
experience-rating arrangement with respect to an employer if the 
employer's cost of coverage for any period is based, in whole or in 
part, either on the benefits experience or on the overall experience 
(or on any proxy for the benefits experience or overall experience) of 
that employer or one or more employees of that employer. The 
prohibition against experience rating with respect to individual 
employers applies under all circumstances, including employer 
withdrawals and plan terminations.
    For purposes of the proposed regulations, an employer's cost of 
coverage is the relationship between that employer's contributions 
(including those of its employees) under the plan and the benefits or 
other amounts payable under the plan with respect to that employer. The 
term benefits or other amounts payable includes all amounts payable or 
distributable (or that will be otherwise provided), regardless of the 
form of the payment or distribution. Benefits experience refers, 
generally, to the benefits and other amounts incurred, paid, or 
distributed (or otherwise provided) in the past. The overall experience 
of an employer is the balance that would have accumulated in a welfare 
benefit fund if that employer

[[Page 45936]]

were the only employer providing benefits under the plan. The overall 
experience of an employee is the balance that would have accumulated in 
a welfare benefit fund if that employee were the only employee being 
provided benefits under the plan. Overall experience is defined 
similarly for a group of employers or a group of employees.
    The proposed regulations illustrate various ways a plan can violate 
the prohibition against maintaining experience-rating arrangements with 
respect to individual employers: By adjusting an employer's 
contributions, by adjusting the benefits for its employees, or by 
adjusting both, based on the benefits experience or overall experience 
of the employees of that employer.
    Thus, a plan maintains an experience-rating arrangement with 
respect to an individual employer if the current (or future) cost of 
coverage of the employer is (or will be) based on either the past 
benefits or other amounts paid with respect to one or more of that 
employer's employees (or any proxy therefor) or on the balance 
accumulated in the fund as a result of the employer's or its employees' 
past contributions (or any proxy therefor). Accordingly, the process 
for determining whether a plan maintains an experience-rating 
arrangement is to inquire whether the past experience of an individual 
employer or its employees is used, in whole or in part, to determine 
the employer's cost of coverage. This determination is not intended to 
be purely a computational one (although actual numbers often can be 
used to demonstrate the existence of an experience-rating arrangement).
    The proposed regulations also include special rules that apply in 
certain situations. One rule applies where a plan specifies a minimum 
contribution required to maintain a benefit level, but permits an 
employer to contribute more, and the amount of benefits and duration of 
coverage are fixed. These plans commonly involve universal life 
insurance contracts with flexible premiums. When analyzing these 
arrangements, for purposes of determining whether an employer's cost of 
coverage is based on past experience, the Commissioner may treat the 
employer as contributing the minimum contribution amount needed to 
maintain that coverage. The relevant question would then be whether the 
relationship between the minimum amount the employer must contribute 
and the benefits or other amounts payable under the arrangement depends 
on the past experience of that employer or its employees.
    Another special rule is provided in the case of a plan maintaining 
an experience-rating arrangement with respect to a group of 
participating employers or a group of employees covered under the plan 
(a rating group). Under that rule, a plan will not be treated as 
maintaining an experience-rating arrangement with respect to an 
individual employer merely because the cost of coverage under a plan 
with respect to the employer is based, in whole or in part, on the 
benefits experience or the overall experience (or a proxy for either 
type of experience) of a rating group that includes the employer or one 
or more of its employees, provided that the employer does not normally 
contribute more than 10 percent of all contributions with respect to 
that rating group.
    Other special rules relate to the treatment of insurance contracts. 
Under those rules, insurance contracts under an arrangement are treated 
as assets of the fund. Thus, any payments under an arrangement from an 
employer or its employees directly to an insurance company will be 
treated as contributions to the fund, and any amounts paid by the 
insurance company under the arrangement will be treated as paid by the 
fund. Further, as of any date, the fund will be treated as having 
either a gain or loss with respect to an insurance contract, depending 
upon the benefits paid under the contract, the value of the contract, 
and the premiums paid on the contract.
    These special rules relating to insurance contracts recognize that 
if whole life insurance policies, or similar policies that generate a 
savings element, are purchased under an arrangement, the retained 
values of those policies (including cash values, reserves, and any 
other economic values, such as conversion credits or high dividend 
rates) reflect the past experience of the employees who participate 
under the plan. As a result, if the retained values associated with 
policies insuring an employer's employees under an arrangement are used 
to determine the current cost of coverage for that employer (as opposed 
to being shared among all of the employers participating in the plan), 
the employer can anticipate that its past contributions in excess of 
incurred losses for claims for its employees will inure to the benefit 
of the employer (as opposed to the other employers participating in the 
plan). This assurance that the employer will benefit from favorable 
past experience is the hallmark of an experience-rating arrangement. It 
is also the hallmark of the type of welfare benefit fund that Congress 
intended to be subject to the deduction limitations of sections 419 and 
419A.
    Furthermore, Congress' expectation that employers participating in 
10 or more employer plans would not have a financial incentive to over-
contribute was the basis for providing the section 419A(f)(6) exception 
from the deduction limits of sections 419 and 419A. Allowing a 10 or 
more employer plan to use insurance contracts for an employer's 
employees with retained values would provide a financial incentive for 
the employer to over-contribute to the plan, contrary to the premise 
underlying the intent of Congress in providing the exception for 10 or 
more employer plans. If the retained values of life insurance contracts 
relating to an employer's employees are used to determine that 
employer's cost of coverage, the arrangement results in a prohibited 
experience-rating arrangement under these proposed regulations.
    These proposed regulations also identify five characteristics that 
are indications that an employer's interest with respect to the plan is 
more similar to the relationship of an individual employer to a fund 
than an insured to an insurer. (See, H.R. Conf. Rep. No. 861, 98th 
Cong., 2d Sess. 1155 (1984), 1984-3 C.B. (Vol. 2) 1, 413.) The presence 
of some of these characteristics in a plan suggests that there are 
multiple plans present instead of a single plan. The presence of others 
tends to indicate that an employer's cost of coverage is (or will be) 
based on that employer's benefits experience. Others tend to indicate 
that the plan is expected to accumulate a surplus that ultimately will 
be used for the benefit of the individual employers (or their 
employees). One way this surplus might be used would be to reduce 
future contributions for the individual employers based on past 
contributions or claims of the employers. Another way would be to pay 
benefits to an employer's employees based on the employer's share of 
the surplus on the occasion of the withdrawal of the employer or at 
plan termination, thereby violating the rule that an employer's cost of 
coverage cannot be based on its overall experience. Accordingly, these 
regulations provide that a plan exhibiting any of these characteristics 
is not a 10 or more employer plan described in section 419A(f)(6) 
unless it is established to the satisfaction of the Commissioner that 
the plan satisfies the requirements of section 419A(f)(6) and these 
proposed regulations. It should be noted that the fact that a plan has 
none

[[Page 45937]]

of these characteristics does not create an inference that it is a 10 
or more employer plan described in section 419A(f)(6).
    The first characteristic indicating that a plan is not a 10 or more 
employer plan described in section 419A(f)(6) is that the assets of the 
plan are allocated among the participating employers through a separate 
accounting of contributions and expenditures for individual employers 
or otherwise. The second characteristic is that amounts charged under 
the plan differ among the employers in a manner that is not reflective 
of differences in risk or rating factors that are commonly taken into 
account in manual rates used by insurers (such as age, gender, 
dependents covered, geographic locale, or the benefit package). The 
third characteristic is that the plan does not provide for fixed 
welfare benefits for a fixed coverage period for a fixed price. The 
fourth characteristic is that the plan charges the participating 
employers an unreasonably high amount for the covered risk. The fifth 
characteristic is that the plan provides for payment of benefits upon 
triggering events other than the illness, personal injury, or death of 
an employee or family member, or the employee's involuntary termination 
of employment.
    A number of examples are provided in the proposed regulations 
illustrating the application of the rules regarding experience-rating 
arrangements to specific fact situations. Many of these arrangements 
exhibit the characteristics of a fund that Congress intended to be 
subject to the deduction limitations of sections 419 and 419A. Each 
example illustrates only the application of the definition of 
experience-rating arrangements under section 419A(f)(6) and these 
regulations, and no inference should be drawn from the scope of the 
examples about whether these plans are otherwise described in section 
419A(f)(6) or about any other provision of the Code. For example, no 
inference should be drawn about whether any plan described in the 
examples is a single plan. In addition, no inference should be drawn 
about the applicability or nonapplicability of any other Code 
provision, such as section 404, that might limit or preclude the 
deduction for contributions to the arrangement. For example, in 
Neonatology Associates, P.A., v. Commissioner, 115 T.C. 43 (2000), 
appeal docketed, No. 01-2862 (3d Cir.), the Tax Court held that the 
contributions were in large part constructive dividends to the 
employee/owners (and thus did not reach the government's alternative 
contention that the plan was maintaining experience-rating arrangements 
with respect to individual employers). In Booth v. Commissioner, 108 
T.C. 524 (1997), the Tax Court held that the arrangement was an 
aggregation of separate plans (and thus was not a single plan) and that 
there were experience-rating arrangements with respect to the 
individual employers.
    Finally, these proposed regulations provide that the plan 
administrator of a plan that is intended to be a 10 or more employer 
plan shall maintain records sufficient to substantiate that the plan is 
described in section 419A(f)(6). An opinion letter stating the plan is 
described in section 419A(f)(6) does not constitute substantiation.

Proposed Effective Date

    Except as explained below, these regulations--which generally 
clarify existing law--are proposed to be effective for contributions 
paid or incurred in taxable years of an employer beginning on or after 
the date of publication of this Notice of Proposed Rulemaking in the 
Federal Register. For contributions made before this proposed effective 
date, the IRS will continue applying existing law, including the 
analysis set forth in Notice 95-34 and relevant case law. Thus, 
taxpayers should not infer that a contribution that would be 
nondeductible under the regulations would be deductible if made before 
that date. In this regard, taxpayers are reminded that, as noted above, 
the IRS has already identified transactions that are the same as or 
substantially similar to the transactions described in Notice 95-34 as 
listed transactions for purposes of Sec. 1.6011-4T(b)(2) of the 
Temporary Income Tax Regulations and Sec. 301.6111-2T(b)(2) of the 
Temporary Procedure and Administration Regulations.
    The requirement that written plan documents contain specified 
provisions relating to compliance information and the record 
maintenance requirement for plan administrators are proposed to be 
effective for taxable years of a welfare benefit fund beginning after 
the publication of final regulations. Existing record retention 
requirements and record production requirements under section 6001 
continue to apply to employers and promoters.
    For the convenience of taxpayers, Notice 95-34 is reproduced below.

Appendix--Notice 95-34

    Taxpayers and their representatives have inquired as to whether 
certain trust arrangements qualify as multiple employer welfare 
benefit funds exempt from the limits of section 419 and section 419A 
of the Internal Revenue Code. The Service is issuing this Notice to 
alert taxpayers and their representatives to some of the significant 
tax problems that may be raised by these arrangements.
    In general, contributions to a welfare benefit fund are 
deductible when paid, but only if they qualify as ordinary and 
necessary business expenses of the taxpayer and only to the extent 
allowable under section 419 and section 419A of the Code. Those 
sections impose strict limits on the amount of tax-deductible 
prefunding permitted for contributions to a welfare benefit fund.
    Section 419A(f)(6) provides an exemption from section 419 and 
section 419A for certain welfare benefit funds. In general, for this 
exemption to apply, an employer normally cannot contribute more than 
10 percent of the total contributions, and the plan must not be 
experience rated with respect to individual employers. The 
legislative history states that the exemption under section 
419A(f)(6) is provided because ``the relationship of a participating 
employer to [such a] plan often is similar to the relationship of an 
insured to an insurer.'' Even if the 10 percent contribution limit 
is satisfied, the exemption does not apply to a plan that is 
experience rated with respect to individual employers, because the 
``employer's interest with respect to such a plan is more similar to 
the relationship of an employer to a fund than an insured to an 
insurer.'' H.R. Rep. No. 98-861, 98th Cong., 2d Sess., 1159 (1984-3 
C.B. (Vol. 2) 1, 413).
    In recent years a number of promoters have offered trust 
arrangements that they claim satisfy the requirements for the 10-or-
more-employer plan exemption and that are used to provide benefits 
such as life insurance, disability, and severance pay benefits. 
Promoters of these arrangements claim that all employer 
contributions are tax-deductible when paid, relying on the 10-or-
more-employer exemption from the section 419 limits and on the fact 
that they have enrolled at least 10 employers in their multiple 
employer trusts.
    These arrangements typically are invested in variable life or 
universal life insurance contracts on the lives of the covered 
employees, but require large employer contributions relative to the 
cost of the amount of term insurance that would be required to 
provide the death benefits under the arrangement. The trust owns the 
insurance contracts. The trust administrator may obtain the cash to 
pay benefits, other than death benefits, by such means as cashing in 
or withdrawing the cash value of the insurance policies. Although, 
in some plans, benefits may appear to be contingent on the 
occurrence of unanticipated future events, in reality, most 
participants and their beneficiaries will receive their benefits.
    The trusts often maintain separate accounting of the assets 
attributable to the contributions made by each subscribing employer. 
Benefits are sometimes related to the amounts allocated to the 
employees of the participant's employer. For example, severance and 
disability benefits may be subject to reduction if the assets 
derived from an employer's contributions are insufficient to fund 
all benefits promised to that employer's employees. In other cases, 
an

[[Page 45938]]

employer's contributions are related to the claims experience of its 
employees. Thus, pursuant to formal or informal arrangements or 
practices, a particular employer's contributions or its employees' 
benefits may be determined in a way that insulates the employer to a 
significant extent from the experience of other subscribing 
employers.
    In general, these arrangements and other similar arrangements do 
not satisfy the requirements of the section 419A(f)(6) exemption and 
do not provide the tax deductions claimed by their promoters for any 
one of several reasons, including the following:
    (1) The arrangements may actually be providing deferred 
compensation. This is an especially important consideration in 
arrangements similar to that in Wellons v. Commissioner, 31 F.3d 569 
(7th Cir. 1994), aff'g, 64 T.C.M. (CCH) 1498 (1992), where the 
courts held that an arrangement purporting to be a severance pay 
plan was actually deferred compensation. If the plan is a 
nonqualified plan of deferred compensation, deductions for 
contributions will be governed by section 404(a)(5), and 
contributions to the trust may, in some cases, be includible in 
employees' income under section 402(b). Section 404(a)(5) provides 
that contributions to a nonqualified plan of deferred compensation 
are deductible when amounts attributable to the contributions are 
includible in the employees' income, and that deductions are allowed 
only if separate accounts are maintained for each employee.
    (2) The arrangements may be, in fact, separate plans maintained 
for each employer. As separate plans, they do not qualify for the 
10-or-more employer plan exemption in section 419A(f)(6).
    (3) The arrangements may be experience rated with respect to 
individual employers in form or operation. This is because, among 
other things, the trust maintains, formally or informally, separate 
accounting for each employer and the employers have reason to expect 
that, at least for the most part, their contributions will benefit 
only their own employees. Arrangements that are experience rated 
with respect to individual employers do not qualify for the 
exemption in section 419A(f)(6).
    (4) Even if the arrangements qualify for the exemption in 
section 419A(f)(6), employer contributions to the arrangements may 
represent prepaid expenses that are nondeductible under other 
sections of the Internal Revenue Code.
    Taxpayers and their representatives should be aware that the 
Service has disallowed deductions for contributions to these 
arrangements and is asserting the positions discussed above in 
litigation.
    Finally, in response to questions raised by taxpayers and their 
representatives, we note that the Service has never issued a letter 
ruling approving the deductibility of contributions to a welfare 
benefit fund under section 419A(f)(6). Although a trust used to 
provide benefits under an arrangement of the type discussed in this 
Notice may have received a determination letter stating that the 
trust is exempt under section 501(c)(9), a letter of this type does 
not address the tax deductibility of contributions to such a trust.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It has also been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) does not apply to these regulations. It is hereby certified 
that the collections of information in these regulations will not have 
a significant economic impact on a substantial number of small 
entities. The collections of information in the regulation are in 
Sec. 1.419A(f)(6)-1(a)(2) and Sec. 1.419A(f)(6)-1(e) and consist of the 
requirements that a plan administrator maintain certain information and 
that it provide that information upon request to the Commissioner and 
to employers participating in the plan. This certification is based on 
the fact that requests for such information are likely to be made, on 
average, less than once per year per employer and that the costs of 
maintaining and providing this information are small. In addition, 
relatively few small entities are plan administrators. Therefore, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the 
Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    A public hearing has been scheduled for November 5, 2002 at 10 
a.m., in room 4718 of the Internal Revenue Building, 1111 Constitution 
Avenue NW., Washington, DC. Because of access restrictions, visitors 
must enter at the main entrance, located at 1111 Constitution Ave, NW. 
All visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 30 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend hearing, see the FOR FURTHER INFORMATION CONTACT 
portion of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit electronic or 
written comments and an outline of topics to be discussed and time to 
be devoted to each topic (preferably a signed original and eight (8) 
copies) by October 15, 2002. A period of 10 minutes will be allotted to 
each person for making comments. An agenda showing the scheduling of 
the speakers will be prepared after the deadline for receiving outlines 
has passed. Copies of the agenda will be available free of charge at 
the hearing.

Drafting Information

    The principal author of these regulations is Betty J. Clary, Office 
of the Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 *  *  *.

    Section 1.419A(f)(6)-1 is also issued under 26 U.S.C. 419A(i). * * 
*
    Par. 2. Section 1.419A(f)(6)-1 is added to read as follows:


Sec. 1.419A(f)(6)-1  Exception for 10 or more employer plan.

    (a) Requirements--(1) In general. Sections 419 and 419A do not 
apply in the case of a welfare benefit fund that is part of a 10 or 
more employer plan described in section 419A(f)(6). A plan is a 10 or 
more employer plan described in section 419A(f)(6) only if it is a 
single plan--
    (i) To which more than one employer contributes;
    (ii) To which no employer normally contributes more than 10 percent 
of the total contributions contributed under the plan by all employers;
    (iii) That does not maintain an experience-rating arrangement with 
respect to any individual employer; and
    (iv) That satisfies the requirements of paragraph (a)(2) of this 
section.
    (2) Compliance information. A plan satisfies the requirements of 
this paragraph (a)(2) if the plan is maintained pursuant to a written 
document that requires the plan administrator to maintain records 
sufficient for the Commissioner or any participating employer to 
readily verify that the plan satisfies the requirements of section 
419A(f)(6) and this section

[[Page 45939]]

and that provides the Commissioner and each participating employer (or 
a person acting on the participating employer's behalf) with the right, 
upon written request to the plan administrator, to inspect and copy all 
such records. See Sec. 1.414(g)-1 for the definition of plan 
administrator.
    (3) Application of rules--(i) In general. The requirements 
described in paragraph (a)(1) and (a)(2) of this section must be 
satisfied both in form and in operation.
    (ii) Plan includes totality of arrangement. For purposes of this 
section, the term plan includes the totality of the arrangement and all 
related facts and circumstances, including any related insurance 
contracts. Accordingly, all agreements and understandings (including 
promotional materials and policy illustrations) and the terms of any 
insurance contract will be taken into account in determining whether 
the requirements are satisfied in form and in operation.
    (b) Experience-rating arrangements--(1) General rule. A plan 
maintains an experience-rating arrangement with respect to an 
individual employer and thus does not satisfy the requirement of 
paragraph (a)(1)(iii) of this section if, with respect to that 
employer, there is any period for which the relationship of 
contributions under the plan to the benefits or other amounts payable 
under the plan (the cost of coverage) is or can be expected to be 
based, in whole or in part, on the benefits experience or overall 
experience (or a proxy for either type of experience) of that employer 
or one or more employees of that employer. For purposes of this 
paragraph (b)(1), an employer's contributions include all contributions 
made by or on behalf of the employer or the employer's employees. See 
paragraph (d) of this section for the definitions of benefits 
experience, overall experience, and benefits or other amounts payable. 
The rules of this paragraph (b) apply under all circumstances, 
including employer withdrawals and plan terminations.
    (2) Adjustment of contributions. An example of a plan that 
maintains an experience-rating arrangement with respect to an 
individual employer is a plan that entitles an employer to (or for 
which the employer can expect) a reduction in future contributions if 
that employer's overall experience is positive. Similarly, a plan 
maintains an experience-rating arrangement with respect to an 
individual employer where an employer can expect its future 
contributions to be increased if the employer's overall experience is 
negative. A plan also maintains an experience-rating arrangement with 
respect to an individual employer where an employer is entitled to 
receive (or can expect to receive) a rebate of all or a portion of its 
contributions if that employer's overall experience is positive or, 
conversely, where an employer is liable to make additional 
contributions if its overall experience is negative.
    (3) Adjustment of benefits. An example of a plan that maintains an 
experience-rating arrangement with respect to an individual employer is 
a plan under which benefits for an employer's employees are (or can be 
expected to be) increased if that employer's overall experience is 
positive or, conversely, under which benefits are (or can be expected 
to be) decreased if that employer's overall experience is negative. A 
plan also maintains an experience-rating arrangement with respect to an 
individual employer if benefits for an employer's employees are limited 
by reference, directly or indirectly, to the overall experience of the 
employer (rather than having all the plan assets available to provide 
the benefits).
    (4) Special rules--(i) Treatment of insurance contracts--(A) In 
general. For purposes of this section, insurance contracts under the 
arrangement will be treated as assets of the fund. Accordingly, the 
value of the insurance contracts (including non-guaranteed elements) is 
included in the value of the fund, and amounts paid between the fund 
and the insurance company are disregarded, except to the extent they 
generate gains or losses as described in paragraph (b)(4)(i)(c) of this 
section.
    (B) Payments to and from an insurance company. Payments from a 
participating employer or its employees to an insurance company 
pursuant to insurance contracts under the arrangement will be treated 
as contributions made to the fund, and amounts paid under the 
arrangement from an insurance company will be treated as payments from 
the fund.
    (C) Gains and losses from insurance contracts. As of any date, if 
the sum of the benefits paid by the insurer and the value of the 
insurance contract (including non-guaranteed elements) is greater than 
the cumulative premiums paid to the insurer, the excess is treated as a 
gain to the fund. As of any date, if the cumulative premiums paid to 
the insurer are greater than the sum of the benefits paid by the 
insurer and the value of the insurance contract (including non-
guaranteed elements), the excess is treated as a loss to the fund.
    (ii) Treatment of flexible contribution arrangements. Solely for 
purposes of determining the cost of coverage under a plan, if 
contributions for any period can vary with respect to a benefit 
package, the Commissioner may treat the employer as contributing the 
minimum amount that would maintain the coverage for that period.
    (iii) Experience rating by group of employers or group of 
employees. A plan will not be treated as maintaining an experience-
rating arrangement with respect to an individual employer merely 
because the cost of coverage under the plan with respect to the 
employer is based, in whole or in part, on the benefits experience or 
the overall experience (or a proxy for either type of experience) of a 
rating group, provided that no employer normally contributes more than 
10 percent of all contributions with respect to that rating group. For 
this purpose, a rating group means a group of participating employers 
that includes the employer or a group of employees covered under the 
plan that includes one or more employees of the employer.
    (iv) Family members, etc. For purposes of this section, 
contributions with respect to an employee include contributions with 
respect to any other person (e.g., a family member) who may be covered 
by reason of the employee's coverage under the plan and amounts 
provided with respect to an employee include amounts provided with 
respect to such a person.
    (c) Characteristics indicating a plan is not a 10 or more employer 
plan--(1) In general. The presence of any of the characteristics 
described in paragraphs (c)(2) through (c)(6) of this section generally 
indicates that the plan is not a 10 or more employer plan described in 
section 419A(f)(6). Accordingly, unless established to the satisfaction 
of the Commissioner that the plan satisfies the requirements of section 
419A(f)(6) and this section, a plan having any of the following 
characteristics is not a 10 or more employer plan described in section 
419A(f)(6). A plan's lack of all the following characteristics does not 
create any inference that the plan is a 10 or more employer plan 
described in section 419A(f)(6).
    (2) Allocation of plan assets. Assets of the plan or fund are 
allocated to a specific employer or employers through separate 
accounting of contributions and expenditures for individual employers, 
or otherwise.
    (3) Differential pricing. The amount charged under the plan is not 
the same for all the participating employers, and those differences are 
not reflective of differences in risk or rating factors that

[[Page 45940]]

are commonly taken into account in manual rates used by insurers (such 
as age, gender, geographic locale, number of covered dependents, and 
benefit terms) for the particular benefit or benefits being provided.
    (4) No fixed welfare benefit package. The plan does not provide for 
fixed welfare benefits for a fixed coverage period for a fixed cost, 
within the meaning of paragraph (d)(5) of this section.
    (5) Unreasonably high cost. The plan provides for fixed welfare 
benefits for a fixed coverage period for a fixed cost, but that cost is 
unreasonably high for the covered risk for the plan as a whole.
    (6) Nonstandard benefit triggers. Benefits or other amounts payable 
can be paid, distributed, transferred, or otherwise provided from a 
fund that is part of the plan by reason of any event other than the 
illness, personal injury, or death of an employee or family member, or 
the employee's involuntary separation from employment. Thus, for 
example, a plan exhibits this characteristic if the plan provides for 
the payment of benefits to an employer's employees on the occasion of 
the employer's withdrawal from the plan.
    (d) Definitions. For purposes of this section:
    (1) Benefits or other amounts payable. The term benefits or other 
amounts payable includes all amounts that are payable or distributable 
(or that will be otherwise provided) directly or indirectly to 
employers, to employees or their beneficiaries, or to another fund as a 
result of a spinoff or transfer, and without regard to whether payable 
or distributable as welfare benefits, cash, dividends, rebates of 
contributions, property, promises to pay, or otherwise.
    (2) Benefits experience. The benefits experience of an employer (or 
of an employee or a group of employers or employees) means the benefits 
and other amounts incurred, paid, or distributed (or otherwise 
provided) directly or indirectly, including to another fund as a result 
of a spinoff or transfer, with respect to the employer (or employee or 
group of employers or employees), and without regard to whether 
provided as welfare benefits, cash, dividends, credits, rebates of 
contributions, property, promises to pay, or otherwise.
    (3) Overall experience--(i) Employers. The term overall experience 
means, with respect to an employer (or group of employers), the balance 
that would have accumulated in a welfare benefit fund if that employer 
(or those employers) were the only employer (or employers) providing 
welfare benefits under the plan. Thus, the overall experience is 
credited with the sum of the contributions under the plan with respect 
to that employer (or group of employers), less the benefits and other 
amounts paid or distributed (or otherwise provided) with respect to 
that employer (or group of employers) or the employees of that employer 
(or group of employers), and adjusted for gain or loss from insurance 
contracts (as described in paragraph (b)(4)(i) of this section), 
investment return, and expenses. Overall experience as of any date may 
be either a positive or a negative number.
    (ii) Employees. The term overall experience means, with respect to 
an employee (or group of employees, whether or not employed by the same 
employer), the balance that would have accumulated in a welfare benefit 
fund if the employee (or group of employees) were the only employee (or 
employees) being provided welfare benefits under the plan. Thus, the 
overall experience is credited with the sum of the contributions under 
the plan with respect to that employee (or group of employees), less 
the benefits and other amounts paid or distributed (or otherwise 
provided) with respect to that employee (or group of employees), and 
adjusted for gain or loss from insurance contracts (as described in 
paragraph (b)(4)(i) of this section), investment return, and expenses. 
Overall experience as of any date may be either a positive or a 
negative number.
    (4) Employer. The term employer means the employer whose employees 
are participating in the plan and those employers required to be 
aggregated with the employer under section 414(b), (c), or (m). In the 
case of an employer that is the recipient of services performed by a 
leased employee described in section 414(n) who participates in the 
plan, the leased employee is treated as an employee of the recipient 
and contributions made by the leasing organization attributable to 
service performed with the recipient are treated as made by the 
recipient.
    (5) Fixed welfare benefit package--(i) In general. A plan provides 
for fixed welfare benefits for a fixed coverage period for a fixed 
cost, if it--
    (A) Defines one or more welfare benefits, each of which has a fixed 
amount that does not depend on the amount or type of assets held by the 
fund,
    (B) Specifies fixed contributions to provide for those welfare 
benefits, and
    (C) Specifies a coverage period during which the plan agrees to 
provide specified welfare benefits, subject to the payment of the 
specified contributions by the employer.
    (ii) Treatment of actuarial gains or losses. A plan will not be 
treated as failing to provide for fixed welfare benefits for a fixed 
coverage period for a fixed cost merely because the plan does not pay 
the promised benefits (or requires all participating employers to make 
proportionate additional contributions based on the fund's shortfall) 
when there are insufficient assets under the plan to pay the promised 
benefits. Similarly, a plan will not be treated as failing to provide 
for fixed welfare benefits for a fixed coverage period for a fixed cost 
merely because the plan provides a period of extended coverage after 
the end of the coverage period to all participating employers at no 
cost to the employers (or provides a proportionate refund of 
contributions to all participating employers) because of the plan-wide 
favorable actuarial experience during the coverage period.
    (e) Maintenance of records. The plan administrator of a plan that 
is intended to be a 10 or more employer plan described in section 
419A(f)(6) shall maintain permanent records and other documentary 
evidence sufficient to substantiate that the plan satisfies the 
requirements of section 419A(f)(6) and this section. (See 
Sec. 1.414(g)-1 for the definition of plan administrator.)
    (f) Examples. The provisions of paragraph (c) of this section and 
the provisions of section 419A(f)(6) and this section relating to 
experience-rating arrangements may be illustrated by the following 
examples. Unless stated otherwise, it should be assumed that any life 
insurance contract described in an example is non-participating and has 
no value other than the value of the policy's current life insurance 
protection plus its cash value. Paragraph (ii) of each example applies 
the characteristics listed in paragraph (c) of this section to the 
facts described in that example. Paragraphs (iii) and (iv) of each 
example analyze the facts described in the example to determine whether 
the plan maintains experience-rating arrangements with respect to 
individual employers. Paragraphs (iii) and (iv) of each example 
illustrate only the meaning of experience-rating arrangements. No 
inference should be drawn from these examples about whether these plans 
are otherwise described in section 419A(f)(6) or about the 
applicability or nonapplicability of any other Internal Revenue Code 
provision that may limit or deny the deduction of contributions to the 
arrangements. Further, no inference should be drawn from the examples 
concerning the tax treatment of employees as a result of the employer

[[Page 45941]]

contributions or the provision of the benefits.

    Example 1. (i) An arrangement provides welfare benefits to 
employees of participating employers. Each year a participating 
employer is required to contribute an amount equal to the claims and 
other expenses expected with respect to that employer for the year 
(based on age, gender, geographic locale, number of participating 
employees, benefit terms, and other risk or rating factors commonly 
taken into account in manual rates used by insurers for the benefits 
being provided), multiplied by the ratio of actual claims with 
respect to that employer for the previous year over the expected 
claims with respect to that employer for the previous year. No 
employer participating in the arrangement contributes more than 10 
percent of the total contributions made under the arrangement by all 
the employers.
    (ii) This arrangement exhibits at least one of the 
characteristics listed in paragraph (c) of this section generally 
indicating that the arrangement is not a 10 or more employer plan 
described in section 419A(f)(6). Differential pricing exists under 
this arrangement because the amount charged under the plan is not 
the same for all the participating employers, and those differences 
are not reflective of differences in risk or rating factors that are 
commonly taken into account in manual rates used by insurers for the 
particular benefit or benefits being provided.
    (iii) This arrangement does not satisfy the requirements of 
section 419A(f)(6) and this section because, at a minimum, the 
requirement of paragraph (a)(1)(iii) of this section is not 
satisfied. Under the arrangement, an employer's cost of coverage for 
each year is based, in part, on that employer's benefits experience 
(i.e., the benefits and other amounts provided in the past with 
respect to one or more employees of that employer). Accordingly, 
pursuant to paragraph (b)(1) of this section, the arrangement 
maintains experience-rating arrangements with respect to individual 
employers.
    Example 2. (i) The facts are the same as in Example 1, except 
that the amount charged to an employer each year is equal to claims 
and other expenses expected with respect to that employer for the 
year (determined the same as in Example 1), multiplied by the ratio 
of actual claims for the previous year (determined on a plan-wide 
basis) over the expected claims for the previous year (determined on 
a plan-wide basis).
    (ii) Based on the limited facts described above, this 
arrangement exhibits none of the characteristics listed in paragraph 
(c) of this section generally indicating that the arrangement is not 
a 10 or more employer plan described in section 419A(f)(6). Unlike 
the arrangement discussed in Example 1, there is no differential 
pricing under the arrangement because the only differences in the 
amounts charged to the employers are solely reflective of 
differences in risk or rating factors that are commonly taken into 
account in manual rates used by insurers for the particular benefit 
or benefits being provided.
    (iii) Nothing in the facts described in this Example 2 indicates 
that the arrangement maintains experience-rating arrangements 
prohibited under section 419A(f)(6) and this section. An employer's 
cost of coverage under the arrangement is based, in part, on the 
benefits experience of that employer (as well as of all the other 
participating employers). However, pursuant to paragraph (b)(4)(iii) 
of this section, the arrangement will not be treated as maintaining 
experience-rating arrangements with respect to the individual 
employers merely because the employers' cost of coverage is based on 
the benefits experience of a group of employees eligible under the 
plan, provided no employer normally contributes more than 10 percent 
of all contributions with respect to the rating group that includes 
the employees of an individual employer. Under the arrangement 
described in this Example 2, the rating group includes all the 
participating employers (or all of their employees), and no employer 
normally contributes more than 10 percent of the contributions made 
under the arrangement by all the employers. Accordingly, absent 
other facts, the arrangement will not be treated as maintaining 
experience-rating arrangements with respect to individual employers.
    Example 3. (i) Arrangement A provides welfare benefits to 
employees of participating employers. Each year an employer is 
required to contribute an amount equal to the claims and other 
expenses expected with respect to that employer for the year (based 
on risk or rating factors commonly taken into account in manual 
rates used by insurers for the benefits being provided), adjusted 
based on the employer's notional account. An employer's notional 
account is determined as follows. The account is credited with the 
sum of the employer's contributions previously paid under the plan 
less the benefit claims for that employer's employees. The notional 
account is further increased by a fixed five percent investment 
return (regardless of the actual investment return earned on the 
funds). If an employer's notional account is positive, the 
employer's contributions are reduced by a specified percentage of 
the notional account. If an employer's notional account is negative, 
the employer's contributions are increased by a specified percentage 
of the notional account.
    (ii) Arrangement A exhibits at least two of the characteristics 
listed in paragraph (c) of this section generally indicating that 
the arrangement is not a 10 or more employer plan described in 
section 419A(f)(6). First, assets under the plan are allocated to 
specific employers. Second, differential pricing exists because the 
amount charged under the plan is not the same for all the 
participating employers, and those differences are not reflective of 
differences in risk or rating factors that are commonly taken into 
account in manual rates used by insurers for the particular benefit 
or benefits being provided.
    (iii) Arrangement A does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. Under the 
arrangement, a participating employer's cost of coverage for each 
year is based on a proxy for that employer's overall experience. An 
employer's overall experience, as that term is defined in paragraph 
(d)(3) of this section, includes the balance that would have 
accumulated in the fund if that employer's employees were the only 
employees being provided benefits under the plan. Under that 
definition, the overall experience is credited with the sum of the 
contributions paid under the plan by or on behalf of that employer 
less the benefits or other amounts provided to with respect to that 
employer's employees, and adjusted for gain or loss from insurance 
contracts, expenses, and investment return. Under the formula used 
by the arrangement in this example to determine employer 
contributions, expenses are disregarded and a fixed investment 
return of five percent is used instead of actual investment return. 
The disregard of expenses and substitution of the fixed investment 
return for the actual investment return merely results in an 
employer's notional account that is a proxy for the overall 
experience of that employer. Accordingly, the arrangement maintains 
experience-rating arrangements with respect to individual employers.
    Example 4. (i) Under Arrangement B, death benefits are provided 
for eligible employees of each participating employer. Individual 
level premium life insurance policies are purchased to provide the 
death benefits. Each policy has a face amount equal to the death 
benefit payable with respect to the individual employee. Each year, 
a participating employer is charged an amount equal to the level 
premiums payable with respect to the employees of that employer. One 
participating employer, F, has an employee, P, whose coverage under 
the arrangement commenced at the beginning of 2000, when P was age 
50. P is covered under the arrangement for $1 million of death 
benefits, and a life insurance policy with a face amount of $1 
million has been purchased on P's life. The level annual premium on 
the policy is $23,000. At the beginning of 2005, when P is age 55, 
the $23,000 premium amount has been paid for five years and the 
policy, which continues to have a face amount of $1 million, has a 
cash value of $92,000. Another employer, G, has an employee, R, who 
is also 55 years old at the beginning of 2005 and is covered under 
Arrangement B for $1 million, for which a level premium life 
insurance policy with a face amount of $1 million has been 
purchased. However, R did not become covered under Arrangement B 
until the beginning of 2005. Because R's coverage began at age 55, 
the level annual premium charged for the policy on R's life is 
$30,000, or $7,000 more than the premiums payable on the policy in 
effect on P's life. Employer F is charged $23,000 and employer G is 
charged $30,000 for the death benefit for employees P and R, 
respectively. Assume that employees P and R are the only covered 
employees of their respective employers and that they are identical 
with respect to any risk and rating factors used by the insurer 
(other than age at policy issuance).
    (ii) Arrangement B exhibits at least three of the 
characteristics listed in paragraph (c) of this section generally 
indicating that the arrangement is not a 10 or more employer

[[Page 45942]]

plan described in section 419A(f)(6). First, assets of the plan are 
effectively allocated to specific employers. Second, there is 
differential pricing under the arrangement. That is, the amount 
charged under the plan during the year for a specific amount of 
death benefit coverage is not the same for all the employers 
(employer F is charged $23,000 each year for $1 million of death 
benefit coverage while employer G is charged $30,000 each year for 
the same coverage), and the difference is not reflective of 
differences in risk or rating factors that are commonly taken into 
account in manual rates used by insurers for the death benefit being 
provided (employees P and R are the same age). Third, there is 
unreasonably high cost, at least during the early years of coverage 
under the arrangement when the amounts charged to an employer for 
that employee's death benefit coverage are unreasonably high for the 
covered risk for the plan as a whole.
    (iii) Arrangement B does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. 
Arrangement B maintains experience-rating arrangements with respect 
to individual employers because the cost of coverage for each year 
for any employer participating in the arrangement is based on a 
proxy for the overall experience of that employer. Under Arrangement 
B, employer F's cost of coverage for 2005 is $23,000 for $1 million 
of coverage. The $92,000 cash value at the beginning of 2005 in the 
policy insuring P's life is a proxy for employer F's overall 
experience. (The $92,000 is essentially the balance that would have 
accumulated in the fund if employer F were the only employer 
providing welfare benefits under Arrangement B.) Further, the 
$23,000 charged to F for the $1 million of coverage in 2005 is based 
on the $92,000 since, in the absence of the $92,000, employer F 
would have been charged $30,000 for P's $1 million death benefit 
coverage. (Note that the conclusion that the $92,000 balance is the 
basis for the lower premium charged to employer F is consistent with 
the fact that a $92,000 balance, if converted to a life annuity 
using the same actuarial assumptions as were used to calculate the 
cash value amount, would be sufficient to provide for annual annuity 
payments of $7,000 for the life of P--an amount equal to the $7,000 
difference from the premium charged in 2005 to employer G for the $1 
million of coverage on employee R's life.) Thus, F's cost of 
coverage for 2005 is based on a proxy for F's overall experience. 
Accordingly, Arrangement B maintains an experience-rating 
arrangement with respect to employer F.
    (iv) Arrangement B also maintains an experience-rating 
arrangement with respect to employer G because it can be expected 
that each year G will be charged $30,000 for the $1 million of 
coverage on R's life. Each year, G's cost of coverage will reflect 
G's prior contributions and allocable earnings, so that G's cost of 
coverage will be based on a proxy for G's overall experience. 
Accordingly, Arrangement B maintains an experience-rating 
arrangement with respect to employer G. Similarly, Arrangement B 
maintains an experience-rating arrangement with respect to each 
other participating employer. Accordingly, Arrangement B maintains 
experience-rating arrangements with respect to individual employers. 
This would also be the result if Arrangement B maintained an 
experience-rating arrangement with respect to only one individual 
employer.
    Example 5. (i) Under Arrangement C, death benefits are provided 
for eligible employees of each participating employer. Flexible 
premium universal life insurance policies are purchased to provide 
the death benefits. Each policy has a face amount equal to the death 
benefit payable with respect to the individual employee. Each 
participating employer can make any contributions to the arrangement 
provided that the amount paid for each employee is at least the 
amount needed to prevent the lapse of the policy. The amount needed 
to prevent the lapse of the universal life insurance policy is the 
excess, if any, of the mortality and expense charges for the year 
over the policy balance. All contributions made by an employer are 
paid as premiums to the universal life insurance policies purchased 
on the lives of the covered employees of that employer. 
Participating employers H and J each have a 50-year-old employee 
covered under Arrangement C for death benefits of $1 million, which 
is the face amount of the respective universal life insurance 
policies on the lives of the employees. In the first year of 
coverage employer H makes a contribution of $23,000 (the amount of a 
level premium) while employer J contributes only $6,000, which is 
the amount of the mortality and expense charges for the first year. 
At the beginning of year two, the balance in employer H's policy 
(including earnings) is $18,000, but the balance in J's policy is 
zero. Although H is not required to contribute anything in the 
second year of coverage, H contributes an additional $15,000 in the 
second year. Employer J contributes $7,000 in the second year.
    (ii) Arrangement C exhibits at least two of the characteristics 
listed in paragraph (c) of this section generally indicating that 
the arrangement is not a 10 or more employer plan described in 
section 419A(f)(6). First, assets of the plan are effectively 
allocated to specific employers. Second, the arrangement does not 
provide for fixed welfare benefits for a fixed coverage period for a 
fixed cost.
    (iii) Arrangement C does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. 
Arrangement C maintains experience-rating arrangements with respect 
to individual employers because the cost of coverage of an employer 
participating in the arrangement is based on a proxy for the overall 
experience of that employer. Pursuant to paragraph (b)(4)(ii) of 
this section (concerning treatment of flexible contribution 
arrangements), solely for purposes of determining an employer's cost 
of coverage, the Commissioner may treat an employer as contributing 
the minimum amount needed to maintain the coverage. Applying this 
treatment, H's cost of coverage for the first year of coverage under 
Arrangement C is $6,000 for $1 million of death benefit coverage, 
but for the second year it is zero for the same amount of coverage 
because that is the minimum amount needed to keep the insurance 
policy from lapsing. Employer H's overall experience at the 
beginning of the second year of coverage is $18,000, because that is 
the balance that would have accumulated in the fund if H were the 
only employer providing benefits under Arrangement C. (The special 
rule of paragraph (b)(4)(ii) of this section only applies to 
determine cost of coverage; it does not apply in determining overall 
experience.) The $18,000 balance in the policy insuring the life of 
employer H's employee is a proxy for H's overall experience. 
Employer H can choose not to make any contributions in the second 
year of coverage due to the $18,000 policy balance. Thus, H's cost 
of coverage for the second year is based on a proxy for H's overall 
experience. Accordingly, Arrangement C maintains an experience-
rating arrangement with respect to employer H.
    (iv) Arrangement C also maintains an experience-rating 
arrangement with respect to employer J because in each year J can 
contribute more than the amount needed to prevent a lapse of the 
policy on the life of its employee and can expect that its cost of 
coverage for subsequent years will reflect its prior contributions 
and allocable earnings. Accordingly, Arrangement C maintains an 
experience-rating arrangement with respect to employer J.
    Example 6. (i) Arrangement D provides death benefits for 
eligible employees of each participating employer. Each employer can 
choose to provide a death benefit of either one, two, or three times 
the annual compensation of the covered employees, provided that no 
employer contributes more than 10 percent of the total contributions 
under the plan by all employers. Under Arrangement D, the death 
benefit is payable only if the employee dies while employed by the 
employer. If an employee terminates employment with the employer or 
if the employer withdraws from the arrangement, the death benefit is 
no longer payable, no refund or other credit is payable to the 
employer or to the employees, and no policy or other property is 
transferrable to the employer or the employees. Furthermore, other 
than any conversion rights the employees may have under state law, 
the employees have no right under Arrangement D to coverage under 
any other arrangement and no right to purchase or to convert to an 
individual insurance policy. Arrangement D determines the amount 
required to be contributed by each employer for each month of 
coverage by aggregating the amount required to be contributed for 
each covered employee of the employer. The amount required to be 
contributed for each covered employee is determined by multiplying 
the amount of the death benefit coverage (in thousands) for the 
employee by five-year age bracket rates in a table specified by the 
plan. The rates in the specified table do not exceed the rates set 
forth in Table I of Sec. 1.79-3(d)(2). The table is used uniformly 
for all covered employees of all employers participating in 
Arrangement D. Arrangement D uses the amount contributed by each 
employer to

[[Page 45943]]

purchase one-year term insurance coverage on the lives of the 
covered employees with a face amount equal to the death benefit 
provided by the plan. No employer is entitled to any rebates or 
refunds provided under the insurance contract.
    (ii) Arrangement D does not exhibit any of the characteristics 
listed in paragraph (c) of this section generally indicating that 
the arrangement is not a 10 or more employer plan described in 
section 419A(f)(6). Under Arrangement D, assets are not allocated to 
a specific employer or employers. Differences in the amounts charged 
to the employers are solely reflective of differences in risk or 
rating factors that are commonly taken into account in manual rates 
used by insurers for the particular benefit or benefits being 
provided. The arrangement provides for fixed welfare benefits for a 
fixed coverage period for a fixed cost, within the meaning of 
paragraph (d)(5) of this section. The cost charged under the 
arrangement is not unreasonably high for the covered risk of the 
plan as a whole. Finally, benefits and other amounts payable can be 
paid, distributed, transferred, or otherwise made available only by 
reason of the death of the employee, so that there is no nonstandard 
benefit trigger under the arrangement.
    (iii) Nothing in the facts of this Example 6 indicates that 
Arrangement D fails to satisfy the requirements of section 
419A(f)(6) or this section by reason of maintaining experience-
rating arrangements with respect to individual employers. Based 
solely on the facts described above, Arrangement D does not maintain 
an experience rating-arrangement with respect to any individual 
employer because for each participating employer there is no period 
for which the employer's cost of coverage under the arrangement is 
based, in whole or in part, on either the benefits experience or the 
overall experience (or a proxy for either type of experience) of 
that employer or its employees.
    Example 7. (i) The facts are the same as in Example 6, except 
that under the arrangement, any refund or rebate provided under that 
year's insurance contract is allocated among all the employers 
participating in the arrangement in proportion to their 
contributions, and is used to reduce the employers' contributions 
for the next year.
    (ii) This arrangement exhibits at least one of the 
characteristics listed in paragraph (c) of this section generally 
indicating that the arrangement is not a 10 or more employer plan 
described in section 419A(f)(6). The arrangement includes 
nonstandard benefit triggers because amounts are made available to 
an employer by reason of the insurer providing a refund or rebate to 
the plan, an event that is other than the illness, personal injury, 
or death of an employee or family member, or an employee's 
involuntary separation from employment.
    (iii) Based on the limited and specific facts described in this 
Example 7, an employer participating in this arrangement should be 
able to establish to the satisfaction of the Commissioner that the 
plan does not maintain experience-rating arrangements with respect 
to individual employers. A participating employer's cost of coverage 
is the relationship of its contributions to the death benefit 
coverage or other amounts payable with respect to that employer, 
including the employer's portion of the insurance company rebate and 
refund amounts. The rebate and refund amounts are allocated to an 
employer based on that employer's contribution for the prior year. 
However, even though an employer's overall experience includes its 
past contributions, contributions alone are not a proxy for an 
employer's overall experience under the particular facts described 
in this Example 7. As a result, a participating employer's cost of 
coverage under the arrangement for each year (or any other period) 
is not based on that employer's benefits experience or its overall 
experience (or a proxy for either type of experience), except as 
follows: If the total of the insurance company refund or rebate 
amounts is a proxy for the overall experience of all participating 
employers, a participating employer's cost of coverage will be based 
in part on that employer's overall experience (or a proxy therefor) 
by reason of that employer's overall experience being a portion of 
the overall experience of all participating employers. Under the 
special rule of paragraph (b)(2)(iii) of this section, however, that 
fact alone will not cause the arrangement to be treated as 
maintaining an experience-rating arrangement with respect to an 
individual employer because no employer normally contributes more 
than 10 percent of the total contributions under the plan by all 
employers (the rating group). Accordingly, the arrangement will not 
be treated as maintaining experience-rating arrangements with 
respect to individual employers.
    Example 8. (i) Arrangement E provides medical benefits for 
covered employees of 90 participating employers. The level of 
medical benefits is determined by a schedule set forth in the trust 
document and does not vary by employer. Other than any rights an 
employee may have to COBRA continuation coverage, the medical 
benefits cease when an employee terminates employment with the 
employer. If an employer withdraws from the arrangement, there is no 
refund of any contributions and there is no transfer of anything of 
value to employees of the withdrawing employer. Arrangement E 
determines the amount required to be contributed by each employer 
for each year of coverage. To determine the amount to be contributed 
for each employer, Arrangement E classifies an employer based on the 
employer's location. These geographic areas are not changed once 
established under the arrangement. The amount charged for the 
coverage under the arrangement to the employers in a geographic area 
is initially determined from a rate-setting manual based on the 
benefit package, but adjusted to reflect the claims experience of 
the employers in that classification as a whole. Arrangement E does 
not have any geographic area classification for which one of the 
employers in the classification contributes more than 10 percent of 
the contributions made by all the employers in that classification.
    (ii) Arrangement E exhibits at least one of the characteristics 
listed in paragraph (c) of this section generally indicating that 
the arrangement is not a 10 or more employer plan described in 
section 419A(f)(6). The amount charged under the arrangement to an 
employer in one geographic area can be expected to differ from that 
charged to an employer in another geographic area (and the 
differences are not merely reflective of risk or rating factors for 
those geographic areas), resulting in differential pricing.
    (iii) Based on the facts described in this Example 8, an 
employer participating in Arrangement E should be able to establish 
to the satisfaction of the Commissioner that the plan does not 
maintain experience-rating arrangements with respect to individual 
employers even though there is differential pricing. Although an 
employer's cost of coverage for each year is based, in part, on its 
benefits experience (as well as the benefits experience of the other 
employers in its geographic area), that does not result in 
experience-rating arrangements with respect to any individual 
employer because the employers in each geographic area are a rating 
group and no employer normally contributes more than 10 percent of 
the contributions made by all the employers in its rating group. 
(See paragraph (b)(4)(iii) of this section.)
    Example 9. (i) The facts of Arrangement F are the same as those 
described in Example 8 for Arrangement E, except that K, an employer 
in one of Arrangement F's geographic areas, contributes more than 10 
percent of the contributions made by the employers in that 
geographic area.
    (ii) For the same reasons as described in Example 8, Arrangement 
F results in differential pricing.
    (iii) Arrangement F does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. An 
employer's cost of coverage for each year is based, in part, on its 
benefits experience (as well as the benefits experience of the other 
employers in its geographic area) and the special rule for 
experience-rating by a rating group does not apply to Arrangement F 
because employer K contributes more than 10 percent of the 
contributions made by the employers in its rating group. 
Accordingly, Arrangement F maintains experience-rating arrangements 
with respect to individual employers.
    Example 10. (i) The facts of Arrangement G are the same as those 
described in Example 8 for Arrangement E, except for the way that 
the arrangement classifies the employers. Under Arrangement G, the 
experience of each employer for the prior year is reviewed and then 
the employer is assigned to one of three classifications (low cost, 
intermediate cost, or high cost) based on the ratio of actual claims 
with respect to that employer to expected claims with respect to 
that employer. No employer in any classification contributes more 
than 10 percent of the contributions of all employers in that 
classification.
    (ii) For the same reasons as described in Example 8, Arrangement 
G results in differential pricing.
    (iii) Arrangement G does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this

[[Page 45944]]

section is not satisfied. The special rule in paragraph (b)(4)(iii) 
of this section for rating groups can prevent a plan from being 
treated as maintaining experience-rating arrangements with respect 
to individual employers if the mere use of a rating group is the 
only reason a plan would be so treated. Under Arrangement G, 
however, an employer's cost of coverage for each year is based on 
the employer's benefits experience in two ways: the employer's 
benefits experience is part of the benefits experience of a rating 
group that is otherwise permitted under the special rule of 
paragraph (b)(4)(iii) of this section, and the employer's benefits 
experience is considered annually in redetermining the rating group 
to which the employer is assigned. Accordingly, Arrangement G 
maintains experience-rating arrangements with respect to individual 
employers.
    Example 11. (i) Arrangement H provides a death benefit equal to 
a multiple of one, two, or three times compensation as elected by 
the participating employer for all of its covered employees. 
Universal life insurance contracts are purchased on the lives of the 
covered employees. The face amount of each contract is the amount of 
the death benefit payable upon the death of the covered employee. 
Under the arrangement, each employer is charged annually an amount 
equal to 200 percent of the mortality and expense charges under the 
contracts for that year covering the lives of the covered employees 
of that employer. Arrangement H pays the amount charged each 
employer to the insurance company. Thus, the insurance company 
receives an amount equal to 200 percent of the mortality and expense 
charges under the policies. The excess amounts charged and paid to 
the insurance company increase the policy value of the universal 
life insurance contracts. When an employer ceases to participate in 
Arrangement H, the insurance policies are distributed to each of the 
covered employees of the withdrawing employer.
    (ii) Arrangement H exhibits at least three of the 
characteristics listed in paragraph (c) of this section generally 
indicating that the arrangement is not a 10 or more employer plan 
described in section 419A(f)(6). First, assets are effectively 
allocated to specific employers. Second, because the amount of the 
withdrawal benefit (i.e., the value of the life insurance policies 
to be distributed) is unknown, the arrangement does not provide for 
fixed welfare benefits for a fixed coverage period for a fixed cost. 
Finally, Arrangement H includes nonstandard benefit triggers because 
amounts can be distributed under the arrangement for a reason other 
than the illness, personal injury, or death of an employee or family 
member, or an employee's involuntary separation from employment.
    (iii) Arrangement H does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. Pursuant 
to paragraph (b)(1) of this section, the prohibition against 
maintaining experience-rating arrangements applies under all 
circumstances, including employer withdrawals. Arrangement H 
maintains experience-rating arrangements with respect to individual 
employers because the cost of coverage for a participating employer 
is based on a proxy for the overall experience of that employer. 
Under Arrangement H, the contributions of a participating employer 
are fixed. The benefits or other amounts payable with respect to an 
employer include the value of the life insurance policies that are 
distributable to the employees of that employer upon the withdrawal 
of that employer from the plan. Thus, the cost of coverage for any 
period of an employer's participation in Arrangement H is the 
relationship between the fixed contributions for that period and the 
variable benefits payable under the arrangement. The value of those 
variable benefits depends on the value of the policies that would be 
distributed if the employer were to withdraw at the end of the 
period. (Each year the insurance policies to be distributed to the 
employees in the event of the employer's withdrawal will increase in 
value due to the premium amounts paid on the policy in excess of 
current mortality and expense charges.) For reasons similar to those 
discussed above in Example 5, the aggregate value of the life 
insurance policies on the lives of an employer's employees is a 
proxy for that employer's overall experience. Thus, a 
participating's employer's cost of coverage for any period is based 
on a proxy for the overall experience of that employer. Accordingly, 
Arrangement H maintains experience-rating arrangements with respect 
to individual employers.
    (iv) The result would be the same if, rather than distributing 
the policies, Arrangement H distributed cash amounts equal to the 
cash values of the policies. The result would also be the same if 
the distribution of policies or cash values is triggered by 
employees terminating their employment rather than by employers 
ceasing to participate in the arrangement.
    Example 12. (i) The facts of Arrangement J are the same as those 
described in Example 11 for Arrangement H, except that (1) 
Arrangement J purchases a special term insurance policy on the life 
of each covered employee with a face amount equal to the death 
benefit payable upon the death of the covered employee, and (2) 
there is no benefit distributable upon an employer's withdrawal. The 
special term policy includes a rider that extends the term 
protection for a period of time beyond the term provided on the 
policy's face. The length of the extended term is not guaranteed, 
but is based on the excess of premiums over mortality and expense 
charges during the period of original term protection, increased by 
any investment return credited to the policies.
    (ii) Arrangement J exhibits two of the characteristics listed in 
paragraph (c) of this section generally indicating that the 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, assets of the plan are effectively allocated to 
specific employers. Second, the plan does not provide for fixed 
welfare benefits for a fixed coverage period for a fixed cost 
because the coverage period is not fixed.
    (iii) Arrangement J does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. 
Arrangement J maintains experience-rating arrangements with respect 
to individual employers because the cost of coverage for a 
participating employer is based on a proxy for the overall 
experience of that employer. Under Arrangement J, the contributions 
of a participating employer are fixed. The benefits or other amounts 
payable with respect to an employer are the one-, two-, or three-
times-compensation death benefit for each employee of the employer 
for the current year, plus the extended term protection coverage for 
future years. Thus, for any period extending to or beyond the end of 
the original term of one or more of the policies on the lives of an 
employer's employees, the employer's cost of coverage is the 
relationship between the fixed contributions for that period and the 
variable benefits payable under the arrangement. The value of those 
variable benefits depends on the aggregate value of the policies 
insuring the employer's employees (i.e., the total of the premiums 
paid on the policies by Arrangement J to the insurance company, 
reduced by the mortality and expense charges that were needed to 
provide the original term protection, and increased by any 
investment return credited to the policies). The aggregate value of 
the policies insuring an employer's employees is, at any time, a 
proxy for the employer's overall experience. Thus, a participating 
employer's cost of coverage for any period described above is based 
on a proxy for the overall experience of that employer. Accordingly, 
Arrangement J maintains experience-rating arrangements with respect 
to individual employers.
    Example 13. (i) Arrangement K provides a death benefit to 
employees of participating employers equal to a specified multiple 
of compensation. Under the arrangement, a flexible-premium universal 
life insurance policy is purchased on the life of each covered 
employee in the amount of that employee's death benefit. Each policy 
has a face amount equal to the employee's death benefit under the 
arrangement. Each participating employer is charged annually with 
the aggregate amount (if any) needed to maintain the policies 
covering the lives of its employees. However, each employer is 
permitted to make additional contributions to the arrangement and, 
upon doing so, the additional contributions are paid to the 
insurance company and allocated to one or more contracts covering 
the lives of the employer's employees. In the event that any policy 
covering the life of an employee would lapse in the absence of new 
contributions from that employee's employer, and if at the same time 
there are policies covering the lives of other employees of the 
employer that have cash values in excess of the amounts needed to 
prevent their lapse, the employer has the option of reducing its 
otherwise-required contribution by amounts withdrawn from those 
other policies.
    (ii) Arrangement K exhibits at least two of the characteristics 
listed in paragraph (c) of this section generally indicating that 
the arrangement is not a 10 or more employer plan described in 
section 419A(f)(6). First,

[[Page 45945]]

assets of the plan are allocated to specific employers. Second, 
because the plan allows an employer to choose to contribute an 
amount that is different than that contributed by another employer 
for the same benefit, the amount charged under the plan is not the 
same for all participating employers (and the differences in the 
amounts are not reflective of differences in risk or rating factors 
that are commonly taken into account in manual rates used by 
insurers for the particular benefit or benefits being provided), 
resulting in differential pricing.
    (iii) Arrangement K does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement 
of paragraph (a)(1)(iii) of this section is not satisfied. 
Arrangement K maintains experience-rating arrangements with respect 
to individual employers because the cost of coverage for any 
employer participating in the arrangement is based on a proxy for 
the overall experience of that employer. Under Arrangement K the 
benefits with respect to an employer for any year are a fixed 
amount. For purposes of determining the employer's cost of coverage 
for that year, the Commissioner may treat the employer's 
contribution under the special rule of paragraph (b)(4)(ii) of this 
section (concerning treatment of flexible contribution\arrangements) 
as being the minimum contribution amount needed to maintain the 
universal life policies with respect to that employer for the death 
benefit coverage for that year. Because the employer has the option 
to prevent the lapse of one policy by having amounts withdrawn from 
other policies, that minimum contribution amount will be based in 
part on the aggregate value of the policies on the lives of that 
employer's employees. That aggregate value is a proxy for the 
employer's overall experience. Accordingly, Arrangement K maintains 
experience-rating arrangements with respect to individual employers.
    (g) Effective date--(1) In general. Except as set forth in 
paragraph (g)(2) of this section, this section applies to contributions 
paid or incurred in taxable years of an employer beginning on or after 
July 11, 2002.
    (2) Compliance information and recordkeeping. Paragraphs 
(a)(1)(iv), (a)(2), and (e) of this section apply for taxable years of 
a welfare benefit fund beginning after the date of publication of final 
regulations in the Federal Register.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 02-17469 Filed 7-10-02; 8:45 am]
BILLING CODE 4830-01-P