[Federal Register Volume 68, Number 137 (Thursday, July 17, 2003)]
[Rules and Regulations]
[Pages 42254-42266]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-18041]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9079]
RIN 1545-BA47


10 or More Employer Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

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SUMMARY: This document contains final regulations that provide rules 
regarding the requirements for a welfare benefit fund that is part of a 
10 or more employer plan. The regulations affect certain employers that 
provide welfare benefits to employees through a plan to which more than 
one employer contributes.

DATES: Effective Date: These regulations are effective July 17, 2003.
    Applicability Date: For dates of applicability, see Sec.  
1.419A(f)(6)-1(g).

FOR FURTHER INFORMATION CONTACT: Betty J. Clary, (202) 622-6080 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1795. Responses to these collections of information 
are required to obtain a benefit (to be treated as a 10 or more 
employer plan excepted from the deduction limits for employer 
contributions to a welfare benefit fund).
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    The estimated annual burden per respondent and/or recordkeeper 
varies, depending on individual circumstances, with an estimated 
average of 25 hours.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP 
Washington, DC 20224, and to the Office of Management and Budget, Attn: 
Desk Officer for the Department of the Treasury, Office of Information 
and Regulatory Affairs, Washington, DC 20503.
    Books or records relating to these collections 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 amendments to the Income Tax Regulations 
under section 419A of the Internal Revenue Code (Code). Sections 419 
and 419A, which were added to the Code by section 511 of the Deficit 
Reduction Act of 1984 (Pub. L. 98-369, 98 Stat. 494) set forth special 
rules limiting the deduction of employer contributions to a welfare 
benefit fund. 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, but only if the plan 
does not maintain 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 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

[[Page 42255]]

(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 10 or more employer plan 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 as the excess is used to provide benefits to 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 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.\1\ 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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    \1\ 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.
    Transactions that are the same as or substantially similar to the 
transactions described in Notice 95-34 are listed transactions for 
purposes of the tax shelter disclosure, registration, and list 
maintenance requirements. See Notice 2000-15 (2000-1 C.B. 826) 
(supplemented and superseded by Notice 2001-51 (2001-2 C.B. 190)), 
Sec.  1.6011-4(b)(2) of the Income Tax Regulations, and Sec. Sec.  
301.6111-2(b)(2) and 301.6112-1(b)(2) of the Procedure and 
Administration Regulations.
    On July 11, 2002, a notice of proposed rulemaking (REG-165868-01) 
relating to whether a welfare benefit fund is part of a 10 or more 
employer plan (as defined in section 419A(f)(6) of the Internal Revenue 
Code) was published in the Federal Register (67 FR 45933). Written and 
electronic comments responding to the notice of proposed rulemaking 
were received. A public hearing was held on November 14, 2002. After 
consideration of all the comments, the proposed regulations are adopted 
as amended by this Treasury decision. The revisions are discussed 
below.

Explanation of Provisions

Overview of Rules

    These 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.
    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. The 
regulations provide that an employer is determined by aggregating all 
of the entities required to be aggregated under the rules under section 
414(b), (c), or (m). This is particularly relevant for purposes of 
determining how many employers contribute, whether an employer normally 
contributes more than 10 percent of the total contributions under the 
plan, and whether the plan maintains experience-rating arrangements 
with respect to individual employers.
    In addition, the 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. The determination of 
whether a plan is described in section 419A(f)(6) is based on 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 can be expected to 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 regulations provide generally that a plan maintains an 
experience-rating arrangement with respect to an employer--making the 
plan ineligible for the section 419A(f)(6) exception--if any 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 of that 
employer or one or more employees of that employer. For purposes of the 
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

[[Page 42256]]

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 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.

Definition of Experience Rating

    A number of commentators suggested that the regulatory definition 
of experience-rating arrangement is inconsistent with industry usage 
and the discussions of experience rating set forth in United States v. 
American Bar Endowment, 477 U.S. 105 (1986) and Sears Roebuck and Co. 
v. Commissioner, 972 F.2d 858 (7th Cir. 1992). These commentators have 
urged that an experience-rating arrangement be narrowly defined to 
include only those situations in which the employer is automatically 
entitled to a refund of a portion of a premium payment if claims 
experience is better than expected.
    The IRS and Treasury have reviewed these comments and have 
concluded that the proposed regulatory definition of experience-rating 
arrangement should be retained in the final regulations. Where a Code 
section provides an exception from the normal tax requirements, the 
exception must be narrowly applied and its exclusions interpreted 
broadly. Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 52 
(1955). See also, Arkansas Best Corporation v. Commissioner, 485 U.S. 
212, 219-220 (1987). Thus, the exclusion for experience-rating 
arrangements under the 10 or more employer plan exception should be 
interpreted broadly.
    While both the American Bar Endowment case and the Sears case 
discuss a specific type of experience rating, there are other ways an 
insurance contract or other arrangement might take experience into 
account. For example, under one type of experience-rating arrangement, 
if the premiums paid exceed the actual cost of providing insurance to 
the group, the excess (the source of the dividend described in American 
Bar Endowment) is not refunded to the premium payer, but is instead 
used to reduce the cost of providing benefits for subsequent periods. 
This reduction in the cost of providing benefits for subsequent periods 
can be accomplished directly by adjusting premiums or indirectly by 
providing additional benefits under the arrangement at no cost to the 
premium payer, or through a combination of premium reductions and 
additional benefits.
    In view of the variety of ways that an arrangement might take 
experience into account, the regulations provide that 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).
    Some commentators suggested that the regulations equate benefits 
provided to the employees of an employer with a payment to the employer 
and that such an equation improperly ignores the existence of the 
employer. This comment is based on a misreading of the regulations. The 
regulations reflect the fact that the provision of a benefit to an 
employee at no cost to the employer is, in effect, a credit to the 
employer that offsets the employer's otherwise applicable cost of 
providing that benefit. Accordingly, if the amount of such a benefit is 
based on the experience of the employer or its employees, the plan 
includes an experience-rating arrangement with respect to individual 
employers and is ineligible for the section 419A(f)(6) exception to 
sections 419 and 419A.

Use of Insurance Contracts

    A number of commentators expressed concern with the results under 
the proposed regulations when the definition of an experience-rating 
arrangement was applied to a plan which provides for contributions 
equal to the premiums on a whole life insurance contract or other life 
insurance contract having level premiums. These commentators asserted 
that the purchase of such policies is not inconsistent with the 
requirements of section 419A(f)(6) and that, if the premiums under the 
contract are established using standardized actuarial factors 
(including issue age), the arrangement is not experience rated.
    The final regulations retain the definition of experience rating 
arrangement and the general results that flow from the application of 
that definition to a level premium life insurance policy. This analysis 
recognizes that if whole life insurance contracts, or other insurance 
contracts that provide for level premiums or otherwise generate a 
savings element, are purchased under an arrangement, the economic 
values reflected under those contracts (including cash values, 
reserves, and any other economic values, such as conversion credits, 
high dividend rates, or the right to continue coverage at a premium 
that is lower than the premium that would apply in the absence of that 
savings element) are based on the excess of the premiums paid over the 
underlying mortality and related expense charges for providing the 
insurance and, hence, reflect the overall experience of the employers 
and employees who participate under the plan.
    If those economic values 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 or its employees 
(as opposed to the other employers participating in the plan). This 
assurance that the employer or its employees will benefit from 
favorable past experience is the hallmark of an experience-rating 
arrangement.\2\
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    \2\ The existence of experience rating in a level premium life 
insurance arrangement can be viewed not only from the perspective of 
overall experience, but also from that of claims experience. For 
example, assume that Employer A and Employer B have the same number 
of employees, and the employees of A have the same ages and other 
risk factors as those of B. If, on the same day in Year 1, each 
employer purchases from the same insurer the same amount of level 
premium whole life insurance coverage for each of its employees, the 
aggregate premium charges for A and B will be equal. Further, assume 
that in Year 5, A's employee who is age 60 dies, and is replaced by 
an individual who is also age 60 and has identical risk 
characteristics. A purchases a new level premium whole life 
insurance contract of the same amount for the new employee who has 
an issue age of 60. A's premiums for the new 60-year-old employee 
will now be higher than those of B for its employee corresponding to 
the 60-year-old who died, because B's premiums for its 60-year-old 
employee are based on an issue age of 55. A's premiums for its other 
employees will be the same as those for B's corresponding employees. 
Thus, after the death of its employee, A's aggregate premium charges 
are higher than those of B, and this is due solely to the fact that 
A's employees have incurred claims in excess of the claims of B's 
employees.

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[[Page 42257]]

    Furthermore, Congress' expectation that employers participating in 
10 or more employer plans would have no 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 with retained values, 
where a participating employer can benefit directly or indirectly from 
the retained values generated with respect to its employees (e.g., 
through enhanced benefits to its employees), would provide a financial 
incentive for the employer to over-contribute to the plan and, thus, 
would be contrary to the premise underlying the intent of Congress in 
providing the exception. This financial incentive can be seen most 
clearly in a flexible premium universal life contract, which is almost 
indistinguishable from the welfare benefit fund that Congress intended 
to be subject to the deduction limitations of sections 419 and 419A. 
The fact that the premiums on a whole life contract or other level 
premium arrangement are fixed ahead of time (at least with respect to 
individual employees) does not alter the fact that the buildup of cash 
value is essentially the same as the accumulation of assets in a fund. 
The result is the same even where there is no cash value, if the 
arrangement uses overpayments in earlier years to levelize the 
premiums. In all these cases, the retained values of life insurance 
contracts relating to an employer's employees are used to determine 
that employer's cost of coverage, and the conclusion remains that there 
is an experience-rating arrangement of the type not allowed by section 
419A(f)(6).
    Some commentators asserted that the definition of experience-rating 
arrangements in the proposed regulations will preclude the use of cash 
value life insurance under section 419A(f)(6) and will therefore 
eviscerate the section 419A(f)(6) exception. Neither section 419A(f)(6) 
nor these regulations regulate the investments of a welfare benefit 
fund, including investments by a trust in cash value policies. Instead, 
section 419A(f)(6) and the regulations are concerned with the economic 
relationship between a fund and participating employers, and whether 
the pass-through of premiums based on the insurance contracts 
associated with an employer's employees has the effect of creating 
experience-rating arrangements with respect to individual employers. 
Moreover, the IRS and Treasury also believe that the exception is still 
viable for many life and health benefit arrangements that are self-
insured in accordance with the Employee Retirement Income Security Act 
of 1974 (ERISA) or state law. Under these types of arrangements, the 
employers contribute the expected cost of claims for their employees. 
Without the section 419A(f)(6) exception, the deduction for these 
contributions would be limited to the welfare benefit fund's qualified 
cost for the taxable year. The section 419A(f)(6) exception allows 
these employers to deduct those contributions without regard to whether 
the employees actually incurred claims.
    A number of commentators cited to other provisions under sections 
419 and 419A for support for their position that a plan can provide for 
accumulations within a welfare benefit fund that are effectively 
allocated to the employees without causing the plan to be ineligible 
for the section 419A(f)(6) exception. The Service and Treasury believe 
that these other provisions are not relevant in the determination of 
whether a plan provides an experience rating arrangement. For example, 
the fact that section 419(e)(4) specifically excludes certain insurance 
contracts (including contracts that provide experience rated refunds or 
policy dividends) from the definition of fund for purposes of section 
419 does not necessarily mean that such contracts may be held within a 
welfare benefit fund while retaining the section 419A(f)(6) exception. 
Similarly, the fact that section 419A(c)(2) permits an additional 
reserve for post-retirement medical and life insurance benefits does 
not mean that such a reserve would not cause the plan to violate the 
prohibition on experience rating under section 419A(f)(6).

Special Rules of Application

    The final regulations retain the special rules of application 
relating to insurance contracts that were set forth in the proposed 
regulation. For example, insurance contracts under an arrangement are 
treated as assets of the fund, and the fund will be treated as having 
either a gain or loss with respect to those contracts.
    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. The effect of this rule is to allow the plan to 
provide for experience rating on a plan-wide basis or on the basis of a 
subset of the employers within the plan, provided that the subset of 
employers is not overweighted by the experience of one employer and is 
not defined based on the experience of the employers.

Characteristics Indicating a Plan Is Not Described in Section 
419A(f)(6)

    These 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 42258]]

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, third and fourth characteristics under the proposed 
regulations indicating that a plan is not a 10 or more employer plan 
described in section 419A(f)(6) (i.e., 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 plan does not provide for fixed welfare benefits for 
a fixed coverage period for a fixed price or the plan charges the 
participating employers an unreasonably high amount for the covered 
risk) have been retained without change.
    The second characteristic under the proposed regulations indicating 
that a plan is not a 10 or more employer plan described in section 
419A(f)(6) 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 benefit terms). In response to comments, this second 
characteristic has been clarified so that the exception for reflection 
of differences in risk or rating factors commonly taken into account in 
manual rates is limited to differences in charges that are merely 
reflective of differences in current risk (such as current age, gender, 
dependents covered, geographic locale, or benefit terms). Accordingly, 
an arrangement that charges different amounts for life insurance based 
on issue age would exhibit this second characteristic, unless the 
differences in amount charged are merely reflective of differences in 
risk or rating factors at the current age (e.g., reflecting select and 
ultimate mortality).
    The fifth characteristic under the proposed regulation indicating 
that a plan is not a 10 or more employer plan described in section 
419A(f)(6) is that benefits or other amounts payable can be provided 
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 commentators expressed concern 
that this fifth characteristic effectively prohibits a termination of a 
welfare benefit arrangement or otherwise redefines what is a welfare 
benefit arrangement. This concern reflects a misreading of the 
regulations, as this fifth characteristic does not prohibit the payment 
of benefits upon termination of the arrangement or withdrawal of an 
employer from the arrangement \3\ or in any other way seek to redefine 
what is a permitted welfare benefit. Instead the characteristic 
reflects the inherent difficulty an insurer would have in determining 
an actuarially appropriate price for providing fixed benefits on the 
occasion of these non-standard benefit triggers and the associated 
likelihood that the amount of the benefits payable on such an occasion 
is being determined based on the overall experience of the employee or 
employer. The fact that some commentators have suggested that an 
employer be able to ``spin-off'' the employer's ``share'' of a fund is 
further indication that many plans that purport to fit within the 
section 419A(f)(6) exception are engaging in prohibited experience 
rating.
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    \3\ A withdrawal of an employer merely terminates the 
arrangement for that employer, but it continues for the other 
employers.
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    Taxpayers are reminded that a plan that exhibits one of these 
characteristics may still establish that the plan satisfies the 
requirements of section 419A(f)(6). For example, in the case of a plan 
that provides for a benefit to be provided on the occasion of an 
employer's withdrawal from the plan, the plan would have to demonstrate 
that the amount provided to an employee is not based on the benefits 
experience or the overall experience of the employee or the employer. 
In addition, in response to comments, the final regulations clarify 
that a plan does not exhibit this fifth characteristic merely because, 
upon cessation of participation in the plan, an employee is provided 
with the right to convert coverage under a group life insurance 
contract to coverage under an individual life insurance contract 
without demonstrating evidence of insurability, but only if there is no 
additional economic value associated with the conversion right.
    The examples in the proposed regulations illustrating the 
application of the rules regarding experience-rating arrangements to 
specific fact situations are included in the final regulations, with 
minor changes, and two additional examples have been included. The 
facts described in some of the examples illustrate arrangements that do 
not maintain experience-rating arrangements with respect to individual 
employers. Other examples, however, describe arrangements that 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.\4\
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    \4\ For example, in Neonatology Associates, P.A., v. 
Commissioner, 299 F.3d 221 (3d Cir. 2002), affirming 115 T.C. 43 
(2000), the Court held that the contributions were in a 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.
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    Pursuant to the authority set forth in section 419A(i), the 
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.

Effective Date

    Except as explained below, these regulations--which generally 
clarify existing law--are effective for contributions paid or incurred 
in taxable years of an employer beginning on or after July 11, 2002. 
For contributions made before this 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 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 effective for

[[Page 42259]]

taxable years of a welfare benefit fund beginning after July 17, 2003. 
Existing record retention requirements and record production 
requirements under section 6001 continue to apply to employers and 
promoters.

Special Analyses

    It has been determined that these regulations are not a significant 
regulatory action for purposes of Executive Order 12866. Accordingly, a 
regulatory assessment is not required. It has 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 collection 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 (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 Code, the notice of proposed 
rulemaking preceding these regulations was sent to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

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.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order 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). * 
* *


0
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 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 (2) of this section must be satisfied 
both in form and in operation.
    (ii) Arrangement is considered in its entirety. The determination 
of whether a plan is a 10 or more employer plan described in section 
419A(f)(6) is based on 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

[[Page 42260]]

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.
    (v) Leased employees. In the case of an employer that is the 
recipient of services performed by a leased employee described in 
section 414(n)(2) 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.
    (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 merely reflective of differences in current risk or rating factors 
that are commonly taken into account in manual rates used by insurers 
(such as current 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 or the distribution of an insurance contract to 
an employer's employees on the occasion of the employer's withdrawal 
from the plan. A plan will not be treated as having the characteristic 
described in this paragraph merely because, upon cessation of 
participation in the plan, an employee is provided with the right to 
convert coverage under a group life insurance contract to coverage 
under an individual life insurance contract without demonstrating 
evidence of insurability, but only if there is no additional economic 
value associated with the conversion right.
    (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) Employer's overall experience. 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

[[Page 42261]]

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) Employee's overall experience. 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).
    (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 with respect to employees of 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, and that no employer normally 
contributes more than 10 percent of the total contributions contributed 
under the plan by all employers. 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 
contributions or the provision of the benefits. The examples are as 
follows:

    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 current 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.
    (ii) This arrangement exhibits at least one of the 
characteristics listed in paragraph (c) of this section generally 
indicating that an 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 merely reflective of differences in current 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 an 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 current 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

[[Page 42262]]

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 current 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 an 
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 merely reflective of 
differences in current 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 whole 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 current risk and rating factors that are commonly 
taken into account in manual rates used by insurers for death 
benefits.
    (ii) Arrangement B exhibits at least three of the 
characteristics listed in paragraph (c) of this section generally 
indicating that an 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, 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 merely reflective of 
differences in current risk or rating factors that are commonly 
taken into account in manual rates used by insurers for the death 
benefit being provided. (The differences in amounts charged are 
attributable to differences in issue age and not to differences in 
current risk or rating factors, as employees P and R are the same 
age). Third, during the early years of the arrangement, the amounts 
charged 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

[[Page 42263]]

the result if Arrangement B maintained an experience-rating 
arrangement with respect to only one individual employer.
    Example 5. (i) The facts are the same as in Example 4 except 
that the death benefits are provided under 10-year level term life 
insurance policies. One participating employer, H, has an employee, 
M, whose coverage under the arrangement commenced at the beginning 
of 2000, when M was age 35. M is covered under the arrangement for 
$1 million of death benefits, and a 10-year level term life 
insurance policy with a face amount of $1 million has been purchased 
on M's life. The level annual premium on the policy for the first 10 
years is $700. At the beginning of 2007, when M is age 42, the $700 
premium amount has been paid for seven years. Another employer, J, 
has an employee, N, who is also 42 years old at the beginning of 
2007 and is covered under the arrangement for $1 million, for which 
a 10-year level term life insurance policy with a face amount of $1 
million has been purchased. However, N did not become covered under 
the arrangement until the beginning of 2007. Because N's coverage 
began at age 42, the 10-year level term premium charged for the 
policy on N's life is $1,100, or $400 more than the premiums then 
payable on the policy in effect on M's life. Neither the policy on 
employee M nor the policy on employee N has any cash value at any 
point during its term. Assume that employees M and N are the only 
covered employees of their respective employers and that they are 
identical with respect to any current risk and rating factors that 
are commonly taken into account in manual rates used by insurers for 
the death benefit being provided.
    (ii) Based on the facts described in this Example 5, this 
arrangement exhibits at least two of the characteristics listed in 
paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, for the same reasons as described in paragraph 
(ii) of Example 4, there is differential pricing under the 
arrangement. Second, assets of the plan are effectively allocated to 
specific employers. This is the case even though the insurance 
policies used by employers H and J have no accessible cash value.
    (iii) The facts described in this Example 5 indicate that the 
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. This arrangement 
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 this arrangement 
employer H's cost of coverage in 2007 is $700 for $1 million of 
coverage. Although the policy insuring M's life has no cash value 
accessible to employer H, the accumulation of the excesses of the 
amounts paid by employer H on behalf of employee M over each year's 
underlying mortality and expense charges for providing life 
insurance coverage to employee M provide economic value to employer 
H (i.e., the ability to purchase future coverage on M's life at a 
premium that is less than the underlying mortality and expense 
charges as those underlying charges increase with M's increasing 
age). Thus, H's cost of coverage for 2007 is based on a proxy for 
H's overall experience. Accordingly, this arrangement maintains an 
experience-rating arrangement with respect to employer H.
    (iv) This arrangement also maintains an experience-rating 
arrangement with respect to employer J because it can be expected 
that for each of the next nine years J will be charged $1,100 for 
the $1 million of coverage on N's life. Each year, J's cost of 
coverage will reflect J's prior contributions, so that J's cost of 
coverage will be based on a proxy for J's overall experience. 
Accordingly, this arrangement maintains an experience-rating 
arrangement with respect to employer J. Similarly, this arrangement 
maintains an experiencing-rating arrangement with respect to each 
other participating employer. Accordingly, this arrangement 
maintains experience-rating arrangements with respect to individual 
employers. This would also be the result if this arrangement 
maintained an experience-rating arrangement with respect to only one 
individual employer.
    Example 6. (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 S and V 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 S makes a contribution of $23,000 (the amount of a 
level premium) while employer V 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 S's policy 
(including earnings) is $18,000, but the balance in V's policy is 
zero. Although S is not required to contribute anything in the 
second year of coverage, S contributes an additional $15,000 in the 
second year. Employer V 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 an 
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 7. (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. 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, the employees are not provided with any right under 
Arrangement D to coverage under any other arrangement, nor with any 
right to purchase or to convert to an individual insurance policy, 
other than any conversion rights the employees may have in 
accordance with state law (and which provide no

[[Page 42264]]

additional economic benefit). 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, which is used uniformly for all covered employees of all 
participating employers. The rates in the specified table do not 
exceed the rates set forth in Table I of Sec.  1.79-3(d)(2), and 
differences in the rates in the table are merely reflective of 
differences in mortality risk for the various age brackets. The 
rates in the table are not based in whole or in part on the 
experience of the employers participating in Arrangement D. 
Arrangement D uses the amount contributed by each employer to 
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 an 
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 7 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 8. (i) The facts are the same as in Example 7, 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 an 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 8, 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 8. 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 9. (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, to the withdrawing 
employer, or to another plan or arrangement maintained by the 
withdrawing employer. Arrangement E determines the amount required 
to be contributed by each employer for each year of coverage, and 
the aggregate amounts charged are not unreasonably high for the 
covered risk for the plan as a whole. 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 determined from a rate-setting manual based on 
the benefit package and geographic area, and differences in the 
rates in the manual are merely reflective of current differences in 
those risk or rating factors. The rates in the rate-setting manual 
are not based in whole or in part on the experience of the employers 
participating in Arrangement E.
    (ii) Arrangement E does not exhibit any of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). Although the amounts charged under the arrangement to an 
employer in one geographic area can be expected to differ from those 
charged to an employer in another geographic area, the differences 
are merely reflective of differences in current risk or rating 
factors that are commonly taken into account in manual rates used by 
insurers for medical benefits.
    (iii) Nothing in the facts of this Example 9 indicates that 
Arrangement E 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 E 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 10. (i) The facts are the same as in Example 9, except 
that 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 and then adjusted 
to reflect the claims experience of the employers in that 
classification as a whole. The arrangement does not have any 
geographic area classification for which one of the employers in the 
classification normally contributes more than 10 percent of the 
contributions made by all the employers in that classification.
    (ii) This arrangement exhibits at least one of the 
characteristics listed in paragraph (c) of this section generally 
indicating that an arrangement is not a 10 or more employer plan 
described in section 419A(f)(6). There is differential pricing under 
the arrangement because the amounts charged to an employer

[[Page 42265]]

in one geographic area can be expected to differ from those charged 
to an employer in another geographic area, and the differences are 
not merely reflective of current risk or rating factors that are 
commonly taken into account in manual rates used by insurers for 
medical benefits.
    (iii) Based on the facts described in this Example 10, 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 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 11. (i) The facts of Arrangement F are the same as those 
described in Example 10, except that K, an employer in one of 
Arrangement F's geographic areas, normally 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 10, 
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 normally 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 12. (i) The facts of Arrangement G are the same as those 
described in Example 10, 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 normally contributes more than 10 
percent of the contributions of all employers in that 
classification.
    (ii) For the same reasons as described in Example 10, 
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 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 13. (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 an 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 6, 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 14. (i)(1) The facts of Arrangement J are the same as 
those described in Example 13 for Arrangement H, except that--
    (A) 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
    (B) there is no benefit distributable upon an employer's 
withdrawal.
    (2) 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 an 
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

[[Page 42266]]

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 15. (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 an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, 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 merely reflective of differences 
in current 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 July 17, 2003.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 4. In Sec.  602.101, paragraph (b) is amended by adding an entry 
in numerical order to the table to read as follows:


Sec.  602.101  OMB control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
1.419A(f)(6)-1..........................................       1545-1795
 
                                * * * * *
------------------------------------------------------------------------


Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: July 9, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-18041 Filed 7-16-03; 8:45 am]
BILLING CODE 4830-01-P