Many U.S. employers set health plan premium rates for their employees based on whether they smoke or use other tobacco products. Employees may be charged a “smoker’s surcharge” – or alternatively, they may receive a “non-smoker’s discount” – on their coverage, which can amount to thousands of dollars in additional costs (or savings) to employees each year, based on their personal tobacco use status. This variance in premium rates is permitted as long as it is designed to meet wellness program rules under federal law.

Several recently filed class action lawsuits alleging that the employer imposed an illegal smoker’s surcharge serve as a reminder to employers of the compliance obligations associated with this type of design. Review these federal wellness program rules to make sure your company’s program is up to snuff.

Review of HIPAA Wellness Program Rules

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) prohibits employers from discriminating against employees in the provision of group health plan benefits on the basis of any health factor. HIPAA’s general rule would prohibit varying the premium rate of any employee on the basis of a health factor, which has been defined to include tobacco use. However, HIPAA creates an exception to the general rule for a wellness program that satisfies certain conditions.

A smoker’s surcharge falls in the category of an “outcome-based wellness program” since it requires the individual to attain or maintain a specific health factor, i.e., be a non-tobacco user. Under HIPAA, an outcome-based wellness program is permitted only if the following requirements are met:

• Individuals must be given the opportunity to qualify for the reward under the program at least once per year: This can be done in connection with the plan’s annual open enrollment period, or a longer period in advance of the plan year that allows time for any reasonable alternative standards (discussed below) to be met.

• The size of the reward (or penalty) is limited to a percentage of the total cost of coverage: For a smoker’s surcharge that applies to employees, the surcharge cannot exceed 50% of the total cost of employee-only coverage. For example, if the total cost of employee-only coverage (employee plus employer contributions) is $500 per month, the smoker’s surcharge cannot exceed $250 per month. If the employer provides financial incentives for other health-contingent activities under its wellness program, those amounts are subject to a lower 30% limit and are also counted in the aggregate 50% limit. In addition, if employees and covered spouses are separately subject to a smoker’s surcharge, the aggregate surcharge can be up to 50% of the total cost of employee plus spousal coverage.

• The program must be reasonably designed to promote health or prevent disease: To meet this requirement, the program must provide a reasonable alternative standard to qualify for the reward for any individuals who do not meet the initial standard. Accordingly, all employees who smoke or use tobacco products must be given a reasonable alternative standard that they can meet to qualify for the lower non-smoker’s premium rate. The program must accommodate an individual’s personal physician with regard to medical appropriateness of any reasonable alternative. An employer that imposes a smoker’s surcharge will commonly provide as a reasonable alternative the completion of a smoking cessation program. This type of program must be offered at no cost to the employee and not be overly burdensome or impractical to complete.

Compliance Pitfall: Some employers incorrectly tell employees that in order to receive the reduced premium rate, they need to actually quit smoking. HIPAA expressly prohibits this approach. While employees who continue to smoke can be required to re-take a smoking cessation course each year (or to comply with a new recommendation from the employee’s personal physician) to continue to qualify for the reduced premium rate, the reduced rate can never be conditioned on their success.

• The full reward must be available to all individuals who complete the reasonable alternative standard: Under the “full reward” requirement, if an employee who is a smoker must complete an eight-week smoking cessation course as a reasonable alternative standard in order to receive a reduced premium, then upon timely completion of the course, the employee must receive the reduced premium rate for the entire plan year. A prospective adjustment to the employee’s premium only after completing the course, without refunding any surcharge amounts previously paid during the year, would violate HIPAA.  

Compliance Pitfall: Employees must be given a reasonable opportunity to complete the reasonable alternative standard. Whether the time period for completion occurs before or after the start of a plan year, timely completion qualifies the employee for the reward for the entire plan year. In some cases, this will require employers to make retroactive premium adjustments to ensure that employees who qualify under a reasonable alternative standard receive the full reward as required by HIPAA. 

• The employer must provide notice of availability of the reasonable alternative standard in program materials: Any notices or program materials provided to employees which state that their premium rates will be based on their tobacco use status must also disclose that employees who smoke or use other tobacco products may still qualify for the lower premium rates for the entire plan year by satisfying a reasonable alternative standard. The disclosure must include contact information for obtaining a reasonable alternative standard and a statement that recommendations of an individual’s personal physician will be accommodated. 

Compliance Pitfall: This disclosure is often overlooked by employers in materials that describe the terms of a smoker’s surcharge. The disclosure does not have to include a description of the reasonable alternative itself (although it can), but it does need to include contact information and a statement that the recommendations of an individual’s personal physician will be accommodated.

If a court or a regulatory agency were to find that a smoker’s surcharge violated HIPAA, the employer could potentially be required to remove the surcharge prospectively and retroactively for affected employees. In addition, if an ERISA plan administrator assesses and collects a surcharge that is found to violate HIPAA, this could potentially give rise to a breach of fiduciary duty claim.

Review of ADA Wellness Program Rules

While the greatest scrutiny of smoker’s surcharges will fall under the purview of HIPAA, the Americans with Disabilities Act (ADA) separately imposes conditions on any wellness program that includes a medical examination, or which asks disability-related questions. A smoker’s surcharge would qualify as a wellness program subject to the ADA in instances where the employer verifies an employee’s tobacco use through administration of a medical examination (e.g., a cheek swab), rather than by self-certification.

The ADA generally prohibits employers from requiring medical examinations or making disability-related inquiries of current employees unless they are job-related and consistent with business necessity. However, an exception to this rule applies in the context of a voluntary wellness program. The ADA wellness program rules sought to define “voluntary” for this purpose. Although they were initially drafted to align closely with existing HIPAA wellness program rules, they were successfully challenged in the courts, and the proposed rules that would replace them have been under a regulatory freeze since 2021. The result is that we do not have clarity as to whether financial incentives under a wellness program that complies with HIPAA will similarly be considered “voluntary” for purposes of the ADA. At the very least, employers that test for nicotine or tobacco use in connection with a smoker’s surcharge should be aware that this approach raises compliance obligations under both HIPAA and the ADA.

We will continue to monitor developments in ongoing litigation regarding the challenges to smoker surcharges. For more information about wellness program requirements for your employee benefit plans, please contact Shalina Schaefer, Tara Sciscoe, Chris Sears, or the Ice Miller Workplace Solutions attorney with whom you regularly work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.