Enclosure.

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PREPAID LEGAL SERVICE PLANS IN THE EMPLOYMENT CONTEXT: A REPORT OF MAJOR CHARACTERISTICS AND TAX AND REGULATORY ISSUES

CHAPTER 1: INTRODUCTION

1.1 Purpose and scope of the study

Legal service plans are a new type of benefit provided in the context of employment as well as to members of non-employment groups such as consumer cooperatives and student organizations. They provide personal legal services, or reimbursement for such services, to employees or members of groups.

In the space of a few years, prepaid legal services have become an increasingly popular employee fringe benefit. A wide variety of unions in every sector of the economy have expressed an interest in prepaid legal services. Pioneered in the construction industry by the Laborers' International Union and rapidly followed by plans for municipal employers, legal service plans of every size and description have been established in every part of the country.

An apparent impetus to this development was the passage of the Tax Reform Act of 1976 which provided employer-funded plans with favorable income tax treatment. The Tax Reform Act of 1976 added section 120 to the Internal Revenue Code, granting an exclusion from employee gross income for both amounts contributed to legal service funds by an employer on behalf of his employees, as well as the value of legal services benefits received by employees.

Other significant federal legislation which impacts legal service plans is the Employee Retirement Income Security Act of 1974 (ERISA). Prepaid legal plans which are subject to ERISA were made subject to its reporting and disclosure provisions and to fiduciary standards.

By the Tax Reform Act of 1976, both the Secretaries of the Treasury and Labor are required to conduct by 1980 for the President and the Congress "a complete study and investigation with respect to the desirability and feasibility of continuing the exclusion from income of certain prepaid groups legal services benefits.

This study of prepaid legal service plans had been conducted under contract to the Department of Labor during the period 1978-1980. It provides the first statistically reliable profile of plans that are subject to either the Employee Retirement Income Security Act (ERISA) or to Section 120 of the Internal Revenue Code. This study has been conducted in order to achieve two principal objectives. The first is to provide a basis for determining whether the mandates of the Employee Retirement Income Security Act are being fulfilled with respect to legal service plans, particularly whether the present provisions of the Act and its administration are adequate to ensure the healthy development and operation of the plans and their compliance with disclosure, fiduciary and other standards of the Act. The second objective is to provide a portion of the data base necessary for the study and investigation mandated by Congress in connection with Section 120 of the Internal Revenue Code.

Accordingly, while the universe of legal service plans includes many types of plans, the study population has been defined to cover principally those plans subject to the Employee Retirement Income Security Act, and those plans funded by employers and therefore subject to recognition under Section 120. Additionally, the study population includes those bona fide group prepaid legal service plans, presently funded by individual contributions, which appear to offer the potential for conversion to the status of a plan subject to ERISA or to Section 120.

The methodology involved in the construction of the study population is described in detail in Appendix A. Briefly, the study population was defined to include plans having all of the following characteristics:

The plan is established, maintained or funded by a group, such that the group sponsors, collects funds, administers, or performs some function in connection with the plan;

The group associated with the plan is employment-related, consisting of either an employer, an employee association, or some other employment-related organization; and

The plan involves prepayment of services.

A list was compiled of those plans in existence as of June 1979 which clearly met or might potentially meet the profile of plans relevant to the study. Non-conforming plans were excluded from the list. Table 1.1 illustrates the decision track involved in

the selection of plans in the study population. The first filter, group identification, is not shown.

TABLE 1.1.—TYPES OF PLANS INCLUDED IN THE STUDY POPULATION

A list of approximately 2700 plans potentially subject to the study was compiled from a variety of sources, including the records of the U.S. Department of Labor, the files of the National Resource Center for Consumers of Legal Services, and filings made with agencies of state governments. This list of 2700 is by definition a subset of the total universe of all legal service plans, since no effort was made to include those group advice and referral plans, consumer plans, and other nonemployment groups that could readily be identified as such. Additionally, of course, no claim is made that the search process identified every single plan potentially subject to the study. (See Appendix À for details.)

After cleaning for duplicate plans, plans no longer in existence, plans declining to participate in the study, and those for whom telephone numbers could not be obtained, a telephone screen was administered to a list of approximately 1600 plans. Of the 1328 completed telephone surveys (and 82 percent response), 266 plans were identified as qualifying for the study population. The majority of those not qualified are believed to be non-prepaid plans, the so-called group advice and referral plans. The group of 266 prepaid plans constitutes the study population.

The study population is characterized by a substantial number of "clustered plans". These are groups of similar plans marketed and administered by a single organization, provided through a number of separate, employment-related groups. Mail questionnaires for these groups often were sent to the central administrator for response. (More detail is provided in Appendix A.) In order to minimize respondent burden, administrators for the larger clusters were permitted to return a single mail questionnaire containing aggregated responses. (Individual plan data covering source of funding, size, retiree and spousal eligibility were obtained for each plan in the study population through the telephone survey.) Table 1.2 describes the configuration of respondent plans. Data for the study is drawn from both the telephone questionnaire (266 cases) and the mail questionnaire (covering 191 cases).

Difficulties were encountered at each step in the survey as a consequence of the extraordinary variety among plans and the absence of a uniform terminology to characterize their differences, and some reluctance on the part of respondents to report on their plans. In addition, plans experienced difficulty in categorizing their structures; interviewers experienced difficulty evaluating answers given them and coders experienced similar difficulties. After survey data had been gathered, coded and data entered by the research subcontractor, examination of the directory by legal service plan experts revealed the omission of certain large, well-known plans. Consequently, for certain tabulations and cross-tabulations of key variables, data values for eight "found" plans were added to the data gathered from the study population and manually recalculated.

1.2 Research objectives

The study of prepaid legal service plans has yielded two concrete products. The first is a directory tape of all plans in the United States which have been identified as meeting the study profile. The directory contains a list of the names and addresses of all currently operating plans provided in the context of the employment relationship. It is organized by state and also contains information on the number of persons covered by each plan.

The study's major product is this descriptive report based on a statistically reliable survey of plans. Ît profiles the major characteristics of plans and analyzes both the federal income tax consequences and the regulatory issues associated with their continued growth.

The profile will describe plans in terms of the following characteristics: Size, source of funding or sponsorship, legal service benefits, delivery system, eligibility requirements, plan costs, utilization of benefits, grievance systems.

More specifically, the study attempts to address some of the following broad questions:

Regulatory analysis

1. How many legal service plans are presently subject to ERISA, what are their characteristics, and how many persons are covered by these plans?

(a) Are there operational or structural characteristics of prepaid legal plans that would warrant reevaluation of the regulatory requirements of ERISA as they presently apply to such plans?

(b) What benefits patterns characterize prepaid legal plans? Which employees are covered? Is coverage provided to spouses and dependents, retirees or other classes of persons?

(c) Are there substantial cost differences associated with different delivery systems.

2. What is the proportion of plans established by employee associations as compared with plans established by employers (unilaterally or through collective bargaining)? Are there differences between employer and employee funded plans that have consequences for regulation?

3. Do plans subject to ERISA have claim and grievance systems as the Act requires? Are the present filing and reporting requirements of ERISA adequate and do they seem to be complied with?

Tax analysis

1. How many employer-funded prepaid legal service plans are there and what is the date of establishment of each plan?

2. How many employees are covered by employer-funded prepaid legal service plans?

(a) What proportion of plans extend services of spouses and dependents of employees?

(b) What proportion of plans extend services to retired employees?

(c) What proportion of plans extend services to officers, directors or shareholders? 3. What is the average cost per person (contribution) of the employer-funded plans?

4. What services are routinely provided under such plans?

1.3 A Definition of Major Plan Variables

The most important variable of stratification for the study is source of funding since categorization by funding type more clearly defines plans in the study which are subject to ERISA or to Section 120. But, as indicated earlier, there is a continuum of funding possibilities and it is not always easy to classify the different funding sources. For example, a credit union may receive an annual lump sum contribution from an employer to defray costs of maintaining an individual enrollment legal service plan for credit union members. A plan that has employer funding may also have employee contributions. (This seems relatively rare in legal services, since the total amount of money involved in an annual legal services "premium" or contribution is relatively small.)

The basic funding types are described below:

Employer-funded through collective bargaining... Full or partial funding of the plan by the employer or group of employers as the result of a collective bargaining agreement.

Unilaterally employer-funded..

Full or partial funding of the plan is provided by the employer or a group of employers as an unbargained fringe benefit of employment.

Union or employee association dues-funded..... Funding of the legal service plan by a union or employee association from membership dues.

General union or employee association funded... Funding of the legal services plan by the union or employee association from any source, except membership dues.

Individual employee-funded...

Funding or partial funding of their enrollment in the plan by individual employees.

The principal distinction between the dues funded plans and those funded out of general revenues is the use in dues plans of a per capita, earmarked payment assessed equally against all members or employees of the group. In the individual payment plans, the individual must decide to enroll in order to participate, but he need not do so.

All of the funding mechanisms are group funding mechanisms. The first four could be characterized as "true group" plans, where every member is automatically covered by the plan. Funding is either from a third party (such as the employer or the union) or from payments made automatically by all members (dues). The individual payment plans could be called “association group" plans, and are primarily distinguished by the voluntary character of enrollment and payment.

Two other stratification variables of less importance require some explanation. One is benefit structure. There have been a number of approaches taken on the structuring of legal services benefits. Generally, the different structure in legal services reflect the same issues that the health care sector has debated in recent years. These include the effect on cost and quality control of the use of schedules of services and copayments; direct service versus indemnity benefits; and other similar issues. In legal services, limitations on attorney time are an additional technique of control.

With the expectation that legal service plans will one day be widely in operation, the use of benefit structures as one of the variables of stratification may provide baseline data useful in future studies of inflation or distortion in legal services costs or service utilization. Such studies, now being conducted in the health care sector, will likely shape the development of public policy toward legal service plans and may directly affect the direction of plan development.

Below is a description of the benefit structures commonly in use in the legal services field:

Hour bank.

Fee schedule

Types

Definitions

The plan provides a certain number of cases or hours of attorney time per year which may be used on any legal service or specified types of legal services.

The plan provides a list of specific legal services (fees schedules), each of which may be

covered fully or partially.

Shreveport plan...

Types

Group advice/referral

Definitions

The plan divides covered benefits into several major service activity categories (such as advice and consultation, office work, court representation) and provides coverage for each of these service categories fully or with dollar or hourly limitations.

The plan provides mainly group and consultation with other legal services provided at reduced fees.

The first structure, the hour bank, is unique to the legal services field, and has its closest analogy in the relative value schedules in use in the medical sector. The second benefit structure, the fee schedule, is commonly in use in the benefits field. The third, named after the first legal service plan to be established, has also been widely imitated. The fourth category represents a version of the group advice and referral plan, but one which requires a substantial prepayment and provides a sufficient level of benefits to justify its being classed as a prepaid plan.

Finally, the issue of delivery system requires some discussion. Respondent plans were asked which of the following delivery systems described their plan:

Open panel.-Services are provided either (1) by any attorney chosen by the plan member, or (2) by an attorney(s) who participates on a panel sponsored by a bar association, or (3) by an attorney(s) who agrees to participate on a panel open to any attorney.

Closed panel.-Services are provided by individual attorneys, a law firm, or several law firms which are selected by the plan.

Staff panel.-Services are provided by an attorney or staff attorneys who are hired by the plan.

These categories necessarily contain some arbitrariness since plan delivery systems describe a continuum rather than falling inevitably into discrete clusters. A closed panel plan in which the number of firms is large begins to resemble the open panel plan which does not have widespread participation by the bar. Still, respondents seemed to have no difficulty in characterizing their plans in one of the three primary delivery system categories.

In the profile of plans which follows in Chapter Two plans are characterized by these three main variables which demarcate the areas of funding, benefits, and service delivery.

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CHAPTER 2: A PROFILE OF OPERATING LEGAL SERVICE PLANS

This chapter provides a profile of the legal service plans in existence as of June, 1979. The sections following describe various aspects of the structure and operation of plans. In this description the statistical measures which are primarily used are those of central tendency and frequency of distribution. The profile analyzes the following basic descriptors: Number and distribution of plans, size of plan, delivery system, benefit structure, types of benefits, eligibility for plan coverage, age and utilization experience of plans, and plan costs.

2.1 Number and distribution of plans

The study population consists of 266 plans carefully screened to ensure that subject plans met the study's operational definition of a plan. the study population is known to be a subset of the universe of plans. However, there are also two known sources of undercounting in the number of plans in the study population. One is that insurance plans are underrepresented (see Appendix A, Research Methodology, for more detail). Between 75-90 additional plans would be subject to the study had the principal insurer participated in the study and these insurance plans had been included.

A second source of undercounting (which is also reported in Appendix A) was the inability of interviewers to secure telephone numbers for 21.5 percent of the potential eligible plans in the master plan list. These plans were therefore dropped from the study. However, if telephone numbers had been secured, and if the screening calls yielded plans eligible for the survey in the same proportion as those which were found to be eligible, it is estimated that an additional 89 plans might have been found. Nevertheless, while there is no basis for believing that the inaccessible plans differed in any substantial respect from the accessible plans, such a calculation remains speculative.