Dependent Eligibility: Another Fiduciary Responsibility for Employers

As the 2025 calendar year winds down, many employers with calendar year plans are diligently working through their annual open enrollment period. It can be common for employers to inadvertently skip over some of the more obscure processes that support open enrollment in the course of juggling the myriad tasks and responsibilities that crop up during this time. But, the steady stream of fiduciary litigation we’ve seen across the past few years reinforces that it’s important for employers, especially those with self-insured plans, to incorporate some of these lesser-known responsibilities into their plan’s open enrollment and monitoring procedures. We’re going to take a look at one of these items, dependent eligibility, and provide some tips to help employers and their advisors avoid unwanted compliance issues.

Let’s begin by emphasizing that it’s always a good idea for employers to ensure that they’re abiding by the written terms of their plan. Plan documents serve as the “source of truth” for how the plan operates and employers, as fiduciaries, need to administer benefits according to those terms. The documents should clearly define who qualifies as an eligible dependent, including who’s specifically eligible for what if the company has rules that differ plan-by-plan, class-by-class, etc. That clarity helps prevent claim denials, affirm that the employer is compliant with state and federal regulations, and offers a framework verifying that only eligible individuals are participating in the company’s benefits. Vague or missing eligibility provisions can cause unwelcome (and potentially costly) confusion for participants and those responsible for actually administering the plan. 

Unfortunately, even employers that clearly define their eligibility provisions may find themselves accidentally covering ineligible dependents. There could be financial, operational, and legal risks associated with this, including:

• Inflated Premium Payments- The employer might incur thousands of dollars in annual premium costs for covering ineligible dependents that could otherwise be directed elsewhere; 
• Higher Claims Activity- Ineligible dependents might have claims that inflate the overall utilization of benefits. This increases both the financial responsibility self-insured plans take on and the likelihood of higher premiums at the plan’s renewal;
• Claims Denials- If an insurance carrier or stop-loss vendor learns that a claim has been incurred by an ineligible individual, they may refuse to cover it, shifting the full financial responsibility onto the employer;
• Tax Consequences- The cafeteria plan rules provide that employers can only offer pretax health benefits to dependents who satisfy specific criteria. Providing tax-favored benefits to dependents who fall outside those requirements could create taxable income issues for the employee and the employer; and
• Employee Confusion- A lack of communication coupled with inconsistent or vague definitions might lead to disputes, especially if there is a denial of coverage.

To avoid these risks, employers can (and should) perform dependent eligibility verification audits. These audits determine the relationship between a plan participant and their dependents to ensure that ineligible individuals aren’t participating in the company’s coverage. We want to underscore that most participants don’t intentionally cover ineligible dependents; oftentimes, there’s simply uncertainty about who can participate and/or what they’re supposed to do if one of their dependents becomes ineligible (e.g. through divorce). While there’s little “official” guidance about how dependent eligibility audits should be performed, we’ve listed a sampling of the items employers might want to keep in mind for the process:

• Employers can either attempt an in-house audit or contract with a vendor that specializes in the service;
• Those employers that want to conduct the audit internally will need to consider logistics such as:
  
  • What communications they’ll share with employees;
  • What documentation they’ll require to perform the audit;
  • When the documentation will be due; and
  • How they’ll approach employees that don’t provide the required documentation;
• This audit can be conducted at any time, bearing in mind that, depending on the size of the group, a thorough review could take several months. Employers may want to aim to have the results available around the beginning of their open enrollment period so they can start the next plan year in good shape;
• Along similar lines, these audits should not be a one-time event. Employers should instead develop a cadence for ensuring their plan is operating appropriately; and
• Different types of documentation will be appropriate depending on the type of dependent being audited. E.g., participants may need to provide marriage certificates for spouses and birth certificates for children. However, we recommend establishing the same type of documentation requirements for all similarly situated employees.

If the audit reveals ineligible dependents are participating in the plan, the employer can terminate their coverage and terminate the employee pretax elections to pay for that coverage. Coverage can be terminated prospectively, but employers need to be very cautious about terminating coverage retroactively, which is only permissible in the cause of fraud, intentional misrepresentation, or in certain circumstances where adequate payment hasn’t been made. Once coverage is terminated, dependents who were never eligible for the plan will generally not be entitled to COBRA. An ineligible dependent who was previously eligible (e.g., a child whose coverage continued after they aged out of eligibility or an ex-spouse) might be entitled to COBRA, depending on their relationship to the employee, the reason eligibility was lost, and when eligibility was lost.  

All in all, dependent eligibility verification audits are a valuable tool for helping employers mitigate financial and compliance risk and fulfill their fiduciary duties. The list above, however, demonstrates that this process can be administratively tedious and complex for employers to take on themselves. For more information about how Lumelight can assist with dependent eligibility verification audits, click here.