Tobacco surcharges in wellness programs offer employers a tool to manage healthcare costs and encourage healthier behaviors. But what was once viewed as a routine feature of plan design now faces growing scrutiny as litigants challenge how programs are structured, administered, communicated, and governed (opens a new window).
As claims activity increases, tobacco surcharges are emerging as a significant source of fiduciary risk for plan sponsors and prompting close attention from fiduciary liability insurance underwriters. For employers, understanding both the legal landscape and the insurance implications has become critical to effectively managing risk.
From cost control to the courtroom
In recent years, employers have increasingly introduced tobacco surcharges as part of broader wellness programs for employees, which are designed to reduce healthcare costs and encourage healthier behaviors. Tobacco surcharges typically impose higher health insurance premiums for employees who smoke cigarettes or use other tobacco products.
In the past, this was viewed as a straightforward, risk-based pricing mechanism, but it has quickly become a growing source of litigation. Before 2024, such cases hardly registered on the fiduciary liability risk terrain. But by 2025, more than 50 class-action lawsuits were filed challenging these practices, signaling a sharp rise in scrutiny.
Plaintiffs in these suits argue that tobacco surcharges unfairly penalize tobacco users, by violating fiduciary duties and federal wellness program rules. These lawsuits reframe what employers see as actuarial fairness into a claim of inequitable treatment.
Legally, these cases are typically brought under the Employee Retirement Income Security Act of 1974 (ERISA) and related benefits laws, focusing on whether plan fiduciaries have met their obligations in designing and administering health plans. They also intersect with wellness program rules under the Health Insurance Portability and Accountability Act (HIPAA), which allow tobacco surcharges only if strict nondiscrimination standards are satisfied.
In administering wellness programs, employers are required under HIPAA to ensure that all participants have a genuine opportunity to earn full financial incentives. As such, an employer must offer a reasonable alternative standard (RAS) for employees who may not be able to meet certain plan standards. An example of an RAS, in the context of tobacco surcharges, is a smoking cessation program.
Litigation tends to focus on:
Whether employees were denied full rewards, particularly when premium discounts are only applied prospectively. Plaintiffs tend to argue that premium discounts should be fully retroactive.
Whether reasonable alternative options were clearly offered; otherwise, surcharges are likely to be viewed as discriminatory and/or punitive.
Whether disclosures in plan materials were adequate. Insufficient transparency and disclosure could lead to findings that plans are noncompliant with ERISA and HIPAA.
In some cases, plaintiffs also argue that collecting the surcharge itself constitutes a breach of fiduciary duty.
Risks expanding beyond retirement plans
The recent wave of tobacco surcharge litigation reflects a broader shift in fiduciary risk. Historically, most litigation involving benefit plans — excessive fee cases in particular — focused on defined contribution plans. However, we are seeing more attention on health and welfare plan design.
Tobacco-related claims, which were rare prior to 2024, have quickly emerged as a leading example of this trend. For employers and insurers, this signals a new area of exposure that requires closer attention to health plan governance, compliance, and communication.
At the same time, the legal landscape remains unsettled. Courts have issued mixed rulings regarding tobacco surcharges. Some employers have paid significant settlements and modified their programs following litigation. But recent decisions in several jurisdictions have favored employers, finding that prospective incentives can meet legal standards and that retroactive reimbursement may not be required.
Despite these developments, uncertainty persists due to the limited body of case law and the ongoing volume of new filings. Beyond litigation, regulators are also particularly attentive to whether employers provide clear disclosures and meaningful access to alternatives, further heightening exposure for employers that fail to design compliant wellness programs or when communications regarding programs are unclear or incomplete.
Evolving insurance considerations
As claims activity increases and uncertainty about tobacco surcharges persists, it’s vital that employers understand how insurance coverage applies. Fiduciary liability insurance policies should be designed to respond to claims alleging breaches of duty under ERISA or similar benefits laws. Tobacco surcharge litigation is increasingly falling within that scope.
Coverage typically extends to defense costs as well as potential settlements or judgments, subject to specific policy terms. Even when claims are ultimately dismissed or resolved favorably, defense expenses alone can be significant, making insurance an important financial safeguard.
While monetary defense and settlement data is anecdotal, it’s reasonable for a plan sponsor to expect to spend over $1 million defending a claim. We are aware of two settlements of nearly $5 million each; it’s too early to tell if these settlements are outliers, or the norm.
Fiduciary liability insurance buyers must also be aware of how insurers are responding to emerging tobacco surcharge exposures. Carriers have begun incorporating more detailed underwriting questions about health and welfare plans in general, and wellness programs and tobacco surcharges more specifically. This signals a heightened focus on how these risks are evaluated.
Given the limited claims history and evolving legal landscape, insurers may also refine coverage terms over time. This could include changes such as higher retentions, targeted sublimits, or exclusions aimed at managing uncertainty until litigation patterns and outcomes become clearer.
Compliance and insurance coverage in focus
With increasing scrutiny from plaintiffs and regulators, plan sponsors should focus on building programs that are defensible, transparent, and fully compliant. This means not only adhering to technical requirements but also ensuring employees clearly understand their options and have meaningful opportunities to avoid surcharges.
Clear communication and accessible wellness support are central to reducing risk. Employers that combine thoughtful plan design with proactive compliance and strong documentation will be better positioned as the legal landscape continues to evolve.
Employers should also consider:
Revisiting wellness program design to confirm full compliance with HIPAA nondiscrimination rules, including offering RASs.
Ensure all employees have genuine opportunities to earn wellness programs’ full rewards.
Strengthen communications, especially for outcome-based programs, so costs and alternatives are clearly understood.
Stay closely aligned with legal and compliance advisors as litigation trends develop.
At the same time, employers should take a proactive approach to managing potential insurance implications. This starts by reviewing existing fiduciary liability coverage to ensure it addresses health and welfare plans, in addition to traditional retirement plans.
The process of moving from plan design to implementation and administration is a spectrum that starts with settlor acts, so settlor coverage is critical here. Policyholders should pay close attention to other policy terms, including definitions of loss, covered claims, and any limitations that may apply to wellness program-related litigation.
Ahead of upcoming renewals, it’s important that risk professionals engage early with insurance brokers and carriers to understand how underwriting perspectives are evolving. As insurers ask increasingly detailed questions about wellness program design, clear, consistent responses can yield more favorable results for employers.
Finally, employers should regularly reassess limits, retentions, and overall program structure to ensure alignment with changing risk profiles. This is especially important as claims activity and legal uncertainty continue to grow.
For more information, please visit our Fiduciary Liability webpage here (opens a new window).
This combines some comments from Steve with guidance from the People Solutions article that is being finalized. We can include a link to that article once it’s published.
