Due to the shifting economic climate, some companies may be contemplating layoffs or reductions in force (RIFs) and whether to subsidize health insurance premiums for impacted employees as a part of a severance package. This article provides an overview of health and welfare compliance issues employers may want to consider when determining if and how to offer COBRA subsidies.
Termination of Active Health Coverage
Most health insurance policies require employees to be “active” or working a specified number of hours to be eligible for coverage. As such, when an employee is terminated, the employee will lose eligibility under their employer-sponsored medical plan(s) and coverage will cease as prescribed in the plan documents (most commonly, medical coverage will cease at the end of the month in which plan eligibility is lost).
Employers should review their health insurance policies or plan documents to determine plan eligibility requirements and when coverage will cease. If an employer wants to keep terminated employees on “active” coverage for a specified amount of time (e.g., 3 months after termination), they should consult with their carrier (if fully insured) or stop-loss provider (if self-insured) to ensure this arrangement will be permitted.
After coverage is terminated, employers will be required to offer federal COBRA continuation coverage if they employed 20 or more employees on a typical business day during the preceding calendar year. Employers that do not meet this 20-employee threshold and sponsor a fully insured medical plan may still have continuation coverage obligations under applicable state law (e.g., Cal-COBRA or NY mini-COBRA). Terminated employees will then have the opportunity to elect COBRA continuation coverage, which could cost the employee up to 102% of the premium.
Although not legally required, employers may provide terminated employees with a subsidy to pay for a portion (or for the total) premiums for COBRA continuation coverage for a specified period of time. Employers should consider the following when determining if and how to offer such a subsidy.
- Eligibility for the Subsidy & Non-Discrimination Issues
Employers may encounter Internal Revenue Code (IRC) Section 105(h) non-discrimination issues if they sponsor a self-insured or level funded plan and only provide subsidies (or disproportionate subsidies) to highly compensated employees (e.g., only providing subsidies to executives or providing executives with larger and/or longer subsidies as compared to other employees). To avoid potential non-discrimination issues, self-insured employers who decide to offer COBRA subsidies should do so on an equitable basis. Alternatively, self-insured employers can offer COBRA subsidies on a taxable basis to avoid non-discrimination issues.
While the Affordable Care Act added non-discrimination rules similar to Section 105(h) to fully insured plans, the government has delayed enforcement of this provision until further regulations are issued (to date, no such regulations have been issued); therefore, fully insured employers are not currently subject to the same non-discrimination restrictions.
- Duration of Subsidy
Generally, federal COBRA provides for continuation coverage of up to 18 months when the loss of coverage is due to an employee’s termination. Certain state mini-COBRA laws may also provide additional coverage, up to 36 months, after federal COBRA coverage is exhausted.
Employers may provide COBRA coverage for a period longer than required under federal or state law; however, they should obtain approval for this extension from their carrier (if fully insured) or their stop-loss provider (if self-insured). If a carrier or stop-loss provider does not agree to this extension (or does not explicitly amend the controlling plan documents to allow for the extension) and an employer continues to extend coverage, the employer may be liable for self-insuring claims after the legally mandated period. As such, employers should be especially cautious and understand the potential liability when deciding to extend coverage beyond the required timeframes. Further, if an employer decides to extend coverage, they should do so equitably.
If offering a COBRA subsidy, employers will want to clearly state in any severance agreement when the subsidy will begin, any eligibility conditions for the subsidy to begin (e.g., an individual must timely elect COBRA), whether the subsidy will run concurrently with the COBRA continuation coverage, the total duration of the subsidy (not to extend beyond the allowable COBRA time period), and any factors that would cause the subsidy to cease.
- Provision & Taxation of the Subsidy
Employers have several options on “how” they can provide the subsidy to individuals; however, they should be aware that the method they choose directly impacts the taxation of the subsidy.
- Non-taxable Options: COBRA subsidies are non-taxable and excluded from wages if:
- An employer pays the entire premium to the insurer or third-party administrator (TPA);
- An employer reimburses individuals only after they provide substantiation of a COBRA payment;
- An employer pays a portion of the premium and permits terminated employees to pay for the remaining portion of the premium on a pre-tax basis from their final paycheck, or
- If terminated employees receive severance payments, the employer allows them to pay premiums on a pre-tax basis through the end of the Cafeteria Plan year. Please note that an employer’s Cafeteria Plan must expressly allow for this arrangement, or an employer must amend their Cafeteria Plan documents accordingly.
- Taxable Options: COBRA subsidies are taxable if the employer provides funds directly to individuals without requiring substantiation. This is because an employee may or may not use the funds to pay for COBRA premiums, and therefore, the funds are treated as wages subject to applicable taxes.
Employers should determine “how” they will provide COBRA subsidies and whether they will allow terminated employees to pay for any remaining premiums through the employer’s Cafeteria Plan. Employers should be sure to communicate this method in the severance agreement.
- Impact of COBRA Subsidies and Special Enrollment Rights
Generally, the termination of employment and the exhaustion of COBRA coverage (e.g., at the end of 18 months) creates a special enrollment right that allows enrollment onto marketplace or other employer-sponsored coverage (e.g., enrollment onto a spouse’s or new employer’s plan). However, it is important for individuals to understand that a voluntary termination of COBRA coverage before the maximum period is exhausted, such as terminating coverage because an employer-sponsored subsidy ends, does not trigger a special enrollment opportunity that would allow enrollment in an employer-sponsored plan.
For example, let’s say that an employer provides a 6-month COBRA subsidy for all terminated employees. Upon termination, a former employee elects COBRA continuation coverage and, within 3 months of being terminated, is hired by a new employer. If the employee decides to continue COBRA continuation coverage under their former employer’s plan to take advantage of the subsidy and forgoes enrollment into their new employer’s group health plan, the employee should be aware that the loss of the COBRA subsidy would not trigger a special opportunity for the employee to enroll onto the new employer’s group health plan. Instead, the employee would need to wait until their COBRA coverage time period is fully exhausted or until the new employer’s open enrollment period to enroll onto the new employer’s plan.
As such, employees who elect COBRA coverage to take advantage of an employer-provided subsidy should be aware of the potential restrictions of gaining other coverage when the subsidy ends.
To avoid potential conflict and liability, employers should ensure any severance agreement clearly outlines terminated employees’ rights to benefits continuation, including, but not limited to, the following:
- When active health care benefits will terminate;
- Whether continuation of coverage is available, and if so, for which types of coverage and whether the coverage will be provided through COBRA coverage or COBRA subsidized by the employer;
- When continuation coverage will commence and terminate (if elected);
- If a COBRA subsidy is provided:
- A statement that the subsidy is subject to the employee’s timely election of, and eligibility for, COBRA coverage;
- The amount and duration of the subsidy;
- When the subsidy begins;
- Which types of coverage (e.g., medical, dental, vision, etc.) and coverage levels (e.g., employee-only or family coverage) to which the subsidy applies;
- How the subsidy will be provided (e.g., directly to the insurer or in the form of taxable funds);
- Conditions under which the subsidy would cease (e.g., enrollment into Medicare).
It is important to highlight that a severance agreement is not a substitute for COBRA compliance and employers must still fulfill any COBRA obligations, including but not limited to, providing COBRA election notices to qualified beneficiaries within the prescribed timeframes. Employers may want to work with outside counsel for assistance in drafting their severance agreements to ensure any potential employer liability is minimized.
Employers who are contemplating whether to provide COBRA subsidies should determine the eligibility for, the amount and duration of, and method by which to provide the subsidies and ensure they obtain approval from their carrier (if fully insured) or their stop-loss provider (if self-insured), as needed. To minimize potential conflict or liability, employers should explicitly outline these details in any severance agreement and communications to terminated employees.
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