Continuation of Coverage in Addition to COBRA | Plan Provisions and Taxation

Even before the passage of COBRA, it was becoming increasingly common for employers (particularly large employers) to continue group insurance coverage for certain employees—and sometimes their dependents—beyond the usual termination dates. Obviously, when coverage is continued now, an employer must at least comply with COBRA. However, an employer can be more liberal than COBRA by paying all or a portion of the cost, providing continued coverage for additional categories of persons, or continuing coverage for a longer period of time. Some states have continuation laws for insured medical expense plans that might require coverage to be made available in situations not covered by COBRA. One example is coverage for employees of firms with fewer than 20 employees; another is coverage for periods longer than those required by COBRA.

Retired Employees

Even though not required to do so by the Age Discrimination in Employment Act, many employers continue coverage on retired employees. Although coverage can also be continued for retirees' dependents, it is often limited only to spouses. Retired employees under age 65 usually have the same coverage as the active employees have. However, coverage for employees aged 65 or older (if included under the same plan) may be provided under a Medicare carve-out or a Medicare supplement. The lifetime maximum for persons eligible for Medicare is often much lower (such as $5,000 or $10,000) than for active employees.

The subject of retiree benefits has become a major concern to employers since the Financial Accounting Standards Board (FASB) phased in new rules between 1993 and 1997 for the accounting of postretirement benefits other than pensions. These rules require that employers do the following:

• Recognize the present value of future retiree medical expense benefits on the firm's balance sheet with other liabilities.

• Record the cost for postretirement medical benefits in the period when an employee performs services. This is comparable to the accounting for pension costs.

• Amortize the present value of the future cost of benefits accrued prior to the new rules.

These rules are in contrast to the long-used previous practice of paying retiree medical benefits or premiums out of current revenue and recognizing these costs as expenses when paid. Although the rules are logical from a financial accounting standpoint, the effect on employers has been significant. Employers who have elected to immediately recognize the liability have had to show reduced earnings and net worth. Firms that have elected to amortize the liability (often because immediate recognition would wipe out net worth) will be affected for years to come.

The FASB rules have resulted in two major changes by employers. First, many employers have lowered or eliminated retiree benefits or are considering such a change. However, there are legal uncertainties as to whether benefits that have been promised to retirees can be eliminated or reduced. Many employers also feel that there is a moral obligation to continue these benefits. As a result, most employers are not altering plans for current retirees or active employees who are eligible to retire. Instead, the changes apply to future retirees only. These changes, which seem to be running the gamut, include the following:

• The elimination of benefits for future retirees.

• The shifting of more of the cost burden to future retirees by reducing benefits. Such a reduction may be accomplished by providing lower benefit maximums, covering fewer types of expenses, or increasing copayments.

• Adding or increasing retiree sharing of premium costs after retirement.

• Shifting to a defined-contribution approach to funding retiree benefits. For example, an employer might agree to pay $5 per month toward the cost of coverage after retirement for each year of service by an employee. Thus, an employer would make a monthly contribution of $150 for an employee who retired with 30 years of service, but the employer would make a contribution of only $75 for an employee with 15 years of service. Many plans of this nature have been designed so that the employer's contribution increases with changes in the consumer price index, subject to maximum increases (such as 5 percent per year).

• Encouraging retirees to elect benefits from managed care plans. With this approach, retirees are required to pay a significant portion of the cost if coverage is continued through a traditional indemnity plan.

A second change is that employers have increasingly explored methods to prefund the benefits. However, there are no alternatives for prefunding that are as favorable as the alternatives for funding pension benefits. One alternative is the use of a 501(c)(9) trust (or VEBA). There are limitations on the deductible of contributions to a 501(c)(9) trust. Furthermore, a 501(c)(9) trust can be used to fund retiree benefits only if it is currently being used to fund benefits for active employees.

Another alternative is to prefund medical benefits within a pension plan. Contributions are tax deductible, and earnings accumulate tax free. The IRS rules for qualified retirement plans permit the payment of benefits for medical expenses from a pension plan if certain requirements are satisfied:

• The medical benefits must be subordinate to the retirement benefits. This rule is met if the cost of the medical benefits provided does not exceed 25 percent of the employer's aggregate contribution to the pension plan. For many employers, this figure is too low to allow the entire future liability to be prefunded.

• A separate account must be established and maintained for the monies allocated to medical benefits. This account can be an aggregate account for nonkey employees, but individual separate accounts must be maintained for key employees, and medical benefits attributable to a key employee (and his or her family members) can be made only from the key employee's account.

• The employer's contributions for medical benefits must be ascertainable and reasonable.

Although the rules for funding retiree medical benefits in a pension plan are restricted and administratively complex, they offer an employer the opportunity to deduct at least a portion of the cost of prefunded benefits.

Surviving Dependents

Coverage can be continued for the survivors of deceased active employees and/or deceased retired employees. However, coverage for the survivors of active employees is not commonly continued beyond the period required by COBRA, and coverage for the survivors of retired employees may be limited to surviving spouses. In both instances, the continued coverage is usually identical to what was provided prior to the employee's death. It is also common for the employer to continue the same premium contribution level.

Laid-off Employees

Medical expense coverage can be continued for laid-off workers, and large employers frequently provide such coverage for a limited period. Few employers provide coverage beyond the period required by COBRA, but some employers continue to make the same premium contribution, at least for a limited period of time.

Disabled Employees

Medical expense coverage can be continued for an employee (and dependents) when he or she has a temporary interruption of employment, including one arising from illness or injury. Many employers also cover employees who have long-term disabilities or who have retired because of a disability. In most cases, this continuation of coverage is contingent on satisfaction of some definition of total (and possibly permanent) disability. When continuing coverage for disabled employees, an employer must determine the extent of employer contributions. For example, the employer may continue the same premium contribution as for active employees, although there is nothing to prevent a different contribution rate—either lower or higher.

Continuation of Coverage under COBRA | Plan Provisions and Taxation

The Consolidated Omnibus Budget Reconciliation Act of 1985, or COBRA, requires that group health plans allow employees and certain beneficiaries to elect to have their current health insurance coverage extended at group rates for up to 36 months following a "qualifying event" that results in the loss of coverage for a "qualified beneficiary." The term group health plan as used in the act is broad enough to include medical expense plans, dental plans, vision care plans, and prescription drug plans, regardless of whether benefits are self-insured or provided through other entities, such as insurance companies, HMOs, or PPOs. COBRA applies even if the cost of a plan is paid solely by employees, as long as the plan would not be available at the same cost to an employee if he or she were not employed. There is one exception to this rule: Voluntary benefit plans under which the employer's only involvement is to process payroll deductions are not subject to COBRA.

Church and government plans are exempt from COBRA, but the act applies to all other employers who had the equivalent of 20 or more full-time employees on a typical business day during the preceding calendar year. For example, an employer who had 10 full-time and 16 half-time employees had the equivalent of 18 full-time employees and is not subject to COBRA. Failure to comply with the act results in an excise tax of up to $100 per day for each person denied coverage. The tax can be levied on the employer as well as on the entity (such as an insurer or HMO) that provides or administers the benefits.

Since the passage of COBRA, a qualified beneficiary has been defined as any employee, or the spouse or dependent child of the employee, who on the day before a qualifying event was covered under the employee's group health plan. HIPAA expanded the definition to include any child who is born to or placed for adoption with the employee during the period of COBRA coverage. This change gives automatic eligibility for COBRA coverage to the child as well as the right to have his or her own election rights if a second qualifying event occurs.

Under the act, each of the following is a qualifying event if it results in the loss of coverage by a qualified beneficiary or an increase in the amount the qualified beneficiary must pay for the coverage:

The death of the covered employee

The termination of the employee for any reason except gross misconduct (This includes quitting, retiring, or being fired for anything other than gross misconduct)

A reduction of the employee's hours so that the employee or dependent is ineligible for coverage

The divorce or legal separation of the covered employee and his or her spouse

For spouses and children, the employee's eligibility for Medicare

A child's ceasing to be an eligible dependent under the plan

The act specifies that a qualified beneficiary is entitled to elect continued coverage without providing evidence of insurability. The beneficiary must be allowed to continue coverage identical to that available to employees and dependents to whom a qualifying event has not occurred.

Coverage for persons electing continuation can be changed when changes are made to the plan covering active employees and their dependents. The continued coverage must extend from the date of the qualifying event to the earliest of the following:

18 months for employees and dependents when the employee's employment has terminated or coverage has been terminated because of a reduction in hours. This period is extended to 29 months for a qualified beneficiary if the Social Security Administration determines that the beneficiary was or became totally disabled at any time during the first 60 days of COBRA coverage.

36 months for other qualifying events.

The date the plan terminates for all employees.

The date the coverage ceases because of a qualified beneficiary's failure to make a timely payment of premium.

The date a qualified beneficiary subsequently becomes entitled to Medicare or becomes covered (as either an employee or dependent) under another group health plan, provided the group health plan does not contain an exclusion or limitation with respect to any preexisting condition. If the new plan does not cover a preexisting condition, the COBRA coverage can be continued until the earlier of (1) the remainder of the 18- or 36-month period or (2) the time when the preexisting-conditions provision no longer applies. Note that COBRA coverage is not affected by entitlement to benefits under Medicare or coverage under another group plan if this entitlement or coverage existed at the time of the qualifying event.

If a second qualifying event (such as the death or divorce of a terminated employee) occurs during the period of continued coverage, the maximum period of continuation is 36 months. For example, if an employee terminates employment, the employee and family are eligible for 18 months of COBRA coverage. If the employee dies after 15 months, a second qualifying event has occurred for the employee's spouse and dependent children. The normal period of COBRA continuation resulting from the death of an employee is 36 months. However, because the spouse and children have already had COBRA coverage for 15 months, the second qualifying event extends coverage for an additional 21 months.

At the termination of continued coverage, a qualified beneficiary must be offered the right to convert to an individual insurance policy if a conversion privilege is generally available to employees under the employer's plan.

Notification of the right to continue coverage must be made at two times by a plan's administrator. First, when a plan becomes subject to COBRA or when a person becomes covered under a plan subject to COBRA, notification must be given to an employee as well as to his or her spouse. Second, when a qualifying event occurs, the employer must notify the plan administrator, who then must notify all qualified beneficiaries within 14 days. In general, the employer has 30 days to notify the plan administrator. However, an employer may not know of a qualifying event if it involves divorce, legal separation, or a child's ceasing to be eligible for coverage. In these circumstances, the employee or family member must notify the employer within 60 days of the event, or the right to elect COBRA coverage is lost. The time period for the employer to notify the plan administrator begins when the employer is informed of the qualifying event, as long as this occurs within the 60-day period.

The continuation of coverage is not automatic; it must be elected by a qualified beneficiary. The election period starts on the date of the qualifying event and may end not earlier than 60 days after actual notice of the event to the qualified beneficiary by the plan administrator. Once coverage is elected, the beneficiary has 45 days to pay the premium for the period of coverage prior to the election.

Under COBRA, the cost of the continued coverage may be passed on to the qualified beneficiary, but the cost cannot exceed 102 percent of the cost to the plan for the period of coverage for a similarly situated active employee to whom a qualifying event has not occurred. The extra 2 percent is supposed to cover the employer's extra administrative costs. The one exception to this rule occurs for months 19 through 29 if an employee is disabled, in which case the premium can then be as high as 150 percent. Qualified beneficiaries must have the option of paying the premium in monthly installments. In addition, there must be a grace period of at least 30 days for each installment.

COBRA has resulted in significant extra costs for employers. Surveys indicate that coverage is elected by approximately 20 percent of those persons who are entitled to a COBRA continuation. The length of coverage averages almost one year for persons eligible for an 18-month extension and almost two years for persons eligible for a 36-month extension. While significant variations exist among employers, claim costs of persons with COBRA coverage generally run between 150 percent and 200 percent of claim costs for active employees and dependents. Moreover, administrative costs are estimated to be about $20 per month for each person with COBRA coverage.