Compliance Considerations for Employers When Offering Post-Employment Benefit Severance

With layoffs on the rise in a rapidly shifting economic landscape, many Employers discuss severance packages which often include health insurance subsidies.

Subsidized health insurance premiums for COBRA continuation, or “Cobra-like” coverage, may seem straightforward, but require careful planning and must operate in compliance with Federal and State laws. In this article, we glance at some “hot tips” for the most commonly asked questions relating to COBRA premium subsidies.

Subsidizing COBRA Premiums As Part of Employer-Paid Severance Package
Can an employer pay COBRA premiums for an employee? While it is not required by law, employers may offer former employees subsidized premiums, covering all or a percentage of the monthly COBRA or continuation coverage premium rate. Subsidized premiums may be offered for specified time-periods, such as one month all the way up to the full eligibility time-period of a COBRA continuation qualified beneficiary (usually 18 months). Companies that choose to offer subsidized health insurance premiums whereby the employer pays for the coverage for a designated amount of time should be mindful of an employee's eligibility for the subsidized premiums, and review the circumstances to ensure non-discrimination issues are covered. See also IRS Code 105 on Nondiscrimination.

When an employee is no longer working for the company, simply keep their benefits active, right?... Wrong.
While it may seem like a beneficial proposition to allow the employee’s benefits to remain active when a severance package is involved, the best practice is to handle the qualifying event the same way that you would for any other employee. That is, coverage should be terminated in accordance with the health insurance policy requirements. Most health carriers require that employees be “terminated” within a 30-to 60-day time period following a COBRA or mini-COBRA qualifying event. From there, coverage may be continued and subsequently reinstated when a former employee elects continuation coverage such as COBRA.

Once coverage is terminated, employers are typically required to offer Federal COBRA if they had more than 20 employees during the preceding calendar year and “mini Cobra” (state continuation) if they had less than the 20-employee threshold.

How Long Should a Premium Subsidy Last?
Employers will need to clearly define and communicate in a COBRA subsidy severance agreement what the COBRA or continuation coverage subsidy entails, such as duration, eligibility conditions, and employee cost (if partial subsidy). 
The duration of a subsidy should be determined by the Employer ahead of time and should run concurrently with the COBRA timeline. For example, if the employer chooses to offer employer-paid COBRA severance for premiums for the entire time someone is eligible then this could be 18, 29, or 36 months depending on the COBRA qualifying event type.

How should Employers handle payment of COBRA premiums and are there applicable taxes to consider?
There are multiple ways to cover the COBRA or continuation coverage premiums that are to be subsidized. Employers should keep in mind that whatever method they choose, will directly affect how the subsidy is taxed.  Here are some examples:
COBRA subsidies are taxable if the employer pays the premiums directly to the former employee. For example, including premiums in a severance payment rather than paying the insurance carrier bill directly. This is because employees can choose to use those funds for other purposes, and may not use them for COBRA premiums, causing the funds to be treated as wages subject to taxes.
Several NO TAXATION options include:

• The employer pays a portion of the premium and allows the former employee to pay for the remaining balance due on a pre-tax basis from the final paycheck;
• The employer sends the employer-paid premiums directly to the insurance carrier or works out an arrangement with the TPA such as a COBRA vendor such as CobraHelp.* (*most common).
• Require former employees to provide substantiation of COBRA premium payment in order for employer reimburse the former employee’s premium payment.
• If Cafeteria Plan applies, the employer may allow the terminated employee to pay premiums on a pre-tax basis via the Cafeteria Plan, through end of plan year. (Employers should verify this is allowed with their Cafeteria Plan documents/provider).

Will subsidizing my terminated employee’s premiums have an effect on Special Enrollment Rights?
It is important for qualified beneficiaries to be made aware of the fact that voluntary termination of COBRA or continuation coverage before the eligibility period ends (e.g. 18 months) does not trigger a special enrollment opportunity. For example, if the individual decided to discontinue COBRA coverage once the employer-sponsored premiums ended, this would not create a special enrollment opportunity for the individual to obtain other health coverage.
This means that if the employee obtains a new job, as an example, and decides to continue COBRA coverage in order to take advantage of the subsidized premiums from the former employer, the employee should understand that this doesn’t create a special enrollment opportunity with the new employer’s group health plan. The individual would have to wait until the next open enrollment in order to enroll in the new group health benefits, which is once per year.

What should an Employer need to do to document the subsidized COBRA premiums?
Thorough, well-documented COBRA subsidy severance agreements help employers and former employees avoid conflict and liability.  Employers should clearly communicate any severance arrangement and carefully outline the employee’s rights to continuation of benefits in the severance agreement. Remember that the Severance Agreement is NOT a replacement for compliance requirements such as the Notice of Right to Elect COBRA so employers will still have compliance obligations beyond the agreement about subsidies offered. Some important details to include are:

• Whether COBRA continuation or “mini Cobra” (state continuation) are offered.
• When the group health plan benefits will terminate (end of month, or day after the qualifying event).
• Whether the continuation coverage (if applicable) will be subsidized by the employer and if so, what is the percentage of premium to be covered by employer and percentage to be covered by employee.
• Statement indicating eligibility requirements such as timely election of continuation coverage such as COBRA.
• How subsidized premiums will be paid by both parties (if both parties are paying a portion).
• When subsidized premiums begin and end.
• List any conditions under which the subsidy would cease. For example, if employee enrolls into Medicare).
• Which lines of coverage are to be subsidized – such as medical, dental, vision and what tier of coverage such as “single”, “employee + spouse”, or “family” coverage.

CobraHelp always recommends that our clients work with Experts such as outside counsel who specialize in ERISA and employment law for help in drafting appropriate severance agreements and post-employment-related documents. This will ultimately help employers minimize potential liability and aid all parties in achieving a smooth transition. 

Legal Disclaimer:
​The information in this website is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from CobraHelp. or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.