COBRA Subsidies and Reimbursement Part III: Reimbursing COBRA Through Prior Employer’s Plan

Question: Can employers reimburse employees’ COBRA premiums for coverage through a prior employer?

Short Answer: Generally yes, COBRA premium reimbursement is a common approach for employees who are not immediately able to enroll in the employer’s health plan, such as new hires in a waiting period.

This is the final entry in our three-part series addressing COBRA subsidies and reimbursement.

• Part I: Avoiding Nondiscrimination Issues

• Part II: How COBRA Subsidies Can Prove Costly

General Rule: COBRA Qualifying Event for Continuation Coverage

Individuals have the right to continue group health plan coverage through COBRA upon experiencing a “qualifying event,” which is a loss of coverage caused by one of the prescribed COBRA triggering events (e.g., termination of employment). Individuals who experience a COBRA qualifying event are referred to as “qualified beneficiaries.”

• For more details: Newfront COBRA for Employers Guide

Why Employers Reimburse COBRA Premiums Through a Prior Employer

Employers may choose to reimburse COBRA premiums for coverage maintained under a former employer’s health plan. These arrangements are common for the following types of situations:

• New hires relying on COBRA for coverage during the new employer’s waiting period;

• New hires who need to continue coverage through the prior employer for access to certain providers involved in an ongoing treatment program (i.e., continuity of care); or

• New hires who are not eligible for the new employer’s plan (e.g., a part-time hire).

The most common arrangement is designed to address the new hire waiting period for coverage.

Why COBRA Premium Reimbursement Makes Sense for New Hires in the Waiting Period

Employer-sponsored group health plans frequently impose an eligibility and/or waiting period before a new hire can participate in the health plan. For example, the plan might impose a 90-day waiting period or a combined eligibility orientation period and waiting period that makes coverage available as of the first day of the fourth full calendar month of employment.

Early Enrollment “Exceptions” Are Not Appropriate

ERISA requires that employers administer and maintain the plan pursuant to its written terms, including its eligibility requirements. Within this ERISA framework, employers should not make “exceptions” to act contrary to plan terms because doing so could be a breach of fiduciary duty. Early enrollment can therefore create an ERISA plan precedent requiring the plan to offer coverage upon satisfying the reduced or eliminated waiting period for similarly situated employees. An employee denied the ability to enroll in similar circumstances (i.e., prior to satisfying the standard waiting period) could have a claim for ERISA breach of fiduciary duty or a claim for benefits. In addition, early enrollment can create insurance carrier or stop-loss provider coverage issues.

For more details:

• Newfront ERISA for Employers Guide

• The Core Four ERISA Fiduciary Duties

• New Hire Exception Requests to Enroll Prior to Satisfying the Plan’s Waiting Period

COBRA Premium Reimbursement as the Workaround

Employers often seek to address situations where the waiting period places the company at a competitive disadvantage in recruiting new employees. For example, key recruits may demand health plan coverage immediately upon hire, and certain new hires may have health concerns that require immediate coverage.

In many cases, a practical solution to address this waiting period issue is for the employer to reimburse all or a portion of the employee’s COBRA premium for coverage through a prior employer. COBRA generally requires the employee to pay up to 102% of the premium, which is often prohibitive. Reimbursing the COBRA premium helps offset that expense and facilitate the temporary coverage bridge before enrollment in the new employer's plan.

COBRA Premium Reimbursement: The Mechanics

Employers have two main options for how to process COBRA premium reimbursements:

Taxable Reimbursement

Unless the employer takes steps to make the COBRA reimbursement non-taxable, the default position is that the reimbursement will be taxable. The employer can pay the employee the amount of the intended COBRA reimbursement (plus a gross up, if desired), and include that amount in standard taxable income subject to withholding and payroll taxes.

Non-Taxable Reimbursement

If the employer wants the COBRA reimbursement to be non-taxable, it generally has two options:

1. Pay the COBRA premiums directly to the COBRA administrator (or to the employee via a check made out directly to the COBRA administrator); or

2. Distribute the reimbursement to the employee only upon the employee substantiating the expenses by providing a. receipt showing proof of payment.

The ability to avoid taxation for the employee (and FICA payroll taxes for the employer) generally outweighs the added administrative burden, making the non-taxable approach preferred for most employers.

COBRA Premium Reimbursement Does Not Implicate ACA Prohibition of Individual Policy Reimbursement

The ACA generally prohibits individual policy premium reimbursement arrangements for employees as an impermissible “employer payment plan,” subject to potential penalties of $100/day/employee. Fortunately, COBRA reimbursement does not implicate these individual policy reimbursement restrictions because it is continuation of group health plan coverage (i.e., COBRA is not an individual policy).

• Note: HRAs that are specifically designed to qualify as an Individual Coverage HRA (ICHRA) do not raise these ACA individual policy reimbursement issues, including for employees who have not satisfied the waiting period. However, few employers are willing to establish an ICHRA for the waiting period population given the cost and administrative burden required for a relatively short period of coverage.

COBRA Premium Reimbursement May Present Theoretical Group Health Plan Issues

There is a potential argument that reimbursing an employee’s COBRA coverage through a prior employer creates a new group health plan offering that could trigger a variety of potential compliance issues. For example, an employee or agency could argue that the reimbursement stream itself is a group health plan subject to the rights and obligations under ERISA, COBRA, HIPAA, the ACA, etc.

However, there are multiple factors mitigating against this potential concern:

• How prevalent the COBRA reimbursement practice is among employers;

• The long-standing nature of these types of arrangements throughout the industry;

• The practice does not reimburse medical expenses under §105, but is instead limited to premium reimbursement under §106;

• The fact that employers do not create a separate group health plan under §106 for the employer-share of the premium under their plan; and

• IRS guidance appears to contemplate a wide variety of forms of employer COBRA premium reimbursement.

Accordingly, these concerns generally are considered theoretical and do not present a practical barrier, though employers concerned about the issue should consult ERISA counsel.

Employee Pre-Tax Contributions Also Permitted through Section 125 Cafeteria Plan

The Section 125 cafeteria plan rules explicitly include a provision designed to accommodate employee pre-tax payroll deductions for prior employer COBRA premiums. While this is a relatively uncommon approach for employers to offer, the pre-tax option may be useful for situations where a) the employer does not offer COBRA reimbursement, or b) the employer’s reimbursement amount is not sufficient to cover the full cost of the employee’s COBRA premium through the prior employer.

Permitting employee pre-tax COBRA premium payments through payroll does impose additional administrative burdens. The employer must substantiate the expense prior to processing the pre-tax deduction, generally requiring that the employee provide a receipt substantiating payment of the applicable monthly COBRA premium. Employers may consider whether the tax savings for the employee—and FICA payroll tax savings for the employer—are sufficient to outweigh those additional administrative obligations.

Summary

COBRA provides continuation coverage for terminated employees that is identical to the coverage made available to similarly situated active employees, which in theory provides a convenient portability mechanism as employees regularly move to new positions in the workforce. However, the cost of COBRA at 102% of the applicable premium is often jarring and unaffordable for employees who are changing jobs.

A temporary COBRA premium reimbursement arrangement can be a valuable tool for employers to bridge gaps in coverage between the employee’s hire date and enrollment in the new employer’s plan, while alleviating the cost concerns associated with COBRA. New hires often are happy with the coverage they had available through their prior employer, but unhappy with both the waiting period to enroll with the new employer and the prohibitive cost to maintain coverage through the prior employer. Employers often can effectively address these issues through COBRA premium reimbursement arrangements.

Relevant Cites:

IRS Publication 15-B:
COBRA premiums. The exclusion for accident and health benefits applies to amounts you pay to maintain medical coverage for a current or former employee under the Combined Omnibus Budget Reconciliation Act of 1986 (COBRA). The exclusion applies regardless of the length of employment, whether you directly pay the premiums or reimburse the former employee for premiums paid, and whether the employee’s separation is permanent or temporary.

IRS Information Letter 2006-0042:
On the other hand, if the employer makes the payments for the health insurance directly to the insurer, then the payments are not included in the employee’s gross income. See Revenue Ruling 61-146, 1961-2 C.B. 25. This holds true even if the payments are routed through the employee to the insurer, as long as the employee’s right to dispose of the funds is not unlimited. However, if the employer makes health insurance payments directly to the employee with only an understanding that the employee will purchase health insurance with them, and there is no verification of or control over the purchase, that amount is included in wages for employment tax purposes and would be subject to FICA taxes.

Prop. Treas. Reg. §1.125-1:
(a) Definitions. The definitions set forth in this paragraph (a) apply for purposes of section 125 and the regulations.
…
(3) Qualified benefit…The following benefits are qualified benefits that may be offered under a cafeteria plan and are excludible from employees' gross income when provided in accordance with the applicable provisions of the Code—
…
(C) Premiums for COBRA continuation coverage (if excludible under section 106) under the accident and health plan of the employer sponsoring the cafeteria plan or premiums for COBRA continuation coverage of an employee of the employer sponsoring the cafeteria plan under an accident and health plan sponsored by a different employer;
…
(iii) Employee B previously worked for another employer, quit and elected COBRA. Employee B begins work for Employer O on July 1, 2009, and becomes eligible to participate in Employer O's cafeteria plan on July 1, 2009, but will not be eligible to participate in Employer O's accident and health plan until October 1, 2009. Employee B elects to salary reduce to pay COBRA premiums for coverage under the accident and health plan sponsored by B's former employer.
…
(vii) The operation of Employer O's cafeteria plan satisfies the requirements of this paragraph (l).

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).