Employers sometimes allow former employees to remain on their health insurance plan for some period of time after termination of employment at no cost or reduced cost to the terminated employee. While this may seem like a generous offer to include in a severance agreement, there can be unintended consequences for both the employer and the former employee if not handled correctly. Questions often arise regarding the interaction of severance agreements and health benefits.
3 tips for employers contributing to or continuing a terminated employee’s health insurance:
- Educate the terminating employee about their coverage options. Make sure that the individual understands that if they accept your offer of COBRA coverage, they may not be able to purchase individual coverage through the Marketplace until the next Marketplace annual enrollment. Individuals who lose job-based coverage generally have 60 days to purchase coverage through the Marketplace. If they stay on COBRA beyond the Special Enrollment Period, they could lose that option. Maintaining COBRA coverage (at a higher cost than Marketplace coverage) until other employer-sponsored coverage becomes available or the next Marketplace annual enrollment could be the individual’s only option for avoiding a gap in coverage and tax penalties.
- Offer the terminating employee COBRA. If the individual is left enrolled as an active employee, fully-insured employers may risk violating the medical plan eligibility requirements in their insurance contract. Similarly, self-funded employers may violate the coverage provisions of their stop-loss agreement. Consequently, failure to offer COBRA can expose an employer to significant financial liability for claims not paid by an insurance carrier or stop-loss insurer. Also, it ensures that coverage obtained through a new employer will pay primary to COBRA coverage. If you want to pay all or a portion of the individual’s coverage, work with legal counsel to draft a severance agreement that includes an employer contribution to offset the cost of COBRA coverage.
- Pay the COBRA premium directly. If the severance agreement includes an employer contribution toward the cost of COBRA coverage, minimize tax consequences by paying the COBRA premium directly to the plan instead of reimbursing the former employee. COBRA premium payments are not treated as taxable wages if made by the employer directly, or if the employer requires verification of or retains control over the purchase of COBRA coverage (such as requiring substantiation of the month’s premium payment prior to providing reimbursement). If you offer a terminated employee cash to purchase their own individual health insurance as part of a severance agreement, use caution. Although this might seem to provide the terminated employee with greater flexibility to choose the type of health insurance coverage that best fits their needs, it may result in the creation of a new ERISA group health plan and additional excise tax liability, among other compliance obligations.
It is important to structure severance agreements in a manner that provides desired benefits to terminated employees while protecting the company from additional liability. Employers sponsoring self-insured plans may also run afoul of the nondiscrimination rules in the Internal Revenue Code if employer contributions toward the cost of COBRA coverage are only provided to highly compensated individuals. Since many employers may not create these agreements frequently, it is easy to run into these issues. In addition to thinking through the structure of what is to be provided, good communication with terminating or former employees is very important. Many terminating employees do not fully understand how to navigate the coverage options available through COBRA and the Marketplace. Both the employer and its former employees should understand the interplay between COBRA and the Marketplace to avoid unintended consequences. For more detail on the taxation of COBRA premiums paid by an employer for a former employee, see IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits.
Make sure that you have experienced legal counsel to guide you, and reach out to HCW consultants at email@example.com if you would like more information.