Important New Guidance Issued on COBRA "Subsidy"

April 3, 2009

As described in our February 24, 2009 client alert, the American Recovery and Reinvestment Act of 2009 (commonly knows as the stimulus bill) implemented a COBRA premium subsidy for employees who are involuntarily terminated between September 1, 2008 and December 31, 2009. The Labor Department and the Internal Revenue Service have issued important guidance to assist employers and plan administrators in satisfying their subsidy-related obligations.

Background

The key rules regarding the COBRA subsidy include:

The subsidy is generally available to any employee who experiences an "involuntary" termination of employment, other than due to gross misconduct, between September 1, 2008 and December 31, 2009. It also applies to qualified beneficiaries of these employees.
The amount of the subsidy is 65% of the COBRA premium actually charged to the eligible individual.
The subsidy is not a direct payment to the eligible individual. Rather, the health plan must charge the eligible individual the subsidized rate, and the employer (or other person that receives the premiums) is entitled to a credit for the subsidy toward its payroll tax liability.
It applies for periods of coverage (monthly or shorter) beginning after enactment of the stimulus bill. For most plans, this means March 1, 2009. Because many plan administrators were not able to implement the subsidy before March 1, the Act’s "grace period" permits a plan to charge eligible individuals the full COBRA premium for March and April 2009, and then allow the individuals to recapture the subsidy by crediting it against future premiums or refunding it.
The subsidy generally is available for up to nine months of coverage (beginning March 1, 2009 or, if later, upon COBRA eligibility), subject to earlier termination in the event of eligibility under another group health plan or Medicare (note that actual coverage under another plan or Medicare is not required; mere eligibility cuts off the subsidy). Covered individuals must notify the employer of such other plan or Medicare coverage or else face a 110% penalty.
The notices required to be provided to COBRA-eligible individuals must specifically describe the availability and mechanics of the subsidy. In addition, special notices must be provided within 60 days of enactment of the Act (i.e., by April 18, 2009) to two groups of subsidy-eligible individuals:

All eligible individuals who have already elected and are receiving COBRA coverage must be advised of the availability of the subsidy and the requirements to qualify for the subsidy.
Any individual who is eligible for a special enrollment period must also receive a notice. The special enrollment period applies to any individual who does not currently have a COBRA election in effect, but who otherwise qualifies for the subsidy (such as any assistance eligible individual who declined COBRA coverage on or after September 1, 2008 or who elected but later dropped such coverage). If coverage is elected under this special enrollment period, it is effective beginning on the first day of the first COBRA coverage period after enactment of the stimulus bill (generally March 1, 2009). Retroactive coverage to the date of involuntary termination is not required. However, the COBRA cut-off date would be the date that would have applied if COBRA coverage had been elected when first eligible for such coverage.

Model Notices from the Labor Department

The Labor Department recently provided model notices for use by plan administrators. There are three versions relevant for plans subject to COBRA:

A full version that includes information on the subsidy as well as all other information required in a COBRA election notice;
An abbreviated version that addresses only the subsidy and may be provided in lieu of the full version to individuals who have: experienced a qualifying event on or after September 1, 2008; have already elected COBRA coverage; and still have such coverage; and
A special enrollment period version for eligible individuals who are eligible for the subsidy but did not previously elect COBRA coverage or discontinued COBRA coverage.

Employers and plan administrators may want to use these model forms directly or draw on them in drafting revisions to their current forms. As described in our previous client alert, there are severe penalties for failing timely to provide required COBRA notices.

IRS Guidance

IRS Notice 2009-27 (the "Notice") provides important guidance on a number of issues raised by the COBRA subsidy. The following items are of particular interest:

Involuntary Termination of Employment. As noted above, only individuals who are involuntarily terminated (and their qualified beneficiaries) are eligible for the COBRA subsidy. The Notice generally provides that whether a termination is involuntary is determined under the facts and circumstances. It includes a severance from employment by the employer’s unilateral exercise of authority; a lay-off or furlough that reduces an employee’s hours to zero, whether or not the employee has recall rights; the non-renewal of a term of employment; early retirement and retirement incentive packages in lieu of termination or a threat of termination; and certain "good reason" terminations (using a standard similar to the good reason rules under Section 409A of the Code). In addition, the Notice clarifies that (a) termination for cause is an involuntary termination for purposes of the subsidy, except where the termination is due to gross misconduct and COBRA is not available, and (b) if a termination is designated as voluntary or as a resignation, but the facts and circumstances indicate that, absent such "voluntary termination," the employer would have terminated the employee’s employment, and that the employee had knowledge that the employee would be terminated, the termination is involuntary.
Other Qualifying Events. The Notice also reiterates that the subsidy is available only for losses of coverage due to involuntary termination of employment. It does not apply to other COBRA qualifying events that result in a loss of health plan coverage, including a reduction in hours, a divorce, or a dependent child "aging out."
Coverage on the Same Terms as Active Employees. Some employers continue to cover terminated employees under their health plans as if they were active employees for a specified time following termination, with the full COBRA coverage period commencing at the end of this time. The Notice clarifies that the effect of this treatment depends on how the employer treats health coverage for the involuntarily terminated employees. If the employer treats the continued provision of health coverage as deferring the loss of coverage for COBRA purposes, then for purposes of the subsidy, the loss of coverage will be considered to occur when the employer’s provision of health coverage on the same terms as for similarly situated active employees ends. However, if the employer treats the provision of health coverage after the involuntary termination as part of its obligation to provide COBRA continuation coverage for the involuntarily terminated employee (so-called "alternative" coverage), then the loss of coverage will be considered to have occurred as of the date employment terminated. Among other things, this is important for determining whether the loss of coverage occurs by the December 31, 2009 subsidy deadline.
Amount of the Subsidy. The premium used to determine the 35% share that must be paid by (or on behalf of) an eligible individual is the cost that would be charged for COBRA continuation coverage if the individual were not eligible for the subsidy. For example, if the individual pays the standard COBRA rate of 102% of the "applicable premium," the subsidy is for 65% of 102% of the applicable premium. However, if the premium actually charged is less than this amount, the subsidy is for 65% of the amount actually charged (e.g., if the employer subsidizes all or part of the cost). Because of this, many employers are eliminating voluntary subsidies for involuntary terminations through December 31, 2009.
Increase in Premiums. The Notice clarifies that, if the plan previously charged less than the maximum COBRA premium but increases the premium in order to take advantage of the subsidy, the subsidy applies to the increased premium, and not the lower amount. This is the case even if the employer pays the employee a separate taxable amount to "make up" for the fact the employee is paying a higher COBRA premium. However, it is not clear if this applies to a nontaxable amount (e.g., if the employer pays more "severance" but that amount is then applied to healthcare premiums on a pre-tax basis under a cafeteria plan.)
Availability of Subsidy for Vision and Dental Coverage. The subsidy is available for vision and dental coverage as well as medical coverage. However, it is not available for health flexible spending accounts.
Failure to Timely Pay Subsidized COBRA Premium. The subsidy ends if COBRA coverage terminates because the eligible individual fails to timely pay the 35% premium.
High Income Individuals. As noted in our previous client alert, the subsidy is phased out for adjusted gross incomes beginning at $125,000 ($250,000 if married filing jointly) and is eliminated for individuals with adjusted gross incomes of $145,000 or more ($290,000 if married filing jointly). However, the Notice clarifies that the subsidy still must be provided to an otherwise-eligible individual unless the individual waives it. (If such an individual receives the subsidy, it must be repaid as an addition to the individual’s income tax.)

Conclusion

The recent Labor Department and IRS guidance answer many of the key questions on the application of the COBRA subsidy. Subsidy-compliant notices generally are required to be sent no later than April 18, 2009 (60 days after enactment of the stimulus bill), so employers and plan administrators need to act immediately to comply with the new law.

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or

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Important New Guidance Issued on COBRA “Subsidy”