Guest Article

From Mandated Health Benefits--The COBRA Guide, published by Thompson Publishing Group, Inc.

Recent IRS Guidance Notes How COBRA Applies to New Defined Contribution Health Plan Design

Employers must provide COBRA coverage for a new type of group health plan -- "health reimbursement arrangements" (HRAs), according to IRS guidance issued in June. IRS Notice 2002-45 and IRS Revenue Ruling 2002-41 primarily describe the tax implications of what was informally known in the health insurance industry as contribution health plans but what the IRS is calling HRAs. Many legal issues are raised by HRAs, significant COBRA issues are raised when an employer establishes an HRA.

Does COBRA Apply to HRAs?

An HRA is just like any other group health plan. Therefore, it is subject to COBRA. Of course, if the employer is otherwise excepted from COBRA (for example, as an employer with fewer than 20 employees), then COBRA will not apply to the HRA.

In applying COBRA's rules to HRAs, employers should consider that, under COBRA, each qualified beneficiary has a separate right to continue coverage. Thus, if an ex-employee and spouse are qualified beneficiaries, they each have a separate right to continue the HRA and group health coverage (as described below) just like any other group health plan.

Is HRA COBRA Coverage Separate From a Related Indemnity Plan?

Once an HRA is subject to COBRA's requirements, the next question is whether that HRA must be offered as a separate stand-alone feature under COBRA. Generally, employers do not offer HRAs without also offering indemnity coverage. This is because HRA coverage usually is limited to a small dollar amount of maximum reimbursement (such as $2,000 per year, with a possible carryover of unused amounts). These amounts are not sufficient to provide the full health coverage that employers need as part of a competitive benefit compensation package.

Therefore, when a qualifying event occurs and a qualified beneficiary is covered by the HRA and indemnity coverage, can he or she only elect the HRA as COBRA coverage? Or can the qualified beneficiary be required to elect the indemnity coverage to benefit from the HRA during the COBRA coverage period?

This specific issue was not directly addressed in the IRS guidance. Nevertheless, the factual assumptions in Revenue Ruling 2002-41 and the existing COBRA regulations suggest the answer to this problem -- it depends on the particular plan design and what options are made available to similarly situated non-COBRA beneficiaries with respect to whom a qualifying event has not occurred. Two approaches can be considered.

What Is HRA COBRA Coverage?

Generally, COBRA coverage must be identical to the coverage that the qualified beneficiary had immediately before the qualifying event. If that coverage can be changed by similarly situated non-COBRA beneficiaries (such as active employees), then qualified beneficiaries have the same rights to change their coverage. Here is how those rules apply to an HRA.

If an individual elects COBRA coverage, an HRA must continue the maximum reimbursement amount available to the affected individual when the qualifying event occurred. That amount then must be increased at the same time and by the same increment (and decreased for claims reimbursed) as for similarly situated non-COBRA beneficiaries.

In all events, the amount of available HRA COBRA coverage depends on the HRA terms. The basic principle to remember in interpreting those rules is that, under COBRA, qualified beneficiaries are treated the same as any similarly situated non-COBRA beneficiaries with respect to whom a qualifying event has not occurred.

Now suppose that an HRA automatically provides for continuing reimbursements after a qualifying event, whether or not a COBRA election is made. For example, an HRA might allow reimbursements up to the unused maximum amount following a termination of employment. In this case, IRS Notice 2002-45 provides that an HRA still must comply with COBRA's requirements.

Unfortunately, the IRS did not provide any examples illustrating what the notice means in this context. Apparently, it is fine for an HRA to make available reimbursements following a qualifying event. However, the plan still must allow for HRA COBRA coverage for the full COBRA period following the qualifying event, subject to future increases (and decreases) in the available amount. The automatic continuation is then either credited toward satisfying COBRA's requirements or is offered in addition to a full COBRA period beginning at the end of the automatic plan-derived continuation period, much like alternative coverage.

Of course, HRA treatment should be very carefully coordinated with the employer's general group health plan so that no inconsistency exists between the two coverages. Perhaps the IRS will expound upon this issue in future COBRA regulations or other guidance.

What Is the COBRA Applicable Premium for HRAs?

Under COBRA, a group health plan may charge up to 102 percent of the full premium (employer and employee shares) for similarly situated non-COBRA beneficiaries. Under COBRA's disability extension rules, plans can charge up to 150 percent of full premium. COBRA does not provide specific guidance on how to calculate premiums, and unfortunately, the IRS' HRA guidance offers little insight.

The HRA guidance only notes a carefully phrased permissive rule. In other words, the IRS did not state what an HRA must do to comply with COBRA in every instance. Instead, the guidance merely stated that an HRA will comply with COBRA if the applicable premium (however it is calculated under COBRA) is the same for qualified beneficiaries with different total reimbursement amounts available from the HRA.

For example, if an HRA's annual additional reimbursement amount credited is $1,000 and the maximum amount remaining for two similarly situated qualified beneficiaries at the time of their qualifying events is $500 and $5,000, the HRA will comply with COBRA if the applicable premium is the same for each individual. This suggests that the cost of HRA coverage should be determined on an actuarial basis, taking into account some measure of expected reimbursements under the plan as a whole and the employee population.

That being said, the IRS left open the possibility of other interpretations. That is, just because an HRA will comply with COBRA's premium requirements by following the IRS notice does not mean that other rules could not also apply, depending on the facts. Therefore, employers should consult with their benefits advisors in determining the COBRA premium for HRAs.

Implications

More employers are using defined contribution health plans or HRAs as a way to control costs. In designing these plans, employers must how COBRA's rules apply. Through its notice and revenue ruling, the IRS has explained the basic COBRA structure for HRAs. Generally, they are just like all other group health plans; therefore, employers must provide COBRA coverage once a qualifying event occurs. How COBRA specifically applies in particular cases must be individually addressed by employers.

Excerpted from the August 2002 supplement to Mandated Health Benefits -- The COBRA Guide, ©Thompson Publishing Group, Inc., 2002. All rights reserved.

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