Link to text of proposed COBRA regulations issued 2/3/99

[Dave Baker]

The IRS issued today a set of proposed regulations -- in

addition to today's new final regulations -- on COBRA.

Hypertext version is online at

http://www.benefitslink.com/taxregs/54.4980B-proposed.shtml (click)

An overview, from the preamble to the proposed regs:

The new set of proposed regulations addresses how the

COBRA continuation coverage requirements apply in

business reorganizations. Also proposed are rules

relating to the interaction of the COBRA continuation

coverage requirements and the Family and Medical Leave

Act of 1993, which were previously published as Notice

94-103 (1994-2 C.B. 569), and certain other issues.

* * *

The new proposed regulations would make a number of

changes to the section in the final regulations that

addresses which plans must comply with the COBRA

continuation coverage requirements. The principal

changes being proposed are to add rules simplifying the

determination of whether the small-employer plan

exception applies, giving employers and employee

organizations broad discretion to determine the number

of group health plans that they maintain, and providing

an exception for certain health flexible spending

accounts.

* * *

Business Reorganizations

The 1987 proposed regulations provide little direct

guidance on the allocation of responsibility for COBRA

continuation coverage in the event of corporate

transactions, such as a sale of stock of a subsidiary or

a sale of substantial assets. Commenters on the 1987

proposed regulations requested further guidance on

corporate transactions, pointing out that the existing

degree of uncertainty tends to drive up the costs and

risks of a transaction to both buyers and sellers. The

IRS and Treasury share this view and believe also that

greater certainty helps to protect the rights of

qualified beneficiaries in these transactions. The IRS

has been contacted by many qualified beneficiaries whose

COBRA continuation coverage has been dropped or denied

in the context of a corporate transaction. In many

cases, these qualified beneficiaries have been told by

each of the buyer and the seller that the other party is

the one responsible for providing them with COBRA

continuation coverage.

The preamble to the 1998 proposed regulations requested

comments on a possible approach to allocating

responsibility for COBRA continuation coverage in

corporate transactions. Commenters suggested that, in a

stock sale, as in an asset sale, it would be consistent

with standard commercial practice to provide that the

seller retains liability for all existing qualified

beneficiaries, including those formerly associated with

the subsidiary being sold. The IRS and Treasury have

studied the comments and given consideration to several

alternatives with a view to establishing rules that will

minimize the administrative burden and transaction costs

for the parties to transactions while protecting the

rights of qualified beneficiaries and maintaining

consistency with the statute.

Accordingly, the new proposed regulations make clear

that the parties to a transaction are free to allocate

the responsibility for providing COBRA continuation

coverage by contract, even if the contract imposes

responsibility on a different party than would the new

proposed regulations. So long as the party to whom the

contract allocates responsibility performs its

obligations, the other party will have no responsibility

for providing COBRA continuation coverage. If, however,

the party allocated responsibility under the contract

defaults on its obligation, and if, under the new

proposed regulations, the other party would have the

obligation to provide COBRA continuation coverage in the

absence of a contractual provision, then the other party

would retain that obligation. This approach would avoid

prejudicing the rights of qualified beneficiaries to

COBRA continuation coverage based upon the provisions of

a contract to which they were not a party and under

which the employer with the underlying obligation under

the regulations to provide COBRA continuation coverage

could otherwise contract away that obligation to a party

that fails to perform. Moreover, the party with the

underlying responsibility under the regulations can

insist on appropriate security and, of course, could

pursue contractual remedies against the defaulting

party.

The new proposed regulations provide, for both sales of

stock and sales of substantial assets, such as a

division or plant or substantially all the assets of a

trade or business, that the seller retains the

obligation to make COBRA continuation coverage available

to existing qualified beneficiaries. In addition, in

situations in which the seller ceases to provide any

group health plan to any employee in connection with the

sale -- whether such a cessation is in connection with

the sale is determined on the basis of the facts and

circumstances of each case -- and thus is not

responsible for providing COBRA continuation coverage,

the new proposed regulations provide that the buyer is

responsible for providing COBRA continuation coverage to

existing qualified beneficiaries. This secondary

liability for the buyer applies in all stock sales and

in all sales of substantial assets in which the buyer

continues the business operations associated with the

assets without interruption or substantial change.

A particular type of asset sale raises issues for which

the new proposed regulations do not provide any special

rules. (Thus, the general rules in the new proposed

regulations for business reorganizations would apply to

this type of transaction.) This type of asset sale is

one in which, after purchasing a business as a going

concern, the buyer continues to employ the employees of

that business and continues to provide those employees

exactly the same health coverage that they had before

the sale (either by providing coverage through the same

insurance contract or by establishing a plan that

mirrors the one that provided benefits before the sale).

The application of the rules in the new proposed

regulations to this type of asset sale would require the

seller to make COBRA continuation coverage available to

the employees continuing in employment with the buyer

(and to other family members who are qualified

beneficiaries). Ordinarily, the continuing employees (or

their family members) would be very unlikely to elect

COBRA continuation coverage from the seller when they

can receive the same coverage (usually at much lower

cost) as active employees of the buyer.

Consideration is being given to whether, under

appropriate circumstances, such an asset sale would be

considered not to result in a loss of coverage for those

employees who continue in employment with the buyer

after the sale. A countervailing concern, however,

relates to those qualified beneficiaries who might have

a reason to elect COBRA continuation coverage from the

seller. An example of such a qualified beneficiary would

be an employee who continues in employment with the

buyer, whose family is likely to have medical expenses

that exceed the cost of COBRA coverage, and who has

significant questions about the solvency of the buyer or

other concerns about how long the buyer might continue

to provide the same health coverage.

Under one possible approach, a loss of coverage would be

considered not to have occurred so long as the

purchasing employer in an asset sale continued to

maintain the same group health plan coverage that the

seller maintained before the sale without charging the

employees any greater percentage of the total cost of

coverage than the seller had charged before the sale.

[Guest]