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BenefitsLink Newsletter

New U.S. tax and labor law materials on the net pertaining to
employee benefits, for employers, participants and service-providers.
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HOW 'BOUT BEST TWO OUT OF THREE?

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

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.
For this purpose, the coverage would be considered
unchanged if there was no obligation to provide a
summary of material modifications within 60 days after
the change due to a material reduction in covered
services or benefits under the rules that apply under
Title I of ERISA. If these conditions were satisfied for
the maximum coverage period that would otherwise apply
to the seller's termination of employment of the
continuing employees (generally 18 months from the date
of the sale), then those terminations of employment
would never be considered qualifying events. If the
conditions were not satisfied for the full maximum
coverage period, then on the date when they ceased to be
satisfied the seller would be obligated to make COBRA
continuation coverage available for the balance of the
maximum coverage period.

Comments are invited on the utility of such a rule,
either in situations in which the seller retains an
ownership interest in the buyer after the sale (for
example, a sale of assets from a 100-percent owned
subsidiary to a 75-percent owned subsidiary) or, more
generally, in situations in which the seller and the
buyer are unrelated. Suggestions are also solicited for
other rules that would protect qualified beneficiaries
while providing relief to employers in these situations.

Although the new proposed regulations address how COBRA
obligations are affected by a sale of stock (and a sale
of substantial assets), the new proposed regulations do
not address how the obligation to make COBRA
continuation coverage available is affected by the
transfer of an ownership interest in a noncorporate
entity that causes the noncorporate entity to cease to
be a member of a group of trades or businesses under
common control (whether or not it becomes a member of a
different group of trades or business under common
control). Comments are invited on this issue.

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