Client Alert

The American Recovery and Reinvestment Act of 2009 (“ARRA”), which was signed into law by President Obama on February 17, 2009, significantly expands the COBRA rules to create a 9-month, 65% federal subsidy of the COBRA premiums payable by certain terminated employees. As a result of this legislation, employers and plan administrators will face significant new notification and premium payment responsibilities.

1. COBRA Premium Subsidy

The new legislation creates a federal COBRA premium subsidy for covered employees (and qualifying dependents) involuntarily terminated from their jobs between September 1, 2008 and December 31, 2009 and otherwise eligible for COBRA during this period. The subsidy will cover 65% of the premium, will last for 9 months, and will apply to premiums paid for periods of coverage beginning on or after March 1, 2009. The subsidy will not be available once the individual becomes eligible for coverage under another group health plan or Medicare or otherwise is no longer eligible for COBRA. The subsidy period does not extend the period of COBRA coverage that would otherwise apply to that individual. Subsidies may not be applied to payments for health flexible spending accounts.

2. Second Chance to Elect COBRA

Within 60 days of the date of the bill’s enactment (i.e., February 17, 2009) employees who were involuntarily terminated on or after September 1, 2008 and were entitled to COBRA coverage before the date of the bill’s enactment must be notified of the availability of the premium subsidy and (if not already enrolled in COBRA coverage) that they will have a new period to enroll for COBRA coverage. The new enrollment period starts on the day of enactment and ends 60 days after notification. If the individual elects COBRA during this period, the coverage becomes effective as of March 1, 2009.

3. New Notices Required

The legislation creates new notice rules. Individuals who experience a COBRA qualifying event during the period beginning September 1, 2008 and ending December 31, 2009 must be notified of the availability of the premium subsidy and, if applicable, of the choice of new coverage options (as described below). This new information will become part of the standard COBRA notice for qualifying events for the duration of the subsidy. The notice must include information about the following:

• The availability of the subsidy;
• The extended election period available to subsidy-eligible individuals who do not have a COBRA coverage election in place as of the date of enactment;
• The obligation of the individual to notify the plan if he or she becomes eligible for Medicare or another group health plan, and the penalty for not doing so;
• If applicable, a description of alternative COBRA coverage options (if the employer elects to provide these);
• The forms necessary for establishing eligibility for the subsidy; and
• Contact information for the plan administrator

In general, the notice must be provided to all individuals who become eligible for COBRA for any reason during the period beginning September 1, 2008 and ending December 31, 2009, including individuals who are clearly not eligible for the subsidy (e.g., individuals whose qualifying event is unrelated to a termination of employment, such as a divorce).

The legislation directs the Secretary of Labor, in consultation with the Secretary of the Treasury and the Secretary of Health and Human Services, to develop model notices for this purpose within 30 days of the bill’s enactment.

4. How Much is the Subsidy?

Under the new rules, eligible individuals will be responsible for paying only 35% of the COBRA premium that the individual would otherwise be required to pay. For example, if the applicable COBRA premium is $500 and the employer charges $510 (i.e., the permitted 102% of the applicable premium), the individual would be required to pay 35% of the $510 amount, or $178.50. The employer would need to pay the remaining 65% of the COBRA premium (i.e., $331.50 in the above example). Employers then recoup the 65% share from the federal government by claiming a payroll tax credit.

The COBRA premium on which the subsidy is based is the premium actually charged to the individual. If the employer subsidizes a portion of the premium (e.g., as part of a severance policy), the eligible individual is responsible for paying only 35% of the subsidized premium. For example, assume that 102% of the applicable COBRA premium is $600 and the employer currently pays 75% of that amount (i.e., $450), and the individual pays the remaining 25% of that amount (i.e., $150). Under the new rules, the individual is now only required to pay 35% of the $150 amount (i.e., $52.50). This means that the employer must pay a total of $547.50 ($600 minus $52.50) and is entitled to a payroll tax credit of $97.50 ($150 minus $52.50). This result punishes the employer for having subsidized COBRA. If the employer had not subsidized COBRA, the employer could have paid much less money ($390 instead of $547.50) and received a much larger credit ($390 instead of $97.50). Employers may decide that they want to amend their existing severance plans and policies to eliminate COBRA subsidies, at least through December 31, 2009.

5. How Does the Payroll Tax Credit Work?

The plan sponsor recoups the subsidy by claiming a credit equal to the subsidy against the requirement to make deposits or payments of payroll taxes. Payroll taxes are defined as income tax withholding, employee FICA withholding, and employer FICA taxes.

No payroll tax credit may be claimed until the reduced premium has been received from an individual eligible for the reduced COBRA premium. If the plan sponsor claims a bigger tax credit than it is entitled to (e.g., by incorrectly treating a termination as involuntary), the plan sponsor is treated as having an underpayment of payroll taxes.

Plan sponsors that claim a credit must provide “attestations of involuntary terminations” with respect to the individuals for whom the credit is claimed. The plan sponsor must also provide a report on the credit claimed and an estimate of the credit to be claimed for the next reporting period. In addition, the plan sponsor must report the following: the taxpayer identification number of all covered employees, the amount of subsidy reimbursed with respect to each covered employee and qualified beneficiaries, and a designation as to whether the subsidy reimbursement is for coverage of one individual or two or more individuals. These reports must be submitted at such time and in such manner as the IRS requires. Guidance on this timing and form issue is needed quickly. There is not a current mechanism to submit such information under the current payroll tax deposit rules, nor under the quarterly employment tax returns.

6. Who is Entitled to be Reimbursed for the Subsidy?

For a group health plan that is a multiemployer plan, the plan will be reimbursed for the premium subsidy. For a group health plan that is not a multiemployer plan and is self-funded, the employer will be entitled to the reimbursement. For the group health plan that is not a multiemployer plan and is fully insured, the insurance company providing the insurance will be entitled to the reimbursement.

7. Employees Eligible for the Subsidy

To be eligible for the subsidy, an employee must be terminated, or have been terminated, from his or her employer during the period starting September 1, 2008 and ending December 31, 2009. Employees must have been terminated involuntarily and not for reasons of gross misconduct. Qualifying dependents of these terminated employees may also be eligible for a subsidy. The subsidy will not be available once the individual becomes eligible for coverage under another group health plan or Medicare or otherwise is no longer eligible for COBRA. An individual will be required to notify the plan of a loss of COBRA entitlement due to eligibility for other health plan coverage and will be penalized for the failure to do so.

Individuals with annual income exceeding $145,000 per year, and married couples with income exceeding $290,000 per year, are not eligible for the subsidy; the subsidy is phased out starting at $125,000 for individuals and $250,000 for married couples. Individuals who receive subsidies during a year in which they exceed these income limits must repay the subsidy; the repayments are captured on the individual’s income tax return. Individuals may make a permanent election to waive the subsidy. As long as an individual is eligible for the premium subsidy, it will not be considered additional taxable income to the individual.

8. Refunds Available to Certain Individuals

Many individuals who are eligible for the new COBRA premium subsidy may have already paid their full COBRA premiums for months in which they are eligible for a subsidy (i.e., for March and/or April of 2009). To remedy this, these individuals may receive a refund of their overpayments for March and/or April (or apply the overpayments as a credit against future premiums). Thus, individuals who have already paid their March and/or April COBRA premiums at the 102% of premium rate could become eligible for the new COBRA subsidy program as of March 1 and receive a refund of the difference in premiums for March and, if necessary, April.

9. Electing a Different Coverage Option

At the option of the employer, an individual eligible for the premium subsidy may elect a different COBRA health coverage option from the one in which he or she had been enrolled at the time of termination of employment. This other coverage must be one of the options offered by the employer to active employees, not be more expensive than the option in which the individual had been enrolled, and not be a health flexible spending account (or certain other forms of limited coverage). Eligible individuals have 90 days after notification to elect this different form of COBRA coverage.

10. Other Continuation Coverage

Similar subsidy rules will apply to governmental plans and to continuation coverage comparable to that required under COBRA but mandated by state law for group health plans not subject to COBRA (such as those run by small employers with fewer than 20 employees).

11. Implications for Employers

Now that ARRA has been signed into law, employers must implement the new COBRA provisions quickly. Employers should be prepared to:

• Identify former employees who must receive notice about the subsidy and new enrollment opportunity;
• Revise and update COBRA notices to include information about the subsidy and new enrollment rights;
• Offer a new enrollment period to subsidy-eligible individuals who previously declined COBRA coverage;
• Develop procedures for complying with the subsidy mechanism and receiving an offset or reimbursement from the federal government; and
• Work with COBRA administrators and other appropriate vendors to develop systems and procedures for tracking subsidy-eligible individuals and eligibility periods for those who enroll in COBRA during the new enrollment period.

If you have questions regarding the COBRA premium subsidy, please contact Patrick M. Allen, the principal author of the alert. You may also contact the Womble Carlyle attorney with whom you usually work or one of our Employee Benefits attorneys.