Traps for the Unwary: COBRA and Retiree Medical

Employers often ask about their obligations to offer COBRA benefits to terminating employees who are eligible for retiree medical coverage, and with good reason. The interplay between COBRA and alternative retiree coverage is complicated, and an employer faces steep penalties in the event of a mistake. Whether COBRA coverage must be offered to a terminating employee eligible for retiree medical depends on two factors: the terms of the plan under which retirees are covered and the steps an employee must take to be covered under retiree medical.

If retirees are covered under the same plan on the same terms and conditions (including percentage of premium paid by the employer) as active employees and are automatically enrolled in retiree coverage, then in most cases COBRA need not be offered at the time of termination. Further, if the period of retiree coverage lasts at least as long as the applicable COBRA coverage period then COBRA need not be offered at the expiration of the retiree coverage. (This is because the loss of coverage did not occur within the maximum coverage period after the termination of employment occurred.) In our experience few employer-sponsored health plans fit into this category.

If, however, retirees are covered under a separate group health plan (even if the plan is identical to the plan covering active employees) or under the same plan as active employees but under different terms or conditions, then COBRA coverage must be offered at the same time retiree medical coverage is offered. This is true even if COBRA coverage is less attractive to beneficiaries than retiree medical coverage. An employer may expressly condition receipt of alternative retiree coverage on the qualified beneficiary’s waiver of COBRA coverage. If an employer does this, then the terminating employee will retain his or her right to elect COBRA coverage throughout the 60-day election period (even if he or she immediately chooses the alternative retiree coverage), and the COBRA waiver will not be final until the election period expires. Each qualified beneficiary has a separate opportunity to waive COBRA. The waiver must be informed, so an employer taking this approach should clearly communicate to the retiree, and any dependents eligible for retiree coverage, that electing retiree coverage will waive the COBRA rights of anyone electing retiree coverage. Once the election period expires the COBRA benefit is generally lost for good and need not be provided when the retiree coverage terminates.

If the spouse or child of a retiree receiving retiree coverage would lose coverage as a result of a qualifying event (death of the retiree, divorce, or a child’s ceasing to be a dependent), the spouse or child must be given the opportunity to elect continued coverage, with a maximum coverage period of 36 months from the date of the qualifying event. If, however, the design of the alternative coverage is such that it is provided only for a fixed period for the retiree’s spouse/dependent children and would not end upon the occurrence of a COBRA-qualifying event, then the employer does not need to offer a COBRA election upon the occurrence of a COBRA-qualifying event.

It is extremely important for employers to be sure that they are properly meeting their COBRA obligations. Code Section 4980B imposes an excise tax of $100 per day ($200 per day per family if more than one qualified beneficiary with respect to the same qualifying event is affected) for each day that an employer fails to offer required COBRA coverage, beginning with the date the failure first occurred and ending the earlier of the date the failure is corrected and six months after the last date on which the employer could have been required to provide COBRA coverage. For a long-standing failure involving a terminated employee, this could mean that an employer may face 24 months of excise tax, at a cost of $100 (or $200) per affected qualified beneficiary per day. There are special limits depending on when the failure is discovered and whether it is due to reasonable cause, but obviously this mistake can get very expensive very quickly. Excise taxes must be reported on Form 8928.

If an employer discovers a mistake in its COBRA administration it may still avoid the excise tax by acting quickly. Code Section 4980B provides that the excise tax will not apply in the case of an error that is corrected within 30 days after discovery, as long as: (1) the failure was due to reasonable cause, as opposed to willful neglect; and (2) the employer has not received an IRS audit letter. A COBRA failure is considered corrected if the failure is retroactively undone to the extent possible and any affected beneficiary is placed in a financial position as good as the beneficiary would have been had the failure not occurred.