Severance plans, Part 2: How savvy employers prevent COBRA issues

In Part 1 of this series, Findley consultants examined how employers can create an ERISA-compliant severance plan.

Sometimes, severance arrangements address a former employee’s right to continue his or her employer-provided health plan coverage. A number of issues concerning COBRA may arise with post termination coverage under the employer’s group health plan, if the severance arrangement is not drafted properly.

Generally, COBRA permits an employee to continue coverage in an employer’s group health plan for up to 18 months after his or her date of termination, if the employee affirmatively elects COBRA coverage and pays the applicable premium. Neither COBRA nor any other federal law requires that an employer subsidize the cost of an employee’s COBRA coverage premium. However, employers and employees may negotiate a severance arrangement providing that former employees may receive coverage for a period beyond 18 months after termination. In addition, a severance arrangement may provide that the employer will pay all or a portion of the COBRA premium for a specific period of time.

If an employer decides to pay for all or a portion of the COBRA premiums, the severance plan must specify how it will affect the former employee’s coverage period under COBRA.

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Where severance arrangements are ambiguous when describing how the employer-provided coverage (whether through subsidies or extended coverage) will affect COBRA continuation coverage period, a dispute inevitably follows. For example, an ambiguous provision may provide something like “employer will pay 100% of the cost of continued coverage under the Plan for six months.” The former employee may argue that this extended coverage is not part of COBRA and that the 18-month COBRA period begins after the six-month period. If the employer’s subsidy is intended for the COBRA coverage, the arrangement should clearly state that the subsidized coverage is part of, and runs concurrently with, COBRA.

An employer may want to provide continuation coverage that extends beyond the 18 months required by COBRA. Employers, who have fully-insured plans or stop-loss insurance, must contact their providers to make sure that such extended continuation coverage is available under the insurance policy or contract. Without prior approval by the provider, the employer may find itself self-insuring this extended coverage.

Additional considerations
The first thing for a savvy employer to remember about severance arrangements is that they are usually gratuitous benefits. No federal law mandates that employers provide severance arrangements for the benefit of their employees.

Second, depending on the job positions and industry at issue, severance arrangements can be all but mandated in order to attract and retain the best talent for the employer’s needs.
Third, severance benefits may be required by a collective bargaining agreement, or by state or local laws. And recall that severance arrangements that also provide for a release of claims under the Age Discrimination in Employment Act require compliance with the Older Workers Benefit Protection Act in order to be legally enforceable.

Finally, Internal Revenue Code Section 409A may or may not apply. Depending on the form, amount, and distribution timing of severance benefits, employers may have to address 409A.

In perspective
An employer’s attorneys have a number of legal compliance issues to consider when drafting severance arrangements. The failure to properly address these issues may result in an employer’s unintended self-insurance of significant medical bills or litigation in unfavorable locations, such as state court. By identifying, documenting, and clearly describing how compensation and benefits are to be provided under a severance arrangement, savvy employers will be protected from such negative consequences.

In addition, where litigation cannot be avoided, their attorneys will have a number of defenses should the former employee bring an action related to his or her severance benefits.

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