A Little Tweak: IRS Finalizes 1999 Proposed Regulations Without Many Changes

On January 12, 2001, the IRS issued new final regulations regarding COBRA continuation coverage. These are the second set of final regulations issued by the IRS on COBRA in two years. In February 1999, the IRS issued final regulations and new proposed regulations. After waiting nearly twelve years to finalize the previous proposed regulations, the IRS has gotten downright speedy in providing COBRA-related guidance.

The new regulations adopt the regulations proposed in February 1999, with a few changes and clarifications and are generally applicable to qualifying events occurring on or after January 1, 2002. The following proposed rules became final when the new regulations were issued:

• Small Employer Exception. The small-employer exception excepts a plan from COBRA for any calendar year if all employers maintaining the plan employed fewer than 20 employees on a typical business day during the preceding calendar year. For purposes of this exception, the final regulations adopt the full-time equivalency rule proposed in 1999, under which a part-time employee counts as a fraction of a full-time employee.
• Health Flexible Spending Accounts. Generally, a health flexible spending account ("FSA") must provide COBRA to qualified beneficiaries who lose coverage as a result of a qualifying event. The 1999 proposed regulations included two limited exceptions for health FSAs that are excepted from HIPAA and have a particular premium structure. Under the first exception, COBRA does not need to be offered to a qualified beneficiaries who has overspent his or her account as of the date of their qualifying event. Under the second exception, COBRA must be offered to a qualified beneficiary with an underspent account, but coverage can be cut off at the end of the year in which a qualifying event occurs. This set of exceptions has been adopted in final form essentially as proposed. In addition, a sentence has been added to clarify that health FSAs required to offer COBRA are subject to all the other requirements of COBRA that apply to a group health plan.
• Asset Sales or Transfers. The detailed provisions governing COBRA responsibility in mergers and acquisitions in the 1999 proposed rules have been adopted with two clarifications. First, the final regulations clarify that asset sales include not only sales but other transfers as well. Second, the final regulations clarify that the rules applicable in an asset sale for determining whether the purchaser of assets is a successor employer apply equally where the assets are transferred as part of a bankruptcy proceeding. Other issues are notable because the IRS has declined to make rules regarding them. For instance, the IRS has not defined what constitutes "substantial assets" for purposes of the asset sale rules. Instead, it takes the position that this issue should be resolved under "the various formulations of successor employer rules that have been fashioned by the court for various labor law purposes." The IRS has also not adopted a rule under which no qualifying event will be deemed to occur where a purchaser of assets maintains substantially the same plan for employees of the seller that it hires in connection with the sale. And, the final regulations do not clarify how COBRA obligations apply in connection with the transfer of an interest in a noncorporate entity.
• Maximum Coverage Period. The final regulations adopt the proposed rules relating to the duration of COBRA coverage, including the rules on:

1. the duration of COBRA in connection with the disability extension,
2. when the maximum coverage period ends,
3. the period applicable to newborn or newly-adopted children of a covered employee, and
4. the period applicable when the plan provides for an extension of required periods.

• Number of Plans. Adopting the proposed regulations, the final regulations specify that all health care benefits provided by a single entity are treated as one plan, unless the plans' governing instruments clearly indicate that the benefits are provided as separate plans under each of the instruments and the plans are operated in this manner.
• Family Medical Leave Act Leave. The new final regulations adopt the proposed regulations, but specify that the applicable Department of Labor regulations (29 C.F.R. Part 825) determine when FMLA leave ends.

The following highlight the new guidance provided by the new final regulations:

• Insignificant Shortfall Defined. The new regulations define a shortfall in a COBRA premium payment as insignificant if it is not greater than the lesser of $50 or 10% of the required premium amount. If a shortfall in a COBRA premium payment is an insignificant shortfall, the plan must handle the payment according to the special rules for such shortfalls added by the 1999 final regulations.
• Qualified Beneficiaries Moving Out of Coverage Area. The new regulations clarify when alternative coverage must be offered to a qualified beneficiary who moved outside the coverage area of a region-specific HMO or similar plan. The plan must offer coverage on the date of the relocation or, if later, on the first day of the month following the month in which the qualified beneficiary requests the alternative coverage. Additionally, the preamble to the new regulations clarify that a plan is under no obligation to incur "extraordinary costs" to provide such alternative coverage in an area where the employer has no active employees. So, for example, the sponsor of an indemnity plan with a preferred provider organization could provide benefits at the "standard rate" (that is, not at the rate for preferred providers) to a qualified beneficiary that moves out of the network area.
• Date of Coverage and Claims Payment. The new final regulations clarify a potential inconsistency under the 1999 final regulations by specifying that indemnity plans and reimbursement arrangements that allow retroactive reinstatement of coverage may terminate coverage and later reinstate it when the election and applicable payment for coverage is made.

ACTION NEEDED: If you have not updated your COBRA forms and procedures for the 1999 final regulations which were effective January 1, 2000, now is a good time to incorporate all of the changes required by those regulations and the new final regulations. If you have updated your forms and procedures, you should review them to make sure that they are consistent with the new regulations. It should only take a little tweak to your forms and procedures in order to update them for the changes and clarifications in the new final regulations, and it will help you avoid COBRA compliance problems.