EMPLOYEE BENEFITS IN BANKRUPTCY: COBRA HEALTH CONTINUATION COVERAGE RULES. Teleconference / Live Audio Webcast May 12, 2004

Transcription

1 American Bar Association Joint Committee on Employee Benefits EMPLOYEE BENEFITS IN BANKRUPTCY: COBRA HEALTH CONTINUATION COVERAGE RULES Teleconference / Live Audio Webcast May 12, 2004 Charles K. Chip Kerby III McDermott, Will & Emery 600 Thirteenth Street, NW Washington, DC 20005

2 I. COBRA LIABILITY IN BANKRUPTCY A. General Rules Under sections of ERISA and section 4980B of the Internal Revenue Code ( Code ), an employer that maintains a group health plan must offer COBRA continuation coverage rights to each qualified beneficiary (the covered employee, spouse and dependents) who loses coverage as a result of a qualifying event (such as termination of employment, divorce, death, disability, Medicare entitlement, or loss of dependent eligibility status). Upon such a loss of coverage, the qualified beneficiary may elect to continue coverage under the group health plan for 18 months (for termination of employment), 29 months (for disability) or 36 months (for all other qualifying events). The employer may charge the qualified beneficiary a monthly premium not to exceed 102% of the cost of coverage under the group health plan. COBRA continuation coverage may be terminated earlier upon the occurrence of specified events, such as failure to pay premiums, the cessation of all group health plans offered by the employer, or if the qualified beneficiary first becomes entitled to Medicare or covered under another group health plan after electing COBRA coverage. For these purposes, the employer includes not only the employer for whom the employee provides services, but any entity that is part of that employer s controlled group and any successor entity (Treas. Reg B-2, Q&A-2 and Treas. Reg B-9, Q&A-8). B. Application of COBRA Rules in Bankruptcy 1. Context A Chapter 11 debtor may have COBRA responsibilities with respect to existing COBRA qualified beneficiaries, active employees and retirees. In addition, an entity purchasing stock or assets in connection with a Chapter 11 proceeding may have COBRA responsibilities with respect to COBRA qualified beneficiaries whose qualifying event occurred before or contemporaneously with the sale. 2. Existing COBRA Qualified Beneficiaries A Chapter 11 debtor may terminate COBRA coverage for existing COBRA qualified beneficiaries only if the employer terminates all group health plan coverage for active employees and retirees. But remember that an employer may not terminate COBRA coverage if the employer maintains a successor plan. Thus, if a debtor terminates group health plan coverage for active employees and institutes a successor plan, the existing COBRA qualified beneficiaries will have continuing COBRA rights with respect to the newly established successor plan. The regulations do not provide definitional or other guidance with respect to the meaning of the term successor plan. See Treas. Reg B-7, Q&A- 1(a)(3)

3 3. Active Employees If a Chapter 11 debtor terminates the employment of active employees, these employees are qualified beneficiaries and are entitled to COBRA continuation coverage rights. The only circumstance under which an employer is not required to offer COBRA coverage to these employees is if the employer terminates all group health plan coverage and does not maintain a successor plan. 4. Retirees In a typical Chapter 11 situation, the debtor obtains agreement (through negotiation and through section 1114 of the Bankruptcy Act) to reduce or eliminate group health plan coverage for retirees. But notwithstanding an 1114 agreement, the bankrupt employer may be required to continue health coverage for retirees who lose their retiree medical coverage. The COBRA rules include a special qualifying event rule under which a bankrupt employer is required to offer retirees (and their dependents) the right to continue health coverage under COBRA if retiree medical coverage is substantially reduced or eliminated within one year of the bankruptcy filing. 1 The COBRA rules do not describe the type of coverage that must be provided to retirees (remember, the employer has terminated its retiree medical coverage), although presumably the obligation can be satisfied if affected retirees are offered coverage similar to that provided to active employees. If the special bankruptcy qualifying event rule applies, the employer must continue the COBRA coverage for the retiree s lifetime and this coverage can not be terminated on account of Medicare entitlement. If a spouse or dependent survives the retiree, the employer generally must continue the spouse or dependent s COBRA coverage for 36 months after the date of the retiree s death. Any asset purchaser or successor to the bankrupt estate retains the obligation to offer COBRA coverage to the retirees. 5. Purchasers of Bankrupt Employers The COBRA rules include detailed requirements regarding business reorganizations. Under these rules, COBRA obligations in business reorganizations are assigned either to the selling group (the controlled group which includes the employer) or the buying group (the controlled group which acquires the stock of assets of the employer). These COBRA obligations apply to the group of qualified beneficiaries whose qualifying event occurred prior to or in connection with the sale (so-called M&A qualified beneficiaries ). Unless 1 Under the COBRA rules, the right to lifetime coverage arises if coverage for retirees is substantially reduced or eliminated within one year of the bankruptcy filing. Due to ambiguities in the statute, however, there are arguments that the lifetime COBRA coverage right applies whenever there is a loss of coverage in connection with a bankruptcy filing, regardless of the one-year rule. In light of this ambiguity, some bankrupt employers voluntarily provide the lifetime COBRA coverage to retirees

4 COBRA responsibilities are allocated in a purchase agreement, the selling group generally has the obligation to provide COBRA coverage to the M&A qualified beneficiaries as long as any member of the selling group maintains a group health plan after the sale. If the selling group ceases to provide any group health plan coverage after the sale, then the buying group has the obligation to provide COBRA coverage to the M&A qualified beneficiaries as long as any member of the buying group maintains a group health plan (in the case of a stock sale), or continues the business operations associated with the purchased assets without interruption or substantial change in which case the buying group is considered a successor employer (in the case of an asset sale). In the case of an asset sale, the buying group is considered to be a successor employer even if the asset sale occurs in connection with a Chapter 11 proceeding. See Treas. Reg B- 9, Q&A-8(c)(1). II. HEALTH CARE TAX CREDIT ( HCTC ) A. Context From a retiree s perspective, COBRA coverage provided by a bankrupt employer is very generous, but very expensive. Typically, the bankrupt employer must offer the same benefits to retirees that it offers to active employees. Retirees do not have the option of selecting less generous, or less expensive alternatives. From the bankrupt employer s perspective, COBRA coverage tends to create significant liabilities. Even though retirees are required to pay for COBRA coverage, the individuals who actually elect and pay for the coverage tend to be significant users of medical coverage (i.e., it is likely that the expected claims for the COBRA coverage group would significantly exceed the premiums paid). Moreover, this liability generally can t be extinguished any asset purchaser or successor to the bankrupt estate succeeds to that COBRA liability. Given this significant adverse selection risk, the COBRA liability creates difficulties in the bankrupt company s ability to negotiate its way out of bankruptcy. B. Description of the HCTC Under section 35 of the Code, eligible individuals are entitled to a tax credit equal to 65 percent of the medical premium for certain qualified health insurance. In the bankruptcy context, an individual is eligible if he or she is age 55 or older and receiving a pension payment from the Pension Benefit Guaranty Corporation ( PBGC ). Qualified health insurance includes, among other things, COBRA coverage and various forms of Stateapproved coverage. 2 An individual isn t eligible for the tax credit if the individual has 2 An example of state approved coverage is the State of Maryland s recent action to approve a coverage option for HCTC-eligible individuals under the State s high risk pool. Following Bethlehem Steel s decision to terminate retiree health coverage effective March 31, 2003, the Maryland legislature passed emergency legislation to expand the eligibility criteria for the Maryland Health Insurance Plan. Under House Bill 1100, a person is eligible to participate in the Maryland Health Insurance Plan if he she is eligible for the tax credit for health insurance under section 35 of the Internal Revenue Code. The legislation was signed into law on April 8, 2003 and, as a result, (continued ) - 4 -

5 other specified coverage. 3 The tax credit continues until the individual obtains health insurance coverage from another source, such as Medicare, Medicaid or from a spouse s employer. The tax credit is available on an advance basis, and a special HCTC website explains the procedure for obtaining the advance tax credit. Essentially, eligible individuals enrolled in qualifying health insurance coverage pay their 35% share of the premium to a government intermediary. The intermediary then combines that amount with the government s 65% share of the premium and facilitates payment of the full premium amount to the qualified health insurance plan in which the individual is enrolled. C. Implications of the HCTC for Bankrupt Employers The HCTC may encourage more retirees of a bankrupt employer to elect COBRA, given the generosity of the government subsidy. This could have the effect of increasing the employer s adverse selection risk (i.e., greater likelihood that it may be more likely that less healthy. But the HCTC might also permit a bankrupt employer to offer retirees an alternative to COBRA coverage in the form of State-approved coverage. Note that an employer may satisfy its COBRA obligation by offering qualified beneficiaries a choice between traditional COBRA coverage and an alternative form of continuation coverage. See Treas. Reg B-7, Q&A-7. For example, if a bankrupt employer offers a State-approved coverage as an alternative to COBRA coverage, several favorable results would occur. First, the State-approved coverage could offer design flexibility not available under COBRA. Retirees might prefer a less comprehensive, and less expensive, level of coverage than that mandated by COBRA. Second, the State-approved coverage might alleviate the financial burden on the bankrupt employer. A successor company might be more interested in acquiring the assets of a bankrupt employer if the continuation obligations are less expensive. Third, the State-approved coverage could alleviate the risk of adverse selection. Unlike COBRA premiums, the premiums for the State-approved coverage could be aligned more closely with the actual claims experience for the retiree group. eligible Bethlehem Steel retirees were able to purchase health insurance coverage under the Maryland Health Insurance Plan effective July 1, Other specified coverage includes: (i) insurance coverage through the spouse s employer, if the spouse s employer contributes at least 50 percent of the cost of coverage for the spouse, the eligible individual and dependents (or the spouse receives coverage in lieu of an employer s cash or other benefits under a cafeteria plan); (ii) coverage under Medicare Part A or Part B; (iii) a State s Medicaid program; (iv) a State s SCHIP program; (v) a plan in the Federal Employees Health Benefit program; or (vi) a Defense Department health plan