Health Reimbursement Arrangements (HRAs) and COBRA

Summary

Employees, spouses and dependents who are provided coverage under a health reimbursement arrangement (HRA), may be entitled to continue this coverage upon the occurrence of a COBRA qualifying event.  If continuation is elected, the individual is required to pay the cost of this coverage, however employers often fail to properly calculate the COBRA premium due for HRA related coverage.

COBRA defines “applicable premium” as the cost to the plan for providing coverage to similarly-situated beneficiaries who have not experienced a COBRA qualifying event.  The applicable premium must be determined prior to each 12-month determination period.  HRAs are typically treated as a self-funded plan and the premium must be actuarially determined or, alternatively, the applicable premium may be determined by using a “past-cost” method.

Actuarial Method

Under the actuarial method, the applicable premium— shall be equal to a reasonable estimate of the cost of providing coverage for such period for similarly situated beneficiaries which…is determined on an actuarial basis, and…takes into account such factors as the Secretary may prescribe in regulations.[i]

Past-cost method

Under the past-cost method, the applicable premium equals—  the cost to the plan for similarly situated beneficiaries for the same period occurring during the preceding determination period…adjusted by…the percentage increase or decrease in the implicit price deflator of the gross national product.  The past-cost method cannot be used “in any case in which there is any significant difference between the determination period and the preceding determination period, in coverage under, or in employees covered by, the plan.[ii]

HRAs cannot use the past-cost method for the first year in which coverage is provided because they have no past cost for a prior year.  Even HRAs that have been around for awhile might not be able to use the past-cost method because the HRA carryover feature may produce a significant difference in coverage from one year to the next (i.e., higher or lower coverage limits in a subsequent year).

Using the “Actuarial Method” to Set HRA COBRA Premiums

Under the actuarial method, the employer must make a reasonable estimate of the cost of providing HRA coverage for similarly situated beneficiaries.  The COBRA statute does not require that an employer hire an actuary in order to use the actuarial method.  However, if a COBRA qualified beneficiary were to challenge the COBRA premium as being too high, the employer would need to be able to defend the premium structure.

For a new HRA with no prior cost history, some employers rely on the first-year experience that other HRAs have had.  For example, a third party administrator (TPA) may be able to provided average utilization data for plan designs similar to that offered by the employer.

Another actuarially defensible approach, depending on the size of the group, would be to consider the prior utilization over a number of years, combined with cost trend adjustments, and factoring for benefits and/or enrollment changes.  In other words, to “underwrite” the plan in the same way you would for a typical self-funded medical plan.

Once the “per member” cost is calculated, the employer should determine the “family” COBRA rate for the HRA.  The easiest and most defensible method is to determine the average family size of the participants enrolled in the plan and simply multiply the single member rate by the average family size for family coverage.  This rate would then be charged whenever a COBRA qualified beneficiary elects family coverage under the HRA.

The HRA COBRA premium should not be based on an individual’s account balance at the time of the COBRA event.  The IRS provides a “safe harbor” for determining premium: “An HRA complies with the COBRA requirements for calculating the applicable premium…if the applicable premium is the same for [all] qualified beneficiaries with different total reimbursement amounts available from the HRA…”[iii] In other words, under the safe harbor, the COBRA applicable premium is “blended” so that it is the same for all HRA qualified beneficiaries, regardless of their account balances.

Other HRA/COBRA Issues

An administrative problem presented by HRAs under COBRA results from the independent right of each COBRA qualified beneficiary to elect continuation coverage. There is no guidance regarding this issue, but informal IRS communications raise the concern that HRAs may be viewed in the same way that Health FSAs are viewed, and that a “mushrooming effect” may occur when qualified beneficiaries elect COBRA coverage under an HRA.

For example, when a divorced spouse elects an HRA under COBRA, they must be given access to the entire benefit available at the time of the COBRA event.  At the same time, the employee would continue their coverage as an active employee under the plan.  As a result, the employer’s liability would effectively double for as long as the divorced spouse continues the HRA under COBRA.

Employers should remember that all COBRA qualifying events give rise to COBRA rights for HRAs, not just termination of employment or reduction of hours.  Divorce is one obvious example, but COBRA election rights for non-employee qualified beneficiaries could also be triggered by an event such as a child ceasing to be a covered dependent under the HRA.

Download as MS Word .doc

Download as .pdf

 

While every effort has been taken in compiling this information to ensure that its contents are totally accurate, neither the publisher nor the author can accept  liability  for any inaccuracies or changed circumstances of any information herein or for the consequences of any reliance placed upon it. This publication is distributed on the understanding that the publisher is not engaged in rendering legal, accounting or other professional advice or services. Readers should always seek professional advice before entering into any commitments.

[i] Code § 4980B(f)(4)(B)(i)

[ii] Code § 4980B(f)(4)(B)(ii)

[iii] IRS Notice 2002-45