12 Jan Paying for COBRA as Part of Severance? Make Sure You Handle it Correctly

I frequently get asked about paying for a separated employee’s COBRA coverage as a partial severance benefit.  Not altogether an unappealing option, but you have to be careful about how you word and administer it.  Unfortunately, many employers think that the solution is just to leave someone on their coverage until the end of the severance period.  But that messes up the COBRA rules and potentially creates a situation where an ex-employee is entitled to COBRA for a full 18 months AFTER the severance period.

The key is to understand what you want to accomplish.  Do you want the employee to remain on your payroll and covered as an employee as part of the settlement?   Or do you want to terminate them and reimburse them for COBRA?  Each would be accomplished in a different fashion.  Say you are giving someone three months of “additional” coverage and pay.  If the severance agreement leaves them on your payroll for three months and then terminates them, the COBRA qualifying event would be the date you actually terminated their employment.

If you want to terminate them as of a date certain, say 12/31, then give them 3 months of coverage as a severance benefits, you have to be careful because their COBRA qualifying event date is their date of termination (12/31).  If you give them 3 months of additional coverage after that, then send them a COBRA notice, they get 18 more months for a total of 21.  Plus, you have the problem of not providing a timely notice of a qualifying event and election option.  You would hate to be sued for not giving notice because you were being nice.

Instead, I have suggested that the appropriate way to handle it is to provide that in the event the ex-employee elects COBRA, the company, as part of the severance benefit, will reimburse the employee for the COBRA premium paid for a period of up to 3 months.  The COBRA time periods for notice and election run as would normally be required and the premium reimbursement is treated as a severance payment for tax purposes.  18 months of COBRA runs from the 12/31 termination date, but the company reimburses the employee for 3 months of premiums.  Some people even suggest grossing up the reimbursement for taxes so there is full premium reimbursement, which is an option.  But it has to be reported as compensation as well.

Option two is definitely preferred for insured plans.  You don’t want to have your insurance company question why they are covering employees not actively at work because they were fired.  Plus they won’t be happy about the extra 3 months of continuation coverage.  For self-insured plans, you have some more latitude, but you have to be wary of Section 105(h) non-discrimination rules (if you only offer it to highly compensated employees).  Plus you might run afoul of your stop-loss coverage if you are keeping people on the plan that should not really be eligible.  So you may end up truly self-insuring the full amount of the risk.

So the point is that paying for COBRA as part of a severance package can be done, but it has benefits and tax implications that should be fully understood before releases are drafted and signed.  Just “agreeing to continue benefits” is too broad of a statement and you should make sure you lay it out clearly and completely to avoid future fights.  As always, consult, before you act and you will be glad you did in the end.

Keith R. McMurdy