H&W: Health FSAs and COBRA Continuation

This is the fourth and final installment of our series of blogs on IRS Notice 2015-87.  The first three blogs (and much of the Notice) focused on issues related to the ACA.  However, the IRS decided to append some guidance on a totally unrelated matter: the handling of COBRA continuation rules as applicable to Health FSAs.

• A health FSA is a health plan and the COBRA continuation applies to FSAs, subject to certain modifications. For example, a health FSA is not obligated to make COBRA continuation coverage available for the plan year in which a qualifying event occurs unless as of the date of the qualifying event, the amount the qualified beneficiary may become entitled to receive during the remainder of the plan year as a benefit exceeds the cost for COBRA continuation coverage under the FSA for the remainder of the plan year.  When this rule was promulgated, the health FSA was strictly a use-it-or-lose-it arrangement.  However, in 2013, the IRS loosened the rules to permit a carry-over of up to $500 of unused amounts from one plan year to the next.

The Notice states that the carryover amount must be included in determining the amount of the benefit that a qualified beneficiary is entitled to receive.

• The maximum premium that a plan may charge for COBRA coverage is 102% of the cost to the plan of providing coverage. A self-insured plan (such as a health FSA) may base the applicable premium on a reasonable estimate of the cost of providing coverage for non-COBRA beneficiaries, provided that the reasonable estimate is determined on an actuarial basis. However, in an illustration of the application of this rule an employer may base its reasonable estimate of the cost of providing coverage on the maximum amount available to the qualified beneficiary under the FSA.

The Notice clarifies that this does not include any unused carry-over amounts carried over from the previous plan year.

• Ordinarily, COBRA coverage can last anywhere from 18 to 36 months depending on the nature of the qualifying event. However, under the special rules applicable to health FSAs, COBRA coverage may be terminated at the end of the plan year in which the event occurs.  A separate rule requires a plan to provide qualified beneficiaries the same coverage as that provided to similarly situated non-COBRA beneficiaries.  This creates a potential conflict when non-COBRA beneficiaries can carry over unused amounts to the next plan year.

The Notice resolves this conflict by providing that health FSAs must allow carryovers by similarly situated COBRA beneficiaries, on the same basis as non-COBRA beneficiaries. However, the FSA is not required to allow a COBRA beneficiary to elect additional salary reduction amounts for the carryover period, or to have access to any employer contributions to the health FSA made during the carryover period. In addition, the carryover is limited to the applicable COBRA continuation period.  Based on the cost-of-coverage rule (see above), the premium for this coverage would be $0.

• The Notice clarifies that a health FSA may condition the ability to carry over unused amounts on participation in the FSA in the next year and can also limit the ability to use the carry-over amount to a maximum period.