Attorney Suggests Changes to Proposed COBRA Regs

May 14, 1999

[1] We are writing on behalf of the Employers Council on Flexible Compensation (ECFC) to express concern about the proposed treatment of Health Flexible Spending Account (Health FSA) arrangements under the newly proposed COBRA regulations [Prop. Treas. Reg. section 54.4980B-2 Q/A-8 (Feb. 3, 1999)]. We generally support the changes made with respect to Health FSAs in the proposed regulations, but believe that COBRA's purpose can better be served by also enabling Health FSA sponsors to meet their COBRA obligations by allowing plan participants to "spend down" their account balances in the event of certain qualifying events (termination of employment, reduction in hours or death). We request an opportunity to present ECFC's views at the public hearing scheduled for June 8, 1999.

[2] ECFC is a non-profit membership association committed to the study and promotion of 401(k) plans, cafeteria plans, and other elective compensation plans. The more than 2800 members of ECFC are plan sponsors, corporations, governments, unions, universities, hospitals, and clinics as well as leading actuarial, insurance and accounting firms that design and administer flexible benefit plans.

BACKGROUND RELATING TO HEALTH FSAS

[3] Health FSAs are supplemental health coverage arrangements made available by many employers to their employees. ¹ The benefits offered through Health FSA arrangements are funded primarily by employee pre-tax contributions -- generally made through a cafeteria plan. Typically, employee contributions are retained by the employer in a non-trusteed bookkeeping account (as permitted under ERISA Technical Release 92-1) and disbursed to employees as claims are submitted. Health FSAs enable employees to budget and pay for incidental ancillary medical expenses. Although Health FSA coverage is often offered in tandem with an employer's comprehensive medical plan, there is seldom a requirement that Health FSA participants also participate in their employer's plan. In fact, many individuals elect Health FSA participation to supplement coverage available from other sources -- e.g., a spouse's comprehensive medical plan.

[4] Under applicable tax law, Health FSAs are limited to reimbursing amounts not otherwise reimbursed under comprehensive medical plans. Typically, employees use Health FSAs to receive reimbursement for deductible and copayment obligations and/or uncovered vision or dental care. Under current law, Health FSAs present a fairly inexpensive benefit for employers to administer. In many cases, employers process Health FSA claims through their payroll department without the involvement of a third-party administrator.

[5] Congress and the federal agencies have historically recognized that Health FSAs and other ancillary health benefits should be treated differently from major-medical type coverage. Under existing authority, most Health FSAs are exempt from HIPAA's requirements. As set forth in ERISA section 732, Congress specifically excepted certain ancillary health benefits -- such as vision, dental, and certain health indemnity coverages -- from HIPAA's portability requirements. The Departments of Treasury, Labor, and Health and Human Services issued clarification to the existing Interim HIPAA regulations in the December 29, 1997 Federal Register ² that provides that the majority of Health FSAs will be treated as an excepted benefit exempt from HIPAA's certification, portability, and creditable coverage requirements. (Hereafter, we refer to such HIPAA exempt Health FSAs as "Qualifying Health FSAs"). Under the guidance, Health FSAs funded entirely with employee salary reduction contributions will be exempt from HIPAA if other significant health coverage is available to participants. On the other hand, Health FSAs funded by employer contributions will generally not be exempt unless such contributions are less than $500 per year or can be received as taxable compensation. ³

THE PROPOSED COBRA REGULATIONS ARE A STEP IN THE RIGHT DIRECTION, BUT PRESENT A DIFFICULT TO ADMINISTER CASE-BY-CASE EXCEPTION FOR HEALTH FSAS

[6] The proposed regulations seek to strike a careful balance between easing Health FSA Plan administration and protecting the interest of participants who have a positive account balance at the time of a qualifying event. This is accomplished by excepting virtually all Health FSAs from continuation coverage under COBRA BEYOND THE YEAR IN WHICH THE QUALIFYING EVENT OCCURS and providing a limited participant-by-participant exception DURING THE PLAN YEAR IN WHICH THE QUALIFYING EVENT OCCURS for participants who do not have a positive account balance at the time of the COBRA qualifying event.

1. Current Proposed Regulations

[7] Under the proposed regulations, a Health FSA is not required to offer COBRA after the year in which the qualifying event occurs if the following two conditions are satisfied:

o 1ST CONDITION: the Health FSA is a QUALIFYING HEALTH FSA exempt

[9] In addition, COBRA coverage is not required to be extended at all (even in the year in which the qualifying event occurs) if a third condition is satisfied:

o 3RD CONDITION: as of the date of the qualifying event, the

"as of the date of the qualifying event, the qualified

[11] We believe the treatment of Health FSAs under the proposed regulations is a step in the right direction as it eliminates some of the COBRA compliance burden applicable to Health FSA arrangements while still protecting the interests of employee participants. However, the limited exception for Health FSAs under the proposed regulations imposes administrative burdens on Health FSA sponsors that may be unnecessary. As proposed, Health FSA plan sponsors must make a case-by-case determination as to whether COBRA applies by checking participant account balances at the time of each qualifying event. Under this approach, participants can "game the system" by delaying the submission of their claims until after they experience a qualifying event. Moreover, even once it is determined that COBRA applies (e.g., because a participant has a positive account balance), several unresolved issues remain -- e.g., what account balance should be assigned when multiple qualified beneficiaries separately elect coverage under COBRA? Does each qualified beneficiary get a portion of the account? How are previously reimbursed expenses allocated? What is the "applicable premium" with regard to Health FSA coverage? These (and many more) unresolved issues with regard to Health FSAs make it virtually impossible for Health FSA sponsors to apply COBRA to Health FSA Plans without substantial additional guidance.

REQUESTED CHANGE IN PROPOSED REGULATION

[12] We believe that Congress did not have the nominal benefits under Health FSAs in mind when it enacted COBRA. Nevertheless, we acknowledge that this may not be the proper forum for excluding Health FSAs from COBRA entirely. ⁶ The careful balancing between the interests of Health FSA sponsors and participants can be better served, however, if the proposed COBRA regulations are modified to enable Health FSA sponsors to offer a "spend-down" approach in lieu of COBRA in the event of certain qualifying events (termination of employment, reduction in hours, death of employee). ⁷

[13] Under the spend-down approach, COBRA would apply to Health FSAs generally, and the exceptions applicable under the current regulations would continue to apply. However, the spend-down approach would enable plan sponsors to satisfy their current year COBRA obligation for certain qualifying events (termination of employment, reduction in hours, death of employee) by allowing former participants to be reimbursed for eligible Health FSA claims incurred between the date of the event and the end of the plan year in which the event occurs, with the maximum available reimbursement being equal to the "unused" amount in the participant's bookkeeping account. For example, Sally elected $2,400 of annual Health FSA coverage under a calendar year plan, contributing $200 per month via salary reductions. Sally quits on June 30. She did not incur any claims between January 1 and June 30. Our recommended approach (which would discharge the employer's COBRA obligation) would permit Sally to get reimbursed for up to $1,200 of claims incurred between July I and December 31 without having to pay any additional premiums.

[14] In the event of any other qualifying event (e.g., divorce or a dependent's loss of dependent status), COBRA rights would continue to apply to the Health FSA (as described in the current proposed regulations), and the "spend-down" approach would not apply.

[15] Adoption of a "spend-down" approach for specified events would be simpler for Health FSA sponsors to administer and will better ensure that participants who cannot afford to continue Health FSA coverage after a qualifying event receive Health FSA benefits attributable to their contributions. This approach would also provide consistency with the current informal IRS position regarding the treatment of dependent care spending accounts (under Section 129 of the Code). Finally, the adoption of such a 66 spend-down" approach would further the purposes sought to be protected by COBRA (extension of coverage in the event of a qualifying event) without upsetting the "use-it-or-lose-it" concept imposed by Section 1.125-2, Q/A-7 of the proposed cafeteria plan regulations -- i.e., participants who fail to incur eligible expenses within the 12-month period of coverage would forfeit their unused account balances.

[16] ECFC requests an opportunity to present its views at the public hearing scheduled for June 8, 1999. In addition, if it would be helpful, ECFC can provide proposed language implementing the "spend-down" approach.

Sincerely,

² 62 Fed. Reg. 67688.

³ Under the clarification, a Health FSA must satisfy two conditions in order to be an excepted benefit under HIPAA:

o The maximum benefit under the Health FSA cannot exceed two

⁴ See discussion in footnote 3 above.

⁵ Prop. Treas. Reg. section 54.498OB-2, Q/A-8(e).

⁶ It appears that COBRA applies to Health FSA arrangements under a literal application of the COBRA definitional provisions. Thus, it appears that Congressional action may be required to carve out Health FSAs entirely.

⁷ Adopting such a "spend-down" approach would require a revision to the proposed COBRA regulations, as well as a revision to the uniform coverage rule contained in Prop. Treas. Reg. section 1. 125-2, Q/A-7(a)(2).