Benefit Plan Provisions in Employment and Separation Agreements (Benefit Minute)

Posted in: Benefit Minute, Employee Benefits

Management-level employment agreements with change-in-control protection often include a provision requiring continuation of welfare benefits in the case of termination of employment or diminution of duties or authority resulting from a merger or acquisition. Similarly, separation agreements offered to terminated employees may provide for continued welfare benefits, among other incentives, in return for the employee’s agreement to waive all claims against the employer. These agreements are often drafted by legal counsel who has no specific knowledge of the provisions of the employer’s welfare benefit plans. Therefore, Human Resources professionals should actively participate in the process to ensure that promises made do not contradict the terms of the underlying benefit plans or unintentionally harm terminating employees.

Insurance Contract/Plan Documents
A welfare benefit plan must operate in accordance with the terms of the underlying insurance contract or plan document. The contract or document defines eligibility and states the conditions under which benefits will be provided. Generally, inactive or terminated employees are not included in the eligible class (except when FMLA, COBRA or other specific continuation provisions apply). By offering benefit plan coverage to severed employees who do not meet the eligibility criteria, a plan sponsor is violating the terms of the welfare benefit plan. The employer is exposed to risk of loss if the severed employee incurs a large claim that is denied by the insurance carrier because the individual was not eligible for coverage under the terms of insurance contract.

One option to minimize this risk is to request that the eligibility criteria in the insurance contract or plan document be amended to include a specified class of severed employees. It is at the discretion of the insurance carrier whether to accommodate such a request. Another option is to pay, as taxable cash compensation, the value of the benefit that has been promised (if such value can be determined). With respect to group health coverage, a third option is for the employer to pay the cost of the COBRA coverage on behalf of the severed employee. This solution is viable for a severance period of eighteen months or less. However, there are other considerations, as discussed in more detail below.

COBRA Coverage or Marketplace Coverage
The Affordable Care Act has provided another option for individuals who lose their employer-sponsored health coverage. For certain terminated employees, the cost of coverage from the Health Insurance Marketplace may be much less expensive than COBRA coverage, especially if premium tax credits are available. While subsidized COBRA coverage has traditionally been an advantageous arrangement for terminated employees who lose group health plan coverage, the election of COBRA can limit the ability of the former employee to switch to a Marketplace plan at a later time (i.e. when the subsidized COBRA ends). This is because enrollment in a Marketplace plan is limited to special enrollment periods and the annual open enrollment. Voluntary termination of COBRA when the subsidized coverage ends does not trigger a special enrollment period.

Under these circumstances, the cash payment option may be more appealing to a terminating employee. The individual then has the option to either elect the COBRA coverage or purchase a Marketplace plan (with or without a premium tax credit).

Discrimination Considerations
Employers who continue benefits for severed employees generally provide them on a tax-free basis, on the premise that coverage is extended due to a prior employment relationship.

However, this may not be appropriate for all benefits. For example, nondiscrimination requirements for self-insured medical plans need to be considered. To the extent that highly compensated severed employees receive continued medical coverage on terms more favorable than available to other former employees (e.g. receive subsidized COBRA coverage while other former employees pay the full cost of coverage), then the self-insured medical plan may be viewed as discriminatory. To avoid potential discrimination, an employer should again consider providing a taxable cash payment to the former employee in lieu of subsidized coverage.

Severance Plans May be Subject to ERISA
Another consideration is whether the severance agreements themselves constitute a welfare benefit plan subject to the reporting and disclosure requirements of ERISA. In general, a severance plan is governed by ERISA if it creates ongoing administrative responsibility to determine eligibility and calculate benefits. While this standard can be difficult to apply, agreements that provide for lump-sum payments are less likely to be considered ERISA plans than agreements that provide for payments over a period of time.

Commitments made in employment or separation agreements require careful scrutiny by Human Resource professionals to ensure they can be met when the agreements are exercised.

© PSA Insurance and Financial Services. Group insurance products offered through PSA Financial, Inc. The Benefit Minute provides general information for your reference.
Please see your benefits consultant to review your specific situation.

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