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California Extends Continuation Health Coverage Period

In September 2002, Governor Davis signed into law California Assembly Bill 1401 ("AB 1401"). The new law extends California's health insurance continuation coverage ("Cal-COBRA") to provide up to 36 months of coverage for all covered employees and their dependents ("Qualified Individuals") who begin receiving such coverage on or after January 1, 2003.

The new law also supplements federal COBRA coverage for Qualified Individuals who begin receiving federal COBRA coverage on or after January 1, 2003, and who have exhausted their continuation coverage under federal COBRA. AB 1401 provides these Qualified Individuals an opportunity to elect additional continuation coverage so that their total coverage is up to 36 months from the date the person's federal COBRA continuation coverage began. Accordingly, if a Qualified Individual is entitled to less than 36 months of continuation coverage under federal COBRA, then Cal-COBRA will provide an opportunity for an extension of group coverage.

We have divided this Alert into three parts. The first part provides information for employers with 20 or more employees (that are subject to federal COBRA) on how the changes to Cal-COBRA affect the continued health coverage they are required to provide. The second part provides information on Cal-COBRA for employers with 2 to 19 employees that are subject to Cal-COBRA rather than federal COBRA. The final part includes information for all employers, including a discussion of whether the changes to Cal-COBRA are preempted by federal law.

Overview of Federal COBRA

Federal COBRA gives Qualified Individuals who lose their health benefits as a result of a "qualifying event," such as a termination of employment, the right to continue group health benefits for periods of 18, 29 or 36 months, depending on the nature of the qualifying event. Federal COBRA generally requires that group health plans sponsored by employers with 20 or more employees in the prior year offer Qualified Individuals the opportunity for such continued health coverage. Qualified Individuals may be required to pay up to 102% (150% for extensions to 29 months on account of disability) of the cost of such coverage under the employer's plan.

How AB 1401 Changes Cal-COBRA

The key provisions of AB 1401 with respect to California employers with 20 or more employees that are subject to federal COBRA are as follows:

• Effective date: AB 1401 applies to Qualified Individuals who begin receiving federal COBRA on or after January 1, 2003.
• Applicability: The new law applies only to insured health plans (called "health care service plans") and to certain disability contracts that provide medical coverage and does not apply to plans that are self-insured. The additional coverage under Cal-COBRA does not apply to a specialized health care plan providing non-core coverage (i.e., vision and dental care plans); only plans that offer medical and hospital benefits are subject to the extension to 36 months.
• Coverage extension: AB 1401 supplements federal COBRA coverage to the extent that federal COBRA coverage is provided for less than 36 months. Thus, spouses and dependent children who already are offered 36 months of federal COBRA coverage because of the death of the employee, divorce, legal separation, or cessation of dependent status are not eligible for the extension under AB 1401. Those persons who are eligible for federal COBRA because of the covered employee's termination of employment or reduction of hours, and who have the opportunity to receive only 18 months of continuation coverage under federal COBRA, will have an opportunity to elect an additional 18 months of continuation coverage under Cal-COBRA.
• Participant must exhaust Federal COBRA coverage: A person covered by federal COBRA must first exhaust his or her federal COBRA continuation coverage period before becoming eligible for supplemental Cal-COBRA coverage. Consequently, the extension of federal COBRA coverage provided by AB 1401 will become practically operative no earlier than July 1, 2004, when the federal COBRA 18-month extension period for individuals losing coverage on account of an employment termination on January 1, 2003, has ended.
• Cost of continuation coverage: AB 1401's extension of coverage after federal COBRA coverage terminates is not required by federal COBRA and is to be provided at the rates specified for Cal-COBRA. The new law states that the supplemental coverage will be at the rates under Cal-COBRA, which are 110%/150% of applicable group rates.
• Impact on disability coverage: It is not clear whether a disabled participant, in order to comply with the exhaustion requirement, must apply for a disability extension (of an additional 11 months) before becoming eligible for the Cal-COBRA supplemental coverage, or whether such person could simply receive 18 months of federal COBRA coverage, not apply for an 11 month extension of federal COBRA, and receive an additional 18 months of supplemental Cal-COBRA coverage.
  
  The premium structure of Cal-COBRA effectively may render disability coverage under federal COBRA moot except in the case of dental and vision coverage, which are not subject to extension under Cal-COBRA. A person covered by federal COBRA would be better off paying 102% of the applicable group rate for the first 18 months of federal COBRA coverage and then 110% of such rate for the subsequent 18 months under Cal-COBRA than he or she would be by electing disability coverage and paying 150% of the applicable group rate for coverage after the first 18 months.
• Maximum period of coverage: The maximum coverage period under AB 1401 is 36 months from the original federal COBRA commencement date.

Overview of Cal-COBRA Prior to AB 1401

Cal-COBRA provides the same general coverage opportunities to employees of small employers with 2 to 19 employees as federal COBRA provides to larger groups. Cal-COBRA premium rates are 110% of the cost of the employer's plan. However, after 18 months of Cal-COBRA, premium rates for extended coverage on account of disability can increase to up to 150% of the group rate.

How AB 1401 Changes Cal-COBRA

The key provisions of AB 1401 with respect to California employers with 2 to 19 employees are as follows:

• Effective date: AB 1401 applies to Qualified Individuals who begin receiving Cal-COBRA on or after January 1, 2003.
• Applicability: The new law applies only to insured health plans (called "health care service plans") and to certain disability contracts that provide medical coverage and does not apply to plans that are self-insured. The Cal-COBRA change applies to both core and non-core heath plans; therefore, it affects vision and dental plans as well as medical plans.
• Coverage extension: Cal-COBRA has been extended to 36 months of continued coverage for all Qualified Individuals for all qualifying events.
• Cost of continuation coverage: AB 1401 does not change the current premium structure for Cal-COBRA, which is 110% of group rates, with an increase to 150% of group rates for a disability extension of continuation coverage.
• Impact on disability coverage: The premium structure of Cal-COBRA effectively may render disability coverage moot. A person covered by Cal-COBRA would be better off paying 110% of the applicable group rate for the entire 36 months than he or she would be by electing disability coverage and paying 150% of the applicable group rate for the final 18 months of the continuation coverage period.
• Maximum period of coverage: In all cases, the maximum coverage period under AB 1401 is 36 months from the original Cal-COBRA commencement date.

What Do Health Care Service Plans and Health Insurers Need to Do?

Under AB 1401, health care service plans and health insurers are responsible for including the required continuation coverage provisions in their plan documents and insurance contracts and for collection of the required premiums.

What Do Employers Need to Do?

Employers should notify Qualified Individuals of their rights under AB 1401 and direct them to the appropriate health care service plan or health insurer. Unless they choose to regard Cal-COBRA as unenforceable (see discussion below), employers should revise their notice procedures for individuals who begin receiving continuation coverage pursuant to Cal-COBRA or federal COBRA on or after January 1, 2003. Large employers (employers with 20 or more employees) that send coverage termination notices to federal COBRA recipients employed or residing in California should include in those notices a statement of

the availability of additional Cal-COBRA continuation coverage. Small employers (employers with 2-19 employees, most of whom work in California) that notify Cal-COBRA recipients of continuation coverage termination should adjust the content and timing of the notices to reflect the longer continuation coverage period. Employers also should verify that insurers have included information regarding the extended coverage period in certificates of coverage distributed to employees.

What Do Federal COBRA Participants Need to Do?

In order to exercise the coverage continuation rights afforded under AB 401, an election to accept the extended coverage must be made in writing to the insurance carrier within the time specified by the insurer at the end of the 18-month (or 29-month in the case of a disability) federal COBRA continuation period.

Is Cal-COBRA Enforceable?

In general, the Employee Retirement Income Security Act of 1974 ("ERISA") preempts, and thus makes unenforceable, any state law that relates to employee benefit plans. However, an exception to this general rule provides that state laws that regulate insurance are not subject to such preemption, except in the case of self-insured plans.

In a recent case, a federal court held that a Maryland state statute that provided for health care continuation obligations very similar to Cal-COBRA (as applicable to small employers prior to AB 1401) was preempted by ERISA because it related to employee benefit plans and was not saved from preemption as a law regulating insurance. Perry v. FTData, Inc., 198 F.Supp.2d 699 (D. Md. 2002). The Maryland statute required group insurance plans to provide continuation coverage in the event of involuntary termination of employment and required employers to notify employees of the availability of such continuation coverage. The court stated that because "[the state statute] does not involve only practices within the insurance industry or an integral part of the policy relationship, but mandates an employer's obligation to its employees," it was not saved from ERISA preemption as a law regulating insurance.

Like the Maryland COBRA-like statute found to be preempted in the Perry case, it could be argued that because the new Cal-COBRA provisions clearly relate to ERISA-covered employee benefit plans and do not meet the criteria for laws regulating insurance, they are preempted by ERISA and thus unenforceable.

The Ninth Circuit also has discussed ERISA preemption in the context of COBRA continuation coverage and noted that the legislative history of COBRA indicates that "Congress expressed mild reservations about the propriety of permitting state-law remedies in view of ERISA's preemptive force." Radici v. Associated Insurance Companies, 217 F.3d 737, 745 (9th Cir. 2000). Although the new Cal-COBRA provisions have not yet undergone judicial review, based on the decision regarding the Maryland statute and the Ninth Circuit's view of ERISA preemption, there is a reasonable possibility that the new Cal-COBRA provisions (and even the provisions of Cal-COBRA prior to AB 1401) would be found to be preempted by ERISA and thus unenforceable if the laws were challenged.

Employers should be aware that non-compliance with the new Cal-COBRA provisions on the basis of ERISA preemption will face a number of obstacles, all of which should be considered carefully. First, an employer that chooses not to provide the enhanced continuation coverage likely will be met with challenges by employees and by the State of California, particularly if the number of affected employees and dependents is significant. Second, the employer may have to deal with an insurance contract that already has been amended by the insurance company to provide the new coverage; this will mean that an employer contemplating not complying with the new law should first discuss with its insurance carrier the deletion of any such contract amendments. Finally, the employer must take into account the possible liability for consequential damages resulting from the failure to extend coverage as required by the new provisions, should those provisions ultimately be found not to be preempted by ERISA.

These obstacles suggest that the preferable course of action for an employer is to comply with the new Cal-COBRA provisions until such time as there has been a declaratory judgment that the new provisions are preempted by ERISA. Since the effect of AB 1401 will not be felt until the initial 18-month continuation periods have been exhausted (July 1, 2004 at the earliest), there should be adequate time for a large employer, an employer association or a trade group to pursue declaratory relief before California employers generally are faced with the need to comply.