Mergers & Acquisitions – Health and Welfare Benefit Considerations

Health and welfare benefits are just one of many important matters that employers must consider when participating in a merger or acquisition. Due diligence efforts prior to a merger or acquisition often focus on benefits with significant financial assets (e.g., retirement plans), while less consideration is given to health and welfare benefits. And unfortunately, the financial advisors the employer engages with to assist in the transaction are not always experts in health and welfare benefits. Even if buyers carefully review the seller’s health and welfare benefits to understand potential future liability, they often aren’t as thorough when considering the impact of the transaction on their own benefit plans. Furthermore, employee communications are complicated by the fact that details of pending transactions must be kept confidential, so important benefits-related employee communications are often not transmitted until the last minute.

It is beneficial for the parties in a merger or acquisition to think about the potential health and welfare plan issues, preferably well in advance. Employers should always turn to a qualified employee benefits specialist to help make sure these important issues are addressed correctly.

Due Diligence Considerations

Asset Purchase

In an asset purchase, the buyer acquires some or all of seller’s assets and liabilities as set forth in the transaction document. The seller may continue to exist following the transaction.

Employees hired by the buyer can be treated as “new hires” and be subject to a waiting period or initial measurement period, as applicable. However, the buyer could waive the new hire waiting period for acquired employees if permitted by the plan’s eligibility rules or coordinated with the carrier.

Stock Purchase

In a stock purchase, the buyer will acquire the seller’s entire legal entity, including all of the assets and liabilities. Compliance liabilities (seller’s failure to comply with requirements under ERISA, COBRA, HIPAA, ACA) would automatically become the liability of the buyer.

Employees acquired by the buyer are viewed as “continuing employees” who must be given credit for previous hours worked (and therefore generally cannot be subject to a new waiting period or initial measurement period).

Plan Exposure & Integration Challenges

Potential benefit plan exposure following a merger or acquisition can stem from differences in employee demographics, the inclusion of previously unknown covered individuals (e.g., COBRA participants or employees with severance arrangements), and contract transition or re-rating provisions that may increase costs. In some cases, a transaction may also trigger a shift from small group to large group status, resulting in new rating structures or compliance obligations.

Common integration and administrative challenges may include:

• Aligning differing plan years;
• Coordinating credit for deductibles and other accumulators;
• Determining full-time employee status and applicable waiting periods;
• Addressing forfeitures in account-based plans;
• Managing service provider transitions;
• Amending plan documents; and
• Overseeing claims administration and final reporting for terminated plans.

Service Provider and Insurance Contracts

Contracts may contain provisions that are triggered by a merger or acquisition. All contracts should be carefully reviewed so there are no surprises. For example:

• Contracts may require minimum advance notice (e.g., 60-90 days) prior to termination.
• Contracts may allow for new terms, fee changes, etc. in the event of an ownership change.
• Contracts could have underwriting or rating provisions related to significant change in membership.
• Stop-loss may not automatically transfer to a buyer taking over a seller’s self-funded plan.

Plan Transitions

If the seller continues to offer group health plan coverage following the transaction, employees acquired by the buyer will generally lose eligibility for the seller’s plans and will need to transfer to the buyer’s plans. If the immediate transition to buyer’s plans will create significant issues, there are a couple alternatives:

• The buyer could set up plans that mirror the seller’s plans for acquired employees; or
• The parties (the seller, the buyer, and involved carriers) could negotiate to keep the acquired employees on the seller’s plans through the end of the current plan year (a temporary MEWA).

If the seller will no longer offer any group health plan coverage following the transaction, employees acquired by the seller will have to transfer to buyer’s plans unless the buyer adopts (or takes over) the seller’s plans. It would be necessary to coordinate with the carrier(s) and follow any contractual terms to formally take over the seller’s plans.

In some cases, rather than immediately transitioning acquired employees to the buyer’s plan(s), the buyer may choose to implement one of the alternatives mentioned above temporarily to ease the transition. If the plan years are the same, the buyer could allow the acquired employees to continue their same benefits through the end of the current plan year and then transition employees to the buyer’s plan upon plan renewal. If the plan years are different, it may be necessary to cut the plan year short or offer a short plan year to transition the acquired employees upon the buyer’s plan renewal.

Plan Termination

For any plans that will terminate in connection with the transaction, termination procedures set forth in ERISA or §125 plan documents should be followed. In general, the termination should be written and formally adopted to officially terminate the plan. From there:

• Any vendors must be contacted in accordance with contractual terms.
• To the extent possible, if the plan is terminating mid-year, 60 days’ advance notice to plan participants, including COBRA participants, is recommended.
• The employer must determine how to handle/ administer any claims incurred up through the date of termination and then also handle any remaining plan assets in accordance with ERISA rules.
• Final reporting will be due for Form 5500s, Form 1094/1095s, PCORI fees (Form 720), and CMS creditable coverage.

ERISA

ERISA requires plans to name fiduciaries (typically the plan administrator(s)) who are responsible for carrying out certain fiduciary duties in accordance with ERISA. The overarching requirement is for plan fiduciaries to act in the best interests of plan participants. Such duties include, amongst other things, following plan terms such as benefit inclusions/exclusions, eligibility for coverage, and claims procedures and properly handling plan assets.

HIPAA Privacy & Security

The HIPAA privacy and security regulations allow a covered entity to disclose protected health information (PHI) in connection with the sale to or merger with another covered entity. However, employers are not typically considered the covered entity; the employer-sponsored health plan is technically the covered entity. Consequently, sharing PHI between employers involved in a transaction must be limited. To comply with HIPAA:

• Use de-identified information whenever possible and share only the minimum necessary;
• Try to use employment-related enrollment information instead of health plan data; and
• Obtain authorizations from participants when possible.

COBRA

IRS guidance for handling COBRA for a merger/acquisition indicates the following, unless the parties mutually agree to different terms contractually:

• If the seller maintains a group health plan after the sale, then a group health plan of the seller must provide COBRA coverage.
  • Even if the seller discontinues its group health plan(s) in connection with the transaction, if the seller is part of a controlled group or affiliated service group (according to Code 414) and any other entities within the controlled group or affiliated service group maintain a group health plan, then COBRA liability remains with the seller and must be offered by one of the plans maintained by the controlled group/affiliated service group.

• If the seller ceases to maintain any group health plan in connection with the sale, then the buyer must provide COBRA coverage under their group health plan if: (i) the buyer maintains a group health plan; and (ii) in the case of an asset sale, the buyer is a successor employer.
  • In an asset purchase, the buyer is a “successor employer” if the seller discontinues all group health plan coverage following the transaction and the buyer “continues the business operations associated with the assets purchased… without interruption or substantial change.”

In a merger or acquisition, “qualified beneficiaries” for purposes of COBRA include:

• those qualified beneficiaries already receiving COBRA coverage before the sale; and
• those qualified beneficiaries who experience their qualifying event (e.g., termination of employment) in connection with the sale.

In a stock purchase, employees continuing employment with the acquired entity after a stock sale have no qualifying event because there is no termination of employment. Similarly, in an asset purchase, if the buyer is a successor employer, employees continuing with the buyer after the asset sale have no qualifying event. In other words, although employees who lose their job (and coverage) in connection with the transaction are likely to have COBRA continuation rights for up to 18 months, those who are employed by the buyer following the transaction often will not, even if the buyer doesn’t offer group health plan coverage.

For small employers (fewer than 20 employees) who are not subject to federal COBRA continuation requirements prior to the transaction, applicable state continuation requirements should be considered. Such requirements vary broadly from state to state. In addition, after the transaction, small employers may immediately become subject to COBRA if, for example, the small employer becomes part of a larger entity or controlled group of entities via a merger or stock purchase. Small employers should not automatically assume that coverage continuation requirements do not apply.

ACA Employer Mandate & Employer Reporting

Guidance for determining applicable large employer status and full-time employee status as well as how to handle associated reporting is currently limited, so it is recommended that employers consult with their advisors after a transaction to best comply with §4980H offer of coverage requirements and §6056 employer reporting requirements.

Applicable Large Employer (ALE) Status

If any of the entities are ALEs prior to the transaction, it is assumed that any smaller entities (non-ALEs) become ALEs as of the date of the transaction. The new ALE would be required to make minimum value, affordable offers of coverage to full-time employees and their dependents for the remainder of the year to avoid potential penalties under §4980H and would have to report offer of coverage information on Form 1094-C and Form 1095-Cs for the year as well.

If two non-ALEs are involved in a merger or acquisition, status as an ALE for the two entities may be tied to whether it was an asset or stock purchase (based on how the IRS handles the COBRA small employer exception):

• If it was an asset purchase, arguably neither becomes an ALE upon the transaction because they both averaged <50 FTEs in the previous calendar year. However, they would have to combine their average FTEs, at least for all months following the transaction, to determine ALE status for the following year.
• If it was a stock purchase, the IRS might look at their combined average FTEs during the previous calendar year and treat them both as ALEs as of the date of the stock purchase if together they averaged 50 or more FTEs in the previous calendar year.

Definition of Full-time Employees

For entities that are ALEs, it’s important to ensure that minimum essential coverage (medical coverage) is offered to full-time employees.

• In an asset purchase, there is an argument that the acquired employees can be treated as new hires, allowing the buyer to impose a new waiting period or initial measurement period, as applicable, upon the transaction. The employer might choose to waive the waiting period but wouldn’t have to.
• In a stock purchase, the acquired employees are likely viewed as continuing employees, in which case the employer must give them credit for hours of service with the seller and could not impose a new waiting period or initial measurement period without risking §4980H penalties. In such cases, the buyer should consider whether the seller used the monthly or the look-back measurement method and transition employees accordingly.

Employer Reporting (Forms 1094 & 1095)

For entities that are ALEs, a Form 1094-C and Form 1095-Cs for all full-time employees must be prepared on a per EIN basis. This is true even if the entities are part of the same controlled group or affiliated service group in accordance with IRS §414 rules. Following the merger or acquisition:

• If the entities involved maintain separate EINs, separate reporting will be required for each entity for the year of the transaction as well as for subsequent years.
• If the entities merge into a single EIN mid-calendar year, it’s possible that separate reporting may still be required for the year of the transaction (with the acquired employees only showing up on the seller’s reporting for the months prior to the transaction and then showing up on the buyer’s reporting for all months following the transaction). Alternatively, it may be an option to report the combined entities under the buyer’s EIN for the entire year of the transaction; we generally recommend whatever approach is used for the W-2s also be used for reporting on the Form 1094-C and Form 1095-Cs.

Whether the entities are ALEs or small employers, if any of the plan options are level-funded or self-funded, reporting is required for any individuals, including spouses and dependents, who were covered under the plan during the year.

§125 Cafeteria Plan

In the case where the seller will no longer exist, the seller’s cafeteria plan and underlying benefits will terminate on or before the transaction date unless the buyer agrees to take over the seller’s plans and continue them.

• If the seller’s plans terminate, the acquired employees will then make new elections under the buyer’s plans for the remainder of the plan year.
• However, if the buyer assumes/adopts the seller’s plans, then acquired employees will not be able to make mid-year election changes when the transaction occurs. Their existing elections and balances, if applicable, will remain in place for the remainder of the current plan year.

Health FSAs & DCAPs

For health flexible spending arrangements (FSAs) and dependent care assistance plans (DCAPs), acquired employees’ participation will generally terminate upon the transaction date and unused amounts will be forfeited, unless:

• The buyer adopts the plans and keeps them going, at least through the end of the current plan year; or
• If the buyer and seller both have the same plan years, the buyer agrees to allow existing elections and balances to transfer over to the buyer’s plans for the remainder of the current plan year.

If either of these scenarios occur, then there is no opportunity for acquired employees to make election changes upon the transaction; their current elections would remain in place through the end of the plan year.

If participation terminates and there are significant balances remaining, the plan could distribute the forfeitures on a uniform basis (i.e., same amount to each participant, or based on a percentage of contribution elections), but not in accordance with an employee’s actual usage or remaining balance.

Benefit Nondiscrimination Rules

Following the transaction, if benefit offerings will differ between different classes of employees (e.g., existing employees versus newly acquired employees), or differ between different EINs that are now part of the same controlled group or affiliated service group (as determined by Code §414 rules), benefit nondiscrimination rules, which restrict the ability to favor highly compensated or key employees on a tax-favored basis, need to be considered.

• 125 nondiscrimination rules apply to all benefits offered through a cafeteria plan.
• 105(h) nondiscrimination rules apply to self-funded group health plans.
• 129 nondiscrimination rules apply to DCAPs.
• 79 nondiscrimination rules apply to group life plans.

However, at least for the first year or so following a merger or acquisition, most assume there is transition relief from applicable benefit nondiscrimination rules. While there isn’t anything specific under health and welfare benefit nondiscrimination rules providing transition relief upon a merger or acquisition, it seems likely the IRS would provide relief similar to that which applies for retirement plans. Code §410(b) provides relief for retirement plans until the last day of the first plan year following an acquisition or disposition transaction. It seems unlikely nondiscrimination rules would be enforced for at least the remainder of the current plan year following a merger or acquisition and perhaps even through the following plan year.

Apex Benefits is not a law firm and cannot dispense legal advice. Anything contained in this communication is not and should not be construed as legal advice. If you need legal advice, please contact your legal counsel.