Health Coverage for Continuing Employees After an M&A Transaction

Question: After an M&A transaction closes, what health benefit options are available for those continuing employment with the new or acquiring entity?

Short Answer: The default approaches are either to immediately move the continuing employees to the buyer’s health plan or to continue coverage under the seller’s health plan for a transitional period. However, in some situations (particularly where the buyer does not acquire the seller’s health plan) the parties will consider a variety of health coverage alternatives for the continuing employees. Each of these alternatives comes with multiple potentially significant issues to consider.

One of the first employee benefits-related issues to address in any M&A transaction is whether the continuing employees (i.e., those who remain employed post-close) will join the buyer’s health and welfare plan—and, if so, when? Unless provisions in the purchase and sale agreement provide otherwise, the buyer generally has full discretion as to if/when the seller’s employees will be eligible for the buyer’s employee benefits plans.

There are two main default approaches for buyers to consider most M&A situations:

1. Continuing Employees Move Immediately to Buyer’s Health Plan; or

2. Continuing Employees Remain with Seller’s Health Plan (Typically for a Limited Duration)

These two options are each considered in turn below, followed by a discussion of three potential alternatives.

Default Approach #1: Continuing Employees Move Immediately to Buyer’s Health Plan
Buyers in an M&A transaction may choose to make their health plan available immediately upon closing for the population of the seller’s employees who are continuing employment. This has the primary advantage of quickly making the seller’s employees feel like part of the new buyer’s organization, while also avoiding the administrative hassle (and potential added costs) associated with maintaining two separate sets of plans.

The primary disadvantage to this approach is there are often benefits administration system and administrative challenges caused by so quickly onboarding a (potentially large) group of new employees onto the buyer’s health plan. There are many moving parts in the period surrounding the close, and adding a large benefit plan communication and enrollment lift can be more than both parties’ benefits teams are able to bear.

Additional potential disadvantages with immediate integration include:

• The buyer’s health plan may not accommodate mid-year deductible and out-of-pocket maximum carryovers for the seller’s employees, which can cause additional employee costs and frustrations in the move.

• Although there are corporate culture reasons to integrate plan benefits to quickly coalesce into one united entity, there may be demographic reasons that the buyer’s plan is not ideally suited to meet the needs of the seller’s population. For example, buyer’s plan may have regional HMOs that do not have service areas within the seller’s primary footprint, network structures that do not include key providers for buyer’s employees, or simple coverage gaps that are exacerbated by the seller’s workforce.

• The employer would have to work with the insurance carriers and/or stop-loss providers to determine whether the scope of the transaction is significant enough to trigger a mid-year re-rating or any other change in control provisions that might apply under the terms of the policy.

Default Approach #2: Continuing Employees Remain with Seller’s Health Plan (Typically for a Limited Duration)
Another common approach in an M&A transaction is to continue maintaining the seller’s health plan for some period post-close. While this can be a strategy maintained into perpetuity, more often it is used as a stop-gap measure to minimize disruption for the employees transitioning to the buyer’s workforce. Under this approach, seller’s employees can remain with the benefit plans they are comfortable with for some period, which has the critical advantage of allowing employees to keep their focus on work priorities in the key transition phase.

For example, this approach is commonly applied through the end of the plan year following the closing, thereby allowing the seller’s employees to transition to the buyer’s plan during its standard open enrollment period. Nonetheless, the buyer could choose any time to move the buyer’s employees to the seller’s plan. The standard new hire rules (e.g., waiting periods) do not have to apply in this context. Absent provision in the purchase and sale agreement dictating the transition, the buyer could choose any point to move seller’s employees, such mid-year as after a few months of transition period.

The only dispositive concern with this approach is in a situation such as a carve-out or spin-off where the “seller” group represents only a portion of the “seller’s” broader controlled group. In that situation, the entity that is carved out or spun off typically is not the plan sponsor of the health plan, and therefore the “seller’s” health plan will continue to be maintained by the “seller’s” parent entity for the ongoing employees that are not affected by the transaction. The “buyer” (whether a separate acquiring entity or simply a portion of the parent entity that is leaving that parent’s controlled group) thus does not have the ability to continue coverage for the affected employees through their prior plan. Similar issues also are inherent in most asset deals.

Otherwise, the more subtle concerns with continuing employees’ coverage through the seller’s group health plan generally involve the duplicative administrative work associating with maintaining two sets of health plans, and the missed opportunity to foster the corporate culture goal of uniting together immediately as one business, including the benefit plan infrastructure. At some point, these downsides will usually convince the buyer to integrate the benefits after the appropriate transitional period (e.g., as of the following plan year).

Alternative Coverage Options for Seller’s Employees Continuing with Buyer
The buyer in an M&A transaction may not have a health plan in place to offer seller’s employees, or the buyer may just prefer to avoid immediately offering coverage to continuing employees under the buyer’s plan. This presents an issue where the buyer does not acquire the seller’s plan. For example, the buyer in a carve out deal acquires only a piece of the seller’s broader business that often does not include the seller’s health plan sponsored by its parent entity. As another example, an entity spinning off from the parent company often will move outside of the controlled group of that parent plan sponsor.

In these types of situations, the buyer will not be able to offer coverage to continuing employees through the seller’s plan because the plan is remaining with the original sponsor at the seller’s parent entity. In other words, the plan will not have been affected by the deal and will continue serving those employees remaining with the seller’s ongoing business that was not part of the transaction—ruling out Default Option #2 discussed above.

There are three main approaches that buyers often consider in these more challenging types of situations:

1. Buyer Subsidizes COBRA Through Seller’s Health Plan for Continuing Employees During Transition Period

2. Continuing Employees Maintain Active Coverage Through Seller’s Parent Entity During Transition Period

3. Continuing Employees Seek Coverage on the Exchange During Transition Period

These options, and the multiple associated issues they raise, are each considered in turn below. Buyers exploring these options often find the concerns significant enough to avoid these approaches where possible.

Alternative Approach #1: Buyer Subsidizes COBRA Through Seller’s Health Plan for Continuing Employees During Transition Period (Multiple Issues)
Buyers attempting to avoid moving continuing employees to the buyer’s health plan (if any) at closing will sometimes consider whether they can simply subsidize COBRA for the continuing employees through the seller’s health plan for a transition period (e.g., until the buyer can establish its own plan or until the next open enrollment period for the buyer’s plan). Unfortunately, there are multiple potential issues with the approach that often make it infeasible or undesirable.

Issue: No COBRA Qualifying Event for Continuing Employees in a Stock Deal

There are two requirements for a COBRA qualifying event:

1. Loss of group health plan coverage;

2. Caused by a COBRA triggering event.

The event causing the individual’s loss of coverage must be one of the listed triggering events set forth by COBRA to constitute a qualifying event. For covered employees, the potential COBRA triggering events are termination of employment and reduction of hours.

• For more details: The COBRA Triggering Events

In a stock deal, those continuing employment with the buyer post-close will not experience a termination of employment—they simply move to the buyer’s controlled group at closing. Even where the seller’s employees moving under the buyer’s umbrella lose coverage under the seller’s plan, the loss of coverage is not caused by a COBRA triggering event. Therefore, the seller employees continuing with the buyer post-close do not experience a COBRA qualifying event, making the COBRA approach unavailable in stock deals.

Issue: No COBRA Qualifying Event for Continuing Employees in an Asset Deal if Seller Terminates Plan
In an asset deal, those continuing employment with the buyer post-close are terminated by the seller and re-hired by the buyer. Accordingly, unlike in a stock deal, the continuing employees will have their loss of coverage caused by a COBRA triggering event (termination of employment).

Nonetheless, if a) the seller terminates its plan at closing, and b) no other group health plan remains in existence with any member of the seller’s controlled group, there is no option for the continuing employees to access COBRA under the seller’s plan. COBRA rights apply only as continuation coverage for a plan that is currently in effect. COBRA provides the same plan coverage and benefits as is available to non-COBRA participants. In other words, an underlying plan for active, eligible employees must continue to be maintained by the seller (or a related entity within its controlled group) for a COBRA qualified beneficiary to have continuation coverage rights. Upon plan termination, there are no COBRA rights for any individuals under the plan because there is no longer an underlying plan under which to continue coverage.

• Note: The COBRA M&A rules do provide rights for “M&A qualified beneficiaries” under the buyer’s plan in certain situations. However, those COBRA rights under the buyer’s plan do not apply for continuing employees immediately rehired by the buyer after the sale.

Issue: ALEs Must Offer Coverage to Avoid Potential ACA Employer Mandate Penalty Liability
As discussed above, in many situations the COBRA route for employees continuing with the buyer will not be an option because the type of transaction will not create COBRA rights. Nonetheless, the COBRA route could in theory be an option available to buyers in an asset deal where the seller will continue to maintain its plan.

However, even in that limited asset buyer situation where those who are terminated by the buyer and immediately rehired by the buyer have COBRA rights to continue coverage through the seller entity’s ongoing plan, the buyer generally should avoid the “COBRA option” if it is an Applicable Large Employer (ALE) subject to the ACA employer mandate.

The primary ACA employer mandate liability at issue here is the §4980H(a) penalty—frequently referred to as the “A Penalty” or the “Sledge Hammer Penalty.” This penalty applies where the ALE fails to offer minimum essential coverage to at least 95% of its full-time employees (and their children to age 26) in any given calendar month. The 2026 A Penalty is $278.33/month ($3,340 annualized) multiplied by all full-time employees (reduced by the first 30). It is triggered by at least one full-time employee who was not offered minimum essential coverage enrolling in subsidized coverage on the Exchange.

• For more details: Newfront ACA Employer Mandate & ACA Reporting Guide

Subsidizing COBRA for continuation coverage under a plan sponsored by an unrelated entity (i.e., the seller) is not an offer of coverage made by the buyer. Therefore, the buyer may expose itself to very large potential ACA employer mandate A Penalty liability for failure to offer coverage to at least 95% of its full-time employees. The buyer generally needs to offer coverage under its plan to avoid those potential penalties. While most of the seller’s continuing employees with buyer would likely choose to enroll in the offer of subsidized COBRA coverage through the seller’s plan, just one such full-time employee instead choosing subsidized Exchange coverage could trigger the mammoth A Penalty.

Alternative Approach #2: Continuing Employees Maintain Active Coverage Through Seller’s Parent Entity During Transition Period (Multiple Issues)
Buyers attempting to avoid moving continuing employees to the buyer’s health plan (if any) at closing may consider whether they can arrange with the seller entity to continue active coverage under the seller’s plan. Typically, the concept is that this seller coverage arrangement would be for a transition period (e.g., until the buyer can establish its own plan or until the next open enrollment period for the buyer’s plan).

This approach is typically contemplated via a “Transition Services Agreement” or “TSA,” which is component of some M&A transactions. TSAs can be broad arrangements that address a wide variety of administrative concerns post-close, far beyond just the health plan. Sometimes, TSA negotiations include a discussion of the seller maintaining health and welfare benefits for those employees moving to the buyer for a transitional period.

The primary issue with this approach is it may create a multiple employer welfare arrangement (MEWA). A MEWA is an arrangement used to provide employee welfare benefits to the employees of two or more employers that are not part of the same controlled group. Covering any non-employees generally creates a MEWA by providing coverage to two or more employers that are not part of the same §414 controlled group.

• For more details: The MEWA Issues with Enrolling Non-Employees in the Health Plan

Once the deal closes and the seller’s employees are no longer part of the seller’s controlled group (whether acquired by the buyer, terminated and rehired by the buyer, carved out from the seller, spun-off from the seller, etc.), an arrangement whereby the buyer/spin-off/carve-out entity is no longer owned by seller, yet its employees receive coverage through the seller’s plan, will generally create a MEWA.

• There are multiple serious concerns with the seller establishing and maintaining a MEWA as a strategy to address a temporary offering of coverage to continuing employees post-close, including:

• Insurance carriers generally will not permit employers to create a MEWA to cover non-employees outside of the arrangements specifically designed for that purpose (e.g., health plans sponsored by a bona fide association). The plan sponsor would need to seek carrier approval for a temporary exception to this general barrier.

• MEWAs are generally subject to the Form M-1 annual filing requirements, with penalties of up to $1,992 per day. However, there is a Form M-1 filing exception that applies where the MEWA formation is caused by a change in control and is only for a temporary purpose not extending beyond the end of the plan year post-close.

• Thanks to the DOL’s wide-ranging trust nonenforcement policy, the vast majority of health plans are not funded by a trust. However, DOL guidance provides that MEWAs generally cannot take advantage of the trust nonenforcement policy that applies to most single employer plans. This can result in the need to establish a trust to hold plan contributions and an audit report included in the Form 5500 filing.

• Some states include strict insurance code restrictions prohibiting the creation or maintenance of self-insured MEWAs. For example, California has prohibited the creation of any new self-insured MEWAs since 1995. MEWAs do not enjoy ERISA preemption from state insurance mandates (even if they are self-insured), and therefore these state insurance restrictions are enforceable against a MEWA.

Furthermore, if the buyer/spin-off/carve-out entity is an ALE, it could face potential ACA employer mandate penalty liability for failure to offer coverage to employees. See “Issue: ALEs Must Offer Coverage to Avoid Potential ACA Employer Mandate Penalty Liability” above for more details. The parties would need to carefully ensure that the seller’s offer of coverage through the seller’s health plan satisfies the “Offer of coverage on behalf of another entity” regulatory provisions (Treas. Reg. §54.4980H-4(b)(2) and §54.4980H-5(b)) to treat the buyer as having made the offer of coverage through the seller’s plan.

One additional point to consider is that if the seller offered coverage only to those former employees who continued employment post-close with the buyer/spin-off/carve-out entity—and no post-close new hires of the buyer/spin-off/carve-out entity—there would not be the same MEWA concern. In that case, the individuals offered coverage would all be former employees of the seller, and continuing coverage post-separation does not create a MEWA (e.g., retiree plans are not MEWAs). However, there would still be significant insurance carrier and/or stop-loss provider concerns with this approach, and it would not solve for how to address the coverage need (and ACA offer of coverage requirements) for the entity’s new hires in the transition period.

Alternative Approach #3: Continuing Employees Seek Coverage on the Exchange During Transition Period (Multiple Issues)
Buyers attempting to avoid moving continuing employees to the buyer’s health plan (if any) at closing will sometimes consider whether they can rely on the individual market (i.e., the Exchange/Marketplace) as a stop-gap measure. Typically, the idea is that employees could utilize the individual market for a transition period (e.g., until the buyer can establish its own plan or until the next open enrollment period for the buyer’s plan).

Unfortunately, there are some significant drawbacks to this approach. For one, the ACA prohibits arrangements designed to pay for or reimburse employee individual policy premiums as an impermissible “employer payment plan.” Only HRAs that are specifically designed to meet the numerous requirements to qualify as an Individual Coverage HRA (ICHRA) could satisfy those ACA requirements and avoid potential penalties of $100/day/employee. Establishing an ICHRA designed for only a short transition period generally will not be a desirable option.

• More details: The Issues with Reimbursement Outside of a Group Health Plan

The buyer could provide additional taxable cash compensation (e.g., a raise or bonus) to assist employees in purchasing an individual policy. The ACA prohibition on reimbursement of individual policy coverage (outside of an ICHRA) requires there not be any conditions associated with those funds. To avoid creating a prohibited employer payment plan under the ACA, the employees would need to have an unrestricted right to receive the taxable funds as cash, could not be required to use the additional compensation to purchase health coverage, and could not be required to substantiate the purchase of individual market coverage.

While this less-than-ideal workaround may seem viable despite not being tax-advantaged or conditioned on actual individual policy enrollment, it still would face the significant ACA employer mandate concerns described above in “Issue: ALEs Must Offer Coverage to Avoid Potential ACA Employer Mandate Penalty Liability.” ALEs would face A Penalty liability in 2026 of $278.33/month ($3,340 annualized) multiplied by all full-time employees (reduced by the first 30) for failure to offer minimum essential coverage to at least 95% of its full-time employees (and their children to age 26). Only establishing a formal ICHRA could avoid that liability.

Reminder: Non-Continuing Employees May Be COBRA M&A Qualified Beneficiaries
The discussion above reviews the coverage options for continuing employees who are retained by the buyer after the close of the M&A transaction. For those not continuing employment post-close, the COBRA rules provide a special category of “M&A qualified beneficiaries” to ensure access to continuation coverage in most scenarios.

• For more details: Newfront COBRA for Employers Guide

M&A qualified beneficiaries include individuals who lose coverage under the seller’s plan in connection with the deal (i.e., seller’s employees who do not continue employment upon acquisition by the buyer). It also includes COBRA participants already receiving COBRA coverage with the seller’s plan before the deal (i.e., existing COBRA qualified beneficiaries).

The buyer’s health plan generally has the obligation to offer COBRA to all M&A qualified beneficiaries as of the later of the date the seller ceases to provide a group health plan or the date of the stock or asset sale. In an asset deal, the buyer must also qualify as a “successor employer,” which (among other conditions) requires that it continue the business operations associated with the assets without interruption or substantial change.

Summary
Employee benefits often are not at the forefront of the concerns in a corporate transaction, and they can be at risk of becoming an afterthought. The broader corporate world is frequently caught off guard by the complexity of employee benefits law, which can lead to rushed, last-minute decisions that do not fully consider the compliance issues (and employee relations concerns) that can result.

The default approaches of moving the seller’s employees immediately to the buyer’s plan or continuing the seller’s plan for some duration prior to transitioning to the buyer’s plan are in most situations likely to be the smoothest way to handle employee coverage in the post-close period. However, particularly in situations where the buyer does not acquire the seller’s plan, the parties may consider a variety of alternatives to address health coverage prior to moving to the buyer’s plan. As discussed above, these alternatives all come with serious concerns and potential pitfalls that the buyer and seller should carefully consider before proceeding.

For more details on M&A considerations, see our Newfront M&A for H&W Employee Benefits Guide.

Relevant Cites:

Treas. Reg. §54.4980B-9:
Q-5. In the case of a stock sale, is the sale a qualifying event with respect to a covered employee who is employed by the acquired organization before the sale and who continues to be employed by the acquired organization after the sale, or with respect to the spouse or dependent children of such a covered employee?
A-5. No. A covered employee who continues to be employed by the acquired organization after the sale does not experience a termination of employment as a result of the sale. Accordingly, the sale is not a qualifying event with respect to the covered employee, or with respect to the covered employee's spouse or dependent children, regardless of whether they are provided with group health coverage after the sale, and neither the covered employee, nor the covered employee's spouse or dependent children, become qualified beneficiaries as a result of the sale.
Q-6. In the case of an asset sale, is the sale a qualifying event with respect to a covered employee whose employment immediately before the sale was associated with the purchased assets, or with respect to the spouse or dependent children of such a covered employee who are covered under a group health plan of the selling group immediately before the sale?
A-6. (a) Yes, unless—
(1) The buying group is a successor employer under paragraph (c) of Q&A-8 of this section or Q&A-2 of §54.4980B-2, and the covered employee is employed by the buying group immediately after the sale….

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).