The Internal Revenue Code and the Employee Retirement Income Security Act (ERISA) provide two methods by which self-insured health plans may compute the "applicable premium" paid by COBRA participants (the COBRA rate):
1. Actuarial basis method. Under this method, the COBRA rate is equal to a reasonable estimate of the cost of providing coverage for similarly situated beneficiaries determined on an actuarial basis, taking into account "such factors as the Secretary may prescribe by regulations." (Note that the Department of the Treasury and the IRS have not issued regulations prescribing factors to take into account.)
2. Past cost method. Under this method, the COBRA rate is equal to "(I) the cost to the plan for similarly situated beneficiaries for the same period occurring during the preceding determination period ... adjusted by (II) the percentage increase or decrease in the implicit price deflator of the gross national product (calculated by the U.S. Department of Commerce and published in the Survey of Current Business) for the 12-month period ending on the last day of the sixth month of such preceding determination period." A plan administrator may not elect to use this method when there is any significant difference between the determination period and the preceding determination period, in coverage under, or in employees covered by, the plan.
The COBRA rate must be determined for a 12-month determination period, and must be determined before the beginning of such period. Use of the actuarial basis method requires the services of an actuary. The actuary would need to be provided with the 12-month determination period; plan claims data for the review period (including the amount of claims incurred and the amount of claims paid with respect to all individuals covered by the plan); information about administrative costs, stop-loss premiums, and stop-loss reimbursements; and an estimate of the number of covered lives for each month of the determination period.
Source: Internal Revenue Code Sec. 4980B(f)(4)(B); ERISA Sec. 604.