Thank you for your question today, I look forward to assisting you. I bring nearly 20 years of legal experience in various disciplines.
Ok. The issue here is that you can't artificially keep him employed. As a smaller employer, you are not legally subject to the FMLA laws that would require you to maintain his employment for up to 12 weeks. So, because you aren't subject to it, maintaining his employment (while I completely understand and admire your desire to do so) is not something that you can point to a law as your basis for doing. If you aren't legally compelled, then your insurance carrier is also not legally compelled.
So, this is really more of a insurance issue. Your insurer is stating that he does not fit their definition of an employee and, as your insurer, they can legally make that definition. If you want your definition of "employee" expanded, you'd have to come to a new group rate agreement.
Certainly, with larger employers, they are already paying a very high group rate and their insurers will give them more latitude in when a person is dropped from the insurance rolls. Smaller employers simply don't have as much leverage.
So, your insurer is not doing anything illegal by asking you to remove this person from the rolls. You can still choose to pay him, but you'll need to speak to the insurer about what status you can refer to this employee as which will allow him to have the "qualifying event" to have COBRA coverage initiated. Most likely, it will be something like a medical leave of absence. You can then do whatever you want, in terms of payment and he can be dropped from the group plan and placed on an individual COBRA plan (which you can also assist with, if you want).
Now, I would explain to the insurance company that you will drop him from the rolls ONLY at a point where his COBRA can be initiated without an interruption in coverage and that they need to figure out how to do that. Put this on them.