The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 includes the most sweeping changes to Medicare since the program was created nearly 40 years ago. In addition to establishing a voluntary prescription drug benefit, the act provides direct U.S. federal subsidies to plan sponsors that provide prescription drug benefits to Medicare-eligible retirees and significantly modifies the Medicare+Choice program (renaming it Medicare Advantage). The act also provides favorable tax treatment for individual health savings accounts (HSAs). The new drug benefit, employer subsidies and most of the Medicare Advantage changes will not be effective until January 1, 2006, but the HSA provisions become effective on January 1, 2004. This memorandum summarizes the key implications for plan sponsors.
New Medicare Drug Benefit
The act establishes a voluntary prescription drug benefit under new Medicare Part D. Each individual entitled to Medicare Part A or enrolled in Part B would be eligible for qualified prescription drug coverage under Part D by enrolling in a Prescription Drug Plan (PDP). An individual enrolled in a Medicare Advantage (MA) plan providing qualified prescription drug coverage would obtain coverage through that plan (an MA-PD plan). Part D coverage would begin January 1, 2006.
For 2006, the standard Part D prescription drug benefit includes a $250 deductible, 25 percent coinsurance up to an initial coverage limit of $2,250 and catastrophic coverage after an individual incurs $3,600 in out-of-pocket expenses. Once the catastrophic limit is reached, individuals would be subject to nominal cost-sharing requirements (the greater of 5 percent coinsurance or $2/$5 per script). The deductible, initial coverage limit and out-of-pocket threshold are indexed to the annual percentage increase in average per capita aggregate expenditures for Part D drugs. Significantly, an individual’s out-of-pocket expenses do not include amounts paid or reimbursed by most third parties, including retiree health plans. Enrollees would have access to negotiated drug prices whether or not Part D benefits are payable. PDP sponsors and MA organizations can also offer drug plans that are actuarially equivalent to the Part D standard prescription drug benefit as well as drug plans providing supplemental benefits.
Each PDP sponsor is required to submit a bid for each PDP plan offering standard Part D coverage within a specified PDP region. Once a bid is submitted, the Secretary of the Department of Health and Human Services has limited authority to negotiate the terms and conditions of each plan, similar to the negotiation authority exercised by the Office of Personnel Management to solicit plans for the Federal Employees Health Benefits Program. PDP sponsors are required to be licensed under state law as risk-bearing entities and must be eligible to offer health insurance in each state in which a PDP is offered. Alternatively, PDP sponsors may meet solvency standards established by the secretary for entities not licensed by the state (these standards must be published by January 1, 2005). The secretary will enter into contracts with approved PDP sponsors, and the contract requirements are similar to those that apply to MA organizations (including provisions regarding minimum enrollment, contract periods, protections against fraud and abuse, intermediate sanctions and contract termination).
The act anticipates that at least two plans, at least one of which is a PDP, will be available within each PDP region. To ensure that Medicare beneficiaries have access to at least two plans, the secretary has the authority to contract with plans on a limited risk basis or, as a last resort, to establish “fallback plans” to provide the drug benefit. The secretary can approve only one fallback plan for all fallback service areas in any PDP region for a contract period. Under a fallback contract, the secretary would pay actual costs for Part D covered drugs taking into account negotiated price concessions.
Enrollees will be required to pay a premium intended to cover approximately 26 percent of overall Part D drug costs, approximately $35 per month for 2006. Medicaid-eligible and other low-income enrollees will pay no premiums or lower premiums, depending on their income level. PDP and MA-PD plans will receive federal subsidy payments equal to the plan’s standardized bid amount adjusted for health status and risk, reduced by the base premium as adjusted to reflect the difference between the plan’s bid and the U.S. average bid. Plans will be at risk for a limited percentage of Part D drug costs over specified target amounts. PDP and MA-PD plans will also receive federal reinsurance payments equal to 80 percent of an enrollee’s Part D drug costs in excess of the annual out-of-pocket threshold.
PDP sponsors and MA organizations sponsoring MA-PD plans are required to disclose to the secretary the aggregate negotiated price concessions made available to the sponsor or organization and passed through in the form of lower subsidies, lower monthly beneficiary premiums and lower prices through pharmacies. Drug manufacturers are required to disclose pricing information to the secretary, but that information would remain confidential.
Covered Part D drugs include Medicaid-covered drugs dispensed pursuant to a prescription, biological products, insulin and vaccines. Coverage for insulin includes medical supplies such as insulin syringes and insulin delivery devices that are not otherwise covered as a Medicare durable medical equipment benefit. Drugs excluded from Medicaid coverage are excluded under Part D with the exception of smoking cessation drugs.
Retiree Prescription Drug Plan Subsidies
The act provides federal subsidy payments to employers and unions that sponsor qualified retiree prescription drug plans. Qualified plans are defined as employment-based retiree health coverage providing prescription drug coverage with an actuarial value equal to or greater than the actuarial value of Part D standard prescription drug coverage. Employment-based retiree health coverage is defined as coverage for health insurance or health care costs under a group health plan for Part D-eligible individuals based on their status as retired participants. For this purpose, a “group health plan” includes ERISA group health plans, plans sponsored by federal and state governments and church plans.
For plan years ending in 2006, the amount of the subsidy is 28 percent of a qualifying retiree’s allowable drug costs between $250 and $5,000. A qualifying retiree is a Part D eligible individual who is covered under the plan but who is not enrolled in a PDP or an MA-PD plan. Allowable drug costs include amounts actually paid for covered Part D drugs by or on behalf of a qualifying retiree and by the plan sponsor (net of discounts, charge backs and rebates), but do not include plan administrative costs. The subsidy will be paid to plan sponsors using payment methods similar to those used to make reinsurance payments to organizations sponsoring a PDP or an MA-PD plan (note that the act does not specify precisely how the subsidy will be paid to plan sponsors). Subsidy payments will be excluded from the plan sponsor’s income for federal income tax purposes.
To qualify for the subsidy, the plan sponsor is required to provide an annual attestation to the secretary that the actuarial value of the plan’s drug coverage is greater than or equal to the actuarial value of Part D standard prescription drug coverage. The plan sponsor is also required to maintain records to ensure the adequacy of the plan’s prescription drug coverage and the accuracy of any subsidy payments. In addition, the plan sponsor is required to satisfy disclosure requirements regarding creditable prescription drug coverage.
According to the act, the federal subsidies for plan sponsors are not to be construed to prevent the following: an individual covered under a retiree health plan from enrolling in a PDP or an MA-PD plan; an employer, plan or another person from paying an individual’s premiums under a PDP or an MA-PD plan; a plan from providing coverage that is better than Part D standard prescription drug coverage, or from providing coverage that is supplemental to coverage provided by a PDP or an MA-PD plan; or an employer from providing flexible benefit design and pharmacy access provisions as long as the actuarial equivalence standard is satisfied.
Under current law, Medicare beneficiaries may elect to receive Part A and B benefits by enrolling in Part C of the program, more commonly known as the Medicare+Choice program. This program offers Medicare beneficiaries the opportunity to receive Medicare benefits through managed care arrangements. The act replaces the Medicare+Choice program with the new MA program and makes several changes intended to strengthen and stabilize the program.
Under Medicare+Choice, enrollment is limited to eligible individuals who reside in a plan’s service area. The MA program expands the potential service area of MA plans by authorizing MA regional plans with a service area covering one or more MA regions (or the entire United States). MA regional plans will be structured more like private health insurance arrangements, with a single deductible for Part A and Part B benefits. The secretary is required to establish between 10 and 50 MA regions by January 1, 2005. A MA regional plan must be licensed in at least one of the regions it intends to cover, and the secretary may waive state licensure requirements for any other region to allow for the processing of the MA regional plan’s state license application(s) for those other regions.
Under Medicare+Choice, many managed care organizations pulled out of Medicare participation after the U.S. Congress “de-coupled” plan payments from Medicare fee-for-service payments. At present, payments to Medicare+Choice plans are based on a monthly per capita rate set at the highest of a minimum payment rate, a blended rate based on a mix of local and national rates, or a rate reflecting a minimum percentage increase, which is currently set at 2 percent. Beginning in 2004, the act adds a fourth payment amount equal to 100 percent of Medicare fee-for-service costs and modifies the minimum percentage increase to the greater of 2 percent or the national per capita MA growth percentage. The new MA payment rates will be announced within six weeks after the act is signed into law. Plans that have previously given notice of termination or service area reduction for 2004 will be permitted to rescind their notice and submit a new proposal. The new rates would be effective March 2004 with retroactive adjustments for January and February 2004.
Under the Medicare+Choice program, participating managed care organizations submit annual adjusted community rate (ACR) proposals to the Centers for Medicare and Medicaid Services (CMS) setting forth their anticipated costs (including member cost-sharing and premium requirements) in comparison to CMS payment rates for the upcoming year. If anticipated costs are less than the CMS payment, M+C plans must use the excess to provide additional benefits or place the excess in a benefit stabilization fund. Beginning in 2006, local and regional MA plans will be required to submit bids rather than ACR proposals. Bids must include a bid amount for all required Medicare items and services based on average revenue requirements in the payment area for an enrollee with a national average risk profile and must be supported by actuarial bases. The secretary will have limited authority to negotiate the monthly bid amount, similar to the authority exercised by OPM to negotiate with plans under the FEHBP. Bids will be compared to a benchmark amount. For MA local plans, the benchmark will be the MA payment rates. For MA regional plans, the benchmark will be the regional blended benchmark. Plans that submit bids below the benchmark will be paid their bid plus 75 percent of the difference between the benchmark and the bid, which must be returned to enrollees in the form of additional benefits or reduced premiums. Plans with bids above the benchmark will receive the bid amount from CMS, and enrollees will pay the balance as a premium.
Beginning in 2010, the act establishes a six-year demonstration project to test whether direct competition between private plans and fee-for-service Medicare will enhance competition, improve health care delivery and provide for greater beneficiary savings and reductions in government costs. The secretary will select up to six demonstration areas from among Metropolitan Statistical Areas that have at least 25 percent of eligible Medicare beneficiaries enrolled in a local coordinated care MA plan and at least two coordinated MA local plans offered by different organizations. Under the demonstration, private plans will submit bids and fee-for-service Medicare will calculate fee-for-service (FFS) amounts, based on the adjusted average per capita cost in the area or region. In addition, payments will be adjusted for health status, demographics and other factors. A competitive benchmark will be set at the weighted average of the private plan bids and the FFS amount in the demonstration area. Beneficiaries enrolling in plans with bids or FFS amounts below the competitive benchmark will receive 75 percent of the difference between the benchmark and bid/FFS amount, and the government will receive 25 percent of the difference. Beneficiaries enrolling in plans with bids/FFS amounts above the benchmark will pay the excess.
Health Savings Accounts
The Internal Revenue Code currently provides favorable tax treatment for several types of individual account health plans, including health flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs) and Archer medical savings accounts (MSAs). The act establishes a new type of tax-favored individual account health plan known as a health savings account (HSA), effective for tax years beginning on or after December 31, 2003. Because HSAs are fully portable and may be offered as a pre-tax option under cafeteria plans, they are likely to further spur the development of consumer-driven health plans.
The act defines an HSA as a tax-exempt trust or custodial account similar to an IRA. An individual is eligible for favorable HSA tax treatment for any month in which the individual is covered under a high deductible health plan and is not covered under any health plan that is not a high deductible health plan. An individual may be covered by certain “permitted” health coverages that are not high deductible plans, including dental, vision and long-term care coverage, but apparently may not be covered simultaneously by an HSA and either an HRA or a health care FSA . A “high deductible health plan” is an insured or self-insured health plan with a minimum annual deductible (at least $1,000 for single coverage or $2,000 for family coverage) and a maximum out-of-pocket limit (no more than $5,000 for single coverage or $10,000 for family coverage). A health plan will qualify as a high deductible health plan even if it does not apply a deductible to preventive care and, in the case of network plans, even if the plan’s annual deductible and out-of-pocket limits for out-of-network services exceed the statutory limits.
Subject to specified limits, contributions to an HSA are excluded from income and wages if made by an employer and/or are deducted from adjusted gross income if made by an individual (whether or not the individual itemizes deductions). In addition, employees may make pre-tax salary reduction contributions to an HSA if their employer offers HSA coverage as an option under a cafeteria plan. Thus, both employers and employees may contribute to HSAs at the same time, subject to the applicable contribution limits. If an individual is covered by a high-deductible health plan for a full year, the maximum amount that can be excluded (or deducted) from income in 2004 is the lesser of the high deductible plan’s annual deductible or a specified contribution limit ($2,600 for single coverage; $5,150 for family coverage). These contribution limits are increased for individuals who attain age 55 before the end of the year by specified amounts, starting at $500 in 2004 and increasing to $1,000 in 2009. No contributions can be made for individuals who are eligible for Medicare, or who may be claimed as a dependent on another person’s tax return. Contributions to an HSA in excess of the statutory limits are subject to a 6 percent excise tax, unless the excess amount is distributed to the individual.
If an employer makes contributions to HSAs for employees, the employer must make comparable contributions on behalf of all employees with comparable coverage (i.e., single or family coverage) during the same period. Contributions are considered comparable if they are either the same dollar amount or the same percentage of the deductible. The comparability rule is applied separately to part-time employees (those working less than 30 hours per week) and does not apply to amounts contributed under a cafeteria plan. Employer contributions that fail to satisfy the comparability requirement are subject to a 35 percent excise tax. On a more positive note, the act clarifies that HSAs are not subject to COBRA.
Distributions from an HSA that are used to pay qualified medical expenses are excluded from an individual’s gross income. A “qualified medical expense” includes any amount paid for medical care within the meaning of Code section 213(d), except for most health insurance premiums. For example, distributions from an HSA cannot be used to pay premiums under the tandem high deductible health plan. But certain health insurance premiums are treated as qualified medical expenses, including COBRA premiums, long-term care insurance premiums, health plan premiums paid while an individual is receiving unemployment compensation and premiums paid while an individual is eligible for Medicare (except for Medigap premiums).
Distributions not used to pay qualified medical expenses are included in income and subject to an additional 10 percent penalty tax. The penalty
tax doesn’t apply if the individual dies, becomes disabled or is eligible for Medicare. Distributions from an HSA are not included in income or subject to the penalty tax if rolled over to another HSA within 60 days. An HAS may accept rollover distributions from another HSA or from an Archer MSA. Special rules apply to distributions from an HSA upon an individual’s death.
Earnings on the amounts contributed to an HSA grow tax-free. The act does not require amounts to be distributed from an HSA during the year to satisfy the deductible under the high deductible plan, nor does it require amounts to be distributed upon the occurrence of certain events such as termination of employment or attainment of age 65. As a result, individuals who are able to make contributions to an HSA without taking distributions may create substantial accumulations to pay for post-retirement medical benefits. The various HSA dollar limits (the minimum deductible, maximum out-of-pocket and contribution limits) are increased annually for cost-of-living adjustments. Future guidance from the IRS regarding HSAs is expected, including guidance on how the cafeteria plan mid-year change in status rules will apply.
The act includes several other provisions with potential implications for plan sponsors, including the following areas.
Form 1099-MISC Reporting
Many plan sponsors are utilizing debit or credit cards to facilitate the payment of claims under health care FSAs and consumer-driven health plans. Earlier this year, the IRS published guidance indicating that payments made to medical service providers through the use of debit, credit or stored value cards must be reported by an employer on Form 1099-MISC under Code section 6041. The act creates a statutory exception indicating that the information reporting requirements do not apply to any payments for medical care made under a health FSA or a health reimbursement arrangement. The provision is effective for payments made after December 31, 2002.
Part B Premium
Some plan sponsors pay all or a portion of Medicare Part B premiums for their retirees. Under current law, Medicare’s Part B premium is set to
cover 25 percent of the costs of Part B services, and all individuals who elect Part B coverage during their initial enrollment period pay the same premiumregardless of income. The act adds a new “means-testing” requirement, under which an individual’s Part B premium will be based on his or her modified adjusted gross income. Individuals with incomes under $80,000 (or under $160,000 for married couples) will continue to pay Part B premiums equal to 25 percent of the costs. But the premium will rise as income rises, so that individuals with incomes above $200,000 (or above $400,000 for married couples) will pay 80 percent of the costs. These changes will be phased in over a five-year period starting in 2006, and the specified income levels will be increased annually for cost-of-living adjustments for each calendar year beginning with 2007.
Importation of Drugs from Canada
A few plan sponsors are considering whether to purchase prescription drugs from Canada to obtain lower drug costs. The act provides the secretary with authority to create a system for the importation of drugs from Canada by pharmacists, wholesalers and individuals. But this authority is conditional, and cannot be exercised unless the secretary first certifies that importation poses no additional risk to the public’s health and safety and results in a significant reduction in the cost of covered products to the U.S. consumer. A similar certification requirement was never implemented under prior law, and it is unlikely that it will be lawful for plan sponsors to purchase drugs from Canada any time soon. At the same time, the act confirms existing FDA enforcement policy by directing the secretary to promulgate regulations permitting individuals to import up to a 90-day supply of prescription drugs from Canada for personal use.
The act does not include provisions that would have permitted employers to reduce or terminate retiree health benefits for Medicare-eligible retirees without violating the Age Discrimination in Employment Act (ADEA); permitted individuals to carryover up to $500 of unused health benefits in a health care FSA; and extended the period that an employer health plan pays primary to Medicare for individuals with end stage renal disease from 30 to 36 months. Although these provisions were included in either the House- or Senate-passed versions of the legislation, they were dropped by the conference committee.
Implications for Plan Sponsors
The act’s provisions on HSAs will be intriguing for employers that have adopted or are considering adopting consumer-driven health plans. Many
of these plans rely on the combination of a high-deductible health plan and an individual health account, typically an HRA financed exclusively by an employer. But HSAs offer an interesting opportunity to create an alternative type of individual account--one that is truly portable, includes carryover features and is funded exclusively with employee pre-tax contributions. In addition, the ability to offer HSAs as a nontaxable benefit under a cafeteria plan will present employers with potential FICA tax savings opportunities. Employers will want to review their consumer-driven health care strategies with their advisors and consider whether HSAs provide a more flexible and attractive individual health account alternative.
Plan sponsors with retiree health plans will need to review their prescription drug strategies and designs in light of the act’s new Medicare prescription drug benefit. Most plan sponsors will want to consider whether and how to minimize their plan’s financial exposure for both moderate and catastrophic drug costs. These sponsors will need to determine whether the federal subsidy provided by the act is more valuable than simple coordination of benefits and whether high-end prescription drug costs should be shifted to the federal government. Other plan sponsors may want to subsidize some or all of the Part D premiums for their retirees or scuttle their retiree prescription drug benefit entirely. Although many of these design changes could provide immediate reductions in FAS 106 expense, there may be significant legal or contractual barriers for plan sponsors that wish to reduce or terminate prescription drug benefits for Medicare-eligible retirees. Unfortunately, the lawmakers’ failure to enact an ADEA exception for sponsors that reduce or terminate retiree health benefits for Medicare-eligible retirees will perpetuate some of this legal uncertainty.
Plan sponsors with retiree health plans will be understandably cautious about the act’s efforts to rejuvenate the newly renamed Medicare Advantage program. The experience of the last several years has been one of frustration, as plan sponsors have watched Medicare managed care programs reduce their service areas and increase their premiums. But the changes contemplated for the MA program are sweeping and may provide sufficient incentives for managed care and other health insurance carriers to re-enter the Medicare market. The prospect of regional and possibly even national MA plans will be especially attractive for plan sponsors that want to consolidate and standardize their retiree health plan offerings.