Employee Benefits Alert Issue No. 10 Legal & Research Group January 2004 Benefits Brokerage & Consulting Services Rx Purchasing Coalition HR Consulting Data Analysis Benefits Administration Retirement Services Predictive Modeling Call Center Services Voluntary Benefits Consumer Driven Healthcare Legislative & Compliance International Benefits 2003: A Look Back The year 2003 brought an intense mix of regulatory and legislative change, updates, and clarifications. Last year might well be remembered as among the first that saw the government seriously turn its attention to the high cost of health insurance and possible solutions to help employers and employees combat ever-increasing health care costs. To put the year into perspective, we offer a year-end overview of some of the benefits highlights of 2003. If you find that you would like more information about any of the following issues, please contact your local Willis office to schedule a meeting. HSAs: Innovative Health Benefit Funding Tool In December 2003 President Bush signed the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act ). Medicare now has a prescription drug benefit with special employer incentives for retiree health benefits. This law also adds new funding vehicles known as Health Spending Accounts (HSAs) to assist employers struggling to maintain viable health plans. It is possible that these new accounts and incentives will facilitate a genuine defined contribution approach to health plans maintaining HSAs in a manner similar to a 401(k) plan. Action may be slow as employers wait for the IRS and DOL to issue guidance about the new law and the status of HSAs under other employee benefits laws. Although an HSA may be in place as early as January 1, 2004, questions on the workings of HSAs plus the high standards for employer involvement, make it prudent for most employers to wait for regulatory guidance. Guidance issued on December 22, 2003 answers some immediate questions, but leaves most unanswered. IRS representatives say they expect to issue final regulations on HSAs by June, 2004. What is an HSA? HSAs resemble Archer Medical Savings Accounts (MSAs) introduced as a pilot program in the Health Insurance Portability and Accountability Act of 1996. Employers who studied MSAs will recall that they are individually-owned accounts that supplement high deductible health coverage. They generally reimburse the same expenses as health care flexible spending accounts (FSAs). Unlike FSAs, however, unused amounts may be carried over from year to year. In addition, MSAs allow tax-free employer contributions that, if used by the MSA owner for medical expenses, are not taxable when withdrawn. Willis Employee Benefits Alert is produced by Willis Legal & Research Group. The information contained in this publication is not intended to represent legal advice and has been prepared solely for educational purposes. You may wish to consult your attorney regarding issues raised in this publication. Willis publications appear on the internet at: www.focusonbenefits.com Copyright 2004
Page 2 As originally introduced, MSAs were deemed either impractical or unavailable in most cases. Special rules governed MSAs which required that they could only be used by self-employed individuals and individuals working for small employers. Moreover, the accounts could only be funded with either employer or employee money, but not both. HSAs, however, do not have these disadvantages. Eligibility is not limited by employment status or employer size, both employees and employers can contribute, and employers can arrange for employees to make pre-tax contributions to HSAs through their cafeteria plans. How do HSAs work? An HSA may be established by an individual, an employer, or even a third party. Regardless, the individual whose expenses are to be paid from the HSA must own the HSA, and the HSA amounts cannot be forfeited. A bank, insurance company or other IRS-approved custodian must hold the money in the account in trust on behalf of the individual. HSAs are subject to some restrictions that do not apply to FSAs and health reimbursement accounts (HRAs), and it is unlikely that HSAs will replace FSAs and HRAs in the near future. To assist you in understanding the relative advantages and disadvantages of HSAs, FSAs, and HRAs, we have separately published an Employee Benefits Alert that provides those details (Willis Employee Benefits Alert Issue #8, December 2003). To get a copy of our Alert, including a helpful comparison chart, please contact your Willis representative. Medicare Prescription Drug Benefit On a related note, if employers offer, or plan to offer, retiree medical coverage, another provision of the Act, starting in 2006, provides a generous tax credit for employers who offer their retirees a prescription drug benefit (if the retirees do not elect Medicare coverage). The credit is intended to induce employers to offer the benefit. It is equal to 28% of the allowable retiree costs ( ARC ) between $250 and $5000 (indexed after 2006). Allowable ARC are the prescription drug costs paid by the employer. The credit is on top of the regular deduction so when added together the tax benefit makes the coverage very affordable. The benefits must be actuarially equivalent to those in the Medicare program, and the employer must retain the appropriate records to demonstrate that. DOL Issues Proposed Rules on COBRA Notices COBRA rules requiring continuation of health benefits after the occurrence of a qualifying event have been in effect for more than 15 years. Before May 28, 2003, no federal agency had ever issued regulations about the exact content of the various required COBRA notices or how to send those notices. However, in May, the Department of Labor published proposed regulations setting forth the required content, recipients, timing, and method of delivery for various COBRA notices.
Page 3 In addition, the DOL provided two notice templates that employers can rely upon. Although the proposed rules provide welcome clarity on employers notice obligations under COBRA, they also would impose notice requirements not previously required. The proposed rules would require that: Employers give a written explanation of the reasons for a denial of COBRA coverage to an individual who notified the employer of a qualifying event. Employers give notice when COBRA coverage ends earlier than the end of the maximum coverage period. With the exception of these two new notice requirements, the proposed rules generally confirm the interpretations most experts have adopted under COBRA with respect to providing notices. The proposed rules would, however, require most employers to revise their COBRA notices to include new details on COBRA rights. The proposed rules also set forth the requirements for handling incoming notices. (The term incoming notice refers to notice that workers and others must provide to the employer regarding events affecting their COBRA rights events like divorce or a dependent child ceasing to be a dependent.) In addition, the proposed rules provide details about the appropriate means of delivering COBRA notices; unfortunately, the delivery process differs from most employers current practices. Although the proposed COBRA changes would not fundamentally change employer COBRA compliance duties, they would require significant revisions in employers notices and delivery procedures. The proposed rules were intended to become effective as of the first day of the first plan year starting on or after January 1, 2004; however, because the proposed rules were not finalized before the end of 2003, there has been no formal amendment to the COBRA requirements. At this point, Willis believes that an employer may continue to use the COBRA notice and procedures that it has been using (as long as the COBRA notice has been continually updated through the years to encompass all of the final COBRA rules). Once final COBRA rules are issued, employers will be bound by those final rules. ERISA Penalties Increasing The Department of Labor announced early in 2003 that employers and plan administrators will incur higher penalties if they fail to provide specified information as required by federal law. The increased penalty amounts apply to any violations occurring after March 24, 2003 and may be assessed in the following circumstances: Failure to provide plan materials upon request from the DOL. In 1999, plans were no longer required to annually file SPDs and other plan documents with the DOL. However, plans remain obligated to respond to DOL requests for such materials, and all requested plan materials must be submitted to the DOL within a very short time after being requested.
Page 4 If an employer or plan administrator fails to comply with this requirement, the penalty will be $110 per day with a $1,100 penalty cap for each DOL request. Failure or refusal to file Form M-1 (an informational filing required for multiple employer welfare arrangements). Filers who do not file the Form M-1 when required to file will face fines up to $1,100 per day. Over-the-Counter Medications May Now Be Reimbursed Late last year the IRS and Treasury Department published Revenue Ruling 2003-102 which allows employees to be reimbursed under their health reimbursement plans for the purchase of over-thecounter (OTC) medicines or drugs. Employers should note that this Ruling potentially impacts any medical reimbursement plan created under Internal Revenue Code Section 105, including health flexible spending accounts (FSAs), health reimbursement arrangements (HRAs) and health spending accounts (HSAs), in the event the employer determines to change its plan to comply with the Ruling. The Revenue Ruling specifically noted that OTC medications could be covered by tax-advantaged medical plans because they are being used to treat medical conditions. The IRS examined a situation in which an employee purchased non-prescription antacid, allergy medicine, pain reliever, and cold medicine from a pharmacy. All of the products were to be used by the employee and the employee s family, and the employee had not been reimbursed for any of the expenses. Along with the other products, the employee had also purchased non-prescription vitamins. As part of its Ruling, the IRS stated that non-prescription items that are used to treat personal injuries or to alleviate sickness are reimbursable on a tax-free basis. However, non-prescription dietary supplements like vitamins are not reimbursable on a tax-free basis because they are viewed as merely promoting general health. This new guidance avoids detailed consideration of the term prescribed drug, but concentrates on the issue of what constitutes an expense for purposes of medical care. Accordingly, the Ruling states that OTC medicines that are purchased for medical care are covered under the rules for tax-deductibility; therefore, they would be reimbursable to employees under an FSA. The Ruling contains no specific effective date. Consequently, the Ruling applies immediately (and retroactively). This leaves employers with a few issues to consider: If an employer s plan specifically excludes from reimbursement the purchase of OTC medicines and drugs, a decision will need to be made, whether or not to change the current plan provision. If the plan sponsor wants to take advantage of the opportunity to reimburse OTC medications because of Revenue Ruling 2003-102, most plans will have to be formally amended. If the plan will be changed to allow reimbursement of non-prescription drugs, employers will need to determine when the change should be made effective and how far back to permit reimbursements.
Page 5 If the plan will permit reimbursement for non-prescription drugs, the employer will need to set administrative standards for FSA reimbursements. Plans must still require claim substantiation and would also have the added burden of distinguishing OTC medications from non-reimbursable items. Plan sponsors who operate FSAs governed by Plan language authorizing reimbursements for any expense that satisfies IRS reimbursement criteria may wish to consider amending the FSA plan to exclude OTC medications or immediately begin reimbursing as provided by Revenue Ruling 2003-102. This Ruling will create an additional consideration for group plans facing increasing health care costs. It is also likely that plan sponsors offering FSAs that reimburse OTC medication expenses will now find more participants interested in using FSAs due to the fact that Revenue Ruling 2003-102 should dramatically ease participant fears about forfeiting money under the IRS use-it-or-lose-it rule. Moreover, some employers may find themselves pressured by employees to cover OTC drugs since the IRS now permits this reimbursement. Employee pressure to provide coverage of OTC drugs under HRAs, which cannot be funded by employees, would represent a direct cost to employers. FDA Issues Warning to Pharmacies Importing Canadian Prescriptions The U.S. Food and Drug Administration (FDA) has started to crack down on mail-order pharmacies importing and distributing Canadian prescription drugs. Last summer the FDA even took formal steps to shut down a mail order pharmacy chain operating in the Midwest. Drug sales are required by law to be conducted by licensed pharmacies, and importing even U.S.-made and approved drugs from outside the country for resale in the United States is illegal. In 2003, the FDA gave notice to importers and insurers who pay for imported drugs and stated that anyone aiding that practice could face legal action. The warning letter from the FDA asserted that the pharmacy chain violated federal law by facilitating the purchase of Canadian drugs, and the company was given 15 days to defend itself before the FDA took additional steps to permanently halt sales. In its warning letter, the FDA said the company not only violated federal drug-importation laws, but it lied to customers on a website that falsely claimed the drugs were approved by the FDA. During 2003 the Wall Street Journal regularly commented on this topic and published several high profile articles warning that the FDA will take a more aggressive stance against consumers who buy prescription medication outside the country. It is important to note that, although the FDA has taken steps against a drug retailer and not an employer-sponsored drug plan, the same legal principles apply to plan sponsors.
Page 6 On a related note, in 2003, the Los Angeles Times reported that Discount Drugs of Canada, one of many Internet and mail-order drug stores has been threatened with federal drug importation violations and other charges regarding their sale of prescription drugs to senior citizens and others in the United States. Although some businesses are backing away from the foreign mail-order service, AARP, the Massachusetts Council on Aging, and other groups are encouraging senior citizens to import their medications from Canada in an effort to save money. The pharmaceutical industry itself has also weighed in and has begun to restrict sales in Canada if they perceive that the pharmacies are re-selling the drugs in the United States. This has resulted in spot shortages of some drugs in Canada. Although the FDA crackdown did little to stop the practice, if shortages for Canadian become an issue, the drive for re-importation may wane. IRS Releases Guidance on Debit Card Use Many employers are considering the option of issuing debit cards to employees instead of maintaining a paper check-writing system to reimburse participants under the employer's flexible spending account or health reimbursement arrangement. The Internal Revenue Service issued Revenue Ruling 2003-43 on this question and noted that debit cards are permissible and will not violate cafeteria plan rules so long as the employer: Obtains certification from the employee that the card will only be used for eligible medical expenses that cannot or will not be reimbursed under another source, and that the card will not be used for expenses which are not eligible for reimbursement; and Has a system for verifying that each expense actually charged to the card is an eligible expense, and that a process is in place for recovering charges made for ineligible items. IRS approval of debit card use relies upon adequate plan controls that are designed to monitor certification and documentation processes to ensure that the card is used only for appropriate expenses. For example, participants who use a card must certify upon enrollment, and each plan year thereafter, that (i) they will only use the card for eligible medical expenses for themselves, their spouses, and dependents, and (ii) any expenses paid with the card have not been reimbursed (and reimbursement will not be sought under any other plan). Moreover, the IRS imposes follow-up and substantiation requirements to assure that the card is used only for medical expenses that are not otherwise covered under the medical plan. Reimbursement programs that only randomly examine claims do not meet the new IRS standard; this will immediately affect employers who have implemented a system that audits claims on a sampling basis. The IRS specifically rejected the sampling technique, characterizing it as an invalid substantiation model.
Page 7 Employers must also implement a chase program to obtain plan reimbursement for claims that are later shown to be unreimbursable. Employee repayment may be either directly or through payroll deduction or by withholding future reimbursements until the claim is repaid. Scope of Ruling The Revenue Ruling only addresses issues under Sections 105, 106, and 125 of the Code. The Ruling does not address other sections of the Code, such as Section 132 (Transportation) and Section 129 (Dependent Care Accounts). Therefore, it is not necessarily the case that it would apply to those programs. However, now that the IRS has opened the door to debit card use, it would be reasonable to believe that the Service will eventually approve debit card availability for these other benefit programs. Interestingly, the Ruling also does not specify how card fees should be addressed; however, prior guidance would strongly suggest that such fees should not be reimbursed from FSAs. The Revenue Ruling left open the possibility that employers who provide medical payment through the use of a debit card would still be required to file Form 1099. However, later in the year, the Medicare Prescription Drug Improvement and Modernization Act of 2003 included a provision which overturned the 1099 requirement. Revenue Ruling 2003-43 also did not address the question of whether debit cards can be used by COBRA participants. The IRS has informally commented that, although this may be a possibility, the IRS is more comfortable with the idea of having the card linked to employment and therefore the card would be shut off at termination. The rationale is that, by denying access to the card after termination, the employer will have more control over chasing COBRA participants for repayment of non-qualifying claims. California Pay or Play Statute Before his defeat, California Governor Gray Davis signed the controversial Senate Bill 2 requiring California employers to provide health insurance to their employees. Questions abound and will not likely dwindle for some time. Here are some answers to immediate concerns: Who is affected? Assuming a related tax credit provision is enacted by the legislature, all employers with 20 or more employees in the state of California have the potential to be covered by the new mandate. If that follow-up tax credit is not enacted, the law will only apply to employers with 50 or more employees in California. Any company with the requisite number of employees in California will be affected by the law.
Page 8 Large employers Defined in the statute as those with 200 or more employees, will be affected beginning January 1, 2006. Medium employers Defined in the statute as those with at least 50 but not more than 199 employees, will first be affected beginning January 1, 2007. Employers with at least 20 but no more than 49 employees are exempt unless the follow-up tax credit is enacted. Small employers Employers with at least two and no more than 19 employees would be exempt from the new law. Is there a way to avoid the mandate? Any employer who is part of an expanded definition of a controlled group under the Internal Revenue Code definition will be counted as a single employer for this purpose. Generally, that rule requires an 80 percent ownership share for the two entities to be considered to be in the same controlled group. New entities will be counted as a single employer if the employer owns at least 50 percent of the entity. Failure to comply If an employer fails to make the make the proper contribution to the fund, that employer will be assessed a penalty of 200 percent of the amount they would have otherwise paid. What about ERISA? Part of the controversy concerning this measure revolves around ERISA. Employee benefit laws are governed by federal law as set forth under ERISA. States are prohibited from establishing any laws that would require that employers take some benefit actions (though an exception applies to ERISA which allows states to control insurance carriers, thereby indirectly affecting employers that purchase insured policies). We anticipate litigation as employers seek to challenge the law. Although it is possible that the courts would strike down the law it is also plausible that the law will survive under the theory that the law does not directly mandate that employers offer benefits. Proponents of the law would likely argue that the law merely establishes an employer tax to apply in situations where the employer fails to volunteer to provide health benefits which are at least 80 percent subsidized. You may remember that the federal courts allowed a New York law to stand which indirectly subjected all employer group health plans to a hospital surcharge even though the surcharge amounted to a state tax directly absorbed by employer sponsored benefit plans.
Page 9 Could the law be rescinded? It is unclear what steps Governor Schwarzenegger might take to address the business community s concern. Rescinding the law would require new legislation and, unfortunately, proponents of the law control two-thirds of both houses of the California legislature. However, enough signatures were collected on petitions to put a referendum on California s November ballot (the referendum also survived a court challenge). How it would fare with the voters is not known, but many employees, especially those without coverage, are in favor of the law. What should employers do now? The law does not take affect until January 1, 2006 at the earliest, so employers have time to consider their options. In addition, there are several ambiguous provisions. Employers may want to wait to see how some of these issues are resolved before making any final decisions.
Page 10 U.S. Benefit Office Locations Benefits Brokerage & Consulting Services Rx Purchasing Coalition HR Consulting Data Analysis Benefits Administration Retirement Services Predictive Modeling Call Center Services Voluntary Benefits Consumer Driven Healthcare Legislative & Compliance International Benefits Anchorage, AK (907) 562-2266 Eugene, OR (541) 687-2222 Mobile, AL (251) 433-0441 Rochester, NH (603) 332-5800 Atlanta, GA (404) 224-5000 Florham Park, NJ (973) 410-1022 Mountain View, CA (650) 944-7000 Roswell, NM (505) 317-3397 Baltimore, MD (410) 527-1200 Ft. Worth, TX (817) 335-2115 Naples, FL (239) 514-2542 St. Louis, MO (314) 721-8400 Birmingham, AL (205) 871-3871 Greenville, SC (864) 232-9999 Nashville, TN (615) 872-3700 San Diego, CA (619) 297-7111 Boston, MA (617) 437-6900 Houston, TX (713) 625-1023 New Orleans, LA (504) 581-615 San Francisco, CA (415) 981-0600 Cary, NC (919) 459-3000 Knoxville, TN (865) 588-8101 New York, NY (212) 344-8888 Seattle, WA (206) 386-7400 Charlotte, NC (704) 376-9161 Lexington, KY (859) 223-1925 Orange County, CA (714) 953-9521 Tampa, FL (813) 281-2095 Chicago, IL (312) 621-4700 Los Angeles, CA (818) 548-7500 Orlando, FL (407) 302-4972 Washington, DC (301) 530-5050 Cleveland, OH (216) 861-9100 Louisville, KY (502) 499-1891 Philadelphia, PA (610) 964-8700 Wichita, KS (316) 264-5311 Columbus, OH (614) 766-8900 Miami, FL (305) 373-8761 Phoenix, AZ (602) 787-6000 Wilmington, DE (302) 477-9640 Dallas, TX (972) 385-9800 Milwaukee, WI (414) 271-9800 Portland, OR (503) 224-4155 Detroit, MI (248) 735-7580 Minneapolis, MN (763) 302-7100 Raleigh, NC (919) 459-3000