In This Issue w HSA Guidance Released Employer Involvement in Subrogation Claims Are Some Tuition Costs Medical Expenses? IRS: Debit Card Commentary Wanted Fake Health Insurers Feed on Small Companies Disabling the Tax on Disability Premiums Double-Dipping Still Tempts Employers Since You Asked: Georgia Use of Unique ID Numbers Issue Spotlight: Subrogation Paid Without Paying for Attorney HSA Guidance Released After a month of delays, the IRS published long awaited and highly anticipated Health Savings Account (HSA) guidance on July 23, 2004. IRS Notice 2004-50 arrived in the form of 88 Questions and Answers, and as expected, it represents the IRS most detailed information released on HSAs to date. Among the items clarified by the guidance are the following: Benefits under Employee Assistance Plans, Disease Management Plans and Wellness Programs generally do not disqualify an otherwise eligible individual from contributing to an HSA. Mistaken distributions from an HSA can be repaid to an HSA without penalty or tax. Payments by individuals due to traditional benefit limits that are part of reasonable plan designs do not count against the outof-pocket maximums. Employer matching contributions made through a cafeteria plan are not subject to the comparability requirements. Account fees paid from HSAs are nontaxable distributions; account fees paid outside of the HSA directly to trustees are not treated as contributions. Although employers have already expressed great interest in HSAs and consumer directed programs in general, we anticipate that the publicity surrounding this IRS Notice will prompt even greater numbers of employers to review their options and consider implementing HSAs. Willis Legal & Research Group (LRG) is now reviewing the IRS just released guidance and will at a future date roll out a number of different August 2004 www.willis.com
tools to assist clients who may be interested in utilizing these accounts. Among proposed forthcoming HSA materials, LRG will provide articles in our sister publication Willis EB Alert (which is available from your local Willis representative), host a series of HSA webcasts, and visit cities around the country conducting seminars that include the information on HSAs. If you would like additional information about when the seminars or webcasts will be held, please contact your local Willis office for more information. Employer Involvement in Subrogation Claims The January 2002 Supreme Court decision in the case of Great-West Life & Annuity Insurance Co. v. Knudson, upheld a plan sponsor s right to subrogation as enforceable under ERISA. On the other hand, the court noted that reimbursement claims based upon a contract theory were not enforceable under ERISA. These decisions continue to live on through other court findings. As the courts continue to struggle with subrogation concepts, plan sponsors can adopt simple strategies which may help reduce the likelihood a subrogation matter will be litigated at all. For one thing, we suggest striking the word reimbursement from any description of the plan s right to subrogation this only tends to muddy the water if the plan language were litigated in court. We suggest using the word subrogation throughout the document. We also urge employers to get involved in the subrogation claim. Among other things, you can assert a lien against the injured party or share in the costs of an attorney. This is often a good strategy because it fits subrogation s core meaning of stepping into the shoes of another. Becoming involved in the litigation shows that the plan is stepping into the shoes of the injured party to collect damages as a result of the injury. Recently, the Sixth Circuit again followed the 2002 Supreme Court decision. QualChoice, Inc. v. Rowland, 2004 U.S. App. LEXIS 9160 (Sixth Cir. 2004), involved a reimbursement clause in the employer s plan. The health plan asserted that its claim should be recognized because the employer was seeking specific settlement funds. Instead, the Sixth Circuit dismissed the lawsuit stating that the claim was not enforceable. Little or no credence was given to the health plan s weak argument that it was, in reality, enforcing the plan s subrogation right. The plan s prominent use of reimbursement language convinced the court that the true nature of the claim was not subrogation but a claim unenforceable under ERISA. The Sixth Circuit also considered that the plan could have become involved in the case against the negligent party. However, the plan failed to look like it was exercising its subrogation right. That was the ultimate downfall distinguishing a reimbursement claim from a subrogation claim no matter what terms were used to describe the plan s legal action. 2
Are Some Tuition Costs Medical Expenses? Generally, even if education affords access to some medical care, it can not be characterized as a medical expense for tax purposes. The IRS recently revisited this issue in IRS Information Letter 2004-0090 (April 29, 2004). The IRS responded to an inquiry asking if tuition for a private school that corrects learning disorders was deductible as a medical care expense. The inquiry arose over information that the IRS had provided over the telephone specifically, that the expense was not medical care because the school did not have a physician on staff. In its written response, the IRS noted that education is not normally medical care consequently, a physician must diagnose a medical condition and recommend special education to correct it in order for the education to be considered medical care. The IRS concluded that the school need not employ physicians to provide that education, but must have a curriculum designed to provide medical care. Overcoming learning disabilities must be the principal reason for attending the school, and any ordinary education received must be incidental to the special education. The response further stated that medical care includes the costs of attending a special school that helps students overcome a physical or mental handicap and move on to normal education and living. It also listed examples of qualifying expenses, such as lip-reading lessons or Braille instruction. The IRS added that medical care would not include the cost of sending a child to a school where the courses and methods have a beneficial effect on the child s attitude if the availability of medical care in the school is not the principal reason for attendance. To explain this point the IRS noted that a parent who sends a misbehaving child to military school is not doing this to overcome a mental or physical disorder but to provide discipline and ordinary education. Plan sponsors may occasionally, need to evaluate which special education expenses might qualify as medical care. However, we think that it will be a rare case where the requirements of this IRS letter are met and employers should be very cautious in this area. IRS: Debit Card Commentary Wanted The IRS has published a request for comments on the use of debit cards to provide qualified transportation benefits under Internal Revenue Code Section 132(f). In Notice 2004-46, IRS said employers have asked for clarification of their ability to use debit cards to provide these benefits which include transportation in a commuter highway vehicle (vanpooling), any transit pass, and qualified parking (collectively referred to as transit benefits ). In the notice, the IRS said it is seeking information about how debit card technology works to better answer questions about how to apply the regulations. 3
Specific questions include: Whether a debit card should be considered a voucher that may be exchanged exclusively for a transit pass; Whether, if this is the case, employers should be barred from using cash reimbursement to provide transit passes to their employees as qualified transportation benefits, even if vouchers are not otherwise readily available; Whether an employer provides an advance or a reimbursement when it provides a debit card for use in purchasing various transportation benefits; and Whether a debit card system can be established to separate amounts for different types of transit benefits to ensure that the legal monthly limit for each type of benefit is not exceeded. The IRS asked for comments by October 19, 2004. We anticipate that the IRS will receive overwhelmingly positive support that will eventually translate into formal regulatory approval for the use of debit cards in this area. Fake Health Insurers Feed on Small Companies The magazine Business Week recently published an expose on fraudulent health insurers and the havoc they are reeking over smaller employers now struggling to furnish employee health benefits. One name prominently featured in the article was Employers Mutual LLC of Carson City, Nevada. Employers Mutual has been cited for collecting premiums, but failing to pay any participant claims. Some participants are now facing tens of thousands of dollars in unpaid medical expenses for chemotherapy, radiation, and surgery. According to the DOL, Employers Mutual collected $16 million in premiums, mostly from small businesses, leaving more than $24 million in unpaid claims in less than a year. The principals were arrested May 10, after a federal grand jury charged them with ten counts of misappropriation of funds. Employers Mutual is just one of many bogus health insurance companies that have cheated smallbusiness owners. The problem is getting worse. The increase in fraud correlates with the rising cost of health insurance premiums. The article quotes Dennis Pompa, director of fraud for the Texas Department of Insurance as saying, We don t see any end in sight. Businesses seeking health insurance need to tread carefully. Above all, employers must thoroughly research any plan before signing on. Business Week notes that even a financial disclosure statement signed by a partner at a big-name accounting firm is not a guarantee the signature may be forged or the accountants may have been fooled. Some counterfeit insurers claim they are not subject to state regulation because their plans are instead in compliance with ERISA. They say this enables them to offer cheaper rates. This is not true; ERISA status is secured whenever an employer sponsors a benefit arrangement (unless the employer happens to be exempt from ERISA). Caution should also be exercised related to association programs or MEWAs. An employer required to join an association or union to participate in an attractive health insurance plan, 4
should be very wary. Phony insurance outfits have even been known to create sham professional organizations so they can collect membership dues as well as premiums. The wave of fraud connected to MEWAs and association plans has made it difficult for Congress to enact laws which would promote the ability of associations to come together for the purpose of delivering health benefit coverage. Disabling the Tax on Disability Premiums Often, when an employer pays for short term or long term disability insurance the premium payments are not included in the employee s taxable compensation. However, when an employee is injured and needs to draw benefits from the disability policy, those benefits are taxable to the employee when they are received. This is sometimes a shock for an employee, particularly at a time when he feels the need to maximize his earnings. On the other hand, if an employer pays for the disability premiums and reports that premium payment as additional taxable income to the employee, then the later receipt of the policy proceeds is tax-free for the employee. Plan sponsors may change their perspective on whether to report disability premiums as income for a variety of reasons. (Some employers frown on the idea of workers drawing a tax-free benefit because the larger payment may prolong the overall period of disability.) Employers need to be aware of the rules associated with making that change. Three-Year Look-Back Rule When an employer changes the tax status of a disability premium payment, there is a special tax calculation rule that applies when an employee receives disability benefits. The IRS says that it will look back three years from the year in which the employee becomes disabled, and the employee will be taxed on the percentage of premiums paid by the employer on a pre-tax basis for that period. A very recent IRS Revenue Ruling outlined the IRS rationale on this topic and introduced a mechanism for avoiding both the look-back calculation and resulting tax burden. Now, employers can pay for the premiums on an after-tax basis (by reporting that premium payment as income) and shield employees from tax consequences when they receive disability benefits. Facts Revenue Ruling 2004-55 addressed a situation in which an employer offered disability benefits to employees through a written plan. The employer typically paid 100 percent of the disability premiums on a pre-tax basis (by not reporting that premium payment as income) for eligible employees, but employees could instead choose to have the employer pay disability premiums on an after-tax basis (by asking the employer to report premium payment as income). If the employee chose this latter option, then the employee would receive disability benefits tax-free. The employer required employees to make an irrevocable election before the beginning of each plan year. (The IRS noted that it would be permissible for the irrevocable election for one year to continue to the next year as an evergreen election.) Additionally, new hires joining the plan mid-year would also be permitted to make irrevocable elections for the remainder of their first year in the plan. Despite the fact that the election could be changed on an annual basis, the IRS ruled that the three-year look-back rule would not apply. 5
IRS Analysis The three-year look-back rule applies to benefits that fall under Internal Revenue Code Section 105. The regulations under Section 105 provide that, if the premiums are financed partially by the employer and partially by the employee, the portion paid by the employer would cause a pro rata portion of the benefits to be taxable to the employee. In this case, where an employee chooses to have the premium paid on an after-tax basis as an irrevocable one-year decision, it is as though the premium is paid by the employee and the benefit generated by that premium is tax-free. Because of the employee s irrevocable election and a single source of premium payment, the plan would fall outside the parameters of Code Section 105 that would otherwise require the three-year look-back. What Steps to Take To implement a disability benefit plan that avoids the three-year look-back tax treatment, an employer needs to take the following steps: An employer must take proactive steps to establish a written plan and must create a legal plan document that refers to the certificate of insurance for plan specifics. The plan materials (both the plan document and the summary plan description) must contain provisions describing the irrevocability of the election for the plan year. The employer must use an election form that allows employees to make an irrevocable election concerning the payment of disability premiums. Employees must choose how to pay disability premiums before the beginning of the plan year. Double-Dipping Still Tempts Employers Double-dipping refers to allowing employees to pay on a pre-tax basis for health premiums and also reimbursing the employees with untaxed dollars for those premiums. Both steps are legal if conducted separately; used together they allow employers to illegally pocket all of employees tax savings without an employee even knowing. Although the IRS has been rooting out these illegal programs for years, new versions of double-dipping have emerged. One such program occurs when an employee is given a nontaxable, advance reimbursement for healthcare expenses at the same time pre-tax salary is taken to pay for healthcare premiums. Another such scheme, called the loan scheme, involves the establishment of a loan for an employee to pay for out-of-pocket medical costs when that employee has already paid his entire health premium amount with pre-tax dollars. The Department of Justice has already filed a lawsuit against one company that used these double-dipping schemes, and legal action against other companies is expected to follow. Employers should exercise care to avoid double-dip programs in any of their many variations. 6
Since You Asked: Georgia Use of Unique ID Numbers In recent years, the concern over identity theft and privacy issues has encompassed the treatment of social security numbers (SSNs). In reaction, California enacted a statute in 2002 that strictly controls the instances in which SSNs may be used on forms, documents, mailings to homes, and on identification cards, like health insurance cards. A FOCUS on Benefits reader had heard that there was a Georgia state statute requiring the use of unique ID numbers (not SSNs) by July 1, 2004. This new rule has not received the wide exposure that the California law generated back in 2002, but it does exist. It was created primarily out of concern for privacy of health care information, and it requires that, by July 1, health insurance ID cards be issued with unique identifiers not related to a participant s social security number. This requirement applies to all fully-insured carriers offering health, dental, and prescription drug coverage under HMOs, PPOs, or accident and sickness coverage in Georgia. The law ultimately controls the following insurers: Fraternal benefit societies Hospital service corporations Medical service corporations Health care corporations Health maintenance corporations Provider sponsored health care corporations Any entities authorized to issue contracts under the insurance laws of Georgia The plan administrator(s) of state employee health insurance plans Although the list of covered benefits is expansive, there are notable exceptions from applicability. Disability (including limited accident and sickness policies) and long term care policies are not subject to the state statute, and neither are Medicare supplement, specified disease, and hospital indemnity plans. Finally, the statute does not cover credit insurance or health insurance provided as part of workers compensation. Employers will be relieved to know that they are not directly subject to this state statute, but that the burden for complying rests solely on insurance companies providing the coverage. This is true for employers even if they offer a self-insured plan. The bottom line is that this law requires Georgia insurers to create and use plan materials and ID cards that comply with state law. Issue Spotlight: Subrogation Paid Without Paying for Attorney Subrogation issues provide fertile ground for benefit plan confusion and plan participant dissatisfaction. Often at issue in subrogation claims are the following questions: Is the plan enforcing its subrogation right or some other right that may not be enforceable? What role must the plan play in the subrogation process? These two issues were at the heart of the case of Bombardier Aerospace Employee Welfare Benefits Plan v. Ferrer, Poirot and Wansbrough, No. 03-10195 (Fifth Circuit, Dec. 17, 2003), in which the plan 7
participant was injured in an accident and resisted the employer s subrogation claim against the proceeds of the financial settlement. Bombardier s medical plan paid nearly $14,000 in medical expenses and then sought subrogation for these expenses against the $65,000 settlement. The plan participant had hired its own attorney who had pursued the settlement of any claims against the parties at fault. When the settlement funds were received, they were put into a special trust account established by the law firm on behalf of the injured person, and Bombardier claimed that the law firm was effectively holding the $65,000 settlement in trust for Bombardier. The medical plan s subrogation provision did not anticipate that the plan would share in attorney s fees, and Bombardier claimed that it should receive the full $14,000 without paying any portion of the accrued attorney s fees. The court reviewed the claims of each party and found that the Bombardier medical plan had pursued its subrogation claims through the right course of action. Additionally, the court in Bombardier agreed with the plan that its subrogation provision should be honored and that the plan should not be required to share in the cost of hiring an attorney to pursue the injured person s claim. The Supreme Court ruling on a pivotal subrogation claim asserts (see the lead article in this issue of FOCUS on Benefits) that exercising the right of subrogation would obligate the plan to take some direct action put a lien on amounts collected in a settlement, pay for an attorney, or share in attorney s fees. The Bombardier decision rested on the wording of the actual subrogation provision in the plan materials which had already been clearly communicated to the plan participant. Although the Bombardier court s decision is only binding on the Fifth Circuit and is a bit unusual, it could be considered by other Circuits facing similar issues. The Fifth Circuit includes Louisiana, Mississippi, and Texas. 8
U.S. Benefit Office Locations Anchorage, AK (907) 562-2266 Eugene, OR (541) 687-2222 Minneapolis, MN (763) 302-7100 Raleigh, NC (919) 459-3000 Atlanta, GA (404) 224-5000 Florham Park, NJ (973) 410-1022 Mobile, AL (251) 433-0441 Rochester, NH (603) 332-5800 Baltimore, MD (410) 527-1200 Ft. Worth, TX (817) 335-2115 Montgomery, AL (334) 264-8282 Roswell, NM (505) 317-3397 Bethesda, MD (301)530-5050 Greenville, SC (864) 232-9999 Mountain View, CA (650) 944-7000 St. Louis, MO (314) 721-8400 Birmingham, AL (205) 871-3871 Houston, TX (713) 625-1023 Naples, FL (239) 514-2542 San Diego, CA (858) 455-4888 Boston, MA (617) 437-6900 Jacksonville, FL (904) 355-4600 Nashville, TN (615) 872-3700 San Francisco, CA (415) 981-0600 Cary, NC (919) 459-3000 Knoxville, TN (865) 588-8101 New Orleans, LA (504) 581-6151 San Juan, PR (787) 756-5880 Charlotte, NC (704) 376-9161 Lake Mary, FL (407) 805-3005 New York, NY (212) 344-8888 Seattle, WA (206) 386-7400 Chicago, IL (312) 621-4700 Lexington, KY (859) 223-1925 Orange County, CA (714) 953-9521 Tampa, FL (813) 281-2095 Cleveland, OH (216) 861-9100 Los Angeles, CA (818) 548-7500 Philadelphia, PA (610) 964-8700 Washington, DC (301) 530-5050 Columbus, OH (614) 766-8900 Louisville, KY (502) 499-1891 Phoenix, AZ (602) 787-6000 Wilmington, DE (302) 477-9640 Dallas, TX (972) 385-9800 Miami, FL (305) 373-8761 Pittsburg, PA (412) 586-1400 Detroit, MI (248) 735-7580 Milwaukee, WI (414) 271-9800 Portland, OR (503) 224-4155 Other Willis Locations: Willis has offices in more than 20 other U.S. cities and in 73 countries around the world, with a total of 260 offices worldwide. FOCUS is produced by Legal & Research Group of Willis: willis.focusonbenefits@willis.com or 877-4WILLIS (toll-free). FOCUS is not intended to provide legal advice. Please consult your attorney regarding issues raised in this publication. Willis publications appear on the internet at: www.focusonbenefits.com. Copyright 2004 Willis 9