Welfare Plan Update

This is a brief summary of some recent welfare plan developments.

IRS Ruling on Medicare Eligibility Following COBRA-Qualifying Event of Termination of Employment/Reduction in Hours. In Revenue Ruling 2004-22, the IRS considered the situation of an employee who has coverage for himself and his spouse under the employer’s group health plan, and who then terminates employment. The former employee and his spouse are eligible to elect COBRA continuation coverage for an 18-month period, and the spouse elects the COBRA coverage. The former employee subsequently becomes entitled to Medicare benefits because he reaches age 65. The ruling generally holds that the covered employee’s Medicare entitlement is not a second qualifying event that results in an extended COBRA period for the spouse (or any dependent children) – that is, the spouse (and dependents) can get up to 18 months of coverage, but not up to 36 months. The rule would be different if the spouse (or dependents) would have lost coverage, absent the COBRA election, when the former employee became entitled to Medicare; however, only small employers not subject to the Medicare secondary-payor requirements could include such a rule in their plans.

In addition, the new rule does not change the statutory rule under COBRA, which provides that if a covered employee becomes entitled to Medicare within the 18-month period before the qualifying event of termination of employment or reduction in hours, the covered employee’s spouse and dependent children (but not the covered employee) are entitled to COBRA coverage for a maximum period that ends 36 months after the employee’s Medicare entitlement, if these persons are qualified beneficiaries. The covered employee, however, is only entitled to 18 months of COBRA continuation coverage in this situation.

Tax-Free Subsidy for Prescription Drug Coverage For Retirees. Beginning in 2006, the new Medicare Law creates a tax-free subsidy for plan sponsors that provide certain retiree prescription drug benefits. For each qualified covered retiree who elects to receive prescription drug coverage under an employer-sponsored retiree plan or a multiemployer plan instead of electing the new prescription drug coverage under Medicare, the plan sponsor will receive a taxfree subsidy of 28% of the "allowable" retiree drug costs that are between $250 and $5,000 (subject to annual increases for inflation). Although the amount of the actual subsidy will depend on the amount of actual expenditures incurred by qualified covered retirees, the maximum subsidy for 2006 would be $1,330 per retiree (e.g., 28% of ($5,000 less $250)). The subsidy is available if the drug benefit under the plan is actuarially equivalent to, or better than, the Medicare drug benefit that will begin in 2006. Each year in which the plan sponsor seeks to obtain the subsidy, the plan sponsor will have to provide the Department of Health and Human Services with an actuarial attestation that the prescription drug benefit provided by the plan is at least equal to the value of the new Medicare drug benefit.

According to a position statement released by the Financial Accounting Standards Board ("FASB"), an employer that sponsors a retiree health plan with a prescription drug benefit can adopt immediate accounting to reflect the impact of the law on the employer’s financial statements. This accounting treatment may result in a significant decrease in the retiree medical liability that an employer reflects in its current financial statements. An employer may instead choose to defer accounting for this change in law until the FASB has issued further guidance.

Health Savings Accounts ("HSA"). An HSA offers a new tax-savings opportunity for an individual covered under a high deductible health plan (an "HDHP"), who is not also covered under another health plan. An HDHP is a medical plan that has specified minimum limits for the annual deductibles and maximum limits for out of- pocket expenses. An HDHP can be structured either as an insured plan or a self-insured medical reimbursement program that is sponsored by an employer.

The HSA is a tax-exempt trust or custodial account – similar to an IRA. Contributions to the HSA may be made by the employer, employee, or both; earnings are compounded on a tax-free basis; and withdrawals are also tax-free if they are used to pay for certain medical expenses. HSAs may also be offered under a cafeteria plan and may be funded either with pre-tax salary reduction contributions or employer-provided "flexible benefit credits." Contributions to an employee’s HSA that are made by an employer are excludable from the employee’s gross income for income tax purposes and from his or her wages for employment tax (FICA and FUTA) purposes. In addition, the employer can deduct the contributions as employer-provided coverage for medical expenses under an accident or health plan for the taxable year in which the contributions are paid. Distributions from the HSA for medical expenses can be made at any time; for example, the individual need not be covered by an HDHP at the time distributions are made for the distribution to be tax-free.

Extension of Mental Health Parity Act. On December 19, 2003, President Bush signed legislation extending the existing Mental Health Parity Act (MHPA) provisions of ERISA and the Public Health Service Act until the end of 2004. The original MHPA contained a sunset provision requiring that provisions of MHPA would not apply to benefits for services furnished on or after September 30, 2001. MHPA has been amended twice before to extend the sunset date, and the new law merely extends the sunset date for MHPA. On January 23, 2004, the Department of Labor announced that it was extending the interim final rules under MHPA to December 31, 2004.

MHPA requires that annual or lifetime dollar limits for mental health benefits under a group health plan be no lower than the dollar limits for medical and surgical benefits offered by a group health plan. MHPA does not require plans to provide mental health benefits.

Coverage for Over-The-Counter Medication In A Health FSA. The IRS has ruled that expenses for over-the-counter medications may be reimbursed from a Health Flexible Spending Account ("Health FSA") under a cafeteria plan. The ruling notes that non-prescription drugs, such as antacids, allergy medicines, pain relievers, and cold medications are for medical care; thus, the cost for these drugs may be reimbursed from a Health FSA, even though only prescription drug expenses are deductible under Internal Revenue Code section 213.