CMS, the federal agency responsible for implementing recent legislation instituting new prescription drug coverage for Medicare beneficiaries, has issued final guidance that fills in many of the holes from the proposed regulation published last August. In most cases, the agency has shown considerable flexibility, particularly with respect to its rules regarding employers with retiree health coverage that wish to receive the new government-provided subsidy. Although some questions remain, employers that sponsor retiree drug plans now have most of the tools they need to determine how this new benefit may best be integrated with their existing coverage. With the benefit set to start in 2006, steps to implement the desired course of action must commence in the very near future.

This Alert updates the previous material sent to you following publication of the proposed Medicare regulation last August.


Background

On December 8, 2003, President Bush signed into law the “Medicare Prescription Drug, Improvement, and Modernization Act of 2003.” This legislation for the first time adds a prescription drug benefit to Medicare, starting in 2006, as a new “Part D.”

The new standard Part D benefit: Under this law, individuals eligible for Medicare may choose to enroll in a standard plan offering this new drug benefit at an estimated cost of $37 per month in 2006. The standard Part D plan provides benefits as follows: after a $250 deductible, the Medicare beneficiary will pay 25%, and Medicare will pay 75%, of the next $2,000 of his or her prescription drug costs. After that, the Medicare beneficiary will pay for all of his or her drug costs until these costs reach $5,100. (At this catastrophic level, the Medicare beneficiary will have incurred $3,600 in out-of-pocket expenses.) After reaching the catastrophic level, Medicare beneficiaries generally will pay only 5%, and Medicare will pay 95%, of additional drug costs in that year. These dollar breakpoints will be indexed starting in 2007.

Access: This new drug benefit will be made available through at least two prescription drug plans (PDPs) and/or Medicare Advantage plans with a pharmacy contract (MA-PD) in each of the designated service regions of the country (34 for PDPs, 26 for MA-PDs). The PDPs or MA-PDs may offer the standard plan design described above, a different design that is actuarially equivalent to the standard plan design, and enhanced benefits over and above the standard plan design. There will be variations in formularies and plan designs that will require Medicare-eligible individuals to review their regional options and consider their different choices.

The employer perspective: Employers that sponsor health coverage for their retirees should find some of their drug costs alleviated as a result of this legislation but will need to analyze how to accommodate these changes in their medical plans. Some will choose to take advantage of a provision in the legislation that grants a tax-free subsidy to employers whose retiree drug coverage is equivalent to the new Medicare Part D benefit. The legislation also specifies several other options available to employers who do not wish to take advantage of this subsidy but, instead, wish to supplement or enhance the new Part D drug benefit available to their retirees. Employers are not locked into their selection of a particular option and may, in fact, change from one year to the next. It is also possible to choose one option for a particular set of retirees and another option for retirees who have a different benefit arrangement under the plan.


Creditable Coverage Notice

Regardless of which avenue they choose to incorporate the Part D benefit into their drug coverage for 2006, all employers that sponsor retiree health coverage will need to comply with a new notification requirement to inform their Medicare-eligible individuals whether or not the employer’s plan is considered “creditable coverage.” (Medicare-eligible individuals who do not have creditable coverage for a specified period of time and who are not enrolled in a Medicare Part D plan are subject to a ”late” penalty if they subsequently sign up for a Part D benefit.) Employers that sponsor drug plans for their active employees that cover “Part D eligible” individuals, as described below, will also be required to provide this notice.

Test for creditable coverage: For this purpose, coverage is “creditable” if the actuarial value equals or exceeds the actuarial value of the Part D benefit. This is primarily a test based on whether paid claims for a year under the employer’s plan are at least comparable to the paid claims under standard Medicare drug coverage; whether the premiums are paid by the employer or the retiree is not relevant.

Eligibility: The notification requirement applies to all “Part D eligible” individuals. For this purpose, an individual generally is “Part D eligible” if he or she is entitled to Medicare benefits under Part A or enrolled in Medicare Part B and lives in the service area of a Part D plan. Thus, this definition will encompass disabled individuals younger than 65 as well as other Medicare-eligible retirees and dependents.

Timing: Notice of creditable coverage must be provided for four events. (The guidance does not spell out a time limit for the notice, only that it be provided beforehand or upon request.) These four events are:

  1. prior to the initial enrollment period for the new Part D benefit. This initial enrollment period generally runs from November 15, 2005 through May 15, 2006.
  2. prior to the effective date of enrollment in the sponsor’s plan and upon any change that affects whether or not the employer’s coverage is considered creditable.
  3. prior to the annual Medicare Part D enrollment periods. After the initial enrollment period for the 2006 year, these annual enrollments will run from November 15th through December 31st for coverage beginning in the following calendar year.
  4. at the request of the individual.

Realistically, the first notice should go out by September 30, once the plan’s actuary has determined whether an employer’s plan is actuarially equivalent to the standard Part D benefit.

Content of notice: The new guidance is fairly cursory with respect to what must be provided in the notice, although CMS indicates that they will furnish a model disclosure notice at a later date. The essence of the notice is to inform the individual whether the employer’s coverage is creditable. If not, the notice must explain that there are limitations on when an individual may sign up for the Part D benefit and, further, that the “late” penalties apply if the individual wishes to enroll in the Part D benefit after a period of not having creditable service.


Options Available to Employers with Retiree Health Coverage

As a result of the Medicare drug legislation, employers have several options to maximize the cost and efficiency of their retiree drug coverage. (Note that employers are not locked into a specific option because of any previous accounting decisions made for FAS 106 purposes.) In general, employers that decide to continue to provide retiree drug coverage have the following options:
  1. apply to receive a subsidy from the government for employer-provided coverage that meets the actuarial equivalence test described below.
  2. with Medicare as the primary payer, coordinate (or “wrap”) the employer’s coverage around the new Part D benefit.
  3. create an employer-specific prescription drug plan or a Medicare Advantage Plan (which will require waivers of certain requirements by CMS.)

Although the remainder of this Alert will be devoted primarily to the subsidy option, one issue in particular deserves further attention, as it potentially will affect employers that select any of these three options. This is the issue involving “true out-of-pocket” (TrOOP) costs, as described below.

TrOOP costs: As discussed above, the Medicare Part D benefit provides significant federal cost sharing for the first $2,250 of covered retiree drug costs. After $2,250 of claims, however, the government does not pay any amounts until the individual incurs $3,600 of drug costs for a year—the infamous “doughnut hole.” After that point, the government again picks up the tab and pays 95% of claims over this catastrophic limit. The issue for employers, however, is that only costs paid by the individual (with some exceptions for family members, charities, and state pharmacy assistance programs) count toward the $3,600; claims paid by an employer’s retiree health plan, for instance, do not count. (For this purpose, contributions from flexible spending accounts and health savings accounts—but not health reimbursement accounts—count as a payment by the individual.) As a result, supplemental or wrap-around coverage by the employer can be considered inefficient because payment by the employer delays, or may preclude, the governmental catastrophic coverage from kicking in. Employers that choose to provide supplemental drug coverage from a vendor separate from the base PDP or MA-PD may also face significant administrative challenges with respect to tracking and reporting drug claims within the doughnut hole, depending on how—and when—CMS implements a tracking mechanism.

The subsidy option: Under this option, employers that sponsor retiree health coverage that satisfies an actuarial equivalence test may apply to receive a tax-free subsidy of 28% of a covered retiree’s incurred drug claims (net of administrative costs, rebates, and other discounts) between $250 and $5,000. (Like the other breakpoints described above, these dollar amounts will be indexed after 2006.) The subsidy is paid for these claims, regardless of whether they are deemed to be paid by the employer or the individual. No subsidy may be paid, however, on behalf of retirees (or their spouses or dependents) who choose to enroll in Medicare Part D.

The application: To be eligible for the subsidy, an employer must file an application with CMS no later than 90 days prior to the beginning of the plan year (unless an extension is granted). In addition to the employer’s identifying and contact information, the application must list all Medicare-eligible individuals who will be covered by the employer’s drug plan. This list must include the individual’s name, the health insurance claim number (HIC) or social security number, date of birth, gender, and relationship to the retired employee. (This information may be satisfied by entering into a voluntary data-sharing agreement with CMS.) The application must also include an actuarial attestation that the employer’s drug coverage meets the actuarial equivalence test, as described below.

The actuarial equivalence test: The point of this test is to show that the overall value of the retiree drug coverage under the employer’s plan is at least equal to the benefit the retiree would receive by enrolling in the Part D plan, net of the premiums paid by the retiree. Thus, under the test, known as the “two-prong” test, the employer first must determine whether the expected amount of paid claims for retirees under its plan is at least equal to the expected amount of paid claims for the same beneficiaries under Part D standard coverage. (This is referred to as the “gross value” test.) Under the second prong, the “net value” test, the gross value for the employer’s coverage and for Part D coverage are both reduced by expected retiree premiums and then compared. (For employers that charge a single integrated premium for medical and drug coverage, the premium may be allocated between the two types of coverage under any method determined by the sponsor or plan actuary.) In addition, the net value of Part D coverage may be reduced to reflect additional benefits provided by the employer. (As mentioned above, TrOOP costs paid by an employer raise the level at which the government’s catastrophic coverage commences and, thus, reduce the value of the Part D coverage.) If the net value of the employer’s plan is less than the net value of the Medicare plan, the employer plan fails the test and is not actuarially equivalent.

The plan: The final CMS regulation offers a fair amount of flexibility in applying the actuarial equivalence test when the employer’s “plan” covers groups of retirees with different benefit options (including different benefit designs, categories of benefits, or cost-sharing arrangements). Under the new rules, the “net value” prong of the actuarial equivalence test may be applied either to the plan as a whole or to benefit options within a plan. The net value test may only be applied to a plan in the aggregate, however, if each benefit option in the plan qualifies as “creditable coverage” (described above). If the plan as a whole does not pass this test, then the net value test must be applied to each separate benefit option; benefit options within the plan that meet the “creditable coverage” test may be aggregated for this purpose. (Thus, this requirement will insure that all groupings of retirees on behalf of whom a subsidy is sought will have creditable coverage.)

Payment methodology: Employers may choose to apply for subsidy payments from CMS on a monthly, quarterly, or annual basis. For purposes of monthly or quarterly payments, employers (or their vendors) would submit gross drug costs and an estimate of expected rebates and other discounts. These amounts would then be trued up (or down) by a date no later than 15 months after the end of the plan year. Employers could also take a similar annual approach or utilize a one-payment annual approach whereby actual net costs are submitted within 15 months of the end of the plan year.

Data: For purposes of the final reconciliation payment, employers (or their vendors) must submit total gross cost data segregated by retiree, with rebates and discounts and other information required by CMS within 15 months after the end of the plan year. Where rebates or discounts are not assigned to individual retirees, the sponsor may assign them using reasonable actuarial principles.

Regardless of the payment option chosen, employers will be required to provide CMS with monthly enrollment information, either full file downloads or additions and deletions. CMS will provide more guidance on this requirement soon.


What to Do Now

Employers that have not yet concluded whether to apply for the government subsidy of their retiree health coverage or to select one of the other paths to reflect the new Part D benefit will want to move ahead quickly with this initial assessment in order to insure that administrative functions and communications strategies are fully in place before the benefit commences in 2006. Depending upon the approach selected, many steps will need to have been completed well in advance of next year.

Initial review: As part of this initial review, employers will want to examine relevant documents to determine what types of plans they have, what different benefit options, structures, arrangements, or cost sharing are present within these plans, and which retirees these cover. Particular attention should be paid to which spouses and dependents of retirees are Medicare-eligible; disabled employees who are Medicare-eligible should not be overlooked. Legal and other constraints (including collective bargaining considerations) that might impede an employer’s ability to implement a plan redesign should also be considered. Although, as noted above, employers are not bound by previous decisions made for FAS 106 accounting purposes, the financial accounting implications of different plan designs should also be taken into account.

Communications strategy: Regardless of which option is chosen, developing an effective communications strategy for retirees and dependents will be paramount. All Medicare-eligible plan participants will need to receive a notice of creditable coverage in the Fall. In addition, many retirees will hear about the new Medicare drug benefit from other sources, and confusion about the new benefit (and concern over its impact) will be rampant. Employers will want to be proactive in explaining to plan participants how the new Part D benefit will affect their current retiree drug coverage.

Significant issues: The choice of a particular approach to take into account the new Part D benefit will, of course, depend on a host of elements that are unique to each option and will vary from employer to employer. Some of the more significant issues to consider with respect to the subsidy approach and the coordination of benefits option are highlighted below. (CMS has not yet provided sufficient information on the waiver process to provide comparable information on the option whereby an employer becomes a PDP or MA-PD plan.)

The subsidy option:

    • Does the plan pass the actuarial equivalence test?
    • Can a more efficient result be achieved if the plan is broken down by different benefit options or arrangements?
    • The subsidy application, at least in part, must generally be submitted by September 30, 2005. Extensive census data, including HIC numbers, must accompany this application. How will this census data be gathered?
    • Will the subsidy payments be requested of CMS on a monthly, quarterly, or annual basis?
    • Are the employer’s current vendors capable of supporting new responsibilities with respect to submitting claims, substantiating claims data, reporting, and record retention?
    • CMS will require that Medicare-eligible enrollment data be updated monthly. How will this be accomplished?
    • How will the employer’s internal administrative functions cope with these new challenges?
    • What strategy will be adopted for participant enrollment (or non-enrollment) in Part D?

The coordination of benefits option:

    • How will the new benefit be designed and delivered? (Some employers will wish to think of shifting to coinsurance rather than co-payments to better coordinate with standard Part D.)
    • Will the employer’s existing vendor (if there is one) become a PDP?
    • Will the chosen PDP cover retirees in different parts of the country?
    • How will the chosen PDP’s formulary compare to the employer’s current formulary?
    • How will claims be tracked for TrOOP purposes?
    • What strategy will be adopted for participant enrollment (or non-enrollment) in Part D?
    • How will the plan treat non-Medicare-eligible participants (retirees, spouses, and dependents) who are not eligible to receive the Part D benefit?