In This Issue

· Group Term Life Insurance Tax Issues

· Imported Drugs — Still Illegal

· New Rules for Generic Medicine

· IRS Planning Various Health Projects

· Medical Cost Inflation — Who’s to Blame?

· Health Care On Credit?

· Since You Asked — Loss of Medicaid Enrollment Trigger

· Since You Asked — Initial COBRA Notice to Spouse

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Group Term Life Insurance Tax Issues

Internal Revenue Code (IRC) Section 79 generally allows an employer to provide each of its employees up to $50,000 in tax-free term life insurance coverage. The cost of the first $50,000 in employer-provided group term life insurance coverage is excludable from the employee’s income. Without the protections of Section 79, employees would pay federal income tax on the cost of this life insurance coverage.

Under IRC Section 79, employees are taxed on the cost of group term life insurance coverage amounts in excess of $50,000, to the extent that the cost exceeds their employee contributions. “Cost” for this purpose generally is not based on the rate the employer pays for the coverage, but on the Table I rates set by the IRS. These Table I rates appear in IRS regulations, and the IRS cannot revise them without issuing new regulations.

If your group plan provides life insurance coverage over $50,000 for any employee, or uses a plan design that discriminates in favor of officers or owners, you will need to address IRS Section 79 requirements and calculate the value of life insurance received by employees for purposes of imputing that cost into forth-coming W-2 wage statements. If you have questions or concerns about these rules, please contact your Willis advisor.

Imported Drugs — Still Illegal

Reacting to ever-increasing prescription costs, employers and employees continually search for ways to control drug spending. Foreign mail-order pharmacies, seizing this opportunity, have intensified their marketing efforts and are hoping to build a U.S. client base. In the heat of the marketing battle, partial truths abound and many employers are examining the viability of a foreign mail-order pharmacy program.

T he law

The Food and Drug Administration (FDA) prohibits the importation of drugs unless a U.S. drug maker is the importer. However, in limited situations and under a doctor’s order, a patient may import a 90-day supply of a drug that is not approved for sale in the United States.

Reportedly, some foreign pharmacies, have told American consumers that a new federal law (the “Medicine Equity and Drug Safety Act”) allows prescription drugs from other countries to be sold to Americans. This new law contained a special provision which allows the Department of Health and Human Services to delay implementation under certain circumstances. Asserting authority under this rule, the Act has not taken effect because the Secretary of Health and Human Services is concerned about the safety of the foreign drugs. Consequently, no laws exist to permit consumers to purchase their prescriptions outside of the U.S.

Law e nforcement

The FDA does not rigorously enforce its position on the importation of foreign drugs and this has led consumers to believe that they are not breaking the law when they purchase drugs from other countries. Although it is technically illegal for employees to purchase and import drugs from outside the U.S., it is not illegal for an employer plan to reimburse the purchase price of the imported drugs. Nevertheless, if an employee is caught, confiscation of the prescription drugs is the likely penalty from the FDA.

Popularity of f oreign d rugs d espite l egal c oncerns

High profile Wall Street Journal articles outline the illegality and popularity of people obtaining prescription drugs from other countries. Another source describes how one Arizona senior center sponsors weekly day-trip bus rides to and from Mexico, where 200 senior citizens make drug purchases. The AARP reports that up to half of Tucson’s 50,000 retirees make trips to Mexico at least once a month to purchase prescription drugs.

The Wall Street Journal notes that a Texas claims processor, SPC Global Technologies, offered employees of its clients ready access to drugs from Canada. In response, an FDA official said that employees who participate in such a drug purchase arrangement are violating of the law. Further, the article suggests that nothing in current law prevents claims processors and employers from offering the availability of the cheaper Canadian drugs (since only the employees are technically violating the law). We believe that to be an aggressive and risky position. To the extent any reimbursement to employees for drugs purchased outside the U.S. generates tax advantages for the employer, the employer’s involvement in the arrangement may be problematic. In addition, as an ERISA fiduciary, the plan sponsor has a duty to ensure that all aspects of the plan are administered in accordance with all applicable law.

Beyond the legal issues that an employee may face and the possible seizure of the imported prescriptions, employees should be cautious concerning their health. The FDA cannot regulate the drugs sold in other countries and cautions Americans that it cannot guarantee the safety and testing of foreign drugs. This consideration might become especially critical if drugs are purchased from Mexico due to the weaker inspections systems currently in place. There have been documented cases where Americans have been sold “equivalents” that did not measure up to U.S. drugs, and in some cases consumers have bought counterfeit prescription drugs.

New Rules for Generic Medicine

Amidst frustration and criticism against the brand-name pharmaceutical companies, President Bush announced a proposal to help lower prescription drug cost. The Washington Post reports that the plan could take effect within the next several months and could shave over $3 billion dollars a year off the nation’s rapidly escalating expenditures on prescription drugs. According to the Post, with pharmaceutical prices growing by nearly 20 percent a year the availability of generic drugs has become a prime political topic.

The proposal is divided into three key provisions:

· The first provision addresses the exploitation of current rules that enable brand-name companies a 30-month stay whenever a generic manufacturer challenges their patent. Limiting them to just one stay would still give the FDA time to determine whether a generic should be allowed into the market and while preventing a brand-name company from obtaining repeated 30-month stays which could block competition for years.

· The second proposed change would make it difficult for brand-name companies to file frivolous new patents on existing drugs. Under the proposal, brand-name companies will not be allowed to pursue new patents to cover new packaging of old medicine, different ingredients added to the medicine, or different forms of the same drugs. The proposal would allow brand-name companies to continue receiving patents for new uses of drugs, which will continue to encourage further research into beneficial therapies.

· The final aspect of the proposal would require enhanced disclosure in the patent application process. The more detailed patent information is designed to help distinguish products and prevent drug manufacturers from benefiting from overly broad patent protections that sometimes “chill” the arrival of new products.

Notably absent from the Bush proposal is a provision in the Senate bill that the White House resisted which would give the generic drug companies the ability to litigate if they believe that a brand-named company is filing a new patent solely to prevent competition.

IRS Planning Various Health Projects

According to BNA’s industry publication, the Daily Tax Report, the IRS is planning to refine guidance on health reimbursement arrangements (HRAs) — specifically to strengthen prohibitions in a “double-dipping” revenue ruling and to consolidate regulations governing cafeteria plans.

Early this year, the IRS published Revenue Ruling 2002-3, which held that exclusions from gross income for medical care under tax code Section 105(b) and employer-provided care under accident and health plans under Section 106(a) do not apply to amounts reimbursed to employees for health coverage paid by employers and already excluded under Section 106(a). This ruling effectively eliminated double dipping programs that had sprung up around the country and would purport to deliver employers enhanced tax savings.

According to Harry Beker, Health & Welfare Branch Chief, IRS Office of Associate Chief Counsel, the IRS plans to publish supplemental guidance in the near future on two variations of the revenue ruling that continue to be peddled around the country and, in IRS’ view, are “not going to work.” The first involves loans to employees to cover future medical expenses. Under this concept, the actual medical expense cost is deducted from the loan amount with the difference forgiven and applied at the end of the year to the worker’s Form W-2. (A loan that is forgiven is includable in the employee’s taxable income.) The second concept is similar and involves an advance reimbursement approach — but is being promoted by benefit industry marketers as “legally viable” because it calls upon the employer to establish a cafeteria plan for future medical expenses with excess amounts applied to the Form W-2 and taxed. The lure of this concept is doubtful since it would seem that the taxable income obviates the entire arrangement.

Beker also said the IRS was looking to deal with the question of COBRA commencement when a spouse is dropped from a health insurance policy in anticipation of divorce. The “anticipation of divorce” rules are relatively clear — the spouse is entitled to COBRA. The problem is that employers have no way to know why a spouse is being dropped until after the fact and that can cause compliance problems under the COBRA notice rules. Finally, Becker noted that the IRS also plans to address debit cards in response to broad interest in using them in connection with flexible spending accounts (FSAs) and health reimbursement arrangements (see the related FSA article in this issue of FOCUS).

Medical Cost Inflation — Who ’ s to Blame?

The BlueCross BlueShield Association commissioned a study that found, not surprisingly, that several components were to blame for the lion’s share of the rising costs. The costs of new medical technologies that raise costs but do not provide improved outcomes and hospital consolidation were the largest factors. Interestingly, one part of the study indicates that over 50 percent of the cost drivers are general price inflation and economic and demographic trends.

No sooner had these results been published than they were attacked by various groups associated with the provision of medical services.

The American Hospital Association (AHA) attacked the findings and charged that they were distorted and had used questionable methodologies. The AHA claimed that hospital inpatient costs rose much more slowly than other industry costs in the last few years and that insurance industry profits were rising while one-third of hospitals were losing money, and finally, that new medical technologies were demanded by patients and consumers. The AHA also felt that consolidation within the insurance industry needed to be studied for its affects on the total cost increases. The Advanced Medical Technology Association (ADVAMED) indicated that its own studies showed net positive effects from new medical technology and also pointed out the “robust” profits being reported by the Blues in the prior year.

As we have reported, there are a number of different cost drivers affecting current trends. All the finger-pointing in the world cannot change some of the factors driving health care cost increases. For example, an aging workforce is a major issue; as the workforce gets older; it demands more and better medical services. Other underlying demographic and economic factors can be equally difficult to overcome. Some new thinking is on the horizon but a multi-solution approach is needed to restrain this growing problem.

Health Care On Credit?

As employers continue to wrestle health care expenses, one innovative company is marketing a product that may help employers regain some control. The idea was favorably profiled in a recent issue of the on-line publication Bizjournals.com; however, employers will want to tread carefully before adopting the touted approach. The idea offers a new twist on a concept that has raised IRS eyebrows in the past, and may create long-term problems for some employees.

Capital One credit card company plans to offer $100 million of credit to certain Texas employees who use a credit card to pay for out-of-pocket medical expenses. The program essentially allows employees to charge their medical expenses on a Capital One MasterCard which is reserved for health care expenses. Under the concept an employee may choose to pay the full balance when due or finance the charged amount over a longer period of time.

This idea presents some issues for employers to consider. Each employee’s credit line would exist outside of his/her medical flexible spending account (FSA) or health reimbursement arrangement. What is being suggested is merely a different “employee friendly” payment mechanism. Essentially, an employer urging the use of the health care MasterCard would be encouraging employees to incur new debt.

Credit l ine v ersus d ebit c ard

In the past, several companies have suggested that a debit card could be attached directly to an FSA and that out-of-pocket medical expenses could be paid via the debit card. The IRS, however, has expressed concerns with this approach because of the difficulty in obtaining claim substantiation for a particular FSA expense after the debit card has already been charged (and the claim paid by the debit card).

Complications connected with the debit card/FSA concept do not appear to exist with the Capital One MasterCard approach since, by using the MasterCard, employees are merely financing a medical service, rather than having payment for that medical service come directly out of an FSA. By using a credit card to pay medical expenses, a worker could later submit all of the required documentation for FSA reimbursement. By proceeding in such manner, the employee would still be subject to the FSA documentation requirements, but would be provided with more options for extending the payment schedule for incurred medical claims. In addition, for employers using an HRA program which might choose to make the employee liable for the first $1000 (or some larger amount) of medical expenses before being entitled to tap into the HRA, this concept offers a way for employees to finance their share of the costs.