In This Issue
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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.
December 2002
www.willis.com
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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.
The 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 enforcement
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 foreign drugs despite legal concerns
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.
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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:
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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.
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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.
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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.
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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 “doubledipping” 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.
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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 fingerpointing 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 online 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 line versus debit card
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).
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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.
Some employers have expressed concern that a credit card program might be abused by workers and
might promote new employee debt. For example, in an FSA scenario, an employee’s being reimbursed in
full (shortly after incurring the expense) could tempt a worker into frivolously spending the
reimbursement rather than paying off the card when the bill comes due. Other workers may be inclined to
pay off the balance of the medical expense credit card over time at the typically expensive credit card
interest rates. (Although in the Capital One business models, medical expenses would receive a more
favorable interest rate than for financing other types of credit expenses.) While this option does avoid
some of the potential issues with debit cards there are still issues that employers should consider carefully.
Since You Asked — Loss of Medicaid Enrollment Trigger
HIPAA requires that group health plans provide a special enrollment opportunity to certain employees
and dependents when they lose other health coverage. Questions sometimes arise about what kind of
coverage must be lost in order to trigger a special enrollment. One of the more difficult questions is
whether loss of Medicaid coverage triggers a special enrollment.
The question is difficult because, while the proposed regulations do not state that Medicaid counts as
"other coverage" for this purpose, the convoluted wording does not say that it does not count as other
coverage. We recently discussed this issue with a contact at the Department of Labor. After consulting
with her colleagues at the Center for Medicare and Medicaid Services, she gave us the following reply.
The DOL representative indicated that loss of Medicaid coverage is not generally a special enrollment
trigger. If, however, the Medicaid coverage is provided through an HMO or other private issuer, the loss
of that coverage does trigger a special enrollment. The central issue is whether a “health insurance issuer”
provides the coverage that was lost. If the Medicaid coverage is purely the traditional program under
which the state is simply the payer — then no health insurance issuer is involved, so loss of the coverage
does not trigger a special enrollment.
Although the rules are even less clear in the Medicare context, this government representative hinted that
the same rationale would apply to Medicare coverage. For those who elect to have their Medicare
coverage provided through an HMO, loss of that coverage will trigger a special enrollment right. For
those who choose traditional Medicare coverage, with the government acting as payer through various
intermediaries, loss of Medicare will not trigger a special enrollment.
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The main question for employers and insurers obviously is how they can determine whether the Medicare
or Medicaid coverage that has been lost is the type that counts as other coverage for purposes of the
special enrollment rules. Unfortunately this difficult task will likely become even trickier as the federal
and state governments continue to implement various risk-sharing and administration arrangements in
hopes of lowering Medicare and Medicaid costs.
Since You Asked — Initial COBRA Notice to Spouse
A FOCUS on Benefits reader contacted us asking; when new employees join the health plan, is the
employer required to mail an initial COBRA notice to the spouse as well, or is giving a notice to the
employee sufficient?
An initial notice provided only to a covered employee would not be considered sufficient notice to a
covered spouse and/or dependent. Meaningful notice must be provided, at a minimum, by first class mail
addressed in the name of both the employee and spouse. Many employers take the extra step of mailing
separate notices to each person and documenting the mailing with a proof of mailing certificate or
something similar.
Problems arise if the initial notice is handled differently. For example, the notice would be especially
weak if hand delivered to the employee at the job site. In addition, an HR manager’s simply counseling a
worker to “share the information at home” is not considered meaningful notice to dependents because
they are equally entitled to COBRA information, and instructing a worker to tell others about the notice is
considered inadequate. Providing the notice only to the covered employee will likely also raise serious
doubts about an employer’s ability to enforce incoming notice requirements such as when a dependent
loses eligibility for plan coverage due to age, or when a divorce occurs. Employers must correctly handle
the initial COBRA notice requirement if they hope to head off potential problems.
The Department of Labor (DOL) has addressed this issue in formal guidance. The DOL says that one
COBRA notice, addressed to both the covered employee and spouse would comply with COBRA’s notice
requirements (ERISA Technical Release 86-2). The notice should be sent to the last known mailing
address. However, if for some reason the employee and spouse live at separate addresses, separate firstclass mailings should be made.
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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 National Benefits Resource of 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  2002 Willis
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