EGWP Whitepaper (2)


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EGWP Whitepaper (2)

  1. 1. 6500 Rock Spring Drive Suite 420 Bethesda, MD 20817 Accounting for Post Retiree Healthcare White Paper By Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP, AEP Elizabeth J. Weber, JDJanuary 2011
  2. 2. ACCOUNTING FOR POST RETIREE HEALTHCAREThe regulatory frenzy surrounding healthcare and accounting have created a perfect storm. Butthis is nothing new. We are besieged with commentary that Medicare is nearly bankrupt and thenew accounting standards require transparency - mark to market and present value calculations oflong term liabilitiesi which creates havoc for tax planning and compliance. In light of the mostrecent announcements there is a ―silver lining.‖ From a planning standpoint, state and localgovernments (―SLGs‖), for profit and non-profit employers and unions can use a tool which will: CREATE an immediate cost savings to the Plan Sponsor; ROLL BACK any charge to earnings that would otherwise be booked before year end; and Provide ONGOING benefit savings over the long run reducing the Plan Sponsor’s administration costs and human resources drain.The ProblemEmployers who provide post retiree medical and/or drug coverage are faced with increasing costsand at the same time they must report the present value of the expected liability to comply withgenerally accepted accounting principles. This is true whether using Financial AccountingStandards Board (―FASB‖), International Accounting Standards Board (―IASB‖) or GovernmentAccounting Standards Board (―GASB‖) standards.The Pieces of the PuzzleEarlier this decade, in order to reduce the health care costs for retirees, legislation was passed toprovide a savings to the employer. The Retiree Drug Subsidy (―RDS‖) was established by theMedicare Prescription Drug, Improvement, and Modernization Act of 2003 (―RSS03‖) foremployers that sponsored group health plans providing prescription drug benefits to retirees.RDS03 created the Medicare Part D Program to provide prescription drug coverage to Medicareparticipants. The purpose was to encourage employers to continue offering prescription drugbenefits to their retirees as opposed to terminating their retiree prescription drug benefit plans. Ifthe employer dropped former employees they would then be forced to seek benefits throughMedicare. Additionally many of these benefits were guaranteed through the collective bargainingprocess or local law and therefore largely non modifiable.Under RDS03, employers were qualified to receive a subsidy equal to 28% of coveredprescription drug costs for their retirees. Employers were entitled to an income tax deductionupon receipt of the subsidy and were permitted to take this deduction into account whenaccounting for their retiree prescription drug expenses.The Patient Protection and Affordable Care Act (―PPACA‖) retained the Retiree Drug Subsidy,but eliminated the employer’s ability to deduct the amount of the subsidy. This change obviouslyincreased the employer’s tax liability, which increased the employer’s cost of providingprescription drug coverage to retirees. The amount by which an employer’s tax liability wasincreased is dependent on the total amount of the subsidy and the employer’s applicable corporatetax rate.2
  3. 3. While employers do not incur the higher tax liability until 2013, under financial accounting rules,(ASC 715 formerly FAS 106, Employers’ Accounting for Postretirement Benefits Other ThanPensions), employers must now include the present value of the future taxes as a current liabilitycharged against earnings.Because of the increased cost of providing retiree prescription drug coverage, employers mayconsider eliminating their retiree prescription drug benefits altogether. If an employer decides toeliminate these benefits, retirees who were previously covered by the employer’s prescriptiondrug plan would be eligible to enroll for prescription drug coverage under Medicare Part D.Although Medicare Part D has historically had a gap in coverage (referred to as ―the donut hole‖)that made the program a much more expensive option for retirees compared to coverage under anemployer’s prescription drug plan, PPACA established a system to eliminate this gap or ―donuthole.‖Essentially, before PPACA, the program provided expansive benefits for the initial $2,830 inprescription drug costs and for prescription drug costs above $6,440, but required enrollees tobear the full cost of prescription drugs within the donut hole (between $2,830 and $6,440).However, PPACA provides for enhanced Medicare Part D coverage, which progressivelynarrows this gap between 2011 and 2020, thus making Medicare Part D a more financially viablealternative to employer-provided prescription drug coverage. This enhanced Medicare Part Dcoverage provides many employers with an additional reason to consider eliminating retiree drugbenefits.By terminating its retiree drug benefits, an employer would avoid the increased tax liability andcurrent accounting hit to earnings. However, this course of action could potentially open theemployer up to legal and reputational liability.Employers should consider the probability of litigation and reputational risk when terminating aretiree drug plan. Relying on provisions of the Employee Retirement Income and Security Act of1974, as amended (―ERISA‖), lawsuits can be filed by affected unions, retirees and planparticipants. While challenges to retiree benefit changes may not be successful in instanceswhere the company has been careful to reserve the right to amend or terminate health benefits itwill no doubt have an impact on employee morale. Termination of retiree prescription drugcoverage generally would result in negative media coverage, reputational risk and employeedissatisfaction for the employer.Usual ResponsesEmployers that provide retiree prescription drug coverage (RDS) will analyze the increased futuretax liability and the current accounting charges necessary to retain retiree prescription drugcoverage, and evaluate the practical and legal risks of eliminating this benefit. Employers thatdecide to retain retiree prescription drug benefits must include the future tax liability of thesebenefits into their current and projected earnings. Employers that eliminate retiree drug benefitswill incur negative employee reaction, negative, community and press coverage and potentiallitigation in response to that decision.The RulesThe accounting guidance for postretirement benefits under ASC Codification Topic 715,Compensation - Retirement Benefits (formerly FAS 106) requires that measurements of benefitobligations be based on facts and circumstances that exist on the measurement date. The3
  4. 4. measurement of the Accumulated Post Retirement Benefit Obligation (―APBO‖) for accountingpurposes after March 23, 2010 (the effective date of PPACA) must be included for financialstatements. This requirement caused substantial confusion for employers shortly after passage ofthe new law. Additional regulatory guidance was required to clarify this matter. In ASC 715-60-35-142 through 35-143, FASB stated that employers must disclose the impact of the law on theirbenefit obligations, including any significant changes to their measurement assumptions.When a significant event occurs impacting financial liability, disclosure is required under ASC715. If the effect of the changes in the APBO is significant, it should be measured in the periodin which the legislation was signed into law (e.g., the first quarter of 2010 for a calendar year-endcompany). This would affect benefit expense for the remainder of the year and future years aswell.If the effect of the changes in the APBO is not significant, it should be reflected in the APBO atthe next measurement date (e.g., December 31 for a calendar year-end company unless asignificant event occurs before year end, such as a curtailment, that would require an interimmeasurement). When reflecting the effect of the changes in either of the above cases, the effectswould be included even if the changes are not yet effective (i.e., 2013 for the retiree health carechange).The impact on the APBO is initially recognized in a category called ―accumulated othercomprehensive income.‖ Plan changes, once adopted, should be accounted for as planamendments with the effect on the APBO accounted for as prior service cost/credit.Impact on active employee benefits. If the Act impacts the level of active employees’ health carebenefits and the cost to the employer of providing those benefits, the impact should generally berecognized in the period the related benefit cost is recognized.Benefit MandatesThe new healthcare law includes benefit mandate provisions that will modify postretirementbenefit obligations and expense. The law effects the elimination of lifetime and annual benefitmaximums, covering dependent children to age 26, and first dollar coverage for preventiveservices among other changes. The fact that the new required benefits have a delayed effectivedate does not extend time for reporting and measuring postretirement benefit obligations. It mustbe prior to the various effective dates. This is because the determination of obligations involveslong-term projections of employer provided benefits.For example the new law imposes an excise tax on the aggregate value of employer-sponsoredhealth insurance coverage for a plan participant if it exceeds a threshold amount (the so-called―Cadillac Plans‖). The excise tax is equal to 40% of the excess over the threshold. In mostcircumstances, the tax will be levied on insurers or third-party administrators (―TPAs‖), notdirectly on employers. However, these additional costs will undoubtedly be passed-through toemployers, thus increasing the net cost of providing benefits by the amount of the expected excisetax. Under the accounting rules, the additional costs employers expect to incur as a result of theexcise tax will be included in current period’s measurement of the benefit obligation, even thoughthe excise tax does not become effective until 2018 and is not levied directly on the employers,but rather reflected as an increased premium.The new law also changes the tax treatment of federal subsidies paid to sponsors of retiree healthcare plans that provide a benefit that is at least actuarially equivalent to the benefits under4
  5. 5. Medicare Part D. As a result of the new law, these subsidy payments are taxable in tax yearsbeginning after December 31, 2012. Accounting rules under ASC 740, Income Taxes, require thechange in tax law to be immediately recognized in continuing operations in the income statementin the period that includes the enactment date, the date the change is signed into law, not when therules are changed. That amount will reduce the deferred tax asset on the balance sheet with anoffsetting charge to the income statement in the period that includes the enactment date (e.g., acalendar year-end public company would record the charge in the quarter ended March 31, 2010).Different accounting for the change in tax treatment is required under IFRS, however with theconvergence of FASB and IASB there may no longer be a difference. By way of example, underMedicare Part D, retirees pay 100% of prescription drug costs once their total drug claims in theplan year reach the Initial Coverage Limit (―ICL‖, which is $2,830 in 2010), until an out-ofpocket cost limit ($4,550 in 2010) has been paid, at that point Part D provides catastrophiccoverage. The new law provides for a phased-in closing of this Part D ―donut hole‖ starting in2011, so that by 2020 the effective retiree coinsurance payment will be 25% for all covered drugs.The loss of the deduction by closing the Part D donut hole is ignored for purposes of determiningwhether an employer’s retiree prescription drug benefit is ―actuarially equivalent‖ to Part D forpurposes of determining eligibility to receive the RDS. Therefore, employers’ eligibility for theRDS is not directly affected by the closing of the donut hole.The decision to accept the requirements of recent legislation and amend the plan will have aneconomic effect on the employer. There are differences in how the deferred amounts arereflected for accounting purposes and subsequently amortized and reported on the incomestatement. Future income will differ depending on the treatment of the impact on the APBO.If the employer intends to amend its’ plan in the near future to mitigate the impact of the new lawby reducing benefits, the effects of the intended amendment should not be reflected currently.The amendment should be accounted for when it is formally adopted and communicated to planparticipants in a reasonable period of time, in line with ASC 715-60-35-21.When the law change impacts the level of active employees’ health care benefits and the cost tothe employer of providing those benefits, the impact will be recognized in the period the relatedbenefit cost is recognized. The fact that these new benefit mandates have a delayed effective datedoes not modify the requirement to report the measurement of postretirement benefit obligationscurrently. This is because the determination of obligations requires projections of employerprovided benefits over the working life expectancies of the participants. The costs and thefinancial reporting impact of these new requirements will vary from employer to employer basedon each employer’s plan provisions.These benefit changes will apply to each separate retiree medical plan. If the retiree medical planis part of the active employee plan, the new requirements will apply to it, also. If the employer isproviding a separate independent retiree plan it may avoid having the benefit mandates apply totheir retiree medical benefits by restructuring their plans so that retiree medical benefits areprovided under a stand-alone plan. In order to maintain the separateness of the plan it wouldrequire that employers obtain a separate plan number and file a separate IRS Form 5500.Another AnswerThe closing of the Part D ―donut hole‖ may provide additional incentives for exploring alternativearrangements. Such arrangements include restructuring the employer-sponsored benefit plan to5
  6. 6. ―wrap-around‖ a Part D plan, and providing coverage through a customized Part D plan offeredexclusively to retirees (such a plan is also known as an Employer Group Waiver Plan or―EGWP‖). The effect of any amendments to a plan on the APBO should be treated as priorservice cost.Employers with prescription drug benefits that are currently provided through a Part D plan or analternate arrangement similar to those described above should consider the effects of closing thePart D donut hole in measurements of postretirement benefit obligations and utilize this tool for asubstantial saving. Under the options presented by Medicare Part D, employers have severalalternatives to RDS: ―wrapping‖ their current prescription program with a Part D drug plan; developing, implementing and operating their own PDP under Medicare’s EGWP; outsourcing these activities to one of the government’s certified Medicare Part D PDP sponsors under Medicare’s EGWP, or eliminating coverage for their retirees due to rising plan costs – an obviously draconian move.For most companies, eliminating coverage is not a viable option because most want to offer theirretirees high-quality prescription drug coverage. Many are doing so by using the EGWP andoutsourcing the administration of their prescription drug benefits to pharmacy benefitsmanagement companies, vendors that have qualified with CMS, which is authorized by Medicareto administer EGWP plans.Why is that a good strategy? The waivers were designed to provide the most flexibility. Waiverssimplify plan design, communication, administration and billing. Using a CMS qualifying ThirdParty Administrator,(―TPA‖) will not only save time and money by providing the administrativerelief associated with applying for the RDS, it will also provide groups with an advantage in cashflow management over inconsistent and untimely reimbursements. The TPA will further alleviatethe Employer/Plan Sponsors HR department as the covered retirees will be serviced by the TPAand not be a drag on the Employer/Plan Sponsors resources. This partnership allows entities tofocus more on their core businesses instead of on having to administer a PDP. The bottom line?Entities will have more staff hours and more cash available to them – becoming a ―profit center‖if you will instead of a ―cost center.‖When selecting an outsourcing partner, employer groups should look for a company that canadminister their benefits and process their claims and that can also be a partner in their retireeshealth care. In addition to Prescription Drug Plans, employer groups can, through the EGWP,provide comprehensive healthcare benefits and prescription drug benefits through MedicareAdvantage Prescription Drug Plans (MA-PDs). Where the TPA can offer PDP or MedicareAdvantage Prescription Drug Plans (a Private Fee-For-Service healthcare plan with integratedprescription drug coverage) to employer or union groups using the EGWP there are additionalcost savings of up to 20%–30% annually.One advantage to MA-PD plans is that they offer groups a comprehensive and holistic strategyregarding a spectrum of healthcare needs. MA-PD plans provide for healthcare services aboveand beyond basic Medicare, including durable medical equipment and other services. Workingwith a qualified PBM will ensure employer groups find the best plan—whether it is a PDP or anMAPD—to suit their needs. Another option for coverage, known as ―wrap-around‖ coverage, iswhen an employer or plan sponsor contracts with a private Medicare PDP as a way to providesecondary coverage for individual plans. Wrap plans provide retirees with a specific Medicare6
  7. 7. Part D program and cover expenses that would not be covered under Medicare Part D PDPs, suchas coinsurance and deductible costs that are typically the responsibility of the beneficiary and gotoward the retirees True Out-of-Pocket Maximum (TrOOP). In this scenario, however, plansponsors are still involved in the logistics of Medicare Part D administrative functions and arecontinuing to work with a prescription benefit manager to administer claims for the ―wrap-around‖ coverage. A qualifying TPA will then be able to pass on the savings to theEmployer/Plan Sponsor also works with employer groups to provide this coverage. The chartbelow is an example of a sample company comparison between the retiree drug subsidy and anEGWP.7
  8. 8. 8
  9. 9. The chart below is a comparison of a RDS with an EGWP, as described in this White Papershowing the net savings.ConclusionsThe group waiver programs are applicable to all plan sponsors (for profit, not-for-profit, state andlocal governments, and Taft Hartley plans). The changes in healthcare rules and the accountingtransparency reporting rules have provided an opportunity for employers and plan sponsors toobtain better cost controls, more rapid subsidization by CMS, and reduction of human resourcecosts through electing to use employer group waiver plans. The decision by CMS to allow thesame approval process for group waivers that is utilized for retiree drug subsidies means there areover 10,000 employers that are preapproved for the program. Savings are based upon a capitationapproach rather than a percentage of reimbursement, thus it is more easily managed and there isreduced audit exposure.iFASB Initiates Projects to Improve Measurement and Disclosure of Fair Value Estimates, FASB announcement2.18.09, Proposed FASB Staff Position (FSP) FAS 107-b and APB 28-a9