FAS 106-2: Too little, too soon
On May 19, 2004, the Financial Accounting Standards Board ("FASB") posted Staff Position FAS 106-2. It's the FASB's most recent pronouncement on the accounting treatment of retiree medical plans under Medicare Part D for fiscal years beginning in 2004. Part D introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree healthcare plans that provide a benefit that is at least actuarially equivalent to the standard benefit defined in Part D. The staff position appears to raise more questions than it answers, though, and could lead employers to expect a 28% reduction in their prescription drug-related liabilities. Such a reduction may never materialize.
Subsidy for Standard Coverage
The 28% subsidy, set forth in section 1860D-22 of the Social Security Act, pertains to employer plans that benefit "qualifying covered retirees" under a qualified prescription drug plan. As part of the requirement for this subsidy, the sponsor of the plan must attest that the actuarial value of the drug coverage under the plan is at least equal to the actuarial value of the standard prescription drug coverage. Standard coverage is defined in 1860D-2 as coverage with an annual deductible of $250 (indexed), 25% coinsurance, and an initial coverage limit of $2,250/year (also indexed.) Annual prescription drug expenses in excess of $2,250 would be the responsibility of the individual up to the out-of-pocket threshold of $3,600 per year (also indexed.) After reaching the out-of-pocket threshold for a year, an individual would have to pay only the greater of 5% of additional costs or $2 per prescription for the remainder of the year.
In order to qualify for the subsidy, the coverage must either be exactly equal to the standard coverage or be subject to a demonstration that it has at least as great an actuarial value. It is evident that such a demonstration won't be possible until we receive more regulatory guidance.
MA-PD Definitions Lacking
But what constitutes a "qualifying covered retiree"? The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the "2003 Act") says that it means a "part D eligible individual who is not enrolled in a prescription drug plan or an MA-PD plan but is covered under a qualified retiree prescription drug plan." This is a bit confusing, but let's focus on the MA-PD reference for a moment. An MA-PD plan is a Medicare Advantage (formerly "Medicare + Choice") prescription drug plan. So if a retiree is enrolled in an MA-PD, for example, the 28% subsidy does not apply.
An employer's first step, then, might be to take a look at the list of MA-PDs to see if their retirees are covered by one of them. Unfortunately, there is no such list, to this author's knowledge. To make matters worse, the organizations which might well qualify as MA-PDs are uncertain of their own status. Nobody will have a definitive answer until the government provides further guidance at some undefined point in the future. In the meantime, since an employer may have no way of knowing whether 0% or 100% of its retirees may be "qualified covered retirees", how is the actuary to know whether to apply 0% or 100% (or any percentage in between) to the 28% subsidy?
Rx as a Percent of the Total Premium
That's not the only complexity, by far. For healthcare plans that charge one premium for medical and Rx coverage combined, the actuary must also make an assessment as to what percent of the total premium pertains to Rx. But again, we're trying to hit a moving target here because even if we knew the exact percentage of the premium that pertains to Rx, based on historical data, the historical data will not be an accurate predictor of Rx costs once the various provisions of Medicare Part D take effect. The FASB acknowledges this difficulty in FAS 106-2, but offer no suggestions as to how to resolve it.
Also, even if we had all the answers to the above questions, there still would be a huge challenge in determining a reasonable percentage to apply to the subsidy. The 28% does not apply to the entire Rx cost of the qualifying retiree - it applies to that portion in excess of $250 but not in excess of $5,000 per year - and these are actual costs, not expected costs. Of course, an actuary may make an assumption as to the actual qualifying costs, but what data to base it on? This type of data will require either a seriatim approach, examining each individual's Rx costs for the year, or perhaps be made available via some sort of standard report from either the TPA or the insurer. Would the 28% translate to 25%, or 22%, or some lower number? Nobody knows for sure, but the actuarial community's initial guess seems to be 25%. My own belief is that it may prove to be somewhat smaller.
Second Subsidy - To plans providing Prescription Drug coverage
Up until now, we've only talked about one small aspect of the 2003 Act - section 1860D-22. There's another subsidy under section 1860D-15 that will be paid directly from the government to the insurers and/or plan sponsors of qualified prescription drug coverage. The purpose of this subsidy is "to reduce premium levels applicable to qualified prescription drug coverage for part D eligible individuals consistent with an overall subsidy level of 74.5% for basic prescription drug coverage, to reduce adverse selection among prescription drug plans and MA-PD plans, and to promote participation of PDP sponsors under this part and MA organizations under part C." Thus, it is an attempt to establish a level playing field between insured and self-insured plans. Insurers and MA-PDs are expected to pass the savings on to subscribers and employer sponsors of group plans that cover Medicare-eligible retirees.
Preliminary indications from the expected recipients of this 1860D-15 subsidy payment, for example the large Medicare HMOs, are that there will be no immediate reduction in rates to reflect the subsidy. Ironically, this is what the Congressional opponents of the 2003 Act had predicted would happen. Cynics are saying that employers will never see a reduction, just smaller rate increases than we would have otherwise had. Now here's where it helps to have an actuary on your side, because an actuary will tell you that the difference between a reduction and a smaller-than-expected increase is one of semantics only.
Once we have a better idea of how to value the 1860D-15 subsidy, we can help our clients to reduce their liabilities. We have the same problem here that we have with 1860D-22, though: we won't know which insurers or plans will be eligible for this subsidy until we get further guidance.
Conclusion
To summarize, then, in our opinion it is extremely premature to modify FAS 106 disclosures to reflect the 2003 Act. Any such modifications should be conservative, gradual steps, because of the many uncertainties that now surround the implementation of the 2003 Act.
