Health Reform and the Changes to the Retiree Drug Subsidy

August 23, 2010

This is the second post written for Extend Health by Avalere. We asked them to take a look at the changes made by the reform legislation to the Retiree Drug Subsidy, and the potential impact to both retirees and their employer sponsors.

Health Reform and the Changes to the Retiree Drug Subsidy: Potential Implications for Seniors

The Patient Protection and Affordable Care Act (ACA) makes several changes that will affect drug coverage for retirees.  Specifically, you may have heard about changes to the Retiree Drug Subsidy (RDS) and wondered what they might mean for your company’s retiree benefits. 

The RDS was part of the Medicare Modernization Act (MMA), which Congress passed in 2003.  It is a tax-free Medicare payment to employer-sponsored plans, worth 28 percent of allowable drug costs between $310 and $6,300 for each covered retiree not enrolled in Medicare Part D in 2010.  RDS payments were excluded from the employer’s gross income for the purposes of corporate income tax, and employers were also allowed to claim a business deduction for retiree prescription drug expenses even though they also received the federal subsidy to cover a portion of those expenses. 

The ACA changes the tax treatment of the RDS beginning in 2013.  Rather than receiving both the subsidy and the tax deduction for retiree prescription drug coverage, the amount allowable as a deduction will be reduced by the amount of the federal subsidy received.  Some employers may choose to eliminate their retiree drug coverage in response to this change.  However, the impact of these changes may be limited since a significant portion of RDS-covered retirees belong to groups that are exempt from federal taxes, such as state and local governments and non-profits. 

In addition, the legislation makes changes to the Part D coverage gap that may affect retiree drug coverage.  In 2011, pharmaceutical manufacturers will be required to provide a 50 percent discount on brand-name drugs in the coverage gap. At the same time, the government is changing the structure of the standard benefits package for Part D, which will incrementally close the coverage gap by 2020. Both of these changes together mean that Part D plan enrollees will pay less for generic and brand-name drugs in the coverage gap and that the coverage gap will no longer exist is 2020.  These provisions make the Part D drug benefit a more attractive option for retirees, which could lead some employers to drop retiree drug coverage in favor of moving those beneficiaries to a stand-alone prescription drug plan.

Because the legislation does not enhance RDS payments in order to reflect these Part D benefit improvements, employers may find less reason to offer retiree coverage than they did before health reform. 

When health reform legislation passed, a number of large employers claimed that the change in tax treatment of the RDS would lead to reduced earnings.  AT&T stated it would take the largest charge against net earnings, at $1 billion.  Other companies that stated they would take charges included Caterpillar, Verizon, Boeing, and Prudential. 

The American Benefits Council is the trade group that represents employer-sponsored health plans.  The Council is currently calling for Congress to make changes to this provision, and is planning to make specific suggestions to the House Energy and Commerce Committee.  The Committee had previously scheduled a hearing and invited representatives from the companies to testify, but the companies requested that the hearing be postponed until further guidance is released.

Bottom line: Changes to the RDS in health reform legislation may lead employers without a commitment to sponsor benefits to drop or reduce the level of retiree coverage.  The creation of the Part D benefit did not lead to a sudden reduction in retiree drug coverage, in part because the RDS gave employers an incentive to maintain their coverage.  Health reform weakens this incentive, and it is possible that we could see a drop-off of coverage for retirees among private sector employers as a result. The public sector is harder to predict: the RDS change does not impact these employers directly, but other revenue-related pressures may cause them to reconsider offering retiree drug benefits as the coverage gap closes and Part D becomes more attractive.

One Response to “Health Reform and the Changes to the Retiree Drug Subsidy”

  1. Kenneth Luithle said

    Keep us informed.

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