With the cost of health care continually on the rise, employees may be unsure of how they will pay for health care when they retire. Not all of these costs can be covered by Medicare, but not all of them can be covered by employers either—leaving retirees to pay the rest.

Originally, Medicare was the primary insurer for the working aged (those individuals who are age 65 and older but continue to work for an employer of 20 or more employees). As the expenses of Medicare rose, Congress began to look for ways to shift the cost burden to private insurance companies.

In 1980, Congress enacted the first set of Medicare Secondary Payer provisions that transferred the responsibility of paying primary health care benefits for the working aged to private employer health plans. The laws were later refined to permit the government to recover overpayments from the person, the employer plan, the provider, any third party or “any entity that would be responsible for payment with respect to such item or service.”

Retiree and Employer Roles

Individuals who are eligible to make contributions to health savings accounts (HSAs) can use HSAs as a tax-advantaged way to save for health care costs in retirement. However, HSAs have strict contribution limits and many individuals are not eligible for HSA contributions. Thus, many individuals have no tax-efficient means to save for health care costs except through retirement plans, which aren’t designed to cover medical costs. Individuals who don’t have employer-sponsored health coverage must pay increasing amounts for medical care.

Due to having more retirees with longer life expectancies and higher health care costs, employers are reviewing and redesigning their retiree health care programs. Employers are faced with the liability for retiree health care costs, and so they are exploring options for tax-effective funding. Some employers are shifting significant health coverage costs to retirees; others have stopped sponsoring retiree health benefit programs altogether.

The Medicare Prescription Drug, Improvement and Modernization Act of 2003, which became effective in 2006, provides a nontaxable subsidy to employers that continue to maintain retiree health plans that provide prescription drug coverage. The subsidy can be excluded from an employer’s income and is equal to 28% of the allowable costs. However, the subsidy is available only for costs incurred by an individual who is eligible under an employer’s plan and who was eligible to obtain prescription drug coverage under the Medicare program but did not elect such coverage. Also, to receive the subsidy, the employer’s coverage must be creditable, which means it must be at least as generous as the Medicare prescription drug coverage.

Role of Medicare

Medicare entitles individuals who are age 65 or over and eligible for Social Security benefits to receive hospital coverage and, at an additional cost, coverage for doctor’s services, outpatient care, and other medical services. These are the two parts of Medicare, known as Part A (Hospital Insurance) and Part B (Medical Insurance). Medicare also has a prescription drug benefit (Part D).

Part A Coverage

Part A of Medicare pays for inpatient hospital care and services and covers skilled nursing home services. Inpatient care includes medically necessary nursing, drugs, diagnostic or therapeutic care, supplies, equipment, and appliances. Home health care or hospice care may also qualify for reimbursement by Medicare. Part A is subject to per-benefit period deductible and to coinsurance for each day of care beyond the sixtieth. There are limits on the number of days allowed for skilled nursing care and psychiatric hospitalization.

Part B Coverage

Part B applies to physician and professional services. Covered services include ambulance, X-ray and diagnostic tests, ambulatory surgical care, outpatient hospital care, physical and occupational therapy, durable medical equipment, and physician charges. This coverage is voluntary and costs the beneficiary a monthly premium.

Because of the deductibles and co-insurance amounts required under both Parts A and B, a large percentage of Medicare beneficiaries have some type of private supplemental health insurance to fill specific gaps in the Medicare coverage system.

As currently structured, Medicare has several significant exclusions, namely, long-term custodial care and elective care.

Medicare Part D

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 created the Medicare Part D Voluntary Prescription Drug Benefits Program. The program is the primary payer of prescription drugs for Medicare-eligible individuals who are no longer employed. A subsidy is available for low-income beneficiaries.

Medicare as Secondary Payer

For individuals who continue to work past age 65, Medicare is usually the secondary payer. For spouses 65 or older, even if the employee is under age 65, Medicare is usually the secondary payer.

Employers are required to offer employees age 65 or over the same group health plan coverage that is available to younger employees. The employee and spouse have the option of choosing to enroll in the employer plan, Medicare or both. If they choose to enroll in Medicare, the employer may not offer secondary coverage. However, if they choose to enroll in the employer’s plan, Medicare is usually the secondary plan.

This does not require employers to offer health plan coverage if they do not normally do so. However, it does mean that employers must extend the coverage to employees who work past age 65 if the employer offers a health plan.

Coordinating Retiree Benefits with Medicare

Coverage and premium costs change, yet employers do not want to absorb the full burden of the hospital, medical and prescription drug costs so long as Medicare coverage is adequate. Many employers have found that coordinating a retiree medical plan with Medicare is the least expensive way to provide coverage to retirees age 65 and over.

The three most common methods of coordinating retiree medical benefits with Medicare are the following:

  • Carve-out method—This method enables a company to limit plan liability to the difference between the amount covered by Medicare and the amount the company’s plan would normally pay;
  • Standard coordination method—This method requires the plan to pay the usual benefit, not exceeding the amount of an expense that has not been paid by Medicare – this provides the most generous net benefit of the three choices; and
  • Government or Medicare exclusion method—This method allows a plan to reduce the amount of an expense not covered by Medicare by applying the plan deductible and coinsurance amounts to determine the actual benefit payable.

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