Health reform tax to cost retirees drug benefits?

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Associated Press

Posted on March 30, 2010 at 5:00 PM

Updated Tuesday, Mar 30 at 5:00 PM

DES MOINES, Iowa (AP) — Corporate America says health care reform is going to cost dearly. One company alone, AT&T, says it will take a non-cash charge of $1 billion to account for the change in how retiree drug benefits are taxed. Ultimately companies may think twice about continuing prescription drug benefits for retired workers, leaving many to wonder if their benefits are safe.

The answer for many will be "no."

Millions of retirees receiving prescription drug insurance from a former employer could see their coverage dropped or changed as companies consider how to offset the new taxes.

The health care overhaul takes back a lucrative tax break first offered in 2003 to entice companies to continue offering drug benefits. Companies were allowed to write-off a tax-free government subsidy of 28 cents for every dollar spent on their programs. Today, hundreds of companies take a tax deduction for the cost of their prescription drug benefits for retirees. The subsidized benefits kept many from having to rely on Medicare.

Under the new health care law, companies will continue to receive a 28 percent tax-free subsidy but they no longer get the double benefit of deducting the value of the subsidy. The government estimates this change will generate about $4.5 billion over the next decade to help pay for the health care overhaul.

Some business consultants studying the tax changes say as many as 2 million retirees could lose their prescription drug coverage if companies decide to offset the tax by cutting their drug benefits. This would lead to a rise in Medicare enrollment, said James Klein, president of the American Benefits Council, an advocate for corporations offering employee benefits.

"So much for the premise that if you like the coverage you have you can keep it," Klein said.

The alternative to private insurance is Medicare Part D, the government's prescription drug program.

One key drawback is what's known as the doughnut hole. This is a gap in prescription drug coverage that forces many retirees to pay for some of their prescription drugs out of their own pockets.

It's a well-known problem that was addressed in the reform legislation by providing a $250 rebate for seniors this year, and a 50 percent discount on brand-name drugs next year. By 2020 the Medicare drug gap will be completely closed.

However this positive news also means that many companies may drop their coverage when the new tax kicks in, knowing the Medicare gap will be fixed in the future and believing retirees won't be worse off, said Dave Osterndorf, chief actuary for human resources consultant Towers Watson.

If companies decide to make changes, it's not likely to be soon since the new tax doesn't start until 2013.

"I don't think employers are going to get rid of their retiree medical plans right now," said Ken Sperling, health care practice leader for Hewitt Associates, a human resources consultant. "They'll take the financial hit this quarter because they have to, then they'll plan on what they're going to do once that subsidy becomes taxable."

Accounting rules require companies to record the new tax liability in the quarter in which a new law imposes the tax. Although it will reduce first-quarter profits, it does not affect the company's long-term financial health.

In addition to AT&T's first-quarter $1 billion non-cash charge, Deere & Co. said it would incur a $150 million charge and Caterpillar Inc., $100 million.

Wall Street analysts caution investors against making too much of the hefty charges.

"Don't overreact to the hit to earnings," said David Zion, research analyst for Credit Suisse in a March 24 note.

Zion analyzed the regulatory filings of S&P 500 companies, of those who receive the drug program subsidy, he said six companies may have to pay an average of more than $10 million a year between 2013 and 2019.

AT&T takes the biggest hit of about $62 million a year. Consider, however, that AT&T posts an annual profit exceeding $12 billion. Verizon Communications Inc.'s cost is about $56 million a year. It earned $12.5 billion in 2008 and more than $10 billion last year.

Others that would pay more than $10 million a year include Alcoa Inc., Exxon Mobil Corp., Lockheed Martin and Qwest Communications. Another 14 companies would pay more than $5 million a year, according to Zion's estimates.

Morgan Stanley analyst Scott Davis said in a recent note that investors should remember the one-time accounting charge will not affect future earnings.

This was underscored by the reaction of the markets to the charge announcements. AT&T stock, for example, has traded narrowly between $26 and $27 in the past few months. On Friday, the day it announced the charge, shares climbed 9 cents to close at $26.24.

Shares were trading at $26.57 on Tuesday.

The Obama administration defends the tax, saying companies come out ahead.

"(The prescription drug) change is not only fair, but it is far outweighed by the benefits that businesses large and small will receive from this bill — from lower premiums, to reinsurance to lower costs for older workers, to reducing the hidden tax that employees are paying today to cover the cost of the uninsured," said Linda Douglass, a spokeswoman in the White House Office of Health Reform.

Some companies facing the additional tax may choose to provide retirees with a payment to buy their prescription coverage privately rather than continue to offer their own drug benefits. Retirees wouldn't necessarily suffer financially, although it would mean they'd have to shop around.

Still, change isn't certain. Some companies will be able to continue to offer their benefits packages.

All of this comes at a time when managers are increasingly aware of lawsuits cropping out of reneged promises to retirees.

"The more companies attempt to cut back retiree benefits, the more likely you're going to have employees fighting back," said Richard Chargar, an employee benefits attorney for the New York-based Kelley Drye & Warren.

For instance, Charger says a lawsuit against Unisys Corp. could be used by retirees seeking a recent precedent.

A federal judge in Pennsylvania held that Unisys violated its fiduciary duties by not informing a group of retirees that the company could terminate health benefits at any time, for any reason. The judge reinstated the health benefits for 12 retirees and awarded $2.3 million in attorney fees.

The 3rd U.S. Circuit Court of Appeals upheld the ruling in September and the U.S. Supreme Court declined to review the decision earlier this month, allowing it to stand.

"If a lot of companies start cutting back on retiree medical plans, I think participants are going to look to the Unisys case to see if they can leverage that into their favor," Chargar said.

Although companies generally retain the right to change their benefits, some union workers may have some temporary guarantees. For instance, AT&T management said it is considering health care benefit changes, but the union covering more than 150,000 of its workers said it has contracts, including a drug benefit, in effect until at least 2012.

The bottom line is some retiree health benefits could be in jeopardy in a few years. If companies realize more benefits than burdens from health care reform, as the government claims they will, cuts may not be necessary. An improving economy also may better prepare them to absorb the impact of additional expenses.

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