course introduction statement...course introduction statement it is your responsibility to be, ce...
TRANSCRIPT
1
Course Introduction Statement IT IS YOUR RESPONSIBILITY TO BE, CE COMPLIANT, INCLUDING PAYMENT OF ALL FEES. IF YOU CHOOSE TO DELEGATE RESPONSIBILITY FOR KEEPING TRACK OF AND/OR ENSURING YOUR CE COMPLIANCE TO ANOTHER PERSON (SUCH AS AN AGENCY MANAGER, SECRETARY, LICENSING CLERK, COMPLIANCE OFFICER, FELLOW AGENT, FAMILY MEMBER, OR OTHER THIRD PARTY), THE ULTIMATE RESPONSIBILITY FOR NONCOMPLIANCE, AND ANY RESULTING PENALTIES, WILL CONTINUE TO BE YOURS.
1. This course is categorized as [Company/Agency] / [Non-Company/Non-Agency]
(highlight the relevant type).
No more than 75 percent of your required credits can come from Company/Agency
course credits (see inside front cover of handbook). Additionally, at least three (3) course
credits must be earned for Ethics (Law and
Regulations).
2. This course has been approved for 4 credits, LH __X__ PC ____ TI ____ OGI ____
LTC Partnership ____
Flood ____ Public Adjuster ____ Law and Regulations ____ Ethics ____ Mitigation
____
3. Classroom courses - One credit hour is 50 minutes of continuous instruction or
participation. Your attendancewill be verified via the sign-in/sign-out sheet located with
the door monitor. Only students meeting minimum attendance requirements may receive
certificates of course completion.
4. Agents cannot receive CE credit for a course taught in alternative formats (a classroom
course, online course, video or audio conference, web-conference–based, etc.) if the
curriculum is based on the same published materials; this rule applies to any variation of
course type. For example, Agents cannot receive CE credit for both a self-study
(examination course) and a classroom course based on the same published materials.
5. Excess earned Ethics credits may be applied to cover other CE requirements in the
current biennium and any remaining credits may be carried over to the next biennium and
applied to either the Ethics requirement or other CE requirement.
6. Agents are not allowed to receive or carry over credit for the same course in the same
biennium.
7. ONLY the Virginia Insurance License Number (VLN) or the National Producer
Number (NPN) are permitted for identification. Please be sure that you have recorded
your number so that the instructor can read it, as illegible submissions will result in a
delay of reporting course credits.
8. This class may be audited by representatives of Pearson VUE. Pearson VUE is a
private company who in partnership with Vertafore was contracted by the Virginia
Insurance Continuing Education Board to administer all facets of the continuing
education program for the Board effective with the 2009-2010 biennium.
9. CE credits for this course should be posted to your transcript within 20 calendar days.
If your transcript does not reflect this course within 20 calendar days, please contact the
provider.
2
10. Agents are expected to give their full attention to this class. All electronic devices
should be turned off and put away along with any reading material other than material
applicable to this class.
11. Agents and consultants who fail to update their address with the Virginia Bureau of
Insurance may not
receive important notices. Agents may update their address and add or update their email
address online at www.scc.virginia.gov/boi.
Each agent should review the Virginia Insurance Continuing Education Agent
Information Handbook for complete
guidelines at www.virginiainsurancece.com. Copies may also be obtained from Pearson
VUE by calling 1-877-234-
6093 or by sending an email to: [email protected].
NOTE: Agents should visit www.virginiainsurancece.com to view updated transcript
information and to pay their biennial Continuance fee of $15.00.
All continuing education providers and instructors must strictly adhere to all relevant
Program Requirements and all other standards as set forth in this Provider Information
Handbook. This Provider Handbook may be modified from time to time, to reflect
Commonwealth of Virginia statutory changes, regulatory changes by the State
Corporation Commission as well as policy changes made by the Virginia Continuing
Education Board.
3
STUDENT CERTIFICATION I do hereby swear and affirm, under oath, that I personally completed this exam without
any outside assistance, including course material, other source material or assistance from
any person(s). I further swear and affirm that I was engaged in the course for at least an
amount of time equal to the credit hours prior to taking the examination.
Course Name: Course Number (if available): Name of student: Address where exam was taken: Date exam was taken: Beginning time: Ending time: Type of monitor: Describe: Print name of person administering test: Job title of person administering test: Company/agency name: Business phone number: Business mailing address: Signature (sign in ink only): Date: The Student Certification must be completed by the student and submitted to the course provider by mail, email or facsimile transmission within seven (7) days of course completion
4
Business Insurance Course # 210320
4 C.E. Credits life & Health
This text is designed to provide accurate information in regard to
the subject matter covered. The readers of this book understand
that the author is not engaged in rendering legal or financial
services. You should seek competent tax or legal advice with
respect to any and all matters pertaining to the subject covered in
this book.
Copyright 2014
Mark Coleman – author
All rights reserved. This book, or any part thereof, may not be
reproduced in any manner without written permission from the
author. Printed in the USA. First Printing, December 2003
5
Table of Contents
Limited Partnership……………………….Unit 1 Notice of transfer of corporate name
Limited partnership – key attributes
Sole Proprietorship ………………………..Unit 2 Buy–Sell Agreement
Survivorship Life
Insurance for Buy-Sell Agreement
Buying Life Insurance
Selling the Business
Partnership…………………………………Unit 3 Cross – Purchasing Plans
Entity Plans
Closed Corporation ………………………..Unit 4 Cross Purchase Plan
Stock redemption plan
Key person insurance
Economic value
Business will
Fund Options
Split – Dollar ……………………………….Unit 5 Background
Valuing Life Insurance Protection
Rule #1 IRC Section 83
Rule #2 IRC Terminating the plan
6
Rule #3 Treatment as a loan
Rule #4 Safe Harbor for termination
Compensation Plans ……………………….Unit 6 What compensation are affected?
Which executives are affected?
Why do companies and executives defer compensation?
What are the other major exexutive compensation strategies
Health Insurance……………………………Unit 7 COBRA
Newborns and mothers health Plan
The Mental Health Parity Act
HIPAA………………………………………..Unit 8 The Women’s Health & Cancer Act
Health Insurance Fundamentals…………. Unit 9 Health Insurance – Short Term Polices
The downside of Short Term policies
Catastrophic Health Insurance
Who purchase catastrophic health insurance?
Is coverage the right choice?
Traditional Health Insurance
Fee for Service
PPOs
Introduction 52
Is a PPO the right choice for you?
Point of Service (POS) Management Care
HMOs
Is a HMO the right choice?
Group Life Insurance ……………………..Unit 10 Term life insurance
7
Permanent life insurance
Group ordinary life plans
The group paid-up plans
Group universal life plans
Flat benefit plans
Other forms of group life
Franchise life insurance
Credit life insurance
Blanket life insurance
Multiple Employer Trust
Disability Income insurance
Jobs & Growth Tax Relief
Reconciliation Act of 2003………………...Unit 11 Introduction
Other provisions
Health Savings Account
Introduction
How are businesses handling HSAs
Basic requirements of HSAs
Cost of servicing HSAs
8
Limited Partnership 1 A limited partnership is a partnership formed by two or more
persons and having one or more general partners and one or more
limited partners. As the definition indicates, the difference between
a limited partnership and a general partnership is that a limited
partnership has two classes of partners: general and limited.
General partners in a limited partnership have all the rights, duties
and obligations of partners in a general partnership. The limited
partner's status, on the other hand, differs from general partner's
status in several ways. The liability of a limited partner is generally
limited to the amount that the limited partner initially contributed
to the partnership; the limited partner generally does not participate
in the control or management of the partnership; a limited partner
may not contribute services to the partnership, only money or
property; and, upon dissolution, a limited partner has priority over
a general partner in asset distribution.
Many states do not require a limited partnership to have a
partnership agreement. Iowa Code section 487.201 does require the
partners in a limited partnership to execute and file with the
Secretary of State an application for a Certificate of Limited
Partnership. Even though the requirements to form a limited
partnership are minimal, a written partnership agreement is
recommended.
9
Limited Partnership - Points to Consider
Limited partner's risk is directly proportional to the limited
partner's capital investment.
Investment by limited partners is a potential source of venture
capital.
No management responsibility for limited partners.
General partner can increase the business's financial resources and
keep personal control of the business without incurring long-term
debt.
General partners remain personally responsible for all liabilities
and debts of business.
Limited partners lack a strong management voice.
Limited Partnership - Procedural Aspects
Formation
Partners should choose a name for the limited partnership. A
limited partnership may also reserve a name according to state
statute by completing an Application for Reservation of Name. A
previously reserved name may also be transferred by completing a
10
Notice for Transfer of Corporate Name.
It is recommended the partners create a written limited partnership
agreement.
Partners must deliver Certificate of Limited Partnership to the
Secretary of State's Office. Certificate must set forth information
required state statute.
A limited partnership may amend its Certificate of Limited
Partnership according to state statute. Any amendments made to
the Certificate of Limited Partnership must be filed with the
Secretary of State.
Dissolution - A limited partnership can be dissolved non-judicially,
judicially, or administratively. A limited partnership may also be
wound up according state statute. If a limited partnership is
administratively dissolved, it may apply for reinstatement by
completing an Application for Reinstatement.
Foreign Limited Partnership - If the limited partnership was
created under the laws of another state, then before transacting
business to that state, many states require a foreign limited
partnership to register with the Secretary of State which may be
done by completing an Application for Certificate of Registration
of Limited Partnership. An agent for service of process for a
foreign limited partnership may resign as agent for service of
process by completing a Statement of Resignation of Registered
Agent according to state statute.
11
Limited Partnership - Key Attributes
Creation (minimum requirements) - Execute and file a Certificate
of Limited Partnership.
Profits / Losses / Distributions - By agreement or according to state
law.
Liability General - partner according to state statute; limited
partner according to state statute.
Capital / Financing - By agreement.
Duration - By partnership agreement.
Transfer of Ownership - By agreement or according to state statute
Management and Control - By agreement . General partners have
authority to manage and control while limited partners do not.
Taxation –
State: Business owners should call the state for information
regarding state taxation.
Federal: call Internal Revenue Service at 800-829-1040.
Reporting Requirements – According to state statute
Fee - none
12
Sole Proprietorship 2
Introduction
The sole proprietorship is the oldest, most common, and simplest
form of business organization. A sole proprietorship is a business
entity owned and managed by one person. The sole proprietorship
can be organized very informally, is not subject to much federal or
state regulation, and is relatively simple to manage and control.
The prevalent characteristic of a sole proprietorship is that the
owner is inseparable from the business. Because they are the same
entity, the owner of a sole proprietorship has complete control over
the business, its operations, and is financially and legally
responsible for all debts and legal actions against the business.
Another aspect of the "same entity" aspect is that taxes on a sole
proprietorship are determined at the personal income tax rate of the
owner. In other words, a sole proprietorship does not pay taxes
separately from the owner.
A sole proprietorship is a good business organization for an
individual starting a business that will remain small, does not have
great exposure to liability, and does not justify the expenses of
incorporating and ongoing corporate formalities.
Sole Proprietorships are the easiest type of business organization to
establish. There are no formal requirements for starting a sole
proprietorship.
13
Characteristics of the Sole Proprietorship:
Decision making is in the direct hands of the owner.
All profits and losses of the business are reported directly to
the owner's income tax return.
The startup costs for a sole proprietorship are minimal.
Owner has unlimited liability. Both the business and personal
assets of the sole proprietor are subject to the claims of
creditors.
Because a sole proprietorship is not a separate legal entity, it
usually terminates when the owner becomes disabled, retires,
or dies. As a result, the sole proprietorship lacks continuity
and does not have perpetual existence like other business
organizations.
It is difficult for a sole proprietorship to raise capital.
Financial resources are generally limited to the owner's funds
and any loans outsiders are willing to provide.
The owner could spend unlimited amount of time responding
to business needs.
Most small business owners have a considerable portion of their
net worth tied up in their business. In terms of personal and family
financial security, the "What happens if the principal becomes
disabled or dies?" is of paramount importance.
14
In a one person operation, the primary concerns are providing
income for surviving family members, and funds to cover estate
settlement costs in the case of death. In such cases (typically sole
proprietorships), the business will usually cease upon the long-
term disability or death of the owner. For this type of business,
adequate protection may be achieved with life and disability
insurance matched to the projected needs of the survivors.
In contrast, consider the example of a small law firm owned by
four owners, one of whom recently died leaving his interest to his
spouse. The surviving spouse has personal income needs and
wishes to sell her deceased husband's share of the business; the
surviving owners are concerned that the former owner's share may
fall into an outsider's hands. How can both parties satisfy their
needs fairly?
Buy-Sell Agreements
For any business owned by more than one person, buy-sell
agreements triggered by disability or death protect both the
disabled/deceased owner's interest and the interests of the
remaining owners. Simply stated, a buy-sell agreement establishes
the conditions under which one owner (or owners) would buy and
one owner (or that owner's estate in the event of death) would sell
shares of the business.
In many multi-owner businesses (small partnerships, closely-held
C or S corporations, limited liability companies), personal
protection concerns extend beyond the desire of the surviving
partners to continue the business (in the event of disability or
death) to include arrangements for a planned, voluntary withdrawal
by an owner from the business (e.g., retirement).
15
In situations in which saving for retirement has been difficult, it is
common for owners to view their shares of the business as equity
for retirement. Many small multi-owner businesses include
retirement in their buy-sell agreements as a way to liquidate a
retiring owner's share on a pre-established, equitable basis.
Buy-sell agreements are typically structured as either cross-
purchase or entity purchase plans. In a cross-purchase agreement,
each owner agrees to purchase another owner's interest in the
business upon the occurrence of a qualifying event. In an entity
purchase agreement, the business entity purchases the stock of the
disabled/deceased/retiring owner. There are advantages and
disadvantages associated with each plan, but one common thread
running through many buy-sell agreements is the use of life
insurance to help ensure that sufficient liquidity will be available
when a death brings about the sale of an ownership interest.
Survivorship Life Insurance
Consider the example of a closely-held business run by a husband
and wife, with a succession plan calling for passing ownership of
the business to their daughter upon the death of the second parent.
The existing estate plan utilizes the unlimited marital deduction at
the first death, meaning all assets (including business interests)
would pass to the surviving spouse with no federal estate tax
burden at the first death.
A significant liquidity problem could arise at the death of the
second spouse. If most of the remaining family wealth is tied up in
the family business, how could it pass intact to the daughter? One
solution to this question might be a survivorship life insurance
policy, which would provide a death benefit when the second
named insured dies. In this example, since the potential estate tax
burden is deferred until the second death, a survivorship policy
could provide liquidity precisely when it is needed most.
16
Since no death benefit is paid at the first death, survivorship life
may be most appropriate when the surviving spouse has sufficient
income from other sources. Income needs for the surviving spouse
must be weighed against liquidity needs at the second death. If
income needs for the surviving spouse are greater than funds
available, it is suggested that two individual life policies be
purchased by the husband and wife (co-owners of the business)
with each policy naming the other spouse as beneficiary. This way
the two policies will provide the additional funds needed at the
time of one of the spouse's (co-owner's) death.
Insurance for Buy-Sell Agreements
Sole proprietorships, partnerships and small closed corporations all
need to consider what happens if the owner or one of the partners
or shareholders dies or becomes disabled. Who will purchase the
company or the deceased partner’s or shareholder’s interest? What
is a fair price? When will the sale be made? Will the deceased
owner’s/partner’s/shareholder’s families be given a fair shake and
taken care of? These are real questions every small business should
deal with before the event occurs.
The business itself may also suffer form a supplier’s or creditor’s
perception of the value of the deceased person to the success of the
business. Key employees may consider the deceased’s death as a
reason to move elsewhere. There needs to be continuity and a
smooth transition in the business when tragic events such as deaths
or disabilities occur. The buy-sell agreement is important to
resolve a lot of problems dealing with employees, creditors,
suppliers and the deceased person’s family.
Importantly, where will the funds come from to provide continuity
and a smooth transition?
17
Everyone is going to die and sometimes it happens totally
unexpectedly and at a much younger age when expected. There are
no dying rules specific to owners, partners and shareholders.
A buy-out sell agreement is, essentially, the will for the business
and it eliminates a lot of difficulties and heartaches when a key
person dies. A plan needs to be in place and a method of funding
that plan must also be available.
There are several options for business owners to fund a buy-sell
agreement:
They can wait and see – “I’ll worry about that if and when it
happens.” A sole proprietor can say, “I’ll be dead, so no reason for
me to worry about it.” Sure! If it is a partnership, the partnership
dissolves automatically and, “My partner will do the right thing.”
Is that what you want? You can use your personal funds to buy out
your partner’s stock. But what if it comes at a bad time? Your
personal stock portfolio is down, you’ve got two children in
college, and you’ve had to take less income form the business
lately because business has been in a slump. Maybe, after a lengthy
probate the corporation can buy the stock and place it into treasury
stock, if funds are available.
But where does this leave the family of the deceased? Would you
leave it up to your partners to do the right thing for your family no
matter what the personal cost would be to the partner?
They can borrow funds -- obviously, borrowing funds is not an
option to a dead sole proprietor. Could a key employee put
together the money to purchase the company? Can the surviving
partner(s) borrow enough to purchase the assets of the deceased
partner? Maybe they can take out a second mortgage on the house?
Maybe the lost one is the one depended upon by bankers and
18
suppliers. Maybe the repayment and interest is simply too
burdensome.
They can set-up a savings account within the company in
anticipation of an event like this happening but, again, if you are a
corporation there may be accumulated earnings tax problems and if
you are not a corporation, it may be difficult to maintain a savings
account or the death may occur prematurely before enough funds
are available.
Buying Life insurance.
Sole proprietor’s, partnership’s and a corporation’s
perspective.
When business people sit down with their lawyer to discuss setting
up a new business, they’re usually thinking about all the great
opportunities in front of them. The promise of unlimited profits,
financial independence, and working for themselves is what they
see. However, one of the most important issues that they need to
examine, an exit strategy, is probably the last thing that they
usually are thinking about.
When business lawyers attempt to discuss this issue with their
business start-up clients, they walk a fine line for several reasons.
During the “dating/honeymoon” stage of new business ventures,
the owners rarely want to think about such negative things as the
death or divorce of their business arrangement. Additionally,
addressing such negative issues as death, disability, dispute
resolution, spousal interference, and business failure are not
viewed as positive karma by most new business people. Finally,
the thought of paying a lawyer to create yet another document that
will never be needed is usually a pretty distasteful thought to most
business owners.
19
Perhaps the most important document that a business lawyer can
prepare for business clients is the buy-sell agreement.
Unfortunately, it is also one of the most difficult business
documents to prepare properly.
Buy-sell agreements serve several important functions. First, they
provide a mechanism to preserve the close ownership of the entity
by restricting how the ownership interests (stock, membership
interests, etc.) can be transferred. Second, they provide a market
for the ownership interests of a closely-held business. Third, they
provide the business owners with an agreed upon method for
valuing their ownership interests. Fourth, in the case of S
Corporations, they should provide protections from doing things
that could terminate the corporation’s S election. Fifth, in the case
of limited liability companies and S Corporations, they can provide
a mechanism to ensure that owners receive enough actual annual
distributions from the business to pay the taxes that are attributed
to them. Sixth, they can be used to allocate entity control among
owners and management. Seventh, they can be used as an estate
planning tool.
Each of these functions is extremely important to the ensure that
business owners have a road map for dealing with these important
issues before they become serious problems. Although most
business owners don’t want to address mortality (theirs or the
business), permanent disability, termination of employment, and
business disputes, it is much easier to deal with them upfront when
you’re not actually living through them.
Having a buy-sell agreement provides business owners, their
lawyers, and in those serious cases where the parties are unable to
resolve disputes on their own, judges and juries, with a framework
for dealing with these difficult issues. It also, provides the parties
with an exit strategy if business issues cannot be addressed
20
satisfactorily by the parties. Therefore, it serves as a business
prenuptial agreement for the parties. In the litigious society in
which we live, having a buy-sell agreement will not necessarily
prevent litigation when disputes occur, but at least it provides a
mechanism to try to resolve the issues.
There are three types of buy-sell agreements. First, there is the
redemption agreement where the entity is required to purchase the
departing owner’s interest. Second, there is the cross-purchase
agreement where the remaining owners are required to purchase
the departing owner’s interest. Third, there is the hybrid agreement
where the departing owner’s interest is first offered to the
remaining owners and if they choose not to purchase the departing
owner’s interest then the entity is required to make purchase this
interest.
Determining what type of buy-sell agreement is appropriate
requires extensive time and planning. The tax consequences to
each owner and the entity must be considered. Additionally, such
non-tax issues as the complexity of the agreement, ownership
issues and restrictions, and life insurance questions must be
examined. There are also ethical issues that need to be addressed
related to what the lawyer’s role is in preparing the agreement and
who the lawyer actually represents since each of the parties (the
individual owners and the business itself) have differing interests.
The need for a buy-sell agreement is therefore not only a tough
concept to sell to business start-up clients, but it is also a difficult
job for the owners and business lawyers to perform together
properly. However, this investment of time and effort is invaluable
in providing an important tool to assist the owners in their attempt
to assure the successful operation of and exit strategies for their
business.
21
Selling the business
Unless a sole proprietor (let’s call the person and “owner”) has a
family member or a close relative to turn the business over to and
feels comfortable the owner’s desires for his/her family members
will be served, the options are limited. The business can be closed,
it can be sold to an outsider, although small businesses are
sometimes difficult to sell, or, if the owner wants his ‘baby’ to
continue, it can be sold to one or more competent and faithful
employees. The buy-sell agreement to a trusted employee becomes
a two-step plan:
An agreement is prepared which sets forth the employee’s
obligation to buy, the price the employee(s) will pay for the
business and the method of payment
The employee takes out a life insurance policy on the owner.
The employee is the owner of the policy, the person who
pays the premiums and the beneficiary.
If the owner dies, the death benefits of the insurance policy would
be used to buy the business from the owner’s estate.
22
Partnership 3
Partnerships are automatically dissolved with the death of one
partner; therefore, a buy-sell agreement is very important. In this
case, a buy-sell agreement would sell the deceased’s interest in the
company to the surviving partner(s) at an agreed to price. For
partnerships there are two different plans:
Cross-Purchase Plan – in this plan each partner buys a life
insurance policy on each of the other partners. The partnership
itself is not a participant in the agreement. Each partner owns, pays
the premium payments and is the beneficiary of the insurance
policies on the other partners in an amount equal to his share of the
purchase price set forth in the buy-sell agreement. The proceeds
are used to purchase the partner’s business interest from the heir’s
of the deceased.
The number of policies required for a partnership with multiple
partners would be the number of partners X (number of partners-
1). For example, a plan for a partnership with three partners would
require six separate insurance policies. Each partner would need a
policy on each of the other parties.
Let’s say a business worth $600,000 is owned by three partners in
equal shares. Each partnership would be worth $200,000 and if one
of the partners died, the other two partners would have to provide
$100,000 each to equally purchase the deceased person’s share.
Therefore, each partner, in this case, would take out a policy on
each of the other two partners in the amount of $100,000 each.
Entity Plan – in this plan partners enter into an agreement with the
partnership who owns, pays the premium payments and is the
23
beneficiary of the policies. When a partner dies, his/her interest is
purchased from his/her estate by the partnership at the buy-sell
agreement price and the interest is then divided among the
surviving partners in proportion to their own interest.
In this case, the $600,000 business discussed above would
purchase a $200,000 policy for each of the three partners. If one of
the partners dies, the business pays the deceased partner’s share
from the death benefit of the policy and distributes those shares
equally to the two remaining partners. The remaining partners, in
this case, would then each own 50% of the business.
Because of origination funding, buy-ins, etc., not all partnerships
are owned equally by the partners. In those cases, both the
insurance policy’s amounts and the benefits distributions would be
made on the basis of each partner’s proportionate share in the
business.
Additionally, none of the premium payments in the above plans are
tax deductible; however, the benefits are tax-free.
24
Closed Corporation 4
Unlike a partnership, a closed corporation (i.e. a small number of
shareholders who run the business) does not cease to exist with the
death of one of its shareholders. For closed corporations, there are
also two different plans:
Cross-purchase plan – each stockholder owns, pays for and is the
beneficiary of life insurance on the other stockholders in amounts
equivalent to his or her share of the purchase price. The
corporation is not a party to the agreement. The surviving
stockholders purchase the interest of the deceased stockholder as
individuals from the estate of the deceased stockholder. This plan
is like the cross-purchase plan described in the partnership section
above. Obviously, the more shareholders the more difficult this
plan becomes.
Stock redemption plan – the corporation, rather than the
stockholders, purchases the insurance policy, pays the insurance
premiums and is the beneficiary on the lives of each shareholder.
The amount of insurance on each stockholder is equal to the
proportionate share of the purchase price. Upon the death of one of
the stockholders, the death benefits are paid to the corporation who
then buys the deceased’s stock from the deceased’s estate.
Premiums are not tax deductible but the proceeds are received
income tax free. Any agreements and insurance polices within a
business must be integrated with the overall plan and objectives of
the business. Careful consideration must be given to the selection
of the plan which is right for your business and to the method of
funding your plan.
25
Key Employee Insurance
Key employee insurance is life insurance purchased by the
company on the life of an employee or employees whose loss
would have adverse effects on the company. Employees are
valuable assets and the loss of some key employees could
significantly impact the profitability, stability and progress of the
company.
Often times certain employees or executives are hired because of
their own specific expertise they bring to the company. Other
employees just seem to represent the persona of the business and
have earned the respect, loyalty and credibility of customers,
vendors, suppliers, creditors, etc. The loss of those persons could
result in some business interruption in some fashion. Small
businesses are just that way. Those intangibles are what make
many small companies successful.
The objective of key employee insurance is to financially protect
the company from adverse impacts if one of those key employees
suddenly dies or becomes disabled. The finances available from a
key person insurance policy would:
provide funds to find, recruit and train a replacement
help replace any profits the company may have earned had
the employee not died
strengthen the company’s working capital and balance sheet
to help assure creditors and suppliers about the continuity of
the business.
26
What if the key employee is the owner? Key employee insurance
can be purchased for him also and can resolve the sole proprietor
issues discussed in a buy-sell agreement.
There is no easy formula for determining the value of a key
employee. Anticipated profit losses, replacement costs, and a
compensation-multiple formula, are typical methods of estimating
a loss. Good planning should examine all these concepts to
develop a program which is right for the company.
The company is the owner of the policy, pays the premiums and is
the beneficiary upon death or disability of the key employee.
Premiums are not tax-deductible but the death benefits are received
tax free.
Clearly, of the four methods of attempting to fund the financial
impact of the loss of a key employee (i.e. wait-and-see, borrow
funds if you can without that employee, set-up a savings account,
or buy insurance), the insurance option is clearly the best option
and the most rewarding to the company.
Any agreements and insurance policies within a business must be
integrated with the overall plan and objectives of the business.
Careful consideration must be given to the selection of the plan
which is right for your business and to the method of funding your
plan.
In every successful small-to-medium business, there are a handful
of men and women who rate the honor of being a key person--the
truly committed men and women, the ones who hold keys to the
company’s success. These gifted managers skillfully guide the
business through operations, sales or financial decisions. They
possess the technical minds whose innovative ideas lead to market
edges. They are the relationship builders who guarantee client and
supplier commitment.
27
The loss of their practical experience, their expertise, their
leadership skill is likely to have such a fundamental effect on the
business that economic loss is certain. That’s the downside risk of
having great people—the continual peril of losing them. Why
would a business take precautions against fire, natural disasters,
theft and vandalism, yet neglect the risk of losing the knowledge
and experience of the people who made it successful?
The Economic Value
Most business owners will claim to have contemplated the loss of
key people and even taken steps to indemnify the company. But it
is rare that the real cost of the loss has been accurately measured,
so the company remains at risk. The cost attributable to the loss of
such key employees through disability or death can be difficult to
quantify since so many components of the business are likely to be
affected. It goes far beyond a job function. Companies must
consider the loss of
• Sales revenues.
• Client goodwill.
• Market share.
• Proprietary knowledge and systems.
• Production capacity.
• Credit standing with lending sources and suppliers.
• Time and money to recruit and develop replacements.
• Cash flow.
Life and disability insurance protection can provide funds to meet
debt obligations offset lost sales and cover the expenses of
28
recruiting, hiring and developing replacement personnel. They are
essential components of any risk management plan for any
business.
Determining the amount of insurance coverage is not a precise
science. Some advisors favor using salary as the starting point, but
the fact that the range runs from 2x to 10x annual salary shows that
the calculation is largely a comfort-level guess. The mid-point ends
up being most typical, so it is hardly a sophisticated approach.
Replacement cost calculation offers a more rational basis. This
begins with the search fees and other costs associated with
bringing a new person onboard, such as a moving allowance.
Salary is still the primary consideration. But the lost key person
might turn out to have been a bargain from a salary perspective—a
leftover from older salary structures—with perks and bonuses
making up the real value. Or, a new person might come at a much
higher base price tag, since performance-based incentives, which
became habitual with the previous employee, can seem like a high
risk to someone new on the job.
Also, the company might consider whether the key person’s
function can really be handled by one replacement. If the key
person wore many hats, the company could be better served by
splitting the roles and hiring two less experienced people. Another
important measure should be a calculation of the impact to sales
and profits of the loss of the key employee. If client relationships
are jeopardized by the loss, there may be costs to rebuilding them.
This is also true with relationships with suppliers and credit
sources.
All of these factors are multiplied when the key man is the owner
of the business. Typically, though, the owners of small-to-medium
companies rarely consider measuring their own loss. They see
what happens when they are gone for the day or the week, and
29
their solution is to never be gone again. But not all absences are a
matter of choice.
Some owners die while they are still active in their businesses. A
greater percentage becomes disabled in a way which forces them to
withdraw from active participation. The rest eventually do retire.
The withdrawal of the owner is not a contingency but a certainty.
The only uncertainty is when it will happen. At that time, some
form of ownership and/or management transfer must take place.
No matter when or how it happens, that transfer must be designed
so it does not cripple the business.
The role of the continuity plan is to separate the life of the business
from the life of its owners, to anticipate possible future events in
the life of the business, and to guarantee that it will continue to
exist in a manner that meets the owners’ goals.
An owner looking ahead to scaling back direct involvement in
anticipation of retirement is likely to form a mental picture in
which the business draws upon his expertise and influence in
return for consulting fees of some kind. If the owner considers the
possibility of a disabling condition, he or she probably expects that
the business will continue to pay a salary for a number of years.
And if he or she contemplates the eventuality of death, there is
probably a mental picture of family members receiving cash for the
business interest so that their income will not be dependent upon
the decisions of surviving partners.
Surviving partners naturally have their own agendas and mental
pictures. Typically, they do not want inexperienced, non-active
members of their partner’s family to be involved in the operations
of the company. Of additional concern is the effect the loss of the
owner could have on credit and bonding capacities.
The owners may actually share these personal scenarios and come
to consensus on alternate futures. But until a plan is drafted that
30
makes these desires contractual, there is no guarantee the desired
future will ever come to fruition. From experience, there is a better
guarantee that it never will.
The Business Will
The most common business continuity tool is a funded buy-sell
agreement, sometimes referred to as a business will. The buy-sell
agreement is inexpensive to draft and less complicated than other
ways of transferring ownership and management of a closely held
corporation. It can be responsive to changing circumstances, since
alteration is possible with the consent of all parties.
The agreement is a legal contract restricting the right to dispose of
a business interest to specified parties according to specified terms.
It typically requires the sale of a business interest at a
predetermined price or by a predetermined formula, triggered by
death, disability, retirement, withdrawal from the business, or
involuntary transfer of one of the owners.
For the family of a retired, disabled, or deceased shareholder, the
agreement provides an orderly transfer of ownership and continuity
of management, freeing it from business worries and assuring a
fair price. If it is funded with life insurance, the agreement
generates liquidity for the payment of the debts, expenses and
taxes of the estate. The family will not be dependent on the
business and its remaining owners.
With the agreement, remaining owners are assured that the stock
will not fall into the hands of anyone not connected to the company
or without an appropriate interest in running it. It may comfort the
potential fears on the part of creditors or bonding companies. The
agreement may also provide a method for withdrawing funds from
a family corporation other than as dividends.
31
In short, the buy-sell agreement controls the disposition of all stock
in the corporation in the event of a spectrum of contingencies. An
effective buy-sell agreement should protect all parties from
disadvantage by including all essential provisions key to the
success of the arrangement. These provisions include, but are not
limited to the following.
• A statement of purpose of the agreement, outlining the intentions
of the parties and objectives for the smooth transfer of the business
interest.
• The promise to purchase/sell, identifying the purchasers and
sellers of the interest and the percentages or shares to be
purchased, as applicable.
• A valuation provision that establishes an agreed-upon price with
provisions for re-evaluation at predetermined times, a formula for
valuing the business at the triggering event, or procedures for
selecting and using outside appraisers.
• For life insurance funded agreements, instructions for the
purchase of the life insurance and requirements for keeping the
policy in force.
• For disability funded insurance funded agreements, a definition
of disability that reflects the provisions of the policy itself and
outlines the circumstances under which, and at what point, the buy-
sell will be activated.
• For installment purchases, the terms and conditions of the
payment plan.
Funding Options
The terms of the buy-sell should specify how the purchasing party
will pay for the business interest. Broadly, options include cash
32
payments from savings, borrowing, installment sale, disability
insurance proceeds, or life insurance proceeds.
Planned saving can be impractical since triggering events are likely
to occur with little or no notice, and complete funding cannot be
assured. Borrowing can be equally impractical since much of the
lender’s security depends on the stability of the company, which
may be threatened by the shareholder’s withdrawal.
Installment sales by themselves can place a burden on both parties
to the transfer. The payments will drain current earnings as well as
forcing the departing owner or heirs to rely upon the future success
of the business, over which they no longer have management
control.
Installment sales are often included among the provisions of buy-
sell agreements to provide for payment beyond insurance funding
solutions. This may be done as a two-pronged payment plan or as a
fail-safe mechanism, should insurance be allowed to lapse or if
increases in the value of the business overtake the amount of the
insurance policy proceeds. Typically, in an installment plan the
estate of the deceased takes a note from the corporation or
remaining co-owners.
The heirs may actually feel very comfortable with this
arrangement, since it provides an income stream for them. But, as
an unfunded obligation of a corporation or its owners personally,
installment payment plans must be carefully analyzed and
periodically reviewed.
The potential mistake of this kind of clause in the buy-sell
agreement is no different in concept from the common mistake of
credit card debt. The business cannot simply expect that future
revenues will be able to support the installment agreement. In
some cases—particularly in businesses with narrow profit
margins—the increased sales needed to generate cash for the
33
payments can far exceed any reasonable revenue expectation or
historical model. Even more sobering is the fact that, since the
installment payment is not deductible, revenue calculations must
reflect after-tax dollars.
Given these potential problems, the combination of disability and
life insurance typically proves to be the least costly of these
options. The most significant advantage is that complete financing
is guaranteed from the beginning. A lump sum payment to the
deceased stockholder’s estate is generally feasible only if life
insurance proceeds are available to fund the payment.
Furthermore, life insurance proceeds are received by the
beneficiaries free from income tax, except for the corporate AMT.
Cash values in the policy can also be utilized for a buyout of a
retiring or disabled partner and allow the withdrawing partner to
keep the policy. However, the trade-off for the tax free proceeds is
that the insurance policy premiums are not tax deductible.
Life insurance funding avoids bank and bonding company
problems. The credit position of the firm is not affected by a
deceased shareholder’s stock in the firm, and the selling
shareholder does not need to depend on the credit-worthiness of
the company for an extended period.
On the disadvantage side, insurability may be a problem or, due to
age differences among shareholders, premiums may not be
equitable. This can usually be addressed with appropriate
compensation measures.
In summary, how much is the company’s key employeeworth?
Measured by his or her potential loss, the employee can be worth
as much as the company, and only key employee coverage and a
funded buy-sell agreement will secure its value.
34
Split-Dollar 5
Background
All pre-January 28, 2002 split dollar insurance agreements must be
reviewed immediately and the income tax, gift tax and
employment tax implications of those agreements ascertained in
light of a safe harbor for terminating such agreements or
converting to a loan by December 31, 2003.
For almost 30 years, the IRS had been relatively silent on the tax
treatment of split-dollar insurance arrangements. Then in 1996, the
IRS began a series of statements and retractions that ultimately
ended with the issuance of a significant Notice in February 2002
and the adoption of final regulations in September 2003.
Concurrent with the issuance of the final regulations applicable to
split-dollar arrangements, the IRS issued Revenue Ruling 2003-
105. This revenue ruling provides the latest guidance on the
taxation of split-dollar life insurance arrangements. Revenue
Ruling 2003-105 provides as follows:
Treasury Decision 9092 issued new regulations. These regulations
directly apply to split-dollar life insurance arrangements that are
entered into after September 17, 2003 or any existing split-dollar
arrangement that is materially modified after September 17, 2003.
Various prior revenue rulings were declared obsolete, including
RR 64-328.
For pre-September 17, 2003 split-dollar arrangements, taxpayers
may continue to rely on Notice 2002-8 (and to the otherwise
obsolete revenue rulings to the extent provided in Notice 2002-8).
35
The purpose of this alert is not to describe how new arrangements
should be constructed, but to describe rules and options applicable
to existing arrangements pursuant to the guidance provided in
Notice 2002-8.
In Notice 2002-8, the IRS provided rules for valuing life insurance
protection and provided four specific transition rules that would
apply to any split-dollar arrangement entered into prior to the date
of the issuance of final regulations applicable to split-dollar
arrangements. However, the last transition rule only applies to
split-dollar arrangements entered into prior to January 28, 2002.
Valuing Life Insurance Protection
For many years, the income tax focus for split-dollar arrangements
was the determination of the value of the annual insurance benefit.
The annual insurance benefit is comparable to the cost of a one-
year term life insurance policy. For many years, the determination
of annual insurance benefit was derived from an IRS schedule
commonly referred to as PS 58 or possibly a lower value issued by
the insurance company. The IRS determined that the old PS 58
values required updating because of the changes in mortality risks
over the past 45 years. A new table to replace PS 58 was set forth
in Notice 2001-10 (although the old PS 58 rates will be applicable
to arrangements that specifically require that rate). As to values
provided by insurance companies, the IRS now requires that the
values be “published premium rates that are available to all
standard risks for initial issue one-year term insurance.” The IRS
added special rules to confirm that such rates are actually
available.
36
Rule #1: IRC Section 83 Inapplicable
Under the first transitional rule, the employee will not be taxed on
any policy equity accruing from interest or dividends that increases
the equity in the portion of policy that is not to be repaid to the
employer. A simple example is as follows: an employer has paid
$500,000 in premiums on a policy held by a trust created by the
employee. The employer is entitled to receive the premiums back
upon termination of the arrangement or death of the insured. In
year 5, the cash value is $600,000 and the cash value is increasing
at $20,000 per year. Under this transitional rule, each year as the
trust’s share of the cash value of the policy increases, the employee
will not be treated as having received any taxable income under
IRC Section 83. However (except as discussed below), the
employee would still be taxed on this amount if the plan is
terminated or the funds are borrowed from the policy. Continuing a
split-dollar plan under this transitional rule results in a plan without
an exit strategy (other than the death of the insured).
Rule #2: Terminated Plan Without Recognizing
Transfer of Assets
If a split-dollar arrangement is terminated, but value of the life
insurance protection continues to be recognized as income, the IRS
will not assert that there has been a transfer of property to the
benefited person by reason of termination of the arrangement.
Accordingly, under this option, the employee will continue to
include in income the annual value of the current life insurance
protection. The negatives of this option include:
The annual income to be recognized can become quite high
as the insured ages.
37
The company probably would not be entitled to an income
tax deduction for the income recognized by the employee.
If the owner of the policy is a trust, the employee will likely
be treated as making gifts to the trust for the value of the life
insurance protection.
Rule #3: Treatment as a Loan
Under this option, the amount owed to the employer can be treated
as a loan. Although somewhat ambiguous, guidance we have
received indicates that this transitional rule only approves the
conversion to a loan and treatment as a loan (whether occurring in
the past or the future). However, this transitional rule does not
protect against other income tax consequences that could arise
upon termination of the arrangement.
This transitional rule requires that all employer outlays for
premiums must be picked up as the beginning loan balance at the
beginning of the taxable year in which the treatment as a loan
began. These loans may be interest-free or low interest loans and
taxed under Internal Revenue Code (IRC) Section 7872 and
Sections 1271-1275.
Rule #4: Safe Harbor for Termination of Arrangement
Under the last transitional rule, a safe harbor for the termination of
insurance arrangements is provided. However, this safe harbor is
only available to split-dollar arrangements entered into before
January 28, 2002. The critical components of this transitional rule
are as follows:
38
If there is a pre-January 28, 2002 split-dollar arrangement and the
sponsor is owed a refund of all payments made (less refunds
already received)
The IRS will not assert that there has been a taxable transfer of
property to the benefited person upon termination of the
arrangement if either (i) or (ii) applies :
(i) the arrangement is terminated before January 1, 2004
(ii) for all periods beginning on or after January 1, 2004, all
unrefunded payments by the sponsor from inception of the
arrangement are treated as loans for Federal tax purposes, and the
parties to the arrangement report the tax treatment in a manner
consistent with this loan treatment, including IRC Sections 1271 -
1275 and IRC Section 7872. Any such payments by the sponsor
before the first taxable year in which such payments are treated as
loans for Federal tax purposes must be treated as loans entered into
at the beginning of that first year in which such payments are
treated as loans.
The loan treatment under transitional rule #3 and the loan
treatment under transitional rule #4 have two different purposes.
Under transitional rule #3, loan treatment is approved for all
existing split-dollar arrangements, but transitional rule #3 does not
provide any special protection from recognition of gain if the
arrangement is terminated. Under transitional rule #4, if the
arrangement is a pre-January 28, 2002 arrangement (with certain
other attributes) and it is converted to a loan prior to January 1,
2004, upon later termination of the arrangement the IRS will not
assert that there has been a transfer of property.
Summary
39
Because the safe harbor for terminating arrangements created
before January 28, 2002 or converting them to loans on a tax
favorable basis only lasts until December 31, 2003, it is important
to identify existing split-dollar arrangements and perform the
analysis necessary to determine whether any actions should be
taken.
Compensation plans 6
Section 162(m) of the Internal Revenue Code establishes a
$1,000,000 cap on deductible compensation. However, with
proper planning, companies can provide substantial compensation
to their executives while minimizing adverse tax consequences.
Here are short answers to some of the most common questions
about managing executive compensation.
What Companies are affected?
Generally, the $1,000,000 deduction limitation applies to
corporations which, on the last day of their taxable year, are
subject to the reporting requirements of Section 12 of the
Securities Exchange Act of 1934 (public companies).
Significantly, there are transition exceptions for new public
companies. Those on an IPO track should adopt executive
compensation plans prior to the IPO, and grant stock or other
awards under the plan as soon as possible in a way that qualifies
under the transition rules to avoid undesired tax liability.
40
Which Executives are affected?
The deduction limitation applies to compensation received by the
CEO or one of the corporation's other four highest paid officers, as
of the last day of the corporation's taxable year.
What is included in "Compensation" for this Purpose?
"Compensation" generally includes all amounts otherwise
allowable as a deduction to the corporation, with respect to
services performed at any time by the executive.
Why do Companies and Executives Defer Compensation?
Deferred compensation is generally counted in the year received.
If a corporation pays a set amount to an individual in installments
over a period of years (with such amounts being deducted only as
paid), only the amount of the current installment will be included
in the dollar limitation for each year. Thus, deferred compensation
is one strategy for compensating executives in cash while
maintaining tax advantages.
What are the other major Executive Compensation Strategies?
There are several other methods of compensation that are not
subject to the deduction limitations. These provide other strategies
for transferring compensation to executives without adverse tax
consequences:
Contributions to qualified pension and profit sharing plans and
deferred compensation programs, benefits paid under health and
welfare plans and other amounts generally excludible from gross
income; and "Qualified Performance Based Compensation, "
which is one of the most important executive compensation tools.
41
What is Qualified Performance Based Compensation (QPBC)?
QPBC is a payment made upon reaching one or more pre-
established objective performance goals. These goals can be based
on one or more business criteria that apply to the individual
executives, a business unit, or the corporation as a whole.
Examples of these goals are increases in stock price, sales,
earnings per share and return on equity, reductions in costs and the
successful completion of specific employment related targets.
What are the rules for Establishing Performance Goals?
Performance goals must meet complex requirements to qualify
under the tax code, and the programs and goals may require
stockholder approval. Some of the key rules for establishing
performance goals are:
1. A performance goal must be "pre-established"--that is, written
within the first 25% or first 90 days of the performance period,
whichever comes first, and before it can be determined with
substantial certainty whether the goal will be met.
2. The goal must be "objective" such that an unrelated third party
with access to company records could calculate the amount to be
paid under the formula. However, the company can maintain some
flexibility by retaining the right to reduce the payment for
subjective reasons. For example, if an incentive program provides
for a maximum payout of 15% of compensation under an objective
formula, but allows the employer to reduce the benefit all the way
to 0% for subjective reasons, it will still pass the "objective goal"
test.
3. Special rules apply to stock options and stock appreciation
rights. These types of awards satisfy the performance goal
requirements without the establishment of an "objective"
performance goal if: (a) the grant or award is made under a plan
42
stating the maximum number of options or rights that may be
granted during a specific period to any executive; and (b) the
compensation upon exercise is based solely on appreciation of the
stock after the date of grant (in another words, the exercise price
must be at least fair market value as of the date of grant).
4. A performance goal must be established by a compensation
committee composed solely of two or more "outside directors" and
receive at least general stockholder approval. The outside directors
must qualify under specific tax law requirements, and must certify
satisfaction of performance goals before each payout.
When should a qualified Executive Compensation program and
other Compensation Strategies be established?
It's usually a good strategy to implement the framework to support
these programs well before they are needed, and while control of
the company is closely held. For more strategy ideas, and to find
out how the general rules above apply to your situation, consult
experienced executive compensation counsel.
43
Health Insurance 7
The Consolidated Omnibus Budget Reconciliation Act
(COBRA)
If an employee loses his job, this law -- commonly called COBRA
-- will help them keep their group health coverage while they make
the transition to a new plan.
COBRA requires most employers to offer employees and their
families the opportunity for a temporary extension of health
coverage under certain circumstances -- such as job loss, job
transition, job reduction, divorce or death of the covered employee
-- after which their health plan coverage would ordinarily end.
These instances are called "qualifying events," and the extension
can last anywhere from 18 months to 36 months, depending on
the situation.
If the reason that you are losing coverage is because you quit your
job, because your employer reduced your hours or because your
employer terminated you (for reasons other than "gross
misconduct"), you can continue coverage for yourself, your spouse
and your dependent children for a period of 18 months.
If you were covered under your spouse's health plan and if you are
losing that coverage because of divorce, separation or the death of
your spouse, you can continue coverage for you and your
dependent children for a period of 36 months.
If you were covered under a parent's health plan and are losing that
coverage because you are no longer a dependent of your parent,
you can continue coverage for yourself for a period of 36 months.
44
Unfortunately for your pocketbook, COBRA is not free coverage,
nor is it a government benefits. The person must pay for the
continued coverage himself. Still, COBRA ensures the person that
he will pay for that coverage under the group rate that was paid by
your employer, which might be less than individual rates.
Employees, employers and the health plan all have responsibilities
under the law. For example, the plan must inform all employees
generally about their rights under COBRA. Employers must notify
the plan of an employee's death, termination of employment, or
reduction in hours. The employee or covered family member must
notify the plan of a divorce, legal separation or disability. The
employee or covered family member must also notify the plan
when a child loses dependent status. If person wants to continue
coverage under COBRA, he has 60 days from the date when his
employer-paid coverage would end to notify the plan that you want
to continue coverage.
The Newborns' and Mothers' Health Protection Act
This Act, signed into law in 1996 and effective for group health
plans since 1998, protects a woman and her newborn child from
being prematurely released from the hospital after childbirth. It
guarantees that a woman and her newborn baby will be allowed to
stay in the hospital for at least 48 hours after a vaginal delivery or
96 hours after a cesarean delivery.
A mother can leave the hospital after a shorter length of time only
if she and her attending healthcare provider -- such as a physician
or a nurse midwife -- agree that the shorter stay is sufficient.
However, the law prohibits health plans and insurers from giving
the mother or the provider any incentives (either positive or
negative) that might encourage a shorter stay.
45
The Mental Health Parity Act
This law seeks to end the practice by health plans and insurers of
providing less coverage for mental disorders than they do for
physical disorders. Data from the federal Bureau of Labor
Statistics indicate that, prior to the Act, approximately 90% of
policies offered fewer benefits for mental health than for physical
health. Indeed, the typical caps for mental illness coverage were
$5,000 per year and $50,000 over the course of a lifetime. These
caps may seem high until you compare them to the caps for
physical disorders: no caps per year and $1 million over the course
of a lifetime.
One key limitation of the Act is that it applies only to health plans
and insurers that cover mental disorders in the first place. It does
not mandate coverage for mental disorders where none is provided.
Another limitation is that the law does not cover businesses with
50 or fewer employees.
An additional limitation is that the Act covers only mental illness;
it does not cover treatment for substance abuse or chemical
dependency. Because the law is about parity, and not about
mandating coverage for mental illness, the law does not define
mental illness. Rather, the law applies to "mental health services"
as the term is used by the individual health plans. Whatever mental
health services the plan covers, it must cover at the same level as
physical health services.
Critics of the Mental Health Parity Act have argued that it has too
many loopholes and too many exclusions to truly end the practice
of providing less coverage for mental health than for physical
health. Fortunately, many states have passed their own parity laws,
many of which provide broader protection. To learn whether your
46
state has a more comprehensive law, visit insure.com at
www.insure.com/health/mentalstate.html.
The Act took effect in January of 1998, and was originally set to
expire in September 2001. But in 2002, Congress extended it for
one more year, and in 2003, bills were introduced to continue and
expand mental health insurance parity. To check the status of these
bills, see the legislative website at http://thomas.loc.gov.
47
The Health Insurance Portability and 8
Accountability Act (HIPAA)
Introduction
This Act provides a range of protection to millions of working
Americans who have some sort of health-related condition or
characteristic that makes them vulnerable to exclusions, limitations
and discrimination in group healthcare coverage. HIPAA applies
mainly to employer-based health coverage. Therefore, if you get
your health insurance through your employer, and if you have what
is called a "pre-existing condition" (see below) or some other
health-related characteristic that makes you "undesirable" in the
eyes of an insurance company, you should get to know HIPAA so
that you can use it to protect yourself and your family.
A pre-existing condition is a condition for which you received
medical advice, diagnosis, care or treatment in the six months prior
to enrolling in your current health plan. Cancer and high blood
pressure are common pre-existing conditions. For example, you
may have received treatment for breast cancer in June, and
enrolled in a new group health plan in July. Prior to this Act, you
faced the possibility that your new health plan would not cover
your breast cancer treatment for several years -- or at all -- simply
because you received treatment for it previously.
The intent of HIPAA is to turn the tables on health plans and
insurance companies by limiting the ways in which they can
exclude coverage of such conditions:
Pregnancy is no longer considered a pre-existing condition.
Therefore, if you are pregnant and want to switch group health
plans, you can do so without risking a break in your coverage. But
be careful: There are some large loopholes in this protection.
48
HIPAA applies only to women who switch from one group health
plan to another. Therefore, if you had no coverage and then
obtained group coverage through a new job after you got pregnant,
your pregnancy may not be covered or you may have to wait for a
period of time before it gets covered. (Ironically, this waiting
period may last longer than your pregnancy.) Similarly, if you had
individual coverage and then switched to either group coverage or
to another individual plan after you got pregnant, your pregnancy
may not be covered at all or for a specified period of time.
Health plans and insurers cannot apply the pre-existing condition
exclusion to newborns or to children younger than 18 who are
adopted or who are put up for adoption so long as the newborn or
the child entered the health plan within 30 days of birth, adoption
or placement for adoption.
The Act places a six-month "look back" limit on identifying pre-
existing conditions. This means that if you have a condition for
which you received medical advice, diagnosis, care or treatment
longer than six months prior to enrolling in your new plan, that
condition is not pre-existing and cannot be excluded from coverage
on that basis.
If the employee does have a pre-existing condition and he has
group health insurance, he faces a shorter pre-existing condition
exclusion periods than he would have faced prior to HIPAA. In
other words, the employee can get covered for his condition faster
than before. The maximum exclusion period is generally 12
months from the date on which you enrolled in the plan.
If the employee switches from one group health plan to another as
the result of a job change, he will not face new pre-existing
condition exclusions so long as there is no more than a 63-day
break in your health coverage. This enables him to switch jobs
49
despite his health status without fear that he will lose coverage for
certain conditions.
In addition to protecting employees from exclusions based on pre-
existing conditions, HIPAA also protects them from discrimination
based on health-related characteristics. The Act prohibits health
plans and insurers from excluding employees from coverage or
charging their coverage because of their health status.
Finally, HIPAA requires health care providers, including doctors
and hospitals, to improve their efforts to keep patients medical
records and health information confidential.
The Women's Health and Cancer Rights Act of 1998
If a woman with breast cancer who has had a mastectomy, this law
places some requirements on how your group health plan,
insurance company or health maintenance organization must treat
you:
Employees are entitled to reconstruction of the breast on
which the mastectomy was performed.
Employees are entitled to reconstruction of your other breast
to produce symmetrical appearance.
Employees are entitled to prostheses and treatment of
physical complications at all stages of the mastectomy,
including lymph edemas.
The Women's Health Act applies only to plans that already provide
medical and surgical benefits with respect to a mastectomy. If the
plan does not provide such benefits, then it is not covered by this
Act and employees are not entitled to the Act's protections.
50
Health Insurance Fundamentals 9
Today's health insurance market is broken into many segments.
Some are highly specialized in their coverage and others are more
comprehensive. The more comprehensive and inclusive the health
insurance is the higher the premiums.
Many experts believe that it is in the employee’s best interest to
purchase group coverage (through an employer) when available.
Group coverage is generally more comprehensive and group rates
are generally lower because there is strength in numbers.
However, group plans are almost always managed care programs
and have lots of restrictions.
If group coverage is not available then employees will have to
purchase an individual plan. Individual plans are medically
underwritten and there are no guarantees that an insurer will
approve your application. Premiums for individual policy holders
are more in line with their expected health care cost than in group
coverage. That means, the premiums will be higher for those who
are older or less healthy.
Health Insurance "Short-Term"
As its name implies, short-term health insurance is temporary
coverage and lasts from one to six months. Some companies may
allow the insured to renew the policy one time but the total length
of coverage will not exceed twelve months. This is perfect for
someone who just dropped off their parents' policy because they
graduated from college or maybe they hit that age limit and need
health insurance before they find a full-time job-or maybe for
somebody between jobs.
51
Coverage is generally comparable to that of an HMO or similar
plan and typically includes various hospital charges, office visits,
diagnostic tests, and prescription drugs. Maternity costs are not
covered, however. Unlike an HMO or PPO, though, a short-term
plan is an indemnity plan, which means you have the freedom to
go to any doctor; you're not confined to a network of doctors.
Plans are typically offered with a number of deductibles ranging
from $200 to $2,000. Most young adults choose the $500
deductible or the $250 deductible. Older adults generally choose
higher deductibles to offset their higher premiums.
The Down Side of Short-Term Policies
In many short-term policies, the deductible you pay is per injury or
illness. That means employees must meet the deductible all over
again each time they are treated for a ear infection or other illness.
After the deductible is met, the company pays 80 percent of the
next $5,000 in expenses and then pays 100 percent.
Short-term policies also have certain strict eligibility requirements,
although they will vary from insurer to insurer. If an employee has
ever been denied health insurance, he won't be eligible for short-
term insurance because a denial indicates you might have
significant health problems. In addition, if he has a pre-existing
condition (an illness or chronic condition within the previous five
years), it won't be covered under most short-term plans. That
means if he has leukemia, a stroke, or even allergies or asthma
within the last five years, those illnesses won't be covered under
the employer’s short-term policy. Pregnancy is not covered either,
although complications arising from pregnancy generally are.
And what happens if a person bought a three-month policy only to
find that the job he hoped to land - with health benefits - has not
52
materialized? He may not be able to renew he short-term policy,
because it doesn't work that way. He will have to go through the
application process all over again and take out a new policy. If he
has any illnesses or injuries during previous policy period, those
now become pre-existing and he won't be eligible for coverage.
People should shop around and compare rates and benefits from
several companies to make sure they get a plan that's right for
them.
Catastrophic Health Insurance
Catastrophic health insurance policies are intended only to pay for
major hospital and medical expenses, not routine visits to the
doctor's office or trips to the ER to get stitched up. A catastrophic
plan would cover things like treatment in an intensive-care unit for
10 days after an auto accident or complications from a pregnancy
that land you in a hospital.
Catastrophic health insurance policies typically come with a very
high deductible from $500 to $15,000 and a high maximum benefit
payment, such as $1, $2 or $3 million.
Who buys catastrophic health insurance?
There are two groups of individuals who commonly purchase
catastrophic health insurance. The first is the young adults who are
self employed or do not have coverage through their employer.
They are healthy on no medications and would rather pay their
own office visit and save the premium. The second group is
primarily made up of individuals between the ages of 50 - 65. They
typically choose high deductibles $5,000 and up and are primarily
concerned with catastrophic losses associated with heart attacks,
cancer and other such illnesses.
53
Is Catastrophic Coverage the right choice?
As with all insurance people are gambling that they are going to
need the coverage. With catastrophic coverage they are eliminating
coverage to reduce premiums. They should be careful not to take a
deductible larger than they can afford and plan for what they are
comfortable with in the worst situation. They should shop around
or talk to an independent insurance agent to make sure they get a
plan that's right for them.
Traditional Health Insurance
Up until about 30 years ago, most people had traditional indemnity
coverage. These days, it's often known as fee-for-service.
Indemnity plans are a bit like auto insurance: people pay a certain
amount of medical expenses up front in the form of a deductible
and afterward the insurance company pays the majority of the bill
Advances in modern medicine increased the cost of providing
health care and made it possible for people to live longer. Those
advances caused many insurance companies to look for ways to
reduce their costs of doing business, giving managed care the boost
it enjoys today.
Fee-For-Service
For years, indemnity or fee-for-service coverage was the norm.
Under this type of health coverage, the insured has complete
autonomy when it comes to choosing doctors, hospitals and other
health care providers. He can refer himself to any specialist
without getting permission, and the insurance company doesn't get
to decide whether the visit was necessary.
54
Insureds don't, however, have complete autonomy. Most fee-for-
service medicine is managed to a certain extent. For instance, if the
insured is not already incapacitated, he may need to get clearance
for a visit to the emergency room.
On the down side, fee-for-service plans usually involve more out-
of-pocket expenses. Often there is a deductible, usually of about
$200, before the insurance company starts paying. Once the
insured pays the deductible, the insurer will kick in about 80
percent of any doctor bills. The insured may have to pay up front
and then submit the bill for reimbursement, or his provider may
bill the insurer directly.
Under fee-for-service plans, insurers will usually only pay for
reasonable and customary medical expenses, taking into account
what other practitioners in the area charge for similar services. If
the doctor happens to charge more than what the insurance
company considers reasonable and customary, the insured
probably have to make up the difference himself.
Traditionally, preventive care services like annual check-ups and
pelvic exams have not been covered under fee-for-service plans.
But as the evidence mounts that preventive care can prevent more
costly illnesses down the road, some insurers are including them.
Fee-for-service plans often include a ceiling for out-of-pocket
expenses, after which the insurance company will pay 100 percent
of any costs. Traditional fee-for-service coverage offers flexibility
in exchange for higher out-of-pocket expenses and is not for
everyone.
Shop around or talking to an independent insurance agent can
assure the person that he is getting the right insurance.
55
Preferred Provider Organizations (PPO'S)
"Managed Care"
A Preferred Provider Organizations is the least restrictive type of
managed care. PPOs have made arrangements for lower fees with a
network of health care providers. PPOs give their policyholders a
financial incentive to stay within that network.
For example, a visit to an in-network doctor might mean the
insured has to pay a $10 co-pay. If he wants to see an out-of-
network doctor, he has to pay the entire bill up front and then
submit the bill to his insurance company for an 80 percent
reimbursement. In addition, he might have to pay a deductible if he
chooses to go outside the network, or pay the difference between
what the in-network and out-of-network doctors charge.
With a PPO, an insured can refer himself to a specialist without
getting approval and, as long as it's an in-network provider, enjoy
the same co-pay. Staying within the network means less money
coming out of pocket and less paper work. Preventive care
services may not be covered under a PPO.
Exclusive Provider Organizations are PPOs that look like HMOs.
EPOs raises the financial stakes for staying in the network. If the
insured choose a provider outside the network, he is responsible
for the entire cost of the visit.
Is a PPO the right choice?
Rates and coverage vary form state to state so people should shop
or talk to an independent insurance agent to make sure the plan is
adequate
56
Point-of-Service (POS) "Managed Care"
A Point-of-Service plan is a little more least restrictive type of
managed care. Point-of Service plans like PPO's have made
arrangements for lower fees with a network of health care
providers and give their policyholders a financial incentive to stay
within that network.
However, Point-of-service plans introduce the gatekeeper, or
Primary Care Physician. Insureds need to choose their primary care
physician (PCP) from among the plan's network of doctors.
As with the PPO, they can choose to go out of network and still get
some kind of coverage. In order to get a referral to a specialist,
though, they usually must go through their PCP. They can still
choose to refer themselves, but it'll mean more hassles and more
money coming out of their pocket.
If a PCP refers a doctor who is out of the network, the plan should
pick up most of the cost. But if the insured refers himself out, then
he probably have to deal with more paper work and a smaller
reimbursement. He may also have to pay a deductible if you go
outside the network.
POS plans may also cover more preventive care services, and may
even offer health improvement programs like workshops on
nutrition and smoking cessation, and discounts at health clubs.
Health Maintenance Organizations (HMO's)
"Managed Care"
57
HMOs (Health Maintenance Organizations)
A Health Maintenance Organization plan is the most restrictive
type of managed care. Like Point-of Service and PPO's, HMO's
have made arrangements for lower fees with a network of health
care providers and give their policyholders a financial incentive to
stay within that network.
HMO plans also utilize a gatekeeper, or Primary Care Physician.
Insureds need to choose their primary care physician (PCP) from
among the plan's network of doctors. HMO's require that they only
see their doctors, and that they get a referral from their primary
care physician before they see a specialist. In most cases they need
to get clearance before they can visit the emergence room, if they
are able. In general, they must see HMO approved physicians and
use HMO approved facilities or pay the entire cost of the visit
themselves.
HMO plans generally cover more preventive care services, and
may even offer health improvement programs like workshops on
nutrition and smoking cessation, and discounts at health clubs.
Is an HMO the choice?
HMO coverage is a trade-off between premiums paid and plan
flexibility. HMO's offer some very attractive rates but are very
restrictive when it comes to coverage. Rates and coverage vary
form state to state so people should shop around on their own or
talk to an independent insurance agent to make sure they get a plan
that's right for them.
58
Group Life Insurance 10
Introduction
Finding quality employees is only part of the challenge of running
a successful business. Maintaining a well motivated staff is
probably a more difficult challenge. In today's labor market the
quality of benefits offered by the employer is a substantial
consideration of both prospective and current employees. They are
also interested in retirement and security for their families and
often times they look at the size of the benefit in contrast to their
out-of-pocket costs.
There are many plans to choose from and there is no right or
wrong answer in selecting a program for the company. Employers
have to think about how they would like to fund the plan, how
much they and their employees want to contribute, and how much
they want to contribute for their employees, if any. employers have
options. they can look at pure term life insurance which is fairly
cheap and provides substantial amounts of insurance or they can
look at a whole life program which provides cash value for
retirement purposes.
Just less than half of all life insurance in force in the United States
is group life insurance and the amount of coverage is in the
trillions of dollars. Many people rely on group insurance as their
primary insurance coverage.
In group life insurance a single contract is issued for a number of
people. In fact, each individual may not even be named in the
insurance contract. The employer will receive the master policy
and the employees will receive a Certificate of Insurance which
summarizes the coverage terms and explains the employee's rights
under the contract.
59
The employer is the applicant for the insurance plan and generally
provides the insurance for its employees as a benefit. The
employer selects the type of coverage and determines the amount
of coverage for each employee. The plan can be a "non-
contributory plan" which is funded entirely by the employer or a
"contributory plan" paid in-part by the employee.
The group must meet the underwriting requirements which rely on
the experience of the group as opposed to mortality or morbidity
tables.
Generally, a group plan has a lower cost than individual insurance
plans because the administrative, operations and selling costs are
much less to the insurance company. The employer either pays the
premiums, if the plan is non-contributory, or collects the funds
through pay-roll deductions and advances the funds to the
insurance company if the plan is a contributory plan.
As long as the "group" was not formed for the purpose of obtaining
insurance, almost any kind of group qualifies for group coverage.
For example, labor unions, trade associations, fraternal
organizations, creditor-debtor groups, and single-employer groups
can be issued group coverage although some states restricts the
groups to a minimum number of participants. Normally, at least 10
people must be enrolled; however, this number may be more or
less in different states.
As noted above, plans can be contributory or non-contributory.
Where the employer pays the premiums for all employees (the
non-contributory plan) it is assumed all employees will participate.
If the employee contributes to the premiums (the contributory
plan), some employees may not wish to participate because they do
not feel they can afford the smaller paycheck or because they have
coverage elsewhere.
60
In order to avoid burdensome and potentially unnecessary
administrative costs for employees who may only be employed a
short time, it is normal to have a probationary period of one to six
months before the employee is eligible to participate. After the
probationary period, a set enrollment window is provided for the
employee to participate. An employee who fails to sign-up during
the enrollment period may be required to provide evidence of
insurability if they should decide to enroll at a later time. Other
normal requirements for employees to qualify are that they must be
full time employees and, if contributory, they must authorize the
employer to deduct their share of the premium payment from their
paycheck (i.e. payroll deduction).
There are basically two types of insurance plans for group life
insurance programs:
Term Life Insurance – an annual renewable term (ART) policy is
the most common plan and provides the lowest cost life insurance
coverage. Participants do not have to provide evidence of
insurability each renewal period. The low costs results from the
fact the insurer has the right to increase premiums each year based
on the group’s experience during the previous year. The
policyholder also has the right to renew coverage each policy year.
Permanent Life (Whole Life) Insurance – there are several
variations of the permanent life insurance option:
Group Ordinary Plan – normally, if the employees contribute to
the plan they are allowed to own the cash portion. However, it may
be set-up that if an employee terminates employment, the cash
value will be forfeited and used to help fund the plan for the
remaining employees.
61
Group Paid-Up Plans – these plans are a combination of term life
insurance, paid by the employer, and whole-life insurance, paid by
the employee. The death benefit is a total of the two plans. At
retirement or termination the employee is entitled to the cash value
(paid-up) policy.
Group Universal Life Plans – these plans offer a greater degree
of flexibility than is usually found in other group life plans. The
employee pays most of the premium payments; however, they are
given certain latitude in selecting the amount of insurance and the
premium amount to be paid.
There are several methods of determining how much insurance
each employee can obtain through the group plan.
Flat benefits – usually when the employer wishes to provide a
small amount of insurance to the employees in order to maintain a
minimum contribution they will provide the same benefits to all
employees regardless of seniority, earnings, or position in the
company.
Earnings – another way to determine the amount of insurance for
each employee is a method based on their earnings. For example,
the plan may provide coverage calculated as a percent of earnings
(2.5 times annual salary).
Position – the position within the company may also be used to
provide different levels of insurance. For example, laborers or
operators may be allowed to participate in a $30,000 policy,
managers in a $60,000 policy and vice-presidents in a $100,000
policy.
Once the plan becomes effective and the employee is enrolled in
the plan, the employee remains qualified until the employee leaves
the plan or the plan is terminated. The plan must allow a
62
conversion privilege to a terminated employee which allows them
to convert their enrollment from a group plan to an individual plan
without providing new evidence of insurability. There is a 31 day
window for the employee to determine if they wish to exercise the
conversion period. If the terminated employee dies within that 31
day window, the benefits would be paid to the beneficiaries even
though cost of the 31 day conversion window is not paid by the
employee. Many group policies require the terminated individual
to enroll in a whole life policy.
Other forms of group life insurance include:
Franchise Life Insurance – used where participants are
employees of a common employer (i.e., the employer may operate
several companies) or are members of a common association or
society. The employer/association/society is a sponsor of the plan
and may or may not contribute to the premium payments. Unlike
the employer’s group plan, each individual will be issued an
individual policy which will remain in force as long as premiums
are paid and the employee/member maintains their relationship
with the sponsor. These are used by small groups who individually
do not meet the state’s minimum numbers laws.
Credit-Life Insurance – these are set-up by banks, finance
companies, etc., to provide coverage if the insured dies before a
loan is repaid; the policy benefits will be used to settle the loan
balance. The premiums are usually paid by the insured as a means
of collateralizing the loan.
Blanket Life Insurance – used to cover a group of individuals
exposed to a common hazard. For example, an airline may use this
type of insurance to cover the passengers on a commercial flight.
The insured are automatically covered and need not apply for the
coverage and are not issued any sort of policy or certificate of
coverage. At the termination of the hazardous event, the coverage
63
is terminated. Schools, sports teams, volunteer fire departments,
etc., are other examples of groups which may obtain coverage for
personnel while engaged in named activities.
Multiple Employer Trusts (MET) – the employer must become a
member by subscribing to the trust and is issued a joiner agreement
which spells out the relationship between the trust and the
employer and the coverage to which the employer has subscribed.
Used for employers who have a small group of employees and may
not meet the state’s minimum numbers laws. Each employee is
provided a certificate of insurance.
Any agreements and insurance policies within a business must be
integrated with the overall plan and objectives of the business.
Careful consideration must be given to the selection of the plan
which is right for the business owners and to the method of
funding their plan. It is important for insurance agents to work
closely with them in order to assure that the selected insurance
policies are suitable for their needs.
Additional Information and Facts
Business health care spending increased more than six-fold
between 1965 and 1994. With medical costs on the rise through
the 1980’s and 1990’s, various management surveys show that
healthcare expenditures remain the single most important concern
for U.S. employers.
Group Insurance Policies
A group insurance policy or master policy is issued to the policy
owner – the employer. Covered employees are issued a certificate
of insurance. The certificate lists what the policy covers, and
explains such things as how to file a claim, the term of insurance,
64
and the right to convert from group coverage to an individual
policy.
Group health insurance is generally subject to experience rating,
under which the premium modification factor is determined by the
experience of the group as a whole.
Disability Income
Group disability income coverage provides for loss of income
benefits due to a disability caused by an accident or sickness. The
amount of benefits paid is usually a percentage of the employee’s
weekly or monthly compensation, such as 60 percent or 70 percent.
This is intended to encourage employees to recover and return to
work. If 100 percent of compensation was paid to the injured
worker, there would be no incentive for him to return to work.
Benefits are payable following the policy’s elimination period
(EP). The EP is a waiting period during which the employee must
be totally disabled as defined by the policy. The elimination
period can be 7, 15, 30 days or longer.
Group disability benefits may be short-term or long term. Short –
term benefits are usually payable for up to one or two years. Short
term policies usually have short elimination periods such as 15 or
30 days.
Long-Term disability (LTD) benefits are usually paid out for a
longer benefit period such as five years or until the employee turns
65. Generally, LTD policies will have longer elimination periods
such as 90 or 180 days.
65
Accidental Death and Dismemberment
Accidental death and dismemberment coverage pays specific
amounts for specific injuries or for death. Benefits are only
payable if the injury or death is caused by an accident. Injuries
must result in specific losses such as loss of sight, arms, legs or
feet.
This coverage can be written as a separate policy or as a part of a
policy providing other group health insurance benefits.
66
67
Jobs and Growth Tax Relief Reconciliation Unit 11
Act of 2003
Introduction
1. The tax rate on long-term capital gains is reduced from 20
percent to 15 percent for taxpayers in the top four tax brackets, and
from 10 percent to 5 percent for taxpayers in the bottom two
brackets, effective for sales and dispositions after May 5, 2003.
The 5-percent rate will drop to 0 percent effective after December
31, 2007, but no change is scheduled for the 15-percent rate. The
new rates are effective for computing both the regular tax and the
Alternative Minimum Tax-these provision sunsets after December
31, 2008.
2. The temporary depreciation “bonus” enacted under the Job
Creation and Worker Assistance Act of 2002 is increased from 30
percent to 50 percent for new depreciable property that is acquired
after May 5, 2003, and generally placed in service before January
1, 2005.
3. The limit on the section 179 deduction for purchases of
qualifying depreciable property is increased from $25,000 to
$100,000 for property placed in service during tax years after 2002
and is indexed for inflation after 2003. The ceiling amount before
the deduction begins to be reduced also is increased, from
$200,000 to $400,000 - these provision sunsets after December 31,
2005. [NOTE the section 179 deduction is available only for
property acquired for use in a trade or business. It is not available
for property held for the production of income – as an investment –
and it is not available to trusts or estates.]
68
In other provisions, the Act:
4. Accelerates the reductions in the marginal tax rates for ordinary
income to 25 percent, 28 percent, 33 percent, and 35 percent,
effective January 1, 2003. These rates are effective for computing
both the regular tax and the Alternative Minimum Tax - these
provision sunsets after 2010.
5. Increases the taxable income level from $6,000 to $7,000 for
single filers and from $12,000 to $14,000 for married taxpayers
filing joint returns, effective in 2003. This provision is indexed for
inflation after 2003, but sunsets after 2004.
6. Increases the standard deduction and the 15 percent tax bracket
for married taxpayers filing joint returns to twice those for single
filers, effective in 2003. This provision also sunsets after 2004.
7. Increases the child tax credit from $600 to $1,000, effective in
2003. This provision also sunsets after 2004.
8. Increases the exemption from the Alternative Minimum Tax to
$40,250 for individuals and $58,000 for married taxpayers filing
joint returns. This provision also sunsets after 2004.
9. Taxes dividends paid by both domestic and foreign corporations
at the same rates as long-term capital gains - provision sunsets
after 2008.
69
Health Savings Accounts (HAS)
HEALTH savings accounts, let consumers set aside money tax-
free to pay for medical expenses, both now and in the future. But
the accounts have been controversial since their introduction in
January 2004.
Depending on the situation, they can be a wonderful tool to help
Americans become wiser, more price-conscious health care
consumers, or just another way for employers to pass along more
health care expenses to their workers. Many experts contend that
the accounts are basically a tax-shelter for people who are healthy
and wealthy enough to invest in them but don’t have to rely on
them to cover their care costs.
How are businesses handling HSAs? 66
Most businesses have not yet offered the accounts as an option to
their insurance plans. But as health costs continue to climb, some
businesses and individuals are more curious to try the idea. Since
they were established under the 2003 law that set up a prescription
drug benefit for Medicare, more than 425,000 accounts have been
established, according to a survey of administrators by Inside
Consumer-Directed Care, a newsletter based in Washington, and
more than 50,000 are being opened each month.
Nearly a year and a half into the experience, however, it is
becoming clear that while the accounts may be a reasonable option
for some people, there are potential drawbacks.
70
Basic requirements of HSAs
A health savings account must be paired with a health plan that
meets certain criteria, including a deductible of at least $1,000 for
individuals and $2,000 for families. Some employers offer them,
although individuals can also apply for a qualifying health plan and
open one of these accounts on their own.
Individuals can deposit money into their accounts to cover the
deductible and other medical expenses, and employers can also
deposit money for employees. Generally, the account balance earns
interest, though some accounts allow holders to invest the money
in mutual funds or other vehicles.
If an employee leaves his job, the money in his health savings
account stays with him. And these accounts, unlike flexible
spending arrangements, have no “use it or lose it” rule, so the
funds roll over from one year to the next. An account holder pays
no tax on withdrawn funds as long as they are used to pay for qual-
ified medical expenses. If the money is used for any other ex-
penses, it is subject to income tax and, for those under 65, to a 10
percent penalty. There are downsides to the Health Savings
accounts. The account balances may shrink even though the money
was used.
Cost of servicing HSAs
Typically, the companies that administer the accounts charge a
set-up fee of around $20, plus a monthly fee of about $2 or $3.
They may also charge an annual fee, as well as a transaction fee
every time a customer writes a check or uses the account’s debit
card. Some charge a fee to close an account. Other health savings
accounts, charges a one-time, $15 fee to open an account, and $36
annually to administer it. There is also a $2.50 monthly service
charge, which is waived if the balance is more than $2,500.
71
In the early years of an account, when the balance is typically
low, fees can take a relatively big bite out of the total.
Some companies permit an account holder to invest the balance in
stocks or mutual funds, though a certain minimum balance — say,
a few thousand dollars — may be required to do so. Such
investments, of course, offer a chance for greater returns — but
also the risk of losing money.
There are also ceilings, indexed to inflation, on annual
contributions: in 2005, it is the lower of the deductible or $2,650
for individuals and $5,250 for families. Account holders who are
55 or over can also make catch-up deposits. In 2005, the ceiling is
$600; it rises gradually to $1,000 in 2009.
But even if the investor deposits the maximum amounts and
don’t touch the money to pay for health care before he is 65,
studies have shown that he won’t accumulate enough to cover
medical expenses in old age.
The amount saved is not the only concern. There are other
wrinkles that can trip up consumers. For example, health savings
accounts cannot be used with many flexible spending arrangements
that are offered by employers.
Prescription drug coverage poses a problem for many people who
are considering whether to open health savings accounts. Starting
in January 2006, many prescription drug expenses in qualified
plans will be subject to the deductible. Now, consumers typically
pay only a portion of the drug costs from the outset.
Many major insurers and banks now offer the accounts to
individuals and companies. But details like fees and investment
options vary widely, as do the basics of the accompanying health
72
plans. The biggest drawback about Health Savings Accounts may
be that they can be very confusing. Because these accounts are still
relatively new and changing fast, the best advice may be to read
the fine print before recommending them or opening one.
AFTER YOU HAVE READ THE MATERIAL, YOU CAN
TAKE THE TEST ON-LINE BY CLICKING THE
FOLLOWING TEST SITE:
Colemantesting.com
A grade of 70 or higher is required to receive Continuing
Education credits.
73