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SENIOR MARKET
SPECIALIST ACCREDITATION
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Pennsylvania Life Senior Market
Specialist Accreditation
Contents
Chapter 1 Critical Issues in the Senior Market ................................................................... 1
Important Lesson Points.....................................................................................................................1
Maintaining Lifestyle.........................................................................................................................1
Providing Adequate Retirement Income........................................................................................2
Overcoming Purchasing Power Risk .............................................................................................2
Protecting Assets While Facing Long Term Care..............................................................................3
Likelihood of Needing Long Term Care .......................................................................................4
Types of Long Term Care..............................................................................................................5
Long Term Care Costs...................................................................................................................6
Sources of Long Term Care Funding.............................................................................................6
Transferring Assets to the Next Generation.......................................................................................9
Determining Asset Disposition......................................................................................................9
Minimizing Estate Transfer Costs .................................................................................................9
Ensuring Liquidity .......................................................................................................................15
Summary..........................................................................................................................................17
Chapter 1 Review.............................................................................................................................19
Chapter 2 Medicare and Medigap....................................................................................... 21
Section A. Medicare.........................................................................................................................21
Basic Eligibility ...........................................................................................................................21
Basic Enrollment..........................................................................................................................22
Basic Benefits ..............................................................................................................................24
Basic Deductibles ........................................................................................................................25
Basic Co-Payments......................................................................................................................25
Basic Claims ................................................................................................................................25
Mechanics of Medicare................................................................................................................29
Mechanics of Part A - Hospital Insurance ...................................................................................30
Skilled Nursing Facilities Covered by the Original Medicare Plan.............................................32
Mechanics of Part B – Medical Insurance ...................................................................................36
Mechanics of Rates......................................................................................................................38
Mechanics of Emergency Services ..............................................................................................38
Mechanics of Appeals and Grievances........................................................................................39
The Medicare Prescription Drug Improvement and Modernization Act of 2003 (MMA) ..............40
Medicare Law Changes ...............................................................................................................40
New Medicare Benefit Coverages ...............................................................................................41
Introduction and Implementation of the New Medicare Part D (Prescription Drug) Program....42
Part B Premium Increases for High Income People beginning in 2007 ......................................44
Medicare Advantage—New Name for Medicare + Choice.........................................................44
Incentives for Private Business to Keep Retired Employees on Group Health Plans .................46
A Revision in Medicare Supplement Rules—Plans “K and L” Replace Plans “H, I, and J” ......48
Commentary ................................................................................................................................49
Section B. Medigap..........................................................................................................................53
Basics of Medicare Supplement ..................................................................................................53
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Pennsylvania Life-Senior Market Specialist Accreditation
Basic Medicare Supplement Plans...............................................................................................54
Basic Enrollment..........................................................................................................................58
Basic Age Rating .........................................................................................................................59
Basic Factors................................................................................................................................60
Basic Prescription Drugs .............................................................................................................60
Basic Rights Upon Leaving a Managed Care Plan......................................................................61
Basic Medicare Supplement (Medigap) Compare.......................................................................61
Medicare Supplement Replacement — Ethics and Legality .......................................................62
Basics of Medicare+Choice — History .......................................................................................62
Introduction to Medicare+Choice — Medicare Advantage.........................................................63
Basic Medicare+Choice (Medicare Advantage)..........................................................................66
Section C. Medicare and the Big Picture .........................................................................................69
Medicare as Secondary Payor — Coordination with Group Health Insurance ...........................69
Medicare Education .....................................................................................................................70
Medicare Fraud............................................................................................................................71
Medicare and Prescription Drugs ................................................................................................75
Medicare+Choice (Medicare Advantage) and Plan Withdrawal .................................................75
Medicare’s Contract with Group Health, Inc...............................................................................76
Medicare’s Customer Service......................................................................................................77
Medicare in the New Millennium — Medicare and Home Health Care .....................................77
Medicare’s Premiums and Benefits .............................................................................................78
Medicare’s Costs and Payments ..................................................................................................79
Chapter 2 Review.............................................................................................................................80
Chapter 3 Introduction and Implementation of the New Medicare Part D Prescription
Drug Program ....................................................................................................................... 81
Choice of Drug Plans .......................................................................................................................81
MA and PDP Regions..................................................................................................................81
Eligibility Guidelines .......................................................................................................................82
Enrollment Periods ......................................................................................................................82
Drug Plan Benefit Designs...............................................................................................................84
The Standard Drug Benefit ..........................................................................................................84
Alternative Coverage ...................................................................................................................85
Enhanced Alternative Coverage ..................................................................................................85
Value-Added Items and Services.................................................................................................85
Covered Part D Drugs......................................................................................................................85
Part D Formularies.......................................................................................................................86
Eligible MA-PD and PDP Enrollee Expenses .............................................................................86
Annual Notice of Change ............................................................................................................86
Consequences for States and People with Low Incomes .................................................................87
State Pharmaceutical Plans: Medicare Part D Implications.........................................................87
State Medicaid Programs: Medicare Part D Implications............................................................87
Medicare Part D Low-Income Subsidies and Groupings.............................................................87
Medicare-Approved Drug Discount Cards ......................................................................................90
Incentives for Private Businesses to Keep Retired Employees on Group Health Plans ..................91
PDP Enrollment Process (The Process May Vary for a MA-PD)....................................................91
Required Materials and Forms.....................................................................................................91
Effective Date ..............................................................................................................................92
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Contents
Enrollment Process ......................................................................................................................92
Summary of Responsibilities .......................................................................................................92
Anti-Discrimination .........................................................................................................................93
Payment Options..............................................................................................................................93
Missed Premium Payments..........................................................................................................93
Disenrollment Procedures................................................................................................................93
Where to Obtain Prescription Drug Services (Claims) ....................................................................94
Appeals and Grievances...................................................................................................................95
Advertising.......................................................................................................................................95
Advertising/Marketing Material Language Requirements: .........................................................95
Solicitation Limitations/Restrictions ...........................................................................................97
General Guidance about Promotional Activities..............................................................................98
Nominal Gifts ..............................................................................................................................98
Drawings/Prizes/Giveaways ........................................................................................................99
Hold Time Messages ...................................................................................................................99
Health Fairs and Health Promotional Events...............................................................................99
Provider Promotional Activities ................................................................................................100
Referrals.....................................................................................................................................100
Market Conduct .............................................................................................................................100
Violations of MA-PD or PDP business policies or CMS/DOI regulations....................................101
Major Violations........................................................................................................................101
Lesser Violations .......................................................................................................................102
Chapter 3 Review...........................................................................................................................103
Chapter 4 Annuities............................................................................................................ 105
Important Lesson Points.................................................................................................................105
The Concept...................................................................................................................................106
Traditional Role .........................................................................................................................106
Accumulation Period .................................................................................................................106
Distribution Period.....................................................................................................................108
Traditional Fixed Annuity Characteristics.....................................................................................111
Premiums ...................................................................................................................................112
Lives Covered............................................................................................................................112
Annuity Starting Date ................................................................................................................113
Accumulated Value....................................................................................................................113
Payout ........................................................................................................................................113
Tax Treatment............................................................................................................................114
Fixed Annuity Variations...............................................................................................................115
Multi-Year Guaranteed Annuities..............................................................................................115
Bonus Annuities.........................................................................................................................116
Equity Indexed Annuities ..........................................................................................................116
Variable Annuities .........................................................................................................................118
Summary........................................................................................................................................119
Chapter 4 Review...........................................................................................................................120
Chapter 5 Long Term Care Insurance ............................................................................. 121
Important Lesson Points.................................................................................................................121
The Concept...................................................................................................................................122
Benefits Provided by Long Term Care Insurance..........................................................................122
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Pennsylvania Life-Senior Market Specialist Accreditation
Nursing Home............................................................................................................................122
Home Care .................................................................................................................................122
Assisted Living Facility.............................................................................................................123
Adult Day Care Facility.............................................................................................................123
Hospice Care..............................................................................................................................123
Benefit Triggers .............................................................................................................................124
Product Characteristics ..................................................................................................................124
Elimination Period .....................................................................................................................124
Benefit Period ............................................................................................................................125
Inflation Protection ....................................................................................................................126
Tax-Qualified vs. Non-Tax Qualified............................................................................................127
Tax Status of LTC Policies........................................................................................................127
Changed Benefit Triggers..........................................................................................................128
Summary........................................................................................................................................128
Chapter 5 Review...........................................................................................................................130
Chapter 6 Life Insurance ................................................................................................... 131
Important Lesson Points.................................................................................................................131
The Concept...................................................................................................................................131
Estate Liquidity..........................................................................................................................132
Equalizing Inheritance ...............................................................................................................135
Replace Gifted Assets................................................................................................................135
Characteristics of Life Insurance Policies......................................................................................137
Whole Life Insurance.................................................................................................................137
Universal Life Insurance............................................................................................................139
Survivorship Life Insurance.......................................................................................................141
Life Insurance for Final Expenses .............................................................................................143
Summary........................................................................................................................................145
Chapter 6 Review...........................................................................................................................147
Appendix A Answers to Chapter Quizzes ........................................................................ 149
iv

Chapter 1
Critical Issues in the Senior Market
Important Lesson Points
The important points addressed in this chapter are:
• Modifying lifestyle to accommodate reduced income may be a difficult transition at any point
in life
• Traditional retirement income replacement levels may be too modest for many retirees
• The risk of loss of purchasing power in retirement has been heightened by increased life
expectancy and must be appropriately addressed in retirement planning
• The need for long term care has increased as a consequence of generally greater life
expectancy
• More than one-half of all Americans will require long term care at some time in their life
• Long term care is more than confinement in a nursing home; it includes home care, adult day
care, hospice care and other types of care
• Long term care provided at home is far more prevalent than institutionalization
• Long term care costs are substantial and are increasing over time
• Although Medicare funding for long term care has increased, the major source of long term
care funding continues to be Medicaid, a program for the indigent
• Strategies for minimizing estate transfer costs include asset re-titling, trust creation and
deferred charitable giving programs
• Additional estate liquidity may be required to replace gifted assets, equalize inheritance or to
provide funds for estate settlement; regardless of why required, its least expensive source is
life insurance
Maintaining Lifestyle
A luxury once enjoyed becomes a necessity. For the couple that spends each holiday in a different
European capital and vacations in their summer home in Nantucket, the need to restrict their vacation
to two weeks in the Catskills may be a hardship, despite the beauty and serenity of the mountains.
Although the example may be hyperbole, the principle is a sound one. The fact is that modifying
one’s lifestyle downward is often a wrenching experience. This principle has important application in
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Pennsylvania Life-Senior Market Specialist Accreditation
two areas for individuals nearing retirement: establishing a retirement income level and maintaining
that level’s purchasing power over the many years in which retirement may stretch.
Providing Adequate Retirement Income
Prevailing wisdom suggests that an individual will have an adequate retirement income upon
replacement of 50 percent to 70 percent of his or her pre-retirement income. To more fully appreciate
that retirement yardstick, one should place him- or herself in the position of the retiree on the day
before retirement. On that day, he or she may be earning $100,000 a year; two days later, on the day
after retirement, that $100,000 has shrunk to $50,000 or $70,000. Income has declined by $30,000 to
$50,000 per year! All of a sudden, that yardstick may seem a little short and will require a serious
review of spending patterns, resulting in a downward revision of one’s lifestyle.
It is far wiser—and much more practical—to plan on replacing one’s entire income in retirement. To
do anything less is to ensure that one’s retirement income will decline just when the retiree has time
available to travel and do those things that are likely to increase his or her spending rather than
decrease it. While establishing an adequate income level in retirement is critical, it is just as important
to ensure that its purchasing power doesn’t decline either.
Overcoming Purchasing Power Risk
Americans are living longer than ever before as a result of medical advances and successful research
into the causes and treatment of various dread diseases. Consider the changes in longevity. When the
19 th century became the 20 th , the average life expectancy of an American was about 47 years. A child
born in 2001, however, can expect to live 77.2 years, a 64 percent increase in average lifespan.
Despite the impressiveness of that statistic, it doesn’t tell the entire story. Much more telling than the
life expectancy of a child at birth, for purposes of retirement income planning, is the life expectancy
of an individual who has reached an age when he or she may retire. According to recent National
Vital Statistics Reports 1 , an individual reaching age 65 has an average life expectancy of 18.1 years—
16.5 years if the individual is male, and 19.5 years if female.
Not surprisingly, Americans over age 85 are the group with the greatest life expectancy gains.
Because of this longevity increase, it would not be unusual for an individual retiring today to have a
period of retirement that is as long as—or, possibly, longer than—his or her working years. While this
increased retirement period is welcome, it creates some significant financial challenges for these
retirees.
The economics of aging have changed dramatically as a result of retirees’ increased life expectancy.
Most significant of the financial challenges that result from this greater longevity is maintaining the
purchasing power of retirement income. Unless appropriate precautions are taken, the likelihood of
long-term inflation could result in the financially-comfortable retiree being hard pressed to maintain a
lifestyle that comes anywhere near the lifestyle he or she enjoyed just after retirement.
To gain some appreciation of the impact of inflation, we need only look at what has occurred over the
last thirty years. If we use the change in the consumer price index as an accurate measure of
inflation’s impact on a retiree, there is sufficient cause for concern. In fact, a 1970 retiree would need
an income in 2000 that was equal to 454 percent of his or her income in the first year of retirement
simply to compensate for the erosion of its purchasing power. If we can reasonably project the same
1 National Vital Statistics Reports, Vol. 51, No. 5, March 14, 2003.
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Chapter 1 — Critical Issues in the Senior Market
inflation rate over the next thirty years, we can gain some insight into the ravages of inflation on a
clients’ life.
Consider what the various consumer items are likely to cost in thirty years, if the same level of
inflation applies as was experienced in the last thirty years:
An average lunch for one at a fast-food outlet will cost $18.00
A gallon of milk will cost $9.50
A new book will cost $130
A new suit (currently about $500) will cost $2,800
Dinner for four at a good restaurant will cost $1,600
New men’s shoes (currently about $85) will cost $385
A gallon of regular gasoline will cost $7.30
A pound of steak will cost $23.00
A pound of hamburger will cost $12.00
A loaf of bread will cost $6.00
Many retirees can modify their lifestyle to accommodate generally rising prices, some more easily
than others. Furthermore, some of the items considered in the inflation indicator may not be things on
which older Americans are likely to spend their money. Specifically, a retired individual may have
little interest in purchasing a new home or sending a child or grandchild to college. There is a sizable
difference in being able to do those things and choosing to do them, however. These inflated numbers
should tell us that any client may face real economic hardship unless the erosion of purchasing power
is not specifically addressed in retirement planning.
Protecting Assets While Facing Long Term Care
The generally longer lifespan enjoyed by retirees has implications that go beyond their ability to
maintain a particular lifestyle in the face of inflation. It seems fairly clear that a continually aging
population is far more likely to require assistance in meeting everyday needs of living as its members
become older. In somewhat more technical terms, gains in mortality have resulted in morbidity
concerns.
According to a survey sponsored by Merrill Lynch, it is anticipated that a male retiree who is age 65
in 2011 will spend about $115,000 in medical costs between the date of his retirement and the date of
his death, while women can expect to spend about 11 percent more. 2 Many of these costs can be
attributed to the expenses of long term care.
In generations past, old age was a rarity. Those individuals that were beyond “working age” often just
died before getting very much older. Unlike these individuals whose typical lifespan was far shorter
than the current average, future generations bear a far greater financial burden resulting from old age.
2 Merrill Lynch Third Annual Retirement Survey, 1991, Dr. B.D. Bernheim, Stamford Univ.
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Pennsylvania Life-Senior Market Specialist Accreditation
Likelihood of Needing Long Term Care
When one thinks about long term care, it is not unusual to conjure up images of bedridden patients
hooked up to monitors and intravenous drips or, in the alternative, to picture rows of slack-jawed
elderly sitting in wheelchairs staring off into space. While both of these pictures may sadly contain a
level of truth, long term care is much broader than either of them suggests.
A good definition of long term care is contained in a booklet on the subject published by the New
York State Insurance Department:
Long-term care (LTC) refers to a broad range of supportive medical, personal, and
social services needed by people who are unable to meet their basic living needs for an
extended period of time because of accident, illness, or frailty. LTC involves receiving
the assistance of another person(s) to perform the essential activities of daily living
(ADLs) when these tasks can no longer be performed independently. The ADLs include
eating, bathing, dressing, mobility, transferring (e.g., moving from bed to chair), using
the toilet, and maintaining continence. ADL assistance may be provided at home by
formal (paid) caregivers, such as home health aides, by informal (unpaid) caregivers,
such as family members or friends, or in a nursing home. 3
When professionals talk about the need for long term care, they generally mean these activities of
daily living. But just how likely is it that anyone will need long term care For many people, the
answer to that question will be even more surprising than the comprehensive definition of long term
care.
According to Americans for LTC Security, over 50 percent of all Americans will need long term care
in their lifetime. 4 By age 75, it is estimated that the likelihood of requiring long term care increase to
almost 60 percent. The Wall Street Journal also weighed in on the likelihood of needing long term
care by observing that “For a couple turning 65, there is a 75% chance that one of them will need long
term care.” 5 Furthermore, one in seven men and one in three women who became 65 in 1990 are
expected to spend at least one year in a nursing home. 6
It seems clear that the likelihood of needing long term care is substantial. When compared to other
insurable—and well-insured risks—the probability of needing long term care is put in much greater
perspective. Although the likelihood of experiencing a fire in your home is one in 1,200, the
probability of having an automobile accident is much greater at about one in 240. However, the risk
of experiencing a long term care event is about one in 2. 7
3 Insider’s Guide to Long Term Care: Understanding the New York Plans, 1995, p3.
4 Americans for LTC Security, August 1999.
5 Wall Street Journal, June 2000.
6 The New England Journal of Medicine, February 28, 1991.
7 National Academy of Elder Law Attorneys, 1999.
4

Chapter 1 — Critical Issues in the Senior Market
Types of Long Term Care
Just as the definition of long term care is replete with myth, the vision of institutionalization as
synonymous with long term care is equally unbalanced. In addition to institutionalization in a nursing
home, the types of long term care include:
• Home care
• Care provided in an assisted living facility
• Adult day care, and
• Hospice care
In fact, home care is far more frequently chosen as the venue of choice than is a nursing home.
Family caregivers provide as much as 80 percent of long term care while institutions such as nursing
homes provide a far smaller, albeit more visible, 20 percent.
So that we all have the same understanding when we talk about these types of long term care, let’s
take a moment to describe each of them.
Nursing homes are institutional settings in which care may be provided in skilled care facilities,
intermediate care facilities or custodial care facilities. A skilled care facility is one that provides a
professional type of nursing assistance performed by trained medical personnel under the supervision
of a physician or other qualified medical personnel; skilled nursing care is the only type of nursing
home care eligible for reimbursement under Medicare. An intermediate care facility is an institution
that provides occasional nursing and rehabilitative care that can be performed by, or under the
supervision of, skilled medical personnel only. Care must be based on a doctor’s orders. A custodial
care facility is an institution that provides care that is primarily for the purpose of meeting personal
needs and assistance with the activities of daily living. Custodial care generally involves help with
bathing, walking, dressing, eating or taking medication. It may be provided by someone without
medical skills or training, but the care must be according to doctor’s orders.
Home health care is a program of professional, paraprofessional and skilled care that is normally
provided through a home health care agency to an individual at home. The care can include nursing
services and physical, speech, respiratory and occupational therapy.
An assisted living facility (ALF) is a residence for individuals requiring some long term care services
but not as many services as individuals that would normally qualify for a nursing home. It provides a
generally less expensive alternative to custodial care.
An adult day care facility is an institution designated to provide custodial and/or minimum health
care assistance to individuals unable to remain alone. Typically, adult day care is provided during
working hours when the primary caregiver is employed.
Hospice care is care designed principally to control the pain and symptoms of the terminally ill but
may also provide support services to family members.
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Pennsylvania Life-Senior Market Specialist Accreditation
Long Term Care Costs
With so many long term care options available in so many different geographic locations, it should
not be any surprise that getting a fix on long term care costs presents certain challenges. Despite this
variation, we can determine some national averages and cost ranges.
The average annual cost for a nursing home is about $45,000 per year. By the year 2030, this annual
cost is expected to increase to at least $190,000 per year.
Assisted living facilities generally range from $12,000 to $36,000 per year, with an average of
slightly more than $25,000. This cost, too, is expected to rise to $109,000 by 2030.
The hourly cost for home health care aides is just as location-dependent and varies from $12 per hour
to about double that. The current average cost per home health aide visit is about $61, and this is
expected to rise to $260 per visit by 2030.
Adult day care costs generally run about $50 per day and are expected to increase to $220 per day by
2030.
While the projected future costs for these long term care services are staggering 8 , current costs are
fairly significant as well. As we will see in just a moment, the magnitude of these costs for many
individuals means that by the time they die they will have exhausted all of their assets and be relying
on state and federal programs for the indigent.
Sources of Long Term Care Funding
There are a finite number of funding sources that individuals or their families look to when in need of
long term care. The traditional long term care funding sources are:
• Medicare
• Medicare supplementary insurance
• Medicaid
• The individual’s assets
• The individual’s family
• Long term care insurance
Let’s consider the probability and consequences of relying on each of these potential sources of long
term care funds.
Medicare is a federal health insurance program for persons age 65 or older, individuals of any age
with permanent kidney failure and certain disabled persons. It provides Hospital Insurance protection
under Part A and a voluntary Medical Insurance program under Part B. Although its main thrust is the
providing of hospital insurance, it also provides for coverage in a skilled nursing facility under certain
circumstances.
In order for an individual to be covered for skilled nursing facility benefits under Medicare, the
individual must meet all of the following five conditions:
8 Source: American Council of Life Insurers
6

Chapter 1 — Critical Issues in the Senior Market
1. The individual’s condition requires daily skilled nursing or skilled rehabilitative services
which can only be provided in a skilled nursing facility;
2. The individual has been in a hospital at least three days in a row (not counting the day of
discharge) before being admitted to a participating skilled nursing facility;
3. The individual must be admitted to the skilled nursing facility within a short time after
leaving the hospital; (the “short time” generally means within 30 days)
4. The individual’s care in the skilled nursing facility is for a condition that was treated in the
hospital, or for a condition that arose while receiving care in the skilled nursing facility for a
condition which was treated in the hospital
5. A medical professional certifies that the patient needs, and receives, skilled nursing or skilled
rehabilitation services (post-hospital extended care) on a daily basis.
In the event that the individual meets all five of these criteria and his or her condition is deemed to be
capable of improving, Medicare Part A will pay for the first 20 days of care in a skilled care facility in
its entirety. After 20 days, the individual must pay a coinsurance amount from the 21 st to the 100 th
day. (In 2005, the daily coinsurance amount is $114; this amount generally increases annually.) After
the 100 th day, nursing home coverage ceases, and the individual is required to pay the entire cost of
the skilled care.
There are a number of issues to consider when evaluating Medicare as a source of long term care
funding:
• First, and most important, is the requirement that the facility be a skilled nursing facility.
Most nursing homes in the United States are not skilled nursing facilities, and many skilled
nursing facilities are not certified by Medicare.
• Second, the individual’s condition must be improving; if the condition is not deemed to be
capable of further improvement, reimbursement for treatment in a skilled care facility ceases.
• Third, the great bulk of nursing home stays are custodial in nature, rather than requiring
skilled care.
• As a result of all of these requirements, Medicare generally pays less than one-fifth of annual
nursing home expenditures
Medicare supplementary insurance fills in some of the long term care financing gaps left by
Medicare—but not many. From the perspective of providing benefits for long term care, Medicare
supplementary insurance policies provide little help. The long term care benefits that these policies
provide are 9 :
Skilled nursing care (Plans C through J)
• These plans provide benefits for the coinsurance payment due from the insured for skilled
nursing care for days 21 through 100 ($114 per day in 2005)
• No benefit is provided under these plans for skilled nursing care beyond day 100 nor for any
custodial care at any time
9 How to Sell Long Term Care Insurance, p 97.
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Pennsylvania Life-Senior Market Specialist Accreditation
• Home health care (Plans D, G, I and J)
• These plans provide an at-home recovery benefit of $40 per day, up to $1,600, following an
illness or injury provided the follow-up care is ordered by a physician
Medicaid is a joint state-federal welfare-assistance program designed to provide access to healthcare
benefits for the indigent. Not surprisingly, given the substantial costs of long term care, Medicaid has
become one of the principal sources of long term care funding as individuals quickly meet the
indigent criteria after they have spent their existing assets on nursing home expenses. According to
recent studies, 10 Medicaid expenditures for nursing home care have declined somewhat from 48.8
percent in 1987 to 44 percent in 1996, at the same time that Medicare’s expenditures have risen from
1.9 percent to 18.9 percent.
Self-payment is, of course, a source of funding for nursing home care. Nursing home care payments
coming from the individual’s assets or those of his or her family accounted for 30.3 percent of the
funding in 1996. In many cases, self-payment is simply the first source of long term care funds and,
when those funds are exhausted, individuals typically rely on Medicaid for future funding.
Although much long term care still takes place in the individual’s home, that type of care often
depends on the availability of extended family caregivers, a commodity that is becoming increasingly
scarce. At one time in the somewhat distant past, the typical family unit consisted of a husband who
functioned as the breadwinner and a wife whose primary occupations were child-rearing and
household-managing. The wife was the principal provider of care of all sorts for members of an
extended family, and children were expected to provide care for their aging parents. This family
model has not depicted the typical American family for several decades. Instead, many families rely
on the incomes of both a husband and a wife simply to meet regular household expenses.
While family economics has played a big role in the reduced availability of family caregivers, that
isn’t the entire reason for the increasing reliance on other arrangements. In addition to the need for
multiple incomes, families have experienced an increased physical separation of the generations. This
geographic dispersal of family generations has usually resulted from employment changes and
transfers. Regardless of the underlying reasons, however, it often means that fewer sons and
daughters are within a reasonable distance of aging parents.
Private insurance, as a funding source, more than doubled in the period 1987 to 1996, from 1.6
percent of expenditures to 3.5 percent.
The payment sources for nursing home care in 1996 were as follows:
Medicaid Medicare Self-Payment Private Insurance Other
44.0% 18.9% 30.3% 3.5% 3.3%
10 MEPS, Nursing Home Expenses, 1987 and 1996, p 5.
8

Chapter 1 — Critical Issues in the Senior Market
Transferring Assets to the Next Generation
The prospect of losing some or all of those assets that have been accumulated over a lifetime is one
that has traditionally caused individuals to seek the most efficient and effective means of minimizing
their erosion and ensuring their transfer to the next generation. Generally, the process of efficiently
transferring assets to the next generation involves three important steps:
1. Determining asset disposition
2. Minimizing estate transfer costs
3. Ensuring estate liquidity
Each of these steps is comprised of two or more other steps. Let’s begin our discussion of the process
of transferring assets to the next generation by considering what needs to be done in determining the
disposition of assets.
Determining Asset Disposition
When we talk about determining asset disposition, we mean the process of gathering data about the
prospect and assisting him or her in establishing financial objectives that involve the transfer of
wealth; in short, estate and financial planning. Although planning for any individual may involve
additional issues, the generally significant considerations for many individuals involve:
• The improper disposition of assets
• Inflation—the reduction in purchasing power
• Inadequate retirement income
• Excessive asset transfer costs
• Lack of estate liquidity
We will discuss the important considerations in the planning process to produce the greatest results in
chapter five. For now, we will briefly look at two of the most critical issues for wealth transfer:
minimizing estate transfer costs and ensuring liquidity.
Minimizing Estate Transfer Costs
The term “estate” is one that is frequently misunderstood, principally because it is used to refer to
somewhat different concepts. For that reason, let’s make a clear distinction early in our discussion.
“Estate” is often used to refer to the assets that are distributed by an individual’s will or under a
state’s intestacy laws. When used in this sense, “estate” means the probate estate.
The other sense in which the term “estate” is used is in reference to the total assets subject to federal
estate taxation at their owner’s death. When used in this sense, “estate” means the federal gross estate.
Although the two concepts have a certain relationship, they are not identical. While any assets
included in the probate estate are also included in the federal gross estate, the reverse is not true.
Many assets included in an individual’s federal gross estate are not included in his or her probate
estate, i.e. they do not pass through the decedent’s will or under intestacy laws.
Although there are many examples that might be used to demonstrate the difference between these
two “estates,” the treatment given to life insurance policy death benefits illustrates it well. In the
typical situation, an insured under a life insurance policy owns all the rights to his or her policy,
including the right to name a beneficiary. If the insured names a beneficiary other than the estate, the
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Pennsylvania Life-Senior Market Specialist Accreditation
death benefits will not be distributed through his or her will; instead, they will be distributed by virtue
of the beneficiary designation. In such a case, the proceeds will not be a part of the probate estate.
However, the death proceeds will be a part of the insured’s federal gross estate—the estate for tax
purposes. Additionally, the value of certain jointly-held property will also be included in the
decedent’s federal gross estate, even though the title to the property, itself, may be transferred
immediately at death to a joint owner. When used in this course, the term “estate” means the federal
gross estate unless the words “probate estate” are used.
Although there are other costs involved in the transfer of assets from one individual to another or
from one generation to another, such as probate and trustee costs, the principal costs in larger estates
are generally tax costs. For persons with substantial assets the largest costs may be federal estate
taxes, but other taxes frequently come into play, such as capital gains taxes on the sale of a family
business and state death taxes.
There are many techniques and strategies that may be employed to minimize estate transfer costs, and
we will look at three of the most useful:
• Asset re-titling
• Trust creation, and
• Deferred charitable giving programs
Asset Re-Titling
Asset re-titling involves changing the way in which property is held by the individual. Often such retitling
involves a non-charitable gift, so the planner needs to be sensitive to any gift tax consequences
of the re-titling. The transfer-cost reason behind re-titling is simple: an individual’s estate for tax
purposes is generally comprised of all property that he or she owns or in which any incident of
ownership is possessed. By re-titling an asset and, thereby, gifting it to its eventual owner it is
normally removed from the estate.
Formerly, all gifts made by an individual who then died within three years following the gift would
be includible in the individual’s estate for tax purposes. The rule by virtue of which gifts made within
three years of death were brought back into the estate was initially known as the causa mortis (in
contemplation of death) rule and subsequently as the “bringback rule.” However, gifts made within
three years of death by individuals that die after 1981 are no longer brought back into the donor’s
gross estate. There are two important exceptions to the rule that gifts made prior to death are excluded
from the donor’s estate, however.
1. If an individual makes a gift of property and retains an interest in the property, the retained
interest will result in the property being included in his or her estate at death. That retained
interest could be any of several interests, including a retained life estate (retaining the right to
use the property during the balance of the donor’s life), a transfer of the property while
retaining the power to revoke or amend the transfer, or retaining one or more rights to a life
insurance policy (the right to receive dividends, change the beneficiary, take a loan, etc.), and
2. The gift of a life insurance policy made within three years of the insured’s death is
automatically brought back into the insured’s estate, even though all right, title and interest to
the life insurance was irrevocably transferred. The value of the life insurance policy in the
estate is equal to the death benefit proceeds.
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Chapter 1 — Critical Issues in the Senior Market
Generally, any gift made is subject to gift tax to the extent that it exceeds the annual gift tax
exclusion. The gift tax exclusion amount in 2005 is $11,000. (If a spouse joins in the gift—making
what is known as a “split gift”—the annual gift tax exclusion amount is doubled.) Any gift tax paid
by an individual on gifts made within three years of his or her death is also included in the donor’s
gross estate, even if the gift itself is not included in the estate.
Trust Creation
Trusts are often used to facilitate the transfer, management and disposition of property and/or its
income. They have particular application in the minimizing of estate transfer costs. Before
considering how trusts work and the types of trusts that can be used, however, let’s get an
understanding of just what a trust is.
A trust is a relationship created through a legal document whereby a trust grantor transfers property to
a trustee who is responsible for carrying out the terms of the trust for the benefit of the trust’s
beneficiaries. The trust grantor is the donor of the property that is gifted to the trust; he or she is also
referred to as the trustor or creator and is the individual that creates the trust and names the trustee.
The trustee is the person—either a natural person or a legal person—that carries out the terms of the
trust document and manages the assets placed in trust. The trust beneficiaries are those individuals for
whose benefit the trust is created. The beneficiaries may be entitled to income from the trust, to the
corpus of the trust or to both.
At the risk of complicating the subject of trusts, it is important that certain trust terms and concepts be
introduced. Trusts are generally categorized according to:
• Whether or not they can be changed
• When they are created
These distinctions are critical to their ability to accomplish the objectives for which they are created.
When we categorize a trust in terms of the grantor’s ability to change it once it is created, we are
considering whether it is:
• Revocable, or
• Irrevocable
A revocable trust is a trust in which the grantor retains the right to change the trust terms or take back
the property he or she placed in the trust at any time. Although this type of trust has no tax
advantages, some of the reasons for its use include:
• It acts as a will substitute with respect to the assets placed in trust, ensuring privacy. Unlike
probate, which is open to public scrutiny, neither the terms of the trust nor the value of the
trust property are made public.
• It can be used to manage and invest property for a beneficiary that is unable or unwilling to
take on that responsibility.
• Payment of insurance proceeds to a trust can provide greater payment flexibility than if those
proceeds were placed under a settlement option.
However, it is important to reiterate that a revocable trust offers no tax benefits. Trust income is
taxable to the trust grantor, and property placed in it becomes part of the grantor’s estate at death.
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Pennsylvania Life-Senior Market Specialist Accreditation
However, since the grantor has not relinquished ownership of the property placed in a revocable trust,
no gift occurs. Since no gift occurs, no gift tax liability arises.
An irrevocable trust is a trust wherein the grantor gives up all control over the assets transferred to it.
Unlike a revocable trust, a grantor cannot recover the assets transferred to an irrevocable trust or
amend its terms. The principal reasons why a grantor might create and use an irrevocable trust are
principally tax reasons and include the following:
• The property placed in the trust, unless subject to the bringback rule, is not included in the
grantor’s estate at death. (Life insurance transferred to the trust within three years of death, or
property in which the grantor retains any interest, is not excluded from the estate.)
• The grantor is not liable for trust income, provided there are no strings attached to the
transfer. The trust is liable for income taxes on income accumulated in the trust, and the
beneficiaries are liable for income tax on income distributed to them.
When a grantor transfers property to an irrevocable trust it is a gift subject to gift tax liability. As long
as the grantor gives the trust beneficiaries certain withdrawal rights to property placed in the trust,
however, the transfer qualifies for the annual gift tax exclusion as a gift of a current interest. As a
result of that qualification, the grantor may make a transfer of property to the trust up to an amount
equal to the annual gift tax exclusion amount without being liable for gift taxes. (The amount that
may be transferred without incurring gift taxation is equal to the annual gift tax exclusion amount
times the number of trust beneficiaries. If the trust has five beneficiaries, for example, a grantor may
transfer $55,000 in 2005 without incurring any gift taxes—or twice that amount if his or her spouse
enters into the gift.)
The withdrawal rights that must be granted to trust beneficiaries in order to cause the transfer to
qualify for the annual gift tax exclusion may be limited to a relatively short period of time, and
beneficiaries must be notified of the gift and their withdrawal rights. Withdrawal rights—often
referred to as “Crummey powers”—are often limited to a 30-day period after the beneficiary receives
notice of the gift. After that 30-day period, the beneficiary’s right to withdraw lapses. These
withdrawal rights are not cumulative. The term “Crummey powers” comes from a lawsuit in which
they were used known as D. Clifford Crummey v. Commissioner, 397 F.2d 82 (9 th Cir. 1968). This
type of trust is frequently used to reduce estate transfer costs, and we will explore its uses more fully
later in this course.
Trusts are also categorized with respect to the time of their creation. Specifically, trusts may be
created:
• During the grantor’s lifetime, in which case the trust is referred to as a living or inter vivos
trust, or
• Upon the grantor’s death, pursuant to a will, in which case the trust is referred to as a
testamentary trust
Irrevocable inter vivos trusts are often used in estate planning to own life insurance policies on the
grantor’s life and/or other assets in order to provide estate liquidity at the grantor’s death. Such a trust
is commonly referred to as an irrevocable life insurance trust, or ILIT. When employed in that way,
the proceeds—which are generally excluded from the insured’s estate—are paid to the trust which
normally uses the funds to purchase assets from the estate or to loan money to it for purposes of
paying the estate tax and other estate transfer costs.
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Chapter 1 — Critical Issues in the Senior Market
An example of a testamentary trust is one commonly known as a “bypass trust” or “credit shelter
trust.” Such a trust is normally used to reduce the federal estate taxes payable on the death of the last
survivor of a married couple when the first to die wants to ensure that his or her spouse has enjoyment
of the income from the entire estate. In this particular testamentary trust, the will provides that an
amount equal to the exemption equivalent of the estate tax unified credit will be placed in the trust
created in the will.
In order to better understand the concept, consider the case of Maggie and Jim Drew. At the time of
Jim’s death in 2003, his personal estate was $2 million, comprised of the family home valued at $1
million and stocks and bonds of another $1 million. Maggie also has assets in her own name
amounting to an additional $2 million. Because of the unlimited marital deduction, Jim may leave his
entire $2 million estate to Maggie without his estate incurring any federal estate tax liability.
Jim Drew’s Death in 2003 — Everything to Maggie
Jim's Estate
$2 Million
$2 Million
Maggie
However, at Maggie’s subsequent death the next year—assuming that she has not depleted the
estate—her estate will be $4 million, which is comprised of her original assets and the $2 million
inherited from Jim. If Maggie has not re-married, her estate will not have a marital deduction and,
consequently, will be taxed on the entire $4 million reduced only by the estate tax unified credit. The
result is that $1.185 million, or almost 30 percent of the estate, will be lost to federal estate taxes. Jim
and Maggie’s children will receive the balance of the assets, amounting to $2.815 million, as shown
in the following graphic:
Maggie Drew’s Subsequent Death in 2004
$1.185 Million
IRS
$4 Million
$2.815 Million
Maggie & Jim's
Children
However, if Jim had used a credit shelter trust, $1 million could have been placed into the trust
without resulting in any estate tax liability at his death. The trust could be designed to pay an income
to Maggie during her lifetime and then pay the corpus of the trust to their children at her death.
Graphically, the results would look as follows:
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Pennsylvania Life-Senior Market Specialist Accreditation
Jim Drew’s Death in 2003 — Credit Shelter Trust
$2 Million
$1 Million
Maggie
$1 Million
Credit Shelter
Trust
Income
Then, upon Maggie’s subsequent death in 2004, her estate would be $3 million instead of $4 million,
thereby reducing the federal estate tax due upon her death to $705,000. The children would receive
$2,195,000 from Maggie’s estate. The $1 million that Jim had placed in the credit shelter trust—and
which had provided an income to Maggie for her lifetime—would also flow to the children
completely without taxation. The results would look like this:
Maggie Drew’s Subsequent Death in 2004
Maggie's Estate
$3 Million
$705,000
IRS
$2.295 Million
Maggie & Jim's
Children
$1 Million Credit Shelter
Trust
As we can see through this relatively simple use of a testamentary trust, Jim’s planning resulted in his
children’s receiving a total of $3,295,000 instead of $2,815,000, or $480,000 more of his and his
wife’s combined assets than if he had given all of his assets outright to his wife when he died. Since
Maggie received the income from the funds placed in the trust—and could receive a portion of its
corpus, if needed—her financial position was not compromised by this planning technique.
Deferred Charitable Giving Programs
Another device that is used to minimize estate transfer costs as well as other tax costs is a deferred
charitable giving program. This device has particular application in those situations in which
individuals have substantial and significantly appreciated assets. It uses an irrevocable inter vivos
trust known as a charitable remainder trust. In addition to providing considerable financial benefit to
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Chapter 1 — Critical Issues in the Senior Market
the right client, deferred charitable giving programs offer civic-minded clients the opportunity to
provide funds to a favorite charity.
In this deferred charitable giving program the grantor typically makes a charitable contribution of
appreciated assets to the charitable remainder trust. The trustee generally liquidates the appreciated
assets and invests them. Each year the income beneficiary—who is normally the grantor—receives an
income from the trust. Upon the death of the income beneficiary, the remaining funds in the trust are
given over to the remainder beneficiary, which is a charitable organization. Here is why this can be
such a valuable device.
Normally when an individual sells a highly appreciated asset—a family business that was grown from
modest beginnings, for example—he or she will have substantial capital gains. Capital gains are
generally taxed at 20 percent on the federal level and average about 7 percent on the state level, for an
approximate 27 percent overall.
If we apply this 27 percent tax bite to the $10 million sale of a small family business with no
remaining cost basis, we can see that the state and federal taxes will diminish the sale proceeds by
about $2.7 million. As a result of these taxes, the client will realize about $7.3 million for investment.
At an 8 percent return, the invested assets will produce $584,000 in annual income.
Alternatively, if the client had transferred the business to a charitable remainder trust and the trust had
sold it for $10 million no taxes would need to be paid since the trust is tax-exempt. Since the asset
would not have been diminished by taxes, the entire $10 million would be available for investment; at
an 8 percent annual return, the income from these invested assets would be $800,000, $216,000 more
each year than if the business had been sold outright.
In addition to the greater annual income that could be expected because of the larger investment, the
client would receive an income tax deduction equal to $10 million less the value of his or her income
stream from the trust. If the client is age 65 at the time of the contribution and will receive an 8
percent annual income, the total tax deduction would be approximately $3.5 million that may be taken
in the year of contribution and carried over to the five following years. If the client pays income taxes
in a total state and federal tax bracket of 40 percent, that tax deduction will save him or her up to $1.4
million in taxes over that six-year period. The tax savings alone may be sufficient to purchase life
insurance to replace the charitable contribution in an amount equal to the after-tax value of the gifted
property.
Ensuring Liquidity
Ensuring liquidity is generally essential to the efficient and effective transfer of assets to the next
generation. For many clients, the least expensive method of providing that liquidity is through life
insurance.
Although liquidity may be required for many different reasons, it is often needed in the estateplanning
scenario to:
• Replace gifted assets
• Equalize inheritance, and
• Provide funds for estate settlement
Let’s briefly consider each of these needs.
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Pennsylvania Life-Senior Market Specialist Accreditation
Replacing Gifted Assets
As we discussed in the previous section, deferred charitable giving programs offer large financial and
psychological benefits to the suitable client. Charitable giving programs may have a downside,
however, in the eyes of the donor’s heirs. Specifically, charitable gifts reduce the inheritance that will
be received by them. For that reason, many clients using a deferred charitable giving program elect to
replace the value of the transferred asset by purchasing life insurance.
Normally, a donor will choose to establish an irrevocable life insurance trust and direct the trustee to
purchase life insurance on the donor’s life with benefits payable to the trust. The trustee will then
apply for life insurance on the donor’s life with the trust as both the policyowner and the beneficiary.
The trust beneficiaries are usually the donor’s heirs. When used in this fashion this ILIT is often
referred to as an asset replacement trust.
When the life insurance policy is issued, the donor will ordinarily make a non-charitable gift to the
trust each year in an amount equal to the policy premium. Provided that the trust gives the
beneficiaries Crummey powers of limited withdrawal, the gift to the trust will qualify for the annual
gift tax exclusion. If there are five trust beneficiaries, the maximum annual gift tax exclusion for a gift
made to the trust in 2005 is $55,000. ($11,000 x 5 = $55,000) If the spouse joins in the gift, that
annual exclusion amount increases to $110,000.
By making a gift to the trust each year equal to the amount of the annual gift tax exclusion, the donor
is able to accomplish two typical objectives:
1. The premium for the trust-owned life insurance will be paid through non-taxable annual gifts,
and
2. The estate will be reduced each year by the amount of the gift, causing the tax liability to
decline
Since the insured donor never owned the life insurance policy being used to replace the value of the
gifted asset and has no incidents of ownership in it, there is no concern that the death benefits will be
diminished by estate taxes. Upon the insured’s death the policy’s death benefits will flow into the
trust and be distributed to the beneficiaries according to the trust terms.
Equalizing Inheritance
It is not unusual for the estate of a family business owner to be large. It is also typical for it to be
unbalanced to the extent that the business constitutes the lion’s share of its assets, leaving relatively
small amounts of non-business assets. While this may be a problem with respect to paying estate
taxes and other estate settlement costs, it may also create a problem of unequal inheritance when the
business owner wants to retain the business in the family. Consider the following fairly common
situation.
Bill Fielding, owner of Fielding Electronics, Inc., built the family business from virtually nothing. By
Bill’s continual attention to the business, he has managed to carve out a niche in the electronics
market resulting in a consistent company profit and an estimated business value of $5 million. Since
Bill’s entire estate amounts to $7 million, the business accounts for over 71 percent of his assets.
Of Bill’s two children, only his youngest son has chosen to enter the family firm. Over the years that
Dan has worked for the company, he has gained experience in all of the important areas, and Bill
considers Dan his successor. However, if Dan takes over the business when Bill retires or dies, Bill’s
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Chapter 1 — Critical Issues in the Senior Market
daughter—a local physician—will be treated unequally with respect to an inheritance. Not
surprisingly, the answer to the problem lies in the purchase of life insurance.
There are two approaches, both using life insurance, that are often employed to equalize inheritance
in this kind of situation:
• Purchase life insurance in an appropriate amount payable to the non-inheriting child by
making annual gifts to an irrevocable life insurance trust or to the child for purposes of
paying annual premiums on the policy, or
• Arrange for a one-way buy-sell agreement funded with $5 million of life insurance under
which Dan will purchase the company upon Bill’s death; the life insurance purchase is
typically funded through a split-dollar plan
Providing Estate Liquidity
In many large estates, a single non-liquid asset, such as a family business, will account for 70 or 80
percent of the entire estate. Often these estates have limited amounts of cash or other liquid assets
with which to pay estate taxes and other estate settlement costs. As a result of this limited liquidity,
non-liquid assets may need to be sold in order to meet the estate’s need for funds.
It is generally agreed that there are four sources of estate liquidity:
1. cash
2. borrowing
3. selling assets
4. life insurance
Of these four sources, life insurance is the least expensive for most people. Often a policyowner can
expect to pay, in the aggregate, less than 50¢ for every dollar of death benefits. Although there are
various ways in which life insurance may be used to provide estate liquidity, depending on the
client’s situation, a frequently-used method begins with the establishment of an irrevocable life
insurance trust. When the trust is created, the trustee applies for life insurance on the grantor’s life.
The life insurance is owned by and payable to the trust.
When the life insurance is issued, the annual premium is paid by the grantor through annual gifts to
the trust. Just as we noted in the case of replacing gifted assets, the grantor may make annual tax-free
gifts provided Crummey powers are given to the trust beneficiaries. Upon the grantor’s death, the life
insurance is payable to the trust which then loans funds to the estate or purchases estate assets as a
method of providing liquidity.
Summary
Three critical issues in managing wealth were discussed: maintaining a particular lifestyle in
retirement, protecting that lifestyle and, ultimately, transferring one’s assets to the next generation.
The traditional retirement income replacement ratio of 50 – 70 percent was questioned as being
insufficient to enable a retiree to maintain his or her pre-retirement lifestyle at a time in life when he
or she may finally have the opportunity to travel and attempt other things that call for increased
spending and which may have been deferred during the working years. The principal causes of a loss
of purchasing power in retirement—vastly improved longevity and ongoing inflation—were
identified and its consequences in terms of higher prices were examined.
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Pennsylvania Life-Senior Market Specialist Accreditation
Discussion then turned to a consideration of long term care as a critical issue and principal risk to
retirees. The probability of requiring long term care was examined, and it was found to be more likely
than the risk of losing one’s assets in an automobile accident or a house fire. The types of long term
care were seen to be far more numerous and varied than generally thought. Long term care includes
home care, assisted living, adult day care and hospice care in addition to institutionalization in a
nursing home. Current and projected long term care costs were examined, and the sources of their
funding were discussed. Although a dramatic increase in Medicare as a funding source was seen in
the period from the mid-1980s to the mid-1990s, the major source of funds for long term care
continued to be Medicaid, a state-federal program to ensure medical care for the indigent.
The concluding segment of the first chapter focused on the transfer of assets to succeeding
generations. The principal concerns with respect to asset transfer generally involve the improper
disposition of assets, inflation, inadequate retirement income, excessive asset transfer costs and a lack
of estate liquidity. The discussion turned to strategies that can be employed to minimize estate
transfer costs and ensure sufficient liquidity. Various strategies were discussed to reduce estate
transfer costs, including the re-titling of assets, use of trust vehicles and instituting a deferred
charitable giving program.
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Chapter 1 — Critical Issues in the Senior Market
Chapter 1 Review
1. Which of the following is considered the most significant financial challenge to retirees
resulting from greater longevity
a. The ability to continue working
b. Maintaining the purchasing power of retirement income
c. Paying for prescription drugs
d. Locating affordable healthcare
2. A/an _______ is a residence for individuals requiring some long term care services, but not
as many services as individuals would normally qualify for a nursing home.
a. nursing home
b. assisted living facility
c. hospice
d. adult day care facility
3. Who or what is normally the income beneficiary in a charitable remainder trust
a. The grantor
b. A charity
c. The grantor’s heirs
d. The trustee
4. Which of the following sources of estate liquidity is generally the least expensive for most
people
a. Cash in the estate
b. Borrowing
c. Life insurance
d. Selling estate assets
Answers to the chapter review can be found in Appendix A
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Pennsylvania Life-Senior Market Specialist Accreditation
20

Chapter 2
Medicare and Medigap
Section A. Medicare
Basic Eligibility
Medicare was originally targeted to people over age 65, on the assumption that they would be retirees
and would be without the benefit of employer-sponsored medical care. The program has never
covered people who take early Social Security retirement, although it does cover Pre-65 Social
Security disability qualified individuals.
Since Medicare was designed as a complement to federal retirement benefits, eligibility is tied closely
to eligibility for Social Security benefits. As with Social Security, the availability of coverage is
determined by an applicant’s age, and the length of time he or his spouse has worked in employment
qualified under the Social Security Act regulations. It must be noted here that people can qualify for,
and receive Medicare without enrolling for Social Security at age 65. They simply enroll in Medicare
and pay the Part B premium as if they had also enrolled in Social Security.
Qualifying Social Security wages are earnings that have had Social Security payroll taxes or Social
Security self-employment taxes paid on them. Earnings can qualify if one worked for someone else or
for himself. Whatever work situation applies, the number of Social Security credits needed for
Medicare coverage is the same. One needs to have accumulated 40 quarters of qualified credits to be
entitled to Medicare coverage. There are options for those who are 65 and have fewer quarters of
coverage. Certain types of employment have been added to the program so it is possible to qualify for
Medicare benefits without having a full 40 quarters of eligible work. These individuals should contact
their Social Security office to discuss the specifics of their situation.
Generally, one is eligible for Medicare if he or his spouse worked for at least 10 years in Medicarecovered
employment, and is 65 years old and a citizen or permanent resident of the United States.
One might also qualify for coverage if he is a younger person with a disability, or with chronic kidney
disease. In addition, people can buy into Medicare without having the 40 quarters of Social Security
coverage, but the premiums are high for both Part A and Part B, and the premiums will increase every
year over age 65.
Accuracy of employment history is the key to obtaining Medicare benefits. The Social Security
Administration keeps all records on file based on W-2 employer-reported earnings and Schedule SE
self-employment taxes reported. Generally, federal workers employed after 1983 are eligible for
Medicare in the same way private industry workers are, because they have paid the Medicare hospital
insurance part of the Social Security tax. Federal workers employed before 1983 may qualify to have
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Pennsylvania Life-Senior Market Specialist Accreditation
their work credited toward Medicare eligibility under special provisions of the regulations. State and
local government workers became eligible for Medicare qualified employment in 1986.
There are special regulations covering people who were employed in domestic work, farm work, or
religious organizations that were exempt from Social Security tax payments. All of these atypical
situations must be evaluated on a case by case basis with a Social Security representative.
To be eligible for Medicare, an applicant must be 65 years of age or older and be either:
• a United States citizen (by birth or naturalization)
• a legal resident alien who has lived in the United States for at least five years.
One can get Part A at age 65 without having to pay premiums if:
• he is already receiving retirement benefits from Social Security or the Railroad Retirement
Board
• he is eligible to receive Social Security or Railroad benefits but have not yet filed for them
• he or his spouse had Medicare-covered government employment
• he has received Social Security or Railroad Retirement Board disability benefits for 24
months
• he is a kidney dialysis or kidney transplant patient
Basic Enrollment
One is enrolled in Medicare
• automatically
• or by application
If one is not yet 65 and already getting Social Security or Railroad Retirement benefits, he does not
have to apply for Medicare. He is enrolled automatically in both Part A and Part B and his Medicare
card is mailed to him about 3 months before his 65th birthday. If he does not want Part B, he must
follow the instructions that come with the card.
A disabled person will be automatically enrolled in both Part A and Part B of Medicare beginning in
his 25th month of disability. His card will be mailed to him about 3 months before he is entitled to
Medicare.
One needs to apply for Medicare if he is not receiving Social Security or Railroad Retirement
Benefits three months before he turns 65, or if he requires regular dialysis or a kidney transplant.
That's the beginning of the 6-month initial enrollment period. By applying early, one will avoid a
possible delay in the start of his Part B coverage. Application can be made by contacting any Social
Security Administration office. If an individual or his or her spouse worked for the railroad, they
should contact the Railroad Retirement Board.
If one does not enroll during this 6-month period, he will have to wait to enroll until the next general
enrollment period. General enrollment periods are held January 1 to March 31 of each year, and Part
B coverage starts the following July.
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Chapter 2 — Medicare and Medigap
If one waits 12 or more months to sign up, his premiums generally will be higher. Part B premiums
go up 10 percent for each 12 months that one could have enrolled but did not. The increase in the Part
A premium (if one has to pay a premium) is 10 percent no matter how late he enrolls for coverage.
Under certain circumstances, however, one can delay his Part B enrollment without having to pay
higher premiums. If he is age 65 or over and has group health insurance based on his own or his
spouse's current employment, or if he is disabled and has group health insurance based on his current
employment or the current employment of any family member, he has a choice:
• he may enroll in Part B at any time while he is covered by the group health plan
• he can enroll in Part B during the 8-month enrollment period that begins the month
employment ends or the month he is no longer covered under the employer plan, whichever
comes first
If one enrolls in Part B while covered by an employer plan or during the first full month when not
covered by that plan, his coverage begins the first day of the month he enrolls. He may also have the
option of delaying coverage until the first day of the following 3 months. If he enrolls during any of
the 7 remaining months of the special enrollment period, his coverage begins the month after he
enrolls. If he does not enroll by the end of the 8-month period, he will have to wait until the next
general enrollment period that begins January 1 of the next year.
Even if one continues to work after he turns 65, he should sign up for Part A of Medicare. Part A may
help pay some of the costs not covered by the employer plan. It may not, however, be advisable to
sign up for Part B if he has health insurance through his employer. He would have to pay the monthly
Part B premium, and the Part B benefits may be of limited value to him as long as the employer plan
was the primary payor of his medical bills. He would also trigger his 6-month Medicare Supplement
open enrollment period.
Applicants have three important decisions to make:
• Do they want to keep Medicare Part B
• If they keep Medicare Part B, how do they want to receive their Medicare-covered services
• Do they need supplemental insurance to pay for services and products that Medicare does not
cover
One must keep Part B if he wants to be able to join any of the Medicare managed care plans (such as
HMOs), Medicare medical savings accounts, Medicare Supplement Plans, or other Medicare health
insurance options. If he does not keep Part B, he will only be eligible to receive Medicare hospital
coverage.
If one is turning 65 or are older, he can delay taking his Part B medical insurance if:
• he or his spouse (of any age) continue to work
• he is covered under a group health plan from that current employment
If one is under age 65 and disabled, he can delay his Part B if
• he, or any member of his family is currently working
• one has group health plan coverage from that current employment
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Pennsylvania Life-Senior Market Specialist Accreditation
If one does not have group health plan coverage based on current employment, and he delays taking
Part B, his monthly premium may be higher. One’s premium will increase by 10 percent for each 12
months that he could have had Part B and did not take it.
If he does not keep Part B now, he will only have a chance to sign up for Part B once a year - between
January 1 and March 31. His Part B insurance will start the following July. If he chooses to delay
taking Part B because he currently has group health plan coverage, he may be able to avoid paying
this higher premium by signing up for Part B while he has this group coverage. He can also sign up
within eight months after the employment ends or the group health coverage ends, whatever comes
first.
Once enrolled, the insured will receive a Medicare card imprinted with his name and Medicare claim
number. It shows what coverage he has (Part A, Part B, or both), and the date his coverage started.
One should show his card whenever he gets medical care. This will assure that a claim for payment is
sent to Medicare. Each person should make sure to use his exact name and claim number. If he is
married, his spouse will have his or her own card and claim number. Under no circumstance should
one ever let anyone else use his Medicare card. He should keep the number as safe as he would a
credit card number. One should take his card with him when he travels, and have it handy when he
calls about a Medicare claim. If he loses his card, he should contact the Social Security
Administration right away.
Basic Benefits
Medicare allows one to choose the way he receives his benefits. Enrollees have been enrolled
automatically in the Original Medicare Plan, which is the traditional payment-per-service
arrangement. If one wants to stay with the Original Medicare Plan, he does not have to do anything.
The basic benefits of this plan are described below.
Starting in 1999, Medicare offered more ways to receive benefits through other health plan choices.
Choices that may be available include: Medicare Managed Care Plans (such as Health Maintenance
Organizations), Preferred Provider Organizations, or Provider Sponsored Organizations. In addition,
Private Fee-For-Service Plans and Medicare Medical Savings Account Plans may be available in
one’s area. No matter what one decides, he is still in the Medicare program. After implementation of
the 2003 Medicare Modernization Act, Medical Savings Accounts will become know as Health
Savings Accounts.
Benefit Periods and Reserve Days
Medicare calculates use of its hospital coverage in benefit periods and reserve days. Understanding
these terms helps to untangle the rules governing the length and frequency of hospital stays, and the
deductibles that apply to different situations.
A benefit period begins on the day one enters the hospital and ends when he has been out of the
hospital, or other covered facility, for 60 consecutive days. So one could actually have two separate
hospital visits within the 60 days and only pay the deductible once, because it is in the same benefit
period.
With the exception of hospice care, there are no limits on the number of benefit periods that one may
use. However if one has to stay in the hospital for more than 90 days, the days beyond the 90th day
fall into a special category called reserve days.
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Chapter 2 — Medicare and Medigap
During each and every benefit period that one uses, Medicare will pay one amount (all but the
deductible) toward the first 60 days of a hospital stay and a lesser amount (coinsurance) toward the
next 30 days. The amount that Medicare will pay the hospital will be determined by a code number
assigned to a certain Diagnostic Related Group (DRG), or reason for the hospitalization, that
Medicare will determine according to the zip code in which the hospital is located. After the 60-day
hospitalization and the additional 30-day coinsurance period, one may use some or all of his reserve
days, and for that, Medicare pays another amount. A Medicare beneficiary is entitled to only 60
reserve days in a lifetime.
Basic Deductibles
A deductible is the amount one must pay for health care, before Medicare begins to pay. There is a
deductible for each benefit period for Part A, and each year for Part B. These amounts can change
every year.
For example, in 2005 the Part A deductible was $912 per Benefit Period. Medicare then paid all
approved expenses for the first 60 days. The Part A deductible applies to each Benefit Period; so it is
possible that one may have to pay more than one deductible in a year if he is hospitalized more than
once.
In 2005, the Medicare Part B deductible was $110 per year. The beneficiary is responsible for the
first $110 of approved expenses for physician and other medical services and supplies per year. After
he has met the annual deductible, Medicare generally pays 80 percent of all other approved charges
for covered services for the rest of the year. The insured is responsible for the other 20 percent copayment,
and/or an additional 15% charge that certain physicians may add to their bill. There is no
deductible or co-insurance for home health services.
Basic Co-Payments
The patient is responsible for deductibles and co-payments. Co-payments are the payments that the
beneficiary, or whatever health insurance he carries in addition to Medicare, must make to cover
expenses that Medicare does not pay.
Basic Claims
Several years ago, Congress decided that one of the ways to control Medicare costs was to have all
claims filed in a similar manner and at some future date, electronically filed. So Congress mandated
that medical service providers, including doctors, must file Medicare claims directly from their
offices for all their Medicare patients. This attempt at cost control actually had a decidedly beneficial
effect for consumers.
It eliminated a great deal of paperwork for Medicare recipients. If one has a Medicare Supplement
policy, that claim is then filed with his Medicare Supplement insurer for him by the Medicare Carrier
after they have processed the original claim. This procedure came to be known as “automatic claims”
and eliminated both the Medicare and Medicare Supplement claim paperwork for the consumer.
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Pennsylvania Life-Senior Market Specialist Accreditation
Part A Claims
Billing for services that are Part A expenses is done directly between the provider and the Medicare
intermediary. The patient is not responsible for filing this claim and should not be billed by the
provider before Medicare reviews the claim. A hospital may ask the patient to pay the deductible and
any non-covered expenses at the time of discharge, however this is very unlikely after presentation of
a Medicare Part A identification card. After making a determination on the claim, Medicare will send
the patient a statement called a Medicare Summary Notice-“MSN”.
This form carries a prominent notice stating: “This is not a bill.” And it is not. The form contains
information about the action that Medicare took regarding the claim. It will indicate:
• The name of the person or organization who furnished (provided) the medical services
• The dates on that the services were rendered
• The date of the notice
• The claim number—and your Medicare number, name, and address.
• The Medicare benefits that were used in payment of the claim, the services provided, the
benefit days used, the non-covered charges, the deductibles and coinsurance.
• The amount, if any, that the patient is responsible for paying
• The phone number and address of the Medicare intermediary that processed the claim.
• The Customer Information Service Box
• Appeals information
If the patient is responsible for a payment, the notice will state the amount and the reason – the
deductible – for the balance due. No payment should be made from this statement; the patient will be
billed separately by the provider for the charges indicated, if they have not already been paid.
Part B Claims
Part B claims may be more confusing to the patient. The provider is still responsible for billing
Medicare, but there are a number of possible variations. The provider may or may not be a
participating provider and he may or may not accept assignment. Both situations influence the amount
that the patient needs to pay.
When a patient seeks treatment from a doctor or other medical provider he will give his Medicare
identification number to the provider. The provider will make a copy of the patient’s Medicare card as
well. After treating the patient, the provider will bill Medicare on behalf of the patient. If the patient
pays the provider at the time of service, Medicare will send the reimbursement to the patient, but
there is absolutely no need to do that since the patient has given the provider the Medicare
identification card. If the provider has not been paid by the patient, Medicare will pay the provider
directly.
Medicare will send a notification to the patient, a Medicare Summary Notice (MSN) form for Part B
claims. This form has the same purpose as the Medicare Summary Notice that is sent after review of
Part A claims. The MSN form for Part B looks different and is slightly more complicated to read and
understand. The amount on the MSN form is the total amount one (or their Medicare Supplement
company) should pay to a provider.
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Chapter 2 — Medicare and Medigap
Medicare Summary Notice
As stated above, CMS redesigned the Part A and Part B notices and created the new Medicare
Summary Notice (MSN). It replaces the Explanation of Medicare Part B Benefits (EOMB), the
Medicare Benefits Notice (Part A), and benefit denial letters. The MSN is not a bill.
To design the Medicare Summary Notice, CMS solicited feedback from contractors, beneficiary
groups, and provider groups. CMS then hired a research contractor to conduct beneficiary focus
groups and make sure beneficiaries liked the new notice. CMS then tested the notice at several
contractors and, after making some changes, began to start using the new notice across the United
States.
It is important to read Medicare notices carefully. One should make sure he received the services,
medical equipment, or supplies for that Medicare were billed. If one has any questions, he should
contact the carrier or intermediary listed on the front of the notice. If he disagrees with a claims
decision, he has the right to file an appeal. He should follow the instructions on the notice to file an
appeal. In addition, if a patient finds a charge (on the MSN) that he did not receive, and Medicare
paid for, the patient may be eligible for a reward of up to $1,000. A complete explanation of this
feature of Medicare is found at the end of this chapter.
The Medicare Summary Notice is not a bill. It is important to study it carefully. One should note the
following:
• The date the MSN was sent
• Refer to the customer service information box if he has questions about his MSN
• For all inquiries, include his Medicare number, the date of the notice, and the specific date of
service he has questions about
• His Medicare number should match the number on his Medicare card
• If one’s name and address is incorrect on his MSN, he should contact both the Medicare
intermediary shown on his MSN and the Social Security Administration immediately
• Read the “help stop fraud” message for information on ways to protect himself and Medicare
against fraud and abuse
• Part A Hospital Insurance - Inpatient Claims
• Part B Medical Insurance -Outpatient Claims—Services provided, amount charged, amount
Medicare approved, amount Medicare paid the provider, and amount the patient may be
billed
• Dates of Service show when services were provided. One may use these dates to compare
with the dates shown on his hospital bill
• Each claim is assigned a claim number, that one may be asked to provide when calling
regarding their MSN
• Benefit Days Used shows the number of days used in the benefit period, for Part A only.
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Pennsylvania Life-Senior Market Specialist Accreditation
Claims Records
It is important to keep track of the MSN’s and medical claims filed and paid. Sometimes providers
bill a patient for more than they are entitled to collect. The total amount due from a patient is not
always readily apparent at the time the service is rendered. A provider may ask for payment of copayment
or deductible amounts at the time of the service. This is based on the fee he expects to
receive from Medicare. It may or may not be accurate. The only way to protect against overpaying a
provider on a claim is to be aware of and fully understand Medicare’s claim decision, and to keep a
log of all payments (MSN’s) made by Medicare, the patient, and any other insurance carriers
involved, such as a Medicare Supplement company. This is not a small item. In the late 90’s, two
articles appeared in the New England Journal of Medicine that indicated as high as 90% of hospital
billings were in error, usually in favor of the hospital. Again, it may be financially rewarding (up to
$1,000) to a patient who finds an MSN error.
Under federal law, the medical care provider must file the claim for the insured. The claim will then
automatically be referred to one’s Medicare Supplement carrier if he has one. Insurance companies
who have a contract with the federal government, process Medicare claims and payments. The
organizations handling claims from hospitals, skilled nursing facilities, home health agencies, and
hospices are called intermediaries. The organizations that handle Medicare’s Part B claims are called
carriers. Sometimes the same organization handles both Part A and Part B claims, but one will still
receive separate notices.
The handbook “Medicare and You—2004” describes a very important additional reason for properly
reading, understanding, and maintaining Medicare claims records (MSN’s). The discussion is entitled
“You Can Protect Yourself and Medicare from Fraud,” and reads verbatim:
“Most doctors and health care providers who work with Medicare are honest. There are
a few who are not honest. Medicare is working very hard with other government
agencies to protect the Medicare program.”
“Medicare fraud happens when Medicare is billed for services you never got. Medicare
fraud takes a lot of money every year from the Medicare program. You pay for it with
higher premiums. A fraud scheme can be carried out by individuals, companies, or
groups of individuals.”
“Use the 3 Step approach if you suspect fraud:
1. Call your health care provider.
2. Call your Medicare Carrier or Fiscal Intermediary
3. Call the Inspector General’s hotline (1-800-447-8477).
“When you get health care in the Original Medicare Plan, you get a Medicare Summary
Notice from a company that handles bills for Medicare. It shows what services or
supplies were charged and how much Medicare paid. You should check the notice for
mistakes. Make sure that Medicare wasn’t charged for any services or supplies that you
did not get. If you see a charge on your bill that may be wrong, call the health care
provider and ask about it. The bill may be correct, and the person you speak to may help
you to better understand the services or supplies you got. Or, you may have discovered
an error in billing which needs to be corrected. If you are not satisfied after speaking
with your provider, call the Medicare Carrier or Fiscal Intermediary. Their telephone
number is printed on top of the notice.”
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Chapter 2 — Medicare and Medigap
“You can also call the Inspector Generals hotline (above) to report Medicare fraud.
Medicare will not use your name if you ask that it not be used.”
“Fighting fraud can pay. You may get a reward of up to $1,000 if:
• You report Medicare fraud, AND
• Your report leads directly to the recovery of at least $100 of Medicare money, AND
• The fraud you report is not already being investigated.”
Mechanics of Medicare
Medicare is a national health insurance plan designed primarily for the benefit of older citizens. Older
adults are not the only beneficiaries of this important program. Certain disabled people, such as those
with kidney failure and people under age 65 who have qualified for Social Security Disability, also
qualify for Medicare.
A misconception about Medicare is that it will pay all of a senior’s health care costs. Medicare was
designed only to assist with those expenses.
There are three important topics to study in Medicare:
• what it covers
• what it does not cover
• how seniors can find private insurance coverage to pay for the difference
In this chapter we are going to discuss the first two topics. We will study the third issue in a later
chapter. Most people have both Medicare Part A and Medicare Part B coverage. This combination
provides all the coverage that is available under Medicare. The two parts of the Medicare program are
intended to work together to give participants a broad range of coverage, although it is not total
coverage.
Medicare is intended to help pay for medical care; it does not promise to pay for all medical care. It
has not covered outpatient prescription costs (except for one year-1989), and that can be substantial.
Then, in 2003, Congress passed and the President signed the 2003 Medicare Modernization Act,
which expanded Medicare to include a Prescription Drug Benefit. The prescription drug benefit will
include a discount card available in 2004, and a prescription drug program beginning in 2006.
Medicare (through laws established by Congress) reserves the right to define the care that it will
cover. All medical procedures and treatments are subject to Medicare’s approval, which is why it is
imperative to understand the ins and outs of the program.
Medicare Part A and Part B not only are responsible for different types of expenses; they are also
subject to different types of deductibles, co-payments, and other benefit limitations. In reality, it is as
if the insured was covered by two different insurance companies.
Medical care must be medically necessary or considered appropriate for the treatment of one’s
medical condition based on the usual standards applied by the health care profession. The
determination is usually made by the attending physician, but is subject to acceptance by Medicare.
Medicare will not cover any services not considered medically necessary. Usually it will not pay for
any care that is not considered mainstream or medically proven to be beneficial. Most alternative
types of health care, such as acupuncture, are not covered. Experimental procedures generally are not
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Pennsylvania Life-Senior Market Specialist Accreditation
covered either. The patient has the right to appeal the decision, if Medicare refuses to pay for
something because they judged it not medically necessary.
Mechanics of Part A - Hospital Insurance
Medicare Part A, Hospital Insurance, is financed directly through Social Security taxes. One’s local
Social Security office provides Medicare information and forms, but the claims themselves are
submitted by the hospital or other providing agency.
Part A helps pay for four kinds of medically necessary hospitalization - inpatient hospital care,
inpatient care in a skilled nursing facility, home health care, and hospice care - as these types of
hospital care are defined by the CMS.
Medicare Part A benefits are also referred to as Medicare Hospitalization Insurance. This is the basic
coverage that all Medicare recipients have. For Medicare Part A, the Benefit Period begins on the first
day one enters a hospital and it ends when he has been out of the facility for 60 uninterrupted days.
Costs associated with readmission to the hospital or to a skilled nursing facility within the 60-day
period are considered part of the same Benefit period. If one is admitted again within the 60 days, he
is still in the same Benefit Period, even if it is the 59th day.
At the end of 60 days if one has not been readmitted to a hospital or other facility, the Benefit period
ends. If one is hospitalized on the 61st day or after, his benefits are calculated and paid as if he had
not been previously hospitalized. He will be responsible for a new deductible and his coinsurance
payments will begin anew at a lower daily amount.
Medicare Part A covers medically necessary inpatient care in a general hospital, a psychiatric
hospital, a skilled nursing facility, and/or medically necessary hospice or home health care. Part A
does not pay for the doctors who attend the patient under Medicare while in the hospital, or for
specialists such as anesthesiologists, psychiatrists, or surgeons. Nor does it pay for long-term care,
such as that provided in a nursing home or intermediate care facility.
Hospital Admission
During an approved hospital admission, Medicare will help pay for the following inpatient hospital
services:
• semiprivate room (two or more beds)
• meals received in the hospital, including any special dietary requirements
• general medical and surgical nursing care
• special unit nursing care (intensive care, cardiac care)
• rehabilitation services, such as physical therapy
• prescription drugs
• medical supplies
• lab tests
• x-rays and radiotherapy
• blood transfusions, except for the first three pints
• operating and recovery room charges
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Chapter 2 — Medicare and Medigap
• other medically necessary services and supplies
For an expense to be covered by Medicare:
• a physician must prescribe the care
• the treatment can only be provided in a hospital
• the hospital must participate in the Medicare program
• the treatment cannot have been denied by a PRO (Peer Review Organization) or Medicare
Intermediary
There is no lifetime limitation on the number of Benefit Periods allowed for each Medicare recipient.
Within each Benefit Period, the patient is responsible for a deductible and for daily co-payments that
increase as the hospital stay lengthens. Medicare benefits for any single Benefit Period run out after
90 days, unless the patient has available lifetime reserve days to use. Every person enrolled in Part A
has a lifetime reserve of 60 days for inpatient hospital care.
As hospital charges grew at unprecedented rates during the 70’s and 80’s, HCFA (Now CMS) saw a
need to change the way in which hospital bills were handled, and redesigned the process of paying for
Medicare approved hospital stays.
In order to hold down hospital Medicare costs, and because of the geographic and demographic
variation in hospital charges, a new type of system was instituted by Medicare-the Prospective
Payment System. PPS is really a means of paying a hospital for a certain number of days of care for
each diagnosis, rather than each hospital submitting a bill for each patient, for each stay. The basis of
payment is based on a formula called Diagnostic Related Group(ing)s. DRG’s (around 495 of them)
were selected as reasons a person would go to a hospital. Medicare decided to allow a hospital a
certain payment for diagnosis of a patient within a certain diagnostic group. For example: broken hip-
8 days. A certain payment is determined by zip code in the USA for that diagnosis, and is made to the
hospital regardless of whether or not the patient is hospitalized for the duration of the fixed number of
days allowed by the particular DRG.
Knowing that some patients would not be fully recovered to return home after certain hospital
procedures-surgery, lingering sickness, etc.-but also knowing that the patient did not really need
expensive hospital care, the trade off was in transferring the patient to skilled nursing facilities. Thus,
the utilization of the PPS/DGR system spurred an incredibly rapid growth in the Nursing home
industry, as terminology such as “extended care,” “swing units,” and “skilled care facilities” became
commonplace. What was originally intended as a cost saving measure to get people out of expensive
hospital beds became its own predicament as people now were forwarded to expensive nursing home
beds.
In short, the implementation of the PPS/DRG system spawned an entire new growth industry-that of
Skilled Care and Skilled Nursing Care facilities.
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Pennsylvania Life-Senior Market Specialist Accreditation
Skilled Nursing Facilities Covered by the Original Medicare Plan
Skilled nursing facilities are not considered the same as custodial care in nursing homes, assisted care
facilities, or intermediate care facilities, although one location may incorporate all three types of
services. Skilled nursing facilities can be part of a hospital complex, or entirely separate.
A skilled nursing facility offers nursing and/or rehabilitation services that are medically necessary to
a patient’s recovery. The services provided are not custodial in nature. Custodial services are those
that basically assist a patient with personal needs, such as dressing, eating, bathing, and getting in and
out of bed. Medicare will not pay for these and similar services. An exception is made when these
services are included as part of the necessary daily medical care being provided on an inpatient basis,
where they are a routine and necessary adjunct to the medical care.
In a skilled nursing facility, Medicare will cover
• semiprivate room (two or more beds to a room)
• meals, including special dietary requirements
• rehabilitation services, such as physical, speech-language, and occupational therapy
• prescription drugs
• other medically necessary services, equipment, and supplies, used in the facility
• skilled nursing care
• Medical social services
• Ambulance transportation (when other transportation endangers health) to the nearest
supplier of needed services that are not availed at the SNF
To be covered, the patient must:
• require daily skilled care that can only be provided as an inpatient in this type of facility
• be certified by a doctor or appropriate medical professional as requiring these services on a
daily inpatient basis
• have been a hospital inpatient for at least three consecutive days (not counting the day the
patient is released) before admission to the skilled nursing facility
• be treated for the same illness or condition for that he/she was a patient in the hospital
• be admitted within 30 days of discharge from the hospital
Coverage in a skilled nursing facility is limited to a maximum of 100 days per Benefit period. The
patient is responsible for daily co-payments after the 20th day. The patient must be alerted that these
daily co-payments are sizeable, and should not be taken lightly. They really amount to deductibles,
and for the year 2005, amount to a $114 per day deductible for the 21st to 100th day. People must
understand that Medicare pays first only for skilled care, and secondly only the full amount for the
first twenty days. From the 21st to the 100th day (of skilled care only), the deductible is $114 in 2005
and has grown each year in the same way that the Part A deductible has grown. In addition, a
Medicare Supplement policy (Plans C through J), which will cover the deductible, will only cover
what Medicare will cover, and that is Skilled Care only. Again, care must be related to a hospital
admission of at least three days duration.
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Chapter 2 — Medicare and Medigap
Home Health Care Covered by the Original Medicare Plan
Home health care services are provided through licensed public or private organizations that are
Medicare approved. The services are generally provided by a visiting nurse or a home health care aide
and are medically necessary services, not personal care or housekeeping services. Medicare approval
of the home health care agency means that the organization meets certain Medicare standards
necessary for reimbursement. It does not signify any type of warranty of the individuals performing
the services.
The types of home health care services available are:
• part time or intermittent skilled nursing services (registered and practical nurses)
• physical therapy
• speech language pathology therapy
• occupational therapy
• home health aide services-does not have a nursing license. The aide provides services that
support any services that the nurse provides. Medicare does not cover home health aide
services unless the patient is also getting skilled care such as nursing care or other therapy.
The home health aide services must be part of the home care for the patient’s illness or injury.
• other medically necessary services for ongoing care
• medical social services
• durable medical equipment ( e.g., hospital beds and wheelchairs) at 80%
• certain medical supplies, such as wound dressings, but not drugs or prescriptions.
What the Original Medicare Plan Does Not Cover Under Home Health Care
Medicare does not pay for the following:
• 24-hour per day care at home
• prescription drugs (prescription drug discount card available in 2004, full program in 2006)
• Meals delivered to the home
• Homemaker services like shopping, cleaning and laundry
Personal care given by home health aides (like bathing, using the toilet, or help in getting dressed)
when this is the only care needed.
Under the provisions of the Balanced Budget Act of 1997, home health care services and supplies will
be gradually transferred to part B coverage over several years. At the end of that period of time, the
only home health care that will be covered under Part A will be 100 days of care required as the result
of an in-patient or skilled nursing facility stay.
To qualify for Medicare reimbursement:
• the patient must be confined to the home (homebound), and
• a physician must certify the medical necessity and must prescribe the program of care (Plan
of Care), and
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Pennsylvania Life-Senior Market Specialist Accreditation
• the services must be provided by a participating Medicare home health care organization, and
• the patient must need at least one of the following: intermittent skilled nursing care, physical
therapy, or speech language pathology services
Home health care benefits are not for custodial care-where a patient has difficulty living on his own
and performing daily tasks. Home health care is for medical care such as physical therapy, or skilled
nursing care required for monitoring the patient’s progress.
There may be deductibles or co-payments required for Medicare approved home health care services.
There are limitations on the maximum number of visits per week and the maximum number of hours
per day that a patient can receive skilled nursing services and home health aide service.
Generally, the total number of hours for both home health aide and nursing services combined cannot
exceed 28 hours per week, or be more than 8 hours in a day. Under certain circumstances the number
of hours can be increased to 35 per week. This increase in hours can only be for a short period of
time, must be approved by Medicare, and requested by a doctor.
Medicare has established new requirements for home health agencies (HHAs). On September 15,
1997, the President announced a moratorium on new HHAs until Medicare could implement a range
of new rules and management tools that enhance oversight of HHAs, and ensure that new Medicare
HHAs are not "fly-by-night" or low quality providers. In January 1998, tougher requirements for
HHA were set. Medicare now asks any new agencies about any "related business interests” that
unscrupulous providers have used to cover up fraud.
Psychiatric Hospitalization
Payment for inpatient psychiatric care is very limited in duration, but during the course of covered
treatment, the types of charges allowed are similar to those of a regular hospital.
Medicare coverage for inpatient psychiatric care covers:
• semiprivate room (two or more beds)
• meals received in the hospital, including any special dietary requirements
• nursing care
• rehabilitation services, such as physical therapy, occupational therapy, and speech therapy
• prescription drugs dispensed during the hospital stay
• medical supplies
• lab tests
• x-rays and radiotherapy
• blood transfusions, except for the first three pints
• other medically necessary services and supplies
To be covered:
• a physician must prescribe the care
• the treatment can only be provided by a hospital
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Chapter 2 — Medicare and Medigap
• the hospital must participate in the Medicare program
• the care cannot have been denied by a PRO (Peer Review Organization) or Medicare
intermediary
Medicare benefits for treatment in a psychiatric hospital are limited to a lifetime maximum of 190
days. If one receives psychiatric care in addition to other medical treatment as part of a regular
hospital stay, this limitation does not apply. Deductibles and co-payments are the same as for a
regular inpatient hospital stay.
For outpatient mental health services, Medicare pays 50 percent of the costs. The patient is
responsible for the other 50 percent. Again, the same requirements for Medicare approved physicians
and facilities are necessary.
Hospice Care
Hospice care is care for terminally ill patients. Special provisions of the Medicare hospice care
program allow for the payment of some expenses not ordinarily covered by Medicare, such as
homemaker services.
Hospice care includes:
• physician services
• nursing care
• prescription drugs, subject to a nominal co-pay
• medical social services
• home health aide and homemaker services
• physical therapy
• occupational therapy
• speech therapy
• dietary and other counseling
• short-term respite care of up to five consecutive days (inpatient respite care allows time off
for the person who regularly provides care in the home)
• medical supplies
To qualify for payment by Medicare:
• the terminal nature of the patient’s illness must be certified by a physician and the hospice
Medical Director
• the anticipated life expectancy must be six months or less
• the patient must choose to use hospice care benefits rather than regular Medicare coverage for
the treatment of the terminal illness (the usual Medicare coverage is still available for medical
expenses not related to the terminal illness.)
• the care must be provided by a hospice care agency that is approved by Medicare
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Pennsylvania Life-Senior Market Specialist Accreditation
A hospice care patient is eligible for two 90-day Benefit Periods followed by an unlimited number of
60-day extensions. One’s physician must certify the terminal nature of the illness at the beginning of
the first 90-day period and again at the beginning of each 60-day period. If the patient chooses to do
so, he may discontinue participation in the hospice care program and switch back to regular Medicare
coverage.
There are no deductibles under the hospice care program, but there is a co-payment for prescription
drugs of five percent of the cost, or $5 per prescription, whichever is less. There is also a co-payment
for inpatient respite care of five percent of the Medicare approved rate. Reimbursement under the
hospice provisions apply only to treatment of the terminal illness. Medical treatment for other
conditions will be paid based on the usual Part A and Part B provisions.
Mechanics of Part B – Medical Insurance
Medicare Part B, medical insurance, is also called Voluntary Supplementary Medical Insurance
(SMI) and is financed by payments from the federal government and by monthly premiums paid by
people enrolled in the plan. Part B helps pay for doctors’ bills and other medical services and supplies
not covered by Part A.
Medicare Part B coverage is much easier to understand than Part A. It does not matter where medical
services are received – at home, in a hospital, in a doctor’s office, or in some other medical facility.
All costs are subject to the same deductible ($110 in 2005) and the same co-insurance payments in
any calendar year. The Benefit Period is the calendar year.
Medicare Part B covers:
• outpatient hospital services
• doctor’s services (not routine physical exams)
• X-rays, MRI’s, CAT scans, EKG’s, and lab tests, diagnostic tests and clinical laboratory
services
• ambulatory surgery center facility fees for approved procedures
• second surgical opinions
• ambulance transportation when other transportation would endanger your health
• breast prostheses after a mastectomy
• physical therapy
• occupational therapy
• speech therapy
• home health care (costs not covered by Part A)
• blood transfusions, except for the first three pints
• mammograms and pap tests
• outpatient mental health services
• artificial limbs and eyes, prosthetic devices, and their replacement parts
• arm, leg, and neck braces
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Chapter 2 — Medicare and Medigap
• durable medical equipment (walkers, wheelchairs, oxygen equipment)
• kidney dialysis and kidney transplants
• heart, liver, lung, kidney, pancreas, intestine, bone marrow, and cornea transplants under
certain conditions and when performed at Medicare-certified facilities
• medical supplies (surgical dressings and casts)
• preventive care: screening for prostate cancer, colorectal cancer, mammography and breast
exams, pap smears and pelvic exams, bone-mass density loss; flu and pneumonia
inoculations, hepatitis B vaccinations, diabetes services and supplies. Beginning in 2005,
preventive care will include: 1) A one-time initial preventive physical exam within 6 months
of when a person with Medicare first becomes enrolled in Medicare Part B. 2) Screening
blood tests for early detection of cardiovascular diseases. 3) Diabetes screening tests for
people at risk of diabetes.
• some oral anti-cancer drugs and certain drugs for hospice patients
• bone mass measurements
• glaucoma screening
• services of practitioners such as clinical social workers, physician assistants, and nurse
practitioners
Medicare Part B requires payment by the patient of a $110 deductible in each calendar year. This
deductible is calculated against the Medicare approved amount, which can be different from the
amount billed by one’s doctor or other medical provider. After one has met the requirements of the
deductible, Medicare will pay for 80 percent of the approved charges. The patient is responsible for
the remaining 20 percent as a co-payment. Additionally, the patient is responsible for an additional
15% charge that some physicians may charge. Certain preventive screening procedures
(mammograms and pap smears) and preventive inoculations (flu shots) are not subject to the Part B
deductible and/or the 20% deductible.
Part B does not cover:
• Outpatient prescription drugs until 2004, when recipients can purchase a discount drug card,
and in 2006, when a prescription drug program will be available.
• routine physical examinations
• eye glasses (except for one pair of standard frames after cataract surgery)
• custodial care
• dental care
• dentures
• routine foot care
• hearing aids
• orthopedic shoes
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Pennsylvania Life-Senior Market Specialist Accreditation
Because of sharp increases in physicians charges for medical care in general, and Medicare in
particular, Congress passed the Physician’s Reform Act, which by 1996, stated that Medicare
approved physicians could not charge or expect payment for more than 115% of what Medicare
determined was an allowable charge. Again, physician’s Medicare allowable charges are determined
by zip code. The purpose obviously was to save Medicare money, but some physicians felt this was
unfair, and that the act would result in limited patient loads and cost shifting.
Mechanics of Rates
Each January 1st, Medicare rates, deductibles, and coinsurance amounts change. Effective for 2005
the changes were:
• Part A Deductible - $912 per Benefit Period
• Coinsurance - $228 a day for the 61st-90th day in each Benefit Period
• $456 a day for the 91st-150th day for each lifetime reserve day
• total of 60 lifetime reserve days -nonrenewable-stays the same.
• Skilled Nursing Facility Deductible -$114 per day for each Benefit Period (paid after first 20
days of care)
Part A Hospital Insurance Premium is $375 per month for people who have less than 30 quarters of
Medicare-covered employment. (NOTE: this premium is paid only by individuals not otherwise
eligible for Premium-free hospital insurance). In addition, there is a Part A premium of $206 for
individuals having 30-39 quarters of Coverage.
Medicare Part B 2005 Premium is $78.20 per month for most beneficiaries. Medicare Part B
premiums will be deducted from one’s Social Security, Railroad Retirement, or Civil Service
Retirement benefits. If one does not receive any of these, Medicare will bill every 3 months for his or
her Part B premium
Mechanics of Emergency Services
Emergency Services are covered inpatient or outpatient services that are furnished by a Provider
qualified to furnish Emergency Services; and needed to evaluate or stabilize an Emergency Medical
Condition. An Emergency Medical Condition is a medical condition manifesting itself by acute
symptoms of sufficient severity (including severe pain) such that a prudent layperson, with an average
knowledge of health and medicine, could reasonably expect the absence of immediate medical
attention to result in:
• Serious jeopardy to the health of the individual or, in the case of a pregnant woman, the
health of the woman or her unborn child
• Serious impairment to bodily functions
• Serious dysfunction of any bodily organ or part
It is important to notify one’s Primary Care Physician or Contracting Medical Group of an
Emergency Medical Condition so that they can be involved in the management of the beneficiary’s
health care, and transfer can be arranged when one’s medical condition is stable. The arrangements
will depend on the distance involved to the Service Area to receive follow-up care through one’s
Primary Care Physician. However, follow-up care will be covered out of the Service Area as long as
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Chapter 2 — Medicare and Medigap
the care required continues to meet the definition for either Emergency Services or Urgently Needed
Services.
Medicare pays for ambulance services when a patient must be taken to a hospital or skilled nursing
facility, and transportation in any other vehicle would endanger the patient’s health. Medicare pays
for the ambulance mileage to the nearest hospital or skilled nursing facility that provides the services
needed. Medicare does not pay for ambulance transportation to a doctor’s office.
Mechanics of Appeals and Grievances
Medicare Appeal Rights
The recipient of Medicare has the right to appeal any decision about Medicare Services. This is true
whether the patient is in the Original Medicare Plan or a Medicare managed care plan. If Medicare
does not pay for an item or service one has been given, or if the patient is not given an item or service
they think they should have received, the patient can appeal.
Appeal Rights Under the Original Medicare Plan
If the patient is enrolled in the Original Medicare Plan, they can file an appeal if they think Medicare
should have paid for, or did not pay enough for, an item or service they have received. If the patient
files an appeal, they must ask the doctor or provider for any information related to the bill that might
help their case. The appeal rights are printed on the back of the Medicare Summary Notice that is
mailed to the patient from a company that handles bills for Medicare. The notice will also tell a
patient why the bill was not paid and what appeals steps one can take.
Appeal Rights Under Medicare Managed Care Plans
If the patient is in a Medicare managed care plan, they can file an appeal if the plan: will not pay for,
does not allow, or stops a service that the patient thinks should be covered or provided. If one thinks
that their health could be seriously harmed by waiting for a decision about the service, they may ask
the plan for a fast decision. The plan must answer the patient within 72 hours.
The Medicare managed care plan must tell the patient in writing how to appeal. After the appeal has
been filed, the plan will review its decision. Then, if the plan does not decide in the patient’s favor,
the appeal is reviewed by an independent organization that works for Medicare, not for the plan. See
the plan’s membership materials or contact the plan for details about Medicare appeal rights.
If a patient has concerns or problems with their plan that are not about payment or service requests,
the patient has a right to file a complaint.
The Patient is Protected While in the Hospital
This is true whether the patient is in the Original Medicare Plan or a Medicare managed care plan.
If the patient is admitted to a Medicare participating hospital, one should be given a copy of “An
Important Message From Medicare.” It explains the rights of the hospital patient. If one has not been
given “The Message,” they should ask for it.
The Message Tells The Patient:
• “You have the right to get all of the hospital care that you need, and any follow-up care after
you leave the hospital.”
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Pennsylvania Life-Senior Market Specialist Accreditation
• “What to do if you think the hospital is making you leave too soon.”
• “If you have questions about this, call the Quality Improvement Organization (QIO). Their
number is on the message. You may be able to stay in the hospital at no charge while they
review your case. The hospital cannot force you to leave before the QIO makes a decision.”
The Medicare Prescription Drug Improvement and Modernization
Act of 2003 (MMA)
Medicare Law Changes
In December of 2003, Congress passed, and the President signed into law, the most sweeping changes
of Medicare law since its inception in 1965. The final enactment of the new legislation covered a
wide spectrum of issues, which embodied much more than the first part of the title—Medicare
Prescription Drug Improvement—would imply. The “Modernization” portion of the title also
became a major factor in redesigning and implementing a great part of the structure of Medicare
itself.
In an initial analysis of the law, an agent could assume that Prescription Drugs were the major part of
the legislation, and indeed, they were “a” major part. But, the law included several components
outside of the scope of what became “Part D” of the new Medicare structure. For purposes of
convenience, let us list the major components of the new law, then discuss them in their relationship
to a “modernized” Medicare.
• New Preventive Medicine Coverages were included in the menu of Medicare covered
services.
• Implementation of a new Medicare plan and terminology—Medicare Part D—which totally
revises previous Prescription Drug treatment of the Medicare program. As a precursor to the
inception of the full-blown plan in 2006, during 2004 and 2005, Medicare recipients could
apply for a Medicare discount card worth up to $600 per year, for discounts, or free
prescription drug purchases. The $600 program was available through Dec. 31, 2005, at
which point the program is curtailed, as the full Medicare Part D program goes into effect.
• The renaming of “Medicare + Choice” to “Medicare Advantage,” and implementation of
the new Medicare Advantage program.
• Changes and incentive programs for America’s employers to continue providing group
health insurance coverage to retired (Medicare age eligible) employees.
• A revision in Medicare Supplement rules, which will eliminate the sale of Plans H, I, and J
after January 1, 2006, and substitute Plans K and L at that time.
As you can see, MMA included much more than the introduction of Part D, or the renaming and
restructuring of Medicare Advantage Plans. In fact, the six hundred pages of legislation, created
significant changes and additions to Medicare, beyond even what we will discuss here. But, in
consideration of brevity, for both agents, and for Medicare enrollees with whom you may wish to
discuss the changes, we will only address these five most important issues, with specific emphasis
placed on the new Medicare Part D prescription drug benefit.
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Chapter 2 — Medicare and Medigap
New Medicare Benefit Coverages
As of January 1, 2005, Medicare began covering:
• Diabetes screening tests for people with Medicare at risk of getting diabetes. (Includes
Diabetes Screening Tests and Diabetes Self-Management Training.)
• A one-time initial preventive physical exam within 6 months of the day the Medicare
enrollee first enrolls in Medicare Part B. (Named a “Welcome to Medicare” physical
examination, this includes height, weight, and blood pressure measurements, an EKG,
education and counseling.)
• Cardiovascular Screening Blood Tests for early detection of cardiovascular (heart) disease.
(Includes blood tests to check cholesterol, lipid or triglyceride levels, and other tests for early
detection of, or to identify a high risk for developing, cardiovascular disease.
The above coverages were added to the list of existing Preventive Services, which had already
included “Bone Mass Measurement”, “Colorectal Cancer Screening”, ”Glaucoma Testing”, “Pap Test
and Pelvic Examination (including a clinical breast exam)”, “Prostate Cancer Screening”, “Screening
Mammograms”, and “Vaccinations.” With this ever expanding list of “Preventive Services,”
Medicare joins the American Medical community in providing medical services designed to increase
health care awareness through detection and prevention of future medical problems, and thereby limit
the cost of treating pre-existing conditions before they manifest themselves as acute medical
problems.
As evidence of this “Preventive” goal, Medicare announced in 2004 and 2005, several other programs
designed to enhance early detection or prevention—programs which were not included in the
legislation of MMA. Each of the announcements are found on the web site, www.cms.gov, under
“Press Releases. We will only refer to the headlines of each announcement, but the student can go to
the web site for full information regarding each program.
• Wednesday, September 15, 2004—“Medicare Posts Coverage Decision To Expand Coverage
of Pet Scans For Alzheimer’s Disease”
• Friday, January 7, 2005—“Medicare Expands Coverage of Cochlear Implants”
• Thursday, January 27, 2005—“Medicare Expands Coverage of Implantable Defibrillators
to Save Lives and Develop Evidence to Maximize Benefits”
• Thursday, February 3, 2005—“CMS Proposes New Coverage Criteria for Wheelchairs,
Scooters”
• Thursday, March 17, 2005—“Medicare Expands Coverage of Carotid Artery Stenting For
Patients at High Risk of Surgery”
• Tuesday, March 22, 2005—“Medicare Adds Coverage of Smoking and Other Tobacco
Cessation Services”
• Monday, April 4, 2005—“Medicare to Expand Coverage For Hearing Loss and Cover
Aprepitant for Chemotherapy-Induced Nausea and Vomiting”
• Wednesday, April 6, 2005—Medicare Implements Demonstration to Expand Coverage of
Chiropractic Services”
While all of the above measures do not deal specifically with Preventive Medicine, they are examples
of the measures Medicare is taking to broaden coverage for recipients now and into the future.
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Pennsylvania Life-Senior Market Specialist Accreditation
Medicare feels that while the initial cost of preventive medicine will be greater, the financial benefits
for the program will result in savings for both Medicare and Medicare recipients within the next
decade. In addition, since several studies have indicated that Americans are struggling with an obesity
problem, Medicare visionaries are considering preventive benefits regarding overweight problems,
once the age 65 individual becomes a Medicare enrollee.
Introduction and Implementation of the New Medicare Part D (Prescription
Drug) Program
In a twelve page bulletin, issued January 21, 2005, CMS released its “Final Rules Implementing the
New Medicare Law: A New Prescription Drug Benefit for All Medicare Beneficiaries, Improvements
to Medicare Health Plans and Establishing Options for Retirees.” The first paragraph of the report
summarizes the intent of the law established by MMA, and it’s content can be used as a starting point
for our discussion of the new Part D program.
“The U.S. Department of Health and Human Services’ Centers for Medicare and
Medicaid Services (CMS) today issued the final regulations implementing the new
prescription drug benefit that will help people with Medicare pay for the drugs they
need. This benefit begins in January 2006 and allows all Medicare beneficiaries to sign
up for drug coverage through a prescription drug plan or Medicare health plan. The
final regulations also provide new protections for retirees who currently receive drug
coverage through their employers or unions, and they strengthen the Medicare
Advantage program.”
There are two major statements contained in the paragraph which we will cover as we move through
this chapter. The first is “drug coverage through a prescription drug plan or Medicare health
plan.” This means utilization of the Medicare Part D plan, or utilization of a Medicare Advantage
plan. The second statement, “provide new protections for retirees who currently receive drug
coverage through their employers or unions,” is in reference to the fear that employers will drop
retirees from their existing group health insurance because of escalating prescription drug costs. We
will address both of these statements, as separate components, in a moment.
A second paragraph in the “Final Rules” document summarizes the outlook for the new program, by
stating:
“With the enactment of the MMA, and the final rules issued today, Medicare looks more
like the rest of the American health care delivery system by giving beneficiaries the
option of new, subsidized drug coverage, as well as new support to keep their
current retiree coverage secure.”
And, a final paragraph describing the implementation of the Part D plan, has significance to both
Medicare Advantage plan representatives and Medicare Supplement producers, stating:
The Medicare prescription drug benefit: The final rules describe the plan options that
beneficiaries will have to obtain their outpatient drug coverage. Prescription drug
plans and Medicare Advantage plans will be required to provide basic coverage, but
may also offer additional plans with supplemental coverage.”
Medicare Supplement producers should not confuse that paragraph with Medicare Supplement plans.
The paragraph is saying “Prescription drug plans…” In this case, that means the Prescription drug
plans (Part D) that health insurance providers will be offering to Medicare recipients beginning
January 1, 2006. In other words, private companies will be offering the Part D plans, and payment
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for them will be through a Part D premium. It does not refer to Medicare Supplement companies.
Those products (Plan K and Plan L), which can be offered by Medicare Supplement companies, will
be discussed near the end of this chapter. Medicare Advantage plans will have the Part D benefit built
into their offerings.
Timelines of Implementation
So, with that background, let’s begin the Part D discussion with some timelines, which scheduled the
implementation of the program:
• December 8, 2003—Bill becomes law.
• January 21, 2005—CMS establishes final rules for implementation of the law.
• May, 2005—SSA begins sending notices to 20 million Medicare beneficiaries—almost
half of them—informing them that they may be eligible for low-income subsidy to assist with
their Medicare Part D premiums and co-payments. Mailings continue through August.
• June, 2005—CMS send notices to beneficiaries who are deemed eligible for low-income
subsidy to tell them they do not have to apply for the subsidy.
• Fall, 2005—Medicaid agencies begins sending notices to dual eligibles that they will be
losing their Medicaid prescription drug coverage on January 1, 2006, and will be
automatically enrolled in a Medicare Part D plan.
• October 15, 2005—CMS sends information to all Medicare beneficiaries describing the
Part D plans that will be available to them.
• November 15, 2005—May 15, 2006—“Initial enrollment” period for the Part D program
for all beneficiaries. Existing beneficiaries who enroll after May 15, 2006, will have to pay a
penalty (1% per month) unless they can show that they had creditable coverage under another
drug program (such as group health insurance).
• January 1, 2006—The Medicare Part D prescription drug benefit begins. Dual eligibles
lose Medicaid coverage for their prescription drugs.
These timelines are important to Medicare enrollees, Medicare Supplement producers, and Medicare
Advantage enrollers—but the most important is the enrollment period of November 15, 2005
through May 15, 2006, because they represent the “Initial enrollment” period for citizens who are
already enrolled in Medicare. The importance of these dates is that anyone who does not take
advantage of the enrollment premium ($37 per month in 2006) will be assessed an additional 1% per
month (cumulatively) for each month they delay enrollment, unless they can prove “creditable
coverage” from an existing plan, such as coming off an employer sponsored group health insurance
program.
As an example, anyone who delayed enrollment for three years (36 months) would see a 36%
additional charge in the enrollment premium. In short, the Part D premiums are surcharged for late
enrollees, and the amount charged at the time of enrollment is cumulative. In other words, the
additional charge is added in perpetuity. How would this happen Suppose an enrollee feels they do
not need Part D at age 70, because they feel completely healthy and do not have a need for
prescription drugs, thereby delaying enrollment. At age 78, conditions set in which would indicate a
need for Part D coverage. The result would be a 96% surcharge for the 96 months of delayed
enrollment. Now, the premiums (for the Part D coverage alone) have perhaps become a financial
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Pennsylvania Life-Senior Market Specialist Accreditation
hardship, when the surcharge is added in. But then, so will the inflationary increases in the price of
the prescription drugs.
Part B Premium Increases for High Income People beginning in 2007
In addition, there are Medicare Part B premium increases for higher income beneficiaries included
in MMA. This process is known as “means testing” (income related) and will go into effect in 2007.
The law allows for higher premium payments for Medicare Part B coverage, and relates to the 25%
payment beneficiaries pay for Part B ($78.20, in 2005) while Medicare picks up the remaining
(approximate 75%) for actual Part B costs. Under the new law, premiums will be tied to income
levels. Beneficiaries who make more than $80,000 ($160,000 if filed jointly) will pay a greater
percentage of the Part B premium. Individuals with incomes between $80,000 and $100,000 will pay
an additional 10% of Part B premiums. Individuals between $100,000 and $150,000 will pay an
additional 25%. Individuals between $150,000 and $200,000 will pay an additional 40%. And
individuals over $200,000 will pay an additional 55%. There is a five year phase-in of these rules,
beginning in 2007, and beneficiaries can appeal if their family situation changes.
Medicare Advantage—New Name for Medicare + Choice
MMA legislation also made provisions for a name change for an existing Medicare Program—
Medicare + Choice—to “Medicare Advantage”, and created more options for people on Medicare.
Three of the most significant changes were: 1) Creation of Managed Care Plans for rural areas. 2)
The addition of Part D prescription drug benefits being included into Medicare Advantage
coverage. 3) A wider variety of health care choices, additional benefits (made available by the
plan), and in some cases, better health care options and benefits than traditional, or “Original”
Medicare.
The most important factor of a Medicare Advantage program, which the student must understand, is
that each Medicare Advantage plan is offered by a private company. Medicare pays a set amount
of money per enrollee, per month to the private company to manage the Medicare coverage for
their members. The company contracts with Medicare to provide services and set rates for the
Medicare beneficiary members of the plan. This combination essentially relieves Medicare of claims
congestion, because the private company handles the administration of its own plan, as well as it’s
enrollee care needs. However, the enrollee must still be enrolled in Medicare Part A, and Part B.
Part D must be coordinated within at least one Medicare Advantage plan, offered by a private
company.
There are rules regarding how a Medicare Advantage (Managed Care Plan) works. We will discuss
the primary foundations of MA plans.
In most Medicare Managed Care Plans, there are doctors and hospitals that join the plan.
This is called the plan’s “network.” Medicare beneficiaries enroll in the plan. An
enrollee may need to get most of the care and services from the plan’s network. If an
enrollee wants to see a doctor, or use a hospital out of the network, the enrollee will
have to ask the plan what the additional cost will be.
• Enrollees may be asked to choose a primary care doctor.
• Doctors can join or leave Medicare Managed Care Plans at any time, but normally are
contracted for a certain period of time with the plan.
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Chapter 2 — Medicare and Medigap
• An enrollee wishes to get health care outside the plan’s service area, there may be more
expense, or it might not be covered.
• The service area is a geographical location where members are accepted, and where plan
services are provided.
• Special rules might apply if a member requires emergency or urgently needed care, and
are not in the managed care plan’s service area.
• Medicare Managed Care Plans may leave the Medicare program or change their benefits
or premiums.
• A few Medicare Managed Care Plans aren’t Medicare Advantage Plans. Generally, these
plans still work the same, but some rules may be different.
• Some Medicare Managed Care Plans offer a Point-of-service option, wherein the member
may go to other doctors or hospitals (out-of-network), but the member may pay extra.
• Medicare Advantage Plans may charge a monthly premium in addition to the monthly Part
B premium.
• Medicare Advantage Plans may pay all or part of the monthly Part B premium.
• Medicare Advantage Plans may offer benefits that go beyond the scope of what Original
Medicare pays, but must include the benefits of Medicare Part A and Part B.
Chapter 7 of this course contains the “nuts and bolts” of Medicare Advantage programs, but a short
description of existing Managed Care Programs, and the addition of more programs created by MMA
would serve the student well.
Remember that Medicare Managed Care Programs come in several different flavors. Here are the
major types of programs that currently exist, and those that have been added.
• Health Maintenance Organizations (HMOs)—A type of Medicare Managed Care Plan where
a group of doctors, hospitals, and other health care providers agree to give health care to
Medicare beneficiaries for a set amount of money from Medicare per month. In an HMO, the
enrollee must usually get all their care from the providers that are a part of the plan.
• Medicare Private Fee-for-Service Plans (PFFSPs)—A private insurance plan that accepts
Medicare beneficiaries. The enrollee can go to any doctor or hospital that accepts the terms of
the plan’s payment. The insurance plan (private company) rather than the Medicare program,
decides how much it will pay, and how much the enrollee will pay. The plan may include
extra benefits, such as coverage for prescription drugs.
• Medicare Preferred Provider Organization Plans (PPOs)—In most of these plans, the enrollee
must use the doctors, specialists, and hospitals in the plan’s network. Doctors, specialists, and
hospitals not in the network, may cost extra. The enrollee does not need referrals to see
specialists. The plan may include extra benefits, such as coverage for prescription drugs.
• Medicare Specialty Plans—Designed to provide more focused health care for certain people.
In an MSP, the normal Medicare health benefits are included, as well as focused care to
manage a specific disease or condition.
• Regional PPO Plans—A provision of MMA, which allows for inclusion of large geographical
rural areas, to receive the PPO offerings, that small geographical (county) areas in urban
locations have had access to. CMS enhanced procedures for identifying and supporting
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Pennsylvania Life-Senior Market Specialist Accreditation
“essential hospitals” as network members. This makes it easier for Regional PPO plans to
provide coverage in rural and other areas with limited hospital availability. In the Final Rules
issued January 21, 2005, CMS stated: “Unlike the current Medicare Advantage program,
which features local plans that service individual counties and groups of counties, the new
regional PPOs will serve one, several or all 26 regions across the U.S., which cover all rural
areas.” In the same bulletin, CMS stated: “In 2003, 59 percent of Medicare beneficiaries had
access to a coordinated care plan… …as of early 2005, more than 80 percent of Medicare
beneficiaries have access to at least one Medicare Advantage plan in their area.”
• Local PPO Plan Participation—Existing Medicare Advantage plans are allowed to offer new
local preferred provider (PPO) plans in existing service areas and not be affected by the local
plan moratorium, providing access to additional PPO coverage. In other words, a PPO may be
established within a local area of a Regional PPO Plan, and not be included in the entire
region.
• PACE—(Program of All-inclusive Care for the Elderly)—Although PACE IS NOT a
Medicare Managed Care Program, we include in here as a point of reference. PACE
combines medical, social, and long-term care services for the frail elderly. Pace is available
only in states that have chosen to offer it under Medicaid, in conjunction with Medicare.
Improvements to PACE were incorporated into MMA to allow flexibility in PACE plans to
provide greater accommodation to the special characteristics of the plans and the special
services they provide to the frail elderly population.
As a point of the significance of Medicare Advantage Plans having a great impact on the American
elderly health care scene, CMS stated in a bulletin issued February 18, 2005, that “CMS received
applications for more than 141 local Medicare Advantage plans in 2005... Beginning later this year,
based on approval of these applications, there will likely be more than 300 Medicare Advantage plans
available for beneficiaries across the nation, the largest number of plans since 1999. CMS received
applications from 55 new health maintenance organizations (HMOs), 73 preferred provider
organizations (PPOs) and 13 new private fee-for-service plans (PFFS). Currently there are 152
HMOs, 26 PPOs and 7 PFFS plans… Fifty-one of the new applications are from organizations
currently not offering Medicare Advantage plans.”
This enormous increase in the revival of Medicare Advantage programs was undoubtedly perpetuated
by the legislation of MMA, which increased the amounts of monthly payments to existing MA plans,
included other incentives for MA, and acted as a reinforcement to plans which felt they had been
underfunded for several years. The loss and bankruptcy of several plans during the early 2000’s had
left over a million Medicare age people without coverage, and forced them to return to traditional
Medicare and Medicare Supplement.
Incentives for Private Business to Keep Retired Employees on Group Health
Plans
One of the fears of the enactment of MMA manifested itself through a number of American
companies who had determined that if a “Medicare Prescription Drug Bill” were passed, they would
be eliminating retirees from group health coverage, because “now the retirees can buy their own drug
coverage from Medicare.” Thus, MMA was designed to alleviate the fears of Medicare age corporate
and union retirees.
The main emphasis toward correcting this possibility was embodied in a part of MMA which offered
$86 billion in payments and tax advantages over 10 years to the nations employers, if they would
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Chapter 2 — Medicare and Medigap
maintain drug coverage for retirees, thus keeping them on their group health plans. The subsidy, in
other words, was intended to discourage companies from dropping retirees from such plans. The
subsidy is available only if the actuarial value of the plan’s drug benefit is equal to or greater
than the actuarial value of the standard Part D drug benefit, and if the company can certify that their
plan(s) qualify as creditable coverage. The “actuarial value” factor should not be a great hurdle for
most companies or unions, since their existing group coverage for prescription drugs is currently far
better than the Plan D coverage, due to the large “Doughnut Hole” $2,800 blackout (no coverage)
zone.
In the Final Rules bulletin on January 21, 2005, CMS broached the subject this way: “Support for
retiree drug coverage plans to ensure beneficiaries will be able to keep the coverage they have: Many
employers and unions have dropped retiree drug coverage over the past decade, and the new
Medicare law provides the first real effort by the federal government to change this trend and to
preserve employer and union-sponsored retiree drug coverage. The Medicare prescription drug
benefit and the retiree subsidy is expected to significantly lower employers’ and unions’ cost of
providing drug coverage, making the provision of high-quality coverage much more affordable to the
employer or union and thus, more likely.”
The new rules adopted by MMA provided employers and unions some options on how to implement
the subsidies.
Option One provides sponsors with federal subsidies of 28% of incurred allowable drug costs
between the $250 deductible and $5,000 in expense (but not over) for each qualifying covered retiree.
In addition, the subsidy is tax favored. In other words, the payments would be made for retired
(Medicare age) employees and/or spouses who would be entitled to enroll in the new Part D program,
but elect not to. The company or union subsidy is based on what both the employer/union and the
retiree spends for prescription drugs. Thus, if the employer/union and the retiree each spend $1,000
on prescription costs, the subsidy is calculated on the $2,000 total. The company/ union would then
receive a payment of $490 from Medicare, and still deduct the $1,000 company reimbursement
from income.
The second option allows for providing (paying for) supplemental drug coverage that wraps
around a prescription drug plan (similar to policies that wrap around Medicare benefits under Part A
and Part B.
The third option allows for providing an employer/union sponsored Medicare Advantage (MA-
PD) or Part D (PDP) plan to provide enhanced benefits to their retirees, either by contracting with a
Part D plan, or choosing to become a drug plan that offers enhanced benefits to their retirees.
In any case, safeguards are in place, in the rules, that prohibit the employer/union from receiving
an economic windfall from the combination of subsidies and tax-free income.
In addition, according to the rules, states, as employers, can qualify for the new retiree drug
subsidies available to employers and unions that furnish qualified retiree drug coverage to Medicare
beneficiaries, or states can choose among the other options available to employers for providing
continued prescription drug assistance to the Medicare retirees.
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Pennsylvania Life-Senior Market Specialist Accreditation
A Revision in Medicare Supplement Rules—Plans “K and L” Replace Plans “H,
I, and J”
Medicare Supplement (Medigap) offerings were also affected by MMA. To say that Original
Medicare and the ability to offer Medicare Supplement products, which work in coordination with
Medicare Part D were overlooked in this law, would be an understatement. In fact, Original
Medicare and the ability of Medicare Supplement companies to enhance Part D either through a
Medicare Supplement “wrap around,” or “supplementary” product were totally ignored. Here’s how
the issue develops.
First of all, MMA, effective January 1, 2006, prohibits sale of Medicare Supplement Plans H, I,
and J. These are the three plans which had originally been built into the “Standardized” set of
Medicare Supplement, (at the very outset of the standardized policy series) which offered some sort
of prescription drug supplementary relief to people enrolled in traditional, or “Original Medicare.” As
MMA, 2003, rolled around, “Original Medicare” took a back seat to the intent of original
Medicare intentions of providing care to Medicare enrollees, and allowing private insurance
companies to offer them a set of “supplementary” products, which would “fill the holes” (deductibles,
co-insurances, etc.) of Medicare.
Since original Medicare itself provided no coverage, or assistance, for enrollees, on an outpatient
basis, for their prescription drug needs, Medicare Supplement Plans H, I, and J were developed. This
allowed the enrollee to “supplement” his or her prescription drug needs with some relief in their
prescription drug needs. But MMA changed that opportunity. The law disallowed sale of H, I, and
J after January 1, 2006.
That would seem to be the end of the matter. But it isn’t. In the place of H, I, and J, MMA substituted
Plans K and L, which would appear to be some form of substitute for H, I, and J. But they aren’t.
The original components of Plans K and L made no reference to outpatient prescription drug
coverage in the Part B outpatient benefits. Thus, the Original Medicare enrollee is left with no ability
to “supplement” outpatient prescription costs. In addition, Plans K and L make no reference to
Medicare Part D, again, not allowing the enrollee to seek relief for these costs in a Part D
supplement. In short, future enrollees (or those currently enrolled) in original or traditional Medicare
are left out of the picture when it comes to seeking a supplement for prescription drug cost relief,
such as those found in Medicare Supplement Plans H, I, and J.
True, MMA allows for traditional or original Medicare enrollees to purchase Plans H, I, and J, until
the cutoff date of January 1, 2006, and in fact, allows those with H, I, and J to retain those plans as
“grandfathered” plans. But, if the enrollee chooses to join Medicare Part D, and pay the Part D
premium, the H, I, or J plans will not be allowed to be renewed. This would appear to indicate that
the enrollee is left with only two choices. One, continue to retain the H, I, or J coverage, and
watch prescription drug inflation eat up any real benefits, or Two, Purchase Medicare Part D, and
just be satisfied with the Part D plan as it is currently structured.
In answer to the question, “What about Medicare Supplement plans H, I, J, which cover prescription
drugs”, Medicare says that, “If you choose to enroll in a Medicare Prescription Drug Benefit Plan,
you can keep your current Medigap policy but the drug coverage will be removed from the
policy or, for a limited time, you can buy a different Medigap policy that does not cover drugs.”
In answer to the question, “I have a Medigap plan that covers prescription drugs. Can I keep that plan
and also choose Medicare’s prescription drug coverage”, Medicare says: “No. If you choose to
enroll in one of Medicare’s prescription drug plans, you won’t be allowed to renew a Medigap
policy that also covers prescription drug (plans H, I, or J). However, you can choose another
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Chapter 2 — Medicare and Medigap
Medigap plan that doesn’t offer drug coverage. And, you can choose to stay with your current
Medicap policy until Medicare’s drug coverage starts in 2006.”
In answer to the question, “I have a Medigap plan that covers prescription drugs. Can I keep that plan
and also choose Medicare’s prescription drug coverages”, Medicare says: “No. If you choose to
enroll in one of Medicare’s prescription drug plans, you won’t be allowed to renew a Medigap policy
that also covers prescription drugs (plans H, I, or J.) However, you can choose another Medigap plan
that doesn’t offer drug coverage. And, you can choose to stay with your current Medigap policy until
Medicare’s drug coverage starts in 2006.
The answers to all three questions are somewhat repetitious, but all are geared to (and very clear in)
informing people that Plans H, I, and J are of no value to those who choose to participate in Plan
D.
Now, here is the heart of the matter. Medicare has made a point. Plans H, I, and J, by virtue of their
high premiums, were not heavily utilized. Many enrollees viewed the high premiums, when balanced
with the limited benefits, to be an exchange of dollars. In other words, the premium cost versus the
limited benefits really amounted to “taking money out of one pocket, and putting it in the other.” In
addition, the limitations of the benefits, provided no catastrophic coverage, which Medicare Part D
does, even in consideration of the expense of the “Doughnut Hole.”
So, the producer can look at this viewpoint. The 2006 premium for Part D ($37 per month), even with
its shortcomings, may result in a better buy for catastrophic needs, than the benefits of H, I, or J,
which offer no catastrophic benefit, and generate a considerably higher premium. For many people
catastrophic needs are not paramount, and a supplement for, at least the Doughnut Hole, would be of
value.
The fact that H, I, and J will be discontinued, and the substitutes K and L, offer no prescription drug
supplemental possibilities in return, leave Medicare Supplement Insurance companies, and the
Medicare Supplement producer no alternative, except to advise those interested in prescription drugs,
to join in the Medicare Part D program.
This end result will undoubtedly be addressed by the Medicare Supplement community in the near
future. And, at this point, even though nearly 80 bills have been presented in Congress addressing
changes in MMA, none of them have been directed to this particular issue. Time will tell, but for the
moment, Part D Medicare Supplement talking points are as they stand—no prescription drug
supplement policies, and no prescription drug replacement Medicare Supplement policies will be
available after December 31, 2005.
Commentary
There were several acrimonious and contentious points in the passage of MMA. Most Americans
don’t know, and therefore can’t remember, that the bill was objected to by a 15 hour cloture
proceeding in the Senate, and that the House of Representatives stayed open until 5 o’clock in the
morning, to round up enough “Yea” votes to pass it. However, there are a large number of
Congressional people who do remember this event, and as examples of their dissatisfaction, within a
year and a half of its passage, introduced nearly eighty additional pieces of proposed legislation to
amend the act.
One of the principal objections of several lawmakers, was the amount of the bill, and what it would
cost American taxpayers over a ten year period. As originally presented, the amount was to be $396
billion, however within a few months, that projection was revised upward to $520 billion, and about
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Pennsylvania Life-Senior Market Specialist Accreditation
a year later, was further revised upward to $720 billion. These upward revisions created a great deal
of anxiety for lawmakers on both sides of the aisle, and resulted in requests for revisiting the issue,
and the entire act.
The media presented a great amount of information regarding the act, both before and after its
passage. Although not all comment was negative, nor positive, some commentary reflected views and
concerns about the original bill and some need for modification. For example, in August of 2004, The
Kaiser Family Foundation and the Harvard School of Public Health completed a somewhat
comprehensive survey of people on Medicare and their “Views of the New Medicare Drug Law.” The
34-page report contained dozens of conclusions, but three are most relevant.
First, the consensus of respondents indicated that: “Despite the apparent unfavorability towards the
law and uncertainty about enrollment, people on Medicare overwhelmingly prefer that lawmakers
work to fix problems in the law, rather than repealing it.” Secondly, “About eight in ten people on
Medicare (79%) say they favor changing the law to allow Americans to buy prescription drugs from
Canada if they think they can get a lower price.” Third, “Eight in ten (80%) also say they favor
changing the law to allow the federal government to use its buying power to negotiate with drug
companies to try to get a lower price for prescription drugs for people on Medicare.” The last two
items were made illegal in MMA.
These three observations embody some of the thinking of Medicare recipients, but the eighty pieces
of proposed legislation obviously cover a much larger spectrum. As Congress continually revisits and
deals with changes and costs in the Medicare program, over the next ten years, these issue will
undoubtedly play a role in revision of MMA. The expense of the entire Medicare program will also
be a focal point.
In March of 2005, the Kaiser Family Foundation also reported in a “Medicare Fact Sheet,” some
figures of interest to those in the Medicare, Medicare Supplement, and Medicare Advantage
industries. Listed below are several relevant findings in regard to various enrollment amounts in plans
we have discussed.
• “Of the estimated 43.1 million Medicare beneficiaries, 29.3 million are expected to enroll in
Part D plans in 2006.”
• “Employer-sponsored plans currently cover drugs for more than 11 million beneficiaries.
• “Medicaid provides drug coverage for 6.3 million Medicare beneficiaries, known as “dual
eligibles.” As of January 1, 2006, dual eligibles will get drug coverage from Medicare Part D
plans, rather than Medicaid.”
• Medicare Advantage plans are a source of coverage for nearly 5 million beneficiaries in
2004.”
In a similar document, an Issue Brief of the American Academy of Actuaries, February, 2005, the
Brief gives us some further idea of Medicare utilization choices, of interest to students and this
discussion. The brief reports: “To fill the gaps in Medicare’s coverage, one-third of Medicare
beneficiaries have supplemental coverage through an employer and one-fourth have coverage
through a Medigap plan... Almost another one-third of Medicare beneficiaries has supplemental
coverage through Medicaid, a Medicare Advantage plan, or through another public plan. Only about
one in eight Medicare beneficiaries has traditional Medicare only, without any supplemental
coverage.”
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Chapter 2 — Medicare and Medigap
In a “Government Relations and Policy Memo” of December I, 2003, the National Committee to
Preserve Social Security and Medicare made two poignant comments regarding MMA. First, one
conclusion states, “The Medicare law doesn’t include any provisions that would control the
skyrocketing costs of prescription drugs in the future.” The second conclusion was that “The
Medicare law creates a new Medicare funding crisis: The new cap on general revenue financing
causes the program to become “insolvent” significantly earlier than the Medicare trustees currently
(2003) projected date of insolvency in 2026.”
This second statement was borne out in a Press release from CMS dated March 23, which opens,
“The trustees (Social Security and Medicare) (2005) estimate that the Hospital Insurance (HI) Trust
Fund will remain solvent until the year 2020, and one-year gain for estimated Part A solvency from
the forecast of 2019 made by the trustees last year.
However, two members of the board of trustees, Republican Thomas R. Saving and Democrat John L.
Palmer issued a statement in the Washington Post of March 24, 2005 which dramatized the
significance of the report. The two wrote in a prepared statement: “The financial outlook for Social
Security has improved marginally since 2000. In sharp contrast, Medicare’s financial outlook has
deteriorated dramatically over the past five years and is now much worse than Social Security’s.”
The Post reported, “they wrote that Medicare’s prospects have ‘deteriorated dramatically’ with rising
medical costs and the addition in 2003 of a prescription drug benefit.” In regard to the trustee’s report,
Federal Reserve Chairman Alan Greenspan, echoed these sentiments stating “The Medicare problem
is several multiples more difficult than is Social Security.”
In an “Abstract” of a May, 2004 Issue Brief from “The Commonwealth Fund,” under the heading
“The Cost of Privatization: Extra Payments to Medicare Advantage Plans,” the report explains that,
“The authors find that, for 2004, Medicare Advantage payments will average 8.4 percent more
than costs in traditional fee-for-service Medicare: $552 for each of the 5 million Medicare
enrollees in managed care, for a total of more than $2.75 billion. In some counties, extra payments by
Medicare are more than double this amount. Although the stated objectives of efforts to increase
enrollment in private plans is to lower costs, the policies of MMA regarding private plans explicitly
increase Medicare costs in 2004 and through 2013.”
In a public letter of December 5, 2004, Senator Christopher Dodd, D-Mass, and Judith Stein,
Executive Director of the Center for Medicare Advocacy, issued the following statement: “Last
month, the top insurance regulators from all 50 states admonished the Bush administration for
misleading American seniors about the new Medicare drug benefit. A month earlier, the Government
Accountability Office released shocking findings showing that the private plans so aggressively
promoted by the president and his allies in the new Medicare law are likely to cost the federal
government between $650 and $750 more per person per year.”
On March 5, 2005, the New York Times reported, “Five weeks ago the budget office predicted that
Medicare would spend $5.55 trillion on health care for the elderly and disabled in the decade from
2006 to 2015. On Friday, it said the figure would be $70 billion higher. Douglas J. Holtz-Eakin,
director of the budget office, said that $54 billion of the increase resulted from a higher estimate of
the cost of the new drug benefit. The new estimate is the first to reflect the effects of Medicare rules
published on Jan. 28.”
At this point, it is imperative to understand that much of Medicare’s increase in costs can be
attributed to the “cost-shifting” of the MMA provision, which states that Medicaid prescription
drug recipient costs would be transferred from Medicaid to Medicare. Obviously, this is a large
item, and in itself, creates cost overruns for Medicare as a result of MMA. On the other hand, one
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Pennsylvania Life-Senior Market Specialist Accreditation
would assume that the federal costs to Medicaid for the same reason would indicate an equivalent
dramatic drop in Medicaid costs, since they have now been transferred to Medicare. But, even with
the drop in Medicaid prescription costs being transferred to Medicare, Medicaid remains a large
problem in itself, with exponential growth of costs in other areas.
Medicare overpayments through fraud, erroneous, and questionable payment, has seriously
plagued the plan over the last fifteen years. For at least ten years, the problem has been in the double
digit billions, varying from $12 billion to $23 billion each year. By its own admission, Medicare
estimates these losses to the program, and is consistently trying to overcome the flow of red ink. Then
in 2005, the 2004 estimates were released, and amounted to $20 billion. Many congressmen are
unhappy with this continuing travesty and it will become a major part of future Medicare
legislation, and in dealing with future Medicare cost containment.
In addition to an array of continuing medical cost problems for American health care, experts are
predicting that by 2014, public health programs such as Medicare and Medicaid will comprise 49%
of all health care spending, which in itself will be nearly 19% of the entire U.S. economy. By then,
Health care spending is expected to approach over $11,000 for every man, woman, and child in the
United States.
One thing is certain, MMA with its heavy concentration on providing prescription drug access
through the low-income and Federal Poverty Level provisions, and simply maintaining the “dual
eligibility” obligations of former Medicaid recipients will have an incredible impact on Medicare.
With 6.3 million dual eligibles, who will automatically be enrolled in Part D, and another 9.4 million
beneficiaries eligible for low income assistance, who are not dual eligibles, the Medicare Part D
program will create major financial stress for both Part D and Medicare.
The popularity of Medicare Advantage plans, Medicare Supplement plans, and Employer/Union plans
will be decided in the market place, and each Medicare beneficiary will make their own choice in
many cases. Some will favor, or stay with one approach—some will favor, or stay with another—and
some will hope that their former employer or union will find the best plan for them. But one thing is
certain. All Americans will be concerned about, and affected by, the financial health of the Medicare
program for decades to come.
As a followup to our meeting today, I've extracted a few PPT slides (they contain speaker's notes).
Also, I've included the basic text in the body of this note. Please let me know if you need additional
info or if you have any questions. I look forward to working with you!
There are three enrollment periods.
• The Initial Enrollment Period (IEP) allows people to enroll in a Medicare prescription drug
plan when they are first eligible for Medicare prescription drug coverage.
• The Annual Coordinated Election Period (AEP) allows people to change their Medicare
prescription drug plan, enroll in a prescription drug plan, or disenroll from a Medicare
prescription drug plan.
• The Special Enrollment Periods (SEP). See below
For the start of the drug coverage, the Initial Enrollment Period (IEP) is from November 15, 2005,
to May 15, 2006, for individuals who
• Are currently eligible, or
• Become eligible in November and December 2005, and January 2006
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Chapter 2 — Medicare and Medigap
For people who become eligible for Medicare after January 2006, the initial enrollment period is
similar to the initial enrollment period for Part B. This is a 7-month enrollment period, including
• 3 months before eligibility for Medicare prescription drug coverage
• the month of eligibility
• 3 months after eligibility for Medicare prescription drug coverage
For the first year, the Annual Coordinated Election Period (AEP) is the same as the Initial
Enrollment Period: from Nov 15, 2005, to May 15, 2006. In 2006 and after, the AEP is from
November 15 to December 31 of each year.
There are circumstances in which people with Medicare are given a special election period (SEP).
These include:
• Involuntary loss, reduction, or non-notification of creditable coverage. This does not
apply when you lose creditable coverage due to non-payment of premiums. If you were not
adequately informed that your coverage was not creditable or that your current coverage was
reduced so that it is no longer creditable, then you qualify for a special election period (SEP).
• Erroneous enrollment, which means you were enrolled in a PDP in error.
• Individuals with Medicaid coverage who will become full dual-eligibles after the initial
enrollment period.
• Individual entering or leaving a long term care facility.
• An individual who enrolls in a MA-PD plan upon first becoming eligible for benefits
under Part A at age 65 and then discontinues that enrollment and elects coverage under
original Medicare and a PDP at any time during the 12-month period beginning on the
effective date of the MA-PD plan election.
• Or exceptional circumstances such as when a PDP terminates its contract, an individual
moves out of a plan’s service area, or a PDP violates its contract.
NOTE: Full-benefit dual eligibles have a continuous special election period. They can change their
Medicare prescription drug plan at any time.
Section B. Medigap
Basics of Medicare Supplement
Though Medicare covers many health care costs, recipients still have to pay Medicare's coinsurance
and deductibles. There are also some medical services that Medicare does not cover.
The first of the solutions to Medicare deficiencies would be what is known in insurance circles as a
“supplement to the Original Medicare Plan.” Historically, there was only “Medicare” and “Medigap”
(Medicare Supplement) coverage available. With the introduction of “Medicare Plus Choice, in 1999,
another program became available. We will discuss Medicare Plus Choice, or what was renamed
Medicare Advantage at the beginning of 2004, in the next chapter, but for now let’s stay with
Medicare Supplement to the Original Medicare Plan.
So, one may want to buy a Medicare supplemental insurance policy, known in government
nomenclature as a “Medigap” policy. Understanding the difference in terminology (Medigap and
Medicare Supplement) is not a significant item, because there is no difference. While only the
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Pennsylvania Life-Senior Market Specialist Accreditation
government calls Medicare Supplement, “Medigap,” they both mean the same thing. Medicare
Supplement is private insurance that is designed to help pay one’s Medicare cost-sharing amounts.
There are 10 standard Medicare Supplement policies, and each offers a different combination of
benefits. The 2003 Medicare Modernization Act will change part of this array. According to
Medicare, beginning in 2006, Medicare supplement policies will include two new plans to help
beneficiaries with out-of-pocket costs, and no new Medicare Supplement policies with drug coverage
may be sold.
Basic Medicare Supplement Plans
A Medicare Supplement plan is a health insurance plan that fills the gaps in Original Medicare plan
coverage. In all states, (with the exception of Massachusetts, Minnesota, and Wisconsin), there are
basic standardized Medicare Supplement plans. Each plan has a different set of benefits. Any
standardized plan may also be sold as a “Medicare Select” plan. Medicare Select plans usually cost
less because one must use certain doctors and hospitals, except in an emergency.
A Medicare beneficiary has certain rights and protections related to Medicare Supplement plans.
Individuals need to be aware of what these rights and protections are as they shop for Medicare
Supplement plans. If one is in a Medicare “managed care plan,” or if he is covered by Medicaid, he
does not need a Medicare Supplement plan. Generally, it is not legal for anyone to sell a Medicare
Supplement plan in these cases.
Every company offering Medicare Supplement insurance must offer Plan A. In addition, companies
may have some, all, or none of the other plans. The Basic Benefits are included in all plans:
• Hospitalization, Medicare Part A coinsurance plus coverage for 365 additional days during
insured’s lifetime after Medicare benefits end
• Medical Expenses, Medicare Part B coinsurance - generally 20% of Medicare-approved
expenses
• Blood: first 3 pints of blood each year
The standard plans adhere to the following formats. Medicare Supplement policies assume that one
has both Medicare Part A and Part B coverage. Each policy provides coverage for gaps in both Parts
of Medicare and one cannot buy a policy that deals with only one Part or the other. Nor can one buy a
Medicare Supplement policy without obtaining Medicare Part B coverage. In other words, for a plan
to “supplement” Medicare, the Part B Medicare provision must be in place, before an insurance
policy can “supplement” it. (Some states and some Medicare Supplement companies may have
variances on these Part B qualifying rules.)
(Beneficiaries and insurance producers alike must not let the phrase “Part A” or “Part B” of
Medicare, be confused with “Plan A” or “Plan B” of Medicare Supplement. “Part” and “Plan” are
two different things, but can sometimes be misunderstood or confused.)
Note in the following descriptions that each of the plans builds on the Basic Plan benefits that are
listed under Plan A. Plan B through Plan J each include these Basic Benefits and add various
additional benefits to it.
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Chapter 2 — Medicare and Medigap
The Plans
Plan A – The Basic Policy
• Coverage for the Part A co-insurance amount for the 61st through the 90th day of
hospitalization in each Medicare Benefit period
• Coverage for the Part A co-insurance amount for each of Medicare’s 60 non-renewable
lifetime hospital reserve days
• After all Medicare hospital benefits are exhausted, coverage for 100 percent of the eligible
Medicare Part A hospital expenses. Coverage is limited to a maximum of 365 days of
additional inpatient hospital care during the policyholder’s lifetime. This benefit is paid at the
Medicare approved rate
• Coverage under Medicare Parts A and B for the reasonable cost of the first three pints of
blood or equivalent quantities of packed red blood cells per calendar year unless replaced in
accordance with federal regulations
• Coverage for the co-insurance amount for Part B services (generally 20 percent of the
approved amount or 50 percent of approved charges for out-patient mental health services
after $100 annual deductible is met
Plan B
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
Plan C
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• Coverage for the Medicare Part B deductible
• 80 percent coverage for medically necessary emergency care in a foreign country after a $250
deductible
Plan D
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
• Coverage for at-home recovery - The at-home recovery benefit pays up to $1600 per year for
short-term assistance with activities of daily living (bathing, dressing, personal hygiene, etc.)
for people recovering from an illness, injury, or surgery. There are various benefit
requirements and limitations
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Pennsylvania Life-Senior Market Specialist Accreditation
Plan E
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
• Coverage for preventive medical care. The preventive medical care benefit pays up to $120
per year for such items as a physical examination, serum cholesterol screening, hearing test,
diabetes screening, and thyroid function test
Plan F
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• Coverage for the Medicare Part B deductible
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
• Coverage for 100 percent of Medicare Part B excess charges. Plan pays a specified
percentage of the difference between Medicare’s approved amount for Part B services and the
actual charges up to the amount of charge limitations set by either Medicare or state law
Plan G
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• Coverage for 100 percent of Medicare Part B excess charges. Plan pays a specified
percentage of the difference between Medicare’s approved amount for Part B services and the
actual charges up to the amount of charge limitations set by either Medicare or state law
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
• Coverage for at-home recovery. The at-home recovery benefit pays up to $1600 per year for
short-term assistance with activities of daily living (bathing, dressing, personal hygiene, etc.)
for those recovering from an illness, injury, or surgery
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Chapter 2 — Medicare and Medigap
Plan H
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
• Coverage for 50 percent of the cost of prescription drugs up to a maximum annual benefit of
$1250 after the policyholder meets a $250 per year deductible. This is called the Basic
Prescription Drug Benefit. New sales of this plan will be discontinued after 2005.
Plan I
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• Coverage for 100 percent of Medicare part B excess charges. Plan pays a specified
percentage of the difference between Medicare’s approved amount for Part B services and the
actual charges up to the amount of charge limitations set by either Medicare or state law
• Coverage for 50 percent of the cost of prescription drugs up to a maximum annual benefit of
$1250 after the policyholder meets a $250 per year deductible. This is called the Basic
Prescription Drug Benefit. New sales of this plan will be discontinued after 2005
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
• Coverage for at-home recovery. The at-home recovery benefit pays up to $1600 per year for
short-term assistance with activities of daily living (bathing, dressing, personal hygiene, etc.)
for those recovering from an illness, injury, or surgery. There are various benefit
requirements and limitations
Plan J
Includes all the Plan A basic benefits, plus
• Coverage for the Medicare Part A inpatient hospital deductible
• Coverage for the skilled nursing facility care co-insurance amount
• Coverage for the Medicare Part B deductible
• Coverage for 100 percent of Medicare Part excess charges. Plan pays a specified percentage
of the difference between Medicare’s approved amount for Part B services and the actual
charges up to the amount of charge limitations set by either Medicare or state law
• 80 percent coverage for medically necessary emergency care in a foreign country, after a
$250 deductible
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Pennsylvania Life-Senior Market Specialist Accreditation
• Coverage for 50 percent of the cost of prescription drugs up to a maximum annual benefit of
$3000, after the policyholder meets a $250 per year deductible. This is called the Extended
Drug Benefit. New sales of this plan will be discontinued after 2005
• Coverage for at-home recovery - The at-home recovery benefit pays up to $1600 per year for
short-term assistance with activities of daily living (bathing, dressing, personal hygiene, etc)
for those recovering from an illness, injury, or surgery. There are various benefit
requirements and limitations.
• Coverage for preventive medical care - The preventive medical care benefit pays up to $120
per year for such items as a physical examination, serum cholesterol screening, hearing test,
diabetes screening, and thyroid function test.
The Balanced Budget Act added two new high deductible versions of Plan F and Plan J to the list of
approved Medigap policy forms. They have the same coverage as Plan F or Plan J, but they have a
$1,620 per year deductible in 2003, which increases each year.
Medicare Select
Medicare Select is another type of Medicare supplemental health insurance sold by insurance
companies throughout most of the country. Medicare Select is the same as standard Medicare
Supplement insurance. The only difference between Medicare Select and standard Medicare
Supplement insurance is that each insurer has specific hospitals, and in some cases specific doctors,
that the insured must use, except in an emergency, in order to be eligible for full benefits. Medicare
Select policies generally have lower premiums than other Medicare Supplement policies because of
this requirement. Medicare Select is a type of standardized Medicare Supplement plan. If one buys a
Medicare Select plan, he is buying one of the basic standardized plans. What makes Medicare Select
different from regular Medicare Supplement insurance is that the insurance company and the hospital
have an agreement which says that the hospital will “forgive” the Part A deductible for the patient
enrolled in the Medicare Select plan. The idea is that the hospital will attract more customers through
the efforts of the agents of the Medicare Supplement company. This theory would be effective in a
county or area of competing hospitals.
When one goes to the Medicare Select “preferred providers,” Medicare pays its share of the approved
charges and the insurance company is responsible for all supplemental benefits in the Medicare Select
plan. In general, Medicare Select plans are not required to pay for any benefits if the insured
does not use a preferred provider for non-emergency services. Medicare, however, will still pay
its share of approved charges with any Medicare certified provider one chooses.
Basic Enrollment
The best time to buy a policy is during one’s Medicare Supplement open enrollment period. For a
period of 6 months from the date he is first enrolled in Medicare Part B and is age 65 or older, he has
a right to buy the Medicare Supplement policy of his choice, without denial by the company based on
pre-existing conditions. This is known as one’s open enrollment period.
He cannot be turned down or charged higher premiums because of poor health if he buys a policy
during this period. Once his Medicare Supplement open enrollment period ends, he may not be able
to buy the policy of his choice. He may have to accept whatever Medicare Supplement policy an
insurance company is willing to sell him, or has available for sale.
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If one has Medicare Part B but is not yet 65, his 6-month Medicare Supplement open enrollment
period begins when he turns 65. However, several states (Connecticut, Maine, Massachusetts,
Minnesota, New Jersey, New York, Oklahoma, Oregon, Pennsylvania, Virginia, Washington, and
Wisconsin) require at least a limited Medicare Supplement open enrollment period for Medicare
beneficiaries under 65.
If one’s income is low, he may qualify for a government program that will help pay his Medicare
costs. The State Medical Assistance Office can give him information concerning this. Medicare
Supplement plans are designed so that one does not need other similar coverage. It is illegal for an
insurance company to sell one a second Medicare Supplement plan, even if the coverage is to
“overlap” for as little as one day. For that reason, years ago the Medicare Supplement replacement
form was developed if a person chose to replace an existing Medicare Supplement plan with another.
Replacement is not illegal if the benefits of the new policy will be greater, or if the new premium will
be equal or less, or the new policy will contain fewer benefits and lesser premium; but the applicant
must sign a notice that they are aware of the differences of the transaction. It is also illegal to sell
someone a Medicare Supplement plan if he is in a Medicare managed care plan.
Depending on one’s health care needs and finances, he may have alternatives including
• health coverage from his current or former employer
• joining a Medicare managed care plan
• buying a Medicare Supplement plan.
When checking into a Medicare Supplement plan, one should find out whether it limits or excludes
coverage for pre-existing conditions. If one has a health problem, and the company limits or excludes
coverage for pre-existing health conditions, the insurance company might not cover his costs for any
care related to that health problem. One should be sure he has a good reason for switching from one
Medicare Supplement plan to another- he should only switch for different benefits, better service, or a
more affordable price. On the other hand, no one should keep an inadequate plan simply because he
has had it for a long time.
The insurance company should deliver a plan within 30 days. If it does not, one can call and ask them
to put the reason for the delay in writing. If 60 days go by without an answer, one should call their
State Insurance Department. It is unlawful for an insurance company or agent to use high pressure
tactics to force or frighten a client into buying a Medicare Supplement plan, or to make false or
misleading comparisons to get one to switch from one company or plan to another.
Medicare Supplement plans are neither sold nor serviced by the State or Federal government. State
insurance departments approve the standardized Medicare Supplement plans sold by private insurance
companies, but approval only means the company and Medicare Supplement plan meet the
requirements of state law.
Basic Age Rating
With attained age rating, one’s premium will increase as he gets older. If one buys the plan at age
65, he will pay what the company charges 65-year-old customers. Then at age 66 he will pay
whatever the company is charging 66-year-old customers.
With issue age rating, if one first buys the plan at age 65, he will always pay the premium that the
company charges 65-year-old customers, no matter what his age. If he first buys the plan at age 70, he
will always pay the premium that the company charges 70-year-old customers.
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The issue of whether to buy an “attained age” plan or an “issue age” plan becomes rather moot when
we see a disparity of as much as $1,000 annually between companies on their “Street rate” (the rate
charged at the original purchase date.) One company may argue that their “issue age” policy is
superior to “attained age rated” policies, but the whole issue becomes insignificant when companies
raise rates for all people in all classifications each year anyway. The “attained age rated” company
may raise rates on an “across-the-board” basis, and the “issue age rated” company will raise rates for
each band simultaneously. Most rate increases are related to the rise in the cost of deductibles and coinsurance
due to high inflation in health care nationwide, as has been the case for nearly two decades.
Basic Factors
Other factors that may affect one’s premium are:
• Discounts for non-smokers
• Discounts for couples
All premiums generally go up each year because of inflation.
One has the right to buy the Medicare Supplement plan of his choice during the first six months he is
age 65 or older and after he first joins Medicare Part B. If one applies for a Medicare Supplement
plan after the first six months he is enrolled in Medicare, companies may reject his application or
charge him more for the plan. The company is also allowed to make the policyholder wait up to six
months for coverage of a pre-existing condition. This is a major reason for choosing a Medicare
Supplement within the six-month open enrollment period.
There are certain situations, however, when one may have the right to get a Medicare Supplement
plan after his open enrollment period. In these cases, the insurance company cannot deny someone
coverage or change the price of a plan because of past or present health problems. For instance:
• The insured loses his health coverage through no fault of his own under a Medicare managed
care plan, Medicare Supplement, or Medicare Select plan, or employer coverage. (Company
goes broke, or managed care plan is terminated)
• he joins a Medicare managed care plan for the first time and within one year of joining, he
decides he wants to leave managed care
• There is a 63-day “open window” during which the insured must apply to the Medicare
Supplement company and show them a letter of plan termination.
If he were new to Medicare when he joined the plan, he may be able to choose any Medicare
Supplement plan he wants. If he already had a Medicare Supplement plan before he joined the
managed care plan, he may be able to get the same plan back. If his previous plan is not available, he
is guaranteed the right to buy Medicare Supplement plans A, B, C, or F from any insurance company
that sells these plans in one’s state.
Basic Prescription Drugs
If a member currently had prescription drug coverage through a managed care plan that is leaving
Medicare, this coverage ended December 31, 1999. Members have the option to enroll in other
managed care plans available in their area that may cover prescription drugs. However, the Medicare
Supplement policies that must be made available to most members of a withdrawing managed care
plan (policies "A", "B", "C" and "F") do not include prescription drug coverage.
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Medicare Supplement policies that contain prescription drug coverage (Plans H, I and J) are available,
but insurers may refuse to sell a policy based on health status and may impose waiting periods for
pre-existing conditions. If one had previous Medicare Supplement drug coverage (plans H, I, or J),
and this was his first time in a Medicare managed care plan, and he leaves the Medicare managed care
plan within 12 months, he can go back to this policy if his old insurer still sells it. Again, according to
Medicare, after the 2003 Medicare Modernization Act, new sales of these plans will be discontinued
after 2005, and two new plans will become available.
If he joined his Medicare managed care plan within the past 12 months as his first choice when he
became entitled to Medicare at age 65 and he disenrolls from the Medicare managed care plan before
the 12-month period has expired, he will have the choice of all plans "A" through "J" that are
available in his State. In either of these cases, he must apply for the Medicare Supplement policy
within 63 days of the date his Medicare managed care plan coverage ends.
Basic Rights Upon Leaving a Managed Care Plan
When a managed care plan leaves Medicare, enrollees have certain rights but must exercise them
within 63 days after their managed care plan coverage ends. If a person applies for a Medicare
Supplement policy within 63 days after a plan leaves the Medicare program, the seller or insurer of
that policy may not:
• Refuse to sell the person any Medicare Supplement policy designated “A”, “B”, “C” or “F”
that the insurer sells in the State
• Discriminate in the pricing of such policy because of health status, claims experience, receipt
of health care, or medical condition
• Impose a pre-existing condition exclusion
These rights are sometimes referred to as "guaranteed issue" rights, because they mean one is
guaranteed the right to buy or be issued a policy.
A Medicare Managed Care Plan (Medicare + Choice, to be renamed Medicare Advantage in 2004)
provides a full range of health care services, including all Medicare covered services. A Medicare
Supplement policy is a private insurance policy. It is designed to work with the Original Medicare
Plan to cover some of the costs that Original Medicare does not cover.
Basic Medicare Supplement (Medigap) Compare
Medigap Compare is a new addition to CMS’s consumer information website. The website can be
found at www.medicare.com. It is designed to help one find the insurance companies in his state that
sell Medigap – (Medicare supplemental) insurance plans, and it will give him information on how to
contact the insurance companies. In addition, Medigap Compare currently contains some basic
information about each reporting insurance company, such as:
• that plans they offer
• if the plans are offered to persons at or overage 65, or under 65 with disabilities
• how they price their plans
• what rating method they use
• if one needs to be a member of a certain organization to buy one of their plans
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Medicare Supplement Replacement — Ethics and Legality
Many Medicare Supplement policies sold prior to July 1, 1993 were better than the current
standardized policy series. Some policies contained provisions, which paid the client an automatic 80
(or more) days of nursing home care at any level of care- skilled, intermediate, or custodial. In
today’s environment, that amounts to about a $10,000 - $12,000 benefit, which was included
automatically as a built-in feature. Replacement of that, or similar products, would result in a loss of
benefits to the insured, a practice that is unethical since the policyholder may not be aware that the
feature is not available in any standardized plan sold after July 1, 1993.
Replacement of an existing policy in order to obtain a new first-year commission is unethical. Most
states by now have enacted legislation that allows only level commission on policy renewal. This is
meant to discourage, and even outlaw, the practice of “rolling,” which meant that agents switched
people each year to obtain higher first-year commissions. The legislation has been high successful.
The practice of “stacking” (selling more than one policy to a client) is illegal under Federal Medicare
law, but some unethical agents still ignore or overlook the law and continue to take advantage of the
client in their desperation to seek new sales. Duplication is illegal.
Replacement of Medicare Supplement policies is legal, and in some cases, can be very beneficial to
the client. Since all Medicare Supplement policies currently sold are identical by Plan (Plan A, Plan
B, etc) there can be no variation as to the benefits of any single plan. However, the agent must
compare “apples with apples.” Comparing a Plan B (which is normally less expensive) with a Plan F
(which offers more benefits) means that the client must be made aware of a loss of benefits, even in
consideration of premium. The client must evaluate what is in their own best interests, or at least what
is in their pocketbook, when considering loss of benefits.
In all instances, a replacement form (Notice To Applicant Regarding Replacement of Medicare
Supplement Insurance), which discloses the reason for the replacement (lower premiums, change of
plan, etc.), must be signed by the applicant at the time of the replacement and forwarded to the
replacing company for it to determine if the replacement procedure is in fact, suitable to the client.
Depending on the premiums involved and coverages replaced, replacement is legal and if done
correctly, ethical. Duplicating coverage, even for one day, is illegal. In addition, not indicating that
the new application is a replacement is illegal.
Variations in annual premium (between two companies) may be as high as $300 for a Plan C product,
and as high as $1,000 for a Plan J, depending on the age of the client. This would be an example of an
ethical replacement of an existing policy-“apples to apples”-for less premium.
Basics of Medicare+Choice — History
Medicare is not a welfare program and should not be confused with Medicaid. The income and assets
of a Medicare beneficiary are not a consideration in determining eligibility or benefit payment.
Medicare is a national program and procedures should not vary significantly from state to state.
Coverage under Medicare is similar to that provided by private insurance companies: it pays a portion
of the cost of medical care. Often, deductibles and co-insurance (partial payment of initial and
subsequent costs) are required of the beneficiary, thus the need for additional insurance coverage.
Part A of Medicare is financed largely through federal payroll taxes paid into Social Security by
employers and employees. Part B is financed by monthly premiums paid by Medicare beneficiaries
and by general revenues from the federal government. In addition, Medicare beneficiaries themselves
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share the cost of the program through co-payments and deductibles that are required for many of the
services covered under both Parts A and B.
A beneficiary may choose to receive Medicare coverage and care through a managed care plan (the
newly renamed Medicare Advantage) by filing an enrollment form. Once the choice is made, the
beneficiary generally must receive all of his or her care through the plan in order to receive Medicare
coverage. Beneficiaries can change their minds, disenroll from their managed care plan, and return to
"original" Medicare.
Introduction to Medicare+Choice — Medicare Advantage
The Balanced Budget Act of 1997 (BBA) signed into law on August 5, 1997 and effective January 1,
1999, divided the Medicare program into multiple financing and delivery systems. The BBA
accomplished this by creating a new Medicare Part C, also called the Medicare+Choice program.
Medicare+Choice expanded options for receiving Medicare coverage through a variety of managed
care plans, including health maintenance organizations (HMOs) and preferred provider organizations
(PPOs), and through new mechanisms such as medical savings accounts (MSAs, which will become
known as HSAs, Health Savings Accounts). The 2003 Medicare Modernization Act revised the name
of Medicare + Choice to Medicare Advantage beginning in 2004.
Since its inception in 1965, Medicare has provided a set of coverage and due process protections so
that all beneficiaries could expect the same basic level of health insurance. As a consequence, all
beneficiaries -rich or poor, well or sick, articulate or silent- had a common interest in making the
program work. This system resulted in the evolution of an imperfect, but functional, basic health
insurance program for all. Thus, the reason for Medicare Part C, the Medicare+Choice alternative.
During the late 90’s, after BBA ‘97, OBRA ‘96, and HIPAA ’97, an increasing number of
beneficiaries financed their health services through Managed care plans. The Medicare managed care
benefit is different from the traditional Original Medicare “fee-for-service” ongoing plan, but basic
coverage generally is the same. Usually, a Medicare managed care plan administers the health care
treatment of an enrollee by the use of a physician (known as a “gatekeeper”) who must approve the
patient’s referral to specialized care. (Some Medicare managed care plans permit beneficiaries to go
directly to a specialized care provider, with the gatekeeper’s approval, in return for payment of an
extra premium.)
Although we offer an introduction to Medicare+Choice here, in fact, many beneficiaries have
experienced difficulties with Medicare managed care plans and appeals. In addition, the methods for
delivering and financing health care are in flux for all Americans. Managed care plans are changing
their benefit packages. Many are disbanding so that leaves some geographic areas with no managed
care options at all. Appeal systems are being challenged; physicians are losing their independence;
and state and federal legislators are proposing protections for managed care patients.
For instance, in the late 90’s and early 2000’s within a few years of establishing managed care plans,
many HMOs nationwide dropped the grand experiment of Medicare HMO and left over 1 million
Americans wondering where to go next for their health insurance supplements. Many of these people
returned to the traditional Original Medicare and Medicare Supplement plans, using the guarantees of
the system we have outlined above. Some were able to find existing HMOs that would allow them to
enroll. The HMOs abandoning their plans normally complained that Medicare did not allow them
enough money (hospital and doctor’s fees) to continue operating at a profit. Some would say that the
HMOs tried to provide too much service at too low a cost in comparison to the structure of the
Original Medicare Plan and Medicare Supplement options. At any rate, Medicare HMOs continue to
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Pennsylvania Life-Senior Market Specialist Accreditation
exist and prosper in some geographical locations, so some of that part of the managed care plan under
Medicare+Choice has remained viable.
Options
Under Medicare+Choice (Medicare Advantage), a Medicare beneficiary may choose to remain in the
traditional Medicare program or their current managed care plan, or to receive Medicare covered
services through any of the additional following types of health insurance plans:
Coordinated Care Plans
These are managed care plans that include health maintenance organizations (HMOs), provider
sponsored organizations (PSOs), and preferred provider organizations (PPOs). These plans will most
closely resemble current Medicare HMOs. They provide coverage for health care services, with or
without a point-of-service option (the ability to use plan or out-of-plan health care providers). Some
plans limit the enrollee’s choice of providers. Some plans may offer benefits, such as prescription
drug coverage, in addition to those in the traditional Medicare program. If supplemental benefits are
offered, an extra premium may be charged. Some plans offer a combination of a limit on the choice of
providers and supplemental benefits. It is very important for the Medicare enrollee to analyze the
coverage details, advantages, and disadvantages of each plan.
In 2006, Medicare Advantage plan choices will be expanded to include regional preferred provider
organization plans (PPOs). Regional PPOs will help ensure that beneficiaries in rural and urban areas
have multiple choices of Medicare health coverage. The Preferred Provider Organization is a
Medicare Advantage plan in which recipients use doctors, hospitals, and providers that belong to the
network. The recipient can use doctors, hospitals, and providers outside of the network for an
additional cost.
Private Fee-for-Service Plans
A private fee-for-service plan is defined as a Medicare Advantage plan that:
• Reimburses providers, on a fee-for service basis, at a rate determined by the plan
• Does not put the provider at financial risk
• Does not vary rates for the providers based upon their particular utilization
• Does not restrict the selection of providers among those who are lawfully authorized to
provide the covered services, and who agree to accept the terms and conditions of payment
established by the plan
The Medicare program makes capitated payments to private fee-for-service plans just as it does to
HMOs. These plans do not have to follow the usual Medicare fee limitations. They establish their
own rates, without reference to the Medicare Part B reasonable charge, or limiting charge restrictions.
The rates set by these plans may be substantially higher than those in the traditional Medicare
program. Providers under contract with a private fee-for-service plan will be required to accept an
amount not to exceed 115% of its contracted rate as payment in full for covered services (including
any permitted deductibles, coinsurance, co payments, or balance billing).
Private fee-for-service plans provide beneficiaries with an appropriate explanation of their benefits
and liabilities. The plans are required to provide Medicare beneficiaries with advanced balance billing
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information before they incur expenses for inpatient hospital services, and for certain other services
for that balance billing amounts could be substantial.
Religious and Fraternal Benefit Society Plans
Medicare+Choice (Medicare Advantage) plans may be offered by religious and fraternal
organizations. These organizations are able to restrict enrollment in their plans to their members. The
plans must meet Medicare financial solvency requirements and Medicare may adjust payment
amounts to the plans to meet the characteristics of the individuals enrolled.
Medical Savings Account (MSA) and Medicare+Choice High Deductible Plan
Commonly referred to as the "MSA" or "medical savings account" option, this complex, experimental
project combines a health insurance plan carrying a high deductible, ($6,000 in 1999, the first year
MSAs were operational,) with a special kind of savings account, called a medical savings account,
which became known as Health Savings Accounts under the 2003 Medicare Modernization Act. The
amount of the deductible will also undoubtedly change.
Each HSA participant is required to purchase a high deductible health insurance plan. The plan will
pay either all medical expenses or all Medicare-covered services after the deductible is met. Medicare
designates a sum of money for each HSA participant according to a statutory formula. Medicare takes
some of this money to pay the premium for the high deductible insurance plan. After the premium is
paid, any money left over will be deposited by Medicare into the participants’ HSA accounts. These
plans will not provide coverage until the deductible has been met by the participant.
The money in the HSA may be used for any medical expenses, either before or after the high
deductible has been satisfied. However, the law does require that enough money be in the MSA to
meet a portion of the deductible until it has been met each year. If there is extra money in the account,
it may be used for non-medical purposes; however, a tax- penalty will be imposed on non-medical
withdrawals from an HSA.
Basic Information
The Balanced Budge Act required the Health Care Financing Administration (now CMS) to conduct a
special educational and publicity campaign to inform beneficiaries about Medicare+Choice (Medicare
Advantage). The Medicare Handbook was substantially revised and tested in certain areas of the
country; CMS implemented a toll free telephone information system and an Internet web site to
describe the programs and to provide comparative information (www.medicare.gov).
At the time of enrollment, and every year thereafter, Medicare Advantage plans must disclose certain
information to enrollees in their service area including: the number and mix of participating doctors,
emergency service options, out-of-service coverage, procedures for obtaining emergency services,
optional supplemental coverage and costs, prior authorization rules, grievance and appeals
procedures, quality assurance mechanisms, the number of grievances and appeals that plans have
received and their dispositions, and a summary of the method of compensating doctors.
Scope of Coverage
Medicare Advantage plans (except for HSAs) must provide coverage for the services currently
available under Medicare Parts A and B. Plans must inform their enrollees about the availability of
hospice care, including whether a Medicare participating hospice program is located within their
service area or whether it is common to refer outside the area.
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Plans must pass on to beneficiaries any cost-savings achieved through efficient plan administration, in
the form of additional benefits. Medicare Advantage plans may offer supplemental benefits, for which
a separate premium is charged, but the separate premium may not vary among individuals within the
plan and must not exceed certain actuarial and community rating requirements. Medicare Advantage
plans may offer supplemental benefits. Again, a separate premium is charged, but the separate
premium may not vary among individuals within the plan and must not exceed certain actuarial and
community rating requirements.
Basic Medicare+Choice (Medicare Advantage)
Eligibility
Generally, a Medicare beneficiary is eligible to enroll in a Medicare Advantage Plan if the following
two conditions are satisfied:
• He or she is entitled to Medicare Part A and is enrolled in Medicare Part B as of the effective
date of enrollment in the Medicare Advantage Plan
• He or she lives in the Service Area covered by the Medicare Advantage Plan. In 2006, the
Medicare Advantage Plan will be expanded to include regional preferred provider
organization plans (PPOs) into rural, as well as, urban areas
There are some exceptions to the general rule, though, and some other eligibility rules:
A Medicare beneficiary is not normally eligible to enroll in the Medicare Advantage Plan if he or she
has end-stage renal disease (ESRD) - that is, permanent kidney failure that requires regular kidney
dialysis or a transplant to maintain life. However, if an individual is already enrolled with the
Medicare Advantage Organization when he or she develops ESRD, and is still enrolled with the
Medicare Advantage Organization at the time he or she becomes entitled to Part A & Part B of
Medicare Organizations.
Enrollment
There are a number of times at that an eligible individual may enroll in the Medicare Advantage Plan.
Eligible individuals can enroll at the following times:
• Initial Election Period. One may elect to enroll in a Medicare Advantage Plan when he first
becomes entitled to both Part A and Part B of Medicare. The Initial Election Period begins on
the first day of the third month before the date on that he is entitled to both Part A and Part B
and ends on the last day of the month before the date on that he became eligible for both Parts
of Medicare.
• Annual Election Period. During the month of November, all Medicare Advantage Plans are
required to accept enrollment-elections, that will be effective the following January 1. During
the November Annual Election Period, one can enroll in the plan or change his enrollmentelection
from his current Medicare AdvantagePlan to original Medicare or to a different
Medicare Advantage Plan. Beneficiaries enrolled in original Medicare or another Medicare
Advantage Plan may also change enrollment-elections to any other Medicare AdvantagePlan.
• Special Election Period. Special periods of time in that an enrollee can discontinue
enrollment in a Medicare Advantage plan and change his/her enrollment to another Medicare
AdvantagePlan or return to original Medicare. In the event of the following circumstances, a
Special Election Period is warranted:
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o
o
o
o
the plan in that the member is enrolled is terminated
the enrollee moves out of the service area or continuation area of the plan. Medicare
Advantage plans will be offered on a regional basis in 2006.
the Medicare Advantage Organization offering the plan violated a material provision of
its contract with the enrollee
the enrollee meets such other material conditions as CMS may provide
Premiums & Payments
As a Member of a Medicare Advantage Plan, one has the following financial obligations:
• All Co-payments/Coinsurance shall be paid at the time of service
• One must continue to pay his Medicare Part B Premium. If he receives a Social Security
annuity check, this premium is automatically deducted from his check. Otherwise his
Premium is paid directly to Medicare by him or someone on his behalf (such as one’s State
Medicaid agency)
• Most Medicare beneficiaries are automatically entitled to Medicare Hospital Insurance (Part
A). If one is not entitled to Medicare Part A, and he has purchased Part A through Social
Security, he must continue to pay his Medicare Part A Premium.
Voluntary Disenrollment
One may choose to end his membership in his Medicare Advantage Plan for any reason. If he wishes
to disenroll, he should write a letter or complete a disenrollment form and send it to his plan’s
Customer Service department. The date of one’s disenrollment will depend on when the Plan receives
the written request to disenroll. In general, written requests to disenroll must be received by the
Medicare Advantage Plan no later than the 10th of the month to be effective the first of the next
month. Written requests to disenroll that are received after the 10th of the month will be effective the
second month after the request is received.
There is an exception to this general rule. Disenrollment requests received between November 1 and
November 10 are usually effective December 1. However, since the month of November is also the
Annual Election Period, one can ask for a January 1 effective date.
Even though one has requested disenrollment, he must continue to receive all covered services from
the Contracting Medical Providers until the date his disenrollment is effective. He will be covered by
Original Medicare after this unless he has joined another Medicare Advantage Plan.
Moves or Extended Absences
If one is permanently moving out of the Medicare Advantage Service Area, or plans an extended
absence, it is important to notify the provider of the move or extended absence before he leaves the
Service Area. He may be eligible to continue to receive benefits if he is in the Plan's continuation
area. Again, Medicare Advantage plans will be available on a regional basis beginning in 2006.
Failure to notify his Medicare Advantage Organization of a permanent move or an extended absence
may result in his involuntary disenrollment from the Plan. The plan is required to disenroll a
beneficiary if he permanently moves outside the service area. An absence from the service area of
more than 12 months is considered a permanent move. If he remains enrolled after a move or
extended absence (and has not been involuntarily disenrolled as described above), the individual
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should be aware that services will not be covered unless they are received from a Medicare
Advantage Plan provider in the Medicare Advantage Plan Service area (except for Emergency
Services, Urgently Needed Services, out-of-area dialysis and Prior Authorized Referrals). Again,
remember, that according to the 2003 Medicare Modernization Act, regional Medicare Advantage
plans are supposed to make geographical restrictions a thing of the past.
Involuntary Disenrollment
The Medicare Advantage Organization may disenroll a beneficiary from their plan only under the
conditions listed below. One will not be disenrolled due to his health status.
• If one moves permanently out of the Service Area and does not voluntarily disenroll before
2006.
• Continuation of coverage A
• If one’s entitlement to Medicare Part A or enrollment in Part B benefits ends
• If he supplies fraudulent information or makes misrepresentations on his individual election
form that materially affects his eligibility to enroll in a Medicare Advantage Plan or Medicare
parts A and B
• If one is disruptive, unruly, abusive or uncooperative in regard to his membership in the
Medicare AdvantagePlan, it seriously impairs the provider’s ability to arrange Covered
Services for him or other individuals enrolled in the plan. Involuntary Disenrollment on this
basis is subject to prior approval by CMS
• One allows another person to use his membership card to obtain Covered Service A, B
• One fails to pay the Plan basic supplemental Premiums. Disenrollment in this case is subject
to the 90-day grace period for late payment of premiums A and B.
Disenrollment on these grounds can only occur after one has been provided notice with an
explanation of the reasons for the disenrollment and information on applicable grievance rights. No
member shall be disenrolled because of the member's health status or requirements for health care
services. Any member who believes he/she was disenrolled by the Medicare Advantage Organization
because of the Member's health status or requirements for health care services should bring the matter
to the attention of the local CMS Regional Office.
Annual Contract
The contract with CMS is renewed on an annual basis. At the end of each contract year, the contract
can be ended by either the Medicare Advantage Organization or CMS. If the Medicare Advantage
Organization ended the contract, one would receive a minimum ninety-day notification before the end
of the contract. If CMS ended the contract, one would receive a minimum thirty-day notification.
CMS would explain what the beneficiary’s options are at that time. For example, there may be other
Medicare Advantage Plans in the area for him to join, if he wishes. Or he may wish to return to
Original Medicare and possibly obtain supplemental health insurance. Whether one enrolls in another
Medicare Advantage Plan or not, there would be no gap in Medicare coverage. Until returning to
Original Medicare coverage, the patient would still be a Member of the Medicare Advantage Plan.
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Appeals or Grievances
Members of a Medicare Advantage plan are encouraged to notify the CMS if they have concerns or
experience any problems with their Medicare Advantage Plan. There are certain procedures necessary
to follow if one has an appeal or grievance that he wants to submit to his Medicare Advantage
Organization for review and resolution. These procedures include:
• General Information on Medicare Appeals Procedures
• Medicare Standard Organization Determinations and Appeals Procedures
• Medicare Expedited/72-Hour Determinations and Appeals Procedure
• The Medicare Advantage Organization Grievance Procedure
• Peer Review Organization (PRO) Immediate Review Of Hospital Discharges
• PRO Quality of Care Complaint Procedure
A member of a Medicare Advantage Plan has the right to appeal any decision about payment for, or
failure to arrange or continue to arrange for, what he believes are Covered Services (including non-
Medicare covered Benefits) under a Medicare Advantage Plan. Coverage decisions that are
commonly appealed include decisions with respect to:
• Payment for Emergency Services, Post-Stabilization Care, or Urgently Needed Services
• Payment for any other health services furnished by a Non-Contracting Medical Provider
• Facility that one believes should have been arranged for, furnished, or reimbursed by the
Medicare Advantage Organization
• Services one has not received, but that he feels the Medicare Advantage Organization is
responsible to pay for or arrange
• Discontinuation of services that he believes are medically necessary covered services
Section C. Medicare and the Big Picture
Medicare as Secondary Payor — Coordination with Group Health Insurance
Some people who have Medicare have other insurance (not including Medicare Supplement policies)
that must pay before Medicare pays its share of their bill. Their other insurance pays first if:
• one is 65 or older
• he or his spouse are currently working at an employer with 20 or more employees
• he has group health insurance based on that employment
• he is under age 65 and is disabled
• he or any member of his family is currently working at an employer with 100 or more
employees
• he has group health insurance based on that employment
• he has Medicare because of permanent kidney failure
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• he has an illness or injury that is covered under workers' compensation, the federal black lung
program, no-fault insurance, or any liability insurance
If one matches any of these descriptions and he has other insurance along with Medicare, his other
insurance will often be the first payer on his health claims. He should tell his doctor, hospital, and all
other providers of services about his other insurance. His claims can then be sent to the right insurer
first.
If one is aged 65 or older and has coverage under an employer group plan of an employer of twenty
(20) or more employees, either based on his own current employment or the current employment of a
spouse, he must use the benefits under that plan. Similarly, if one has Medicare based on disability
and is covered under an employer group plan of an employer of one hundred (100) or more
employees (or a multiple employer plan that includes an employer of one hundred or more
employees) either through his current employment or that of a family member, he must use the
benefits under that plan. In such cases, he will only receive benefits not covered by his employer
group plan through his contract with Medicare. A special rule applies if one has or develops End-
State Renal Disease (ESRD).
If any no-fault or any liability insurance (or payment from a liable third party) is available to one,
then benefits under that plan (or from that liable third party) must be applied to the costs of health
care covered by this plan. Where Medicare has provided benefits and a judgment, or a settlement is
made with a no fault or liability insurer (or liable third party), the beneficiary must reimburse
Medicare. However, their reimbursement may be reduced by a share of procurement costs (e.g.,
attorney fees and costs). Workers' compensation for treatment of a work-related illness or injury
should also be applied to covered health care costs by this plan.
If one has or develops ESRD and is covered under an employer group plan, he must use the benefits
of that plan for the first thirty (30) months after becoming eligible for Medicare based on need to tie
in line below
ESRD Medicare is the primary payer after this coordination period. (However, if his employer group
plan coverage was secondary to Medicare when he developed ESRD because it was not based on
current employment as described above, Medicare continues to be primary payer.)
Medicare Education
The Health Care Financing Administration’s Advisory Panel on Medicare Education, that expands the
agency’s use of outside experts, held its inaugural meeting on February 15, 2000 in Washington, D.C.
The new panel will provide counsel to the CMS Administrator under the Federal Advisory
Committee Act to help strengthen and improve the National Medicare Education Program.
This panel of independent experts represents a diverse mix of organizations that work with seniors,
disabled persons, and the health care community. They will advise CMS about how to best reach
beneficiaries about their Medicare benefits and choices. They will help them do even more to provide
easy-to-use information to the 40 million Americans who rely on Medicare for their health care
coverage.
The advisory panel meets quarterly to help CMS:
• support the National Medicare Education Program, that provides information about Medicare
to beneficiaries and those who help them make their health care decisions
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• enhance the federal government's effectiveness in informing Medicare consumers including
the appropriate use of public-private partnerships
• expand access to Medicare information to vulnerable and undeserved communities including
racial and ethnic minorities, through the National Medicare Education Program
• assemble an information base of best practices for helping consumers evaluate health options
and building a community infrastructure for information, counseling and assistance
Medicare Fraud
Medicare Fraud is an intentional deception or misrepresentation that an individual knows to be false
and makes in the knowledge that the deception could result in payment of an unauthorized Medicare
benefit. Some examples are:
• Intentionally billing for services that have not been provided
• Kickbacks or bribes
• Intentionally billing non-covered services as covered services
• Forgery (unauthorized use of a person's signature)
Medicare is taking strong action to combat fraud and abuse in key areas. The goal is to make sure
Medicare only does business with legitimate providers and suppliers who will provide Medicare
beneficiaries with high quality services. The effort to prevent and detect fraud, abuse, and waste is a
cooperative one that involves CMS as well as Medicare beneficiaries, Medicare contractors,
providers, and State and Federal Agencies such as the Office of the Inspector General, HHS, the
Federal Bureau of Investigation (FBI), and the Department of Justice.
Patients should be suspicious if the provider tells them that:
• The test is free; they only need his Medicare number for their records
• Medicare wants the beneficiary to have the item or service
• They know how to get Medicare to pay for it
• The more tests they provide the cheaper they are
• The equipment or service is free; it will not cost anything
One should be suspicious of providers that:
• Routinely waive co-payments without checking on one’s ability to pay
• Advertise "free" consultations to Medicare beneficiaries
• Claim they represent Medicare
• Use pressure or scare tactics to sell high priced medical services diagnostic tests
• Bill Medicare for services one does not recall receiving
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Consumer Tips
The following is a list of tips to prevent fraud:
• One should not give out his Medicare Health Insurance Claim Number except to his doctor or
other Medicare provider
• He should not allow anyone, except appropriate medical professionals, to review his medical
records or recommend services
• Patients should not contact their physician to request a service that they do not need
• One should be careful in accepting Medicare services that are represented as being free
• One should be cautious when he is offered free testing or screening in exchange for his
Medicare card number
• One should be cautious of any provider who maintains they have been endorsed by the
Federal government or by Medicare
• One should avoid a provider of health care items or services who tells him that the item or
service is not usually covered, but they know how to bill Medicare to get it paid
Health care fraud, whether against Medicare or private insurers, increases everyone's health care
costs, much the same as shoplifting increases the costs of the food we eat and the clothes we wear. If
we are to maintain and sustain our current health care system, we must work together to reduce costs.
The Medicare recipient must remember the importance of eliminating fraud in the program. That is
why Medicare developed the possible $1,000 reward to recipients.
Government Attention
In May 1995, President Clinton launched Operation Restore Trust (ORT) to develop several
innovations in fighting fraud and abuse in Medicare. During a two-year demonstration, ORT
identified:
• $23 in overpayments for every $1 spent looking at home health care, skilled nursing facilities,
and suppliers of durable medical equipment
• 2,700 fraudulent home care providers and entities who were then excluded from doing
business with Medicare and other federal and State health care programs
For example, efforts to fight durable medical equipment fraud and abuse in 1997 produced the
following results:
• convicted 59 suppliers on fraud and abuse charges
• denying $509.7 million in improper payments before they were made
Medicare and its contractors actively work to prevent attempts to defraud Medicare and to support
investigations and prosecutions of such defrauders. Many of the successful law enforcement actions
were begun through Medicare contractors and regional office staff identification of problems and
issues, and through referrals by the contractors to the HHS Inspector General.
A Federal law, the Health Insurance Portability and Accountability Act of 1996 provided powerful
new tools and more than $100 million dedicated to fight fraud. In just one year, the law helped return
nearly $1 billion to the Medicare Trust Fund from collections of fines, judgments, settlements, and
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administrative actions. Health fraud convictions grew nearly 20 percent and the number of civil health
fraud cases increased 61 percent.
Fraud or Abuse
Fraud and abuse have the same effect: They steal valuable resources that should go toward
beneficiaries’ Medicare benefits. Fraud robbed the Medicare system of more than $20 billion in 1997,
according to the Department of Health and Human Services Office of the Inspector General. The
primary difference between fraud and abuse is the person’s intent. Did they know that they were
committing a crime
Fraud, as defined by CMS, is an intentional deception or misrepresentation that someone makes,
knowing it is false, that could result in the payment of unauthorized benefits. A scheme does not have
to be successful to be considered fraudulent.
Abuse involves actions that are inconsistent with sound medical, business, or fiscal practices. Abuse
directly or indirectly results in higher costs to the Medicare program through improper payments that
are not medically necessary.
The Centers for Medicare and Medicaid Services (CMS), Medicare enrollees themselves, fellow
Medicare contractors, the Department of Health and Human Services Office of Inspector General
(HHS-OIG), the Federal Bureau of Investigation (FBI), the United States Attorney's Offices, and
other partners are working closely together to identify fraud and abuse. In the process they develop
cases for referral to federal law enforcement authorities, support civil and/or criminal prosecutions,
recover lost money, and pursue the exclusion of bad providers from the Medicare system.
Fraud and abuse can take many forms. Some common forms may include, but are not limited to:
• Billing for services or supplies never provided
• Misrepresenting the services rendered
• Misrepresenting the diagnosis to justify payment for services
• Altering claim forms to obtain a higher payment amount
• Soliciting, offering or receiving a kickback, bribe or rebate
• Secret, unlawful agreements between a supplier, beneficiary, and/or other health care
provider that results in higher costs or charges to Medicare
• Deliberately applying for more than one payment for the same service
• Unlawfully completing a Certificate of Medical Necessity
• Falsifying documents
• Misrepresenting the place of service
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Pennsylvania Life-Senior Market Specialist Accreditation
Penalties for Fraud
The United States Attorney's Office targets fraudulent health care providers for civil and/or criminal
prosecution. Among the penalties:
• The False Claims Act provides fines of up to $10,000, damages up to three times the amount
of the fraudulent submission, and up to five years in prison.
• The Anti-Kickback Provisions of the Social Security Act provide for fines of up to $25,000
and up to five years in prison.
• Civil Monetary Penalties (CMP) provide for fines of up to $50,000 and damages up to three
times the amount of the fraudulent submission.
• The Racketeer Influenced and Corrupt Organizations (RICO) Act has recently been used in
Medicare fraud cases. Those convicted criminally can be sentenced up to 20 years in prison.
Civil conviction under RICO provides for asset forfeiture.
• The Health Insurance Portability and Accountability Act, often called Kassebaum-Kennedy,
created a new crime called Health Care Fraud. This crime allows for up to ten years in prison,
up to 20 years if serious bodily injury results, or up to life in prison if death occurs
• HHS-OIG can also exclude a health care provider from all government-paying programs
including the Medicare system.
Medicare Overpayments
The office of June Gibbs Brown, Inspector General, reported in June of 1999 that improper Medicare
payments to hospitals, doctors and other health care providers declined dramatically last year to the
lowest error rate since the beginning of comprehensive audits three years ago. The error rate for fiscal
year 1998 was estimated $12.6 billion in improper payments. The figure compares with an error rate
of 11 percent in FY 1997 ($20.3 billion); and 14 percent in FY 1996 ($23.2 billion).
OIG auditors, with the support of medical experts, reviewed a comprehensive statistically valid
sample of Medicare fee-for-service claim expenditures and supporting medical records to determine
the accuracy and legitimacy of the claims. They looked at a statistical selection of 600 beneficiaries
nationwide with 5,540 claims valued at $5.6 million and determined that 915 of the claims did not
comply with Medicare laws and regulations.
By projecting the sample results over the universe of Medicare fee-for-service benefit payments, that
totaled $176.1 billion during the fiscal year, it was calculated that $123.6 billion was the mid point in
the estimated range of improper payments. As with past years, the improper payments could range
from inadvertent mistakes to outright fraud and abuse. Regardless of the reason for the improper
payments, though, its money lost to the Trust Fund that is better spent on quality care for
beneficiaries. This 45% reduction in overpayments since FY 1996 is a truly remarkable improvement.
The office of the OIG is encouraged by the determined and concerted effort of the Secretary, the
Health Care Financing Administration, the Administration on Aging and its grantees, the Department
of Justice, the Congress, and the provider community to effectively address the overpayment
problem. This clearly demonstrates what can be accomplished when we work cooperatively to solve
such significant problems.
Two major problem areas were identified:
• billing for services that were not medically necessary
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• coding services to secure higher reimbursement than justified
They combined to account for about $9.3 billion of the estimated $12.6 billion in improper payments.
Another $2.1 billion in overpayments was attributed to document discrepancies, and the remaining
$1.2 billion to billing for services not covered by Medicare, and other types of errors. Hospitals,
physicians, and home health agencies accounted for more than 77 percent of the improper payments,
with approximately 39 percent of the erroneous claims attributable to hospitals, nearly 26 percent to
physicians, and almost 13 percent to home health agencies.
Skilled nursing facilities, non-prospective payment system (PPS) hospitals, laboratories, end stage
renal disease centers, ambulance companies, ambulatory surgical centers, durable medical equipment
suppliers, and hospices were responsible for the balance of the improper payments, in that order.
Virtually all major provider groups had significant error reductions after FY 1996.
Medicare and Prescription Drugs
Under current law, the Original Medicare Plan does not cover outpatient prescription drugs except in
a few cases, like certain cancer drugs. However, many Medicare managed care plans cover outpatient
prescription drugs, up to certain limits. Some Medicare Supplement policies (Plans H, I, and J) also
cover certain outpatient prescription drugs, and will continue to do so until 2006, when the 2003
Medicare Modernization Act will discontinue allowing sales of H, I, and J, and will implement two
other plans to fit into the Medicare Supplement array. Congress debated an entirely new concept of
Medicare Prescription Drug benefits during the spring and summer of 2003, but actual passage of the
new overhaul was not completed until November and December, with full implementation of the
prescription drug program scheduled for January, 2006.
Medicare+Choice (Medicare Advantage) and Plan Withdrawal
Those who are affected by a withdrawal will have to make a new health care choice. But for most
beneficiaries, there will be time to make a choice. Since changing the way one receive one’s health
care is an important decision, beneficiaries may want to ask those they trust such as family or friends
for help. Special rules may apply when one de-enrolls from a Medicare Advantage health plan and
return to the Original Medicare Plan with a Medicare Supplement insurance policy. If the insured or
his spouse has health care coverage through a former employer or union, they should contact a
company representative before they make a new health plan choice. If they have Medicaid coverage,
they should not make a new health plan choice until they contact the State Medical Assistance Office
or the State Medicaid Program.
To ease this transition, CMS is committed to ensuring that beneficiaries have useful information
about Medicare and the rights and protections available to beneficiaries affected by these plan
withdrawals. Medicare managed care plans are independent businesses that make business decisions
to contract or not contract with Medicare. Managed care plans voluntarily choose to enter into
contracts with CMS to serve Medicare enrollees. Each year, plans have to make a choice to continue
their contracts or adjust premiums and/or benefits. Some plans have made business decisions to end
their Medicare contracts in certain areas, and have left 1 million people in a less than satisfactory
situation.
While CMS is responsible for ensuring that contracting managed care plans meet their contractual
obligations, they cannot influence their core business decisions, nor can they force them to stay in the
Medicare program.
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Pennsylvania Life-Senior Market Specialist Accreditation
CMS has established a Special Election Period for beneficiaries affected by plan withdrawals or
service area reductions. As a result, CMS will require that managed care plans, continuing to service
areas affected by either a plan withdrawal or a service area reduction to accept elections (also known
as enrollments) from beneficiaries affected by a plan withdrawal or service area reduction.
There is an exception for a small number of beneficiaries with end stage renal disease (ESRD) and
who only have Medicare Part B who are enrolled in a plan that is leaving Medicare. These
beneficiaries cannot enroll in a plan offered by another managed care company. However, these
beneficiaries may enroll in other plans offered by the same company.
Medicare’s Contract with Group Health, Inc.
(CMS) announced its first-ever national contract to ensure that Medicare does not pay health-care
claims that are the responsibility of private insurance companies. (A distinction must be made here.
We are talking about basic Medicare claims, not Medicare Supplement claims.)
The contract helps Medicare increase the roughly $3 billion that Medicare saves each year by
ensuring that private insurance companies pay their share of Medicare beneficiaries’ health-care bills.
By consolidating these efforts into a single contract, CMS expected to improve service to Medicare
beneficiaries, health-care providers, insurance companies, and employers.
Many of the 39 million elderly and disabled Americans who receive Medicare benefits have other
insurance that covers some of their health-care costs. The other insurance companies often are legally
responsible for paying certain claims before they are submitted to Medicare.
CMS’s first national Coordination of Benefits contractor was Group Health Inc. In the past,
Medicare’s benefits coordination efforts have been carried out by a variety of contractors.
They are using private-sector techniques and expertise to modernize Medicare’s accounting systems
to better protect beneficiaries and taxpayers. Medicare dollars must be spent on legitimate services for
elderly and disabled Americans, not to pick up the tab for other insurance companies. This new
contract builds on successes in fighting waste, fraud and abuse, while ensuring that beneficiaries
receive the maximum coverage from all their health benefits.
CMS obtained the authority to hire a national Coordination of Benefits contractor as part of the
Medicare Integrity Program, which was created by the Health Insurance Portability and
Accountability Act of 1996.
Under its contract, Group Health, of New York, N.Y., coordinates Medicare payments with other
insurance companies by collecting, managing, and reporting claims information. The national
contract streamlines the process to ensure that health care claims are paid by the primary insurer
whether it is Medicare or another insurer before uncovered expenses are sent to the secondary insurer.
Since Medicare’s inception, Group Health has served as one of the private companies that Medicare,
by law, hires to pay and process health care claims. Medicare will pay for the new national contract
with a portion of the dedicated funds for program integrity established by HIPAA. The total cost of
the contract will be $87 million over five years.
Earlier CMS chose 13 other companies with special expertise in stopping and preventing waste,
fraud, and abuse as its first-ever Medicare Integrity Program contractors. Medicare is using those
contractors to perform specific tasks to protect the Medicare Trust Fund, including audits, medical
reviews, site visits and provider education efforts.
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Medicare’s Customer Service
CMS worked with the Office of the Inspector General to help design messages that would better
enable beneficiaries to identify any potential fraud or abuse of the program. The result is a simple,
easy-to-read format that all users agree is the most useful tool developed to date to inform
beneficiaries about actions on their Medicare claims.
Telephone Service
When they need information, the majority of Medicare beneficiaries use the telephone as their
principal source of help and information. Medicare receives over 15 million telephone calls per year
with questions about billing and understanding the Medicare program.
To continually review, renew, and improve their approaches as new activities emerge, CMS
developed an overall Medicare beneficiary telephone customer service strategy that also includes
standards and performance measures to evaluate the effectiveness of customer service. The strategy
incorporates feedback on customer service goals and expectations from: beneficiaries, CMS staff,
carriers, and fiscal intermediaries, Peer Review Organization (PROs), State Health Insurance
Assistance Programs, and the Social Security Administration (SSA).
The following initiatives have been implemented:
• The Continuous Improvement Quality Call Monitoring initiative is an effort to develop a
systematic national approach to ensuring quality of Medicare contractor beneficiary
telephone service. This initiative will provide CMS with the direct means to ensure that all
call centers handling Medicare inquiries adhere to acceptable performance standards
including waiting time, call backs, transfers, busy signals, hours of operations, etc.
• The Customer Service Assessment and Management System (CSAMS) is a performance
measurement tool that will help meet CMS’s Government Performance and Results Act
(GPRA) goal to improve telephone customer service to beneficiaries, including accessibility,
accuracy of response, and caller satisfaction. A baseline of call center performance is being
established in FY2000, so improvements in telephone customer service can be monitored in
following years.
• The Beneficiary Satisfaction Survey initiative is an extended customer evaluation program
that will continuously and consistently monitor nationwide beneficiary satisfaction with
telephone customer service. Beneficiaries will be called within a short time of receiving
services and asked to rate their experience using a uniform national system to ensure
comparability of results among centers.
Medicare in the New Millennium — Medicare and Home Health Care
Medicare beneficiaries throughout the country experienced alarming reductions and terminations of
their home care services. Many have been told by their home health agencies that the changes are
because of the new law or some patients have simply been told that their care costs the agency too
much. The federal Balanced Budget Act of 1997 (BBA) made significant changes to the Medicare
program and to the Medicare home health care reimbursement system. The BBA did not change the
substantive Medicare coverage criteria.
Under the BBA, home health agencies are paid a maximum amount per patient based on a formula
established by Congress. This payment system, known as the Prospective Payment System (PPS), has
been derived from the similar Part A Hospital PPS system. Unfortunately, the PPS annual "cap" paid
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Pennsylvania Life-Senior Market Specialist Accreditation
per patient to home health agencies does not account for the cost of caring for individuals with more
significant care needs than the norm. Afraid they will not receive sufficient reimbursement to cover
the cost of providing their care, many home health agencies were forced to attempt to discharge these
patients.
The Prospective Payment System (for Home Health Care) was implemented pursuant to the Balanced
Budget Act of 1997. Home health agencies say the PPS payments are too low to allow them to
provide care for long term and high need patients. Patients with multiple sclerosis and other chronic
conditions say they have lost all or much of their necessary home care as a result. While no one
debates the need to eliminate fraud wherever it exists, we urge circumspection and caution. We must
not cut benefits and services to those who truly need them because of the abuses of an unscrupulous
few. MMA 2003 raised the payment formula for HHC agencies, making it more fair.
CMS has long recognized that home health care for chronic conditions is an increasingly needed,
fiscally sound, and humane method of providing care. It is imperative that these truths are not lost in
the zeal for cost containment. Sound public policy must take into consideration the very real home
care needs of our most vulnerable citizens.
Medicare’s Premiums and Benefits
Premiums
The Medicare premium that people pay is just on one part of the program, the physician services side
of the program. That means that over time these folks are going to be asked to pay a larger share of
the costs of the program for two reasons:
• The government is freezing in place the share that they have to pay physicians, although the
2003 Medicare Modernization Act increased the physician payment by 1.5%, rather than the
4.5% cut which had been due for 2004. The act also provided for a 10 year $25 billion
increase to rural providers of Medicare in rural areas.
• Some of the benefits that used to be in Part A are being shifted into Part B
Medicare has enlarged the part B program, therefore the premiums rise. By the year 2007, Part B
premiums may approach $105 a month so people will not feel very much of a change right away. But
they will see some real changes in three or four years in terms of how fast their premiums will rise.
Another issue is that those new protections do not rise very far up the income scale, so a woman, for
example, who has an income of about $15,000, will see her premiums as a share of her income nearly
double by from 2002 to the year 2007. This is not going to be an insignificant change for average
people.
Benefits
In the last few years a lot of cancer screening benefits have been added to Medicare. Benefits now
include annual mammograms. In years past, Medicare paid for them every two years, including
cervical cancer screening, and prostate cancer screening. Benefits now include a diabetes selfmanagement
program, which is basically education programs for diabetics to help them better cope
with their disease
Medicare used to be what was called the sickness model. It paid for one when he got sick. The health
care system, in general, is changing, with more emphasis on prevention. Congress has made an effort
to get Medicare started along the road to a more comprehensive preventive benefit package. The 2003
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Medicare Modernization Act added further preventive benefits, which have been previously
discussed.
The $220 billion a year (2002), Medicare program provides health care benefits to 42 million elderly
and disabled Americans.
Until the balanced budget bill was enacted, the government projected Part A, the Trust Fund, would
go bankrupt in the year 2001, but it didn’t, and similar projections have been moved forward to 2010.
Medicare costs are increasing by more than eight percent a year, well above the overall rate of
inflation. And many analysts say the program’s costs will balloon further as baby boomers retire and
the ranks of the elderly grow.
Medicare’s Costs and Payments
Still, efforts to rein in costs have proved politically difficult. In 1995, for example, a Republicansponsored
bill providing for $270 billion in Medicare savings ran into strong opposition from the
elderly and was vetoed by the President. There were some cost-cutting changes that year but not
nearly as much as the Republicans had proposed. Medicare changes adopted in 1997 were designed to
save $115 billion over the next five years, more than in any other social program.
The two providers taking the biggest reduction in payments were:
• Hospitals
• Health plans
Those are the two sets of providers who have been doing the best under Medicare.
Something else that Congress has done in the process of taking this $115 billion in savings is the
restructuring of some of the ways they pay some different providers.
• They restructured hospital payments in 1983 (Prospective Payment System-DRG’s)
• They restructured physician payments in 1989 (Physicians Reform Act)
• Restructuring of payments for home health care, for nursing home care, and for hospital
outpatient care, that is getting to be a larger and larger portion of the Medicare program
(OBRA 96, BBA 97, HIPAA 97, MMA 2003)
• They restructured home health care payments (Prospective Payment System)
In the past, all health care providers had been paid based on what they charged, and it was found that
if they were given the money based on what they charged, they kept increasing their charges. With
the above mentioned legislation, Congress has voted to no longer do that for hospitals, doctors, home
health care agencies, or for the nursing homes and the hospital outpatient costs.
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Chapter 2 Review
1. Generally, the number of quarters of qualified credits required for Medicare coverage is
a. 25
b. 40
c. 60
d. 100
2. For outpatient mental health services, Medicare pays ______% of the costs.
a. 25
b. 50
c. 75
d. zero
3. The best time to buy a Medicare Supplement policy is during one’s
a. hospital stay
b. retirement
c. Medicare Supplement open enrollment period
d. retirement
4. Medicare Fraud is an intentional deception or misrepresentation, which an individual
knows to be false and makes in the knowledge that the deception could result
a. in getting no insurance
b. a life sentence
c. in payment of an unauthorized Medicare benefit
d. year to year
Answers to the chapter review can be found in Appendix A
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Chapter 3
Introduction and Implementation of the
New Medicare Part D Prescription Drug
Program
Starting January 1, 2006, the new Medicare prescription drug coverage will help seniors manage the
high cost of prescription drugs. This drug benefit, introduced by the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (MMA), will be offered through private insurance
plans, not as part of the traditional Medicare program. Medicare beneficiaries must affirmatively
choose and enroll in a Part D plan.
Because the Part D drug benefit is new, it is still uncertain which private drug plans will be available.
Choice of Drug Plans
The Medicare Part D benefit is premised on the notion that individual Medicare beneficiaries should
have a choice of private drug plans to select a drug benefit that best meets their needs. The statute
creates three drug plan categories: stand-alone plans that offer only prescription drug coverage,
Medicare Advantage plans with a drug benefit, and fallback plans. (It does not appear that fallback
plans will be needed or offered in 2006). Medicare prescription drug plans will be offered by private
companies and regulated by the Centers for Medicare and Medicaid Services (CMS) in two separate
formats: drug coverage offered in conjunction with Medicare Advantage plans (MA-PDs), and standalone
prescription drug plans (PDPs)
Medicare Advantage Plans (MA-PDs)—Individuals enrolled in a Medicare Advantage plan must
receive drug coverage through a MA-PD. They may not purchase a separate PDP. The only exception
to this rule is that individuals enrolled in a Medicare Advantage Private Fee-For-Service (PFFS) plan
that does not include a prescription drug option may purchase a stand-alone PDP.
Prescription Drug Plans (PDPs)—The majority of Medicare beneficiaries are enrolled in Medicare
Part A and have the option to purchase a stand-alone PDP offering prescription drug coverage. PDPs
will be offered by private insurance companies pursuant to a one-year contract with CMS.
MA and PDP Regions
To manage these new plans, CMS has grouped the country into 34 regions. Most of these regions
represent a single state; however, nine regions are made up of multiple states.
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Pennsylvania Life-Senior Market Specialist Accreditation
MA (Medicare Advantage) Regions
Under the law, an MA Regional plan must operate in all areas of the region. However, MA Regions
are not specifically related to the effort to provide prescription drug coverage to beneficiaries.
Instead, the intent of CMS was to provide all Medicare beneficiaries the opportunity to enroll in a
regional Preferred Provider Organization (PPO), including those in rural areas. We will instead focus
on prescription drug coverage.
PDP Regions
Unlike the MA Region initiative to bring PPOs to the rural area, the introduction of PDPs into regions
is to provide adequate access to the new Medicare Part D prescription drug coverage. A minimum of
two plans will be established in each region and at least one of those plans must be a stand-alone
PDP. PDPs are filed directly with CMS, not with the state insurance departments. The map below
illustrates the regional breakdown for Medicare Part D plans.
Eligibility Guidelines
Prescription drug coverage under Medicare Part D is voluntary. Beneficiaries entitled to Part A and/or
enrolled in Part B may purchase PDP plans available in the particular geographic region in which
they reside.
Enrollment Periods
• Initial Enrollment Period (IEP)—Begins November 15, 2005, and runs for six months,
ending on May 15, 2006. If enrollment occurs by December 31, 2005, coverage begins with
the start of the program on January 1, 2006. Enrollment during the remaining IEP results in
coverage beginning the first day of the month following enrollment. The IEP for those
turning 65 years old begins three months prior to the month he or she turns 65 and ends three
months after the month he or she turns 65, providing a seven-month window of initial
eligibility.
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• Annual Coordinated Election Period (AEP)—Runs annually from November 15 to
December 31, with enrollment effective January 1 of the following year.
• Special Enrollment Period (SEP)—Allowed for Medicare beneficiaries where a special
enrollment period is necessary:
o
o
o
o
o
Involuntary loss, reduction, or non-notification of creditable coverage (refer to Medicare
rules for definition of “credible coverage”). This does not apply when creditable coverage
is lost due to non-payment of premiums.
Erroneous enrollment (i.e., accidentally enrolled in PDP).
Individuals with Medicaid coverage who will become full dual eligibles after the initial
enrollment period.
Individuals entering or leaving a long-term care facility.
Individuals enrolling in a MA-PD upon first becoming eligible for benefits under Part A
at age 65, then discontinuing that enrollment and electing coverage under original
Medicare and a stand-alone PDP at any time during the 12-month period beginning on
the effective date of the MA-PD election.
o Exceptional circumstances such as a terminated or violated PDP contract or a move out
of a plan’s service area.
After choosing a PDP, beneficiaries will generally remain enrolled for the year. They will have an
opportunity to change plans during the AEP (November 15 to December 31 each year).
As it applies to a MA-PD, beneficiaries will generally remain enrolled in the plan unless the MA-PD
does not renew its bid with CMS for an upcoming year. If this occurs, the beneficiary would
involuntarily loss their credible coverage and the Special Enrollment Period (SEP) would apply. The
beneficiary can then obtain drug coverage through a PDP without premium penalty. If an individual
covered by a MA-PD voluntarily disenrolls, the SEP does not apply.
Late Enrollment Premium Penalty
Beneficiaries who decline enrollment at the first opportunity may pay more for their coverage if they
enroll after May 15, 2006. This is similar to the late enrollment provisions for Medicare Part B.
Even if an individual does not use many prescription drugs now, they should still consider purchasing
coverage. Most people become more dependent on prescription drugs to stay healthy as they age.
PDPs consist of a series of insurance products designed to protect individuals from future increasing
prescription drug costs.
Individuals who join after their open enrollment period will accrue a 1% penalty for each month they
are not enrolled in a PDP. This 1% penalty can result in a significant impact in later years. An
individual who waits three years to purchase a PDP will pay an additional 36% of the premium at the
time of purchase. In other words, a $50 monthly premium becomes $68 for that individual, an
increase of $216 for the entire year.
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Pennsylvania Life-Senior Market Specialist Accreditation
Drug Plan Benefit Designs
The Standard Drug Benefit
The MMA established a standard drug benefit that MA-PDs and PDPs may offer. The standard
benefit is defined in terms of the benefit structure, not in terms of the covered drugs. In 2006, this
standard benefit requires a $250 deductible payment. The beneficiary then pays 25% of a covered
drug’s cost up to an initial $2,250 coverage limit. Once the initial coverage limit is reached, the
beneficiary is subject to another deductible—known as the “doughnut hole”—in which they must pay
the full cost of additional eligible prescriptions up to $2,850. When total out-of-pocket drug expenses
(includes: the $250 deductible; initial 25% coinsurance up to $500; and, “doughnut hole” deductible
of $2,850) reach $3,600, the beneficiary pays $2 for a generic or preferred drug, and $5 for other
drugs, or 5% coinsurance, whichever is greater.
Standard Medicare Part D Drug Benefit (2006)
$250 Deductible
(Individual pays $250 for $250/Rx) Plus premiums ~ $444/yr*
$2,250/yr
Initial Coverage Limit
25%
Co-pay
Medicare pays 75%
(Individual pays $500 for 2,000/Rx)
(Total OOP = $750** Plus ~ $444/premiums)
$5,100
Total on Formulary Drugs by
Beneficiary & Medicare
$2,850 “Doughnut Hole” Deductible
(Individual pays $2,850 for $2,850/Rx)
(Total OOP = $3,600*** Plus ~ $444/premiums)
5% Co-pay
($2 generic co-pay or $5 brandname
co-pay, if > 5% co-pay)
Medicare pays 95%
(After individual pays $3,600 OOP)
*Annual premium of $444 based on CMS-estimated premium projection of $37 per month.
**Total Out-of-Pocket consists of $250 deductible and $500 coinsurance.
***Total Out-of-Pocket consists of $250 deductible, $500 coinsurance and $2,850 “doughnut hole”
expense.
NOTE: The $3,600 amount is calculated on a yearly basis; a beneficiary who amasses $3,600 in outof-pocket
costs on December 31 will start at $0 on January 1. Because the deductible, initial coverage
limit and annual out-of-pocket threshold will increase annually due to increases in Part D drug
expenditures, beneficiary out-of-pocket expenses will also increase annually.
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Alternative Coverage
MA-PDs and PDPs are not required to offer the standard drug benefit, but can offer alternative
prescription drug coverage. Alternative coverage must be actuarially equivalent to the standard
benefit, meaning the benefit package’s value must be equal to or greater than the standard benefit
package’s value. In an actuarially equivalent plan, the cost-sharing varies through the use of such
mechanisms as tiered copayments. For example, a beneficiary’s share of cost may be less for a
generic or preferred brand drug than for a non-preferred brand drug. However, a plan that offers an
alternative benefit package cannot impose a higher deductible ($250 in 2006) or require a higher outof-pocket
limit ($3,600 in 2006) than required by the standard benefit.
Enhanced Alternative Coverage
Enhanced Alternative Coverage plans differ from Alternative Coverage plans in that they may include
changes to the deductible and the initial coverage limit, although the deductible cannot be higher than
$250. Enhanced alternative coverage might also include coverage of drugs excluded under Medicare
Part D. A MA-PD or PDP that offers a drug plan with enhanced alternative coverage must also offer a
PDP with the basic benefit package in that region. (Basic coverage is either the statutorily-defined
Standard Drug Benefit or the Alternative Coverage without any supplemental benefits.
Value-Added Items and Services
CMS permits Value-Added Items and Services (VAIS) to be offered to plan enrollees, subject to
specific rules and restrictions. VAIS are provided to PDP enrollees through a separate plan involving
only administrative or minimal costs that do not meet the definition of “benefits” under the Part D
program and are not funded by Medicare program dollars. Nonetheless, VAIS may be of value to
some beneficiaries, and CMS does not wish to deny Medicare beneficiaries access to items and
services commonly available to commercial enrollees. There are two types of VAIS: Health-Related
VAIS and Non-Health-Related VAIS.
Health-related VAIS are intended to maintain or improve the health status of enrollees, where plans
incur an administrative or minimal cost that is not included within the plan’s bid to CMS. Examples
of health-related VAIS are discounts on eyeglasses and health clubs. Plans are permitted to contact
Medicare beneficiaries about health-related VAIS provided by the plan without prior written
authorization to the extent permitted under the HIPAA Privacy Rule.
Non-health-related VAIS are not intended to improve or maintain the health status of enrollees. The
cost incurred by the plan is usually only administrative and is not included within the plan’s bid to
CMS. Furthermore, to the extent required under the HIPAA Privacy Rule, plans generally must
receive prior written authorization from Medicare beneficiaries before contacting them regarding nonhealth-related
VAIS.
Covered Part D Drugs
The MMA defines which drugs are covered under Medicare Part D, and therefore the drugs for which
payment will be made under MA-PD or PDPs in relationship to their coverage under Medicaid and
other parts of Medicare. Medicare Part D drugs are approved by the Food and Drug Administration,
for which prescriptions and payments are required under Medicaid. The MMA excludes from
coverage those categories of drugs for which Medicaid payment is optional. Of particular significance
to Medicare beneficiaries is the exclusion of drugs for weight gain (used in connection with treating
weight loss due to cancer or HIV/AIDS), barbiturates (used to treat seizures in older people),
benzodiazepines (used to treat acute anxiety, panic attacks, seizure disorders, and muscle spasms in
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Pennsylvania Life-Senior Market Specialist Accreditation
those with cerebral palsy), and over-the-counter medications. Nursing home residents use many of
these excluded medications. The MMA also excludes from Medicare Part D coverage those drugs for
which payment could be made under Medicare Part A or Part B. CMS has determined these drugs are
excluded from Medicare Part D coverage even if the beneficiary does not have coverage under the
part of Medicare which would generally pay for the drug.
Part D Formularies
MA-PDs and PDPs are not required to pay for all covered Medicare Part D drugs. They may establish
their own formularies, or list of covered drugs for which they will make payment, as long as the
formulary and benefit structure are not found by CMS to discourage enrollment by certain Medicare
beneficiaries. Plans that follow the formulary classes and categories established by the United States
Pharmacopoeia will pass the first discrimination test. However, CMS indicates it will still review
formularies to determine whether the placement of specific drugs in each category or class, as well as
other benefit design issues, discriminates against particular individuals.
NOTE: Plan formularies may change during the year with a 60-day notice to affected parties.
Eligible MA-PD and PDP Enrollee Expenses
Another critical and often overlooked factor is that only the cost of Medicare Part D covered drugs
that are included on a plan’s formulary count toward the deductible and out-of-pocket limits. For
example, a beneficiary whose only monthly drug expense in January 2006 is $300 for a coverable
Medicare Part D drug that is not on their plan’s formulary will not meet her deductible. If this
individual continued to purchase this medication each month, the $3,600 in out-of-pocket expenses
incurred for the year will not qualify for the reduced cost-sharing for high out-of-pocket costs.
Payments that can be applied toward the annual $3,600 out-of-pocket limit are referred to as true outof-pocket
expenses (TrOOP). Only out-of-pocket costs for formulary drugs that are paid for by the
beneficiary, a family member or other person acting on their behalf, or by a state pharmacy assistance
program are considered true out-of-pocket expenses and count toward the $3,600 out-of-pocket limit.
Payments made by other insurance, including employer-sponsored plans and AIDS Drug Assistance
Programs (ADAPs), do not count toward the limit. Such payments work to increase the amount a
beneficiary must spend before the reduced cost-sharing for high drug expenses begins. Thus, not only
is the beneficiary responsible for paying the full costs of non-formulary prescriptions, they receive no
credit toward the Medicare Part D out-of-pocket limit for the expenses incurred.
Annual Notice of Change
If a private insurance company plans to change its MA-PD or PDP for an effective date of January 1
of the upcoming year, the insurance company must provide members notice of the changes by
October 31 of the current year.
The MMA does not mandate a set premium amount. Premiums will be determined by a bidding
process and will vary from plan to plan and from region to region. Private insurance companies that
want to continue participating in the Medicare Part D drug benefit must submit new bids each year.
Thus, plan premiums may change annually, as may potential annual deductible adjustments,
coinsurance amounts and gaps.
Be advised that Medicare Part D premiums, deductibles, coinsurance amounts and “doughnut hole”
gaps paid by beneficiaries are designed to increase annually. By 2013, the Congressional Budget
Office (CBO) predicts those increases will reach the following amounts: Premium, $696; Deductible,
$445; Coinsurance plateau, $4,000; “Doughnut Hole” gap, $5,066; Catastrophic plateau, $9,068.
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There are several reasons for the expected increases according to CBO including inflation in drug
prices, the cost of new drugs included in the private drug plans, and increased usage by Medicare Part
D enrollees. All tracks of expected increase are estimated at 10% annually, which equates to a greater
amount when the compounding of each year’s increase is taken into consideration.
Consequences for States and People with Low Incomes
The MMA establishes a low income subsidy for Medicare Part D costs. As of January 1, 2006,
individuals with incomes up to 150% of the federal poverty level and with limited resources are
eligible for the subsidy (refer to the Medicare Part D Low-Income Subsidies and Groupings section).
Unfortunately, the MMA also eliminates all Medicaid drug coverage for the more than six million
individuals eligible for both Medicare and Medicaid (dual eligibles). Moreover, it requires states to
pay the federal government—through a mechanism referred to as “the clawback”—much of the
savings they would otherwise realize from the state’s reduced Medicaid obligation, and includes other
provisions that will affect state budgets.
State Pharmaceutical Plans: Medicare Part D Implications
States may be able to provide cost-sharing and supplemental drug coverage for dual eligibles and
other low-income residents through their State Pharmaceutical Assistance Program (SPAP). Any
payments made by a SPAP on behalf of a Medicare Part D enrollee will count toward the enrollee’s
true out-of-pocket costs (TrOOP), which count toward the catastrophic threshold leading to reduced
or eliminated enrollee cost-sharing. State Medicaid programs, including Pharmacy Plus waivers under
Section 1115 of the Social Security Act, ADAPS, and any other programs where the majority of the
funding is from federal programs, cannot be SPAPs. SPAPs must not discriminate among drug plans
with respect to their supplemental coverage; this requirement prevents a SPAP from automatically
enrolling subsidy-eligible individuals into one particular drug plan. Plans must coordinate with
SPAPs concerning certain basic elements. For example, a card issued by a plan may also be used in
connection with coverage of benefits provided under a SPAP. If this is the case, the card may contain
an emblem or symbol indicating such connection.
State Medicaid Programs: Medicare Part D Implications
Because of the design of the Medicare drug benefit, many dual eligibles will find themselves with less
prescription drug coverage than they had under Medicaid and with less protection to challenge denials
or other barriers to coverage. Further, they will have to make co-payments for their prescriptions,
with co-payment amounts increasing yearly. Medicaid can continue to cover drugs which are
excluded from Medicare Part D and are optionally covered by Medicaid, and receive federal financial
participation (FFP). Such drugs include benzodiazepines, barbiturates, prescription vitamins, cough
and cold relief drugs, non-prescription drugs and others. States also have the option of paying copayments
for dual eligibles and/or for drugs that are not on a plan’s formulary but will receive no
federal matching payments.
Medicare Part D Low-Income Subsidies and Groupings
People with limited incomes and resources may be eligible for assistance with drug plan costs.
This assistance provides extra help with Medicare prescription drug plan premiums, deductibles and
copayments—an average of $2,100 annually. Income and resources are used to determine the
applicant’s eligibility.
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• Counting Income—Income is counted the same way as for the Supplemental Security
Income (SSI) program. For married couples living together, both incomes are counted even if
the spouse isn’t applying for extra help. Contact the Social Security Administration (SSA) for
more information on income rules.
• Counting Resources—Resources for married couples living together are counted somewhat
differently from the SSI program. Only two types of resources are considered for this extra
help: liquid assets (savings, stocks, bonds, cash value life insurance and other funds that
could be changed to cash within 20 days) and real estate (land or property that is not a
primary residence). Items such as vehicles, wedding rings and family heirlooms are not
counted.
Four groups may be eligible for help with Medicare prescription drug plans. Calculations are
measured against the Federal Poverty Levels (FPL) Annual Income Limits, which adjust annually to
determine the subsidy groupings. New poverty guidelines are generally published in February or
March of each year. The 2005 levels will be used to compute Medicare Part D low-income subsidies
for the beginning of 2006. (FPL varies depending on the size of the family unit, and is the same for
the 48 contiguous states. Income amounts are higher in Alaska and Hawaii.)
• Group 1—Includes people with Medicare and full Medicaid benefits and incomes at or
below 100% of FPL in 2005. These people are referred to as “dual eligible.” These
individuals are automatically enrolled into a PDP by Medicare, subject to guidelines.
o
Help for Group 1—These people are not required to pay the monthly premium or
deductible. They pay only small co-payments of $1 for generic drugs and $3 for brand
name drugs. If the low-income assistance and these co-payments total $3,600, they do not
pay any other costs for the remaining year.
• Group 2—Includes people with Medicare and Medicaid benefits and incomes between 100%
and 135% of FPL in 2005. Qualified Medicare beneficiaries (QMBs) and specified lowincome
Medicare beneficiaries (SLMBs) fall into this category. These individuals are
automatically enrolled into a PDP by Medicare, subject to guidelines.
o
Help for Group 2—These people are not required to pay the monthly premium or
deductible. They pay a $2 co-payment for generic drugs and a $5 co-payment for brand
name drugs. If the low-income assistance and these co-payments total $3,600, they do not
pay any other costs for the remaining year.
• Group 3—Includes people with incomes between 100% and 135% of FPL in 2005 and with
resources less than $7,500 for single people or $12,000 for married couples. These
individuals must apply for PDP coverage.
o
Help for Group 3—Same as Group #2. These people are not required to pay the
monthly premium or deductible. They pay a $2 co-payment for generic drugs and a $5
co-payment for brand name drugs. If the low-income assistance and these co-payments
total $3,600, they do not pay any other costs for the remaining year.
• Group 4—Includes people with Medicare and incomes below 150% of FPL in 2005 with
resources less than $11,500 for individuals or $23,000 for married couples. These individuals
must apply for PDP coverage.
o
Help for Group 4—Monthly premiums are less and are based on incomes. These people
are responsible for a reduced annual deductible of $50, as well as for 15% of the cost of
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prescriptions up to the $3,600 out-of-pocket maximum. Once these payments and the
low-income assistance reach that maximum, they pay a $2 co-payment for generic drugs
and a $5 co-payment for brand name drugs for the remaining year.
Who’s Eligible
Level 1 Level 2 Level 3 Level 4
In addition to being on Medicare, in 2005 you must be receiving the following:
Full Medicaid
benefits and income
no higher than
$9,570 (single) or
$12,830 (couple)*
Medicaid (but with
income higher than
level 1)*; or SSI
(without Medicaid);
or Medicare
premiums paid by
your state
Income no higher
than $12,919
(single) or $17,320
(couple)*
Income no higher
than $14,355
(single) or $19,245
(couple)*
Value of assets (not including your home, vehicles, burial plot or personal
possessions)
Not applicable
To find out eligibility
Automatically
enrolled
Not applicable
Automatically
enrolled
No more than
$7,500 (single) or
$12,000 (couple)
Must apply
No more than
$11,500 (single) or
$23,000 (couple)
Must apply
What You Get
Level 1 Level 2 Level 3 Level 4
Drug coverage Full (no gap) Full (no gap) Full (no gap) Full (no gap)
Reduced on
Monthly premium $0 $0 $0
sliding scale
based on
income
Annual calendar
year deductible
$0 $0 $0 $50
Co-payment per
prescription
Co-payment
under
catastrophic
coverage**
$1 for generics,
$3 for brands
($0 if you’re in a
nursing home)
$2 for generics
$5 for brands
$0 $0 $0
$2 for generics
$5 for brands
15 percent of
cost of each
prescription
$2 for generics
$5 for brands
*If your income is higher, you may still qualify in certain circumstances—for example, if you live in
Alaska or Hawaii, or have certain earnings that don’t count, or if you or your spouse pays at least
half the support of relatives living with you.
**After you’ve spent $3,600 in true out of pocket (TrOOP) in a calendar year.
SOURCES: Centers for Medicare & Medicaid Services; Social Security Administration; AARP
Public Policy Institute
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Eligibility and Enrollment
Eligibility for this extra help may be determined by either the SSA or the state Medicaid office. In
mid-2005, those who may qualify for extra help will receive information and an application from the
SSA. Individuals receiving applications should complete and return them as soon as possible. Those
who do not receive applications may still qualify for the extra help and should visit the SSA website
at www.socialsecurity.gov or call 1-800-772-1213.
Applicants will be asked for income and resource information and to sign a statement that the answers
are true. The SSA will verify information and may contact applicants if more information is needed.
After applications are processed, individuals will receive confirmation letters if they qualify for the
extra help.
Certain Medicare beneficiaries will automatically qualify for this extra help and don’t have to
apply:
• People with Medicare and full Medicaid benefits
• People with Medicare receiving SSI
• People who belong to a Medicare Savings Program (MSP)
Those with Medicare and full Medicaid benefits must choose and enroll in a PDP to get extra help
with drug costs. Medicare will enroll those who don’t enroll in a plan by December 31, 2005.
Coverage begins January 1, 2006. Enrollees may change plans at any time if the plan they chose does
not meet their needs. Those who belong to a Medicare Savings Program or get SSI must choose
and enroll in a PDP to get extra help with drug costs. Medicare will enroll those who don’t enroll in a
plan by May 15, 2006. Coverage begins June 1, 2006. Those who apply for and are found eligible
for the low-income assistance and don’t choose a plan by May 15, 2006, will receive assistance
from Medicare to enroll in a plan effective June 1, 2006.
SPAPs may provide extra help with drug plan costs for their members who sign up for Medicare
prescription drug coverage. Contact the state program for more information. Those who enroll in a
PDP won’t pay anything for prescription drugs if they live in a long-term care facility such as a
nursing home, or belong to a PACE program (Program of All-Inclusive Care for the Elderly).
Medicare-Approved Drug Discount Cards
As a result of the new Medicare prescription drug plans, all Medicare-approved drug discount cards
will expire on May 15, 2006 or on the date the policyholder’s drug plan coverage becomes effective,
whichever is first.
Private insurance companies may continue to distribute a non-Medicare approved discount card to
new policyholders. These discount cards can be used by policyholders before enrollment in a PDP, or
by policyholders who choose not to purchase a PDP, or if eligible, by other family members not
covered by Medicare. Discount cards are generally not issued to individuals covered under a MA-
PD.
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Chapter 3 — Introduction and Implementation of the New Medicare Part D
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Incentives for Private Businesses to Keep Retired Employees on
Group Health Plans
A number of Medicare age corporate or union retirees who had medical coverage through companies
have been concerned that passage of the MMA would prompt employers to eliminate retirees from
group health coverage since retirees could then buy their own drug coverage from Medicare. As a
result, the MMA incorporated tax-favored subsidies for unions and employers that maintain drug
coverage for retirees by keeping them on their group health plans. The subsidy was intended to
discourage companies from dropping retirees from such plans.
Refer to additional detail as outlined in the Incentives for Private Business to Keep Retired
Employees on Group Health Plans section.
PDP Enrollment Process (The Process May Vary for a MA-PD)
Required Materials and Forms
The following are CMS-required materials for use during the enrollment process.
Required Pre-Enrollment Materials
Agents are responsible for providing prospects with the following materials at the point of sale:
• Cover letter
• Enrollment forms and instructions
• Summary of Benefits
• Exceptions, Appeals, and Grievances packet
• Termination or Non-Renewal Disclosure
• Network Pharmacy Directory
• Formulary
Required Post-Enrollment Materials
Agents are responsible for providing beneficiaries with the following at the time of enrollment:
• Evidence of Coverage
• Summary of Benefits
• Formulary
• Pharmacy Directory
Insurance companies should distribute the following to all enrollees annually:
• Annual Notice of Change
• Summary of Benefits
• Evidence of Coverage
• Abridged Formulary (includes information on how to obtain a comprehensive formulary)
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Effective Date
Enrollees joining in the first half of the Initial Enrollment Period (November 15, 2005 to December
31, 2005) will have an effective date of January 1, 2006.
After January 1, 2006, the effective date of enrollment is the first day of the month after receipt of an
enrollment form. During the enrollment process, the agent must write on the enrollment form the
“proposed effective date” of coverage.
Enrollment Process
The following steps describe general protocol for agents to follow pertaining to the enrollment
process.
Summary of Responsibilities
Agent Responsibilities
1. Agent meets with Medicare beneficiary to review needs and available prescription drug
product options.
2. Agent and enrollee complete enrollment package. Agent collects first month’s premium.
3. Agent reviews enrollment form for completeness using Agent Checklist.
4. Agent assigns tentative “effective date” to beneficiary.
5. Agent mails the original enrollment form package to their respective company within 24
business hours.
Summary of Prohibited Activities
CMS prohibits the following activities during the enrollment and disenrollment process:
• No retrospective enrollment: No backdating of the enrollment form is permitted.
• No prospective enrollment: In most cases, an enrollment cannot be effective beyond the
“next” month rule (first day of month after month of enrollment). Some exceptions may
apply.
• No health screening is allowed in order to enroll in a PDP.
• No requesting or encouraging the member to disenroll, once they have enrolled in the
plan. Exceptions are made for the following circumstances: failure to pay premiums; a move
outside the plan region; fraud, abuse of membership card; loss of Part A; or disruptive
behavior, where CMS has approved disenrollment.
Review the additional sections ahead for reference information on Market Conduct issues and other
prohibited activities that are not directly associated with the enrollment or disenrollment process.
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Anti-Discrimination
Medicare Part D plans may not discriminate based on race, ethnicity, religion, gender, sexual
orientation, health status or geographic location within the service area. All items and services of
Medicare Part D plans must be available to all eligible beneficiaries in the service area with the
following exceptions:
• There may be additional eligibility standards for enrollment in the low-income subsidy, and
agents cannot infer that a plan has the authority to determine member eligibility for a lowincome
subsidy program.
• Certain products and services may be made available to enrollees with certain diagnoses
(medication therapy management programs for individuals with chronic illnesses or
medically-necessary coverage provisions, etc.).
Agents may not engage in discriminatory practices such as targeting marketing to beneficiaries from
higher income areas or implying that plans are available only to seniors rather than to all Medicare
beneficiaries.
Payment Options
Private insurance companies have the flexibility to determine their protocol for premium collection.
Generally, enrollees will be required to pre-pay the first month’s premium (with the enrollment form).
For subsequent payments, there may be several premium payment options available to MA-PD or
PDP members, including Social Security deductions.
Missed Premium Payments
MA-PDs and PDPs can disenroll member who fail to pay in full the premiums, subject to a 30-day
grace period for late payments.
When members fail to pay the monthly premium on a timely basis, they will receive a written notice
of nonpayment within 20 days after the date the delinquent charges were due. Members are alerted
that the premiums are delinquent and provided with an explanation of the disenrollment procedures. It
further advises that failure to pay the premiums within a 30-day grace period, from the premium due
date will result in termination of coverage.
Payments not received within the 30-day grace period will have an effective date of disenrollment on
the first day of the month after the 30-day period ends. Disenrolled members who attempt to re-enroll
must pay any outstanding premiums owed to the plan before considering the enrollment to be
complete.
Disenrollment Procedures
Agents or companies may not request or encourage individuals to disenroll from the plan either
verbally or in writing, by any action or inaction. However, there are certain circumstances where the
MA-PD or PDP is either required to disenroll a member or may cause the coverage of a member to
end. Individuals may be disenrolled from MA-PDs or PDPs if they:
• do not pay their monthly beneficiary premiums or required copayments on a timely basis
(subject to the grace period for late payments—90 days from date of initial notice of nonpayment),
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• are disruptive for reasons unrelated to the use of medical services and the behavior prevents
treatment to themselves or other members of the plan (must have prior CMS approval),
• commit fraud (provide fraudulent information on an election form), or
• knowingly permit the misuse of their membership cards.
Required Disenrollment—Individuals must be disenrolled from a MA-PD or PDP in any of the
following circumstances:
• Loss of entitlement to Part A benefits. The disenrollment is effective the first day of the
calendar month following the last month of entitlement to Part A benefits.
• Death. If a member dies, disenrollment is effective the first day of the calendar month
following the month of death.
• MA-PD or PDP termination. If the service area is reduced with respect to all members in the
area in which they reside, the MA-PD or PDP must give each member a written notice of the
effective date of the plan termination or area reduction.
Note: A member’s coverage may not be terminated because of the member’s health status or
requirements for health care services.
Where to Obtain Prescription Drug Services (Claims)
MA-PDs and PDPs require the use of network pharmacies for the dispensing of covered prescription
drugs. Prescription drugs purchased at a non-participating pharmacy will not be covered. All MA-PDs
and PDPs are expected to contract with a Pharmaceutical Benefit Manager (PBM).
To obtain prescription drug services, beneficiaries must present their MA-PD or PDP card at all
times. This allows the pharmacy system to track users’ TrOOP in real time. Beneficiaries must pay
the amount due at the time of purchase. This includes any deductible amounts, coinsurance or
copayments. MA-PDs and PDPs are required to provide beneficiaries access to obtain an up-to-date
TrOOP count.
The MMA requires MA-PDs and PDPs constructing their pharmacy networks to provide convenient
access to Medicare beneficiaries. CMS regulations define convenient access as networks with 90% of
beneficiaries living within 2 miles of a network pharmacy in urban areas, 90% living within 5 miles
in suburban areas, and 70% living within 15 miles in rural areas.
CMS expects robust competition among prescription drug plans in all areas. Therefore, plans will be
under strong pressure to enable beneficiaries to conveniently fill prescriptions at pharmacies they
know well.
The MMA allows any pharmacy willing to meet a plan’s terms and conditions to join that plan’s
network, so even if a plan does not need to include a particular pharmacy in order to meet the
convenient access standard, the pharmacy has an opportunity to participate.
CMS believes mail order presents a cost-effective choice for chronic, recurring medications. MA-PDs
and PDPs cannot require that beneficiaries use mail-order pharmacies to get extended supplies of
drugs.
The MMA has a specific provision that requires extended supplies available through mail order
(usually a 90-day supply) also be available at retail pharmacies contracted with a plan. The law also
notes that the beneficiary must pay any cost difference between retail and mail order.
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Appeals and Grievances
Each private insurer participating in the Medicare Part D program must establish Appeals and
Grievances protocol as directed by CMS. Generally speaking, MA-PD or PDP member complaints
are divided into two types: member grievances and appeals (or reconsiderations). Complaints are
resolved through one of two distinct processes, depending on the type of complaint (as defined
below). MA-PD or PDP procedures should be designed to handle member issues expeditiously and
equitably.
Grievance procedures apply when a member complains about services, quality of care or involuntary
disenrollment issues. The grievance process is not utilized to appeal claims or service denials.
Grievance examples include complaints about alleged agent misrepresentation, lack of follow-up by
the MA-PD or PDP administrator, no return phone calls or inability to reach the MA-PD or PDP
administrator, rude office staff, or disputing involuntary disenrollment issues.
Appeal procedures apply when a member disagrees with a decision about payment for or provision of
services or a denial of medication or an out-of-network pharmacy purchase. Reconsideration or
appeal requests can be about either an initial denial for service authorization or claim denial.
It is possible to have issues that apply both to grievances and appeals. The procedures for grievances
and appeals are mutually exclusive. If a member addresses two issues on one complaint, each issue is
processed separately and simultaneously under the proper procedure.
Advertising
Advertising materials are primarily intended to attract or appeal to potential Medicare Part D plan
enrollees. Advertising materials are intended for quick view; thus, they do not contain the same level
of detail expected in other marketing materials. Insurance companies assume the responsibility of
filing advertising with CMS under File & Use certification. Agents are only permitted to use
marketing materials and scripts that have been reviewed and approved by their insurance
company.
Agents are not permitted to use self-made advertising materials to market MA-PD or PDPs. Examples
of advertising include but are not limited to:
• Television ads
• Radio ads
• Banner/banner-like ads
• Outdoor advertising (billboards, signs, etc.)
• Direct mail (postcards, self-mailers, newsletters, etc.)—does not include enrollment forms
• Print ads in newspapers, magazines, flyers, etc.
• Internet advertising
Advertising/Marketing Material Language Requirements:
• Banner ads, banner-like ads and outdoor advertisements are not required to include any plan
disclaimers or disclosures.
• All other advertising materials not listed above must include the statement that the MA-PD or
PDP organization contracts with the federal government.
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• In addition to the disclaimers required above, presentation flyers and invitations used to invite
beneficiaries to a group session with the intent of enrolling them must also include the
following two statements:
o
o
“A sales representative will be present with information and applications.”
“For accommodation of persons with special needs at sales meetings, call [insert phone
number].”
Reference to Studies or Statistical Data
Plans may refer to the results of studies or statistical data in relation to customer satisfaction, quality,
cost, etc., as long as specific study details are given, such as the source and dates. Agents and
insurance companies are prohibited from using study or statistical data to directly compare their plan
to another.
Co-branding Requirements
Co-branding is defined as a relationship between two or more separate legal entities, one of which is
sponsoring a Medicare Part D plan. The sponsoring Medicare Part D plan displays the name(s) or
brand(s) of the co-branding entity or entities on its marketing materials to signify a business
arrangement. Co-branding relationships are entered into independently from the contract the plan has
with CMS. Some restrictions apply.
Product Endorsements/Testimonials
Product endorsements and testimonials must adhere to the following guidelines:
• Content of product endorsements and testimonials, including statements by plan members,
must comply with CMS marketing guidelines.
• Speakers must identify the Medicare Part D plan by name.
• Individuals paid to promote a Medicare Part D plan must be clearly stated (i.e., “paid
endorsement”).
• Individuals paid to portray real or fictitious situations must be clearly stated in the ad as a
“paid actor portrayal.” However, non-members cannot say they belong to the plan. This
requirement only applies to product endorsements/testimonials.
• If Medicare beneficiaries offer their endorsements, they must be current plan enrollees and
offer the endorsement in their capacity as Medicare beneficiaries, not as actors paid to portray
fictitious situations or celebrities paid for their endorsements.
Product endorsements and testimonials cannot use:
• Negative testimonials about other plans
• Quotes by physicians and other health care providers
• Anonymous or fictitious quotes by Medicare beneficiaries
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Solicitation Limitations/Restrictions
Disclosure
During the initial steps of a presentation, sales agents will disclose their name, the MA-PD or PDP
product name, the insurance company’s name, and the purpose of their visit. They will make no claim
other than to explain the appropriate plan, its benefits and limitations, and how to enroll.
Misrepresentation is strictly prohibited.
Door-to-Door Solicitation
Agents are prohibited from marketing or using Medicare Part D plans to solicit door-to-door prior to
receiving an invitation from members to provide assistance in their homes. When beneficiaries
request assistance with Medicare Part D, agents can solicit accordingly.
Unsolicited E-mail Policy
Agents may not send beneficiaries e-mails pertaining to Medicare Part D unless they agree to receive
e-mails from agents and provide their e-mail addresses to the agents. Furthermore, agents may not
rent e-mail lists to distribute information about Medicare Part D and may not acquire e-mail addresses
through any type of directory.
Telemarketing
Agents may call prospective customers whose names have been given to them as personal referrals.
Names obtained through special events may be called. Leads may be called seven (7) days after the
initial presentation. If no sale or appointment is generated, no other calls are to be made to the lead.
• Outbound—Agents continue to be subjected to “Do Not Call” regulations. Agents are not
allowed to purchase or use lists of prospective customers for telemarketing in any market,
without the prior written approval of their insurance companies. With respect to Medicare
Part D activity, a company-approved telemarketing script is required and enrollments cannot
be completed by phone.
• Inbound—CMS guidelines do not allow agents or companies to enroll Medicare
beneficiaries for Medicare Part D plans by phone, although pre-population of enrollment
information on enrollment forms is acceptable. Enrollees must sign the applicable enrollment
forms with a “wet” signature.
Seminars
Agents may sponsor seminars or other promotional events. Seminars conducted prior to October 1,
2005, must be educational in nature and cannot promote specific Medicare Part D plans, pre-selling or
distribution of enrollment materials. However, agents may collect names and addresses of potential
enrollees to contact after October 1.
Seminars conducted between October 1, 2005 and November 15, 2005 can promote specific Medicare
Part D plans through pre-selling efforts and distribution of enrollments materials, but enrollment
forms may not be accepted. NOTE: Ongoing discussion within CMS is underway to allow collection
of enrollment forms beginning October 1, 2005, but they cannot be processed until November 15,
2005.
Names obtained through seminars may be called. Leads may be called seven (7) days after the initial
presentation. If no sale or appointment is generated, no future calls may be made to that lead.
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Only an agent who enrolls the prospect may sign the enrollment form as the agent of record. If an
agent is not present during a seminar, his/her name may not be signed on the enrollment form.
Internet Enrollments
Insurance companies may market and enroll other lines of business concurrently with Medicare Part
D plans on the Internet, though to avoid beneficiary confusion, companies must continue to maintain
a separate and distinct section of their websites for Medicare Part D plan information only. CMS will
review corporate websites to ensure companies maintain separation between Medicare Part D plan
information and information on other lines of business.
Outreach Assistance
Agents may not contact members who have refused outreach assistance or have not responded to
telephone calls or follow-up letters until at least six months following the last outreach attempt.
General Guidance about Promotional Activities
Promotional activities (including provider promotional activities) must comply with all relevant
federal and state laws including, when applicable, the anti-kickback statute and the civil monetary
penalty prohibiting inducements to beneficiaries. Agents may be subject to sanctions if activities offer
or give something of value to Medicare beneficiaries that will likely influence their selection of a
particular provider, practitioner or supplier of items or services for which payment may be made, in
whole or in part, by Medicare. Additionally, agents are prohibited from offering rebates or other cash
inducements of any sort to beneficiaries.
Furthermore, agents are prohibited from offering or giving remuneration to induce referrals of
Medicare beneficiaries, or to induce people to purchase, arrange for or recommend the purchase or
ordering of items or services paid, in whole or in part, by Medicare.
• Agents may not offer post-enrollment promotional items that in any way compensate
beneficiaries based on their utilization of services. Any promotional activities or items
offered by agents, including those that will be used to encourage retention of members, must
be of nominal value, offered to all eligible members without discrimination and not in the
form of cash or other monetary rebates.
Nominal Gifts
Agents can offer gifts to potential enrollees if they attend a marketing presentation, as long as such
gifts are of nominal value and are provided whether or not individuals enroll in the plan offered.
Nominal value is defined as an item worth $15 or less, based on the retail purchase price of the item.
If coordinating a promotional activity with a medical provider, the value of medical services,
examinations and laboratory tests can be determined by the local Medicare fee-for-service fiscal
intermediary and/or carrier charge listing for that service.
Cash gifts are prohibited, including charitable contributions made on behalf of people attending a
marketing presentation, and including gift certificates that can be readily converted to cash, regardless
of dollar amount.
An organization may offer a prize of over $15 to the general public ($1,000 sweepstakes on a
corporate website) as long as the prize is not routinely or frequently awarded, and is offered to the
general public, not just to Medicare beneficiaries.
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Drawings/Prizes/Giveaways
Agents are prohibited from using free gifts and prizes as an inducement to enroll. Any gratuity must
be made available to all participants regardless of enrollment. Gift values must be less than the
nominal amount of $15. In accordance with this guideline, agents offering drawings, prizes or
giveaways must state one of the following phrases in at least 12-point font:
• “Eligible for a free drawing and prizes with no obligation.”
• “Free drawing without obligation.”
Agents cannot state, “Eligible for free drawing and prizes.”
Hold Time Messages
Hold time messages (recorded information played to caller while waiting on hold) within telephone
scripts must only discuss health-related features.
Health Fairs and Health Promotional Events
Agents may participate in health fairs and health promotional events as either sole sponsors or cosponsors
of events hosted by multiple organizations. CMS policies for sponsoring health fairs and
health promotional events are divided into three sections:
1. Sole-Sponsor Event—A single sponsor for an event. If offered, door prizes/raffles cannot
exceed $15 each.
2. Multiple-Sponsor Event—More than one sponsor for an event. Door prizes/raffles can
exceed the $15 limit if a MA-PD or PDP contributes to a cash pool for prizes or contributes
to a prize pool such that prizes are not individually identified with the MA-PD or PDP, but is
identified with a list of contributors. A jointly sponsored event may consist of the MA-PD or
PDP and one or more sponsors who are not contracting providers with the MA-PD or PDP. A
MA-PD or PDP may also contribute cash toward prize money to a foundation or another
entity sponsoring the event. For example: A radio station, along with many sponsors,
organizes a senior health fair. Anyone who attends may register for the door prize: a weekend
trip. The MA-PD or PDP may participate in the fair, contribute to the door prize, and permit
attendees to register for the prize at its booth (as well as other sponsor booths). However, the
MA-PD or PDP cannot claim to be the sole donor of the prize. It must be clear that the prize
is attached to the senior fair. No sales presentation may be made at the event.
3. Both—The policy applies to both sole- and multiple-sponsor events.
a. Such events should be social and should not include sales presentations.
b. MA-PD or PDP representatives’ responses to questions asked at the event will not be
considered sales presentations as long as enrollment forms are not accepted at the event.
c. Advertisements for the event may be distributed to enrollees, non-enrollees or both.
d. The value of giveaways or free items (e.g., food, entertainment, etc.) cannot exceed $15
per attending person. For planning purposes, event budgets can be based on projected
attendance. The cost of overhead for the event (e.g., room rental) is not included in the
$15 limit.
e. Pre-enrollment advertising materials, including enrollment forms, can be made available
as long as enrollments are not accepted at the event.
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Provider Promotional Activities
• Providers (hospitals and physicians) may:
o
o
o
hold health fairs or cosponsor events with the MA-PD or PDP
distribute plan brochures and enrollment forms, but not accept enrollment forms at health
fairs
distribute plan brochures and posters announcing plan affiliation
• Marketing presentations are allowed in clinics, hospitals or physician offices and must:
o
o
o
be conducted in common areas
not coerce patients into attending
send out only one notice to patients of plan affiliation
• Sales agents are prohibited from:
o
o
o
taking enrollment forms in the place where health care is delivered
offering inducements to persuade beneficiaries to join the plan
offering anything of value to induce plan enrollees to elect them as their provider
Referrals
The following general guidelines apply to referral programs under which agents solicit leads from
members for new enrollees. These include gifts that would be used to thank members who encourage
enrollment. Gifts for referrals must be available to all members and cannot be conditioned on actual
enrollment of the person being referred.
• Agents may not use cash promotions as part of a referral program.
• Agents may offer gifts worth less than $15 nominal value (e.g., thank you note, calendar, pen,
key chain) when enrollees respond to a plan solicitation for referrals. These thank you gifts
are limited to one gift annually per member.
• Letters sent from agents to members soliciting leads cannot announce that gifts will be
offered for referrals.
• Agents can ask for referrals from active members, including names and addresses, but cannot
request phone numbers for the direct solicitation of MA-PD or PDP coverage. Agents can use
referral information to solicit MA-PD or PDP coverage by mail.
Market Conduct
Agents must subscribe to the code of ethics and all CMS regulations, state laws and insurance
company policies. Any violation of the code may subject an agent to termination and/or possible
legal action as specified in CMS regulations and/or state statutes. It is the agent’s responsibility to
be familiar with the content covered here. In addition to those issues addressed above, the following
must be applied:
• Agents must conduct themselves with courtesy, professionalism and with respect for the
rights and reasonable requests of prospective enrollees at all times.
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• Agents will assure, to the best of their ability, that prospective enrollees are of sound mind
and capable of thoroughly understanding the plan. If at any time they doubt an enrollee’s
mental capability, they will discontinue the enrollment until they can meet with someone with
appropriate legal authority to enroll the eligible prospect.
• Agents may indicate that the plans meet criteria specified by government agencies. They
must never imply that their visit is in any way connected with the government or approved by
a particular government agency or official, or portray themselves as agents of any
government agency.
• Agents will base their presentations on the merit and quality of the respective plans and will
not disparage competitors or their plans.
• Agents must make only company-approved claims and shall use no forms of pressure,
coercion, deception, sympathy, appeal or other unethical sales tactics in their presentation.
• Agents must always give clear, thorough and accurate information regarding the product.
False, misleading, half-true or exaggerated statements are prohibited.
• Agents are responsible to ensure that all information on the enrollment form is complete,
accurate and legible.
• Agents, in their relationships with professional contacts, must not involve themselves in
accepting gifts or additional financial incentives, arranging to share or split their incentives,
or otherwise allow themselves to be influenced or coerced in any way in the conduct of their
business. Agents will not involve themselves in any non-sales-related paperwork such as, but
not limited to, disenrollments.
• Agents may not store or share any member information, financial or otherwise, specific to the
low-income subsidy, with any entity not directly involved in the outreach process.
Violations of MA-PD or PDP business policies or CMS/DOI
regulations
CMS has established regulations that govern MA-PD and PDP marketing and sales. The Department
of Insurance in each state maintains regulations governing the sales of all insurance products.
Insurance companies must abide by these regulations without exception. Violations of these policies
or regulations may lead to disciplinary actions up to and including termination of appointment.
Major Violations
Major violations are violations of the Code of Ethics, CMS, state insurance regulations, or policies of
the insurance company, which may justify immediate contract termination. Allegations of major
violations are investigated and referred to a company’s Compliance Officer or other designated party.
Examples of Major Violations:
• Dishonesty or theft
• Threatening, coercing, intimidating or deceiving members or prospective members, or the use
of any other unethical sales tactics, including the sale of products to people who obviously
are unable to understand the product
• Door-to-door solicitation for PDP sales
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• Misrepresentation of the product, the purpose of the agent’s visit, or an implication that the
visit is in any way connected with the government
• Forging or knowingly accepting a forged signature on an enrollment form
• Deliberate or negligent omission or falsification of significant information on any company
form
• Sale of a PDP product by an individual other than the licensed agent who presented the
product and signed the enrollment form
• Accepting any monetary or other rewards, including but not limited to rewards for
influencing the enrollee’s choice of physician or medical center
• Asking questions about the potential enrollee’s health care status and using that information
to qualify or disqualify a person for enrollment into a MA-PD or PDP
• Willful failure to explain the Network Pharmacy provision which specifies that, except for
emergencies, all prescription drug benefits must be provided by pharmacies in network
• Willful use (with intent to misrepresent) of marketing material not provided by the insurance
company, and therefore not filed with and approved by CMS and the DOI for use by the
insurance company
• Rebating is prohibited, and includes splitting commissions with another person, or payment
of any kind or amount to a member or non-member as reimbursement for a referral name on
the condition that the referred person purchases a specific MA-PD or PDP plan
• Any marketing activity that is a violation of the insurance company, CMS, or DOI
regulations
Lesser Violations
Lesser violations are not as critical as major violations but may require immediate disciplinary action.
If an investigation proves that an agent has committed a lesser violation, he/she will be placed on a
30-day improvement plan.
Agents found to have committed a second lesser violation may be required to repeat training before
resuming selling, and may be considered grounds for termination if it is determined the violation is
willful. Results of violation investigations will be sent to the insurance company’s Compliance
Officer or other designated party to be included in the agent’s file.
Examples of Lesser Violations:
• Failure to properly present MA-PDs or PDPs
• Use of marketing material not provided by the insurance company and not previously filed
with and approved by CMS
• Use of door prizes, gifts or giveaways with a value greater than $15 or without prior approval
of sales management
• Gifts or payments of any kind or amount to members or non-members for referral names
without condition of purchase when gifts or payments have not previously been approved by
sales management.
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Chapter 3 Review
1. Health-related Value-Added Items and Services (VAIS) are:
a. Intended to maintain or improve the health status of the enrollees
b. Used to screen members for illness and disease
c. Employed to provide members with services that do not improve their health status
d. Utilized to attract undecided prospects
2. The Group 1 group of people eligible for help with Medicare prescription drug plans
includes those who:
a. Have Medicare and Medicaid benefits with incomes between 100% and 135 % of the Federal
Poverty Level.
b. Have incomes between 100% and 135% of the Federal Poverty Level.
c. Have Medicare and full Medicaid benefits with incomes at or below 100% of the Federal
Poverty Level.
d. Have incomes below 150% of the Federal Poverty Level.
3. What is an example of the Health-related VAIS
a. Screening for diseases, such as AIDS or Hepatitis
b. Discounts on eyeglasses or health clubs
c. Screening for diseases that would disqualify enrollees from continued service
d. Discounts on social clubs and organizations that promote healthy lifestyles
Answers to the chapter review can be found in Appendix A
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104

Chapter 4
Annuities
Important Lesson Points
The important points addressed in this chapter are:
• The traditional annuity role as the systematic liquidation of a principal sum has expanded to
include the accumulation of principal
• Deferred annuities may be purchased with a single premium or through the payment of
regular periodic premiums
• Fixed annuities grow by the payment of premiums and the crediting of regular interest
• The significant tax benefits of an annuity are its tax deferred growth and partially tax-free
periodic payments
• The annuity starting date is the date at which the annuity begins to receive periodic payments
• Periodic payments made under a life annuity are affected principally by the annuitant’s age
and gender
• Life annuities are differentiated from one another by the presence or absence of minimum
payment guarantees, such as a period certain or a refund period
• Life annuities may involve a single life or multiple lives
• Temporary annuities provide for the liquidation of a principal sum without reference to life
contingencies
• A back-end load—also known as a surrender charge—is levied in the event of an annuity
contract surrender during the surrender charge period and is designed to recover new business
acquisition expenses
• Multi-year guaranteed annuities (MYGAs) are fixed annuity contracts that offer contract
owners a specified interest rate for greater than a single year—usually three to ten years—and
often compete favorably with certificates of deposit
• Bonus annuities are fixed annuities that provide contract owners a first-year interest rate that
includes an additional interest amount
• Equity indexed annuities are fixed annuities to which insurers credit interest based on the
change in a specified equity index, such as the S&P 500 index
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• Equity indexed annuities may contain various interest rate-limiting provisions, such as caps,
participation rates and spreads
• Variable annuities give contract owners the opportunity to allocate premiums to a range of
investment options through variable subaccounts that differ from one another based on risk
and potential return characteristics
The Concept
The application of annuities has grown over time from its initial concept as a vehicle for the
systematic liquidation of a sum of money to assume a much broader role. While the systematic
liquidation of a principal sum continues to be a legitimate function of an annuity, it has taken on a
much expanded accumulation role.
Traditional Role
The word “annuity,” not unlike many words in our language, comes from Latin. The word from
which “annuity” is derived means year and, as such, connotes an annual payment.
The traditional role of an annuity is to liquidate a principal sum and is founded in the unpredictability
of human life. The need for continued income despite human life’s unpredictability and variability
requires that a vehicle be available that will guarantee a continued income regardless of how long an
individual lives. Since the duration of any individual human life remains as unpredictable today as it
was a decade, a century or millennium ago, that need continues.
Although the need for annuities in the traditional sense continues, the annuity vehicle addressing that
need has changed considerably. From the original concept of a single premium product that
guarantees a payment for life at a level based on a fixed interest rate, the concept of an annuity has
grown to include many types of annuities, each created to satisfy a particular financial requirement.
Accumulation Period
While an annuity may certainly be purchased through the payment of a single premium and is often
funded in that way as a result of a qualified plan distribution, it may also offer contract owners an
opportunity to accumulate funds over time.
Annuities fall into two broad categories:
1. Immediate annuities, and
2. Deferred annuities
An immediate annuity is an annuity whose first income payment is due one payment interval
following the date it was purchased and reflects the traditional role of an annuity. Since annuities may
provide for periodic income payments on a monthly, quarterly, semi-annual or annual basis, an
immediate annuity is generally defined as one under which periodic payments begin within one year.
Except for these immediate annuities, which have no provision for additional premium payments, all
annuities have an accumulation period. These annuities that have an accumulation period are deferred
annuities.
Deferred annuities may be purchased through the payment of a single premium or through the
payment of periodic premiums. If deferred annuity premiums are periodic, they may be rigidly fixed
or—more commonly—flexible and dependent entirely on the contract owner’s choice of payment
timing and amount. Deferred annuities funded by single premiums are appropriately known as single
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premium deferred annuities, or SPDAs. Deferred annuities whose premium payment timing and
amount are determined by the contract owner are known as flexible premium deferred annuities, or
FPDAs.
Regardless of whether a deferred annuity is funded by a single premium or by periodic premiums, it
offers the contract owner the ability to accumulate a substantial fund. The annuity’s cash value may
grow as a result of the payment of additional premiums and/or the crediting of interest in the case of a
fixed annuity. Alternatively, an annuity’s cash value may grow as a result of the payment of
additional premiums and/or the performance of a separate account in the case of a variable annuity.
We will discuss variable annuities later in this lesson. For now, our focus will be on fixed annuities.
In a fixed annuity, the insurer credits interest to the cash value each year. Each subsequent year, the
interest credited in previous years also earns interest, i.e. compound interest. Annuities also offer
contract owners an additional advantage: tax deferral. Unlike many other interest-earning
investments, taxation of the interest credited to the cash value each year is deferred until the funds are
paid out. As we will see later, when we discuss annuity taxation, the tax advantages of an annuity
may continue even through the payout period.
We can readily appreciate the importance of tax deferral to the accumulation of cash value by looking
at the following comparison between the accumulated amounts in a tax-deferred account and the
accumulated amounts in an account on which current income taxes are being paid from the account.
The amounts shown assume that a deposit of $5,000 is made to each account each year, the funds are
invested at 8 percent, and the account owner is in a 35 percent tax bracket.
End Of Year
Tax Deferred
Accumulation
Currently Taxable
Accumulation*
Difference +
1 $5,400 $5,260 $140
5 $31,680 $29,181 $2,499
10 $78,227 $66,781 $11,446
20 $247,115 $177,649 $69,466
30 $611,729 $361,711 $250,018
35 $930,511 $495,240 $435,271
* Amounts shown assume that any income tax due is withdrawn from the account
before interest is credited.
+ The difference does not reflect the income tax that would be due if a full
withdrawal was taken from the tax-deferred account. The difference, although still
substantial in most cases, would be smaller.
Based on these accumulations for a male age 65, he could expect to receive a monthly life income
(assuming a monthly income of $9.50 per $1,000) as follows:
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End Of
Year
Tax-Deferred
Account
Monthly Income
Currently-Taxable
Account Monthly
Income*
Annual
Difference
1 $51 $50 $12
5 $301 $277 $288
10 $743 $634 $1,308
20 $2,348 $1,688 $7,920
30 $5,811 $3,436 $28,500
35 $8,840 $4,705 $49,620
* The portion of the monthly income from the currently-taxable that would be
tax free as a return of basis would be somewhat larger than in the taxdeferred
account, reflecting the greater amount of taxes paid in the currentlytaxable
account.
These comparisons are intended only to show the value of tax-deferral. They do not reflect any
guarantees or expenses that might be incurred in any annuity contract.
Distribution Period
At some point, an annuity contract owner usually stops making premium payments to the annuity and
begins taking periodic income payments from the contract; this point in the annuity contract is known
as the annuity starting date. The contract owner may access cash in the contract by making a
withdrawal at any time before the annuity starting date; however, once the annuity payments begin
further withdrawals may not be permitted, depending on the payout option selected.
Life Annuities
At the annuity starting date the payout begins. The payout chosen by the contract owner may involve
life contingencies or not. If the payout chosen involves life contingencies, the payout is a life annuity,
and the annuitant’s death affects the payments. If the selected payout does not involve life
contingencies, the payout is considered a temporary annuity. If the option selected is a life annuity,
the income level is affected principally by two factors:
1. The annuitant’s age, and
2. The annuitant’s gender
The annuitant’s age will affect the life annuity’s periodic payment level since younger annuitants can
generally expect to receive a greater number of payments, on average, than older annuitants. As a
result, periodic life annuity payments per dollar of accumulated value are higher for older annuitants
than for younger annuitants.
Similarly, the annuitant’s gender affects the periodic payment level. Unless the annuity rates applied
are unisex rates, female annuitants will generally receive smaller periodic payments than male
annuitants of the same age per dollar of accumulated value. The reason for the disparity is due to the
generally greater life expectancy experienced by females. Unisex annuity rates apply to annuities
provided under qualified retirement plans.
Life annuities are differentiated from one another by their minimum payment guarantees. The
simplest life annuity is known as a straight life annuity. A straight life annuity is an annuity that pays
a periodic benefit for as long as the annuitant lives. When the annuitant dies, no further payments are
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made to anyone. Although a straight life annuity pays the highest amount of income per dollar of
accumulated value, it is possible that the annuitant will die after receiving only one periodic payment.
In such a case, no further payments are made. However, the annuitant may live to be well over 100,
in which case the annuity would still continue to make periodic payments until his or her death.
A life annuity with a minimum guaranteed payout can be a:
• Life annuity with a period certain, or
• Refund annuity
A life annuity with a period certain is identical to a straight life annuity with one important
difference: if the annuitant dies before the end of the “certain period,” periodic payments will
continue to a beneficiary until the end of the certain period. However, if the annuitant lives beyond
the certain period, the annuity contract will continue to provide periodic income payments for the life
of the annuitant. For example, if the annuitant selects a 10 year certain period and dies after receiving
5 years of periodic payments, the remaining 5 years of periodic payments will be made to a
designated beneficiary. Also, if that annuitant lives 50 or more years beyond the certain period, the
periodic payments will continue until the annuitant’s death.
The certain periods generally offered by insurance companies include:
• 5 year certain
• 10 year certain
• 15 year certain
• 20 year certain
Although these four certain periods are generally the most popular, virtually any certain period that is
desired by the annuitant and permitted by the insurer may apply.
A refund annuity also provides a life income and a guaranteed minimum payment, but it is couched
somewhat differently than the period certain. In a refund annuity, the insurer guarantees that if the
annuitant dies before total periodic payments have been made equal to the purchase price, the
difference will be refunded to a beneficiary. The refund annuity may be a/an:
• Cash refund annuity, which provides that any refund payment will be made in a lump sum, or
• Installment refund annuity, which provides for a continuation of periodic payments until an
amount equal to the purchase price has been paid
It should be no surprise that the greater the guarantee provided by the insurer, the smaller the periodic
payment will be. Although the rates per $1,000 of purchase price shown below are not reflective of
any particular life insurance company’s rates, they provide a sense of the difference in periodic
payments based on age, gender and minimum payment guarantees.
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Sample Monthly Annuity Benefits per $1,000 of Purchase Price
Type of Life Annuity
Male Age
60 65 70 75 80
Straight life annuity $9.32 $10.00 $11.26 $12.82 $15.12
Life annuity with 10-year period certain $9.03 $9.50 $10.26 $10.94 $11.60
Refund annuity $9.06 $9.50 $10.50 $11.55 $12.87
Type of Life Annuity
Female Age
60 65 70 75 80
Straight life annuity $8.66 $9.00 $10.11 $12.60 $13.78
Life annuity with 10-year period certain $8.52 $9.00 $9.67 $10.46 $11.08
Refund annuity $8.52 $9.00 $9.85 $11.00 $11.74
In addition to the life annuities that we have just described, a life annuity need not be based on only a
single life. Instead, a popular type of annuity, particularly among retired couples, is a joint and
survivor annuity. A joint and survivor annuity is simply an annuity whose periodic payment benefit
continues until the death of the survivor of two or more annuitants. Common options provide the
following periodic payment levels following the first death:
• 100% to the survivor for life
• 66 2/3% to the survivor for life, or
• 50% to the survivor for life
The rationale behind the payment reduction following the death of the first annuitant to die is that it is
more expensive for two individuals to live than for one individual to live. Since payments under a
joint and survivor annuity continue to the survivor at some level for life, a joint and survivor annuity
tends to be the most expensive of life annuity forms, and the form that provides a 100 percent
survivor income is the most expensive.
The joint and survivor annuity may also be issued with guaranteed minimum payment features. The
guaranteed minimums that are sometimes found on joint and survivor annuities are:
• Joint and survivor annuity with 10-year period certain, or
• Joint and survivor annuity with 20-year period certain
Under these period certain arrangements, payments would continue to a designated beneficiary if the
last survivor of the two annuitants were to die before the end of the ten- or twenty-year period
selected.
We noted at the outset that periodic payment options may or may not involve life contingencies. Now
that we have considered those involving life contingencies, let’s turn our attention to those annuities
whose payments are not affected by the annuitant’s death: temporary annuities.
Temporary Annuities
Unlike life annuities, whose central feature is a guaranteed income for the life of the annuitant,
temporary annuities do not involve life contingencies. They simply make payments of a principal sum
plus interest until the funds are exhausted, at which point periodic payments cease.
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Temporary annuities are further divided into two categories:
1. Fixed amount, and
2. Fixed period
Under a fixed amount temporary annuity, periodic payments continue at the prescribed fixed amount
level until the principal and interest are exhausted, whether or not the annuitant is still alive at that
time. If the annuitant dies before the principal and interest are exhausted, any principal and interest
remaining will be paid to a designated beneficiary.
To illustrate a fixed amount temporary annuity stream of payments of $1,000 per month and a
purchase price of $60,000, periodic payments would continue for slightly more than 5 years, i.e. 60
months. The fact that periodic payments would continue beyond a 60-month period is attributable to
the interest that would accrue on the $60,000 purchase price.
Under a fixed period temporary annuity, periodic payments continue for a prescribed period, during
which time the principal and interest are exhausted. At the conclusion of the fixed period, the periodic
payments cease, regardless of whether or not the annuitant is still alive at that time. If the annuitant
dies before the end of the prescribed period, payments will continue to a designated beneficiary for
the balance of the period.
A fixed period temporary annuity for five years with monthly payments and a purchase price of
$60,000 would result in periodic payments of slightly more than $1,000. The fact that periodic
payments would exceed $1,000 per month for 60 months is the result of the interest accruing on the
$60,000 purchase price.
When payments are made as an annuity—whether as a life annuity or a temporary annuity—the payee
enjoys certain income tax benefits that we will examine at some length later in this chapter. In a
nutshell, however, the tax benefits of nonqualified annuity payments amount to a portion of each
payment being receive tax-free as a return of the contract owner’s cost basis.
Traditional Fixed Annuity Characteristics
Although annuities may differ, there are certain characteristics or range of characteristics that are
common among them. In this section we will deal with the traditional fixed annuity characteristics
and address:
• Premiums
• Number of lives covered
• Annuity starting date
• Accumulated value
• Payout, and
• Tax treatment
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Premiums
There are three arrangements that apply to annuity premiums. Annuities may provide for:
1. Level scheduled premiums
2. Periodic flexible premiums, or
3. A single premium
Annuity contracts that provide for level scheduled premiums have a “forced savings” element to
them. Under these contracts, the contract owner would be required to make the regular premium
payments or the contract would lapse. Although retirement annuities typically provide for regular
scheduled premiums that are level, the introduction of universal life insurance with its premium
flexibility resulted in the decline in popularity of these “non-flexible” annuity premiums. While
annuities with level scheduled premiums may still be found, they have been largely replaced by
flexible premium annuities.
Annuities with periodic flexible premiums are known as flexible premium deferred annuities—or just
as FPDAs. Under this premium arrangement, a contract owner may make premium payments at any
interval and in almost any amount. Generally, insurers limit the FPDA premiums that they will accept
with respect to both minimums and maximums. An insurer may require that a minimum premium
payment to an FPDA be at least $25; this minimum requirement is normally imposed to eliminate the
very small premium payments that are prohibitively expensive to administer. Conversely, insurers
may limit the amount of any FPDA premium payment to no more than $250,000 or some similar
amount in order to ensure that the funds can be promptly invested. Whether the annuity contract calls
for scheduled premiums or flexible premiums, periodic premium annuities may only be deferred
annuities. Such annuity contracts may not be immediate annuities.
The third annuity premium arrangement is a single premium. A single premium annuity is simply an
annuity under which the contract owner makes one premium payment. No further premium payments
are expected nor may they be made. Although never as popular as FPDAs, single premium annuities
have gained in popularity as individuals receive severance packages from employers or qualified plan
distributions. Unlike a periodic premium annuity, which may only be a deferred annuity, a single
premium annuity may be either a deferred annuity or an immediate annuity.
Lives Covered
Annuities may cover a single life or multiple lives. If the annuity is designed to pay benefits only so
long as the annuitant lives, and cease upon his or her death, it is a straight life annuity. As we noted
earlier when we examined the payout period, annuities may provide for certain minimum payout
guarantees, such as period certains and refund periods.
Annuities that cover more than a single life are referred to as joint and survivor annuities. These
annuities pay a benefit until the last of the annuitants dies. Although a joint and survivor annuity may
cover more than two lives, none of whom need to be related by blood or marriage, the most popular
form is a two-life joint and survivor annuity covering a husband and wife. While a joint and survivor
annuity pays a benefit until the last of the annuitants dies, the payment level may—but need not—
reduce at the time of the first death. Joint and survivor annuities generally pay a periodic income
payment to the survivor after the first death that is 100 percent of the former periodic payment, 66 2/3
percent of it or 50 percent of it.
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Annuity Starting Date
As we saw earlier, annuities may be either immediate annuities or deferred annuities. An immediate
annuity is one whose payout begins no more than one year following its purchase. In the case of
deferred annuities, however, the contract owner normally indicates on the application when he or she
wants the periodic payment benefits to begin. The date on which the periodic payment benefits under
a deferred annuity are scheduled to commence is known as the annuity starting date.
Accumulated Value
The accumulated value in a traditional fixed (that is, a non-variable) annuity is determined by two
primary factors: the premiums paid and the interest credited. There are two interest crediting rates in
the case of a traditional fixed annuity:
1. A current interest rate, and
2. A guaranteed interest rate
Periodically, an insurer sets the interest rate that it will pay on its interest-sensitive products, such as
its portfolio of fixed annuities. The interest rate that is established by the insurer generally reflects the
earnings that the insurer is obtaining on the investment of its general account and the competitive
annuity environment. However, regardless of the earnings that the insurer is obtaining on its general
account, it may not credit less than the interest rate guaranteed in the policy.
The accumulated value is generally available to the contract owner to access for withdrawals.
However, during the early years of the annuity contract—often referred to by the insurer as the
“surrender charge period”—the insurer may levy a surrender charge on any surrender or withdrawal.
In many contracts, however, the contract owner is entitled to withdraw up to 10 percent of the
accumulated value with incurring a surrender charge. Annuity surrender charges often begin at as
high as 7 percent and decline periodically to zero over a period of from five to ten years, depending
on the contract.
Surrender charges imposed by an insurer are designed to accomplish two objectives:
1. To recover any new business acquisition expenses—typically commissions—incurred in
writing the annuity contract, and
2. To discourage contract owners from surrendering their contracts
Some annuity contracts offer a “bailout” provision that enables the contract owner to avoid surrender
charges on surrendering the contract if the insurer fails to maintain a stated minimum interest
crediting rate.
In addition to any surrender charges that may apply in the case of a surrendered annuity contract, the
IRS generally levies a premature withdrawal penalty on any annuity withdrawal or surrender before
the owner’s age 59½.
Payout
It was noted earlier in the discussion of the distribution period that annuity contracts may pay benefits
in a number of ways that may or may not involve life contingencies. If life contingencies are
involved, the periodic payout is known as a life annuity and may or may not have minimum payment
guarantees. These guarantees are referred to as a:
• Period certain, or
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• Refund period
If the payout does not involve life contingencies, it is known as a temporary annuity. These temporary
annuities are of two types:
1. Fixed period annuity
2. Fixed amount annuity
Tax Treatment
Annuities offer their owners a number of advantages. Chief among those advantages is its tax
treatment. Although certain annuities—known as tax-qualified annuities—enable contract owners to
fund their contracts with before-tax earnings, premium payments made to nonqualified annuities are
not tax deductible. These premiums constitute after-tax funds.
The principal tax benefit afforded nonqualified annuities is the tax deferral of cash value earnings.
We noted earlier just how important tax deferral is to the accumulated value. These earnings are not
recognized until the annuity cash value is distributed.
The annuity’s cash value may be received by the annuity in periodic income payments or it may be
withdrawn from the contract from time to time. The tax treatments of these two means of accessing
the contract’s value are different.
A contract owner that chooses to withdraw funds from the annuity contract is subject to LIFO, i.e. last
in, first out, tax treatment. Under LIFO treatment, the last thing added to the cash value—its
earnings—are deemed to be the first received. As a result of this LIFO tax treatment, the contract
owner will be required to recognize income to the extent that the withdrawal does not exceed the
contract’s earnings. For example, suppose that George Wilson owns a nonqualified annuity contract
with a cash value of $50,000 for which he paid $40,000 in premiums. If George took a withdrawal of
$15,000, the withdrawal would be deemed to be comprised of:
• $10,000 of earnings, and
• $5,000 of tax-free premium paid
That result occurs because the contract earnings are deemed to be withdrawn before any premiums
are withdrawn. In addition to being required to recognize the earnings in any withdrawal, the IRS
generally levies a premature distribution tax penalty of 10 percent of the amount includible in income
if the contract owner was less than age 59½ at the time of the withdrawal. If the premature
distribution tax penalty applied to this withdrawal, George would be required to pay a tax penalty of
$1,000. ($10,000 x .10 = $1,000)
Suppose, however, that George elected to receive his $50,000 as a life annuity. If we further suppose
that his life only annuity rate is $10 per month per $1,000, George could receive a monthly income
for life of $500 per month. That periodic payment of $500 a month, however, would be deemed to be
comprised of part taxable earnings and part tax-free return of premium.
To determine the amount of each $500 monthly income payment that is tax-free, we need to calculate
the exclusion ratio, which is nothing more than the ratio that the total investment in the contract
(George’s $40,000 in premiums) bears to George’s total expected return. If George’s life expectancy
is 20 years, his total expected return is $500 per month multiplied by 240 months—$120,000. To
determine the exclusion ratio, we need only divide $40,000 by $120,000, and we find that one-third
of every periodic payment is tax-free as a return of premium. ($40,000 ÷ $120,000 = .3333) We need
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only multiply the $500 monthly payment by .3333 to determine that $166.65 of each periodic
payment is received tax free until the entire $40,000 paid in premium is recovered tax free.
Fixed Annuity Variations
Thus far, we have considered only the traditional fixed annuity contract, under which an insurer
establishes a crediting interest rate annually. There are, however, a number of variations on this basic
theme that deserve mention. The contracts that we will briefly consider are:
• Multi-year guarantee annuities (MYGA)
• Bonus annuities, and
• Equity indexed annuities
Multi-Year Guaranteed Annuities
The name “multi-year guaranteed annuity” aptly describes the fundamental characteristic of this
annuity. It is a fixed annuity that offers contract owners an interest rate that the insurer guarantees it
will credit on the contract for more than a single year. Sometimes referred to as “certificate annuities”
because of their multi-year guarantees and competition with certificates of deposit, multi-year
guaranteed annuities (MYGAs) offer purchasers a choice of interest rate guarantee periods that
typically range from three to ten years. While not always the case, higher interest rates are normally
credited on contracts with longer guarantee periods. In addition, some MYGAs may offer individuals
a first-year bonus of 1 percent or so.
MYGAs typically have surrender charge periods that coincide with their guarantee period but
normally give contract owners surrender charge-free access to the earnings on their contracts’ cash
value. So, although a MYGA may have a 10 percent surrender charge throughout the guaranteed
period, any earnings may be withdrawn without a surrender charge. (A note of caution: even though
an insurer may waive surrender charges for a withdrawal of earnings, the IRS premature distribution
tax penalty of 10 percent may apply if the contract owner is younger than 59½.) In most cases—
although not in every case—the surrender charge ceases at the end of the guarantee period. If the
contract is renewed, the surrender charge begins anew.
In addition to surrender charges, a MYGA may use a market value adjustment (MVA). Provisions for
an MVA generally permit insurers to offer somewhat higher interest crediting rates than they might
otherwise offer. An MVA works in this fashion. If a contract owner surrenders the contract during the
surrender charge period or takes a withdrawal in excess of the contract earnings, the value of the
MYGA may be adjusted up or down, generally depending on the prevailing interest rates. If the
current interest rates available are higher than the interest rate being credited on the MYGA, the
MVA will generally be downward and will cause the contract to lose value. Conversely, if the current
interest rates available are lower than the interest rate being credited on the MYGA, the MVA will
generally be upward and will cause the value of the contract to increase.
At the conclusion of the guarantee period, MYGAs normally provide contract owners with a 30-day
“window” during which they may elect to renew the contract for another guarantee period (which
may be of the same or a different duration than the previous guarantee period) or move their funds
elsewhere. If the contract owner fails to make an election during this period, MYGAs are usually
automatically renewed at the then-current rate for the same guarantee period.
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As noted at the outset, MYGAs compete for the client’s CD funds. In addition to the strength of the
insurer offering the product, MYGAs give their owners an important advantage not available in a
certificate of deposit: tax-deferred growth.
Bonus Annuities
Bonus annuities credit additional interest to new annuity contracts for a limited period—usually one
year. At the end of the bonus year, the interest crediting rate falls to a lower percentage. The lower
percentage current rate to which the interest rate falls at the end of the bonus period may be
guaranteed for one or more years. Some bonus annuity contracts may credit the bonus rate during the
bonus period only if certain conditions are met. For example, the contract owner may not withdraw
more than the earnings from the contract for a specified time period.
The bonus feature of a bonus annuity facilitates the movement of money into the annuity in the face
of various penalties levied or losses incurred in the products from which the funds are being taken.
Such penalties and losses include:
• CD penalties
• Surrender charges
• Market value adjustments
• Bond losses
• Stock or mutual fund losses
• Transfer costs
• Capital gains taxes
Although certain insurers may attempt to recoup the bonus in a bonus annuity by providing
inordinately low renewal interest rates, this is certainly not a universal practice. Clearly, any prudent
agent thinking of recommending a bonus annuity to a client will review product interest rate histories
from competing companies.
Equity Indexed Annuities
Equity indexed annuities (EIAs) are generally considered fixed (rather than variable) annuities under
which insurers credit interest based on the change in an underlying equity index. The actual interest
that is credited in an EIA depends on several factors, including the:
• Change in the underlying index
• Indexing method
• Index term period duration
• Participation rate
• Spread or margin, and
• Cap
An equity index is a number that is used to measure the general behavior of stock prices by measuring
the current price behavior of a representative group of stocks in relation to a base value. Some of the
more well-known equity indexes are the NYSE index, the AMEX index, the various Nasdaq indexes
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and the Standard & Poor’s 500 index. Although there are many equity indexes, the most popular
index for purposes of EIAs is the S&P 500.
Although there are many variations on this basic idea, a better sense of EIA interest crediting may be
gained by an example. The basic interest crediting begins with the change in the applicable index
between the start point and the end point. Suppose that a point-to-point indexing method is used, and
the index level at the start point is 1,000. Further suppose that the index level at the end point is
1,200. During this period, then, the equity index has increased by 20 percent. If the EIA contract
provides for a 100 percent participation rate, along with no spread or cap, the interest rate applied to
the contract’s cash value would be 20 percent. Often, however, the EIA has one or more of these
provisions.
The EIA’s participation rate is a numerical factor that may limit the interest rate applied to the funds
in the equity index account. For example, suppose that the EIA contract whose indexing method
produced the 20 percent raw interest rate also had an 80 percent participation rate. If there were no
other limiting factors—such as a cap or spread—the interest rate that would be credited is 16 percent.
(.20 x .80 = .16)
The EIA may have a spread or margin instead of, or in addition to, a participation rate reduction. By
using a spread or margin, the insurer simply reduces the raw interest rate by its spread before
applying the resulting rate to the funds in the equity index account. For example, suppose that an
insurer had a 2 percent spread rather than the 80 percent participation rate we just considered. In such
a case, the 20 percent raw interest rate would be reduced by the 2 percent spread to produce a
crediting interest rate of 18 percent.
In addition to the participation rate and/or a spread, an insurer may apply a cap. A cap is an upper
limit imposed on the interest rate to be credited. It may be applied to a one-year interest rate or to a
multi-year interest rate. Normally, caps are applied after the interest calculation is made and the
participation rate is applied or the spread is deducted. In the case of an indexing method that produced
a 20 percent raw interest rate and to which an 80 percent participation rate was applied, we noted that
a 16 percent interest rate would be credited if there were no other limiting factors. Suppose, however,
that a 12 percent cap provision was in the contract. In such a case, the actual crediting rate would be
12 percent.
Because the principal is guaranteed in an EIA contract and yet the interest rate reflects positive
changes in the stock market, an EIA may be perceived as a contract with an upside but no downside.
In addition to a current interest rate that is a function of the market’s performance, EIAs also provide
a guaranteed interest rate. Since the guaranteed interest rate in an EIA contract has an adverse effect
on the contract’s participation rate—generally the higher the interest rate guarantee, the lower the
participation rate in an otherwise identical contract—EIA contracts tend to have somewhat lower
guaranteed interest rates than found in other fixed annuity contracts.
Because the indexing methods are so varied and may produce such differing interest rate results under
identical conditions, it is unsound to attempt to evaluate the competitiveness of any particular EIA
contract on the basis of any one factor, such as its participation rate or spread. Instead, EIA contract
evaluation needs to consider all of the factors in the contract that may impact on the interest rate
actually credited.
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Variable Annuities
To this point in our annuity discussion, our focus has been on fixed annuities—annuities that provide
owners with a guarantee of both principal and interest. That focus will change now to a consideration
of a product in which neither the principal nor the interest is guaranteed: variable annuities.
In a fixed annuity, the insurer bears the investment risk. Regardless of the insurer’s investment
results, it must credit the interest that it promised. However, the insurer also enjoys the rewards of
better-than-anticipated investment results. In a variable annuity, that risk and reward are both
transferred to the contract owner. Since the contract owner bears the investment risk, variable
annuities are securities as well as insurance products and, therefore, subject to both insurance
regulation and securities regulation.
Fixed annuity premiums received by the insurer are credited to the insurer’s general account, whose
investment is closely regulated by state insurance departments. When premiums are received for a
variable annuity, those premiums are directed—according to instructions from the contract owner—to
the separate account and/or the Fixed Account. Premiums allocated to the variable annuity contract’s
Fixed Account become part of the insurer’s general account and receive interest at a level at least
equal to the guaranteed interest rate. Premiums allocated to the insurer’s separate account, however,
enable the contract owner to direct their investment among a wide range of investment options
contained in variable subaccounts.
These variable subaccounts are investment portfolios differentiated by investment objective and risk.
Typically, a variable annuity contract owner may allocate his or her premiums to any one or multiple
variable subaccounts that may contain the following portfolios:
• Money market
• Corporate bonds
• Government bonds
• Blue chip stock
• Small cap stock
• International stocks
The variable subaccounts offered by an insurer in its separate account may make up to twenty or more
portfolios available to the contract owner. Usually, the only limitation imposed on the allocation of
premiums to a variable subaccount is that the percentage by a whole number, i.e. 2%, 5%, 12%, etc.,
rather than 3.5% or some other non-whole percentage.
During the variable annuity’s accumulation period, any premium allocated to a variable subaccount
purchases accumulation units. These accumulation units may increase or decrease in value each day
based on the performance of the underlying portfolio. At the annuity start date, those accumulation
units, along with the value of the Fixed Account, purchase annuity units, and the number and value of
the annuity units determine the individual’s periodic payment. As the value of the annuity units
increases, the contract owner’s periodic payments increase. Conversely, as the value of the annuity
units decreases, the payments decline.
Although this brief overview of variable annuities has concentrated on those features that are different
from fixed annuities, it is important to remember that many of the characteristics and features of fixed
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annuities—tax-deferred growth and partially tax-free payouts, for example—are shared by variable
annuities.
The variable subaccounts in the insurer’s separate account generally offer portfolios with both
varying risk and potential return characteristics. Because of the potential for growth that certain
subaccounts offer, they may provide a good hedge against purchasing power risk—one of the critical
issues in managing wealth for individuals at all ages.
Summary
The perception of an annuity as a vehicle for the systematic liquidation of a principal sum has given
way to an expanded view that sees the role of an annuity as accumulation as well as distribution.
Although traditional fixed annuities continue to enjoy an important role in the financial plans of many
individuals, several variations on the traditional fixed annuity have become available: bonus
annuities, multi-year guaranteed annuities and equity indexed annuities.
Multi year guaranteed annuities are fixed annuities that compete favorably with certificates of deposit
by offering guaranteed long-term interest rates coupled with tax-deferred growth. Bonus annuities
offer a first-year bonus that may facilitate the acquisition of new business by offsetting various fees
and penalties that may be levied when existing financial vehicles are terminated. Equity indexed
annuities, by offering both a guarantee of principal and the opportunity to participate in stock market
gains, may be attractive to risk-averse individuals who, nonetheless, wish to participate in stock
market gains.
Variable annuities offer contract owners the opportunity to allocate their premiums to a broad range
of investment options through variable subaccounts that differ from one another based on risk and
potential return characteristics. In light of the significant risk to retirees’ income posed by inflation,
investment of a portion of their retirement savings in certain variable annuity equity-based
subaccounts may be suitable and constitute a sound financial recommendation.
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Chapter 4 Review
1. What is the traditional role of an annuity
a. To liquidate a principal sum
b. To accumulate funds for retirement
c. To accumulate funds for education
d. To be a funding vehicle for IRAs
2. Which of the following is considered a temporary annuity
a. A straight life annuity
b. A joint and survivor annuity
c. A fixed period annuity
d. A cash refund annuity
3. Which of the following is NOT a fixed annuity
a. Multi-year guarantee annuity
b. Bonus annuity
c. Equity indexed annuity
d. Variable annuity
4. The _____ bears the investment risk in a variable annuity contract.
a. contract owner
b. insurer
c. agent
d. fund manager
Answers to the chapter review can be found in Appendix A
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Chapter 5
Long Term Care Insurance
Important Lesson Points
The important points addressed in this chapter are:
• A substantial number of people—as many as 1 out of 2—will face the expense of long term
care as the average age of the population increases
• Long term care is a far broader concept than nursing home care and includes care provided in
other settings
• Long term care insurance policies generally provide benefits for nursing home care as well as
care provided at home, in an assisted living facility, an adult day care facility or in a hospice
• The criteria that must be met for long term care insurance benefits to be payable—benefit
triggers—are generally the same, regardless of the type of care being furnished
• The three benefit triggers in a non-qualified long term care insurance policy are cognitive
impairment, medical necessity and inability to perform the activities of daily living (ADLs)
• A long term care insurance policy’s elimination period is similar to the elimination period in
a disability income policy; it is the period following the onset of a covered condition during
which no benefits are payable
• A long term care insurance policy may require that its elimination period be satisfied with
consecutive days or, more favorably to the insured, cumulative days
• A long term care insurance policy’s benefit period may be stated as a pool of money available
to purchase long term care or in terms of the time for which benefits may be paid
• Long term care insurance policy inflation protection may provide for a specific annual
increase or may be tied to an inflation index, and it may provide for simple or compound
benefit growth
• Tax-qualified long term care insurance policies—a concept created by the Health Insurance
Portability and Accountability Act of 1996 (HIPAA)—provide for tax-free benefits within
certain dollar limitations
• Long term care benefits may be more difficult to qualify for under tax-qualified long term
care policies since medical necessity is not a benefit trigger in these policies
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The Concept
Approximately one out of every two people will need long term care. As noted in Chapter One, the
cost of long term care is substantial and likely to increase dramatically. This enormous expense and
high risk can be hedged against through the use of long term care insurance. In this chapter the long
term care product will be examined.
Benefits Provided by Long Term Care Insurance
Long term care insurance isn’t insurance that pays a benefit only in the event that the insured enters a
nursing home; coverage under long term care insurance is much broader than that. It normally
provides benefits for care received in:
• A nursing facility
• At home
• An assisted living facility
• An adult day care facility, or
• A hospice
Let’s look at each of these long term care benefits.
Nursing Home
Long term care policies normally provide for nursing home benefits up to the daily maximum when
the insured is confined as an inpatient in a nursing facility. Unlike Medicare, which requires that
confinement be in a skilled nursing care facility and required following a period of hospital
confinement, long term care policies pay benefits for:
• Skilled nursing care
• Intermediate care, and
• Custodial care
Furthermore, there is no requirement that the insured be hospitalized prior to entry into a nursing
home.
Home Care
There probably aren’t very many individuals that would choose to enter a nursing home if they could
receive appropriate long term care in their own home. The fact is that medical advances have resulted
in virtually all types of treatments being available in the home setting. And, as long as the individual
does not require ongoing skilled care, the individual’s home is the most likely setting for long term
care. Most long term care policies address this reality and provide for benefits to be paid for long term
care provided at home, either in the basic policy structure or through the addition of an optional rider.
Home care benefits are generally paid at the rate of the daily benefit amount, although some policies
permit an individual to purchase home care benefits that are some smaller percentage of the daily
benefit. This percentage might be 50 percent or 80 percent of the daily benefit.
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Assisted Living Facility
When people envision a nursing home, the picture in their mind is often tainted by the sporadic
problems and unfortunate traditional images they have of a nursing home. As a result, they expect to
see warehoused patients subject to abuse and neglect. Picture, instead, a residence with a quasi hotellike
atmosphere in which residents share a common dining room and can look to the staff for
assistance when they need it. The picture in your mind’s eye may be one of an assisted living facility.
Assisted living facilities typically provide hands-on help with their residents’ dressing, bathing and
taking medications to the extent that they need that kind of assistance. Since these residents seldom
need skilled nursing care nor the greater supervision of a nursing home, their entry into an assisted
living facility is often far less costly than confinement in a nursing home. Not only is this alternative
more desirable from a financial perspective, it is a more popular option in other ways.
Since these assisted living facilities generally serve a population that is far less ill than those confined
in a nursing home, they tend to be more relaxed and populated by individuals that are more aware and
lively than the residents of nursing homes. According to an article that appeared in the National
Underwriter 11 , a typical assisted living facility resident is an 82 year-old mobile female who requires
assistance with two to four activities of daily living.
Coverage for care provided in an assisted living facility is generally a standard feature of long term
care insurance policies.
Adult Day Care Facility
An adult day care facility is an institution that provides custodial and/or minimum health care
assistance to individuals that are unable to stay alone. The care in adult day care facilities is normally
provided during daytime working hours when the primary caregiver is employed. In certain cases, the
adult day care facility will pick up individuals at their homes early in the day, deliver them to
facilities where they receive care and then return them to their homes in the late afternoon or early
evening.
The concept of adult day care is not substantially dissimilar to day care for a dependent child. In these
facilities the individual receives supervision rather than skilled nursing care. In fact, the level of care
approximates the custodial care found in other venues. If the insured meets one of the benefit triggers
and care is provided in one of these adult day care facilities, its cost will generally be considered a
covered expense under the policy.
Hospice Care
Hospice care is generally considered a coordinated program for the control of the pain and symptoms
of the terminally ill. Although designed principally for the care of the terminally-ill individual,
hospice care usually extends to the provision of support services—often administered by grief
counselors—to family members of the ill person. While hospice care is normally administered to
individuals on an inpatient basis, there are programs that may be done at home.
Hospice care is usually covered in a long term care insurance policy on the same basis as nursing
home care.
11 “Assisted Living Market Could Mean Strong ROI for Insurers,” p 33.
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Benefit Triggers
A benefit trigger is that condition that must be present for benefits to be payable under a long term
care insurance policy. Although it might seem appropriate that a long term care insurance policy
would have separate benefit triggers for different types of care or different facilities, such is not
usually the case. Generally, the benefit triggers are the same, regardless of the facility in which the
care is provided. Those traditional benefit triggers are:
• The presence of a cognitive impairment (Alzheimer’s disease or senile dementia)
• The determination by a physician that long term care is a medical necessity, or
• An inability to perform two of six activities of daily living
The activities of daily living (ADLs) are those functional routines that relate directly to the ability of
an individual to live independently. The six ADLs are:
Bathing
Dressing
Eating
Toileting
Mobility
Continence
To the extent that an individual is unable to bathe, dress, eat, go to the toilet, move from place to
place or maintain continence, he or she is unlikely to be capable of living independently.
In addition to requiring assistance with two of these six ADLs, benefits are also triggered when the
individual has a cognitive impairment. A cognitive impairment, as one of the determinants of
eligibility for long term care insurance benefits, is the deterioration or loss of one’s intellectual
capacity, confirmed by clinical evidence and standardized tests, with respect to:
• Short and long term memory
• Orientation as to person, place and time, and
• Deductive or abstract reasoning
Product Characteristics
In this section we will review the salient features and characteristics of long term care insurance
policies. While not intended to be a thorough discussion of every long term care insurance product
feature, it will provide an understanding of the most important characteristics of this product.
Elimination Period
The elimination period in a long term care insurance policy is similar to the elimination period in a
disability income policy. It is the period of time, following the onset of a covered condition, for which
no benefits are payable. In long term care insurance, the elimination period is sometimes referred to
as a deductible, and it is the period in which the individual self-insures. The typical elimination
periods in long term care insurance policies are:
0 days 30 days 60 days 100 days
20 days 45 days 90 days 365 days
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In addition to these customary elimination periods, some insurers add other wrinkles. For example, an
insurer may require that a 30-day elimination period be satisfied in 30 consecutive days but may
permit longer elimination periods to be satisfied in cumulative, non-consecutive days. The insurer
may also provide that an elimination period of 60 days or more need be satisfied only once in an
insured’s lifetime.
Despite the apparent uncomplicated nature of the decision as to what elimination period to choose,
the choice of an elimination period is not a particularly easy one. Practitioners have suggested several
questions that should be posed 12 , the answers to which will offer some assistance in selecting an
appropriate elimination period:
1. May the elimination period be satisfied in cumulative, rather than consecutive, days
2. Must the elimination period be satisfied in consecutive days
3. Are the days a singular occurrence
4. Does the period of accumulation have time limitations
5. Does the elimination period need to be satisfied within a benefit period
6. Is the elimination period a singular occurrence for both facility and home care
7. If the elimination periods are separate for facility and home care, do they offset one another
8. Is the elimination period for home care treated differently than the elimination period for
facility care
9. If it is treated differently, in what way does the treatment differ
10. Is the elimination period for home care based on days of services
11. Do the Medicare days of service count towards satisfying elimination periods
12. Are the home care elimination periods credited based on days of services or from point of
claim
As in most types of coverage, the length of the elimination period has a direct impact on the cost of
the long term care insurance policy. For example, just changing the elimination period from 20 days
to 100 days will reduce the premium for an otherwise identical policy by anywhere from 20 percent to
40 percent.
Benefit Period
Unlike the elimination period, which is fundamentally the same concept for all long term care
insurance policies, the benefit period may be couched in two quite different ways:
1. In terms of the time for which benefits are paid, or
2. As a “pool” of money
The straight time concept is a fairly simple one and one with which most people are familiar. Under
that concept, benefits cease after they have been paid for the period stated in the policy. The usual
benefit periods available that are couched in terms of time are:
12 Kim Purnell, “Specialization Key to Addressing LTC Complexity,” National Underwriter, July 14, 1999, p
29.
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Pennsylvania Life-Senior Market Specialist Accreditation
2 years 4 years 6 years
3 years 5 years Unlimited
Although the straight time approach to benefit periods appears to work well in most situations, the
pool of money concept gives the policyowner considerably more freedom of choice. In the pool of
money approach, the policyowner elects a maximum daily benefit amount and then chooses a
multiplier: 1,000 or 2,000, for example. If the policyowner elected a $150 daily maximum benefit
amount and a 2,000 multiplier, a total of $300,000 would become available to the policyowner. ($150
x 2,000 = $300,000)
Once the pool of money is selected and the insured satisfies the benefit trigger, the policyowner may
access it up to the daily maximum benefit amount for any type of covered benefit. (Certain types of
coverage—home care or adult day care, for example—may have lower daily maximum benefit
amounts.) The benefits continue to be available as long as the insured continues to satisfy the benefit
trigger (ADLs, medical necessity or cognitive impairment) and any money remains in the pool. When
the pool runs dry, the benefits cease. This pool of money approach tends to make the policyowner a
more thoughtful consumer of long term care and provides much more freedom. By judiciously
utilizing long term care insurance benefits, the policyowner may cause those benefits to last far longer
than they might otherwise last.
Inflation Protection
There probably is no reasonable individual that expects the cost of long term care to decrease as time
goes on. In fact, as discussed in Chapter One, the cost of long term care is expected to rise
dramatically in the next 20 to 30 years. That is the reason why a policyowner might purchase inflation
protection.
Inflation protection is an optional benefit that is designed to help preserve the purchasing power of
the daily benefit amount by automatically increasing the daily benefit each year. These increases may
be calculated on a simple basis or on a compound basis; furthermore, they may be couched in terms
of a specified percentage or in terms of an index, such as the consumer price index (CPI).
When considering how best to handle anticipated inflation in long term care costs when purchasing
long term care insurance, there are generally four approaches that may be taken:
Don’t purchase the inflation protection. Although benefits under the policy remain level over the
years, the policyowner may apply for additional coverage. There are three concerns that accompany
this approach. First, the insured may be in claim; in such a case, no further long term care insurance is
likely to be available and the increases in costs will come out of the insured’s pocket. Second, even if
the insured is not in claim, he or she will still need to present evidence of insurability to qualify; as
individuals age, they tend to become less insurable. Third, if the individual can qualify for the
additional coverage, the premium rates for the coverage will be higher since the insured is older.
Purchase simple inflation protection coverage. Under simple inflation protection coverage, the
coverage is adjusted each year based on a stated percentage multiplied by the original benefit amount;
that percentage is often 5 percent. For example, if the insured purchased a $150 daily maximum
benefit, the benefit would be increased by $7.50 each year. In the tenth year, a $150 daily maximum
benefit would be $218 at 5 percent simple inflation protection; in the twentieth year, the daily benefit
would be $293.
Purchase compound inflation protection coverage. Under compound inflation protection coverage,
the coverage is adjusted each year based either on a stated percentage or on the change in the
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consumer price index multiplied by the benefit amount in effect in the previous year. If the same 5
percent inflation protection was purchased by the policyowner with a $150 daily maximum benefit as
a compound benefit, the benefit in the tenth year would be $233 per day, and, in the twentieth year, it
would be $379 per day. By purchasing compound inflation protection coverage, the benefit will be
considerably higher over the years.
Purchase a higher benefit amount. Under this approach, the policyowner would not elect the inflation
coverage; he or she would simply purchase the greater amount of benefit that applying the cost of the
inflation coverage to the base benefit would result in. For example, suppose that a $100 daily benefit
with 5 percent simple inflation protection coverage would result in an annual premium of $2,480 for a
69 year-old applicant. However, if the applicant used the same $2,480 to purchase a larger daily
benefit with no inflation coverage, the daily benefit that could be purchased would be $150. Which is
better The answer, of course, is that it is impossible to know, but framing the question provides a
context in which to find the answer for any particular client.
Tax-Qualified vs. Non-Tax Qualified
Before 1997, a long term care insurance policy was just a long term care insurance policy. And then
came the Health Insurance Portability and Accountability Act of 1996 (HIPAA)—also known as the
Kennedy-Kassebaum bill—intending to clarify the tax treatment of long term care insurance. The net
result of HIPAA was to create two types of long term care insurance: tax-qualified and non-qualified
long term care insurance.
Without examining each component of HIPAA, it is, nonetheless, possible to understand the
difference between tax-qualified and non-qualified long term care insurance by considering the two
areas in which they differ: tax status and benefit triggers. We will begin with their tax status.
Tax Status of LTC Policies
Premiums for tax-qualified LTC policies are tax deductible to the extent that they, along with any
other medical expenses, exceed 7.5 percent of the taxpayer’s adjusted gross income. In addition,
deductible premiums for tax-qualified LTC policies may not exceed the following in 2005:
Age of Insured
Maximum Deductible
Premium*
Age 40 or younger $270
Age 41 – 50 $510
Age 51 – 60 $1,020
Age 61 – 70 $2,720
Over age 70 $3,400
*Maximum amounts deductible in 2005; indexed annually.
However, self-employed individuals may deduct 100 percent of the premiums for tax-qualified long
term care policies up to the maximum for their age without regard to the 7.5 percent limitation.
Benefits received under a tax-qualified LTC policy are generally received tax-free but subject to
certain limits. If the tax-qualified LTC policy benefits exceed a per diem limitation, they must be
included in the insured’s income. The per diem limitation is equal to the greater of $240 per day
(2005) or the costs incurred for qualified long-term care services.
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The premiums for a non-qualified LTC policy may also be deducted to the extent that they, along
with any other medical expenses, exceed 7.5 percent of the taxpayer’s adjusted gross income. There is
no stated dollar amount limitation on the deductibility of non-qualified LTC policy premiums.
However, the special deductibility of tax-qualified LTC policy premiums enjoyed by self-employed
individuals does not extend to non-qualified policies.
The tax treatment of benefits received under non-qualified LTC policies is considerably murkier than
the treatment given to tax-qualified policy benefits. Specifically, the Internal Revenue Code does not
address the income taxation of premiums paid for or benefits received from non-qualified LTC
policies. So, at least for policies issued on and after January 1, 1997, it is not clear just how these
policy benefits will be taxed, if at all. Policies issued before 1997, however, are treated as taxqualified
LTC policies, provided they met the long term care insurance requirements of the state in
which they were issued.
Making this “iffy” tax status more worrisome is the reporting requirement imposed on LTC insurers.
Specifically, long term care insurers are required to report all long term care policy disbursements
from both tax-qualified and non-qualified LTC policies on Form 1099-LTC.
Changed Benefit Triggers
It was noted earlier that benefits under long term care policies are triggered by three criteria:
• The presence of a cognitive impairment (Alzheimer’s disease or senile dementia)
• The determination by a physician that long term care is a medical necessity, or
• An inability to perform two of six activities of daily living
HIPAA changed those triggers for tax-qualified LTC policies and removed the medical necessity
trigger. Under HIPAA rules, a tax-qualified LTC policy may provide benefits only for qualified long
term care services. Qualified long term care services are various long term care services that are
required by a chronically ill individual. It is the definition of a chronically ill individual that
effectively removes the medical necessity trigger.
HIPAA defines a chronically ill individual as one who:
• Is unable to perform, without substantial assistance, at least two activities of daily living
(ADLs) for at least 90 days, or
• Requires substantial supervision to protect himself from threats to his health and safety due to
severe cognitive impairment and this condition has been certified by a licensed health care
practitioner within the previous 12 months
The 90-day period noted in the ADL benefit trigger is not a waiting period before benefits can be
paid; instead, it is an estimation by a licensed health care practitioner.
Summary
The possibility that any individual is going to require long term care during his or her lifetime is
great; about one-half of the population will need it. When many people think about long term care,
the vision they see is one of nursing homes and warehoused old people, but long term care is much
more than care in a nursing home. Although the concept of long term care certainly includes nursing
home care, it more frequently means care provided at home, in an assisted living facility, an adult day
care center or in a hospice.
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Long term care insurance is available to provide funds for the significant expenses incurred in
providing long term care in any of these settings. The criteria that an insured must satisfy for benefits
to be payable—referred to as “benefit triggers”—generally fall into one of three categories: a
cognitive impairment, a determination by a physician that long term care is a medical necessity, or the
inability to perform certain normal activities known as the activities of daily living (ADLs). The same
benefit triggers apply to long term care provided in a nursing home or under alternative arrangements.
Following the onset of a covered condition, the insured under a long term care insurance policy must
satisfy an elimination period before benefits become payable. The long term care insurance policy
may require that the elimination period be satisfied in consecutive days or may permit it to be
satisfied in cumulative days. Furthermore, the elimination period may need to be satisfied only once
in the insured’s lifetime or each time he or she requires long term care, depending upon the long term
care insurance policy.
Long term care insurance policy benefit periods may be couched in terms of the number of days of
care for which the policy will provide benefits or may provide a pool of money available to the
insured with which he or she may purchase needed long term care. Additionally, the benefits provided
may remain level throughout the lifetime of the policy or may be adjusted for inflation. Inflation
adjustments may be based on the change in an inflation index, such as the consumer price index, or
may be the result of a specified percentage increase each year; inflation adjustments may be made on
a simple or compound basis.
Long term care insurance policies may be tax-qualified or non-qualified. Tax-qualified long term care
insurance policies provide for tax-free benefits within certain dollar limitations and enable selfemployed
individuals to fully deduct the premiums for income tax purposes. However, insureds may
find it more difficult to qualify for benefits under tax-qualified long term care insurance policies since
the benefit trigger of medical necessity—a standard benefit trigger under non-qualified policies—
does not apply to tax-qualified long term care insurance policies.
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Chapter 5 Review
1. Long term care insurance policies generally provide benefits for care received by the
insured in all of the following EXCEPT:
a. a skilled nursing care facility
b. a custodial care facility
c. a hospital
d. an intermediate care facility
2. The condition that must be present in order for benefits to be payable under a long term
care insurance policy is known as a/an:
a. recovery element
b. benefit trigger
c. gatekeeper
d. respite
3. _______ are those functional routines that relate directly to the ability of an individual
to live independently.
a. Activities of daily living
b. Cognitive requirements
c. Medically-necessary activities
d. Respite activities
4. The period of time following the onset of a condition covered in a long term care
insurance policy for which no benefits are payable is known as:
a. the benefit period
b. the elimination period
c. the cession period
d. the residual period
Answers to the chapter review can be found in Appendix A
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Chapter 6
Life Insurance
Important Lesson Points
The important points addressed in this chapter are:
• In many large estates—especially estates of business owners—a single non-liquid asset may
comprise 70 – 80 percent of the estate
• Large, non-liquid estates may be required to liquidate assets to meet the need for estate
settlement funds
• Of the sources of funds to pay estate costs—cash in the estate, sale of estate assets, borrowing
and life insurance—life insurance is the least expensive method
• An important aspect of life insurance for providing estate liquidity is that it may be kept out
of the estate through the use of appropriate ownership provisions that may involve the use of
trusts
• Life insurance is particularly appropriate for equalizing inheritance, particularly in cases
involving the succession of a family business
• Owners of highly appreciated assets may find that a charitable remainder trust allows them to
increase their income, reduce their taxes and endow a favorite charity—while life insurance
enables them to replace the value of the gifted asset for the heirs
• Whole life insurance policies are characterized by formidable guarantees but are generally
inflexible with respect to premiums and death benefits
• Universal life insurance policies provide enormous flexibility but lack the substantial
guarantees of whole life insurance
• Survivorship life insurance pays a benefit only on the death of the survivor of two or more
insureds and is particularly suitable for funding estate settlement costs of married couples
• Survivorship life insurance may be written on a universal life or whole life basis and tends to
provide needed coverage at the smallest premium outlay
The Concept
Life insurance is often used to create wealth where only potential wealth previously existed; this is
frequently the case in situations involving young families whose breadwinner maintains large
amounts of life insurance to protect loved ones against the possibility that this enormous potential
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wealth may never come to be because a life is cut short. In other cases, however, life insurance may
be employed to ensure that the wealth already created is not destroyed in the process of being
transferred to later generations. It is this latter use that is the focus of Chapter Four.
In this chapter we will consider the use of life insurance in three separate wealth transfer-facilitating
applications:
1. Providing estate liquidity
2. Equalizing inheritance, and
3. Replacing gifted assets
We will begin with a look at its use in providing estate liquidity.
Estate Liquidity
We noted earlier in Chapter One that in many large estates, a single asset may account for 70 or 80
percent of the entire estate—and that asset is often fairly non-liquid. Because of the limited liquidity
of these estates, the estate may be placed in the position of being required to sell non-liquid assets just
to meet its need for funds. Sometimes that means a family business must be sold, despite the family’s
desire to keep it. Alternatively, family heirlooms may go on the block at prices far lower than they are
worth—and constitute a loss both financially and emotionally.
Of the four sources of funds for providing liquidity to an estate: cash, borrowing, selling assets and
life insurance, it is life insurance that is generally the least expensive. A policyowner can generally
expect to pay, in total, less than 50¢ for every dollar of death benefits that the estate receives.
However, rather than simply accepting that life insurance makes the most sense, let’s look more
closely at each of these four ways of providing estate liquidity, beginning with the use of liquid estate
assets.
Cash in the Estate
Liquidity, of course, refers to the ease at which an investment may be converted to cash quickly and
at little or no loss of value. The investments that offer the highest level of liquidity are savings-type
instruments, such as passbook savings accounts and money market accounts. Although passbook
savings and money market accounts have a place in an individual’s financial planning, an investor
isn’t likely to maximize his or her investment return in them. In other words, there is a cost for the
liquidity that is characteristic of these accounts. This opportunity cost reflects the lost earnings that
result from placing significant funds in these vehicles. An individual that needs substantial liquidity
and has decided to provide it by keeping large amounts of cash in savings vehicles must be prepared
to forgo higher earnings.
We can demonstrate the cost of maintaining significant liquidity by comparing the average returns
obtained by investors. Although common stock investors reaped average annual returns in excess of
10 percent over the last 60 years, passbook savings accounts have averaged a return of about 4
percent. It doesn’t take very much analysis to appreciate that the cost of liquidity may be fairly
substantial. But, let’s go beyond the concept and consider the actual annual cost of maintaining
$500,000 in liquid assets.
The need to keep a liquid fund of $500,000 to pay estate liabilities would mean that they could
probably produce an average annual return of about 4 percent, or $20,000. ($500,000 x .04 =
$20,000) If the same $500,000 could be invested in a common stock portfolio producing the historical
10 percent return, the annual earnings could be $50,000. If allowed to accumulate over a 10-year
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period, the 4 percent investment would grow to $740,100, while the 10 percent investment might
have grown to $1.3 million. The difference represents a 10-year opportunity cost of over $500,000 as
a result of the decision to pay estate liabilities with liquid estate assets. Clearly, there are differences
in the safety and guarantees in these two investments, and they should not be compared for a client
without a complete comparison of all their features, including the differences in safety and
guarantees. The intention in showing the possible investment results at different rates of return is
simply to put a hypothetical number on the cost of maintaining large levels of liquid funds.
However, even if the lost earnings resulting from maintaining a large liquid position are not
considered, the estate owner has still paid his or her estate taxes with dollars that cost 100 cents, and
the estate is reduced dollar-for-dollar by the amount required to meet liabilities. Furthermore, not only
are the assets depleted, any income that might have been produced by those assets is also lost to the
heirs. So, even if the possibly-substantial opportunity costs of using liquid estate assets to pay estate
liabilities are not taken into account, we can assign a relative cost of $1.00 to pay each dollar of estate
liabilities using liquid assets and can use that as a standard with which to measure the cost of the other
three sources of cash to pay estate liabilities.
Selling Illiquid Estate Assets
The second potential fund source for estate liability payment is from the sale of “hard” estate assets.
No one who has not attended at least one estate sale can fully appreciate the cost of selling illiquid
estate assets. Not surprisingly, an estate sale has two faces: the face of the buyer and the face of the
seller. An estate sale is a place for a buyer to obtain exceptional bargains. But, an estate sale is a zero
sum game; for each gainer, there is a loser, and the losers are the estate and its heirs. It is a sad event
for the heirs and similar to the liquidation of a company. Family heirlooms are picked through and
likely to produce less than 50¢ for every dollar of actual value.
It is no secret why estate sales result in prices far below fair market value: the estate is under great
pressure to sell. It must pay federal estate taxes within nine months after the decedent’s death, so the
assets need to be sold as quickly as possible. Because the executor feels the hand of the tax collector
on his or her shoulder, an estate sale cannot be considered an arms-length arrangement under any
circumstances. Instead, the executor must sell the assets for whatever they will bring. If that is a
bargain for the seller, it is a tragedy for the heirs.
To continue with the comparison, it will be assumed that the executor can sell the assets for more than
is customary in an estate sale. Rather than the 40¢ or 50¢ for each dollar of assets sold that represents
the usual estate sale “discount,” we will assume that the executor is able to get 75¢. So, for the
executor to have one dollar of cash for the estate, the executor must sell illiquid assets worth at least
$1.33. ($1.33 x .75 = $1.00)
Borrowing to Pay Taxes
Selling the estate’s non-liquid assets in an estate sale is clearly a more costly alternative than using
liquid estate funds to pay the estate’s liabilities. We are not finished with our analysis, however; two
other options remain to be examined. Let’s consider the cost of borrowing the needed funds.
When banks and other lenders loan money, it is in order to obtain loan interest—the banker’s income.
That interest is an additional cost to the estate. And, in addition to paying the loan interest that is due,
the estate must also eventually repay the loan principal. If the executor of the estate borrowed the
$500,000 needed to meet estate costs at 5 percent annual interest, the interest alone on a 10-year
declining note is about $140,000. The total cost of paying the estate liabilities has increased to
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$640,000 as a result of borrowing the funds, so each dollar used to pay these expenses has cost the
estate $1.28.
Using Life Insurance to Pay Taxes
Thus far in the comparison, using liquid assets to pay estate liabilities is the least costly method if we
ignore the opportunity cost it involves. It shouldn’t come as a surprise that life insurance—the last
fund source that we will examine—is the least costly method by a substantial margin. For that reason,
life insurance is the appropriate choice to pay estate liabilities for most people. It is only when the
individual is uninsurable or very highly rated that life insurance may be inappropriate as a means of
paying estate liabilities. When life insurance is purchased by an individual that can qualify for life
insurance at standard rates, the total premium paid will not normally exceed 50¢ for each dollar of
death benefit proceeds that are paid.
However, premium cost isn’t the only advantage of life insurance when used to pay estate liabilities.
Another important benefit of life insurance to pay estate liabilities is that it can be kept out of the
decedent’s estate. Even if life insurance were not less expensive than the other alternatives, its
possible exclusion from the federal gross estate by vesting the ownership in a third party makes it a
big money saver. In using life insurance solely to pay estate liabilities, the most suitable third parties
are normally an irrevocable life insurance trust (ILIT) or the estate owner’s children.
Simply arranging for a life insurance policy to be owned by an ILIT or the estate owner’s children
can enable the policy’s death benefit proceeds to completely avoid inclusion in the estate. Since the
policy is not a part of the estate, the death benefit proceeds are not subject to federal estate taxes. In a
sense, the estate liabilities are paid for the estate but not from it.
Despite the fact that the policy’s death benefit proceeds avoid inclusion in the decedent’s estate, they
may be made available to the estate in either of the following ways:
• The policyowner—the trust or the children—may loan the funds to the estate, or
• Funds can be used to purchase non-liquid assets from the estate
Typically, the beneficiary of the policy makes the death proceeds available to the estate by loaning
them to it or by purchasing the estate’s assets. In that way, the estate receives the funds it requires to
meet its liabilities, and the estate’s beneficiaries receive their full inheritance, undiminished in any
way.
So, using life insurance to provide estate liquidity offers two important benefits:
1. The needed funds may be shielded from additional estate taxes, and
2. The funds can be purchased usually for about half the value of the death benefit
Obtaining Cash for Estate Liquidity – Comparison of Methods
Source of Funds
Comparative “Cost”
Use liquid estate assets $1.00
Sell illiquid estate assets $1.33
Borrow funds $1.28
Use life insurance $0.50
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Chapter 6 — Life Insurance
There are clear advantages of purchasing life insurance for the purpose of paying estate liabilities. In
addition to the other benefits of life insurance, the total cost of providing the needed funds is likely to
be no more than one-half the cost of the next best alternative. In view of these advantages, any estate
owner that can qualify for life insurance is likely to find it to be the most advantageous approach to
funding estate liabilities.
Equalizing Inheritance
The estate of family business owners tend to be large. In addition to being generally illiquid, the
typical family business owner’s estate is also predominantly comprised of business assets. We noted
that the illiquidity may present a problem in the payment of estate taxes and other estate settlement
costs; however, it may also create problems of unequal inheritance, particularly when the business
owner wants to retain the business in the family.
Two methods are often used to equalize inheritance for other children when one child in the family
stands to inherit the family business:
1. The business owner may purchase life insurance to equalize the inheritance to the child or
children that are not inheriting the family business. By making regular gifts not exceeding the
annual gift tax exclusion amount to an ILIT or to the children for purposes of paying annual
premiums on the policy, the business owner will reduce the value of his or her estate for tax
purposes through gift tax-free transfers, or
2. The business owner can arrange for a one-way buy-sell agreement between the business
owner and the child that will take over the business. The agreement would be funded with an
appropriate amount of life insurance—possibly funded through a split dollar plan—and the
child would purchase the company upon the business owner’s death
Replace Gifted Assets
We noted in Chapter One that deferred charitable giving programs offer large financial and psychic
benefits to the suitable client. However, the fact that the donor has given away estate assets is often
viewed with a jaundiced eye by the heirs since charitable gifts reduce their inheritance. Because of a
desire not to reduce their heirs’ inheritance, many clients that employ deferred charitable giving
programs replace the value of the gift through life insurance.
Let’s look, briefly, at how a deferred charitable gift can make a big difference to a client and how life
insurance can replace that gift for the client’s heirs. For this illustration, we will consider the situation
of hypothetical clients, Bob and Barbara Watson who own substantial appreciated assets.
Bob and Barbara began a small company thirty years ago in the then-fledgling personal computer
industry. Over the years, the company grew, and now it is valued at $8 million. Since virtually all of
their extra funds were reinvested in the company, they never installed a pension plan; instead, they
looked to the value of the business to provide their retirement. In addition to their work in the
company, both Bob and Barbara volunteered at the local shelter for battered women and made
generous contributions to its upkeep. After thirty years, they are looking forward to retirement and
having more time to spend with their children and grandchildren.
Since the Watsons had built their company principally through their hard work, they had little
remaining cost basis. As a result, virtually all of the proceeds from the sale of their company would
be subject to capital gains and state income tax. They consulted their accountant about their tax
concerns, and he suggested they consider a charitable gift to the shelter that they had supported in the
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past. Instead of an outright gift, however, he suggested they consider using a charitable remainder
trust under which they would receive an income until the last of the two of them died. At that time,
the value of the gift would go to the shelter. He then told them that the gift could be the entire value
of their business; in fact, it probably should be. The accountant then showed the Watsons the
investment asset analysis that he had prepared.
Investment Asset Analysis
Value of the stock
Minus the Watsons’ cost basis
Capital gains realized on the sale
Total tax rate
Taxes on the sale
Sale proceeds
Minus the taxes to be paid on the sale
Assets available for investment
Sell the Company
Stock Outright
$8,000,000
- 0
$8,000,000
x .27
$2,160,000
$8,000,000
-2,160,000
$5,840,000
Sell the Company
Stock in a CRT
$8,000,000
- 0
$8,000,000
x 0
0
$8,000,000
- 0
$8,000,000
He explained that since the charitable remainder trust received the tax treatment of a charity, it could
receive the business and sell it to a buyer without being liable for any income taxes. The trust would
then invest the $8 million proceeds and provide an income to both Bob and Barbara for the remainder
of their life. When the last of the two died, the assets in the trust would pass to the shelter. The
accountant then showed them a cash flow analysis using both approaches.
Cash Flow Analysis
Annual gross income from investment*
Annual net income after 40% state & federal tax
Times the Watsons’ life expectancy
Lifetime net income
Charitable income tax deduction
Times the Watsons’ income tax bracket
The Watsons’ income tax saving
Annual life insurance premium to replace gift
Times the number of assumed years payable +
Total life insurance cost
The Watsons’ lifetime net income
Plus their income tax savings
Less their total life insurance premiums
Lifetime spendable income
*Assumes an 8% annual return
+Based on non-guaranteed current dividend scale
Sell the Company
Stock Outright
$ 467,200
$ 280,320
x 24
$6,727,680
$ 0
x 40
0
$ 0
x 0
$ 0
$6,727,680
+ 0
- 0
$6,727,680
Sell the Company
Stock in a CRT
$ 640,000
$ 384,000
x 24
$9,216,000
$1,398,152
x 40
$ 559,260
$ 62,000
x 11
$ 682,000
$9,216,000
+ 559,260
- 682,000
$9,093,260
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Chapter 6 — Life Insurance
The accountant explained that the life insurance premium would purchase a survivorship life
insurance policy that would replace the value of the gifted asset for their three children. And, even
after purchasing the life insurance and providing a sizable gift to the shelter, Bob and Barbara would
have a lifetime income that was 35 percent greater than if they had sold their business outright. Upon
Bob and Barbara’s death, the shelter would receive the remaining funds in the trust which may be
more or less than $8 million.
In order to purchase the life insurance, Bob and Barbara will establish an ILIT and direct the trustee
to purchase survivorship life insurance on their life with benefits payable to the trust. The trustee will
then apply for the life insurance and make the trust the policyowner and the beneficiary. Bob and
Barbara’s three children are the beneficiaries of the ILIT.
Bob and Barbara will make a non-charitable gift to the trust each year in the amount of $62,000—the
policy’s annual premium. The three children will be given limited powers to withdraw the gifts from
the trust each year, i.e. Crummey powers. Therefore, the gift to the trust each year will qualify for the
annual gift tax exclusion.
Since neither Bob nor Barbara ever owned the life insurance policy being used to replace the value of
the gifted asset, there is no concern that the death benefits will be diminished by estate taxes. Upon
both of their deaths the policy’s death benefits will flow into the trust and be distributed to the three
children according to the trust terms.
The children received their full inheritance, Bob and Barbara increased their net income by about 35
percent, and the shelter for battered women received a gift that might be $8 million or more.
Everybody won.
Characteristics of Life Insurance Policies
Certain types of life insurance have characteristics that make them particularly appropriate for one
kind of application or another. In this section, we will discuss the salient characteristics of the three
types of life insurance generally chosen by clients for use in facilitating the transfer of their wealth
and conclude the chapter with a comparison of the policies. The three life insurance policies that will
be considered are whole life insurance, universal life insurance and survivorship life insurance.
Whole Life Insurance
Whole life insurance is considered by many to be the perfect blend of death benefits, premiums and
cash values—and particularly appropriate for long-term life insurance needs. Its primary advantage,
compared to other types of life insurance, is its guaranteed nature. Its principal disadvantage is its
relative lack of flexibility. In light of its long-term suitability, we will begin with a discussion of the
elements of whole life insurance.
Premiums
The premiums in a whole life insurance product are established by company actuaries based on a
consideration of anticipated mortality, expenses and earnings. Once the policy is purchased, the
premiums must be paid regularly in order to keep the policy in force for its full face amount.
Although whole life insurance premiums may be reduced or offset by any dividends received under
participating policies, the general inflexibility of premiums is the policy’s biggest drawback.
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Expenses
Expenses are considered in the process of determining premiums for the product and become one of
the components of whole life insurance premiums. Unlike universal life insurance, which we will
consider next, premiums cannot be increased if the insurer’s expenses exceed the assumptions built
into the premium structure. Any dividends on participating policies would, however, generally be
adjusted downward if actual expenses exceeded the actuaries’ assumptions.
Cash Values
Policy cash values in a whole life contract are stated in the contract and constantly increase. The
investment risk with respect to whole life insurance cash values are borne by the insurer. Guaranteed
cash values generally equal the policy’s face amount at the insured’s age 100. Guaranteed cash values
may be increased in participating policies by dividends. Accessing whole life insurance cash values is
generally accomplished through a policy loan, although the policyowner may surrender the policy in
whole or in part.
Death Benefits
Whole life insurance death benefits are guaranteed, provided premiums are paid when due. Changes
in whole life insurance death benefits generally require the part-surrender of the contract (in the case
of a death benefit reduction) or the writing of an additional life insurance policy (if death benefits are
to be increased). Whole life insurance policy death benefits may be increased through policy riders or
through insurance-purchasing dividend options in a participating policy. Changing death benefits to
meet changing policyowner needs presents the biggest concern in whole life insurance.
Guarantees
It is in the area of guarantees that a whole life insurance policy offers its principal advantages. As
long as the policyowner pays the premiums when due, the death benefit is guaranteed to be available
at the insured’s death. The cash values cannot be less than guaranteed in the policy, although they
may be higher in the case of dividends held on deposit or used to purchase paid-up additional
insurance in participating policies. Premiums are also guaranteed at their original level. If the
policyowner terminates the policy, the nonforfeiture provisions also guarantee certain levels of
reduced paid-up insurance or extended term insurance, depending on the policyowner’s choice.
Advantages and Disadvantages of Whole Life Insurance
Virtually every type of life insurance has advantages and disadvantages, although whether a particular
characteristic is an advantage or disadvantage may depend upon how the life insurance is used by the
policyowner. The primary advantages of whole life insurance are:
• Guaranteed death benefits
• Guaranteed cash values
• Fixed and known annual premiums
• Mortality and expense charges will not reduce guaranteed cash values below amounts shown
in the policy
The disadvantages of whole life insurance are:
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Chapter 6 — Life Insurance
• Premium inflexibility - there is little flexibility in the premiums to allow a policyowner to
accommodate personal cash flow changes
• Death benefit inflexibility - increases in the whole life insurance policy’s death benefit
require the writing of an additional life insurance policy; reductions in the policy’s death
benefit require a part-surrender of the contract with possible adverse income tax
consequences
• Cash value accessibility is limited - it is accessible only through policy loans, which
envision repayment, or through part-surrenders that may cause adverse income tax
consequences
• Non-competitive rate of return - The rate of return of a whole life policy’s cash value may
not be competitive with returns enjoyed by alternative savings and investment vehicles
Universal Life Insurance
Universal life insurance is a type of life insurance in which the elements of a whole life insurance
policy are unbundled, causing the policy to be far more transparent than whole life insurance. As a
result, the policyowner may easily determine the competitiveness of the interest credited, or the
expense or mortality charges assessed by the insurer. Although the universal life insurance policy
guarantees that interest crediting will not fall below a certain minimum—typically 3 or 4 percent—
and that mortality and expense charges will not exceed a stated maximum, the insurer normally
credits interest at a higher rate and deducts mortality and expense charges at a lower level. The
universal life insurance concept may be applied to a life insurance policy insuring a single life or to
the insuring of multiple lives.
In a universal life insurance policy, the insurer credits some or all of the premiums paid by the
policyowner to the policy’s cash value. To those premiums the insurer adds interest and makes certain
deductions for mortality charges and, possibly, expense charges. The crediting of interest and
deducting expenses normally occurs on a monthly basis.
Premiums
Universal life insurance premiums are characterized by significant flexibility. Normally after the first
policy year, the policyowner may pay—typically within certain minimum and maximum limits—any
premium he or she chooses or no premium at all. Since the monthly deductions that maintain the
universal life insurance policy’s viability are made by the insurer from the policy’s cash value, the
direct connection between ongoing premium payments and keeping the policy in force that is
characteristic of whole life insurance is severed.
Expenses
Expenses in a universal life insurance policy are generally deducted from its cash value or from its
premiums before being credited to the cash value. Similarly, the cost of insurance is deducted
monthly from the policy’s cash value. Both the expenses and mortality charges are guaranteed in the
policy not to exceed a certain level. However, insurers are generally conservative in setting these
guarantees, and normally the expense and mortality deductions made from a universal life insurance
policy are less than the guarantees. To the extent that monthly deductions exceed illustrations or
expectations, the policy’s cash value will tend to be smaller than illustrated; conversely, if monthly
deductions are smaller than illustrated, the policy’s cash value will tend to be greater than illustrated.
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Cash Values
Unlike whole life insurance, the cash values of universal life insurance policies are not guaranteed;
they may be larger or smaller than illustrated, depending on premium payment levels, the amount of
interest credited and the size of monthly deductions taken. Cash values tend to increase to the extent
that premium payment levels increase and/or interest credited increases, and they tend to decrease as
premium payment levels decline, credited interest is reduced and/or monthly deductions increase.
When a universal life insurance policy’s cash value becomes insufficient to permit the insurer to
make monthly deductions, the policy lapses, irrespective of the level of premiums paid into the policy
by the policyowner.
Cash values may be reduced by surrender charges during the policy’s surrender charge period. The
surrender charge period is found in the early years of the policy but may extend for as long as twenty
years in certain contracts. It is normally a declining charge that is intended to enable the insurer to
recover its new business acquisition costs in the event of an early surrender and to discourage
policyowners from surrendering their contracts. The universal life insurance policy’s cash value less
any surrender charge is generally referred to as its surrender value.
Universal life insurance policy cash values may be accessed through policy loans and withdrawals up
to an amount not exceeding the policy’s surrender value. Universal life insurance policy withdrawals
enjoy certain favorable tax advantages. Unless the universal life insurance policy is deemed to be a
modified endowment contract 13 , policy withdrawals are given first in, first out (FIFO) tax treatment.
Under FIFO tax treatment, the policyowner’s entire cost basis may be withdrawn before any policy
gains are deemed to be withdrawn. The net result of this favorable tax treatment is that the
policyowner may withdraw his or her entire cost basis in the policy without any income tax liability.
Death Benefits
Death benefits under universal life insurance policies may be increased or reduced without writing a
new policy or causing the policyowner adverse income tax consequences. (Universal life policy death
benefit reductions in the first seven policy years, however, may cause certain adverse tax
consequences under modified endowment contract rules.) Death benefit increases generally require
the insured to present satisfactory evidence of insurability.
In addition, policyowners may choose a level death benefit equal to the policy’s initial specified death
benefit amount or may elect a death benefit option under which the total policy death benefit is equal
to the policy’s initial specified death benefit plus the policy’s cash value. In certain other universal
life insurance policies, policyowners may elect a third death benefit option under which the total
policy death benefit is equal to the policy’s initial specified death benefit plus the aggregate premiums
paid for the policy. These death benefit options are generally known as Option A, Option B and
Option C, respectively.
13 A modified endowment contract is a life insurance policy that fails to meet the 7-pay test, i.e. the amount paid
under the contract at any time during its first seven contract years exceeds the sum of the net level premiums
that would have been paid on or before such time if the contract provided for paid-up future benefits after the
payment of the seven level annual payments.
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Guarantees
It is in the overall guarantees that universal life insurance policies suffer in comparison with whole
life insurance policies. However, universal life insurance policies have certain important guarantees.
The most significant guarantees typically found in a universal life insurance policy relate to:
• Interest crediting rates - the insurer promises not to lower crediting interest rates below the
level guaranteed in the policy; declared rate universal life insurance policies typically
guarantee interest levels in the 3 – 4 percent range, while equity indexed universal life
insurance policies generally guarantee a somewhat lower rate
• Expense and mortality charges - the insurer promises not to increase expense charges or
cost of insurance rates above the levels guaranteed in the policy
The most significant area in which a universal life insurance policy lacks guarantees is in connection
with the policy’s remaining in force. Although a universal life insurance policyowner may pay any
premium between zero and a certain maximum, there is generally no premium level that guarantees
the policy will not lapse. While not particularly likely, it is at least theoretically possible that the
insurer’s increasing the expense and mortality charges to the guaranteed levels and lowering the
interest crediting rate to the policy guarantees will result in the policy’s cash value being insufficient
to pay the monthly deductions despite the policyowner’s high level of premium payments. In such a
case, the policy would lapse.
Advantages and Disadvantages of Universal Life Insurance
The most significant advantage of universal life insurance is its flexibility. Because of that flexibility,
a policyowner may change the universal life insurance policy’s:
• Premium payment level
• Death benefit option
• Death benefit amount
• Cash value (by increasing premiums or taking withdrawals)
Since laws may be amended or the client’s cash flow may change, resulting in increased or reduced
need for the death benefits or a temporary inability to pay premiums, the flexibility of universal life
insurance is likely to be welcome.
The principal disadvantage of universal life insurance is related, in part, to its flexibility; it is the
contract’s lack of fundamental guarantees. Although universal life insurance policies offer guarantees
with respect to mortality costs, expenses and interest rates, the insurer does not guarantee that the
policy will be in force at the insured’s death, regardless of the level of premiums paid by the
policyowner.
Survivorship Life Insurance
Most life insurance policies insure one individual; survivorship life insurance policies insure multiple
individuals and pay a death benefit only when the last of those insured individuals dies. Although
some insurers offer survivorship life insurance policies under which there are three or more insureds,
survivorship life insurance is generally written to cover two lives. Those two lives need not be related
in any way, but, in most cases, the two insureds are husband and wife.
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Survivorship life insurance grew out of a change in the U.S. Tax Code. At one time, the transfer of
property from the estate of a decedent to his or her spouse was not completely tax-free. Only a portion
of the property so transferred would avoid estate taxation. When this partial tax-free transfer became
an unlimited marital deduction, married couples found that they were able to avoid estate taxes
completely until the survivor of the two of them subsequently died (assuming that he or she had not
re-married). Since people would generally prefer to defer the payment of taxes to the latest possible
moment, many couples took advantage of this unlimited marital deduction.
Although the unlimited marital deduction enables married couples to defer estate taxation until a later
period, it does not eliminate the taxes. In fact, in certain cases, the complete deferral of estate taxes
may actually increase the total taxes due. However, since estate taxes can be deferred until the death
of the survivor of two people, it may seem eminently sensible to purchase a life insurance policy that
pays a death benefit when that tax liability arose—upon the second death. For that reason,
survivorship life insurance became—and continues to be—a very popular method of funding for
estate taxes.
Survivorship life insurance may be designed around a whole life policy or a universal life policy. If
the policy chosen is survivorship whole life insurance, it has the general characteristics of a whole life
insurance policy. Its premiums and death benefits are somewhat inflexible, but the contract offers the
incredible guarantees of whole life insurance.
Alternatively, if the survivorship policy is survivorship universal life insurance, it contains the
enormous flexibility of universal life insurance: the premium payments may be varied, and the
policyowner may increase or decrease the face amount. What survivorship universal life insurance
lacks, of course, are whole life insurance guarantees.
The fact that survivorship life insurance—whether whole life or universal life—pays a death benefit
only upon the occurrence of the death of the survivor of the insureds has certain interesting
consequences that make the product very desirable:
• Generally lower premium cost, and
• Somewhat relaxed underwriting rules
Since the insurer is not required to pay the death benefit until two events occur, i.e. the death of both
insureds, the premium for the coverage is lower than for equivalent coverage in two separate policies.
Furthermore, since the benefit isn’t paid until both insureds die, survivorship policies may cover
individuals that would be considered uninsurable for single-life coverage. Typically, the insurable
individual must be able to qualify for the survivorship life insurance coverage as a standard risk.
Since survivorship life insurance policies are more frequently purchased by older insureds, these
liberalized underwriting rules are important.
Advantages and Disadvantages of Survivorship Life Insurance
With respect to the facilitating of wealth transfer, survivorship life insurance has particular
applicability. The use of survivorship life insurance to provide estate settlement costs has the
following advantages:
• The death benefit is paid at exactly the point at which the estate tax liability arises: upon the
second death
• The death benefit is provided at the lowest possible premium outlay
• Medical underwriting standards are generally eased
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There are, however, certain disadvantages in survivorship life insurance policies, including the
following:
• No benefits are paid upon the death of the first insured, without the addition of a special rider
• If the survivorship life insurance policy is of the whole life insurance variety, its premiums
and death benefits tend to be inflexible
• If the survivorship life insurance policy is written on the universal life insurance plan, it lacks
the formidable guarantees of whole life insurance.
Life Insurance for Final Expenses
The vast majority of estates, as discussed in chapter 1, are unlikely to ever pay any federal estate
taxes since federal estate taxes aren’t levied on estates smaller than the exemption equivalent of the
estate tax unified credit. What that means is that estates will avoid federal estate taxes unless they
exceed the following:
Death In
Year
Estate Value
Must Exceed
2004 $1,500,000
2005 $1,500,000
2006 $2,000,000
2007 $2,000,000
2008 $2,000,000
2009 $3,500,000
In the year 2010, the federal estate tax is repealed entirely, although it may be reinstated the following
year.
As we can see from these numbers, the estates of many people will not be required to pay federal
estate taxes. Does this mean that owners of estates smaller than the exemption equivalent need not be
concerned about final expenses The answer is, of course, “no.” Although federal estate taxes may
not be a concern for these individuals and their estates, there are many other final expenses that need
to be provided for. Let’s look at some of these, beginning with funeral costs.
Studies have suggested that, for many people, a funeral is the most expensive product or service that
they will purchase after a house and a car. The National Funeral Directors Association has provided a
list of the national average costs of commonly-selected funeral services. The total average amounts to
$5,180 and includes:
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Professional services charges, which includes consultation with family $1,213
and clergy, obtaining and filing the death certificate and burial permit, the
preparation and filing of newspaper notices, printing and supplies, etc.
Embalming and cosmetology (hairdressing, etc.) $570
Visitation and viewing $275
Funeral at funeral home $350
Transfer of remains to the funeral home $154
Local hearse service $270
Acknowledgement cards $18
Casket $2,330
Total $5,180
Although these costs are the national average, many grieving survivors pay far more than these
amounts. A funeral home’s 2001 pricelist provides some indication of possible costs that may be
incurred and includes:
Caskets Priced at $895 - $24,000
Outer burial containers Priced at $495 - $18,000
Cremation urns Priced at $195 - $5,000
Forwarding remains to another funeral home Priced at $1,895
Receiving of casketed remains from another funeral home Priced at $795
In addition to these funeral expenses, survivors may expect to pay cemetery charges for a cemetery
plot, vaults, crypts or mausoleum space, monuments and fees for opening and closing the grave.
Depending on where the burial takes place and what is chosen, an additional $1,000 to $3,000 is often
spent on these products and services. To these expenses must be added the cost of providing music
and a clergyman.
The decedent’s estate must also be probated, and that function generally involves a cost of
approximately 5% of the value of the probated assets. There may also be legal fees, executor’s or
administrator’s fees, appraisal fees and costs for selling the decedent’s real estate and personal
property. There are often final medical and hospital expenses that must be paid.
Few people have no debts, and those debts don’t die with the individual; any amounts owed by the
decedent must also be paid. The typical debts that might need to be paid at death include outstanding
loans, household bills, credit card balances, telephone and utility bills.
Finally, there are numerous taxes that must be paid other than federal estate taxes. Any or all of the
following tax bills may be due:
• state estate or inheritance taxes
• unpaid federal and state income taxes
• personal property taxes, and
• real estate taxes
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It should be clear that even the smallest estate is likely to incur substantial costs at its owner’s death.
It would not be unusual for small estates to find that final expenses amount to $15,000 to $50,000.
Fortunately, life insurance is generally available to pay some or all of these costs.
Some life insurance companies make their products available on a simplified underwriting basis
particularly to serve the smaller estate marketplace. What simplified underwriting means to the agent
and his or her client is that life insurance may be issued—in amounts that are usually limited by the
proposed insured’s age—based solely on answers to a few health questions. No medical examination
is required, regardless of the proposed insured’s age. And, final expense life insurance may be issued
through relatively high ages—as high as 85—on this basis.
Simplified issue life insurance amounts may be available from companies working within this
marketplace based on age as shown in the chart below:
Age of
Proposed Insured
Policy Face
Amount Available
45 – 64 $2,500 - $35,000
65 – 80 $2,500 - $25,000
81 – 85 $2,500 - $10,000
While companies normally reserve the right to decline coverage in appropriate cases, simplified issue
underwriting of these policies often operates as follows. If the proposed insured can respond
negatively to specific health questions on the application, the coverage is issued with the full face
amount applied for. Alternatively, if the proposed insured’s answers indicate particular health
problems, a policy with a graded death benefit may be offered. Such a policy would typically pay a
death benefit of:
• 30% of the face amount for nonaccidental death in the first policy year
• 70% of the face amount for nonaccidental death in the second policy year, and
• 100% of the face amount for death at any time after the second policy year
So, if the insured lives at least 2 years following the date of issue, the death benefit will equal the full
face amount. Death as a result of accident would, of course, be paid at the full face amount regardless
of when death occurred.
Summary
It is not uncommon for large estates to be dominated by a single asset. Often that asset is a family
business, which may account for upwards of 70 or 80 percent of the estate. Because of their nonliquid
nature coupled with their substantial size, these estates—absent sufficient life insurance—may
need to liquidate estate assets just to meet the need for estate settlement funds—resulting in the loss
of family mementos and a severe diminishing of the estate’s value.
The possible sources of funds to meet estate cost needs include cash in the estate, the sale of estate
assets, borrowing or life insurance. Of these four methods, life insurance is the least expensive option
by a wide margin for most people. In addition to being the least expensive method of paying estate
taxes, it offers an additional benefit: its death benefits may be kept out of the decedent’s estate
through the use of appropriate ownership arrangements. In effect, life insurance provides funds for
the estate rather than from the estate.
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Pennsylvania Life-Senior Market Specialist Accreditation
Owners of highly appreciated assets, such as family businesses, may find that the use of a charitable
remainder trust provides significant income, tax and psychic benefits. By transferring highly
appreciated assets to a charitable remainder trust, clients may increase their income, reduce their taxes
and endow a favorite charity. In addition, life insurance may be employed to enable the clients to
replace the gifted asset for the benefit of their heirs.
No life insurance policy is the best in all situations. Whole life insurance provides policyowners with
the most significant guarantees available. However, these policies tend to be somewhat inflexible
with respect to their premiums and death benefits. Universal life insurance policies, alternatively,
provide policyowners with the maximum amount of premium and death benefit flexibility. However,
universal life insurance policies lack the impressive guarantees of whole life insurance.
Survivorship life insurance is life insurance that insures two or more individuals and pays a death
benefit only on the death of the last survivor. Since married couples’ estate plans may call for the
deferral of all estate taxes until the death of the survivor of the two individuals, survivorship life
insurance may be a particular appropriate policy.
Survivorship life insurance may be written as universal life insurance or as whole life insurance, and
each type shares both the advantages and disadvantages of universal life or whole life insurance, as
appropriate. Regardless of how written, survivorship life insurance has two important advantages: it
provides life insurance benefits on the second of two individuals to die at the lowest possible
premium outlay, and its relaxed underwriting rules enable insurers to insure an otherwise uninsurable
individual, provided the other insured is insurable as a standard risk.
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Chapter 6 — Life Insurance
Chapter 6 Review
1. How quickly following an individual’s death must any federal estate taxes be paid
a. Within 9 months
b. Within 12 months
c. Within 24 months
d. Within 60 months
2. Whole life insurance premium levels are based on all of the following EXCEPT:
a. expected mortality
b. expected expenses
c. expected earnings
d. expected tax benefits
3. What premium level must a universal life insurance policyowner pay in order to guarantee
that the policy will not lapse
a. The minimum premium
b. The target premium
c. The maximum premium
d. There is no premium level that will guarantee the policy will not lapse
4. Which of the following is NOT an advantage of survivorship life insurance to provide funds
to meet estate settlement costs
a. Death benefit is paid exactly when required
b. Benefits are generally provided at the lowest possible premium outlay
c. Medical underwriting standards are generally eased
d. Survivorship life insurance policy proceeds are not includible in the federal gross estate
Answers to the chapter review can be found in Appendix A
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Pennsylvania Life-Senior Market Specialist Accreditation
148

Appendix A
Answers to Chapter Quizzes
Chapter 1
1.1. B
1.2. B
1.3. A
1.4. C
Chapter 2
2.1. B
2.2. B
2.3. C
2.4. C
Chapter 3
3.1 A
3.2 C
3.3 B
Chapter 4
4.1. A
4.2. C
4.3. D
4.4 A
Chapter 5
5.1. C
5.2. B
5.3. A
5.4. B
Chapter 6
6.1. A
6.2. D
6.3. D
6.4. D
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