Retiree Health Benefits: Options for Employment-Based		 
Prescription Drug Benefits under the Medicare Modernization Act  
(14-FEB-05, GAO-05-205).					 
                                                                 
The Medicare Prescription Drug, Improvement, and Modernization	 
Act of 2003 (MMA) created a prescription drug benefit for	 
beneficiaries, called Medicare part D, beginning in January 2006.
The MMA included incentives for sponsors of employment-based	 
retiree health plans to offer prescription drug benefits to	 
Medicare-eligible retirees, such as a federal subsidy when	 
sponsors provide benefits meeting certain MMA requirements. Plan 
sponsors cannot receive a subsidy for retired Medicare		 
beneficiaries who enroll in part D. In response to an MMA	 
mandate, GAO determined (1) the trends in employment-based	 
retiree health coverage prior to the MMA and (2) which MMA	 
prescription drug options plan sponsors said they would pursue	 
and the effect these options might have on retiree health	 
benefits. GAO identified trends using data from federal and	 
private sector surveys of employers' health benefit plans and	 
financial statements of 50 randomly selected Fortune 500	 
employers. Where data for Medicare-eligible retirees were not	 
available, GAO reported data for all retirees, including	 
Medicare-eligible retirees. To obtain plan sponsors' views about 
options they were likely to pursue, GAO reviewed the 50 	 
employers' financial reports and interviewed benefit consultants;
private and public sector plan sponsors, including the Office of 
Personnel Management for federal employees' health benefits; and 
other experts.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-205 					        
    ACCNO:   A17598						        
  TITLE:     Retiree Health Benefits: Options for Employment-Based    
Prescription Drug Benefits under the Medicare Modernization Act  
     DATE:   02/14/2005 
  SUBJECT:   Drugs						 
	     Employee medical benefits				 
	     Federal employee retirement programs		 
	     Health care programs				 
	     Health surveys					 
	     Retirement benefits				 
	     Elderly persons					 
	     Health insurance					 
	     Health statistics					 
	     Statistical data					 
	     Eligibility determinations 			 
	     Federal Employees Health Benefits			 
	     Program						 
                                                                 
	     Medicare Advantage Program 			 
	     Medicare Program					 

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GAO-05-205

United States Government Accountability Office

GAO

                       Report to Congressional Committees

                                 February 2005

RETIREE HEALTH BENEFITS

Options for Employment-Based Prescription Drug Benefits under the Medicare
                               Modernization Act

GAO-05-205

February 2005

RETIREE HEALTH BENEFITS

Options for Employment-Based Prescription Drug Benefits under the Medicare
Modernization Act

  What GAO Found

A long-term decline in the percentage of employers offering retiree health
coverage has leveled off in recent years, but retirees face an increasing
share of costs, eligibility restrictions, and benefit changes that
contribute to an overall erosion in the value and availability of
coverage. Although the percentages and time frames differed, two employer
benefit surveys showed that the percentage of employers offering health
coverage to retirees has declined since the early 1990s; this trend,
however, has leveled off. The cost to provide retiree health coverage,
including coverage for Medicare-eligible retirees, has increased
significantly: one employer benefit survey cited double-digit increases
each year from 2000 through 2003. Prescription drugs for Medicare-eligible
retirees constituted a large share of retiree health costs. Employers and
other plan sponsors have used various strategies to limit overall benefit
cost growth that included increasing retiree cost sharing and premiums,
restricting eligibility for benefits, placing financial caps on health
care expenditures, and revising prescription drug benefits.

Many plan sponsors had not made final decisions about which MMA
prescription drug options they would choose for their Medicare-eligible
retirees at the time of GAO's review. Specifically, 13 of the 15 private
and public plan sponsors GAO interviewed were undecided for some or all
retirees. However, most plan sponsors interviewed had chosen the federal
subsidy option for some or all retirees or were considering the subsidy as
one of several options. Alternatively, some plan sponsors that had set
caps on their retiree health benefit obligations were considering
supplementing (known as "wrapping around") the new Medicare prescription
drug benefit for some or all retirees rather than providing their own
comprehensive prescription drug coverage in lieu of the Medicare drug
benefit. Also, some plan sponsors and benefit consultants said they were
waiting to see how the market for other MMA options, such as Medicare
Advantage plans, develops. About two-thirds of financial statements GAO
reviewed for Fortune 500 employers reporting obligations for retiree
health benefits had begun to reflect reduced obligations resulting from
the MMA options. While plan sponsors contacted said they did not
anticipate reducing their drug coverage in view of new coverage offered
through the MMA, increasing health care costs might cause them to do so in
the future. Benefit consultants and other experts interviewed said that
the MMA was not likely to induce employers to begin to provide
prescription drug coverage or to supplement the Medicare drug benefit if
they had not previously offered retiree health coverage.

In commenting on a draft of this report, the Centers for Medicare &
Medicaid Services and four experts generally agreed with the report's
findings. The Office of Personnel Management indicated that it has not
made final decisions about which MMA prescription drug option it would
choose for the Federal Employees Health Benefits Program, but it does not
expect to choose the subsidy option.

                 United States Government Accountability Office

Contents

     Letter                                                                 1 
                                    Results in Brief                        4 
                                       Background                           6 
                      Long-term Decline in Employment-Based Retiree Health 
                                                                  Coverage 
              Has Leveled Off, with Retirees Paying an Increasing Share of 
                                                                       the 
                                         Costs                             13 
                Employers and Plan Sponsors Considering MMA Options for    
                Prescription Drug Coverage, Often Considering Subsidy as   
               Primary Option for Some or All Medicare-Eligible Retirees   31 
                                Concluding Observations                    46 
                           Agency and Other External Comments              46 
Appendix I                    Scope and Methodology                     50 
                      Surveys of Employment-Based Health Benefits          50 
                                    Federal Surveys                        52 
                       Financial Data from Fortune 500 Employers           55 
              Interviews with Benefit Consultants, Plan Sponsors, and      56 
              Others                                                       

Appendix II	Comments from the Centers for Medicare & Medicaid Services

        Appendix III Comments from the Office of Personnel Management 61

  Appendix IV GAO Contact and Staff Acknowledgments 62

GAO Contact 62 Acknowledgments 62

  Tables

Table 1: Status of Decisions by 15 Private and Public Sector Plan Sponsors
Interviewed regarding the MMA Subsidy Option for Prescription Drug
Coverage 33

Table 2: Actions Taken in Response to the MMA by 50 Randomly Selected
Fortune 500 Employers, Most as of the Quarter Ending September 30, 2004 42

  Figures

Figure 1: Medicare Part D Standard Prescription Drug Benefit 10 Figure 2:
Mercer Survey Results-Percentage of Employers with

500 or More Employees Offering Health Benefits to

Medicare-Eligible Retirees, 1993-2004 15 Figure 3: Kaiser/HRET Survey
Results-Percentage of Employers with 200 or More Employees Offering Health
Benefits to All Retirees and to Medicare-Eligible Retirees, 1991-2004 16
Figure 4: Percentage of Medicare-Eligible Retirees and Their

Insured Dependents with Employment-Based Health

Benefits, by Age Group, 1995-2003 20 Figure 5: Under the MMA Subsidy
Option, the Portion of Retired Medicare Beneficiaries' Prescription Drug
Expenditures Paid by Employment-Based Coverage and Paid Out-of-Pocket
Eligible for Subsidy, Estimate for 2006 36

Abbreviations

CMS Centers for Medicare & Medicaid Services
CPS Current Population Survey
EEOC Equal Employment Opportunity Commission
FAS Financial Accounting Standards
FASB Financial Accounting Standards Board
FEHBP Federal Employees Health Benefits Program
GASB Governmental Accounting Standards Board
HMO health maintenance organization
HRET Health Research and Educational Trust
HSA health savings account
MEPS Medical Expenditure Panel Survey
MCBS Medicare Current Beneficiary Survey
MMA Medicare Prescription Drug, Improvement, and

Modernization Act of 2003 OPM Office of Personnel Management PPO preferred
provider organization SEC Securities and Exchange Commission

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United States Government Accountability Office Washington, DC 20548

February 14, 2005

Congressional Committees

As prescription drug costs have continued to increase, many retired senior
citizens face significant out-of-pocket costs for prescription drugs.
Because the Medicare program as originally designed did not cover
outpatient prescription drugs, many beneficiaries relied on other sources
to cover the costs of drugs. About a third of all retired Medicare
beneficiaries obtained supplementary health benefits through plans
sponsored by former employers or other employment-based groups, and most
of these plans covered prescription drugs. However, most retired Medicare
beneficiaries, including those with employment-based health plans, still
relied to varying degrees on their own financial resources to pay for
prescription drugs. More broadly, there has been concern in recent years
about a long-term decline in the availability of employment-based retiree
health coverage.1 To help senior citizens with increasing prescription
drug costs and encourage employment-based retiree health coverage,
especially for prescription drugs, Congress passed the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) in
December 2003 that among other things, created a new prescription drug
benefit as part D of the Medicare program.2 The Medicare part D benefit
begins in January 2006. The MMA also established various options and
incentives to encourage sponsors of employment-based retiree health plans
to offer prescription drug benefits to retired Medicare beneficiaries.

Once the Medicare drug benefit is available in 2006, employers and other
sponsors of health coverage will have several options to provide
prescription drug benefits to Medicare-eligible retirees. To encourage
plan sponsors to offer prescription drug coverage to retired Medicare

1See, for example, Frank McArdle, Amy Atchison, and Dale Yamamoto, Hewitt
Associates; and Michelle Kitchman and Tricia Neuman, The Kaiser Family
Foundation, Current Trends and Future Outlook for Retiree Health Benefits:
Findings from the Kaiser/Hewitt 2004 Survey on Retiree Health Benefits
(Menlo Park, Calif., and Lincolnshire, Ill.: The Henry J. Kaiser Family
Foundation, December 2004), and GAO, Retiree Health Benefits:
Employer-Sponsored Benefits May Be Vulnerable to Further Erosion,
GAO-01-374 (Washington, D.C.: May 1, 2001).

2Pub. L. No. 108-173, sec. 101, S:S: 1860D-1-1860D-42, 117 Stat. 2066,
2071-2152 (to be codified at 42 U.S.C. S:S: 1395w-101-1395w-152).

beneficiaries-which they generally do on a voluntary basis-the MMA
established a federal subsidy payment for plan sponsors that offer
comprehensive drug benefits meeting certain MMA requirements.3, 4 Subsidy
payments will be available for each retiree who chooses to enroll in the
sponsor's plan in lieu of enrolling in part D. Alternatively, plan
sponsors can provide coverage that supplements (wraps around) the
retiree's Medicare part D prescription drug benefit and forgo eligibility
for the subsidy. Plan sponsors also have several other options for
providing prescription drug coverage to retired Medicare beneficiaries
under the MMA, such as contracting with private plans that provide
standard or enhanced Medicare part D prescription drug benefits.

The MMA required that we conduct a study documenting trends in
employment-based retiree health coverage prior to the enactment of the
MMA, including coverage provided under the Federal Employees Health
Benefits Program (FEHBP),5 and the options and incentives available
through the MMA that could affect the voluntary provision of
employmentbased retiree health benefits.6 As discussed with the committees
of jurisdiction, this report addresses the following questions:

o 	What were the trends in employment-based retiree health coverage,
particularly for Medicare-eligible retirees, prior to the MMA?

3"Plan sponsor" refers to a sponsor of employment-based retiree group
health coverage, including private sector employers and public sector
employers, including federal, state, or local governments; sponsors of
church plans; and sponsors of plans offered under collectively bargained
agreements.

4MMA sec. 101, S: 1860D-22, 117 Stat. 2125-28. The subsidy will be
available to employmentbased group health plans regulated under the
Employee Retirement Income Security Act of 1974 (29 U.S.C. S:S: 1001 et
seq. (2000)) as well as to federal government and other public sector
plans and church plans.

5The federal government, through FEHBP, is the nation's largest purchaser
of employmentbased health benefits. All active and retired federal workers
and their dependents are eligible to enroll in health plans offered
through FEHBP. For 2005, 11 nationwide fee-forservice plans, some of which
are available only to certain federal retirees and most of which offer a
preferred provider organization (PPO), will be participating in FEHBP.
While federal retirees also have more than 260 health maintenance
organization (HMO), point-ofservice, consumer-driven, and high-deductible
health plan options, the number available varies by state.

6MMA S: 111, 117 Stat 2175-76. The MMA also required that we conduct a
second study after the implementation of the Medicare drug benefit,
following up on trends and the options selected.

o 	Which MMA prescription drug coverage options do plan sponsors say they
are likely to pursue and what effect will these options likely have on
health benefits for Medicare-eligible retirees?

To identify trends in employment-based retiree health coverage and
expenditures, we reviewed data from several sources, including (1) three
private sector surveys of employers' health benefit plans nationwide, two
of which covered both private and public sector employers and have been
conducted annually for more than a decade; (2) three large federal
surveys, which contained information on public sector employers' retiree
health benefit offer rates, retired Medicare beneficiaries covered by
employment-based health coverage from 1995 through 2003, and retired
Medicare beneficiaries' prescription drug expenditures, respectively; (3)
financial statements that 50 randomly selected Fortune 500 employers filed
with the Securities and Exchange Commission (SEC) reporting their
anticipated obligations for retiree health benefits;7 and (4) studies,
reports, and analyses from the literature on retirees' health benefits. To
supplement these sources and to obtain more in-depth information, we
interviewed officials at (1) 6 firms providing benefit consulting services
primarily for large public and private sector employers; (2) 12 Fortune
500 employers that sponsored retiree health benefit plans;8 (3) 3 public
sector sponsors of retiree health benefits, including the Office of
Personnel Management (OPM), which administers FEHBP; (4) 1 association
representing unions and 1 representing multiemployer plans that sponsor
retiree health benefit plans for unionized workers;9 (5) 2 associations
representing small to midsized employers; (6) 4 trade organizations,
including those representing large employers; and (7) 1 professional

7"Obligations" are incurred during employees' active service and refer to
projected costs that employers will likely pay in the future for retirees.

8Ten of the 12 Fortune 500 employers we interviewed were selected from the
50 randomly selected Fortune 500 employers whose financial statements we
reviewed; the other 2 Fortune 500 employers we interviewed were selected
prior to our review of financial statements on the basis of
recommendations by a benefit consultant.

9A multiemployer plan is a pension, health, or other employee benefit plan
to which more than one employer is required to contribute; that is
maintained under one or more collective bargaining agreements between one
or more employee organizations, such as a union, and more than one
employer; and that satisfies such other requirements as the Secretary of
Labor may prescribe by regulation. 29 U.S.C. S: 1002(37) (2000). They are
common in industries that typically include smaller employers and have a
mobile workforce, such as construction, trucking, and communications. A
multiemployer plan's board of trustees, which has equal representation
from labor and management, as opposed to an individual employer or union,
controls the design and financing of the plan.

organization for actuaries. We focused on trends particularly affecting
Medicare-eligible retirees, but in some cases when information specific to
Medicare-eligible beneficiaries was not available, we reported on trends
affecting all retirees, including those who were under age 65 and those
who were eligible for Medicare.10 To determine which MMA prescription drug
coverage options plan sponsors said they would likely pursue and what
effect these options might have on retiree health benefits, we relied
primarily on our review of the annual and quarterly financial statements
that 50 Fortune 500 employers filed with the SEC and on our interviews
with benefit consultants, private and public sector sponsors of
employment-based retiree health benefit plans, and other experts. We also
interviewed officials at the Centers for Medicare & Medicaid Services
(CMS), the federal agency that administers Medicare, to obtain information
on MMA prescription drug options for plan sponsors. We assessed the
reliability of the data from the three employer benefit nationwide surveys
and three large federal surveys and determined that the data were
sufficiently reliable for the purposes of our study. (App. I provides more
detailed information on our methodology.) We performed our work from April
2004 through February 2005 in accordance with generally accepted
government auditing standards.

A long-term decline in the percentage of employers offering retiree health
coverage has leveled off in recent years, with retirees shouldering a
steadily increasing share of costs and facing additional constraints on
eligibility and benefits. Although the percentages and time frames
differed, two employer benefit surveys showed that the percentage of
employers that offer health coverage to retirees has declined since the
early 1990s, but this trend has leveled off in recent years. For example,
one survey found that the percentage of employers with at least 500
employees offering coverage to Medicare-eligible retirees declined from
about 44 percent in 1993 to 27 percent in 2001, then remained relatively
stable through 2004. Meanwhile, the cost for employers and other plan
sponsors to provide health coverage to retirees, including
Medicare-eligible retirees, has increased significantly, with one employer
benefit survey reporting double-digit increases each year from 2000
through 2003. Prescription drugs represent a large share of these
increases and a large share of plan

10For this report, we specify when information is for Medicare-eligible
retirees (primarily those aged 65 years or older) and when it is for
retirees under the age of 65. If information is not specific to
Medicare-eligible retirees or to those under the age of 65, we use the
term retirees to refer to those that may be Medicare-eligible, under 65,
or both.

  Results in Brief

sponsors' overall health coverage costs for Medicare-eligible retirees.
Employers and other plan sponsors have used various strategies to limit
overall benefit cost growth, usually requiring retirees to pay more for
coverage and thus contributing to an overall erosion in the value and
availability of coverage. Cost-cutting strategies have included increasing
retiree cost sharing; restricting eligibility for benefits, including
eliminating coverage for future retirees; and redesigning prescription
drug benefits to encourage the use of lower-cost drugs. Public sector
sponsors' measures to cut costs have mirrored those in the private sector,
with one major difference: they generally have not eliminated coverage for
future retirees.

Many employers and other plan sponsors had not made final decisions about
which MMA drug coverage options they would choose for their
Medicare-eligible retirees at the time of our review. Although they were
in various stages of decision making, 13 of the 15 plan sponsors we
interviewed were undecided with respect to some or all of their retirees.
However, most plan sponsors we interviewed were considering the federal
subsidy as the primary option in their deliberations-2 had chosen the
subsidy option for all of their retirees; 10 had chosen the subsidy option
for some of their retirees or were considering it as one of their options;
and 3, including OPM for FEHBP, said that they would not or did not expect
to choose the subsidy option. Where plan sponsors had set financial caps
on their retiree health benefit obligations, they often were considering
offering benefits that would wrap around Medicare's drug benefit for all
of their retirees or for those retirees whose benefits would not qualify
for the subsidy. Plan sponsors would offer coverage wrapping around
Medicare part D rather than providing their own comprehensive prescription
drug coverage in lieu of the Medicare drug benefit. Also, some plan
sponsors and benefit consultants said they were waiting to see how the
market for other MMA options, such as private health plans offered through
the Medicare Advantage program, developed before they made final
decisions. About two-thirds of the financial statements we reviewed from a
sample of Fortune 500 employers reporting obligations for retiree health
benefits had begun to reflect reduced obligations for retiree health
benefits from the federal subsidy or other options, whereas the remainder
had not reflected any changes as a result of the MMA. Generally, in
response to our questions about the effects of the MMA on their retiree
drug coverage, plan sponsors said that they did not anticipate immediately
reducing the current drug coverage they provided for Medicare-eligible
retirees but that increasing health care costs might cause them to reduce
coverage in the future. Benefit consultants and other experts we
interviewed said that the MMA was not likely to induce employers that did

not already offer prescription drug coverage to retirees to begin to
provide such coverage or to supplement the Medicare drug benefit but that
each employer would have to make this decision while considering its own
financial and business strategy.

In commenting on a draft of this report, CMS and four experts generally
agreed with the report's findings. In its written comments, CMS confirmed
that many plan sponsors are still considering their options under the MMA.
Having just released its final rule, CMS stated that it intends to provide
additional guidance and continue conducting outreach and education efforts
on the options for retirees' prescription drug coverage available to plan
sponsors. While at the time of our interviews OPM officials indicated that
the agency was considering the federal subsidy for FEHBP, OPM indicated in
its written comments on a draft of this report that it does not expect to
choose the federal subsidy option, and we revised the report accordingly.

Background 	For retirees aged 65 or older, Medicare is typically the
primary source of health insurance coverage. Medicare covered about 41
million beneficiaries as of July 2003. The program covers hospital care as
well as doctor visits and outpatient services but has never covered most
outpatient prescription drugs.

    Medicare and Supplemental Coverage before Implementation of Medicare Drug
    Benefit

Under traditional Medicare, eligible individuals may apply for part A,
which helps pay for care in hospitals and some limited skilled nursing
facility, hospice, and home health care, and may purchase part B, which
helps pay for doctors, outpatient hospital care, and other similar
services. Depending on where they live, individuals may have the option of
obtaining traditional Medicare coverage (on a fee-for-service basis) or
coverage from a managed care or other private plan offered through the
Medicare Advantage program.11 Many beneficiaries have been attracted to

11The MMA created the Medicare Advantage program to replace the
Medicare+Choice program (MMA S: 201, 117 Stat. 2176). Medicare+Choice was
established in the Balanced Budget Act of 1997 (Pub. L. No. 105-33, sec.
4001, S:S: 1851-1859, 111 Stat. 251, 275-327 (codified at 42 U.S.C. S:S:
1395w-21-1395w-28)) to expand Medicare beneficiaries' health plan options
and encourage wider availability of HMOs and other types of health plans,
such as PPOs, as an alternative to traditional fee-for-service. H.R. Conf.
Rep. No. 108-391, at 524 (2003). While retaining many of the same
provisions in Medicare+Choice, including the eligibility, enrollment,
grievance, and appeals provisions, Medicare Advantage provides additional
features, such as increased payment rates and a new option for Medicare
beneficiaries-regional PPOs. MMA S: 221, 117 Stat. 2180-93.

these plans because they typically have lower out-of-pocket costs than
feefor-service plans and offer services not covered by traditional
Medicare prior to the MMA, such as routine physical examinations and most
outpatient prescription drugs.12 Nearly 4.7 million Medicare beneficiaries
were enrolled in a local Medicare Advantage plan as of July 2004.

To cover some or all of the costs Medicare does not cover, such as
deductibles, copayments, and coinsurance, Medicare beneficiaries may rely
on private retiree health coverage through former employment or through
individually purchased Medicare supplemental insurance (known as
Medigap).13, 14 For example, for 2001, the Medicare Current Beneficiary
Survey (MCBS) found that about three-fourths of Medicare-eligible
beneficiaries obtained supplemental coverage from the following sources: a
former employer or union (29 percent); individually purchased coverage,
including Medigap policies (27 percent); both employment-based and
individually purchased coverage (7 percent); or Medicaid (13 percent).15
About 24 percent had Medicare-only coverage.

12For Medicare beneficiaries who purchase part B coverage on or after
January 1, 2005, Medicare will cover a one-time preventive physical exam
within the first 6 months that the beneficiary is enrolled in part B. MMA
sec. 601, S: 1861 (s)(2) and (ww), 117 Stat. 2303-24 (to be codified at 42
U.S.C. S: 1395x(s)(2) and (ww)).

13Medigap is a privately purchased health insurance policy that
supplements Medicare by paying for some of the health care costs not
covered by Medicare. 42 U.S.C. 1395ss (2000). Medicare beneficiaries can
purchase 1 of 10 standardized Medigap benefit packages. Three of the 10
standardized Medigap benefit packages offer limited prescription drug
benefits, paying 50 percent of drug charges up to either $1,250 per year
or $3,000 per year after the beneficiary pays a $250 deductible. New
Medigap plans sold after January 1, 2006, will no longer include
prescription drug benefits. MMA sec. 104(a)(1), S: 1882(v)(1), 117 Stat.
2161 (to be codified at 42 U.S.C. S: 1395ss(v)(1)).

14Health plans typically require enrollees to pay a portion of the cost of
their medical care. These cost sharing arrangements include deductibles,
which are fixed payments enrollees are required to make before coverage
applies; copayments, which are fixed payments enrollees are required to
make at the time benefits or services are received; and coinsurance, which
is a percentage of the cost of benefits or services that the enrollee is
responsible for paying directly to the provider.

15Low-income Medicare beneficiaries may qualify for assistance from
Medicaid, a joint federal-state program that covers health care services
for certain individuals with low incomes and resources. 42 U.S.C. S: 1396
et seq. (2000). For Medicare beneficiaries qualifying for full Medicaid
benefits, known as "dual eligible" individuals, state Medicaid programs
pay for Medicare's part A and part B cost sharing requirements up to the
Medicaid payment rate as well as for services that are not generally
covered by Medicare, including prescription drugs.

Employers generally offer health benefits to retirees on a voluntary
basis.16 While these benefits vary by employer, they almost always include
prescription drugs and often cover both retirees under age 65 as well as
those eligible for Medicare. However, coverage can vary between these
groups of retirees. For example, premiums are often lower for those aged
65 and over because Medicare pays for certain costs, and cost sharing
requirements, which can make retirees more sensitive to the costs of care,
may differ.17 Plan types may also differ based on Medicare eligibility.
For example, some employers offer retirees under age 65 a preferred
provider organization (PPO) plan but offer a fee-for-service plan for
retirees eligible for Medicare. Regardless of the type of plan offered,
retirees who have employment-based coverage generally have a choice of
more than one plan.

Plan sponsors typically coordinate their retiree health benefits with
Medicare once retirees reach age 65, with Medicare as the primary payer
and the plan sponsor as the secondary payer. Several types of coordination
occur between plan sponsors and Medicare. For example, some plan sponsors
coordinate through a carveout approach, in which the plan calculates its
normal benefit and then subtracts (or carves out) the Medicare benefit,
generally leaving the retiree with out-of-pocket costs comparable to
having the employment-based plan without Medicare. Another approach used
by plan sponsors is full coordination of benefits, in

16Since World War II, many employers have voluntarily sponsored health
insurance as a benefit to employees for purposes of recruitment and
retention and some have also offered these benefits to their retirees. The
federal tax code provides incentives for employers to offer health
benefits because qualified employer contributions do not count as taxable
income to employees and may be deducted from the employer's income for tax
purposes. 26 U.S.C. S:S: 106(a) and 419(a), respectively (2000).
Requirements for most employmentbased health plans for workers or retirees
are prescribed by the Employee Retirement Income Security Act of 1974,
which gives employers considerable flexibility to manage the cost, design,
and extent of health care benefits they provide. 29 U.S.C. S:S: 1001 et
seq. (2000).

17In 2000, a federal court held that an employer providing
Medicare-eligible retirees a health benefit that is different from that
offered to other retirees constitutes age discrimination unless, under an
exception established by regulation, the health benefits provided by both
the employer and Medicare are equal to, or cost the employer as much as,
the health benefit provided to other retirees. Erie County Retirees Ass'n
v. County of Erie, 220 F.3d 193 (3d Cir. 2000), cert. denied, 532 U.S. 913
(2001). The Equal Employment Opportunity Commission (EEOC) published a
proposed rule on July 14, 2003, that would establish an additional
exception under which altering, reducing, or eliminating health benefits
when retirees are eligible for Medicare would not constitute age
discrimination. 68 Fed. Reg. 41,542. During a public meeting on April 22,
2004, EEOC voted to approve the final rule, but before it becomes final,
it must be published in the Federal Register.

which the plan pays the difference between the total health care charges
and the Medicare reimbursement amount, often providing retirees complete
coverage and protection from out-of-pocket costs.18 According to one
employer benefit survey, carveout is the most common type of coordination
used by employers that sponsor retiree health plans.19

The MMA Established a In January 2006, Medicare will begin offering
beneficiaries outpatient New Prescription Drug prescription drug coverage
through a new Medicare part D. Medicare Benefit for Medicare beneficiaries
who choose to enroll for this voluntary benefit will have Beneficiaries
some of their prescription drug expenditures covered by prescription drug

plans authorized by the MMA.20 In addition to paying a premium- estimated
initially to be about $35 per month ($420 per year)- beneficiaries must
meet other out-of-pocket expense requirements:

o  a $250 deductible;

o  25 percent of their next $2,000 in prescription drug expenditures; and

o 	100 percent of the next $2,850 in prescription drug expenditures, a
coverage gap often referred to as the Medicare part D benefit "doughnut
hole."

Medicare beneficiaries must therefore pay $3,600 out-of-pocket for
prescription drugs in 2006 before part D catastrophic coverage begins.
Part D catastrophic coverage pays most drug costs once total costs exceed
$5,100, with beneficiaries paying either the greater of a $2 copayment for
each generic drug and $5 copayment for other drugs, or 5 percent
coinsurance. Only prescription drug costs paid by the part D enrollee or
by another person or certain charitable organizations or state
pharmaceutical assistance programs on behalf of the enrollee, rather than
by a plan

18Different coordination approaches can result in different costs for plan
sponsors and retirees. For example, consider an individual with total
health care costs of $10,000 and retiree health benefits paying (without
Medicare) $8,500 of these costs. Under full coordination of benefits, if
Medicare paid $8,000, the plan payment would be $2,000, and the retiree
would have no out-of-pocket costs. In a carveout, if Medicare paid $8,000,
the plan payment would be $500, and the retiree would pay $1,500
out-of-pocket. See Frank B. McArdle and Dale H. Yamamoto, Hewitt
Associates LLC, for the Kaiser Medicare Policy Project, Retiree Health
Trends and Implications of Possible Medicare Reforms (Washington, D.C.:
The Henry J. Kaiser Family Foundation, September 1997).

19Kaiser/Hewitt 2004 Survey on Retiree Health Benefits.

20The initial enrollment period for Medicare part D will run from November
15, 2005, to May 15, 2006. MMA secs. 101 and 102, S:S: 1860D-1(b)(2)(A)
and 1851(e)(3)(B)(iii), 117 Stat. 2073 and 2152 (to be codified at 42
U.S.C. S:S: 1395w-101(b)(2)(A) and 1395w-21(e)(3)(B)(iii)).

sponsor, are considered in determining a beneficiary's true out-of-pocket
costs. (See fig. 1.)

Figure 1: Medicare Part D Standard Prescription Drug Benefit

Source: GAO analysis of the MMA.

aIf a $2 copayment for generic drugs and a $5 copayment for other drugs is
greater than the 5 percent coinsurance, the beneficiary is required to pay
the copayment.

After the part D benefit becomes effective in January 2006, Medicare
beneficiaries will be able to receive prescription drug coverage in
several ways, such as the following:

o 	Beneficiaries covered through the traditional fee-for-service Medicare
program will be able to enroll in privately sponsored prescription drug
plans that contract with CMS to receive their drug benefits.

o 	Beneficiaries enrolled in Medicare Advantage plans providing part D
prescription drug benefits will receive all of their health care services,
including part D benefits, through their Medicare Advantage plan.21

o 	Beneficiaries will be able to continue to receive prescription drug
benefits from other sources, such as an employment-based plan, if the plan
sponsor chooses to provide prescription drug coverage to Medicare-eligible
retirees.

The MMA Provides Plan The MMA creates options and incentives for a current
or a potential Sponsors Options and sponsor of an employment-based retiree
health plan to provide Incentives for Providing prescription drug coverage
to Medicare-eligible retirees. Options for plan Prescription Drug sponsors
under the MMA include the following:

Coverage  o  Offer retirees comprehensive prescription drug coverage
through an employment-based plan in lieu of Medicare part D prescription
drug coverage. Under this option, a sponsor of a plan with prescription
drug coverage actuarially equivalent22 to that under part D will receive
an

incentive to maintain coverage through a federal tax-free subsidy equal to
28 percent of the allowable gross retiree prescription drug costs over
$250 through $5,000 (maximum $1,330 per beneficiary) for each individual
eligible for part D who is enrolled in the employment-based plan. For
2006, CMS estimated that the average annual subsidy would be $668 per
beneficiary.23 In order to qualify for this subsidy, however, a plan
sponsor

21MMA sec. 101, S: 1860D-21, 117 Stat. 2122 (to be codified at 42 U.S.C.
S: 1395w-131). Medicare Advantage plans will be required to offer basic
drug coverage starting in 2006. They may also offer additional drug
benefits for an increased cost. A beneficiary enrolled in a Medicare
Advantage plan generally will receive prescription drug coverage through
that plan and may not enroll in a part D prescription drug plan.

22Specifically, when applying for the subsidy, the plan sponsor will have
to provide an attestation that the actuarial value of its prescription
drug benefits available to Medicareeligible retirees is at least
equivalent to the actuarial value of the standard part D benefit. MMA sec.
101, S: 1822D-12(a)(2)(A), 117 Stat. 2125, (to be codified at 42 U.S.C. S:
1395w132(a)(2)(A)).

2370 Fed. Reg. 4,194, 4,462 (Jan. 28, 2005). For a plan sponsor in the 35
percent tax bracket, this would be the equivalent of receiving taxable
income of $1,028. In the case of a private employer, this amount would be
in addition to the employer's savings resulting from the deductibility of
qualified plan contributions from taxable income. 26 U.S.C. S: 419 (2000).
However, CMS estimated that at least 60 percent of retirees receiving
employment-based prescription drug coverage do so through plan sponsors
that are exempt from federal income taxes-for example, state and local
governments or not-for-profit corporations.

must attest that the actuarial value of prescription drug coverage under

the plan is at least equal to the actuarial value of standard Medicare
part D

prescription drug coverage.24 Furthermore, a plan sponsor will receive a

subsidy only for those Medicare beneficiaries who do not enroll in the
Medicare part D benefit.

o 	Offer prescription drug coverage that supplements ("wraps around") the
part D benefit, as health plans commonly do for hospital and physician
services under Medicare parts A and B.

o 	Pay all or part of the monthly premium for any of the prescription drug
plans or Medicare Advantage plans in which Medicare-eligible retirees (and
dependents) choose to enroll.

o 	Contract with a prescription drug plan or Medicare Advantage plan to
provide the standard part D prescription drug benefit or enhanced benefits
to the plan sponsor's retirees who are Medicare-eligible (equivalent to
offering a fully insured benefit) or become a prescription drug plan or
Medicare Advantage plan (equivalent to offering a self-insured benefit).25

Plan sponsors also have other options. As has always been the case, plan
sponsors could stop providing any type of subsidized health care coverage,
including prescription drugs, to Medicare-eligible retirees and their
dependents. While they are not available for current Medicare
beneficiaries, the MMA also authorized the use of health savings accounts
(HSA) to which employers and active workers and retirees not eligible for
Medicare can contribute to cover future health care costs.26 This option
could provide a means for employees who are not offered employmentbased
retiree health coverage to save money for health coverage when they
retire.

On August 3, 2004, CMS published a proposed rule for implementing the
Medicare part D prescription drug provisions of the MMA, and the comment
period closed October 4, 2004.27 The proposed rule provided a preliminary
overview of how CMS intended to implement the MMA, including the subsidy
and other options. On January 28, 2005, CMS

2470 Fed. Reg. 4,407.

25MMA sec. 101, S: 1822D-22(b), 117 Stat. 2127 (to be codified at 42
U.S.C. S: 1395w-132(b)).

26MMA sec. 1201, S: 223, 117 Stat. 2469-79 (to be codified at 26 U.S.C. S:
223). Amounts contributed to HSAs will receive preferential income tax
treatment.

2769 Fed. Reg. 46,632.

  Long-term Decline in Employment-Based Retiree Health Coverage Has Leveled Off,
  with Retirees Paying an Increasing Share of the Costs

published a final rule implementing the MMA.28 CMS also indicated that it
will provide further guidance relating to the subsidy for plan sponsors
providing retiree drug coverage.

The percentage of employers offering health benefits to retirees,
including those who are Medicare-eligible, has decreased since the early
1990s, according to employer benefit surveys, but offer rates have leveled
off in recent years. At about the same time, the percentage of
Medicare-eligible retirees aged 65 and older with employment-based
coverage has remained relatively consistent. Meanwhile, employment-based
retiree health plans experienced increased costs to provide coverage, with
one employer benefit survey citing double-digit annual average increases
from 2000 through 2003. Financial statements we reviewed for a random
sample of 50 Fortune 500 employers showed that over 90 percent of the
employers that offered retiree health coverage had increased
postretirement benefit obligations from 2001 through 2003. Private and
public plan sponsors, including those that provide coverage for
Medicare-eligible retirees, have responded to increasing costs by
implementing strategies that require these retirees to pay more for
coverage and thus contribute to a gradual erosion of the value and
availability of benefits.

    Employer Benefit Surveys Show Decrease in Share of Employers Offering Health
    Benefits to Retirees, but Trend Has Leveled Off in Recent Years

Employer benefit surveys reported that the percentage of employers
offering health benefits to retirees has decreased since the early 1990s;
however, these offer rates have remained relatively stable in recent
years. A series of surveys conducted by Mercer Human Resource Consulting
indicated that the portion of employers with 500 or more employees
offering health insurance to Medicare-eligible retirees declined from 44
percent in 1993 to 27 percent in 2001, and leveled off from 2001 through
2004, with approximately 28 percent offering the benefits to
Medicareeligible retirees in 2004 (see fig. 2).29 A second series of
surveys conducted by the Kaiser Family Foundation and Health Research and
Educational Trust (Kaiser/HRET) estimated that the percentage of employers
with 200 or more employees offering retiree health coverage-for those
Medicare

2870 Fed. Reg. 4,194. In its written comments, CMS indicted that it
released this final rule on January 21, 2005.

29See, for example, Mercer Human Resource Consulting, National Survey of
Employer-Sponsored Health Plans 2004 (forthcoming).

eligible or those under age 65 or both30-decreased from 46 percent in 1991
to 36 percent in 1993 and then leveled off from 1993 through 2004, with
approximately 36 percent of employers with 200 or more employees offering
retiree health benefits to these groups in 2004 (see fig. 3).31 For
Medicare-eligible retirees specifically, the percentage of employers in
the Kaiser/HRET survey offering coverage fluctuated from 1995 to 2004, but
differed by only 1 percentage point in 1995 (the earliest data available)
and 2004, with 28 and 27 percent of employers, respectively, offering
coverage in these 2 years. Coverage for early retirees, those under age
65, has also been significantly affected since the early 1990s. For
example, the Mercer surveys showed a steady decline in employers with 500
or more employees offering coverage to this population from 50 percent in
1993 to 34 percent in 2001, although this percentage has generally leveled
off since 2001.

30Unless otherwise specified, the percentage of employers in the
Kaiser/HRET study that offer retiree health benefits may include employers
that offer health benefits to Medicareeligible retirees, retirees under
age 65, or both.

31Gary Claxton and others, The Kaiser Family Foundation; and Jon Gabel and
others, Health Research and Educational Trust, Employer Health Benefits
2004 Annual Survey (Menlo Park, Calif., and Chicago, Ill.: The Henry J.
Kaiser Family Foundation, 2004),
http://www.kff.org/insurance/7148/index.cfm (downloaded Dec. 8, 2004).

Figure 2: Mercer Survey Results-Percentage of Employers with 500 or More
Employees Offering Health Benefits to Medicare-Eligible Retirees,
1993-2004

Percentage 50

44

40

30

20

10

0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Not available

Sources: Mercer Human Resource Consulting; William M. Mercer,
Incorporated; and Foster Higgins.

Notes: Based on employer benefit surveys from 1993 through 2004. The
Mercer data include employers that offer coverage on a continuing basis to
newly hired employees as well as employers that may limit coverage to
individuals who were hired or who retired before a specified year. The
dotted line from 2001 to 2003 indicates that comparable 2002 data were not
available because of a wording change on the 2002 survey questionnaire. In
2003, Mercer modified the survey questionnaire again to make the data
comparable to prior years (except 2002). Thus, consistent with the Mercer
2003 survey, we have excluded data for 2002. Although Mercer provided us
with the 2004 data, the comprehensive 2004 annual report will not be
available until March 2005.

Figure 3: Kaiser/HRET Survey Results-Percentage of Employers with 200 or
More Employees Offering Health Benefits to All Retirees and to
Medicare-Eligible Retirees, 1991-2004

Percentage 50

46

40

30

20

10

0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

All

Medicare-eligible

Not available

Sources: Kaiser/HRET and KPMG Peat Marwick.

Notes: Based on KPMG Peat Marwick surveys from 1991 through 1998 and
Kaiser/HRET surveys from 1999 through 2004. The data for "all" retirees
may include employers that offer health benefits to Medicare-eligible
retirees, retirees under age 65, or both. Data for all retirees were
unavailable for 1994 and 1996. Data for Medicare-eligible retirees were
unavailable from 1991 through 1994 and for 1996.

In 2003, Kaiser/HRET made changes to its survey methodology that resulted
in adjustments to some of the estimates reported in prior-year reports.
The differences resulting from these adjustments for the retiree health
benefits data were not statistically different.

Employer benefit consultants and the 15 private and public sector plan
sponsors that we interviewed consistently cited a general erosion in
health benefits for all retirees, including those who are
Medicare-eligible, but some officials we interviewed also told us that
plan sponsors that could eliminate benefits had already done so, which is
consistent with the period of leveling off shown in the Mercer and
Kaiser/HRET surveys. For example, although the provision of health
benefits for all retirees by employers is generally voluntary, officials
we interviewed noted that employers that continue to offer retiree health
benefits may be limited in their ability to decrease benefits further
because of existing contracts with unions, which are generally negotiated
every 3 to 5 years. According to the 15 private and public sector plan
sponsors and employer benefit consultants that we interviewed, many plan
sponsors have restricted coverage for future retirees-including those who
are Medicare-eligible-

but have continued to offer benefits to existing retirees, which would
also contribute to a leveling off of these rates.

Large employers are more likely than small employers to offer retiree
health coverage, including coverage for Medicare-eligible retirees. For
example, Kaiser/HRET data for 2004 showed that 36 percent of employers
with 200 or more employees offered health benefits to retirees compared to
approximately 5 percent of employers with 3 to 199 employees. Within the
Mercer and Kaiser/HRET definitions of large employers (at least 500 and at
least 200 employees, respectively), those with the greatest numbers of
employees were the most likely to sponsor health benefits for retirees.
For example, Kaiser/HRET reported that approximately 60 percent of
employers with 5,000 or more employees offered health benefits in 2004 to
retirees compared to about 31 percent of employers with 200 to 999
employees. Based on the 2003 Mercer survey, 63 percent of employers with
20,000 or more employees offered coverage specifically to Medicareeligible
retirees compared to 23 percent of employers with 500 to 999 employees.32

In addition, employers with a union presence were more likely to offer
retiree health coverage than those employers without a union presence.
According to the 2004 Kaiser/HRET survey, among employers with 200 or more
employees, 60 percent of these employers with union employees offered
health coverage to retirees compared to 22 percent of these employers
without union employees.

The provision of retiree health coverage also varies between the private
and public sector and by industry type. For example, employers in the
public sector were more likely than employers in the private sector to
offer coverage to retirees, including those who are Medicare-eligible. All
federal government retirees-Medicare-eligible and those under age 65- are
generally eligible for FEHBP health benefits and pay the same premiums as
active federal workers for the same benefits, including

32Mercer Human Resource Consulting, National Survey of Employer-Sponsored
Health Plans: 2003 Survey Report (New York, N.Y.: Mercer Human Resource
Consulting, Inc., 2004).

prescription drugs.33 State plan sponsors also typically have higher offer
rates than private sector employers for retirees. For example, the 2004
Kaiser/HRET study showed that 77 percent of state and local government
employers with 200 or more employees offered coverage to retirees compared
with the average offer rate of 36 percent across all employer industries.
For retirees aged 65 and older, Medical Expenditure Panel Survey (MEPS)
data for 2002 indicated that approximately 86 percent of state entities
offered health insurance to this group of retirees.34 After government
employers, according to the 2004 Kaiser/HRET study, the industry sector
with the next highest percentage offering retiree coverage was
transportation/communication/utility, with 53 percent of all employers in
this industry sector (200 or more employees) offering health benefits to
their retirees in 2004. The industry sectors in this survey least likely
to offer coverage were health care and retail, with 22 percent and 10
percent, respectively, of employers (200 or more employees) in these
industry sectors offering retiree health benefits.

    Percentage of Medicare-Eligible Retirees with Employment-Based Health
    Coverage Remained Consistent

The overall percentage of Medicare-eligible retirees and their insured
dependents aged 65 and older obtaining employment-based health benefits
through a former employer has remained relatively consistent from 1995
through 2003, based on data from the U.S. Census Bureau's Current
Population Survey (CPS). According to our analysis of CPS data, the
percentage of Medicare-eligible retirees aged 65 and older with
employment-based health coverage and their insured dependents was

33To qualify, a federal retiree must have been continuously enrolled (or
covered as a family member) in any FEHBP plan(s) for the 5 years of
service immediately before retirement begins, or for the full period(s) of
service since the first opportunity to enroll (if less than 5 years). 5
U.S.C. S: 8905(b) (2000). When a federal retiree covered by Medicare uses
health care, the bill for the care is sent first to Medicare, which pays
for covered care according to its payment rules and then the bill is sent
to the FEHBP plan, as secondary payer, which pays for care covered under
its policy that is not covered by Medicare. In 2003, OPM reported that
about 2.6 million people (including spouses, dependents, and survivors)
received benefits through retirees who were enrolled in FEHBP. Of this
group, approximately 1.7 million were Medicare beneficiaries.

34This percentage had increased from about 69 percent in 1998. MEPS also
reported for both 1998 and 2000 that about 80 percent of full-time
employees at large public sector employers (1,000 or more employees)
worked where health insurance was offered to retirees aged 65 and older.

approximately 32 percent in 1995 and 31 percent in 2003.35 Among
Medicare-eligible retirees and their insured dependents aged 65 through 69
and aged 70 through 79, there was a modest decline in the percentage with
employment-based health coverage from 1995 through 2003, but a modest
increase among Medicare-eligible retirees and their insured dependents
aged 80 and over (see fig. 4). The modest decline among those aged 65
through 69 and aged 70 through 79 relative to all Medicare-eligible
retirees aged 65 and over may be because plan sponsors are more likely to
reduce benefits for future or recent retirees than for all retirees. Thus,
the effect of changes that plan sponsors have made to their retiree health
benefits may take additional time to be evident in the percentage of
current retirees receiving employment-based health benefits.

35These percentages include retirees aged 65 or over with employment-based
health coverage from a former employer or union as well as the insured
dependents of these individuals who are also Medicare-eligible retirees
aged 65 or over and who have employment-based health coverage, such as
spouses.

Figure 4: Percentage of Medicare-Eligible Retirees and Their Insured
Dependents with Employment-Based Health Benefits, by Age Group, 1995-2003

                                 Percentage 50

                                       39

                                       40

Retiree health costs continue to increase for many plan sponsors of
retiree health coverage, including those that provide coverage to
Medicareeligible retirees. Our analysis of financial statements filed with
the SEC by a sample of 50 Fortune 500 employers pointed to increases-some
50 percent or higher-in employers' obligations for postretirement benefit
obligations from 2001 through 2003. Employer benefit surveys and our
interviews with officials from 15 private and public plan sponsors have
also cited increased retiree health costs. These increases often have
prompted plan sponsors to attempt to contain cost growth to provide
coverage in a variety of ways, including requiring greater cost sharing
from retirees.

                                       30

                                       20

                                      10 0

1995 1996 1997 1998 1999 2000 2001 2002 2003

65 to 69

                                  Age in years

70 to 79

80 and older Source: GAO analysis of March CPS Supplement and Annual
Social and Economic Supplement to the CPS.

Notes: Based on the March CPS Supplement from 1996 through 2002 and the
Annual Social and Economic Supplement to the CPS from 2003 through 2004.
The age categories for insured dependents are based on the age of the
actual individual, not the primary policyholder. For example, an
80-year-old insured dependent is counted as 80 years of age regardless of
the age of the primary policyholder. All differences by age group
comparing 1995 to 2003 CPS data are statistically significant.

    Faced with Increasing Costs, Plan Sponsors Have Implemented Various
    Cost-Cutting Strategies, Which Often Require Retirees to Pay More for
    Coverage

Increasing Cost of Providing Retiree Health and Prescription Drug Coverage

The cost of providing retiree health coverage-and prescription drug costs
in particular-is increasing for many plan sponsors. Financial statements
filed with the SEC by 50 randomly selected Fortune 500 employers showed
that over 90 percent of the 38 employers that reported postretirement
benefit obligations from 2001 through 2003 had an increase in these
obligations during this period.36 About 20 percent of these 38-8
employers-had an increase in their obligations above 50 percent, while
one-third of these 38-13 employers-had an increase of between 25 and 50
percent from 2001 through 2003. During this same period, the Bureau of
Labor Statistics estimated that the Consumer Price Index, which reports
prices for all consumer items, increased 5.3 percent, a 1.8 percent
average annual rate of increase. Over 80 percent of the 38 employers that
reported postretirement benefit obligations from 2001 through 2003 had a
change in their postretirement benefit obligations that exceeded the
Consumer Price Index increase of 5.3 percent for all consumer items from
2001 through 2003.37

Data from employer benefit surveys also showed increased costs for plan
sponsors for roughly the same period. For example, a survey conducted in
2004 by the Kaiser Family Foundation and Hewitt Associates reported that
the total cost of providing health benefits to all retirees for employers
surveyed (1,000 or more employees) rose rapidly between 2003 and 2004,
with an estimated average annual increase of nearly 13 percent.38 Mercer
data projections by employers for 2003 also showed an average annual cost
increase of approximately 11 percent from 2002 for Medicare-eligible
retirees from-$2,702 to $3,003-the fourth straight year of double digit
increases. (For active employees, employers in the Mercer survey reported

36The postretirement benefit obligations included retiree health benefits
and other postretirement benefits, but not pensions. One employer in our
sample of 50 Fortune 500 employers that sponsor health coverage for
retirees is not included in this analysis because it did not report
postretirement benefit obligations for 2001 and 2003.

37The Consumer Price Index for medical care increased by 13.1 percent from
2001 through 2003, an average annual increase of 4.3 percent.

38Kaiser/Hewitt 2004 Survey on Retiree Health Benefits. The data in this
report reflect the responses of 333 private sector employers with 1,000 or
more employees that offered health benefits to retirees at the time of the
survey. Because the sample in this study is nonrandom, its results cannot
be compared to data from prior Kaiser/Hewitt surveys.

a 10 percent increase in 2003 in the average total health benefit cost
from 2002.39)

The cost for public sector plan sponsors to provide retiree health
coverage, both for Medicare-eligible retirees and those under age 65, is
also increasing. For example, one public sector plan sponsor we
interviewed reported that retiree health care costs had doubled in a
6-year period, from $440 million in 1998 to over $900 million in 2003,
with an average annual cost in 2004 of $3,542 per Medicare-eligible
retiree, compared to $1,822 per Medicare-eligible retiree in 1998. For
FEHBP, as set in statute, the federal government pays 72 percent of the
weighted average premium of all health benefit plans participating in
FEHBP but no more than 75 percent of any health benefit plan's premium.40
Thus, retirees and active workers pay approximately 28 percent of their
plan premiums-a share that has not changed since it became effective in
January 1999.41 While the percentage of plan premiums contributed by the
government has remained constant in recent years, the actual rates have
increased over time. In December 2002, we reported that health insurance
premiums for FEHBP plans had increased on average about 6 percent per year
from 1991 through 2002.42 According to OPM, average FEHBP premiums
increased by 11 percent in 2003, about 11 percent in 2004, and about 8
percent for 2005.

Prescription drug benefits represent a large share of plan sponsors'
retiree health costs, particularly for Medicare-eligible retirees. In
2002, prescription drug costs were cited as a key driver of increases in
employment-based retiree health costs and were estimated to be typically
50 to 80 percent of an employer's total health care costs for Medicare

39Mercer noted that the 10 percent increase in the average total health
benefit cost for active employees was less than the previous annual
increase of 14.7 percent that occurred between 2001 and 2002 and likely
reflected steps taken by employers to cut costs, such as changing plan
design to increase employee out-of-pocket costs, reducing covered
services, and dropping costly plans. Costs reported for active employees
and retirees include both employer and employee/retiree shares.

405 U.S.C. S: 8906(b)(1) and (2) (2000).

41The Balanced Budget Act of 1997 authorized the current formula for
calculating the federal government's share of FEHBP premiums, effective
January 1999. Pub. L. No. 105-33, S: 7002, 111 Stat. 251, 662.

42See GAO, Federal Employees' Health Plans: Premium Growth and OPM's Role
in Negotiating Benefits, GAO-03-236 (Washington, D.C.: Dec. 31, 2002).

Private Sector Plan Sponsors' Cost-Cutting Strategies

eligible retirees.43 According to 2001 MCBS data, prescription drug
expenditures for retired Medicare beneficiaries that were paid by
employment-based insurance accounted for 45 percent of all health care
expenditures for these beneficiaries. Three Fortune 500 employers we
interviewed reported that prescription drug costs for Medicare-eligible
retirees and their dependents ranged from approximately 56 to 64 percent
of their total estimated annual cost of providing health benefits for this
same population.

Faced with increasing costs, private sector plan sponsors have implemented
certain strategies to reduce these obligations that often require retirees
to pay more for coverage and contribute to a general erosion in the value
and availability of health coverage for retirees. For example, many plan
sponsors have increased cost sharing through increased copayments,
coinsurance, and premium shares; restricted eligibility for benefits based
on retirement or hiring date; implemented financial caps or other limits
on plan sponsors' contributions to coverage; and made changes to
prescription drug benefits, such as creating tiered benefit structures and
increasing retiree out-of-pocket contributions. These cost-cutting
strategies are not new-in 2001 we reported that employers had implemented
similar mechanisms designed to control retiree health care expenditures.44
However, according to private plan sponsors we interviewed, the share of
costs paid by retirees is increasingly affected as the plan sponsors reach
and enforce financial caps and other limits they had set. While these
strategies are intended to limit the increase in plan sponsor obligations,
the information provided by employer benefit surveys and the plan sponsors
and consultants we interviewed did not specify the magnitude of any
decrease in plan sponsors' costs for retiree health benefits that could be
attributed to these changes.

Increasing Retirees' Cost Sharing. One strategy that plan sponsors have
adopted to limit their obligations for retiree health costs is increasing
the share of costs for which the retiree is responsible. For example,
employers have increased retiree copayments and coinsurance. When asked
about changes made "in the past year," Kaiser/Hewitt reported that

43Anna Rappaport and Derek Guyton, Mercer Human Resource Consulting,
Retirees and Focused Prescription Drug Programs (New York, N.Y.: Apr. 18,
2002),
http://www.mercerhr.com/knowledgecenter/reportsummary.jhtml?idContent=1011310
(downloaded Dec. 29, 2004).

44GAO-01-374.

nearly half of its surveyed private employers (1,000 employees or more)
had increased cost sharing.45 The majority of employers in the
Kaiser/Hewitt study reported that they expected to make similar increases
"for the 2005 plan year," with 51 percent indicating they were very or
somewhat likely to increase retiree coinsurance or copayments. These
increases are consistent with the changes cited in our interviews with
private employers and with officials we interviewed at other
organizations, including benefit consulting firms and an organization
representing unions. For example,

o 	one employer we interviewed reported cost sharing increases for all
retirees every year since 1993;

o 	another employer we interviewed introduced a mix of coinsurance and
copayment requirements in January 2004 to address rising health care costs
and make retirees more aware of the cost of the benefits they received;
and

o 	a third employer we interviewed that had historically paid
approximately 90 percent of total retiree health care costs was planning
to increase the share of costs borne by retirees who had retired prior to
1994 from approximately 10 percent to 20 percent of health care costs by
January 1, 2006.

Increasing Premiums. Increased contributions by retirees to health care
premiums is another area where plan sponsors have continued to make
changes to control their health care expenditures. Kaiser/Hewitt data
showed that 79 percent of surveyed employers had increased retiree
contributions to premiums in the past year, and 85 percent reported that
they were very or somewhat likely to increase these contributions for the
2005 plan year. Retiree contributions for new retirees aged 65 and over
increased, on average, 24 percent from 2003 to 2004, according to the
Kaiser/Hewitt study. The Mercer 2003 study reported that employers varied
retiree premium contributions, with Medicare-eligible retirees paying on
average about 38 percent of plan premiums when the cost was shared between
the employer and the retiree, an increase of approximately 4 percentage
points since 1999.46 Four of the 12 Fortune 500

45The survey was conducted from May through September 2004. Unless
specifically noted, the data reported by Kaiser/Hewitt regarding the
changes made by employers "in the past year" and the changes that
employers expect to make "for the 2005 plan year" were not specific to
Medicare-eligible retirees or retirees under age 65.

46Data reported for retiree-only coverage. The Mercer survey sample also
included some government agencies.

plan sponsors we interviewed also reported changes to premiums. For
example, one plan sponsor made a change in 2004 to increase premiums for
all individuals retiring after January 1, 2004, consistent with increases
in premiums for active workers, whereas previously retirees kept the same
premiums for life. Officials we interviewed representing unions and their
members also cited increased premiums for many retired union workers.

Some employers are also beginning to offer access-only coverage to some or
all retirees, in which employers allow retirees to buy into a health plan
at the group rate, but without any financial assistance from the employer.
For example, according to 2003 Mercer data, about 37 percent of retiree
health plans for employers with 500 or more employees required
Medicare-eligible retirees to pay the full cost of the employment-based
plan. Thirteen percent of the Kaiser/Hewitt employers reported making a
change in the past year to provide access-only coverage to retirees, with
retirees paying 100 percent of the costs. A supplement to the 2004
Kaiser/HRET survey examined the percentage of Medicare-eligible retirees
with access-only coverage and found that 5 percent of Medicare-eligible
individuals who are retired from employers with 200 or more employees that
offer retiree health benefits had such coverage.47 While 5 of the 12
Fortune 500 plan sponsors we interviewed had implemented access-only
coverage, 1 of these plan sponsors had implemented this level of coverage
for all of its retirees in the early 1990s in response to health care
costs. The other 4 plan sponsors had implemented the access-only change at
a later date, implementing it for some or all employees ranging from those
hired after January 1, 1995, to those retiring on or after January 1,
2007.

Reducing Benefits for Future Retirees. Implementing access-only coverage
is often part of a broader movement by plan sponsors to restrict
eligibility or offer reduced benefits for employees who are hired or
retire after a certain date. In December 2004, Kaiser/Hewitt reported that
8 percent of surveyed employers (with 1,000 or more employees) said they
had made a change "in the past year" to eliminate their subsidized health
benefits for future retirees, typically for those hired after a specific
date. Of the 12 Fortune 500 plan sponsors we interviewed, 5 plan sponsors
had eliminated retiree health coverage for some or all individuals hired
after a certain date, ranging from January 1, 1993, to January 1, 2003,
while 4 of

47"Retiree Health Benefits, 2004: The Medicare Payment Advisory
Commission's Supplement to the Kaiser/HRET Survey of Employer-Sponsored
Health Benefits" (public meeting sponsored by the Medicare Payment
Advisory Commission, Ronald Reagan Building, Washington, D.C., Nov. 16,
2004).

the 5 plan sponsors that had switched to providing access-only coverage
did so for some or all of their future retirees. Some plan sponsors said
that they generally avoided making changes for current retirees rather
than for future retirees, who may be in a position to make other
arrangements. In addition, plan sponsors generally tried to minimize the
disruption when making changes for those already in retirement. For
example, one Fortune 500 plan sponsor we interviewed carried 15 separate
health plans for several years that had accumulated as the result of
grandfathering in current coverage levels for existing retirees. It was
only in 2003 that the company consolidated the 15 plans into 3 plans and
instituted changes affecting both existing and some future retirees. Plan
sponsors that have either eliminated coverage or created access-only plans
for some or all retirees generally reported that recruitment had not been
affected. One plan sponsor we interviewed, however, noted that current
employees' retirement planning could be affected, as some employees might
stay longer with the company because they could not afford to retire. This
sentiment is consistent with data reported in Mercer's 2003 annual survey
of employer-sponsored health plans showing that retirees tended to delay
retirement when their employers did not sponsor retiree medical plans.

Introducing and Enforcing Financial Caps. In 2001, we reported that some
employers had established caps and other limits on expenditures for
retiree health benefits, but it was not clear at that time how employers
would ensure that spending did not exceed the caps and how coverage would
be affected.48 Employers began to implement caps in response to rising
retiree health costs and to accounting changes introduced in the early
1990s when the Financial Accounting Standards Board (FASB) adopted
Financial Accounting Standards (FAS) 106, requiring employers to report
annually on the obligation represented by the promise to provide retiree
health benefits to current and future retirees.49 The 2003 annual survey
of employer-sponsored health plans conducted by Mercer shows

48GAO-01-374.

49FAS 106, Employers' Accounting for Postretirement Benefits Other Than
Pensions, required employers to report accrued retiree medical obligations
beginning with plan years starting after December 15, 1992 (implementation
for some employers began after December 15, 1994). By capping employer
premium contributions above the then-current levels, employers could
substantially reduce their obligations and still shield retirees from
large premium increases. Some employers have said that FAS 106
requirements were a reason for reducing retiree health benefits. While FAS
106 did not affect an employer's cash flow, there was concern that listing
this future obligation could affect companies' stock prices because the
reporting of projected retiree health care costs affects the overall
statement of financial profitability.

that 18 percent of employers with 500 or more employees have implemented
caps, while an additional 10 percent of such employers were considering
them. Caps were most common among the employers with the largest number of
employees in the Mercer study (20,000 or more employees); 33 percent of
such employers had implemented these limits on overall spending and 9
percent were considering them. Similarly, 54 percent of employers with
1,000 or more employees offering retiree coverage in the 2004
Kaiser/Hewitt employer survey reported having capped contributions. Ninety
percent of employers in the Kaiser/Hewitt study that have hit caps or
anticipated hitting caps in the next year reported that they intended to
enforce them or already had.

Of the 12 Fortune 500 plan sponsors we interviewed, 8 had implemented
capped contributions or other limits on retiree health spending. For
example, 1 plan sponsor reported monthly caps of $217 per person for
nonunionized retirees under age 65 and $51 per person for nonunionized
Medicare-eligible retirees. Another plan sponsor provided fixed company
health care credits for its retirees under age 65 (unionized and
nonunionized) in which an individual could receive up to $3,750 to apply
to the plan sponsor's estimate for health care costs for a retiree under
age

65. While many plan sponsors had implemented these types of limits, they
varied as to whether all groups of retirees were affected and whether the
caps had been reached and thus enforced. For example, 2 of the 12 Fortune
500 plan sponsors we interviewed had capped benefits for some individuals
depending on the individual's date of retirement (typically more recent
retirees were affected), and in some cases the caps varied by whether
retirees were part of a union or former employees of an acquired company.
The plan sponsors we interviewed whose retiree health benefit costs had
reached the caps generally were enforcing them. For example, one plan
sponsor required some retirees-both Medicare-eligible and those under age
65-to pay a portion of premiums for the first time after the plan's costs
reached the cap in 2002. However, implementing and enforcing caps can be
an issue in union negotiations. One plan sponsor we interviewed had opted
in the past to negotiate benefit changes with unions to delay hitting the
caps, but now expects to hit and enforce the caps by 2007. Another plan
sponsor, while enforcing the financial caps for retiree health benefits,
has agreed in some union negotiations to give retirees an additional
contribution toward health care expenses that effectively offsets the
premium increases triggered by reaching the caps. A few plan sponsors and
benefit consultants we interviewed noted that employers are more likely
today to enforce caps than to raise them. For example, the 2003
Kaiser/Hewitt study stated that there is some concern that auditors

Public Sector Plan Sponsors' Cost-Cutting Strategies

will question the effectiveness of a cap if there is a pattern of
continually raising it once costs approach the set limit.

Implementing Changes to Prescription Drug Benefit Design. Given the
sensitivity of retiree health benefits to prescription drug costs, many
plan sponsors have made changes to prescription drug benefits. The primary
mechanisms cited by the 2004 Kaiser/Hewitt employer benefit survey and
benefit consultants and the 12 Fortune 500 plan sponsors we interviewed
included increasing copayments; switching from copayments to coinsurance;
and implementing tiered benefit structures in which generic drugs,
formulary/preferred drugs, and nonformulary/nonpreferred drugs are subject
to different retiree copayment and coinsurance rates. Over half of the
employers in the 2004 Kaiser/Hewitt study reported having increased
copayments or coinsurance for prescription drugs in the past year, and 15
percent had replaced fixed-dollar copayments with coinsurance in the past
year. Over half of the plan sponsors offered a three-tiered benefit
structure, and among plans with this design, about two-thirds require
copayments and nearly one-fourth required coinsurance for retail pharmacy
purchases. In addition, about one-fourth of the Kaiser/Hewitt-surveyed
employers had instituted a three-tiered drug plan in the past year to save
money.

The 12 Fortune 500 plan sponsors we interviewed echoed these types of
changes in their prescription drug benefit for retirees within the last 5
years. For example, 3 plan sponsors had instituted retiree coinsurance
requirements, which can make retirees more price conscious because the
retiree out-of-pocket cost is higher for more expensive drugs than for
less expensive drugs. One plan sponsor reported it had increased drug
copayments for retirees. Several of the 12 Fortune 500 plan sponsors we
interviewed already had tiered benefits in place. One plan sponsor had
implemented a three-tiered structure as well as mandatory use of a
mailorder pharmacy for some prescription drugs. Another plan sponsor
reported it planned to implement "step-therapy" in January 2005, in which
retirees would have to demonstrate the ineffectiveness of a lower-cost
generic drug before receiving coverage for a higher cost brand-name drug.
Officials we interviewed representing unions and their members noted
similar prescription drug trends for many former union workers.

While public sector plan sponsors generally offer more coverage than those
in the private sector, these plan sponsors are also starting to implement
cost-cutting mechanisms similar to those implemented in the private
sector, with one major exception-they generally are not eliminating
retiree health benefits for future retirees. For example, in

December 2002, we reported that FEHBP plans had implemented some benefit
reductions for all enrollees-mostly by increasing enrollee cost sharing.50
We reported that three large fee-for-service plans had increased or
introduced cost sharing features such as copayments or coinsurance for
prescription drugs and deductibles for other services.51 OPM officials
informed us that FEHBP plans have implemented cost-containment strategies
relating to prescription drugs, such as three-tiered cost sharing,
comparable to private sector employers. However, OPM does not implement
cost-containment strategies for retirees that do not also affect active
workers.

Similarly, other public sector plan sponsors, such as state governments,
are starting to reduce benefit levels and implement cost-cutting
mechanisms, including changes to prescription drug benefits. However,
eliminating retiree health benefits entirely for current or future
retirees does not appear to be as prevalent in the public sector as the
private sector. For example, a 2003 survey conducted by the Segal Company,
a benefit consulting firm specializing in the public sector, reported that
no state plan sponsor in its survey was considering eliminating retiree
health coverage as a cost-containment strategy.52 A 2003 study prepared by
Georgetown University for the Kaiser Family Foundation that collected
survey data from 43 states and the District of Columbia also found that no
state government had terminated subsidized health benefits for current or
future retirees and no state government was planning to do so.53 However,
the Georgetown study found that 24 of these states reported increased cost
sharing in the past 2 years, while 13 had increased retiree premium shares
in the past 2 years. A study released by AARP in July 2004 on state
government retiree health benefits found that 11 states required Medicare

50GAO-03-236.

51In 1990, OPM required all FEHBP plans to provide prescription drug
coverage.

52The Segal Company, 2003 Segal State Health Benefits Survey: Medical
Benefits for Employees and Retirees (n.p.: The Segal Group, Inc., 2003),
http://www.segalco.com/government/pub-govt.cfm?ID=458 (downloaded Dec. 2,
2004). Segal surveyed all 50 states after collecting information available
on state Web sites and requesting enrollment packages from each state.
Thirty-nine states provided their enrollment packages and 34 states
completed all or portions of the survey questionnaire. According to the
report, the survey covers more than 80 percent of total state health plan
enrollment, representing more than 3 million employees and retirees.

53Jack Hoadley, Health Policy Institute, Georgetown University, How States
Are Responding to the Challenge of Financing Health Care for Retirees
(Menlo Park, Calif.: The Henry J. Kaiser Family Foundation, September
2003).

eligible retirees to pay the full amount of the premium.54 Almost all of
the states in the Georgetown study cited prescription drugs as the most
important driver behind the growth in state retiree health spending and,
as a result, have taken specific steps to manage these costs, such as
increasing cost sharing and implementing tiered benefit structures. The
majority of states in the AARP study had three-tiered copayment benefits.
One public sector plan sponsor we interviewed is proposing significant
changes to keep its retiree health benefits fund solvent that would vary
the employer's contribution toward retiree health care costs on the basis
of the retiree's age and years of service, rather than paying the full
cost of coverage for those meeting the minimum age and service
requirements.

Benefit consultants and officials from other organizations we interviewed
noted new pressures on public sector funding of retiree health care
benefits as a result of standards adopted in 2004 by the Governmental
Accounting Standards Board (GASB) that affect the reporting of
postretirement benefit obligations for many public sector sponsors of
employment-based retiree health coverage.55 Similar to FAS 106 for private
sector employers, the new standards require public sector plan sponsors,
including state governments, to accrue the costs of postretirement health
care benefits during the years of service as opposed to reporting these
costs on a pay-as-you-go basis. However, the GASB standards are not
identical to those in the private sector, and the July 2004 AARP study
noted that it is unclear whether the experience of FAS 106-and its
frequently cited impact on the decrease in employment-based retiree health
coverage-would directly translate to the public sector. While the study
stated that the new GASB standards might encourage state governments to
reduce retiree health benefit programs in order to reduce

54Stan Wisniewski and Lorel Wisniewski, State Government Retiree Health
Benefits: Current Status and Potential Impact of New Accounting Standards
(Workplace Economics, Inc., commissioned by the AARP Public Policy
Institute) (Washington D.C.: AARP, July 2004),
http://research.aarp.org/health/2004_08_benefits.html (downloaded July 29,
2004).

55Statement No. 43, Financial Reporting for Postemployment Benefit Plans
Other Than Pension Plans, and Statement No. 45, Accounting and Financial
Reporting by Employers for Postemployment Benefits Other Than Pensions.
The requirements apply to all public sector plans that cover
postemployment benefits (other than pensions) and the sponsoring entities,
such as public employee retirement systems, public colleges, and
hospitals. The standards are effective in three phases based on a public
sector entity's total annual revenues. For Statement No. 43, the largest
employers begin in the first period after December 15, 2005, and the
smallest employers begin 2 years later. For Statement No. 45, the largest
employers begin in the first period after December 15, 2006, and the
smallest employers begin 2 years later.

  Employers and Plan Sponsors Considering MMA Options for Prescription Drug
  Coverage, Often Considering Subsidy as Primary Option for Some or All
  Medicare-Eligible Retirees

obligations, it also noted that these standards alone were not likely to
cause major program changes. Regardless, benefit consultants and other
officials we interviewed cited notable implications for public sector
employers. For example, large unfunded obligations can affect bond ratings
in the public sector, which affect these public sector entities' ability
to borrow money. One benefit consultant told us that its public sector
clients are raising issues such as plan design, cost, financing, and the
possible reduction of retiree health benefits in light of the new GASB
standards. The provision of retiree health benefits in the public sector
may also be affected by other factors, such as state budget deficits and
state political pressures.

At the time of our review, many employers and plan sponsors said they had
not decided which MMA options they would implement for their
Medicare-eligible retirees, but the primary option many sponsors were
considering was the subsidy. Ten of the 15 plan sponsors we interviewed
said that while undecided, they were considering the federal subsidy
option for some or all of their Medicare-eligible retirees, while 2 other
plan sponsors had chosen the subsidy option for all their
Medicare-eligible retirees. Four plan sponsors we interviewed were
concerned that because their benefits already had reached or soon would
reach the caps they had set on their retiree health benefit obligations,
they would be ineligible for the subsidy and therefore said that
redesigning their benefits to wrap around Medicare would be prudent. In
our random sample of 50 Fortune 500 employers, most that reported
obligations for retiree health benefits indicated that they would choose
the federal subsidy or other options, but others had not reported their
final MMA decisions on their financial statements filed with the SEC as of
November 2004. In addition, 2 plan sponsors we interviewed were
considering Medicare Advantage plans, but these plan sponsors were waiting
to see how the market for these developed. While plan sponsors generally
expected to continue to maintain coverage levels for their retirees as
they considered their MMA options, they acknowledged that cost pressures
could cause them to reevaluate their benefits. If employers were not
already providing prescription drug benefits to retirees, most benefit
consultants and other experts we interviewed said that the MMA was not
likely to prompt employers to begin providing coverage or supplementing
the Medicare benefits.

    Plan Sponsors We Interviewed Were Considering MMA Options for Prescription
    Drug Coverage, but Few Had Made Final Decisions

The Federal Subsidy

The 15 private and public sector sponsors of retiree health benefit plans
we interviewed were considering their MMA options for prescription drug
coverage, but few had decided which MMA options they would choose for all
their Medicare-eligible retirees. Of the 15 plan sponsors we interviewed,
12 were Fortune 500 private sector employers. Two of the 12 had made a
decision for all of their Medicare-eligible retirees, and 10 said they had
not yet made their final decisions for some or all of their retirees and
were assessing the implications associated with the MMA options. Officials
from the three public sector sponsors of health benefit plans we
interviewed- the federal government and two state retirement systems-said
they were considering their options. Both private and public sector plan
sponsors told us they anticipated making their final decisions by early
2005. In addition, officials we interviewed representing multiemployer
plans told us that most multiemployer plans had not focused on the MMA
options to the same extent as single-employer private sector plan
sponsors, and therefore most were undecided about the options they would
implement. As part of their deliberations, plan sponsors were considering
several MMA options, including the federal subsidy option if they decided
to provide their own prescription drug benefits for Medicare-eligible
retirees; coordinating with part D by wrapping their prescription drug
benefits around the Medicare part D benefit, thus providing secondary
coverage; and several other options. In some cases, plan sponsors were
considering implementing a combination of options for different groups of
Medicareeligible retirees.

Ten of the 15 private and public sector sponsors of employment-based
retiree health benefits that we interviewed were considering the 28
percent federal subsidy for prescription drug costs for some, if not all,
Medicare-eligible retirees, although they were in different stages of the
decision-making process at the time of our interviews. Two private sector
sponsors had chosen the subsidy option for all of their Medicare-eligible
retirees. Three of the private and public sector sponsors, including OPM
for FEHBP, said they would not or did not expect to choose the subsidy
option.56 (See table 1.)

56Several recent surveys have also found that the subsidy is the primary
option employers are considering. Kaiser/Hewitt reported that 58 percent
of employers said they expected to choose the subsidy option for
prescription drug benefits in their largest plans; Kaiser/HRET reported
that about half of employers surveyed in early 2004 were likely to choose
the subsidy option; and Mercer reported that about 40 percent of plan
sponsors would apply for the subsidy. Each of the surveys also found that
some employers remained undecided about which MMA option they would select
for prescription drug coverage.

Table 1: Status of Decisions by 15 Private and Public Sector Plan Sponsors
Interviewed regarding the MMA Subsidy Option for Prescription Drug
Coverage

    Number choosing or considering MMA subsidy option Private sector Public

Fortune 500 sponsors

sector sponsors

                               MMA subsidy option

Subsidy

Choosing the subsidy option for all Medicare-eligible
retirees 2

Choosing the subsidy option for some Medicare-eligible
retirees and considering other options for other Medicare
eligible retirees 3

Considering the subsidy option 5

                                   No subsidy

Not choosing the subsidy option for any Medicare-eligible
retirees 2 1a

Total 12

Source: GAO.

Note: Based on information from 15 sponsors of retiree health benefit
plans in the private and public sectors.

aOPM said it did not expect to choose the subsidy option for FEHBP.

Retiree health benefit plan designs and other circumstances affected plan
sponsors' decisions regarding the subsidy. In particular, whether a plan
sponsor had implemented financial caps on retiree health benefit
expenditures played a major role in the decision-making process.57 In
addition, plan sponsors that negotiated retiree health benefits with
unions said that they did not have as much flexibility to change these
benefits prior to negotiations. Three of the private sector plan sponsors
we interviewed said they would choose the subsidy option only for some of
their Medicare-eligible retirees because of capped benefits, the role of
unions, or both, as described in the following:

o 	One of the three plan sponsors capped health benefits for workers who
retired after a specific date, so it offered richer uncapped benefits to
those who retired before that date. This sponsor determined that the
uncapped

57Caps on benefits could cause an employer's prescription drug plan to have less
value on an actuarial basis than the standard part D benefit and not qualify for
                              the subsidy option.

benefits would be actuarially equivalent. Therefore, this plan sponsor
said it would choose the subsidy option for the uncapped benefits but was
not certain that the capped benefits would be actuarially equivalent for
purposes of the subsidy.

o 	Another of these sponsors offered many different prescription drug plan
designs to retirees with collectively bargained benefits (union retirees)
and those without collectively bargained benefits.58 This sponsor chose
the

subsidy option for all plans that met the actuarial equivalence test. The
sponsor's plans that were not likely to meet the actuarial equivalence
test typically had financial caps.

o 	The third sponsor said it was fairly certain it would choose the
subsidy option for its collectively bargained retiree prescription drug
benefits. While both the collectively bargained and noncollectively
bargained retiree benefits were capped, the unions had renegotiated higher
capped amounts for the collectively bargained benefits. The next
negotiation session with the primary union was scheduled for July 2006,
thereby making it difficult to make changes to these benefits other than
accepting the subsidy in the interim. The caps for the retirees with
noncollectively bargained benefits would be reached sooner and were less
likely to be actuarially equivalent. Therefore, this sponsor said it was
considering other options for the retirees with noncollectively bargained
benefits.

Although they had not made any final decisions on the MMA options at the
time of our interviews, 5 of the 12 private sector Fortune 500 sponsors of
employment-based health benefit plans we interviewed were considering the
subsidy option. Two of these 5 plan sponsors said they were likely to
apply for the subsidy for their Medicare retirees. Of the 2, 1-whose
employees were partially unionized and that had not capped any of its
retiree health benefits-said it did not "strongly consider" any other
options during its deliberations. The other of the 2 sponsors expected to
apply for the subsidy for all of the prescription drug plans for
Medicareeligible retirees that met the actuarial equivalence test. At the
time of our interviews, 3 of these 5 plan sponsors said they either needed
additional information from CMS regarding actuarial equivalence or needed
more time before they could make their final decisions about the subsidy
option.

58This plan sponsor obtained different plans through acquisitions. Also,
the plan sponsor negotiated about 80 to 90 contracts with about 20
different unions. However, not all the plans provide retiree health
benefits. In most cases, the plan sponsor could not change the retiree
health benefits without renegotiating with the unions. Taking collectively
bargained and noncollectively bargained retiree health benefits together,
the plan sponsor had about 100 different prescription drug plans. Some of
the retiree prescription drug plans had capped benefits amounts.

Two large state sponsors of health benefits for Medicare-eligible retirees
were considering the subsidy option along with others. OPM had not made
any decisions at the time of our interview, but in written comments on a
draft of this report it indicated that it did not expect to choose the
federal subsidy for FEHBP.

The subsidy option offers plan sponsors several advantages. Cost savings
associated with the subsidy played a major role in the plan sponsors'
decision-making process. Several benefit consultants and plan sponsors we
interviewed stressed the importance of cost savings when considering the
MMA options. Most of the plan sponsors we interviewed considered the
savings associated with the subsidy to be an advantage. For example, one
plan sponsor estimated that it would reduce its accumulated postretirement
benefit obligations by about $161 million just by choosing the subsidy
option for one group of its Medicare-eligible retirees.

Some plan sponsors and benefit consultants we interviewed said that most
of the prescription drug expenditures for Medicare-eligible retirees would
be eligible for the subsidy because most retirees incurred costs from $251
through $5,000, the range eligible for the subsidy as defined in the MMA.
While Medicare-eligible retirees' prescription drug expenditures could be
paid by several different sources, employment-based coverage accounted for
about 27 percent of total expenditures in 2001, while out-of-pocket
payments accounted for about 37 percent, according to our analysis of
MCBS. According to our projections of the estimated amount of
Medicareeligible retirees' total prescription drug expenditures that
employmentbased plans would pay for and that beneficiaries would pay
out-of-pocket in 2006, most of the expenditures from employment-based
coverage and from out-of-pocket-about 75 percent-could be eligible for the
subsidy (see fig. 5).59

59Also, when only considering Medicare-eligible retirees' prescription
drug costs covered by employment-based plans, our analysis showed that
about 76 percent of these expenditures are projected to be $251 through
$5,000, the range eligible for the subsidy in 2006.

Figure 5: Under the MMA Subsidy Option, the Portion of Retired Medicare
Beneficiaries' Prescription Drug Expenditures Paid by Employment-Based
Coverage and Paid Out-of-Pocket Eligible for Subsidy, Estimate for 2006

Source: GAO analysis of MCBS data.

Note: MCBS data for 2001 inflated to 2006 using CMS's National Health Care
Expenditures Projections.

Preserving the benefits the plan sponsors currently provide and retaining
the control over and flexibility of the benefits were also cited as
advantages to choosing the subsidy option. Benefit consultants, plan
sponsors, and others we interviewed said that it would be easier for
beneficiaries if the benefits offered did not change. Choosing the subsidy
option also gave plan sponsors the ability to maintain control over the
benefits and their costs. In addition, preserving their current benefits
allowed plan sponsors time to see how other MMA options would play out in
the marketplace. For some plan sponsors, these advantages made the subsidy
the easiest, most seamless, and least risky option to pursue.

Several benefit consultants we interviewed said that to receive the
subsidy, sponsors of employment-based retiree health plans would have to
fulfill certain administrative reporting and record keeping requirements,
as identified by CMS. For example, sponsors will have to apply for the
subsidy no later than 90 days prior to the start of the calendar year,60
including providing an attestation regarding actuarial equivalence. Each

6070 Fed. Reg. 4,410. A plan sponsor would have to apply by September 30,
2005, to receive the subsidy for 2006.

application must include the names of all people enrolled in the sponsor's
drug plan to ensure that a sponsor is not receiving a subsidy for an
individual who is enrolled in a part D prescription drug plan or a
Medicare Advantage plan. The plan sponsor must also notify
Medicare-eligible retirees and their spouses and dependents whether their
retiree health plan provides "creditable coverage"-that is, generally
whether the expected amount of paid claims under the plan sponsor's
prescription drug coverage is at least equal to that of the expected
amount of paid claims under the standard part D coverage. This notice is
important because retirees who do not enroll in part D when first eligible
will be charged a penalty for late enrollment if they enroll after finding
that their previous employment-based coverage did not meet CMS's
creditable coverage criteria.61 A special enrollment period will be
provided, however, without a late enrollment penalty, when there is an
involuntary loss of creditable coverage because, for example, an employer
eliminates or reduces coverage.62 All plan sponsors choosing the subsidy
will have to document prescription drug costs that fall within the MMA's
eligibility criteria.

Although several benefit consultants saw the potential administrative
requirements as a disadvantage of the subsidy, most of the plan sponsors
we interviewed were not concerned about the subsidy's proposed
administrative requirements. For example, one plan sponsor told us it was
less concerned about how it would manage the subsidy's administrative
requirements than about how it would manage relations with retirees if it
changed prescription drug benefits under other MMA options. At the time of
our interviews, however, some plan sponsors said they were not fully aware
of or had not considered all of the administrative requirements.

Besides cost savings, ease for retirees, and administrative requirements,
plan sponsors we interviewed said they also considered other factors when
making decisions about the subsidy. For example, plan sponsors considered
as part of their decision-making process possible negative press,
potential for lawsuits, relations and communications with Medicareeligible
retirees, benefit equity between Medicare-eligible retirees and retirees
not yet eligible for Medicare, future union negotiations, hiring and

61MMA sec. 101, S:1860D-13(b), 117 Stat. 2104-06 (to be codified at 42
U.S.C. S: 1395w113(b)).

62MMA sec. 101, S: 1860D-1(b)(3) and (6), 117 Stat. 2073-74 and 2374-75
(to be codified at 42 U.S.C. S:S: 1395w-101(b)(3) and (6)).

Wrapping Retiree Drug Benefits around Medicare Part D

retention of workers, marketplace competition, and uncertainty about CMS
rules.

One alternative to choosing the federal subsidy option for plan sponsors
that provide prescription drug coverage to Medicare-eligible retirees is
the option of coordinating with part D by wrapping their benefits around
the new Medicare part D benefit by covering some drug costs not paid by
Medicare. Plan sponsors would offer coverage wrapping around Medicare part
D rather than providing their own comprehensive prescription drug
coverage. Prescription drug costs not covered by Medicare part D that plan
sponsors could cover might include the $250 deductible or the retirees'
costs within the coverage gap (i.e., the doughnut hole) until the Medicare
catastrophic coverage begins paying for most drug costs. Several plan
sponsors we interviewed said they were considering this option for
Medicare-eligible retirees along with the subsidy and other options as
part of their overall MMA deliberations. For example, one plan sponsor
said it was considering wrapping its drug benefits around the part D
benefit as its primary option for all its Medicare-eligible retirees
because it had set financial caps on its retiree health benefit
obligations that would eventually render it ineligible for the subsidy.
Three other plan sponsors told us they were considering wrapping their
prescription drug benefits around the part D benefit for those
Medicare-eligible retirees for whom they could not qualify to receive the
federal subsidy. Furthermore, OPM officials said that wrapping
prescription drug benefits around the part D benefit could be more complex
for the federal government than for employers in the private sector
because, in contrast to many large private sector employers, FEHBP does
not provide different benefits for active workers and for retirees.

Some plan sponsors and benefit consultants we interviewed expected that
wrapping prescription drug benefits offered to Medicare-eligible retirees
around the new Medicare part D benefit would provide several advantages.
For example, some benefit consultants said that this option could save
more money than the subsidy. However, they said plan sponsors would have
to do a cost/benefit analysis to make this determination. Also, plan
sponsors could continue to provide the same level of benefits to
Medicare-eligible retirees in coordination with the Medicare part D
coverage, thereby maintaining benefit continuity. Conceptually, sponsors
of employment-based health benefit plans and benefit consultants generally
viewed the option to wrap prescription drug benefits around the part D
benefit as being similar to how most now coordinate other benefits with
Medicare parts A and B. Some sponsors we interviewed planned to rely on
their pharmacy benefit managers, benefit

consultants, and others for assistance in administering the benefit.
However, plan sponsors and benefit consultants we interviewed were waiting
to learn more from CMS about how the benefit coordination would operate.
As a result, at the time of our interviews, employers and others had
questions about how prescription drug benefit designs would wrap around
the Medicare part D benefit.

Wrapping benefits around the Medicare part D benefit also could present
some administrative and other challenges for plan sponsors. Two benefit
consultants we interviewed told us that wrapping benefits around the
different Medicare part D plans, such as Medicare Advantage or a private
prescription drug plan, in which retirees might enroll could add to the
administrative complexity. Also, according to one benefit consultant and
CMS officials, while coordinating with the Medicare program can be a
fairly straightforward task for part A and B services, part D coordination
might be more difficult because each Medicare-eligible retiree's true
outof-pocket costs must be determined. Part D requires that Medicare
beneficiaries must have $3,600 in out-of-pocket expenses for covered drugs
in 2006 before federal catastrophic coverage begins.63 Generally,
beneficiaries' expenses reimbursed by other sources such as
employmentbased plans are not counted. This can become complicated for
plan sponsors that have different copayment and coinsurance requirements
for different groups of retirees.

Another possible challenge for plan sponsors in wrapping around Medicare
part D coverage is financial. Plans sponsors that supplement the Medicare
part D benefit could spend thousands of dollars for each retiree before
the Medicare catastrophic coverage begins. Two plan sponsors and several
benefit consultants were concerned about how employment-based drug
benefits that wrap around the Medicare part D benefit would affect the
out-of-pocket payment requirements for beneficiaries. For example, if a
plan sponsor covered 75 percent of a Medicare-eligible retiree's
expenditures within the coverage gap (i.e., the doughnut hole) the plan
sponsor would have to spend $8,550 before the retiree reached $3,600 in
out-of-pocket expenditures as required by the MMA. Specifically, under
this wraparound scenario,

63MMA sec. 101, S: 1860D-2(b)(4)(B), 117 Stat. 2077-78 (to be codified at
42 U.S.C. S: 1394w102(b)(4)(B)).

o 	the Medicare-eligible retiree would spend $3,600 out-of-pocket-$250 for
the part D deductible, $500 in coinsurance for the next $2,000 in
expenditures, and $2,850 for the expenses not covered by Medicare;

o 	Medicare would spend $1,500-75 percent of the next $2,000 in
expenditures after the deductible is met; and

o  the plan sponsor would spend $8,550.

                                 Other Options

This would require a total of $13,650 in expenditures from all sources
before the retiree would reach the amount-that is, combined Medicare and
beneficiary expenditures equal to $5,100-at which Medicare part D
catastrophic coverage would begin.

Under the MMA, sponsors of employment-based health benefit plans for
Medicare-eligible retirees have several other options. For example, plan
sponsors could contract with privately marketed prescription drug plans
and Medicare Advantage plans to cover the part D benefit, or they could
become prescription drug plans or Medicare Advantage plans.64 In addition,
while not allowed for current Medicare-eligible retirees, plan sponsors
could establish HSAs for their active workers, who could use these
benefits when they retire.

Several benefit consultants told us their clients might consider these
other MMA options, and some plan sponsors we interviewed were doing so.
For example, four benefit consultants we interviewed said that Medicare
Advantage plans could offer advantages to plan sponsors. Two of these
benefit consultants said that having Medicare-eligible retirees enroll in
Medicare Advantage plans would shift the financial risk away from the plan
sponsor to the Medicare Advantage plan. The other two said that Medicare
Advantage plans could help to reduce costs, and they also believed that
having Medicare-eligible retirees enroll in these plans could help reduce
administrative burdens associated with the Medicare part D benefit. Two
benefit consultants noted that these plans might not be available in all
parts of the country, but others said that increased federal reimbursement
rates established as part of the MMA might cause more private plans to
enter this market in the future. In addition, two benefit consultants
commented that their clients might be more interested in Medicare
Advantage once the market for these plans is established. During our
interviews, some Fortune 500 plan sponsors generally discussed Medicare
Advantage plans as an option they might consider. While several

64MMA sec. 101, S: 1860D-22(b), 117 Stat. 2125 (to be codified at 42.
U.S.C. S: 1395w-132(b)).

plan sponsors said that none of their Medicare retirees were enrolled in a
health maintenance organization (HMO), two said that HMOs might be a
viable option in the future as long as managed care plans continued to
participate in the Medicare program. One plan sponsor considered Medicare
Advantage plans as an option during its deliberations but determined that
based on its past experience with Medicare+Choice, it did not provide many
savings.

One benefit consultant we interviewed said that plan sponsors might be
reluctant to form their own Medicare Advantage plans because many HMOs
left the Medicare+Choice program in the past. However, new options that
had not yet been offered under the Medicare Advantage program might also
be attractive to employers with retirees living all across the country.
CMS officials said that they are currently developing the waivers that
plan sponsors would need to form their own Medicare Advantage plans.

The MMA also established HSAs, which receive preferential tax treatment,
that are used in conjunction with high deductible health insurance
plans.65 The HSA can be used to pay for qualified medical expenses not
covered by insurance or other reimbursements. Although HSAs cannot be set
up to fund health benefits for current Medicare-eligible retirees, they
can be a savings vehicle for workers to pay the cost of their health care
coverage when they retire. However, some benefit experts said it is
unlikely that enough money would accumulate in these accounts for
retirees, especially for older workers, to benefit substantially from
them.66 Six of the 15 plan sponsors we interviewed said they were
exploring how HSAs would integrate into their overall benefit programs or
were considering them for the future.

65MMA S: 1201, S: 223, 117 Stat. 2469-79 (to be codified at 26 U.S.C. S:
223). While employers, employees, or both can set up and contribute to
these accounts, employees own the accounts. In general, individuals making
contributions can deduct the lesser of the deductible or up to $2,650 for
self-only coverage or $5,250 for family coverage from federal taxes in
2005. Any funds remaining in an HSA at the end of the year can be carried
over to the next year.

66According to the Employee Benefit Research Institute, HSAs will be of
limited benefit to people who are already 55 years of age or older because
they would not produce enough savings to substantially offset retiree
health expenses. See Paul Fronstin and Dallas Salisbury, Health Care
Expenses in Retirement and the Use of Health Savings Accounts, Issue Brief
No. 271 (Washington, D.C.: Employee Benefit Research Institute, July
2004).

    Most Plan Sponsors in Our Sample Reported MMA-Related Changes on Recent
    Financial Statements, While a Third Were Considering MMA Options

According to financial statements filed with the SEC as of November 2004,
most of the Fortune 500 employers we reviewed that reported postretirement
benefit obligations67 (27 of 39) reflected the effect of the MMA options
on these obligations.68 For example, 3 of these plan sponsors each
reported reductions in accumulated obligations of over $100 million. The
other 12 employers did not report on their MMA decisions in these
financial statements. (See table 2.)

Table 2: Actions Taken in Response to the MMA by 50 Randomly Selected
Fortune 500 Employers, Most as of the Quarter Ending September 30, 2004

Number of Action employers

                  Employers reporting postretirement benefits

Addressed impact of the MMA on postretirement benefit obligations
Did not address impact of the MMA on postretirement benefit obligations
12a

Subtotal

Employers not reporting postretirement benefits or not filing statements

Did not report postretirement benefits on annual or quarterly financial
statements

     Did not file annual or quarterly financial statements with the SEC 3b

Subtotal

Total

Source: GAO.

Notes: Based on analysis of annual (10-K) and quarterly (10-Q) financial
statements Fortune 500 employers filed with the SEC. The 50 employers
represent a randomly selected group of employers from the Fortune 500 list
for 2003. Most of these employers' fiscal years ended in December 2003, so
their most recent quarterly financial statement covered the period ending
September 30, 2004.

aOne of the 39 employers that sponsored retiree health benefit plans
addressed the MMA but did not provide complete information on
postretirement benefit obligation amounts.

bThree of the 50 randomly selected employers were private, not publicly
traded, employers and were not required to file annual 10-K or quarterly
10-Q financial statements with the SEC.

67Publicly traded companies account for their postretirement benefit
obligations in their financial statements. The postretirement benefit
obligations we refer to here include obligations for retiree health
benefits and other retiree benefits, such as life insurance, but not for
pensions (which are separately reported). This information is included in
the annual (10-K) and quarterly (10-Q) financial statements they file with
the SEC.

68At the time of our analysis, most of these employers' fiscal years ended
in December 2003, so their most recent quarterly financial statement
covered the period ending in September 2004, which most filed in November
2004. A few employers had already reflected changes in obligations as a
result of the MMA in prior annual or quarterly filings with the SEC.

Thirteen of the 27 plan sponsors that reflected the effect of the MMA
options reported they would be choosing the subsidy option, which reduces
their postretirement benefit obligations and other expenditures. However,
even among these 13 plan sponsors, 3 reported that they would be choosing
the subsidy option for some but not all of their retirees. They had not
reported what options they would pursue for the remaining retirees. While
the remaining 14 plan sponsors addressed the MMA options in their
financial statements, their MMA decisions for Medicare-eligible retirees
were not as clear. These plan sponsors generally reported that the MMA
options either reduced their postretirement benefit obligations or that
the changes they made because of the MMA were not expected to have a
material impact on their postretirement benefit obligations.69

Twelve of the 39 employers that reported sponsoring retiree health benefit
plans and having postretirement benefit obligations did not report on
their MMA decisions in financial statements filed as of November 2004. One
of these 12 plan sponsors reported that it had determined that its
prescription drug benefits were not actuarially equivalent to the Medicare
part D benefit and could not take advantage of the subsidy option. This
plan sponsor reported that it was evaluating the impact of other MMA
options. The remaining 11 plan sponsors did not report on the impact of
the MMA on their postretirement obligations; 4 of these 11 plan sponsors
did not expect any changes they made to be material.

69In May 2004, FASB issued guidance regarding how employers that sponsor
postretirement health benefit plans were to account for the effects of the
MMA-FASB Staff Position FAS 106-2, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization
Act of 2003. Under this guidance, employers were required to report the
effect of the MMA on their retiree health benefit obligations for the
first interim or annual period that began after June 15, 2004. However, if
employers could not determine the effect of the MMA, they could reconsider
the impact periodically.

    Sponsors of Retiree Health Benefit Plans We Interviewed Unlikely to Reduce
    Current Drug Benefits for Medicare Retirees in Response to the MMA

In interviews, sponsors of health plans that included prescription drug
benefits for Medicare-eligible retirees told us they did not expect to
reduce these benefits in response to the new Medicare part D benefit and
the MMA options. Although one benefit consultant said that some of his
clients might consider reducing benefits in response to the MMA, plan
sponsors we interviewed that were considering choosing the subsidy option
said they did not expect to reduce their benefits in response to the MMA,
even though some could do so and still qualify for the subsidy.70 Plan
sponsors considering wrapping their benefits around the Medicare part D
benefit were focused on wrapping benefits in a way that would maintain,
not restrict, the current level of benefits. According to a benefit
consultant, many employers who sponsored retiree health benefit plans
supplemented Medicare parts A and B with additional benefits and might
also do so for Medicare part D. However, plan sponsors change benefits for
different reasons. Even though they said they were not considering a
reduction in prescription drug benefits in response to the MMA, some plan
sponsors and benefit consultants said that ongoing cost pressures prompt
plan sponsors to constantly review and, if necessary, adjust their
benefits for future retirees.

Two of the 12 private sector employers that sponsored retiree health
benefits told us that during their deliberations on the MMA options they
had considered, but dismissed, elimination of some or all retiree
prescription drug benefits as one of several options. One of these plan
sponsors said eliminating prescription drug coverage would not be
realistic, especially with collectively bargained benefits. The other plan
sponsor said it was easier to continue to provide the benefits to this
declining population-it no longer offered retiree health benefits to new
hires-than to contend with the negative press and relations with current
retirees and active workers.

None of the three public sector sponsors of health benefits for
Medicareeligible retirees we interviewed expected to reduce or eliminate
prescription drug benefits in response to the MMA options. OPM officials
said that they did not plan to decrease or eliminate any prescription drug
coverage for Medicare-eligible retirees in response to the MMA. These
officials, who administer health benefits for federal employees and

70In the Kaiser/Hewitt 2004 Survey on Retiree Health Benefits, 85 percent
of the employers who planned to choose the subsidy said they would likely
retain current benefit levels, 7 percent would modify benefits to match
the standard part D benefit, and 8 percent did not know about possible
changes in their benefits.

retirees, noted that eliminating prescription drug benefits would not be a
politically realistic option. An official at a public sector plan that
provides health benefits to Medicare-eligible retirees in one state said
that the state also was not planning to reduce its benefits in response to
the MMA. However, the state had already planned to make extensive changes
to its benefits in response to rising health care costs about a year
before Congress passed the MMA, and eliminating or further reducing
benefits for public sector retirees was not an option currently being
considered.

    The MMA Is Not Likely to Induce Employers Not Already Offering Retiree
    Health Coverage to Begin Doing So

Few employers, if any, that were not sponsoring retiree prescription drug
benefits were expected to begin sponsoring them in response to the MMA.
Benefit consultants and experts we interviewed consistently agreed that it
was doubtful that an employer would want to assume new benefit obligations
for retiree health or prescription drugs if it did not already do so,
regardless of the MMA options. Furthermore, the availability of Medicare's
prescription drug benefits in 2006 might give employers more of an
incentive not to start to provide these benefits because prescription drug
benefits would be available without the employer's participation.
Ultimately, benefit consultants and experts told us this decision would
vary by employer. An employer's particular financial, business, and
competitive situation could affect the employer's decision to provide any
new benefits or to provide supplemental coverage-pay the part D premium,
cover out-of-pocket expenses, or consider a Medicare Advantage plan as an
option-to Medicare-eligible retirees in response to the MMA.

According to officials at organizations representing small and midsized
employers and other experts, the MMA is not likely to encourage such
employers to add to their operating costs by beginning to offer retiree
health benefits or supplementing the prescription drug benefits available
through Medicare part D. These employers are more concerned about
providing health benefits to active workers rather than to retirees.
However, as with large employers, employers' specific circumstances drive
their business and benefit decisions. Therefore, according to these
officials, while there may be isolated individual employers that might
begin to provide retiree health benefits or prescription drug coverage
supplementing the benefits established by the MMA, they would likely be
the exception rather than the rule.

  Concluding Observations

The provision of employment-based retiree health benefits for Medicare
beneficiaries continues to be an issue for evaluation and change with
employers and other plan sponsors even as they begin to choose options
available as a result of the Medicare drug benefit enacted as part of the
MMA. The long-term decline in the percentage of employers offering retiree
health benefits to Medicare-eligible individuals has leveled off in recent
years. Plan sponsors have continued to modify their requirements for
eligibility, benefits, and cost sharing in an effort to contain cost
growth. As employers and other plan sponsors choose options as provided
under the MMA, they likely will continue to face rising health care costs,
particularly for prescription drugs, that will increase their obligations
for retiree health benefits. The Medicare drug benefit is expected to
provide some insulation from these cost increases for plans that qualify
and employers that receive a subsidy for a portion of their drug
expenditures or that choose to allow Medicare to bear primary
responsibility for these costs for Medicare-eligible retirees.
Nonetheless, even after employers select a particular option in response
to the Medicare drug benefit, it is likely that they will continue to
reshape their retiree health benefits in response to cost pressures, as
they have for the last decade. However, few employers not already offering
retiree health or prescription drug coverage are likely to begin doing so
as a result of the options available under the MMA.

  Agency and Other External Comments

We provided a draft of this report to CMS, OPM, and experts on retiree
health benefits at the Employee Benefits Research Institute, Health
Research and Educational Trust, Hewitt Associates, and Mercer Human
Resource Consulting.

In its written comments, CMS generally agreed with our findings. CMS
stated that the new Medicare drug benefit and the subsidy can help plan
sponsors continue to provide drug coverage to Medicare-eligible retirees.
Consistent with our finding that plan sponsors intend to continue offering
prescription drug benefits, CMS cited a survey released in January 2005
that indicated that most plan sponsors intended to continue offering
prescription drug coverage after the Medicare part D benefit begins. CMS
confirmed that many plan sponsors are still considering their options
under the MMA. CMS also indicated that some employers may reevaluate their
retiree benefits and that some plan sponsors may begin to offer
prescription drug benefits. In its comments, CMS noted that it had
recently released its final rule implementing the Medicare part D benefit
and plan sponsor options. CMS also noted that it plans to provide
additional guidance to respond to issues raised by comments on the
proposed rule,

including guidance on actuarial equivalence. CMS acknowledged that plan
sponsors need to have timely guidance because of the complexity of the
process, and CMS intends to continue to conduct outreach and education
efforts on the options for retirees' prescription drug coverage available
to plan sponsors. (CMS's comments are reprinted in app. II.)

In its written comments, OPM highlighted its role in limiting premium
increases while continuing to provide the same level of health insurance
coverage at the same premium rates for retirees that it provides to active
federal employees. While at the time of our interviews OPM officials
indicated that OPM was considering the federal subsidy for FEHBP, in its
written comments the agency said that it does not expect to choose the
federal subsidy option. We revised the report to reflect that OPM does not
expect to choose the subsidy option. (OPM's comments are reprinted in app.
III.)

The experts who reviewed the draft report generally indicated that the
report provided a comprehensive and accurate portrayal of employmentbased
retiree health benefits and prescription drug benefits under the MMA. Two
of the experts noted that while they concurred that the percentage of
employers offering retiree health benefits has leveled off in recent
years, this finding may understate the impact of other changes that reduce
the extent of retiree health benefits. They highlighted other changes, as
we cited in the draft report, such as reduced eligibility for future
retirees, increased cost sharing and premium contributions, and financial
caps. We agree that as noted in the report, these changes contribute to an
overall erosion in the value and availability of retiree health benefits.

CMS and several of these experts also provided technical comments, which
we incorporated as appropriate.

We are sending copies of this report to the Administrator of CMS, the
Director of OPM, and interested congressional committees. We will also
provide copies to others on request. In addition, this report is available
at no charge on the GAO Web site at http://www.gao.gov.

If you or your staffs have any questions about this report, please contact
me at (202) 512-7118. Another contact and staff acknowledgments are listed
in appendix IV.

Kathryn G. Allen Director, Health Care-Medicaid and Private Health
Insurance Issues

List of Committees

The Honorable Charles E. Grassley
Chairman
The Honorable Max Baucus
Ranking Minority Member
Committee on Finance
United States Senate

The Honorable Michael B. Enzi
Chairman
The Honorable Edward M. Kennedy
Ranking Minority Member
Committee on Health, Education, Labor,

and Pensions
United States Senate

The Honorable John A. Boehner
Chairman
The Honorable George Miller
Ranking Minority Member
Committee on Education and

the Workforce
House of Representatives

The Honorable Joe Barton
Chairman
The Honorable John D. Dingell
Ranking Minority Member
Committee on Energy and Commerce
House of Representatives

The Honorable William M. Thomas
Chairman
The Honorable Charles B. Rangel
Ranking Minority Member
Committee on Ways and Means
House of Representatives

                       Appendix I: Scope and Methodology

To identify trends in employment-based retiree health benefits, we
analyzed data from (1) two annual private sector surveys of employer
health benefits conducted since the early 1990s through 2004, (2) one
private sector survey on retiree health benefits conducted in 2004, and
(3) three surveys conducted by the federal government that included
information on Medicare beneficiaries and employment-based health
benefits. We also reviewed financial data for fiscal years 2001 through
2003 that a sample of Fortune 500 employers submitted to the Securities
and Exchange Commission (SEC) to identify changes in large employers'
retiree health benefit obligations. To supplement the trend and financial
data and to identify which options for prescription drug coverage provided
under the Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 (MMA) sponsors of employment-based retiree health benefits said
they planned to implement, we interviewed benefit consultants, private and
public sector sponsors of employment-based retiree health benefits,
officials at associations and groups representing large and small
employers and others. In addition, we reviewed studies and literature
addressing retiree health benefits. We conducted our work from April 2004
through February 2005 in accordance with generally accepted government
auditing standards.

We relied on data from two annual surveys of employment-based health
benefit plans. The Kaiser Family Foundation and the Health Research and
Educational Trust (Kaiser/HRET) and Mercer Human Resource Consulting each
conduct an annual survey of employment-based health benefits, including a
section on retiree health benefits. Each survey has been conducted for at
least the past decade, including 2004.1 We also used data from a survey
focused solely on 2004 retiree health benefits that the Kaiser Family
Foundation and Hewitt Associates (Kaiser/Hewitt) conducted in 2004. For
each of these surveys of employment-based benefits, we reviewed the survey
instruments and discussed the data's reliability with the sponsors'
researchers and determined that the data were sufficiently reliable for
our purposes.

1Year-to-year fluctuations or gradual changes in these employer benefit
survey results need to be interpreted with caution. These surveys are
based on random samples designed to be representative of a broader
employer population and are used widely but may not have the precision
needed to distinguish small changes in coverage from year to year because
of their response rates and the number of firms surveyed.

  Surveys of Employment-Based Health Benefits

                       Appendix I: Scope and Methodology

                                  Kaiser/HRET

Since 1999, Kaiser/HRET has surveyed a sample of employers each year
through telephone interviews with human resource and benefits managers and
published the results in its annual report-Employer Health Benefits.2
Kaiser/HRET selects a random sample from a Dun & Bradstreet list of
private and public sector employers with three or more employees,
stratified by industry and employer size. It attempts to repeat interviews
with some of the same employers that responded in prior years. For the
most recently completed annual survey, conducted from January to May 2004,
1,925 employers completed the full survey, giving the survey a 50 percent
response rate. In addition, Kaiser/HRET asked at least one question of all
employers it contacted-"Does your company offer or contribute to a health
insurance program as a benefit to your employees?"-to which an additional
1,092 employers, or cumulatively about 78 percent of the sample,
responded. By using statistical weights, Kaiser/HRET is able to project
its results nationwide. Kaiser/HRET uses the following definitions for
employer size: (1) small-3 to 199 employees-and (2) large-200 and more
employees. In some cases, Kaiser/HRET reported information for additional
categories of small and large employer sizes.

    Mercer

Since 1993, Mercer has surveyed a stratified random sample of employers
each year through mail questionnaires and telephone interviews and
published the results in its annual report-National Survey of
Employer-Sponsored Health Plans.3 Mercer selects a random sample of
private sector employers from a Dun & Bradstreet database, stratified into
eight categories, and randomly selects public sector employers-state,
county, and local governments-from the Census of Governments. The random
sample of private sector and government employers represents employers
with 10 or more employees. Mercer conducts the survey by telephone for
employers with from 10 to 499 employees and mails questionnaires to
employers with 500 or more employees. Mercer's database contains
information from 2,981 employers who sponsor health plans. By using
statistical weights, Mercer projects its results nationwide and for four

2Kaiser/HRET has been conducting the survey of small and large employers
since 1999. From 1991 through 1998, KPMG Peat Marwick conducted the survey
using the same instrument. However, data for all sizes of employers are
not available for all years. For example, KPMG Peat Marwick only sampled
large employers in 1991, 1992, 1994, and 1997 and sampled both large and
small employers in 1993, 1995, 1996, and 1998.

3Foster Higgins, which later merged with Mercer Human Resource Consulting,
began conducting the survey in 1986.

                       Appendix I: Scope and Methodology

geographic regions.4 The Mercer survey report contains information for
large employers-500 or more employees-and for categories of large
employers with certain numbers of employees as well as information for
small employers (fewer than 500 employees). We have excluded from our
analysis Mercer's 2002 data on the percentage of employers that offer
retiree health plans because Mercer stated in its 2003 survey report that
the 2002 data were not comparable to data collected in other years because
of a wording change on the 2002 survey questionnaire. In 2003, Mercer
modified the survey questionnaire again to make the data comparable to
prior years (except 2002).

    Kaiser/Hewitt

  Federal Surveys

The Kaiser/Hewitt study-Current Trends and Future Outlook for Retiree
Health Benefits: Findings from the Kaiser/Hewitt 2004 Survey on Retiree
Health Benefits-is based on a nonrandom sample of employers because there
is no database that identifies all private sector employers offering
retiree health benefits from which a random sample could be drawn.
Kaiser/Hewitt used previous Hewitt survey respondents and its proprietary
client database-a list of private sector employers potentially offering
retiree health benefits. Kaiser/Hewitt conducted the survey online from
May 2004 through September 2004 and obtained data from 333 large (1,000 or
more employees) employers. According to information provided by Hewitt,
these employers included about one-third of the 100 Fortune 500 companies
with the largest retiree health obligations in 2003. Because the sample is
nonrandom and does not include the same sample of companies and plans each
year, survey results for 2004 cannot be compared to results from prior
years.

We analyzed three federal surveys containing information either on
Medicare beneficiaries or on the percentage of public sector employers
that offer retiree health benefits. We obtained information on retired
Medicare beneficiaries' sources of health benefits coverage, including
former employers and unions, from the Current Population Survey (CPS),
conducted by the U.S. Census Bureau. We obtained data on the sources of
coverage for all health care expenditures and for prescription drug
expenditures for retired Medicare beneficiaries from the Medicare Current

4However, the 2003 Mercer report states that the average annual cost
increase data cited for Medicare-eligible retirees are not projectable
beyond a group of 158 total employers that were able to provide cost
information for both 2002 and 2003.

                       Appendix I: Scope and Methodology

Beneficiary Survey (MCBS), sponsored by the Centers for Medicare &
Medicaid Services (CMS). We obtained data on the percentage of public
sector employers that offer retiree health benefits from the Medical
Expenditure Panel Survey (MEPS), sponsored by the Agency for Healthcare
Research and Quality. Each of these federal surveys is widely used for
policy research, and we reviewed documentation on the surveys to determine
that they were sufficiently reliable for our purposes.

                           Current Population Survey

We analyzed the Annual Supplement of the CPS for information on the
demographic characteristics of Medicare-eligible retirees and their access
to insurance.5 The survey is based on a sample designed to represent a
cross section of the nation's civilian noninstitutionalized population. In
2004, about 84,500 households were included in the sample for the survey,
a significant increase in sample size from about 60,000 households prior
to 2002. The total response rate for the 2004 CPS Annual Supplement was
about 84 percent. Because the CPS is based on a sample, any estimates
derived from the survey are subject to sampling errors. A sampling error
indicates how closely the results from a particular sample would be
reproduced if a complete count of the population were taken with the same
measurement methods. To minimize the chances of citing differences that
could be attributable to sampling errors, we present only those
differences that were statistically significant at the 95 percent
confidence level.

The CPS asked whether a respondent was covered by employer-or
unionsponsored, Medicare, Medicaid, private individual, or certain other
types of health insurance in the last year. The CPS questions that we used
for employment status, such as whether an individual is retired, are
similar to the questions on insurance status. Respondents were considered
employed if they worked at all in the previous year and not employed only
if they did not work at all during the previous year.

The CPS asked whether individuals had been provided employment-based
insurance "in their own name" or as dependents of other policyholders. We
selected Medicare-eligible retirees aged 65 and older who had
employment-based health insurance coverage in their own names because

5See http://www.census.gov/hhes/www/hlthins/hlthin03.html (downloaded Dec.
22, 2004) for additional information. We analyzed data from the March CPS
Supplement from 1996 through 2002 and the Annual Social and Economic
Supplement to the CPS from 2003 through 2004.

                       Appendix I: Scope and Methodology

this coverage could most directly be considered health coverage from a
former employer. For these individuals, we also identified any retired
Medicare-eligible dependents aged 65 or older, such as a spouse, who were
linked to this policy. We used two criteria to determine that these
policies were linked to the primary policyholder: (1) the dependent lived
in the same household and had the same family type as the primary
policyholder and (2) the dependent had employment-based health insurance
coverage that was "not in his or her own name."

    Medicare Current Beneficiary Survey

MCBS is a nationally representative sample of Medicare beneficiaries
sponsored by CMS.6 The survey is designed to determine for Medicare
beneficiaries (1) expenditures and payment sources for all health care
services, including noncovered services, and (2) all types of health
insurance coverage. The survey also relates coverage to payment sources.
The sample represents 16,315 Medicare beneficiaries from CMS's enrollment
files who are interviewed three times a year at 4-month intervals. The
complete interview cycle for a respondent consists of 12 interviews over 4
years. Response rates for initial interviews ranged from about 85 to 89
percent. After completing a first interview, individuals had a response
rate of 95 percent or more in subsequent interviews. Interview data are
linked to Medicare claims and other administrative data, and sample data
are weighted so that results can be projected to the entire Medicare
population.

The MCBS Cost and Use file links Medicare claims to survey-reported events
and provides expenditure and payment source data on all health care
services, including those not covered by Medicare. Therefore, this file
contains data on Medicare beneficiaries' expenditures and sources of
coverage for prescription drugs. Among other items, the prescription drug
data include the following payment source categories: Medicare, Medicaid,
health maintenance organizations (HMO), Medicare HMO, employmentbased
insurance, individually purchased insurance, unknown, out-ofpocket,
discounts, and other.

We analyzed prescription drug expenditure data for retired Medicare
beneficiaries aged 65 and older who had employment-based health coverage
in 2001, the most current data available at the time we did our

6See http://www.cms.hhs.gov/MCBS/Overview.asp (downloaded Dec. 22, 2004)
for additional information.

                       Appendix I: Scope and Methodology

analysis. We extrapolated these data to 2006-when the Medicare part D
benefit begins-using projections based on National Health Care
Expenditures per capita data developed by CMS to provide estimates of
prescription drug expenditures paid by employment-based insurance or paid
out-of-pocket for retired Medicare beneficiaries with employmentbased
insurance. We did not make adjustments to reflect significant changes in
payment sources for prescription drug coverage once the Medicare part D
benefit begins in 2006. For employers that elect to continue covering
prescription drugs, these projections provide an estimate of the share of
these prescription drug expenditures covered that could be eligible for
the MMA subsidy.

    Medical Expenditure Panel Survey

  Financial Data from Fortune 500 Employers

MEPS, sponsored by the Agency for Healthcare Research and Quality,
consists of four surveys and is designed to provide nationally
representative data on health care use and expenditures for U.S. civilian
noninstitutionalized individuals.7 We used data from the MEPS Insurance
Component, one of the four surveys, to identify the percentage of state
entities that offered retiree health benefits in 1998 and 2002. Insurance
Component data are collected through two samples. The first, known as the
"household sample," is a sample of employers and other insurance providers
(such as unions and insurance companies) that were identified by
respondents in the MEPS Household Component, another of the four surveys,
as their source of health insurance. The second sample, known as the "list
sample," is drawn from separate lists of private and public employers. The
combined surveys provide a nationally representative sample of employers.
The target size of the list sample is approximately 40,000 employers each
year. The response rate for the public sector MEPS Insurance Component was
about 88 percent in 2002.

We reviewed selected financial data for a stratified random sample of 2003
Fortune 500 employers, which is a list of the U.S. corporations with the
highest annual revenues. First, we stratified the Fortune 500 list into
five groups of 100 in descending order of revenues.8 We then randomly
selected 10 Fortune 500 employers from each of the five groups, for a
total of 50 employers. To identify the 50 employers' postretirement
benefit

7See http://www.meps.ahrq.gov/default.htm (downloaded Dec. 22, 2004) for
additional information.

8See "The 500 Largest U.S. Corporations," Fortune, vol. 149, no. 7 (2004).

                       Appendix I: Scope and Methodology

  Interviews with Benefit Consultants, Plan Sponsors, and Others

obligations,9 we reviewed the annual financial statements (Form 10-K) that
these employers submitted to the SEC.10 We reviewed the Form 10-K that
each employer submitted for its most recent fiscal year, ending in 2003 or
early in 2004.11 Then, to identify each employer's postretirement benefit
obligations for the two previous fiscal years, we reviewed the Form 10-K
filed in either 2002 or 2003. To identify the types of changes these
employers planned to make to their postretirement benefits in light of the
MMA, we reviewed the latest quarterly financial statements (Form 10-Q)
that employers submitted to the SEC, most as of November 2004.12

We interviewed representatives of six large employer benefit consulting
firms. Benefit consultants help their clients, which include private
sector employers, public sector employers, or both, develop and implement
human resource programs, including retiree health benefit plans. While
most of these benefit consulting firms' clients were large Fortune 500 or
Fortune 1,000 employers, some also had smaller employers as clients. One
benefit consulting firm that we interviewed, in particular, provided
actuarial, employee benefit, and other services to a range of public
sector clients, including state and local governments, statewide
retirement systems and health plans, and federal government agencies. It
also provided human resources services to multiemployer plans.

To learn more about retiree health benefit trends and MMA options from
large private sector plan sponsors, we interviewed 12 Fortune 500
employers that provided retiree health benefits. From the stratified
random sample of 50 Fortune 500 employers selected for a financial data
review, we judgmentally selected 10 employers for interviews. We

9Postretirement benefit obligations included retiree health and other
postretirement benefits, but not pensions.

10See http://www.sec.gov/edgar.shtml (downloaded Dec. 22, 2004) for
additional information. Information, including revenues and obligations,
reported to the SEC reflect employers' worldwide operations.

11Forty-seven of the 50 employers we reviewed submitted Forms 10-K to the
SEC. Thirtyeight of these employers had fiscal years that ended in
December 2003. Of the remaining employers, 5 employers had fiscal years
that ended earlier in 2003 and 4 had fiscal years that ended in either
January or February 2004.

12Generally, companies had to file their Forms 10-Q 45 days after the end
of each quarter for fiscal years that ended on or after December 15, 2002,
and before December 15, 2004. Most of the quarterly statements we reviewed
covered the quarter ending in September 2004.

Appendix I: Scope and Methodology

interviewed at least 1 employer from each of the five groups of 100
Fortune 500 employers that were stratified on the basis of annual
revenues. In addition to considering revenues, where data were available,
we considered each employer's industry, number of employees,
postretirement benefit obligations, preliminary MMA option decision as
reported on its annual Form 10-K, and union presence when making our
selection. We also interviewed officials at two additional Fortune 500
employers at the recommendation of a benefit consultant.

While small and midsized employers are less likely than large employers to
offer retiree health benefits, we also assessed small and midsized
employers' preliminary reactions to the MMA options. We relied primarily
on discussions with officials at two organizations representing the
interests of small and midsized employers-the National Federation of
Independent Business and the United States Chamber of Commerce-and benefit
consultants.

To learn more about retiree health benefit trends and MMA options at
public sector plan sponsors, we interviewed officials at the Office of
Personnel Management (OPM), two state retirement systems, and one
association. OPM administers the Federal Employees Health Benefits
Program-the country's largest employment-based health plan. We
judgmentally selected two large states' retiree health benefits systems on
the basis of a review of selected state data and referrals from a benefit
consultant that works with public sector clients. We also interviewed
officials at the National Conference on Public Employee Retirement Systems
and reviewed available studies on retiree health benefits in the public
sector.13

13See Jack Hoadley, Health Policy Institute, Georgetown University, How
States Are Responding to the Challenge of Financing Health Care for
Retirees (Menlo Park, Calif.: The Henry J. Kaiser Family Foundation,
September 2003). Responses to this study were provided by 43 states and
the District of Columbia. These state retirement systems had about 1.8
million retirees and dependents, approximately three-fourths of whom were
Medicare-eligible. See also Stan Wisniewski and Lorel Wisniewski, State
Government Retiree Health Benefits: Current Status and Potential Impact of
New Accounting Standards (Workplace Economics, Inc., commissioned by the
AARP Public Policy Institute) (Washington, D.C.: AARP, July 2004). The
AARP Public Policy Institute commissioned Workplace Economics to conduct
research on retiree health benefits in state governments. Workplace
Economics analyzed information in its proprietary database on benefits
provided to state government employees in all 50 states (excluding the
District of Columbia, which is not part of the state government database).
Workplace Economics also analyzed state governments' annual financial
reports as part of this study.

Appendix I: Scope and Methodology

To obtain broader-based information about retiree health benefit trends
and MMA options, we interviewed officials at several other groups and
associations. Specifically, we interviewed the President of the National
Business Group on Health and the Director of the Health Research and
Education Program of the Employee Benefit Research Institute to obtain
more information about large private sector employers. We also interviewed
officials from the American Academy of Actuaries, the Kaiser Family
Foundation, the American Federation of Labor and Congress of Industrial
Organizations, and the National Coordinating Committee for Multiemployer
Plans. Finally, we reviewed other available literature on retiree health
benefit trends, cost-containment strategies, and plan sponsors' likely
responses to MMA options.

Appendix II: Comments from the Centers for Medicare & Medicaid Services

Appendix II: Comments from the Centers for Medicare & Medicaid Services

Appendix III: Comments from the Office of Personnel Management

Appendix IV: GAO Contact and Staff Acknowledgments

GAO Contact John E. Dicken, (202) 512-7043

Acknowledgments 	Laura Sutton Elsberg, Joseph A. Petko, Kevin Dietz,
Elizabeth T. Morrison, and Suzanne Worth made key contributions to this
report.

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