As long-time readers of the AHCP Blog as well as agents who have attended our Motivation Monday webinars know, we’re pretty big fans of supplemental coverage. In fact, AHCP works with a number of carriers to provide these solutions for your clients.
That’s why we were initially alarmed when we heard that the Biden administration was planning to tax some of the benefits paid out by supplemental insurance policies. And if you sell these sorts of products, we’re guessing you were also concerned when you read the headline for this article. Don’t worry – it’s not as bad as it sounds.
A recent ThinkAdvisor article by Allison Bell says that carriers who sell “critical illness insurance and hospital indemnity insurance are facing a tough fight in Washington.” That’s because the Biden administration wants to include some of the policy benefit payments from fixed indemnity policies in the policyholder’s taxable income.
As Bell explains, this “change is part of the president’s budget proposal for fiscal 2023,” so nothing’s been finalized at this point, but if President Biden gets his way, payments exceeding the cost of care provided could be treated as taxable income.
Fixed indemnity products like critical illness policies, cancer insurance, and hospital indemnity plans work differently than a traditional health insurance plan. Usually, as Bell explains, most “medical insurance policies pay doctors and hospitals directly for any care patients receive. Insurers typically pay an amount equal to or less than the billed amount. The insurer never sends any excess cash to the patient.”
Indemnity plans are different. These “policies pay a set amount of cash when an insured patient has an illness or injury, or uses health care, in a way that triggers a benefit payment.” And, right now, those payments, which are usually paid directly to the policyholder, are not taxable—but that could change.
What Brokers Need to Know
First, the entire payment would not be treated as taxable income; only the portion that exceeds the cost of care received would be. This could happen if the claims cost is fully or even partially paid by the patient’s health insurance plan. It could also happen if someone receives a payout on a diagnosis as a benefit of their Critical Illness insurance for example, but then chooses not to undergo treatment.
Second, according to the Treasury Department’s “Greenbook” for 2023, which outlines the administration’s tax proposals, the benefits would only be taxable if the premium for the policy was paid with pre-tax dollars through an employer’s section 125 plan. Employees who pay for their policies with after-tax dollars, as well as individual consumers, would not have to pay a tax on their indemnity benefits.
Here is the wording of the proposal from page 104 of the 120-page Greenbook.
The proposal would amend section 105(b) of the Code to clarify that the exclusion from gross income for payments received through an employer-provided accident or health plan applies only to the amount paid directly or indirectly for a specific medical expense. Any fixed payment (in the form of a direct payment, reimbursement, loan, or advance reimbursement) to an employee under a fixed indemnity arrangement that is paid without regard to the actual cost of the medical expenses the employee incurred would not be excluded from gross income and would be treated as wages subject to FICA and FUTA taxes. Under the proposal, fixed indemnity arrangements would be defined to include certain critical disease or specified disease policies and arrangements that provide fixed payments for specific items and services according to detailed payment schedules, thus making payments from these policies subject to Federal income, FICA, and FUTA taxes. Individuals would still be able to exclude from gross income any fixed amounts paid through an accident or health policy purchased with after-tax dollars.
The proposal would be effective for taxable years beginning after December 31, 2022.