MacGray Matter –July 26, 2010
GOOD NEWS DROWNS OUT BAD, EQUITIES RISE:
There was a fair bit of bad news this past week in the unemployment and housing numbers. In addition, Ben Bernanke’s testimony was far from a Knute Rockne speech. However, the markets gained. A big driver for domestic equities was positive earnings reports. Among the companies that beat quarterly expectations were Caterpillar, 3m, Air Products, UPS, Morgan Stanley, Wells Fargo, Ford, Honeywell and McDonald’s. In addition, economic reports showed surprise growth in European manufacturing and United Kingdom retail sales. German confidence data came out stronger than expected on increasing exports. The Dow rose 3.24% (down 0.03% for the year). The S & P 500 rose 3.55% (down 1.12% for the year) and the NASDAQ Composite rose 4.15% (up 0.01 for the year). We seem to be back to square one again for the year.
THE NEXT BUBBLE-COLLEGE TUITION?:
No cost can stay way ahead of the general rate of inflation indefinitely. For years, we have been watching college tuition costs stay ahead of the general rate of inflation by a wide margin. What is causing this, and what kind of bubble might this create? Anecdotally, I have heard many more people steering their children to more inexpensive options in the past couple of years. The combination of the rising costs and the troubled economy has moved many parents to think differently than they might have just a few years ago. What are some of the indicators that we are running into a problem? 1) Tuition has been increasing at two to three times the rate of inflation, about 8% per year, 2) students are borrowing more than ever, for example the number of college students graduating with over $25,000 in debt has tripled in the past decade, 3) in the past two decades, colleges have doubled their non-teaching staff while enrollment has increased by only 40%, 4) publicly traded, for-profit education companies derive 75% of their revenue from federal funds, up from 48% in 2001, and quickly approaching the 90% limit imposed by federal law, 5) colleges are spending large amounts of money on amenities such as luxury dorms, gyms, pools to lure students, 6) college president salaries are rapidly increasing, for example, 23 private college presidents made more than $1 million in 2008 and 110 made more than $500,000 (there were no million dollar presidents in 2002). Federal student loans became non-dischargeable in bankruptcy in 1998, and then private loans became non-dischargeable as well in 2005. Will we hit a tipping point when students begin defaulting on these loans at a more rapid rate, and colleges begin to face the need for cost cutting?
LENGTH OF UNEMPLOYMENT:
Congress passed, and President Obama signed an extension of unemployment benefits. As you can see from the chart below (from the U.S. Department of Labor, see here), the unemployment in this economic downturn has been long term like no other in the recent past. The median duration of unemployment we face now is incredibly long compared to anything we have seen in the last fifty years:
MORE ON UNEMPLOYMENT:
Unemployment has by far been the most-watched metric to determine the strength, or lack thereof, of the recovery. One highly watched number has been the number of Americans filing for initial unemployment on a weekly basis. This past Thursday, the announced number for the prior week was 464,000. That is up 37,000 from the week before. The number of Americans filing for initial unemployment insurance climbed last week, the government said Thursday. The 4-week moving average of initial claims, which is calculated to smooth out volatility, was 456,000, up 1,250 from the previous week’s revised average of 454,750.
HEALTH SAVINGS ACCOUNTS:
One in ten new health plans currently sold in the United States is a high deductible health plan (HDHP) with a health savings account (HSA). The primary sales argument for these plans has been a reduction in health premiums. However, there is also a strong advantage in the tax advantages that accompany such plans. To be qualified as a plan that can be paired with an HSA, an HDHP must
1) have an annual deductible of at least $1,200 for an individual and $2,400 for a family of two or more,
2) cannot exceed $5,900 out-of-pocket maximum for an individual or $11,900 for a family of two or more (out-of-pocket expenses are those you have to pay before the insurance company starts to pay 100% of covered charges), and
3) limits first dollar coverage to certain preventative services and for everything else, you must satisfy the high deductible before the policy pays.
The premiums for such plans are considerably less, and the savings are generally used to fund an HSA, which can be used to pay the out-of-pocket expenses. Deposits in HSAs are generally pre-tax for employer-sponsored plans. Employers can also make pre-tax contributions to employee HSAs. The combination of employee and employer contributions cannot exceed the out-of-pocket maximum for the year (see above). HSA funds can be invested like most traditional investment or retirement accounts. The earnings grow tax-deferred and remain tax-free if withdrawn for allowable medical expenses. Funds can also be used to pay for qualified long term care insurance premiums. If funds are taken out prior to age 65, it is taxable as ordinary income and subject to a 20% penalty (increased from 10% by the new health care reform law). If funds are withdrawn after age 65, you must pay ordinary income tax, but no penalty will apply. Presumably, people have lots of medical expenses after age 65, so for most people, it will not be difficult to use accumulated HSA assets in a manner that allows tax-free withdrawal many years after the initial deposits are made.
Unfortunately, an ambiguous provision in the new health reform bill threatens the very existence of these plans. As of January 1, 2011, insurers will be required to maintain an 80% medical loss ratio for policies meaning 80% of the premium must be spent on actual medical claims, not administrative costs or profit. If “premium” is considered to be just the premium on the high-deductible insurance policy, most such plans would fail the test since most of the medical claims are paid from the HSA and not the policy. However, if money from HSAs is considered, most such plans would meet the ratio test. The way the bill was written, this decision rests entirely on the HHS Secretary, Kathleen Sebelius.
| Douglas R. MacGray, J.D., C.F.P., C.E.A.
Principal, Senior Vice President of Financial Planning |
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