Health Care Reform Stalling

President Obama’s vision may still be carried out – but only in part.... and maybe not at all.

The nearly 100 year saga to provide health care to all Americans, free of charge, seems likely to make some progress, but far less than many expect. The Administration’s goal of expanding government sponsored health care to the 30-50 million uninsured seems likely to result in another round of limited modification of the current private system. This suggests that health care stocks, on average, are likely undervalued.

Compromises, compromises
The most controversial aspects (and where the substance lies) of the bill seem likely to be watered down. Part of that has to do with cost; part of it has to do with appeasing the private sector. The Senate and House must reconcile different versions of the bill. In the House version, 95% of Americans would be eligible for health coverage; in the Senate version, 97% of Americans would qualify.

A government-run option now seems off the table
The most challenging task for the bill’s proponents has been explaining how anyone could compete with a truly functioning public health option. Private insurers have portrayed themselves as in a struggle for their lives and this legislation as tantamount to completely socializing the health care sector.
Most polls recent and historic strongly suggest that Americans prefer private insurance and generally like their current health plan - which suggests that public support for a public option will be lukewarm - as most Americans would prefer not to need it. (Must be something about their experience with other government services...) Consequently, an increasing number of Democrats have started to break ranks.
Last week, Senate Finance Committee members Sen. Max Baucus (D-MT) and Sen. Chuck Grassley (R-IA), worked in late June to whittle down the House’s $1.6 trillion version of the bill to less than $1 trillion. Baucus, who is Chair of the Committee and Sen. Kent Conrad (D-ND), another Committee member, have let it be known for several days that talk was shifting away from that concept of a "public alternative" in the Senate and toward ‘nonprofit cooperatives’. This is likely a consequence of poll numbers that show weak public support rapidly deteriorating as the $1.6 trillion+ price tag became increasingly discussed (and criticized) in the media.
However, the House version of the bill still includes the government-run plan component – which is not a good sign for proponents – as this means negotiations will need to be complicated and contentious with the Senate. This will allow for attention to pass on the issue. The parallels between current events and the Clinton Administration's 1993 efforts are uncanny. Death by debate and a transition to greater fiscal discipline seem in the cards here.

And so does a mandatory employer offering…
As originally conceived, most major backers saw the private sector as bearing the majority of the burden in any major reform. Sen. Clinton’s (D-NY) presidential campaign plan largely proposed that businesses would pay federal fines in the future if they refused to provide health coverage to workers.
Increasingly concerned about poll numbers expressing greater concerns about economic issues, and in the face of a resurgent lobbying effort by industry, congressional Democrats are concerned about seeming anti-business. What employer expectations remain seem to be rapidly deteriorating. According to Sen. Conrad, the Senate version of the bill would now ask businesses to shoulder a portion of the cost of Medicaid coverage received by their workers, or 100% of the Medicaid tab for certain workers poor enough to qualify for a tax credit that could help them buy health insurance.
If the bill passes, the amount of employer-provided health benefits exempt from income taxation might be limited. Sen. Max Baucus (D-MT), current chair of the Senate Finance Committee, has suggested a $15,000-$17,000 ceiling on that tax exclusion, which would likely have a minimal impact on employers at present (at least outside of the executive suite.)

Reforms to Medicare are also losing steam from unlikely bedfellows…
Ironically, the Administration has helped ally two old enemies – health care companies and physicians. President Obama’s June 15th speech to the American Medical Association in Chicago, while at times incurring thunderous applause, seems to have had little effect in generating new support from doctors.
Ultimately, physicians understand that greater government involvement in health care will eventually result in loss of prerogatives and income and this places them firmly (and permanently in the camp of the private sector.) The AMA’s resistance is a product of reformers’ efforts to require that doctors participating in Medicare also be required to participate in the new government plan.
The Administration has, as part of it's package, set goals of ending ‘overpayment’ to Medicare Advantage, which it has claimed would save the government $177 billion over the next ten years. In that same time frame, it also wants to use Medicare reimbursements to reduce preventable hospital re-admissions – for a projected $25 billion in additional savings. The reforms would also give Medicaid members a bigger prescription drug discount, while reducing that discount for high-income Medicare members. But all of these changes will ultimately result in less flexibility in Medicare benefits, particularly for upper middle class Americans who access them most frequently. This erodes some of the grass roots, fundraising support of the Democrats and encourages apathy in the ranks.
The popularity of Medicare Advantage, and the AMA’s hostility to linking the plan with Medicare (while officially providing statements suggesting endorsement) are helping to derail any meaningful proposals on this front as well. And while drug companies like the increased benefit – managed care organizations are resentful of efforts to destroy Advantage.
In testimony before the House energy and commerce panel, Blue Cross and Blue Shield Association senior VP Alissa Fox contended that any cuts in Medicare funding “would cause millions of Medicare Advantage enrollees to lose their coverage and lead to significant reductions in benefits or increases in premiums for millions more.” In addition, Blue Cross, Blue Shield and the industry-sponsored America’s Health Plan recently presented a letter to the ailing Sen. Ted Kennedy (D-MA), referencing a study that found the average family of four pays $1,700 a year more than they should in health insurance premiums due to Medicare and Medicaid underpaying hospitals and physicians.

The problem is taxes…
Obviously, tax increases would fund the majority of reforms. More specifically, the President has talked about cutting back the value of the itemized deductions available to the wealthiest American taxpayers. But recent revolts (tea parties and the voters in California’s response to budget propositions seen as “tax increases”) have got many congressional Democrats scared and looking for alternatives – causing a breaking of ranks and division between the two houses. House Ways and Means subcommittee chair Rep. Richard Neal (D-MA) said other ideas a payroll tax and a value-added tax. The Senate seems to prefer the idea of taxing employee health benefits.

Something coming, but likely very watered down
This chapter in the saga of health care reform is hardly over, but we’re already seeing signs of capitulation by the President. “We are still early in this process," he noted Thursday. “We have not drawn lines in the sand.”
Expect those sands to shift further. Much further.

Roth IRA Conversions: Coming in 2010!

Next year, anyone may convert a traditional IRA to a Roth IRA. No income limits will stand in the way of the conversion.

Why it might be a good idea
A Roth IRA permits tax-free growth and tax-free income distributions in retirement (assuming you are age 59½ or older and have held your Roth account for 5 years or longer). You can contribute to a Roth IRA after age 70½, without having to take mandatory withdrawals. While contributions to a Roth IRA aren’t tax-deductible, the younger you are, the more attractive a Roth IRA may seem.
However, older investors have reason to go Roth as well – especially if they don’t really need to withdraw IRA assets or would plan to reallocate their IRA holdings towards fixed income investments and other tax inefficient tools (e.g. Mortgage Backed Bonds, High Yield Funds, Hedge Funds). Roth IRAs are particularly well-suited to fixed income investments, as the consequences of potentially lower returns are ameliorated by the low taxation of those returns, either when the funds are earned or withdrawn.
Also, under present tax law, converting an untapped traditional IRA to a Roth will shrink the size of your taxable estate, and careful estate planning could foster many years of tax-free growth for those assets.
Currently, if you pass your Roth IRA to your spouse when you die, they can treat the inherited IRA as his or her own and forego withdrawals. So those Roth IRA assets can keep compounding untaxed across the rest of their life.
If your spouse then names a son or daughter as a beneficiary, that heir has the choice to make minimum withdrawals according to his or her life expectancy, all while the assets continue to compound tax-free. Currently, withdrawals from an inherited Roth IRA are not subject to income tax.

Why it might not be a good idea
The IRS regards a traditional IRA-to-Roth IRA conversion as a distribution from a traditional IRA – a taxable event. You’ll need to pay taxes on the entire amount of the conversion.
But, with the recent carnage in the markets, many IRA values are (hopefully) at a very low point. That translates to paying less tax on eventual gains. In addition, there’s strong reason to believe that income tax rates will increase in the coming years – another reason why now may be a good time to convert. (Another alternative is to do a partial Roth IRA conversion if converting the full amount would send you into a higher tax bracket.)
Using IRA assets to pay the conversion tax isn’t advisable. If you’re younger than 59½, you’re looking at a 10% penalty on the amount you withdraw, and you’ll lose the chance for tax-free compounding of those assets within the Roth IRA. What this means is that you should generally be comfortable with spending funds out of a taxable account.

Why you might want to fund a Roth IRA this year
In 2009, any withdrawals from a traditional IRA can be used to fund a Roth IRA. In years past, mandatory withdrawals from a traditional IRA typically couldn’t be deposited into a Roth IRA. But the federal government has suspended mandatory IRA withdrawals for 2009. Any IRA withdrawals made in 2009 are thereby elective withdrawals. So, if your adjusted gross income (AGI) is $100,000 or less, you have an option to fund a Roth IRA with a withdrawal from a traditional IRA – at least through the end of 2009.
In 2009, you can fund a Roth IRA with after-tax contributions to a 401(k), 403(b) or 457 retirement savings plan. This year, you can take those contributions and convert them to a Roth IRA tax-free, provided your AGI is $100,000 or less. Additionally, there is no limit to the conversion amount.

A potential tax break for those who convert in 2010
If you do a Roth conversion during 2010, you can choose to divide the taxes on the conversion between your 2011 and 2012 federal returns.
Be sure to consult your tax advisor and financial advisor before you proceed. (This is definitely a team effort, as the issue of expected returns is a major factor in the analysis.) In fact, you should generally consult your advisors before you arrange any rollover, trustee-to-trustee transfer, or same-trustee transfer of your IRA assets. In any year, you should fully understand the potential tax impact of a Roth conversion on your finances and your estate. Also, remember that while the income limit on Roth IRA conversions will go away in 2010, the income limits on Roth IRA contributions still apply next year and for the foreseeable future.

The Administration's "Overhaul" of Wall Street

Since September 2008, the federal government has committed $10.5 trillion to fixing the economy – bailing out Citigroup, Bank of America, AIG, Freddie Mac, Fannie Mae, Chrysler and General Motors in the process. To try to prevent further crises of this nature, President Obama is proposing a “sweeping overhaul” of the U.S. financial system on a level unseen since the 1930s. While there are some substantial changes structurally, the new proposals stop far short of what some (including myself) feared, and others (also including myself) hoped. For most working in finance, the changes under the PATRIOT Act were far more significant. Proably the best way to think of it is an expansion of the role and power of existing federal bodies.

Expanded Powers for Existing Agencies
If enacted, Obama’s plan would hand more power to the Federal Reserve, the Treasury and the Federal Deposit Insurance Corporation, fuse two federal agencies into a single regulator of the nation’s largest banks, create a new agency to regulate consumer financial products, police hedge funds and private equity funds, and rein in the use of mortgage-backed securities. Hedge and Private Equity regulation are likely to endure the most major effects and the legislation is likely to face substantial resistance from senior lawmakers associates with the industry like Charles Schumer (D-NY) or Nancy Pelosi (D-CA).

An Expanded Fed Mandate
Under the plan, the Federal Reserve would become the top watchdog of the U.S. financial system. It would regulate the banks, brokerages, insurers and hedge funds deemed too big to fail, see that they are keeping enough capital in reserve, and respond quickly in a crisis. The goal is to avoid another Bear Stearns or Lehman Bros. debacle, and the system-wide shock that could follow.
The Treasury could get veto power. Treasury Secretary Timothy Geithner would chair a regulatory council to work side-by-side with the Fed as it monitors the biggest financial firms. This council could potentially veto emergency loans made by the Fed to financial companies.3
The FDIC could expand its reach. It would gain the ability to seize and unwind not only banks, but other kinds of financial firms.

Goodbye (Good Riddance?) OTS
The Office of Thrift Supervision would merge with the Office of the Comptroller of the Currency. This revamp would create a new entity, a National Bank Supervisor to monitor all deposit-taking thrifts. Under current rules, some banks may essentially select their regulator, leading to what Sen. Chris Dodd (D-CT) has described as "regulatory arbitrage".

A New Regulator Cometh
That’s the Consumer Financial Protection Agency. This new office would regulate credit cards, mortgages and other consumer-marketed financial products. If would set guidelines for banks and bank holding companies, and if they got out of line, it would punish them with penalties and fines.

More Regulation of Accredited Investment Pools
Under the plan, all private equity and hedge funds would have to register with the Securities and Exchange Commission, and throw open their books when regulators demand. The specifics of this (and how effective new regulation actually is) will depend upon how the SEC uses this power. Many (including myself) are concerned that the SEC isn't sufficiently suspicious of the funds and may not regulate them adequately.

Finally Regulating Derivatives
This has seemingly taken forever. Over the counter derivatives would now be run through a central clearinghouse, similar to how exchange traded options and futures are today. Lack of transparency and regulation (in my opinion) are what got us here. The specifics are still unclear on how this would be executed, but a gradual adjustment is probably warranted.
To avoid future bad faith in the securitization of various assets (including mortgages) - banks that package and sell mortgage-linked securities (and other debt-linked securities) would have to keep at least 5% of those securities on their books. (An idea floated by Greenspan in the 4th quarter of 2008). In fact, all financial firms that originate a security would have to retain 5% of the “securitized exposure” and maintain an investment interest in that security even if it is resold. The idea here is to discourage the promotion of exotic home loans and other complex financial products that were half-understood by investors and borrowers. This is something of a giveaway to the larger investment banking houses and is likely to be treated with hostility by many smaller entities.

When?
As I said, the reforms are generally not too substantial, but certainly will ruffle feathers. It will likely take several months for any version of the Obama proposal to become law. The plan notes that the Fed has “the most experience to regulate systemically significant institutions.” But some Capitol Hill opinion leaders are especially concerned about expanding the Fed’s powers. Chris Dodd is "unconvinced". “Giving the Fed more responsibility at this point … is like a parent giving his son a bigger … faster car right after he crashed the family station wagon.”
“You cannot convene a committee to put out a fire,” Treasury Secretary Tim Geithner noted June 18, defending the idea of the Fed as the “first responder” to any future financial crisis. But Sen. Richard Shelby (R-AL) pointed out that the Fed could end up regulating “insurance companies, hedge funds, asset managers, mutual funds, and a variety of other financial institutions that it has never supervised before.” Rep. Jeb Hensarling (R-TX), a vocal critic of last fall’s Wall Street bailout, says the plan “disappointed” him: “They essentially leave all the old regulatory infrastructure in place, and then they simply add on to it.”
Consequently, it's likely to be a long, hot summer.

Some Good Tax Legislation for a Change

There are a couple of pieces of tax legislation that would be particularly valuable, not just for our clients, but long term investors and retirees in general. Email your Representatives and Senators (Better yet, write a letter.)

HR 882

Unfortunately, for quite a few Americans, a longer time horizon to retirement is very likely. Sponsored by Rep. Peter King (R-NY), HR 882 proposes to increase the required age for distributions from qualified retirement plans to 75 from 70½. The effective date would be for years beginning after the date of enactment. Thus, if the bill were to become law this year, the age 75 rule would be effective for 2010 and thereafter. The bill would also provide for contributions to traditional individual retirement accounts to the year prior to age 75 rather than the present rule of 70½. This would provide needed additional years of saving and accumulation for many Americans and would encourage longer holding times for investments.

HR 883

Also introduced by Rep. King, this bill repeals that vile and silly increase in income taxes on Social Security benefits. The 1993 increase added the provision that required up to 85% of Social Security benefits be taxed, based upon a complex two-tiered formula. The 85% inclusion rate would be repealed. The maximum inclusion rate for Social Security benefits would be reduced to 50%. The proposed effective date is 2009 for calendar-year taxpayers. Lowering taxes on benefits will have the immediate effect of reducing the drain on retiree portfolios, while allowing some individuals greater flexibility in saving for retirement. Also - taxing government old age pensions never makes any sense.

SR 978

Sen. Blanche Lincoln's (D-AR) bill proposes to increase the limitations on capital losses applicable to individuals. The proposal would increase the annual capital loss limit for individuals to $10,000 from $3,000. The proposed effective date is for tax years beginning after Dec. 31, 2008. Therefore, the proposed increase would apply for the entire 2009 tax year for calendar-year taxpayers. The proposal would also provide for inflation indexing of the $10,000 capital loss limit beginning in 2010. This make it more advantageous for younger investors to take greater risks (by making losses more 'valuable'), make portfolio rebalancing easier for the middle aged (and let people diversify their risk more regularly) and let financial advisors generate more interest income for clients (thus allowing older investors to invest more conservatively).

KKR and Fidelity Doing an End Run Around the I-Banks

As many of you know, I've felt for some time that the IPO market has remained in the doldrums largely because of the incompetent, corrupt and oligopolistic management of the process by investment banks.

This can be attributed to both the regulatory environment, which has justified very limited IPO distributions to retail investors on the grounds that there's less liability with institutional clients such as mutual and pension funds, and the argument that retail investors are more likely to "flip" (immediately sell) the shares they receive.

The evidence of the latter is scant (there's no way to track it, as institutions immediately transfer the shares they buy from brokerage firms to custodians elsewhere), but the circumstantial data strongly suggests that institutions are among the worst flippers.

This monopsony (opposite of monopoly) of institutional investors probably has been driven by a quid pro quo with brokerages where IPO allocations are driven by a willingness to pay more for standard brokerage transactions that could be conducted elsewhere far more cheaply.

The limited number of buyers has (in my opinion) probably created a false sense of lack of demand by investment banks, when it's really a result of the financial crisis, against a backdrop of secular decline in mutual funds (to ETFs) and pension funds' eschewing of any risk in the wake of Madoff. Individual investor interest in speculation hasn't declined as much as many believe, as evidenced by the growth in leveraged ETFs and other speculative retail products.

Probably in response to the success of firms like SharesPost, Second Market and Advanced Equities in selling shares of private companies to individual investors, KKR, the well-known private equity firm, has decided to start a marketing process through Fidelity Investments - essentially doing an end run around investment banks and selling shares directly to smaller investors.

Expect a great deal of consternation about this from various parties that are "concerned about the risks to smaller investors", but who are really shills attempting to protect the investment banks' monopoly. If this works, it will represent a significant first step in how funds are raised. In many respects this will be a return to an earlier era (pre 1990s), where retail played a much greater role in IPO distribution.

I see this as an extremely positive development, from both the perspective of an advisor with clients who are looking for liquidity from their "perpetually pre-IPO" company shares and who is looking for long-term investment opportunities from these new companies.

$250,000 Bank Deposit Account Insurance Limit Extended

While it's looking increasingly less relevant, the recent extension of the $250,000 limit on interest bearing deposit accounts is still comforting. (It's important to remember that non-interest bearing deposit accounts are currently under unlimited insurance until the end of the year.) What this means is that under each title FDIC coverage applies for up to $250,000 - which would allow a household to hold interest bearing cash at an institution and exceed that limit - as long as the accounts are titled correctly.

The coverage was extended under the Helping Families Save Their Homes Act of 2009, which was signed by the President on May 20th. Included in the legislation was a provision that postpones until January 1, 2014 the expiration of the $250,000 limit on Federal Deposit Insurance Corp. (FDIC) insurance for bank deposit accounts. The limit was raised in 2008 from $100,000 per depositor at a given institution, and had been scheduled to revert to the previous $100,000 limit on December 31, 2009.

The legislation covers all account categories other than: (1) IRAs and certain other retirement accounts, which will continue to be covered up to $250,000 per owner after January 1, 2014, and (2) non-interest bearing transaction deposit accounts, which temporarily have unlimited coverage and are insured under the Transaction Account Guarantee Program, which is still scheduled to expire after December 31, 2009.

The Act also extended to January 1, 2014 the National Credit Union Share Insurance Fund's $250,000 share insurance coverage of accounts at credit unions.

Please give us a call if you would like to review your current cash accounts and their insurance status.