| How Will Health-Care Reform Impact These Funds? by David Kathman | 2010-03-29 |
| The U. S. House of Representatives just passed the health-care reform bill already passed by the Senate, along with a companion bill of changes that the Senate later approved. When President Obama signed the main bill into law, it put a cap on a long, contentious political fight over reforming the U.S. health-insurance system. Health care is likely to remain a hot political issue for a while, but much of the uncertainty that has hung over the health-care sector for the past year is gone. That uncertainty was one of the factors that caused health-care stocks to underperform the market in 2009's rally. Once it became clear that the bill was likely to pass and the market saw more details, many health-care stocks rose modestly in a "relief rally." Going forward, though, investors still need to evaluate what the reality of health-care reform means for individual stocks in the sector, not all of which will be affected in the same way. Earlier this week, Morningstar stock analysts Matthew Coffina (in this note ) and Alex Morozov reviewed the new law's provisions and discussed what they may mean for various types of health-care stocks. Pharmaceutical and biotech companies are likely to be the biggest beneficiaries, as newly insured patients will be able to afford more drugs and biologics get stronger patent protection. Drugstores and medical distributors will likely also benefit from higher volume, but it looks like a more mixed bag for medical-device makers and health insurers. Even after the stocks' recent gains, health care looks like one of the cheapest sectors, with plenty of stocks trading well below Morningstar analysts' estimates of their fair values. Some smart mutual fund managers agree that there are attractive opportunities in health-care stocks. A couple of months ago, we looked at funds with the most prominent stakes in health insurers, which stood to be affected most directly by reform. Now that reform is a reality, we've taken a broader view to look at good funds with especially heavy health-care exposure. The following are all topnotch funds that keep at least 20% of their stock holdings in health care, although they differ in which specific areas and industries they find most attractive. Fairholme FAIRX Manager Bruce Berkowitz has achieved a fantastic long-term record (and been named Morningstar's Domestic-Stock Manager of the Decade) by running a concentrated, flexible portfolio that consists of solid businesses trading at cheap prices, along with some bonds and a significant cash stake. Berkowitz has seen good values in health care for a while. As of Nov. 30, 2009, about 25% of the fund's stock assets were in the sector, with health insurers Humana HUM and WellPoint WLP soaking up more than 10% of total assets. Berkowitz remained fans of those two stocks as the health-care debate raged, reasoning that they still looked attractive even if the most likely health-care reform plans passed. He sold most of his stake in former top holding Pfizer PFE last year after the stock inched up a bit, but he still has a significant weighting in another pharma name, Forest Laboratories FRX. PAGEBREAK Vanguard Primecap VPMCX The Primecap management team uses a contrarian growth strategy that's similar to Berkowitz's in some ways, but different in others. It has long had big health-care weightings in all six of its funds, because it strongly believes the market has been too pessimistic about the sector's problems. This fund had 22% of its stock portfolio in health care as of Dec. 31, 2009, while Primecap Odyssey Growth POGRX and Primecap Odyssey Aggressive Growth POAGX, which are smaller and more nimble, had more than 35% in the sector. The managers are particular fans of big pharmaceutical names such as Eli Lilly LLY and Novartis NVS, biotech firms such as AmgenAMGN, and medical-device makers such as Medtronic MDT, all of which are top holdings in this fund. In Primecap Odyssey Growth, their top holdings also include smaller niche health-care firms such as Conceptus CPTS, Immunogen IMGN, and Cepheid CPHD. They've generally avoided health insurers. Dodge & Cox Stock DODGX This is more of a classic-value offering than either Fairholme or the Primecap funds, with a bottom-up approach that seeks out good businesses that are trading cheaply. In keeping with the managers' contrarian bent, 23% of the fund was in health care as of Dec. 31, 2009, about twice the large-value average. Most of that exposure came via pharmaceutical stocks such as Novartis, Merck MRK, and GlaxoSmithKline GSK, all of which are among the top 10 holdings. Health insurers WellPoint and UnitedHealth UNH are also among the top 20 holdings, but the managers were trimming both of those stocks throughout 2009, while ramping up their pharma exposure. Jensen Fund JENSX This fund's managers will only consider stocks that have earned returns on equity of at least 15% in each of the past 10 years. From that exclusive club of about 150 stocks, they choose 25 to 30 stocks that are attractively valued, and they tend to hold on to them for years. Quite a few health-care stocks meet the managers' strict criteria. Their two pharma holdings are Abbott LaboratoriesABT and Johnson & Johnson JNJ, neither of which is held by the above three funds except for a small Johnson & Johnson position in Vanguard Primecap. Other than that, Jensen holds medical-device makers Medtronic and Stryker SYK and medical instrument makers C.R. Bard BCR and Waters WAT, of which only Medtronic is held by any of the other three funds. If nothing else, this example shows that there are a range of potentially attractive stocks in the health-care sector, and that good managers can and often do disagree about which stocks in the sector are most attractive. David Kathman is a mutual fund analyst with Morningstar. |
Monday, June 21, 2010
How Will Health-Care Reform Impact These Funds?
Health Care Bill and related taxes
Individuals earning more than $200,000 and couples making more than $250,000 will pay for a good chunk of health care reform through higher Medicare taxes on their earnings and a new Medicare tax on investment income such as dividends, interest and capital gains.
The Medicare tax increases start in 2013. The $200,000 and $250,000 thresholds are not indexed for inflation, so they eventually could reach into the middle class.
The two new Medicare taxes are estimated to raise about $210 billion over 10 years, which accounts for 48 percent of the new tax revenueassociated with the act, according to accounting firm Deloitte.
Other parts of the two health care bills signed into law last month will affect people at all income levels. Starting next year, for example, people can no longer use their flexible spending accounts to buy over-the-counter drugs.
Here's a closer look at these and other provisions affecting individual taxpayers, and how much revenue they are expected to raise over 10 years.
-- Higher Medicare tax on earned income: Today, employees pay 1.45 percent of their wages for Medicare tax. The employer pays an additional 1.45 percent of employee wages. Self-employed people pay the employer and the employee's share, or 2.9 percent, of their self-employment income.
Unlike Social Security tax, which does not apply after a certain level of annual income, Medicare tax applies to an unlimited amount of income.
Starting in 2013, employees and the self-employed will pay an additional 0.9 percent in Medicare tax on employment income that exceeds $200,000 per year for single people and $250,000 for couples filing jointly.
Impact: A single person with $250,000 in earnings or a couple with $300,000 would each pay 0.9 percent on $50,000 in earnings, or $450.
If a husband and wife each earns $150,000, their employers won't withhold the additional Medicare tax, but the couple will have to pay it when they file their tax return.
The tax increase does not raise the employer's share of the Medicare tax.
Ten-year revenue estimate: $86.8 billion.
-- Medicare tax on investment income: Today, Medicare tax applies only to income from employment.
Starting in 2013, high-income people will also pay a 3.8 percent Medicare tax on most types of investment income over a certain threshold, including interest, dividends, capital gains, rental income, annuities and royalties. The new tax will not apply to retirement-plan distributions or tax-exempt interest from municipal securities.
The tax is applied to the lesser of the taxpayer's net investment income or the amount of modified adjusted gross income that exceeds $200,000 for singles and $250,000 for couples.
For example, a single man with $220,000 in adjusted gross income and $40,000 in investment income would pay 3.8 percent on $20,000 (the amount over $200,000) or $760, according to publishing firm CCH.
Revenue estimate: $123.4 billion.
-- Applying the two Medicare taxes: The 0.9 percent tax on earned income and the 3.8 percent tax on investment income will be applied separately. Deloitte gives some examples:
A single woman has $190,000 in wages, $30,000 in investment income and adjusted gross income of $210,000. She would owe no additional tax on her wages but would pay 3.8 percent tax on $10,000, the amount of income that exceeds $200,000.
A man has $300,000 in wages, $60,000 in investment income and $350,000 of adjusted gross income. He would pay the extra 0.9 percent tax on $100,000 and 3.8 percent on $60,000.
-- Reining in flex accounts: Beginning in 2013, employees can not put more than $2,500 per year into a cafeteria plan flexible spending account for health care. These accounts, offered by many employers, let employees set aside part of their salary before taxes to pay for medical expenses. Today there is no federal limit, but many employers set limits ranging from $2,500 to $7,500 annually.
The $2,500 limit is indexed to inflation.
Ten-year revenue estimate: $13 billion.
-- No more OTC drugs: Starting next year, employees will no longer be able to use money from their flexible spending accounts to pay for over-the-counter drugs. They will still be able to use them for prescription drugs and insulin. This new rule also applies to health savings accountsand Archer medical savings accounts, which are other ways to save pre-tax money for health care expenses. Estimated revenue: $5 billion.
-- Bigger penalty: People who take money out of a health savings account or Archer medical savings account and don't use it for qualified medical expenses will pay a 20 percent penalty on the amount starting next year. Today, the penalty is 10 percent for HSAs and 15 percent for MSAs.
Estimated revenue: $1.4 billion.
-- Higher hurdle for medical deduction: Today, people who itemize deductions can write off unreimbursed medical expenses that exceed 7.5 percent of their adjusted gross income. This threshold rises to 10 percent of adjusted gross income starting in 2013 for most people and in 2017 for everyone else.
From 2013 through 2016, if a person or the person's spouse is at least 65 at the end of the year, the threshold remains at 7.5 percent.
Revenue estimate: $15.2 billion over 10 years.
-- Penalizing the uninsured: Starting in 2014, most Americans not eligible for Medicare, Medicaid or other government health care must buy a minimum level of coverage or pay a tax penalty.
The annual penalty is a flat dollar amount or a percentage of income, whichever is greater. The flat amount for an adult starts at $95 in 2014 and increases to $695 by 2016. After that, it is indexed to inflation. The penalty for a minor dependent is half the adult amount.
The percent of income starts at 1 percent in 2014, rising to 2.5 percent in 2016 and thereafter. A family's total penalty generally can not exceed three times the adult flat amount.
-- Subsidies for health coverage: Starting in 2014, lower-income people can get a tax credit to help pay for health care. The credit will be on asliding scale for people whose income falls between 100 and 400 percent of the poverty line. The Internal Revenue Service will determine eligibility.
This article appeared on page E - 1 of the San Francisco Chronicle
Summary and Timeline of the Patient Protection and Affordable Care Act
Summary and Timeline of the Patient Protection and Affordable Care Act
The Patient Protection and Affordable Care Act was signed into law on Tuesday, March 23, 2010. A second, smaller measure - making changes to the first – was passed by Congress on Thursday, March 25th. It is expected that the President will sign that measure into law. Below is a summary of the benefits and tax implications of those bills.
Highlights
*No lifetime benefit limits and only limited annual benefit limits *Coverage for dependent children up to age 26, as long as they do not have access to other employer-sponsored health coverage (the reconciliation bill also assures that this coverage can be provided on a tax-free basis) *No preexisting conditions for children under age 19 *No cancellation of health coverage, except in cases of fraud (primarily an individual insurance policy issue)
*New limitations on Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) *Higher taxes on wages and investment income for taxpayers with earnings over $200,000 and 250,000 (joint)
*Requires employers with 50 or more employees to offer coverage to their employees or pay a fine
2010
Immediate Access to Insurance for Uninsured Individuals with a Pre-Existing Condition. Provides eligible individuals access to coverage that does not impose any coverage exclusions for pre-existing health conditions. This provision ends when Exchanges are operational. Exchanges will be created to help people purchase health insurance from a variety of plans on the open market. This provision is effective 90 days after enactment, and coverage under this program will continue until new Exchanges are operational in 2014.
Small Business Tax Credits. Tax credits of up to 35 percent of premiums will be immediately available to firms that choose to offer coverage; later, when Exchanges are operational, tax credits will be up to 50 percent of premiums. The full credit will be available to firms with 10 or fewer employees with average annual wages of $25,000, while firms with up to 25 or fewer employees and average annual wages of up to $50,000 will also be eligible for the credit. There is also up to a 25 percent credit for small nonprofit organizations.
Eliminating Pre-Existing Condition Exclusions for Children. Bars health insurance companies from imposing pre-existing condition exclusions on children’s coverage, effective six months after enactment and applying to all new plans in the individual market. (This provision will apply to all people in 2014).
Prohibiting Rescissions. Prohibits abusive practices whereby health insurance companies rescind existing health insurance policies when a person gets sick as a way of avoiding covering the costs of enrollees’ health care needs (except in cases of fraud or intentional misrepresentation of material fact). This takes effect for plan years beginning on or after the date that is six months after enactment.
Patient Protections. Protects patients’ choice of doctors by allowing plan members to pick any participating primary careprovider, prohibiting insurers from requiring prior authorization before a woman sees an ob-gyn, and ensuring access to emergency care. This provision takes effect six months after enactment and applies to all new plans.
Eliminating Lifetime Limits and Restricting Use of Annual Limits. Prohibits lifetime limits on benefits in all group health plans and in the individual market and restricts the use of annual limits. This takes effect for plan years beginning on or after the date that is six months after enactment. When the Exchanges are operational in 2014, the use of annual limits will be banned for new plans in the individual market and all employer plans.
Extending Dependent Coverage. Requires any group health plan or plan in the individual market that provides dependent coverage for children to continue to make that coverage available until the child turns 26 years of age. This takes effect for plan years beginning on or after the date that is six months after enactment. FPA updated 3/26/2010
Prohibits Discrimination Based on Salary. Will prohibit group health plans from establishing any eligibility rules for health care coverage that have the effect of discriminating in favor of higher wage employees. This provision takes effect six months after enactment and applies to group health plans.
Reducing the Cost of Covering Early Retirees. Creates a new temporary reinsurance program to help companies that provide early retiree health benefits for those ages 55-64 offset the expensive cost of that coverage. Effective 90 days after enactment.
Reducing the Medicare (Part D) “Donut Hole” or Coverage Gap. Provides a $250 rebate check for all Part D enrollees who enter the “donut hole.‟ Currently, the coverage gap falls between $2,830 and $6,440 in total drug spending. Effective calendar year 2010. (Beginning in 2011, institutes a 50 percent discount on brand-name drugs and begins generic coverage in the donut hole; fills the donut hole by 2020.)
Ensuring Medicaid Flexibility for States. A new option allowing States to cover parents and childless adults up to 133 percent of the Federal Poverty Level (FPL) and receive current law Federal Medical Assistance Percentage (FMAP) will take effect. Effective April 1, 2010.
Expanding the Adoption Credit and Adoption Assistance Program. Increases the adoption tax credit and adoption assistance exclusion by $1,000, makes the credit refundable, and extends the credit through 2011. The enhancements are effective for tax years beginning after December 31, 2009.
Tax Relief for Health Professionals with State Loan Repayment. Excludes from gross income payments made under any State loan repayment or loan forgiveness program that is intended to provide for the increased availability of health care services in underserved or health professional shortage areas. This provision is effective for amounts received by an individual in taxable years beginning after December 31, 2008.
2011
Providing New, Voluntary Options for Long-Term Care Insurance. Creates long-term care insurance programs to be financed by voluntary payroll deductions to provide benefits to adults who become disabled. Effective January 1, 2011.
Standardizing the Definition of Qualified Medical Expenses. Conforms the definition of qualified medical expenses for HSAs, FSAs, and HRAs to the definition used for the itemized deduction. An exception to this rule is included so that amounts paid for over-the-counter medicine with a prescription still qualify as medical expenses.
Increased Additional Tax for Withdrawals from Health Savings Accounts and Archer Medical Savings Account Fundsfor Non-Qualified Medical Expenses. Increases the additional tax for HSA withdrawals prior to age 65 that are not used for qualified medical expenses from 10 to 20 percent. The additional tax for Archer MSA withdrawals not used for qualified medical expenses would increase from 15 to 20 percent.
Cafeteria Plan Changes. Creates a Simple Cafeteria Plan to provide a vehicle through which small businesses can provide tax‐free benefits to their employees. This would ease the small employer’s administrative burden of sponsoring a cafeteria plan. The provision also exempts employers who make contributions for employees under a simple cafeteria plan from pension plan nondiscrimination requirements applicable to highly compensated and key employees.
2012
Information Reporting on Payments to Corporations. Businesses paying corporate and non-corporate providers of property and services (e.g., office equipment, cleaning services, shipping services) $600 or more during the year will be required to file information reports with the IRS and the providers reporting the amounts that were paid. FPA updated 3/26/2010
2013
Additional Hospital Insurance Tax for High Wage Workers. Increases the hospital insurance tax (commonly referred to as Medicare payroll tax) rate by 0.9% to 2.35% on taxpayers with wages and earnings over $200,000 ($250,000 for married filing jointly).
Tax on Investment Income. “Medicare contribution tax” of 3.8 percent on net investment income (e.g., dividends, capital gains, rents, passive income) for taxpayers with Adjusted Gross Income greater than $200,000 ($250,000 for joint returns).
Limiting Health Flexible Savings Account Contributions. Limits the amount of contributions to health FSAs to $2,500 per year, indexed by CPI for subsequent years.
Eliminating Deduction for Employer Part D Subsidy. Eliminates the deduction for the subsidy for employers who maintainprescription drug plans for their Medicare Part D eligible retirees.
Increased Threshold for Claiming Itemized Deduction for Medical Expenses. Increases the income threshold for claiming the itemized deduction for medical expenses from 7.5 to 10 percent. Individuals over 65 would be able to claim the itemized deduction for medical expenses at 7.5 percent of adjusted gross income through 2016.
2014
Establishing Health Insurance Exchanges. Opens health insurance Exchanges in each State to the individual and small group markets. This new venue will enable people to comparison shop for standardized health packages. It facilitates enrollment and administers tax credits so that people of all incomes can obtain affordable coverage.
Promoting Individual Responsibility. Requires most individuals to obtain acceptable health insurance coverage or pay a penalty of $95 for 2014, $325 for 2015, $695 for 2016 (or, up to 2.5 percent of income in 2016). Families will pay half the amount for children, up to a cap of up to a cap of $2,250 per family. After 2016, dollar amounts are indexed. If affordable coverage is not available to an individual, they will not be penalized.
Promoting Employer Responsibility. Does not include an employer mandate but does impose a fee on larger businesses that do not provide insurance for their employees. The fee applies to employers with 50 or more employees and is calculated based on the number of full-time employees. The reconciliation bill excludes the first 30 employees from the payment calculation. It also changes the amount for firms with more than 50 employees that do not offer coverage to $2,000 per full-time employee.
Reforming Health Insurance Regulations. Insurers can no longer exclude coverage for treatments based on pre-existing health conditions. It also limits the ability of insurance companies to charge higher rates due to heath status, gender, or other factors. Premiums can vary only on age (no more than 3:1), geography, family size, and tobacco use.
Eliminating Annual Coverage Limits. Prohibits insurers from imposing annual limits on the amount of coverage an individual may receive.
Ensuring Choice through a Multi-State Option. Provides a choice of coverage through a multi-State plan, available nationwide, and offered by private insurance carriers under the supervision of the Office of Personnel Management.
Providing Health Care Tax Credits. Makes premium tax credits available through the Exchange to ensure people can obtain affordable coverage. Credits are available for people with incomes above Medicaid eligibility and below 400 percent of poverty who are not eligible for or offered other acceptable coverage. They apply to both premiums and cost-sharing to ensure that no family faces bankruptcy due to medical expenses again. FPA updated 3/26/2010
Ensuring Choice through Free Choice Vouchers. Workers who qualify for an affordability exemption to the individual responsibility policy but do not qualify for tax credits can take their employer contribution and join an Exchange plan.
Increasing Access to Medicaid. Medicaid eligibility will increase to 133 percent of poverty for all non-elderly individuals to ensure that people obtain affordable health care in the most efficient and appropriate manner.
States will receive 100 percent federal funding for the first three years of this coverage expansion.
Small Business Tax Credit. Continues the second phase of the small business tax credit for qualified small employers.
2015
Continuing Innovation and Lower Health Costs. Establishes an Independent Payment Advisory Board to develop and submit proposals to Congress and the private sector aimed at extending the solvency of Medicare, lowering health care costs, improving health outcomes for patients, promoting quality and efficiency, and expanding access to evidence-based care.
2018
High-Cost “Cadillac” Plan Excise Tax. Imposes an excise tax of 40 percent on insurance companies and plan administratorsfor any health insurance plan that is above the threshold of $10,200 for self-only coverage and $27,500 for family plans. The tax would apply to the amount of the premium in excess of the threshold. The threshold would be indexed at CPI-U plus one percentage point for 2019 and CPI for years thereafter. An additional threshold amount of $1,650 for singles and $3,450 for families is available for retired individuals over the age of 55 and for plans that cover employees engaged in high risk professions. Employers with higher costs on account of the age or gender demographics of their employees when compared to the age and gender demographics nationally my adjust their thresholds even higher.
Sources
Deloitte. Prescription for change ‘filled’: Tax provisions in the Patient Protection and Affordable Care Act. (www.deloitte.com)
United States. Cong. Senate. Democratic Policy Committee. The Patient Protection and Affordable Care Act Implementation Timeline. (http://dpc.senate.gov/)
The Financial Planning Association is providing this information as a service to its members. While this information deals with legal issues, it does not constitute legal advice. If you have specific questions related to this information, you are encouraged to consult an attorney who can investigate the particular circumstances of your situation.
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