Personal Finance Tips

The world is often a confusing place and nowhere is the confusion likely to be so complete as in the tax system. Here we have the best brains in the Government taking on the best brains in the private sector. The Government wants the maximum tax take. The private sector wants to arrange things so that no one with money ever has to pay any tax. Somewhere in the middle the two world-views collide and, usually, some tax is paid. Anyway, when President Obama signed the healthcare reform bill into law, some of the largest employers in the US let out a collective sigh of pain. As an example, Caterpillar is the world’s largest manufacturer of excavators and bulldozers. The day after the President’s signature, Caterpillar announced it was taking a charge of $100 million to earnings over an expected loss of tax benefits. A number of other influential corporations have also made allowances in their accounts. The reason is that the healthcare reform ended a tax break given to cover the cost of supplying drugs to early retirees.

Let’s take this step by step. If a person continues to work, he or she will be covered under the employer’s plan. All other things being equal, working up until you are entitled to Medicare gives continuity of coverage. But there was always a problem if someone took early retirement. Health insurance companies were reluctant to insure older people who might more quickly develop serious medical problems. So, to give people aged between 55 and 64 a bridge until they became eligible for Medicare, employers were given a tax break to enable them to pay for their ex-employees’ drugs. With the disappearance of the tax break, employers were therefore left with an obligation to pay for drugs without any relief.

Acting through Kathleen Sebelius, Secretary to the Department of Health and Human Services, President Obama has announced a $5 billion package to offset the loss of the tax break. This will run from June 2010 to January 2014 when the individual health insurance plans offered through the new exchanges should come onto the market. It is estimated that about 4,500 private and public employers will be eligible to claim from this new fund. The intention is to provide continuity of coverage under the current health plans and it will be condition that the employers maintain their contributions, i.e. federal money is a top-up not a substitute for payment by employers. Ms Sebelius has also made it clear that the individual health plans offered to early retirees must include coverage for chronic and high-cost diseases and disorders. Employers cannot cherry pick the diseases to be covered. That means the victims of heart attacks or those diagnosed with diabetes and cancer will get continuing support under the plans if federal funding is to be drawn down.

In general, the business community has been slow in showing its gratitude. The feeling seems to be that Government made a mistake when pushing through the reform bill and was now offering a fraction of the total money required to fill in the hole. Nevertheless, the President has recognized the problem and made funds available to help offset it. Whether these funds will prove sufficient is something we will have to wait and see. For the retirees, it should mean access to benefits with fewer hassles.

The business of insurance is called underwriting. The company enters into a contract (called a policy) and agrees to indemnify a group of people like you against defined losses. So it uses some heavy duty math to work out the probability of the losses being incurred. It’s called risk assessment and relies on a complicated use of statistics. For vehicle insurance, the companies collect the details from every reported traffic accident in the US looking at the age, sex and occupation of the driver, the make and model being driven, the time of day, the road conditions, and the extent of the damage. The insurers share the information on the current costs of replacement parts and the labor to fit them.

They also manage to talk the health insurance companies into sharing their current costs on medical treatment for those injured in traffic accidents. With all this information, they can make good estimates of the cost of loss, i.e. the total amount they may have to pay out if they insure, say, 100,000 drivers. They take this estimate, add the cost of running the insurance company and a profit margin. This total is then divided between all the 100,000 as their premiums. Some companies divide the total equally so the good drivers subsidize the bad. But the majority adjusts the individual amounts based on the driver’s safety record. That way, each policy holder pays more or less depending on how well he or she drives. This is more fair.

But, to cut costs, some insurance companies make more general assumptions about the likelihood of losses. Instead of personalising the risk assessment, they focus the assessment on generalities. The most common is the use of the zip code. In some areas of a town or city, there are higher levels of vehicle theft and vandalism. Some areas have more people driving while intoxicated or impaired through drugs. Because of the design of the local road system, there may also be a higher number of accidents. The insurers therefore charge everyone living in those areas a higher premium. Apart from the unfairness at an individual level, some lawyers believe it is active discrimination because many of the zip code areas loaded with higher premiums have higher concentrations of particular racial or ethnic groups. California has formally prohibited insurance companies from using zip codes, credit scores and other factors not directly relevant to the assessment of driver safety. In those states, insurers continue to trade and make a profit. It has not been the end of the world they predicted.

So, depending on the US state in which you live, your premium may either be calculated based on your personal driving record, or it may be based on your zip code and credit score. Either way, the task of finding the cheapest car insurance remains the same. You have to shop around the companies licensed to sell policies in your state and find the best deal. If there is active competition between the insurers, the premiums will be lower and you will find cheap car insurance without too much difficulty. But if the state is unregulated and insurers do not compete, it will be more difficult to find a cheap policy.

This February, the Department of Health and Human Resources has issued a report identifying an alarming trend for insurance companies to seek premium rate increases. This is not limited to one or two states. This is not limited to one or two percentage increases in the rates. This is all the leading insurance companies asking for the right to significantly higher premiums: in Michigan hikes of 56%, in California hikes of 39%, and so on. If this only affected small numbers of policyholders, it might have passed unnoticed. But, with millions of policyholders affected across the country, these rate increase requests have attracted the full scrutiny of the federal government. Secretary Sibelius has been leading the attack, using the requests to push the reform agenda forward.

Because of the national anger, some companies have paused. WellPoint had proposed the increases take effect from March 1. Any increases, even if approved by the states, will now be delayed until May at the earliest. This decision is partly in response to the summons of WellPoint’s chief executive officer to Washington to justify the requested increases. Insurance companies find themselves in a difficult political situation. Their management teams accept a duty to maximize profits for the benefit of the stockholders. They look around at an America seriously affected by the recession. Increasing numbers of people are unable to afford the premiums, some because of unemployment, others because of a squeeze on credit. More worrying from the insurance industry is that more healthy people are deciding not to insure at all. This means the group of people left holding policies has a higher percentage of those with existing health problems. Without more healthy people in the group paying premiums and not claiming, it becomes more expensive to insure those less healthy people who remain. It is also a verified fact that hospitals and healthcare service professionals have also been increasing their fees and charges. The pharmaceutical companies have increased the price of almost all the most commonly used drugs. The insurance industry is under pressure from both sides. As Secretary Sibelius points out, however, this is not a completely accurate picture. Every year, insurance companies are required to submit reports to all the US states in which they are licensed to sell policies. This data shows many companies actually increased the number of policyholders during 2009.

The market in health insurance plans is complicated by the political situation. Democrats and Republicans are two armies unable to agree a truce long enough for some reform to be made. As it stands, there is no immediate likelihood that medical costs will be controlled. If the costs continue to rise faster than inflation, insurers will have no choice other than increasing their premiums. If they do not, they will not have enough cash in hand to pay out on all the claims. This means, for the average person, it will become increasingly difficult to find cheap health insurance. For those with a pre-existing condition, group health insurance will be the only option but, for those plans, premiums are rising at their fastest rates. For years, it has been obvious that the healthcare industry is broken. It would be ironic if, having come this close to some meaningful reforms, we not only saw the reform bills lost in Washington, but also found every major insurer imposing massive premium increases. That really would be the final nail in the coffin.