Managing Health Care Costs

Posted by   admin on    February 3, 2005

According to health care studies conducted by the Cato Institute and National Coalition of Health Care, health care costs have increased dramatically over the last few decades and spending in 2003 was estimated at five times the rate of inflation. Whats more, health insurance premiums in 2002 experienced the largest single year increase in more than a decade at reportedly eight times the general inflation rate.

Sound alarming? It should! In a July 2003 Health Poll Report, by the Kaiser Family Foundation, Thirty-four percent of Americans said they were very worried about increased out-of-pocket costs for health care or insurance. That was more than twice the proportion of people who were worried about not being able to pay their mortgage, or about losing money in the stock market, or of being a victim of a terrorist attack or about losing their job.

Also, the Kaiser Foundation reports, economists have found that rising health care costs correlate to drops in health insurance coverage and job losses. Apparently, since 2000, Americans have experienced economic circumstances in which the likelihood of employer-sponsored coverage was lower and the probability of being uninsured increased. With large decreases in the number of workers in larger firms being partially offset by small firm and self-employment opportunities, much of the workforce moved to employment arrangements in which the likelihood of employer-sponsored insurance was lower or non-existent.

University of Texas economics professor, Stan Liebowitz, suggests: The cure for the present problems is straightforward: the patient must once again be made the central actor in the medical marketplace. Patients need to be given the same motivations to economize on medical care that they have to economize in other markets. Tax laws need to be rewritten. The use of medical savings accounts needs to be promoted. High-deductible health insurance should be encouraged. 

As mentioned in our prior newsletters, we strive to provide articles on various aspects of wealth management to assist your understanding of why planning for the present and for your future has importance. Yes, we also promote our services; yet, you will find that we always seek to present thought provoking topics that are relevant to our wide audience.

This months letter will review health savings accounts and other tax-favored health plans. The US Congress enacted these plans with hopes of creating a constituency for future reforms based on choice and competition, rather than rationing and controls. And, with alarming increases in health care costs, employers are already looking to consumer driven health plans to help rein in expenses. Unfortunately, many consumers and employers are confused about which approach is best. Hopefully, this letter will help you understand how to save hard earned health care dollars and, maybe build an additional nest egg you can use in retirement. Lastly, and as always, we will finish with an update on our investment activities.

FSAs, MSAs, HRAs and HSAs

Flexible Spending Arrangements. Health FSAs are employer established benefit plans that may be offered in conjunction with other employer provided benefits as part of a cafeteria plan. A cafeteria plan (sometimes called a flexible benefit or Section 125 plan) is a benefit plan that allows an employee to have some choice in designing his or her own benefit package by selecting different types and/or levels of benefits that are funded with nontaxable employer dollars. Authorized under the Revenue Act of 1978, FSAs were Congress first attempt at health care reform.

An FSA allows employees to be reimbursed for qualified medical expenses. The word qualified may seem limiting, however, the scope of what qualifies is not very restrictive. You can use funds to pay any covered out-of-pocket medical expenses not paid by your health insurance. Plus, you can use these funds to pay for things like dental and vision care, chiropractors, non-prescription medicines and even bandages. FSAs are usually funded through voluntary salary reduction agreements and employer contributions are permitted as well. Also, contributed amounts are free from both employment and income taxes. The entire benefit can be completely tax-free!

At years end, however, unused funds are forfeited. This means that amounts carried at the end of the year cannot be paid out to the employee or carried over to the next year. This use-it-or-lose-it feature often encourages people to engage in wasteful year-end spending.

Employers, be advised that in order to maintain tax-qualified status, the FSA must comply with certain requirements that apply to cafeteria plans. There are restrictions for highly compensated and key employees and the plan must also comply with rules applicable to other accident and health plans.

Lastly, self-employed persons are not eligible for an FSA. The definition of self-employed includes sole proprietors, partners in a partnership, LLC and LLP members, and 2% or greater shareholders in an S Corporation.

Medical Savings Accounts. A MSA is a tax-exempt trust or custodial account  much like an IRA  that you set up with a US institution that allows saving money exclusively for future medical expenses. Congress, in an effort to expand health care reform to a larger part of the population, authorized MSAs under the Health Insurance Portability and Accountability Act of 1996 (HIPAA). MSAs were created to help the self-employed; employees of certain small firms; and persons eligible for Medicare in meeting the growing burden of medical care costs.

Like the FSA, an employee or employer can make contributions to the MSA free from employment and income taxes. Plus, any earned income or capital gains earned on funds in your MSA accumulate tax-free. Unlike the FSA, however, the contributions remain in your MSA from year to year until you use them. And, the MSA is portable so it can stay with you if you change employers or leave the work force. Once funded, distributions taken from the account are tax free if used to pay or reimburse qualified medical expenses. But beware, money taken out for anything other than qualified medical expenses is deemed taxable income and you'll pay an additional 15% penalty on top.

To qualify for an MSA, you need: (a) to be eligible for Medicare, or be an employee of a small firm, or be self-employed  spouses may also qualify; and, (b) to obtain and be covered by a high deductible health plan (HDHP). While the terminology for HDHP sounds self-explanatory, the IRS has specific criteria for what qualifies and it is best to check this with your tax advisor.

Despite Congress efforts, very few insurers, employers and employees have found MSAs very attractive. The main problem often cited for this lack of interest is that they enacted too many rules for determining who qualifies, what type of health insurance must be purchased, and so on. In addition, the rules restricted MSA contributions to a fraction of the required HDHP insurance deductible. Perhaps, the administrative burden for smaller taxpayers and their advisors just didn't seem worth the trouble to gain the benefit.

Health Reimbursement Arrangements. In June 2002, the IRS provided guidance in the form of Revenue Ruling 2002-41 and Notice 2002-45 with respect to what are now referred to as "health reimbursement arrangements" (HRAs). A HRA is an employer-funded plan, reimbursing employees only for eligible and substantiated health care expenses, and may not under any circumstances allow employees to contribute on any pre-tax basis.

Employers have complete flexibility with the plan and it can be offered in conjunction with other health benefit plans, including a FSA. There is no limit on the amount of money an employer can contribute to the accounts and unspent HRA balances may accumulate from year to year. Since it is the employers money, there is no requirement to provide departing employees access to the balances after they have left the company.

Only current and former employees (including retired employees), their spouses and dependents are eligible to participate in an HRA. Like a FSA, self-employed individuals are not eligible to participate in an HRA.

Health Savings Accounts. The newest kid on the block  the Medicare Prescription Drug, Improvement and Modernization Act of 2003 authorized the establishment of health savings accounts (HSAs) effective January 1, 2004. Make no mistake. The HSA is a new and improved version of the MSA, which the government is presently seeking to phase out, with less restrictions and limitations. In fact, the new HSAs are much better and worth looking at.

Now, almost everyone is eligible for HSA enrollment. And, like the MSA, if you change insurance plans, providers or even jobs, the HSA remains yours.

Remember, similar to the MSA, a HSA is a tax-exempt trust or custodial account that you set up with a qualified trustee to pay or reimburse qualified medical expenses you incur. To qualify, you must pair the account with a HDHP (high deductible health plan). The minimum deductible that qualifies is $1,000 for an individual and $2,000 for a family. You cant be eligible for Medicare, nor can you be claimed as a dependent on someone else's tax return. Also, the insurance policy you choose must have a provision that limits out-of-pocket expenses to a maximum of $5,000 for an individual and $10,000 for a family. There are some lenient exceptions to consider, so check with your tax advisor.

The amount you can contribute to your HSA depends on the type of HDHP coverage you have and your age. For 2004, if you have self-only coverage, you can contribute up to the amount of your annual health plan deductible, but not more than $2,600 ($3,100 if aged 55 or older). If you have family coverage, you are again limited to the lesser of the HDHP deductible or $5,150 ($5,650 if 55 or older). Given how the limits are worded in the IRS publications, I expect these amounts may be indexed each year. The limits are also impacted by many how many months out of the tax year you are covered under an HDHP.

When it comes to the insurance plan, remember, the higher the deductible, the lower your monthly premium. Most insurance providers will offer a range of deductible options so you can choose what might best fit your situation.

Some Concluding Thoughts

As I mentioned in the beginning of this letter, Congress enacted these plans with the hope of creating a constituency for future reforms based on choice and competition, rather than rationing and controls. They did this upon the belief that private health accounts will be a crucial component of health care and Medicare reform.

Health-policy experts have been universally critical of these plans. They don't refute the cost savings, but their concern is with the effect on public health. They point out that the best way to prevent sickness and high medical costs is through regular preventative examinations. Since preventative maintenance costs are paid from funds in the HSA custodial account until the (high) deductible has been met, the concern is that people will put off the exams until they are already sick. While this is certainly a risk for the public in general, it is definitely appears a manageable risk for those who are informed.

Don't skimp on your regular check-ups and health screenings. Sure, you'll pay a few more dollars out-of-pocket for a visit to the doctor, but the lower premiums should more than make up for these costs. In healthy years, the low premiums will allow you to increase your savings  on a pre-tax basis. In years with high medical costs, you are no worse off than you would have been under a traditional plan.

We're At Your Service

At ELF Capital Management, our focus is to help our clients achieve a more certain future. As such, our wealth management clients gain comfort in knowing that they've hired disciplined decision makers whose objective favors consistency of returns and capital preservation rather than magnitude of returns. And, were always thinking of ways to help our clients keep what they've earned!

ELF Capital Management Investment Performance Update

There seemed to be a lot of selling by traders prior to the elections in Iraq at the end of January. Not only did the markets ups and downs provide us some indication of this, but Ive been reading reports that as much money flowed out of mutual funds in the first three weeks of January as had flowed in during all of November and December combined. This selling seemed to impact most of the equity markets we follow, including REITs. To provide you some gauge of how US equity markets fared in January: the S&P 500 (large cap stocks) was off better than 2.5% for the month; the Russell 2000 (small cap stocks) was off almost 4.25%; and, the Dow Jones REIT Index (real estate) was off more than 9.0%. Despite these losses, our defensive strategy managed to protect value in our client portfolios.

For the month ended January 31, 2005, our one-month performance is down 0.20%, our three-month return is up 1.26% and our one-year return is down 3.07%.

For disclosure purposes, past performance is not necessarily indicative of future results and ELF Capital Management LLC (ELF), formerly Hoffman White & Kaelber Financial Services LLC, cannot guarantee the success of its services. There is a chance that investments managed by ELF may lose a substantial amount of their initial value.

ELF is an independent discretionary investment management firm established in February 2003. ELF manages a strategic allocation of primarily exchange-traded index funds (ETFs), and may invest in other carefully selected securities. ELF may also employ hedging techniques, through the use of short positions and options. ELF manages individual portfolio accounts for both individual and business clients.

The ELF ETF Strategy returns presented herein represents a composite of actual results from all client portfolios managed by ELF. Currently, it is the only composite presented by ELF and separate client account portfolio positions are substantially similar, except as may be modified for retirement plan accounts and accounts with net equity of $60,000 or less. There is no minimum account size for inclusion into ELFs ETF Strategy composite and accounts with net equity of $60,000 or less have a tendency to downwardly skew the combined results.

The performance data presented herein includes the reinvestment of dividends and capital gains; as well, ELFs ETF Strategy composite returns are presented after deducting actual management fees, transaction costs or other expenses, if any. ELF charges an annual investment management fee as follows: 1.25% on the first $250,000; 1.00% on the next $750,000; 0.95% on the next $4,000,000; and, 0.75% thereafter.

Copyright 2005 ELF Capital Management, LLC. All rights reserved.