Implications of the ACA Supreme Court Case

The Trump Administration presented an amicus brief before the Supreme Court arguing the entire ACA is now unconstitutional because Congress in a 2017 tax law eliminated fines for violating the individual mandate.  This note summarizes the brief, evaluates the likelihood the argument that the ACA is unconstitutional will prevail, and discusses potential actions Democrats can take to protect health insurance.

Summary:

The brief makes four arguments

  • Plaintiffs have the right to sue,
  • Eliminating the fines for the individual mandate means the law is no longer a tax law and is instead an unconstitutional mandate,
  • The individual mandate is inseverable from the guarantee-issue provision and the community-rating provision of the law,
  • The remaining provisions of the ACA are inseverable either due to the repeal of the fine for violating the individual mandate or the finding that guarantee-issue and community-rating provisions no longer apply.

Comments:

Comment One:   I am not a lawyer and cannot comment on standing, which is a pure legal issue.

Comment Two:  The previous Supreme court case decided 5-4 that the ACA was a tax law and not an unconstitutional mandate. This article explains that Roberts saved the ACA by finding that it was consistent with Congress’s tax authority.

Now that the tax rate for violating the individual mandate has been zeroed out it is harder to argue the individual mandate is a tax.

Comment Three: Many Congress people supported the provisions on guarantee issue and age rating in the ACA because the individual mandate forced healthy people to obtain insurance even if they were highly leveraged and struggling financially.   There is a lot of empirical evidence supporting the view that in the absence of the individual mandate fewer healthy people would obtain health insurance and more people would take out short-term health plans leaving themselves underinsured.  The increase in the number of healthy people who go without health insurance or choose to underinsure increases insurance premiums and decreases competition in state exchange markets.

The ACA states that provisions of the law are severable and that the removal of one provision does not invalidate the rest of the law. However, there is no doubt the modification of the law by eliminating fines for the individual mandate alters the risk pool, has a large impact on insurance firms, and was not the outcome desired by many in Congress when they voted for the ACA.

Comment Four: The elimination of the guarantee-rating and community-rating provisions of the ACA would also alter the economic impacts of other aspects of the law including the premium tax credit, annual and lifetime benefit caps, and the employer mandate.

Currently, premiums and the premium tax credit are based on the age of insured households.  A ruling by the Supreme court on behalf of the plaintiffs in this case would allow insurance companies to base premiums on health status instead of or in combination with age.  The actual regulatory authority over premiums would probably revert to state governments.

These changes in premiums would result in either the denial of insurance coverage or prohibitively expensive insurance for people with pre-existing conditions.   It is likely most insurance plans would impose annual and/or lifetime caps on benefits.  These changes would even make health insurance unaffordable or unavailable for some high-income people with pre-existing conditions.

The premium tax credit would be unworkable or would work in a way drastically different than intended by the ACA even if the Supreme Court ruled that it was severable from protections in pre-existing conditions.

Comment Five:  The court may side with plaintiffs on the main issues raised in this case.  Thomas and Alito dissented in the previous case and are likely to do so again. The logic used by Roberts has been undermined by the repeal of fines for the individual mandate.  One Bloomberg law article found that Gorsuch and Thomas are the justices most likely to overturn an entire law because of the removal of a specific item.   However, other justices may be willing to remove the protections for people with pre-existing conditions, which would essentially cripple other aspects of the law like the premium tax credit.

It is easy to envision an outcome to this case where a majority of justices rule the ACA unconstitutional in separate decisions reflecting different legal theories.

Potential Actions by Democrats:

 The overwhelming majority of Republicans in the U.S. Senate (perhaps all) want to kill the entire ACA.  If the Republicans retain control of the U.S. Senate and the Supreme court rules the ACA is unconstitutional, millions will lose their health insurance or gravitate towards inadequate insurance coverage.  The avoidance of this outcome and near-term progress in improving health insurance markets in the United States requires a Democratic sweep in November 2020.

 The legal threat to the ACA before the Supreme court is the result of a tax law change.  The easiest way to save the law is through the passage of a new tax law.  Most legislation requires 60 votes to clear the U.S. Senate.   Tax changes can clear the Senate with a simple majority though a process called reconciliation.  Tax changes addressing issues raised in the case before the Supreme court could conceivably take place before the Supreme Court ruling rendering the current court case moot.

The simplest or most obvious tax change ending the legal challenge to the ACA is is to restore fines for violating the individual mandate.  However, the individual mandate is unpopular, and the fines could be zeroed out again when the Republicans regained power.

The imposition of fines for violating the individual mandate is not the only way to discourage people from foregoing health insurance or underinsuring and assuring stable state exchange health insurance markets.   For example, the tax code could be modified to reduce standard or itemized tax deductions for people forgoing health insurance coverage.  Congress could expand the premium tax credit used to purchase state exchange health insurance markets for middle-income young adults.  Congress could expand volume of transactions and increase competition in state exchange health insurance markets by creating an incentive for employers to subsidize the purchase of state exchange insurance by employees. Readers interested in some potential tax proposals impacting health insurance markets and this case should consider this other article on Medium.

Another way to protect people with pre-existing conditions, if the Supreme Court rules that the individuals mandate and protections for people with pre-existing conditions are inseverable, involves giving people with pre-existing conditions an affordable public option.  This approach requires a 60-vote majority in the U.S. Senate unless the Democrats eliminate the filibuster.

Wouldn’t the creation of a robust public option be an ironic outcome of a court case seeking to eliminate the entire ACA?

Concluding Remark: The Supreme Court is likely to overturn significant portions of the Affordable Care Act.  However, a future Congress and a future President can overturn this result and create a much better insurance system. The future of the ACA and health insurance more broadly depends on control of the U.S. Senate than on the confirmation of a new Supreme court justice.

 

 

Health Care Reform and the Tax Code

Many problems with health insurance markets in the United States are associated with aspects of the tax code.

  • A large tax preference for employer-based insurance often results in discontinuities in insurance coverage during job transitions and periods of unemployment.
  • The preferential treatment of employer-based insurance reduces competition and adversely impacts insurance outcomes in state exchange markets.
  • The reliance on tax preferences for employer-based insurance favors workers at large profitable firms over workers at small less profitable firms.
  • Tax rules prevent low-income workers at firms with an offer of affordable health insurance from claiming the premium tax credit for purchase of health insurance on state exchanges even when the state exchange plan is superior to the employer-based insurance.
  • Middle-income people without offers of employer-based insurance are not eligible for the premium tax credit used to purchase state exchange insurance.
  • Tax incentives favoring the use of high-deductible health plans impose hardships on low-income and middle-income households, create an incentive for some people to forego necessary treatments or prescription drugs and create a tradeoff between saving for retirement and saving for health care.
  • The 2017 Tax Reconciliation bill zeroed out fines for the individual mandate, increasing incentives for people to forego health insurance or underinsure and led to a court case challenging the constitutionality of the entire ACA.

The purpose of this memo is to propose and evaluate tax policy changes, which would reduce imperfections in health insurance markets.

Modify tax preferences for employer subsidies of health insurance to promote the increased use of ACA state exchanges:

The ACA maintained long standing tax preferences provided to employer-based insurance and included rules favoring employer-based coverage over state exchange coverage.  Employer payments for health insurance premiums are deductible to the employer and untaxed to the employee.  Currently, around 11 million Americans obtain health insurance from state exchanges compared to around 157 million who obtain health insurance from their employer.

The continued dominance of employer-based health insurance has resulted in several problems including — discontinuities in insurance coverage during periods of job transitions or during unemployment and a lack of competition and choice in state exchange markets.  A merger of employer-based and state exchange insurance markets by having employers subsidize health insurance purchases for their employees in state exchange markets would benefit participants in both markets.

Employer contributions to state-exchange health insurance would facilitate continuous coverage during job transitions.  A person switching jobs with state exchange insurance would keep the same health insurance plan and would not have to meet a new deductible in order to receive benefits.

A single health insurance market separate from the employer facilitates lower cost continuous coverage for the unemployed.  COBRA allows unemployed people to maintain their current employer-based health insurance; however, the worker is responsible for the entire cost of the health insurance plan plus a 2 percent administration fee.  COBRA is unaffordable to many unemployed workers.  By contrast, unemployed people with state exchange health insurance who experience a reduction in income and a loss of their employer subsidy might automatically become eligible for a premium tax credit that covers part of the cost of state exchange health insurance.

The possibility of keeping an employer-based health insurance plan through COBRA payments is often not possible in a bankruptcy situation.   Employers experiencing a Chapter 11 bankruptcy often eliminate coverage or reduce subsidies.   Chapter 7 bankruptcy generally results in the termination of all employer-based health insurance including COBRA.  By contrast, state exchange health insurance is unaffected by corporate bankruptcy.

The increased ability for the unemployed to retain continuous affordable health insurance coverage would greatly benefit the current economy.  A recent study by the Economic Policy Institute found that around 9.2 million people have lost their health insurance due to the COVID pandemic.

The creation of large statewide health insurance markets serving both people with employer-based subsidy and people with state exchange health insurance will expand health insurance choices for many households.

Currently, most people with an offer of employer-based health insurance will not qualify for premium tax credits on state exchanges and the employer health plan is often insufficient or not affordable for lower-income households. The creation of a single health insurance market allows workers to use employer subsides and also claim the premium tax credit if the worker’s income was low and the employer subsidy was insufficient to cover the entire health insurance premium.

Many employers, especially small firms, only offer a single insurance option.   The proposal presented here would allow all people access to any insurance plan offered on state exchanges.

The plan increases competition and offerings of health plans on state exchanges.  A report by the Kaiser Family Foundation found in 2020 two state exchanges were served by only one insurance company and another fourteen state exchanges had two insurance companies offering products.  Research has revealed that health insurance plans offered on state exchanges often lack access to top hospitals or specialists.  The larger single market would result in more competition, which should improve insurance plan quality and reduce premiums.

Most people who forego health insurance are both healthy and lack subsidies for insurance premiums.  The decision of healthy people to forego health insurance until they become sick increases insurance premiums.   The larger state exchange health insurance market including people with employer subsidies will have a smaller share of people who forego health insurance coverage.

The creation of a larger insurance market where a larger share of people automatically purchase health insurance due to generous employer subsidies will reduce the need for an individual mandate because the small share of people foregoing health insurance will have a relatively small impact on insurance premiums.

Modify the tax code to promote additional employer contributions for small firms and firms with low-income workers:

The current tax code treats employer payments on employee health insurance premiums as a tax-deductible business expense.   The value of this deduction is larger for more profitable companies than less profitable companies.   The current tax code also exempts insurance premiums from taxable income of households creating a benefit that is more valuable to taxpayers with high marginal tax rates.

The expansion of and modification of the small business tax credit could promote additional contributions for employer-based health insurance on state exchanges targeting small firms with low-income households.

The modified program would be available for firms subsidizing insurance for employees on state exchanges rather than firms providing employer-based insurance.   The modified program would be open to all firms where more than half of the employees had a salary less than a certain threshold rather than the average salary of all employees.

The proposal to expand tax benefits associated with health insurance subsidies for smaller firms with low income workers is similar in structure and spirit to a a new Biden 401(k) tax proposal which expands tax breaks for contributions to 401(k) contributions to low-income households.

Make several modifications to rules governing health savings accounts and high-deductible health plans to make these plans less burdensome to low-income households and people with expensive health conditions:

 Health savings accounts coupled with high-deductible health plans passed as part of the 2003 Medicare law are growing in popularity.  The use of high-deductible health plans reduces insurance premiums.   The use of health savings accounts creates pre-tax savings for health expenses.  However, current health savings accounts and high deductible health plans create several problems for low-income and middle-income people including increased out-of-pocket expenses, reduced adherence to prescription drug regimens and a tradeoff between saving for retirement and saving for health care.

Four policy changes, which could mitigate problems associated with increased use of health savings accounts and high deductible plans, are proposed and discussed below.

The first two proposals attempt to mitigate financial hardship imposed on households from increased cost sharing.

  • A tax credit for contributions to health savings account would be established for households with income below a particular threshold.Higher income households would continue to make untaxed contributions to health savings account.   This provision would encourage use of less expensive health plans by lower income households and reduce disparities occurring because of the difference in the value of tax subsidy stemming from differences in marginal tax rates.
  • Rules governing contributions to health savings accounts would be modified to allow contributions to health insurance plans with higher coinsurance rate plans even if their plan had a relatively low deductible.The current laws governing health savings accounts only allow contributions from people with a high deductible health plan even though health plans with a relatively low deductible and high coinsurance rate allow for substantial cost sharing and can provide better outcomes to households than a high deductible plan.

Many low-deductible health plans pay most costs for prescription drugs even prior to the deductible being met.  However, many of the new high-deductible health plans do not pay for any prescription drug treatments prior to the deductible.  The more onerous rules on prescription drug payments by high-deductible health plan have created an incentive for many people to forego or cut short necessary prescriptions.  This incentive is especially large for people with diseases like diabetes where the patient does not have immediate symptoms.  The failure to control chronic health problems can lead to bad health consequences and more expensive health services in the long or medium term.  For example, the failure by diabetics to control blood sugar can lead to kidney problems, eye problems, amputation and heart issues.

Two additional proposals are presented to address potential problems associated with reduced use of prescription medicines stemming from increased use of high-deductible health plans.

  • Regulations governing prescription benefit formulas for high-deductible plans should be modified to require partial payment by insurance firms on prescription drugs for the treatment of chronic diseases prior to the deductible being met. Current law allows high-deductible health plan to make payments for some preventive treatments prior to the deductible being met.It should be possible for Health and Human Services to mandate coverage for some prescriptions treating chronic diseases as a preventive method under current regulations.
  • Congress could establish a fund to directly pay part of the cost of necessary health prescriptions for low-income and middle-income households.The funds for this effort could be obtained through an excess profit tax on pharmaceutical companies.

Both approaches have advantages and disadvantages.  The adoption of a regulation requiring greater insurance payments for prescription drugs would increase insurance premiums.   The creation of a new fund subsidizing insurance payments for prescription drugs would not increase premiums but would have to be enacted through new legislation.

All four of the proposals presented here could make cost sharing between insurance firms and household more palatable to low-income households.  Any proposal that shifts households to a plan that imposes more cost sharing could reduce premiums and tax expenditures for premium subsidies.

Note also, that a new tax credit associated with health savings accounts requires households have a particular form of insurance coverage would also reduce the number of households forgoing health insurance.

Modify the premium tax credit to include some assistance for middle-income households and eliminate the:

The current ACA premium tax credit does not provide any assistance to people with income over 400 percent of the federal poverty line, around $50,000 for a person seeking an individual only health plan.  This abrupt cutoff of benefits creates two problems.

  • People with household income under 400 percent of the federal poverty line often forego health insurance or underinsure.
  • Many people claim an advanced tax credit to pay for their health insurance prior to knowing their actual annual income.People who earn more than 400 percent of the federal poverty line lose access to the entire tax credit and often owe substantial tax payments to the Treasury.

The most effective way to fix both of these problems is to modify the premium tax credit and guarantee a minimum tax subsidy (perhaps $1,000 for an individual and $2,000 for a family).

The minimum tax credit could be given either to all people without access to an employer-based insurance plan or all people in the population.   The former approach would be less expensive to taxpayers but some small firms could decide to forego employer-based subsidies so their employees could claim the premium tax credit.   The later approach by having firms and taxpayers share the cost of premiums would reduce cost to employers.

The proposal presented contrasts sharply with Vice President Biden’s proposal to extend the premium tax credit past 400 percent of the federal poverty line and increase the generosity of the tax credit.  Vice President Biden’s plan does not provide any assistance to many middle-income households. For example, based on calculations obtained from the Kaiser Family Foundation Health Insurance Marketplace Calculator a 30 year old person making $60,000 per year seeking an individual-only health plan would pay $409 per month and receive no support from the premium tax credit. (Figures presented here are based on average U.S. insurance premiums.)

Reduce standard or itemized deductions for people who choose a public health insurance plan over a private health insurance plan:

People who are uninsured and healthy tend to forego health insurance and immediately seek coverage if they become ill or injured.  In order to deter this behavior, the ACA included a financial penalty in the form of a tax fine for people without health coverage.   The individual mandate was resented and opposed by many individuals.  The 2017 tax reconciliation bill zeroed out fines for the individual mandate.  The repeal of fines led to litigation, brought by some state attorney generals, claiming that the entire ACA without the individual mandate was unconstitutional.   The fifth circuit federal appeals court agreed that the ACA is unconstitutional without the individual mandate and this court case is now heading to the Supreme Court.

It is difficult to predict with certainty the outcome of any Supreme Court case.    The court upheld the law in a 5-4 decision in a previous case.   The new more conservative court is more likely to repeal the law.

A 2017 tax reconciliation bill modified the individual mandate and led to the current challenge.  Depending on the outcome of the 2020 election, a 2021 tax reconciliation bill could either restore fines for the individual mandate or create some other financial incentives designed to assure that people maintain continuous health insurance coverage.

One way to create incentives for people to maintain continuous health insurance coverage and to address legal concerns about the constitutionality of the entire ACA is to create a new financial penalty for people choosing to forego health insurance coverage.  The financial incentive could be implemented in the form of the loss of some standard or itemized deduction for people who do not have health insurance and need not be as large as the original fines for violating the individual mandate.

Concluding Remarks on Tax Policy and Health Insurance:

The tax proposals presented here expand the size of state exchange markets, reduce the number of people who forego health insurance coverage, improve the quality of health insurance coverage, and obviate the need for an onerous individual mandate.  The passage of these tax reforms would address legal concerns stemming from the litigation following the passage of the 2017 tax reconciliation bill.

 

 

Finance Data

Attached is a spreadsheet with financial data.

The first dataset involves data on sales growth for 35 companies in a growth fund and 35 companies in a value fund.  Fund  number one is the the growth fund.  Fund number two is the value fund.   The data is year over year for the most recent quarter, usually the third quarter of 2017.

 

Go here for this sales growth data:

sales growth

Using Excel to Calculate Mortgage Qualification Amounts

The attached spreadsheet shows how to use an Excel spreadsheet to calculate the amount of mortgage a person with student or consumer debt might qualify for.   One scenario estimates the impact of increasing maturity of student loan from 10 years to 20 years on increase in potential mortgage and cost to student borrower.

Examples of solving for mortgage qualification amounts in Excel.

qualification-for-house-by-student-borrower (3)

Using contingency tables to measure systematic risk.

Contingency Tables Versus Beta

Question:  Below are two contingency tables describing the relationship between daily stock prices and daily changes in the S&P 500 for two companies.   One of the companies is a high-beta firm.   The other company a low-beta firm.

Movements in Stock Price Versus S&P Company One
Stock Close<Prior Low Stock Between Prior Low and High Stock Close>Prior High
S&P Close < Prior Low 12 18 4
S&P Between Prior Low & High 26 80 28
S&P > Prior High 5 31 48

 

Movements in Stock Price Versus S&P Company Two
Stock Close<Prior Low Stock Between Prior Low and High Stock Close>Prior High
S&P Close < Prior Low 10 21 3
S&P Between Prior Low & High 19 68 47
S&P > Prior High 14 48 22

The rows of the contingency table were formed by comparing the S&P close to the value of the low or high of the S&P on the previous market day.

The columns of the contingency table were formed by comparing the closing stock price to the low or high of the stock price on the previous day.

What table depicts the high beta stock?    What table depicts the low beta stock?  Defend your answer?

Use Stata to calculate Kendalls Tau B and Spearman’s rank correlation coefficient for the two firms.

How do these non-parametric statistics differ for these two firms?

Discuss implications of these results for future research.

Analysis:

 The count of observations on the diagonal of the contingency tables starting from the top right cell to the bottom left cell of the table represent the number of instances where stock prices move in tandem with the market.

The proportion of observations on this diagonal is 55.6% for company one compared to 39.7% for company 2.

Beta is the most common measure of the movement of stock prices with the market so it is relatively clear that company one has a higher beta than company two.

In fact, company one is Apple and company two is Duke Power.   According to yahoo finance, the beta for Apple is 1.40 and the beta for Duke Power is 0.01.   The values of the proportions of observations on the diagonal of the contingency table appear to correspond to yahoo finance beta estimates.   (Sample size of two is admittedly very small.)

Kendall’s Tau and Spearman’s rho are two statistics commonly used to measure the association between row and column variables of a contingency table.    The table below lists these two statistics for these two companies

Comparison of Non-Parametric Measures of Association Between Stock Price Movements and Market Movements
Apple Duke Ratio Apple to Duke
Kendall’s

Tau

0.3672 0.0247 14.9
Spearman’s

Rho

0.3980 0.0658 6.0

Concluding Thoughts:   Financial analysts use beta to measure the price of a stock.   The preliminary results presented here indicate that contingency tables and non-parametric statistics can be used to measure the association between movements company stock price and the overall market.   More research will be available on this topic shortly.

Authors Note:   I am planning the launch of a monthly financial and economics newsletter.  Please follow this blog to obtain advanced notice of this product.

 

Proposal One: Increased Financial Assistance for First-Year Students

There is little doubt that failure to reduce college debt levels will dramatically worsen the economic situation of many people who borrow for college.   However, free college or debt-free college is not a viable economic program.   This proposal targeting aid towards first-year students is part of an economically viable program to reduce burdens caused by college debt.

Description of program:  The federal government would provide all accredited four-year and two-year universities with funds to cover 50 percent of the tuition of the average four-year state university for all first-year students with household income less than a threshold.   The subsidy would be phased out for students above the threshold.  Schools and states could differ on the income threshold defining the group of students obtaining a subsidy.  Schools that wish to participate in this program would be required to match 25 percent of the federal contribution.

 Comment One:   The program is far less costly and far less ambitious than the programs offered by Senator Sanders and Secretary Clinton.   The total estimated cost of Senator Sanders’ proposal is $70 billion a year, with around two thirds of the costs of the program borne by the federal government and one third borne by state governments.

Comment Two:   The program described here allows for greater control at the state level than the program advocated by Hillary Clinton.  Hillary Clinton’s proposal would provide grants for tuition assistance only in states that fund public universities at a high level. Her proposal also includes penalties for universities that fail to meet certain goals including reducing costs, earnings of graduates, and reduced tuition. These conditions are problematic because state differ in their resources and priorities. Moreover, this approach would favor state university systems that emphasized research over teaching

This program is designed to allow schools and states to select a sustainable subsidy level.   The subsidies proposed by Sanders and Clinton will prove to be unsustainable during economic downturns.

Comment Three:  The four-year exclusively-for-public university benefit would have a devastating impact on enrollment in all private universities including historically black colleges.  Many of these universities have excellent track records for educating students and preparing students for careers.  This benefit is available at both private and public universities but the total cost of the program is much lower because it targets first-year students only.

Comment Four:  First-year students with no academic track record past high school are more likely to drop out of college than students further along in their academic career.    The possibility of failing academically and incurring debt at the age of 18 may deter some students from entering college even though education past high school is increasingly necessary for career advancement.  Targeting financial aid for first-year students is the most effective way to enroll students who might otherwise be deterred from every trying college.

Comment Five: The government pays interest on some student loans until the student leaves school and starts repayment. On other student loans, the cost of interest is borne by the student as soon as the loan is issued.  Cumulative interest on student debt is highest when debt is issued years prior to the initiation of repayment.   Cumulative interest on student loans are best reduced through subsidies that reduce loans incurred by first-year students.

Comment Six:  Students who drop out of college after one year of school have lower salaries than students who complete more college.  The lower salaries of students who only complete one year of college suggests that a program targeting first-year students will be more progressive than a program targeting all students throughout their entire career.

The lower salaries for students who incur first-year debt and leave school will also result in higher default and delinquency rates.  Programs that reduce loans for first-year students will result in a larger improvement in default or delinquency rates than financial aid programs targeting all students.

Comment Seven:  The requirement that schools publish the percent of first-year students incurring debt will provide valuable information to students on the cost of their education prior to students incurring too much debt.   This requirement will create an incentive for colleges to expand assistance for first-year students, which as shown in the comments here results in substantive benefits for the borrowers and the government lender.

Concluding Comment:   The increased financial assistance in this proposal is far smaller than the increased assistance offered under the more expansive proposals presented by Secretary Clinton and Senator Sanders.   A totally free college program provides extensive assistance to many people who do not need help. Around 30 percent of graduates from four-year institutions finish school with no debt and many student borrowers have sustainable debt levels

The principle, that subsidies should target people who would not otherwise do the socially desirable action is central to proper public policy.  One should not target tax subsidies for fuel efficient cars if people were eager to buy the car without the subsidy.  Similarly, financial assistance should target students who could not enter or complete school without taking out large amount of debt.

Other initiatives including other forms of targeted financial assistance, improvements in loan forgiveness programs, initiatives to improve on-time graduation rates and improved information on school quality and costs will reduce college debt burdens in a way that is fairer to taxpayers than free college for all.

 

Timing of Drug Purchases and Out-of-Pocket Costs for HDHPs

Timing of Drug Purchases and Out-of-Pocket Costs for HDHPs

Background:  A lot of analysts advocate high deductible health plans (HDHPs) for two reason — low premiums and access to tax deductible savings accounts.  These advantages are real.

Less attention has been spent on differences between how HDPPs and standard plans differ in their reimbursement of prescription medicine.  Most standard deductible health plans with low deductibles pay a share of prescription drug costs prior to the deductible even being met.   By contrast, most high-deductible health plans do not reimburse any health care costs until the entire deductible is met.

Moreover, many insurance companies that sponsor both standard and high-deductible health plans have less generous benefits for certain drugs under the high-deductible health plan.

Drugs can be very expensive especially when a generic alternative does not exist. The prices of some commonly used drugs presented below was obtained from a major reputable insurer which offered both a standard deductible and HDHP.

Prices of Some Drugs
Atorvastatin $30
Cialis $923
Trulicity $1,994
Metopropol $3.60
Welchol $1,753
Janumet $1,177
Jardiance $1,273

Prices are for 90-day supplies.

This insurer typically  required consumers to pay around 25 percent of the cost of the non-generic drug.   However, I noted that the insurer paid 25 percent of the cost for a 90-day supply of Cialis 5-mg daily use under the standard plan and 0 percent under the HDHP.

Most consumers evaluate insurance plans based on broad reimbursement levers, deductibles, out-of-pocket expense limits, and coinsurance rates.   However, increasingly narrow policy rules including the reimbursement rate for a drug or whether a procedure is medically necessary can have a large impact on out-of-pocket costs and financial exposure.

There is another complexity associated with the use of high-deductible health plans and reimbursement for prescription drugs.   The complexity is the result of the higher coinsurance rate for prescription drugs than for most hospital services.   In some plans the coinsurance rate (the share paid by the customer) is 25 percent for prescription drugs and only 5 percent for hospital visits.    This feature combined with rules governing deductibles can result in the timing of medical services impacting the total amount paid by the customer.

A person who pays $X for a car and $Y for a vacation will pay a total of $X +$Y for both items regardless of when the purchases occur.   However, the amount of out-of-pocket expenses incurred by a person purchasing prescription drugs and a visit to the ER or a hospital can vary quite a bit depending upon when the purchases occur.

The purpose of this post is to show that the timing of drug purchases and visits to the hospital can have a nontrivial impact on out-of-pocket health costs when reimbursement is guided by the rules of a high-deductible health plan with a high coinsurance rate for drugs and a low coinsurance rate for hospital stays.

Examples:

Let’s illustrate the timing effect with a couple of simple examples.

Situation One:   An individual-only health insurance policy has a $1,500 deductible and a catastrophic limit of $5,000.   The plan has a 5 percent coinsurance rate on hospital visits and a 25 percent coinsurance rate on prescription drug purchases.

How much does a person insured by this plan pay if she purchases $1,500 of prescription drugs prior to December 2018 and then has a $1,500 ER visit in the middle of December?

How much does a person insured by this plan pay if she has a $,1500 ER visit in early January 2018 followed by $1,500 in purchases of prescription drugs though out the year?

Assessment of Situation One:

The person who starts off the year with prescription drug expenses pays $1,500 on the prescription drugs and $175 (0.05 x $1,500) for the ER visit.

The person who starts off the year with an ER visit will pay $1,500 for the visit to the ER and $375 (0.25*$1,500) for the drugs.

The difference is around 19 percent of the lower amount.

The lesson here is that you should consider scheduling your ER visits for early in the year.   (Just kidding.  It is obviously very hard to schedule your ER visit.)

Situation Two:   A family has household coverage with $5,000 deductible.   The catastrophic limit on the plan is $13,500.    The family incurs two types of expenses during the year — $5,000 of drug costs and a $20,000 operation.

How much does the person who starts off the year with prescription drug expenses and ends with the operation pay in total out-of-pocket expenses?

How much does the person who starts off the year with the operation and ends with prescription drugs pay in total out-of-pocket expenses?

Assessment of Situation Two:

The person purchasing drugs prior to the operation pays $5,000 out-of-pocket for drugs and $1,000 for (0.05*$20,000) for the operation.

The person with the early operation pays $5,750 for the operation ($5,000+0.05*$15,000) and $1,250 (0.25*$5,000) for the drugs for a total of $7,000.   The difference as a percent of the smaller amount rounds to 16.7 percent.

A Note:   The two examples presented here result in the person who has the major-medical event later in the year incur more expenses than the person who starts the year with a major- medical event.   This is not always the case when the major-medical event is very large.   I hope to address this post in a separate post.

 Implications: I am the first to acknowledge that disparities resulting from timing of drug purchases under a HDHP are not the largest factor impacting health insurance markets.  As many have noted crappy insurance beats no insurance every single time.

However, the issue raised here is non-trivial for a few reasons.  First, a few hundred dollars or a thousand dollars is a non-trivial amount for a household struggling with student debt or just generally living pay check to pay check.   Second, the lack of transparency on this issue reduces the credibility of the insurance industry and the economists and financial advisors who work for it.   Third, based on the calculations demonstrated here some people may underutilize pharmaceutical drugs and/or delay needed medical services.   Fourth, based on the findings presented here policymakers should consider changing the rules governing eligibility for health savings accounts.

Other readings on advantages of different plan types can be found here.

 Health Insurance Math – Problem One

http://www.dailymathproblem.com/2013/12/health-insurance-policy-math-post.html

High Deductibles Versus High Out-of-Pocket Limits

http://www.dailymathproblem.com/2013/12/high-deductibles-versus-high-out-of.html

Health Plan Comparisons:

http://www.dailymathproblem.com/2013/12/health-plan-comparisons.html

My sense from these papers is that lower deductible plans with high catastrophic limits and higher coinsurance rates would benefit both the industry and the consumer.    The decision to only provide tax preferences for holders of high deductibles was a very bad one.

I would be happy to write the definitive study on this topic but funding and data are both needed.

Buy or Rent a House?

  Discussing Buy Versus Rent Calculators

Realtor groups have created a number of on-line calculators that attempt to provide an objective view of the advantages of buying a home versus renting a home.  The link to one such calculator is presented below.

http://www.realtor.com/mortgage/tools/rent-or-buy-calculator/

First, I describe the calculator.   Then I critique it.

Description of Calculator:

The simple version of the buy/rent calculator at www.realtor.com allows one to put in an address and get financial estimates for renting or buying.  The more advanced and interesting version allows a consumer to select assumptions on costs of buying and cost of renting.

The key assumptions on the cost of buying involve home price, down payment mortgage term, buying costs, selling costs, house appreciation, real estate taxes and miscellaneous homeowner fees.

The most important renting costs include the initial rent and the yearly appreciation in rent.

Other key assumptions include the exemption of  $500,000 on capital gains in housing, an investment return, and an inflation rate.

Based on the inputted assumptions the model provides an estimate of the amount of time that it takes for buying a home to be cheaper than renting a home.

The model at www.realtor.com assumes that buying costs are 4.0 percent of the purchase price and selling closing costs are 6.0 percent of the final sales price.   Due to transaction costs associated with home purchases, renting will be less expensive than buying for people who stay in a house for a short period of time.   The output of the model is the number of years it takes for buying to be less

Comments on the calculator at www.realtor.com

 

Comment One:  Often realtors and bankers persuade young homebuyers to use available cash for a down payment rather than immediately retire consumer or student debt.  The model does not have an option to explicitly consider the impact of credit card debt or student debt on the buy versus rent outcome.   The model does require input on the assumption of investment returns.   One way to model the impact of keeping debt is to increase the investment return assumption so that it equals cost of credit cards and student loans.   It would be useful if the model allowed for separate assumptions on investment return and the cost of existing debt.

Comment Two:   I modified one example to consider the breakeven point of a transaction with a 15-year FRM at current interest rates.   I found that buying was preferable to renting after a 6-year period for the 15-year FRM compared to 8 years for the 30-year FRM.   Essay Four provides more information on mortgage choice and lifetime savings.

Comment Three:   The model cannot be easily modified to allow for interest rate uncertainty associated with adjustable rate mortgages.

Comment Four: The model requires an assumption of average annual growth in house appreciation over the entire period and does not consider issues related to the uncertainty of future house appreciation.  House prices do not appreciate in a steady or reliable fashion.   The realtor’s model would have severely overestimated the value of buying a home during the 2004 to 2009 time period and would have underestimate returns from purchasing in 2011 or 2012.  The argument that housing prices would continue to rise was made quite strenuously in 2007 and was used to motivate unrealistic price appreciation assumptions in the breakeven analysis.

The house price appreciation assumption is usually based on what the analyst expects will occur.   An alternative approach would involve basing this parameter on the certainty equivalent.   A certainty equivalent is the guaranteed return that someone would accept rather than take a risk on a higher but uncertain return.

Comment Five. Many people are forced to move because of a new job or divorce.   The rent versus buy calculator does not allow for economic costs associate with moving when house prices fall and house equity turns negative.   Nor does the buy versus rent calculator consider economic costs associated with negative equity that make it difficult for a home buyer to refinance should interest rates fall.

 

The more relevant question not answerable from this calculator is it better for a person to buy now or reduce debt and buy in a couple of years.

Comment Six:  Often realtors will expect home sellers to put additional investments into the property prior to selling the home.  (Most recently in many neighborhoods realtors are pushing home sellers to install granite kitchen tops.)   The model does not include an option to consider likely upgrade costs.  It may be able to correct for this problem by reducing the price appreciation assumption in the model.  However, the need for upgrades appears to differ widely across properties.

Comment Seven:: The buy-sell calculator can also be used to evaluate mortgage properties financed with FHA loans.   The FHA loan program is geared for relatively small mortgages.  The program has a loan limit that varies across counties and can change over time.   The FHA loan program allows for down payments as low as 3.5% FHA loan costs include mandatory mortgage insurance premiums, part of which is paid up front.  Due to the insurance premiums the cost of the FHA loan is often one percent point higher than the cost of conventional loans.  Most often, the number of years it takes for a home buyer to break even on an FHA loan program will be substantially higher than the number of years it takes to break even on a transaction financed with a conventional loan.   Not surprisingly, the use of real estate break- even calculators is usually illustrated with conventional loan examples rather than FHA loan examples.

Comment Eight: The assumption regarding the rate of appreciation of rents has a major impact on the buy versus rent decision.    A larger percent of people are choosing to rent rather than buy consequently more rents are continuing to rise often at a rate that exceeds the increase in the value of the home.   In some markets it may be legitimate to assume a higher increase in rents than home prices.  This alternative assumption might persuade more people to buy rather than rent.

Comment Nine:  Realtors often argue that a house purchase should occur now rather than later because macroeconomic conditions are about to change.   Over the last three or four years realtors have argued that people should buy because the FED is about to raise interest rates.  An increase in interest rates induced by Fed policy would increase the cost of interest on a home but might also lower house prices.

The Fed will eventually raise interest rates but even Nobel Prize winning economists are confused about when this will happen.  Potential homebuyers should not rely upon the interest rate forecasts of realtors when determining whether or not or buy or rent a home.

Concluding thoughts on the Limitations of Buy Versus Debt Calculators:  My comments suggest that for a wide variety of reasons buy versus debt calculators often overstate the case for buying rather than renting a home.    The approach relies on subjective assumptions on a wide variety of economic variables.   Assumptions on the most crucial variable – the future growth of housing prices have been grossly inaccurate in the past.

The one factor that favors buying over renting in the current environment is that stock prices are currently at historic highs and long term interest rates are at historic lows.   I suspect that based on the current market conditions returns on real estate will outpace returns on financial assets in the near future.  Hence an assumption of a low future return on financial assets might be justified at this time.

The buy versus rent calculator does not accurately measure the benefits of delaying a home purchase until consumer debt and student loans are substantially reduced or eliminated.   Nor does the model allow for active consideration of costs, which might be incurred if a young worker with little initial house equity is forced to sell a home in order to take advantage of a new job opportunity.  Usually younger households will be much better off by delaying the home purchase and using all available funds to retire student loans and consumer debt.

Two Ways to Calculate a Portfolio PE Ratio

Two Ways to Calculate a Portfolio PE Ratio 

Question:  The table below contains data on the market cap and the earnings for four high-tech firms.

Market Cap and Earnings for Four Tech Firms
Market Cap

($ B)

Earnings

($ B)

AAPL 892.16 46.65
MSFT 585.37 21.2
AMZN 475.37 1.92
TWTR 13.11 -0.44797

 

In this post, I am asking you to use two methods to calculate the PE ratio of this four-stock portfolio and to confirm that both methods provide the same answer.

Method One:

Calculate the PE ratio of this portfolio by taking the sum of the market cap numbers for the four stocks and dividing by the sum of the earnings of the four stocks.

Method Two:

Calculate the ratio of (market cap minus earnings) divided by market cap for the four stocks.

Calculate a weighted average of the values (MC-E)/MC for the four stocks with the ratio weighted by MC.  Give the name to this weighted average the letter f.

Calculate 1/(1-f).

Show that the PE ratio from method one is identical to 1/(1-f).

Analysis:

The straight forward way to calculate the PE ratio by taking the ratio of the sum of the market caps to the sum of the earnings is presented below.

Portfolio PE Ratio – Method One
Market Cap

($ B)

Earnings

($ B)

AAPL 892.16 46.65
MSFT 585.37 21.2
AMZN 475.37 1.92
TWTR 13.11 -0.44797
Total 1966.0 69.3 28.4

 

This four-firm portfolio has a PE ratio of 28.4.

The PE ration calculation for method two  is presented below.

 

Portfolio PE Ratio — Method Two
Market Cap Earnings (MC-E)/MC Weight
AAPL 892.16 46.65 0.9477 0.4538
MSFT 585.37 21.2 0.9638 0.2977
AMZN 475.37 1.92 0.9960 0.2418
TWTR 13.11 -0.44797 1.0342 0.0067
1966.01 1.0000
f 0.9647
1/(1-f) 28.4

 

The second method for calculating a PE ratio gives the same result as a the first – 28.4.

Implications:   The PE ratio of a portfolio can be expressed as function of the weighted average of the ratio of the difference between market cap and earnings of the firm to market cap of the firm.    This is a very useful result.

PE ratios of firms are frequently not useful.

First, the PE ratio can become very large when earnings are very small. This means it is misleading to look at a weighted average of PE ratios because one firm can have a a very large impact. In our current example, the PE ratio of Amazon is 248 and the weighted average PE ratio for the four stocks is  77.

Second, PE ratios have no economic meaning when earnings are negative.

The PE ratio of a firm with negative earnings would reduce the weighted average of PE ratios in a portfolio.  By contrast, (MC-E)/MC will be larger than 1 if E is less than 0.

A firm with slightly negative earnings would have a negative PE ratio with a larger absolute value than a firm with very large losses.  This ranking of firms is incorrect because larger losses should be associated with lower relative valuations.   By contrast, (MC-E)/MC will always rise when E falls.

By contrast, the ratio of the difference between market cap and earnings over market cap is inversely related to the valuation of a firm.   When earnings are negative this ratio is greater than one.   When earnings are zero the ratio equals one.   When earnings are very small the ratio approaches one and is not an outlier.  The ratio of the difference between the market cap and earnings to market cap is intuitively defined for all earnings and not impacted by outliers.

In my next post, I will show that statistical tests based on samples of the ratio of the difference between the market cap and earnings to market cap are more useful than statistical tests based on PE ratios.