Bringing it home

Industry is coming back to the USA.  Some call it “insourcing” or "onshoring".

Yesterday Apple CEO Tim Cook announced a $100 million investment returning the manufacture of Mac computers to the USA in 2013: “We’ve been working for years on doing more and more in the United States.” He added that he hoped it would spur on more U.S. manufacturing. “The consumer electronics world was really never here. It’s a matter of starting it here.”  Whether this is the start of something bigger or an attempt at good PR in Washington, the Apple announcement comes on the heels of GE’s recent reintroduction of its appliance manufacturing assembly lines to its Louisville Kentucky “Appliance Park” which had been languishing since the 1980s decision to shift manufacturing to China.  The GE initiative is costing $800 million and CEO Jeffrey Immelt said, “I do that because I think we can do it here and make more money.”  The Atlantic Magazine December 2012 contains a fascinating article on the topic entitled “The Insourcing Boom”.

Global economic factors are now in play:-

·         Oil prices are three times what they were in 2000, making cargo-ship fuel much more expensive now than it was then.

·         The natural-gas boom in the U.S. has dramatically lowered the cost for running something as energy-intensive as a factory in the USA. (Natural gas now costs four times as much in Asia as it does in the U.S.)

·         In US dollars, wages in China are some five times what they were in 2000—and they are expected to keep rising 18 percent a year.

·         American unions are changing their priorities. Appliance Park’s union was so fractious in the ’70s and ’80s that the place was known as “Strike City.” That same union agreed to a two-tier wage scale in 2005—and today, 70 percent of the jobs there are on the lower tier, which starts at just over $13.50 an hour, almost $8 less than what the starting wage used to be.

·         U.S. labor productivity has continued its long march upward, meaning that labor costs have become a smaller and smaller proportion of the total cost of finished goods.

The compressed and ever shortening product cycle, coupled with the adaptation of "mature" products such as dishwashers and water heaters to include computer software to improve efficiency and functionality also drives changes to factory processes.  Factories take a while to settle into a new product, a new design. They face a learning curve. But models that have a run of only a couple years become outdated just as the assembly line starts to hum. That, too, makes using faraway factories challenging, even if they are cheap.

GE is rediscovering that how you run the factory is a technology in and of itself. The R&D that can happen there, if you pay attention, is worth a lot more to the bottom line than the cost savings of cheap labor in someone else’s factory. GE’s appliance unit does $5 billion in business—and today, 55 percent of that revenue comes from products made in the United States. By the end of 2014, GE expects 75 percent of the appliance business’s revenue to come from American-made products like dishwashers, water heaters, and refrigerators, and the company expects that its sales numbers will be larger, as the housing market revives.

What’s happening in factories across the U.S. is not simply a reversal of decades of outsourcing. If there was once a rush to push factories of nearly every kind offshore, their return is more careful; many things are never coming back. Levi Strauss used to have more than 60 domestic blue-jeans plants; today it contracts out work to 16 and owns none, and it’s hard to imagine mass-market clothing factories ever coming back in significant numbers—the work is too basic.

Appliance Park once used its thousands of workers to make almost every part of every appliance; today, every component GE decides to make in Louisville returns home only after a careful calculation that balances quality, cost, skills, and speed. Appliance Park wants to make its own dishwasher racks, because it can, and because the rack is an important part of the dishwasher experience for customers. But Appliance Park will likely never again make its own compressors or motors, nor is it going to build a microchip-etching facility.

Manufacturing employment will never again be as central to the U.S. economy as it was in the 1960s and ’70s—improvements in worker productivity alone ensure that. Back in the ’60s, Appliance Park was turning out 250,000 appliances a month. The assembly lines there today are turning out almost as many—with at most one-third of the workers.

All that said, big factories have a way of creating larger economies around them—they have a “multiplier effect,” in economic parlance. Revere Plastics Systems, one of GE’s suppliers, has opened a new factory just 20 minutes north of Appliance Park, across the Ohio River in Indiana, and has 195 people there working in three shifts around the clock. The manufacturing renaissance now under way won’t solve the jobs crisis by itself, but it could broaden the US economy, and help reclaim opportunities—and skills—that have been lost across the past decade or more.

Many offshoring decisions were based on a single preoccupation—cheap labor. The labor was so cheap, in fact, that it covered a multitude of sins in other areas. The approach to bringing jobs back has been much more thoughtful.  

It bodes well for the US economy and we consider it’s a trend for Australian investors to watch closely.

Beware! SMSFs investing in property

From time to time the Tax Office issues “Taxpayer Alerts” intended to be an “early warning” of significant new and emerging higher risk tax and superannuation planning issues or arrangements.  This is published for SMSF trustees and their financial advisers “to exercise care” .

The latest Taxpayer Alert TA 2012/7 published 20 November 2012 relates to self managed superannuation funds (SMSFs) which acquire property in contravention of the superannuation laws.  You can find it in full here.  The ATO is particularly concerned about acquisitions involving limited recourse borrowing arrangements (LRBA) or the use of a related unit trust.

Incorrect structuring of such arrangements may lead to a range of significant consequences for the fund such as:

• Having to include the SMSF loan repayments in members’ assessable income;
• Members having to declare the income and associated deductions from the investment rather than by the SMSF;
• Rendering the SMSF non compliant for tax purposes, leading to the requirement that it include amounts of income from previous years in its assessable income (45% tax rate applied to its income and market value of its assets other than undeducted contributions measured at the start of the income year in which the fund becomes non-complying.  There may also be civil or criminal penalties for trustees);
• The unit trust might incur a capital gains tax liability in relation to the disposal of the property; and
• The Members and the SMSF may be required to include a capital gain in their assessable income on redemption of their units in the unit trust.

Structuring such property acquisitions by SMSFs within the rules is complex and requires great care and knowledge of the Superannuation laws and regulations.  We have done these transactions for clients who have specific knowledge of the property in question together with a clear idea of its likely future performance and who are prepared to very carefully negotiate and structure the requisite documents.  It’s certainly not for everybody.

We also note that residential real estate in Australia would need to rise around 8% from today to reach its all time high (in 2010) and we consider generally that now is not the time to consider such an acquisition within super, with the primary purpose of seeking capital gains.  The Australian equity market by comparison needs to rise by over 50% from today to reach its all time high (2007).  In all likelihood both asset classes will make new highs in the next decade but this comparison shows equity markets have more to gain than Australian residential real estate.  The comparison is different for commercial and industrial property.

We know you won’t find many financial advisers in Australia taking this line –there are many spruikers out there offering to SMSFs the prospect of property investments using LRBA or related unit trusts.  Be warned!

SMSFs - the less change the better

Cartoon by Nicholson from "The Australian" newspaper: www.nicholsoncartoons.com.au

Rumours  abounded prior to the recent Mid-Year Economic and Fiscal Outlook (MYEFO) that Treasurer Swan was looking to fill a hole in the Budget by attacking the superannuation industry one way or another. Changes to capital gains tax had been mentioned by various commentators.  We saw the significant labour union and industry super figure in Bill Kelty come out and make a strongly worded statement via the weekend papers that the government should "be very careful" when tinkering with the superannuation system.  As it's turned out the only measure to hit  self-managed funds is the increase in the SMSF levy from $191 to $259, which equates to around $32 million a year in extra revenue.

An additional pleasing measure for self managed fund trustees and their advisers to know about is the government's move to amend the law as it relates to the tax exempt status of fund income earned on investments used to support pensions.

The government decision overturns a draft ruling made by the Tax Office last year and will allow the pension earnings tax exemption to continue after the death of a pensioner until the deceased member's benefit has been paid out of the fund.

Andrea Slattery, CEO of the SMSF Professionals Association of Australia said on 22 October 2012:

This is excellent news for the thousands of SMSFs in the pension phase which could otherwise have faced significant capital gains tax bills on the payment of death benefits.

The new law will apply for the 2012-13 tax year.

Trustee Penalties - Self Managed Super laws

The Government has released draft legislation which introduces administrative consequences and penalties for trustees of self managed superannuation funds (SMSFs) and the accompanying explanatory material which will apply from 1st July 2013.

The Cooper Review had found that the existing penalty regime applicable to trustees of SMSFs limits the Commissioner of Taxation’s (the Commissioner’s) ability to achieve optimal regulation of the SMSF sector. It concluded that additional tools (both punitive and educational), in conjunction with its existing powers are required to give it more flexibility to deal with non-compliance with the law. In exposure draft stage, the legislation gives the Commissioner powers to issue rectification directions, educational directions and administrative penalties to individual trustees and directors of corporate trustees who contravene the SMSF rules.

Currently, the Commissioner has the following options to rectify non-compliance:-

• making an SMSF non-complying for taxation purposes;
• applying to a court for civil penalties to be imposed. A person may also face criminal penalties for more serious breaches of the law;
• accepting an enforceable undertaking in relation to a contravention; and
• disqualifying a trustee of an SMSF.

These could all lead to members suffering a penalty arguably disproportionate to the breach. Applying current penalties can be costly and time-consuming. The Commissioner is unlikely to use the existing range of powers except in cases of significant non-compliance with the law. The absence of graduated penalties results in a number of SMSF trustees avoiding sanction for contravening conduct by simply rectifying the conduct when it is detected. This may be appropriate in certain circumstances, but the Explanatory Memorandum to the draft legislation states "it is not appropriate that trustees can continue to contravene the law and for their actions to have no consequences".

The new legislation will allow the ATO to levy penalties upon the trustee (i.e. personally payable by the individual person who committed the breach) and which must not be paid or reimbursed from assets in the SMSF. These penalties could range from monetary fines (up to $6,600) through to attending educational courses that relate to their responsibilities as a trustee.

It is intended that the range and type of remedy and penalty will give the ATO greater flexibility and additional tools to regulate SMSF trustees.

This is going to become a greater issue in the context of SMSFs taking a greater proportion of the superannuation industry in Australia.  Disaffected investors are moving into SMSFs at a great pace as the big listed funds are looking at woeful performance results.  Robert Gottliebsen wrote recently:

In a vast number of cases individuals have found they are able to tailor their investments to their own needs and slash their costs. The strong performance of bank deposits has been a major factor in self managed funds doing well.

From minor amounts a decade ago, self managed funds have captured an incredible 35 per cent of the market and look set to take half of all superannuation. 

Opportunities from QE3?

Chairman Bernanke and the FOMC have acted strongly in their announcement of “QE3” overnight.  An immediate share market rally is expected by many, some argue that it’s been already priced in.  A complex web of domestic and international influences should be considered by Australians in making their investment decisions.

Commentators vary in their response to the Fed’s announcement ranging from Goldman Sachs’ view that “further stimulus represents a clear signal that economic growth remains stalled” to UBS’ strategic view essentially ignoring QE3 and taking steps to position for a pullback in stock prices post-easing and as the fiscal cliff approaches toward the end of the year.

Karen Maley writing in the AFR said today:

Critics argue that QE3 will undoubtedly affect the prices of assets, such as shares and commodities, but will have no effect on US employment. The Fed is able to affect asset prices because when it buys US Treasuries and mortgage-backed securities, it effectively removes these assets from the market. That pushes up the price (and reduces the yield) on those ‘safe haven’ assets. (Incidentally, it also pushes up the price, and reduces the yield of other ‘safe haven’ assets, such as Australian government bonds, which boast a triple-A rating.)

But QE3 won’t encourage businesses to borrow more money to invest and hire new workers, because companies are worried about feeble demand for their products. And QE3 won’t encourage consumers to spend more, because they’re worried about their job prospects, and banks remain extremely reluctant to lend to debt-laden households.  By pushing up their cost of living, QE undermines the living standards for millions of low- and middle-income households. The wealthy – who own large share portfolios – get a benefit from rising equity markets, but most people end up worse off financially.

By targeting mortgage bonds in his latest round of QE3, Bernanke is clearly trying to spread the benefits of QE3 to the US middle classes – for whom their house is their important asset. But with an estimated one in seven US households underwater on their mortgages, and with a mountain of foreclosed houses yet to hit the market, it’s unlikely that a marginal reduction in US mortgage rates will provide much of a boost to home prices, or spur activity in the embattled housing sector.

Back in March 2012 we wrote about Investing in a QE World.  In that piece we explained what QE is and how it has been implemented by the major central banks.  Since that time we have observed the European ECB and Bank of England response.

The Economics editor of the Guardian reflected on 6 September 2012:

In one important respect, QE did the trick, because without it there is no telling what would have happened to the global economy in the winter of 2008-09. By the summer of 2009 there was clear evidence that the decline in output had bottomed out. Fears of a Great Depression 2 were scotched.

And yet, QE was supposed to be a temporary measure, with the process reversed once the global economy returned to normal. Far from that happening, central banks kept on buying bonds. The Bank of England is on its fourth round of QE; the Fed is about to embark on its third. Despite an unprecedented stimulus, the global economy is losing momentum

Is it all bad, though? Before answering this question, Australian investors need to consider the following six interlinked areas:-

1. The Australian dollar:  Our earlier post set out the critical issues for our dollar including commodity prices and demand from foreign sovereigns.  Devaluation of the US Dollar inflates the value of ours – this correlation must be watched closely mindful of the negative effects on Australian producers & exporters of a high dollar.
2. Commodities prices: (especially iron ore) but also metals including gold and silver – to a very large extent these are determined by demand for our commodities from China.   Slowing global demand for our commodities particularly iron ore and other mining exports will be the greatest influence on our domestic economy for the near future.  The recent price falls in the iron ore price and its partial recovery will be pivotal.   The speed with which change in this sector can occur is exemplified by Fortescue  this week which is now in a trading halt as the company approaches its banks to waive lending conditions.  Watch this space – China is key.
3. Shares: There will undoubtedly be winners in equity markets in Australia and overseas.  The challenge is in picking suitable stocks (or ETFs) which sit happily with your risk profile and your proposed holding time.  We all know a trade is different from an investment.  Our summary of the current position is: Expect market volatility between now and the start of 2013 as global issues dominate including further chapters in the European debt crisis, Arab political instability, US presidential elections and dealing with the “fiscal cliff”. Traders may wish to consider income producing stocks including global ETFs. Traders may wish to consider diversification into natural resources funds as a potential hedge against future inflation (see more on inflation below).  Longer term investors may prefer to remain prudent in the face of continued volatility  and uncertainty and stay out of stocks until the start of 2013.   US equities may appear more attractive than Australian shares if you can manage the currency issues.
4. Inflation:  How do you protect your investments against this?  Protecting yourself against future inflation is going to be an increasingly important consideration now.  There are a number of options to consider – ranging from investments in gold, hedged equities, commodities, inflation protected bonds and ETFs.   We consider these options at length and propose specific strategies suited to our clients’ investment profiles and needs.  This is a sophisticated and complex area and we do not make any general recommendations at this point in time.
5. House prices: Australian house prices continue to be considered overpriced by international and historical standards.  Overseas commentators remain negative about future capital growth in the Australian real estate sector.  Domestically, there are mixed messages coming from different markets across the country.  However, the overall trend is that things are tracking sideways, with risks to the downside.  This is no environment in which to recommend investment properties with enthusiasm.  Yet we continue to receive multiple calls weekly from property spruikers wanting to put our self funded retirees into residential real estate investments.  We are currently resisting this trend and do not recommend Australian residential investment to our SMSF clients generally at this time.   We mention house prices now as we are going into a new spring selling season, mindful that supply of housing stock is at record highs, the time it takes to sell a house is also very long in Melbourne and Sydney and the recent volume of mortgage transfers reported by government is at historic lows.  We would not be surprised to see a flat or negative selling season ahead.  This has an effect on the Australian banking sector and bank stocks in particular given the huge focus they have had on domestic mortgage lending over the past decade.  Their massive profitability has ridden the “house price increase” wave and all commentators seem to agree that this ride is over: see Gail Kelly’s recent comments here.
6. Australian interest rates: Expectations are that the RBA will lower interest rates again, and that the immediate future looks like a lower rate environment. This is a further blow to self funded retirees looking to live off their super pensions and those for whom a large part of their super is currently held in bank deposits. Lower returns on investments are the “new normal” and the only thing that will change these returns at this time is increased risk in investments – and that brings greater risk to the downside as well.  Speculative investment within super is not good if you want to rest easy at night.  It may prove good for the hip pocket but then again it may not go well at all.  That’s the risk. Lower rates are reflected in the Australian Bond yield curve, to which we have made reference before.  It continues to be in a negative yield curve – a negative portent for our economy generally.

We haven’t talked in this post about other economic indicators such as unemployment, GDP and PMI.  Neither have we mentioned industrial unrest, wages pressure, political issues such as funding for government spending programmes such as the NDIS, Gonski and the Dental Scheme which are looking like blowing a big hole in the Commonwealth Budget.  These issues are all bubbling away in Australia and whilst we have no doubt on the scale of relativities that we are indeed a fortunate country, there remain risks to our domestic economy which provide significant challenges ahead for us all.

The major message coming from the Fed today is that the US Central Bank is going to continue its active and open ended interventions for as long as it takes to improve the employment market in the USA.  There are big consequences for global trade in all this.

The rule of law and GDP

This blog post is a little different from most we have written but we consider it to be extremely important at the systemic level.  At its most basic, it can be said that all institutions require confidence in them for them to function effectively. Of central importance to that confidence is the Rule of Law.  We now also know that the trait most positively correlated with a country's GDP growth is the strength of its rule of law.  In other words, a country will perform better economically if it has a sound, functioning and respected set of laws which are enforced broadly.

Experts such as Michael Porter of Harvard Business School define "economic competitiveness"  to include the ability of the government to pass effective laws; the protection of physical and intellectual property rights and lack of corruption; the efficiency of the legal framework, including modest costs and swift adjudication; the ease of setting up new businesses; and effective and predictable regulations.

The USA now fares markedly worse than Hong Kong in all 15 of the measures of the rule of law shown in the World Economic Forum's annual Global Competitiveness Index.  These measures range from the protection of private property rights to the policing of corruption and the control of organised crime.  In the Heritage Foundation's Freedom Index the USA now ranks 21st in the world in terms of freedom from corruption, a considerable distance behind Hong Kong and Singapore (Australia ranks #3) and in the World Bank's Indicators on World Governance, since 1996 the USA has suffered a decline in the quality of its governance in three different dimensions: government effectiveness, regulatory quality and control of corruption.

Niall Ferguson, Professor of History at Harvard and Oxford Universities, makes the argument in his 2012 Reith Lecture (you can read it here) that these indicators show that the USA, and to an extent, the UK are suffering a deterioration in the rule of law.

China is now the most talked- about country whose future economic prosperity will depend on whether impartial legal institutions can replace personal and particular network- based mechanisms for ensuring compliance in commercial contracts.

The Rule of law and economic development was considered by Michael Heller, on Project Syndicate July 3, 2012. He states:

The quality of enforcement matters more than substantive content of law in developing countries. Good or good-enough law dealing with even sophisticated financial, corporate, or bankruptcy regulation is often already on the books. What is frequently absent is a credible expectation that law should and will work.

Structural and behavioural independence of the judiciary is seen to be a critical factor in the ability for laws to be enforced.

A number of other authors offer China as an example of a dictatorship that achieves economic growth by prioritizing good-enough security for property rights. Others question whether China will improve economic governance fast enough to avoid disaster. These are familiar arguments. Kenneth Dam, on the other hand, detects a promising ‘guided evolutionary approach’ to rule of law that could allow China to avoid serious economic crises. Political leaders, he thinks, seem to be coming around to an awareness of the need to enforce market rules.

Niall Ferguson has also considered this issue recently. He considers the problems of the "West" characterised as "excessive debt, mismanaged banks, widening inequality" are rather, symptoms of underlying institutional malaise.

He turns to English history and cites  the establishment of the institution of Parliament as a seminal moment empowering economic and social change:

From 1689, Parliament controlled and improved taxation, audited royal expenditures, protected private property rights and effectively prohibited debt default. This arrangement, they argued, was ‘self-reinforcing’, not least because property owners were overwhelmingly the class represented in Parliament. As a result, the English state was able to borrow money on a scale that had previously been impossible because of the sovereign’s habit of defaulting or arbitrarily taxing or expropriating. The late 17th and early 18th Century thus ushered in a period of rapid accumulation of public debt without any rise in borrowing costs – rather the reverse.

and

Not only did it enable England to become Great Britain and, indeed, the British Empire, by giving the English state unrivalled financial resources for making – and winning – war. By accustoming the wealthy to investment in paper securities, it also paved the way to a financial revolution that would channel English savings into everything from canals to railways, commerce to colonisation, ironworks to textile mills. Though the national debt grew enormously in the course of England’s many wars with France and others, reaching a peak of more than 260 per cent of GDP in the decade after 1815, this leverage earned a handsome return, because on the other side of the balance sheet, acquired largely with a debt-financed navy, was a global empire. Moreover, in the century after Waterloo, the debt was successfully reduced with a combination of sustained growth and primary budget surpluses. There was no default. There was no inflation. And Britannia bestrode the globe. 

Fast forward to today and he identifies:

The heart of the matter is the way public debt allows the current generation of voters to live at the expense of those as yet too young to vote or as yet unborn. 
But the official debts in the form of bonds do not include the often far larger unfunded liabilities of welfare schemes like – to give the biggest American programs – Medicare, Medicaid and Social Security. The most recent estimate for the difference between the net present value of federal government liabilities and the net present value of future federal revenues is $200 trillion - nearly thirteen times the debt as stated by the U.S. Treasury. Notice that these figures, too, are incomplete, since they omit the unfunded liabilities of state and local governments, which are estimated to be around $38 trillion. 

Ferguson opines that the biggest challenge facing mature democracies is how to restore the social contract between the generations and that there are three possible solutions:

1. The proponents of reform succeed, through a heroic effort of leadership, in persuading not only the young but also a significant proportion of their parents and grandparents to vote for a more responsible fiscal policy
2. Public sector balance sheets can - and should be - drawn up so that the liabilities of governments can be compared with their assets. That would help clarify the difference between deficits to finance investment and deficits to finance current consumption. Governments should also follow the lead of business and adopt the Generally Accepted Accounting Principles. And, above all, generational accounts should be prepared on a regular basis to make absolutely clear the inter-generational implications of current policy; or
3. The debt continues to mount up. But deflationary fears, central bank bond purchases and flight to safety from the rest of the world keeps government borrowing costs down at unprecedented lows. The trouble with this scenario is that it also implies low to zero growth over decades: a new version of Adam Smith’s stationary state - only now it is the West that is stationary.

He finishes with an interesting reflection (in an answer to a question from the audience): 

Debt is just a symptom of a chronic inability to take difficult decisions in the present when it is so much easier to pass the cheque to a future generation that isn’t represented. 

The laws of nations must be upheld in the face of financial crimes whatever the extent or cost.  Further, the economic benefits of doing so will be positive.

The Australian Dollar

 

In the past 12 months Australian commodity export prices have reduced by around 30%.

At any other time in our history this would have meant a corresponding drop in the Australian Dollar.

Not this time.

This week the RBA has considered the level of the Australian dollar. RBA Governor Glenn Stevens said yesterday that the exchange rate has remained high "despite the observed decline in the terms of trade and the weaker global outlook". This is a significant shift.

Today's Financial Review reports that the "tech giants" being Apple, Google and Microsoft together have stored significant holdings of short term Australian treasury bills from their cash reserves. This follow's Monday's Reuters report that Shell has announced it is shifting $15 billion of its cash reserves out of European banks into US treasuries and US bank accounts "to avoid growing macroeconomic risk" in the words of Shell's CFO.

It is argued that upward pressure on the Australian Dollar has been supported by acquisition of Aussie dollars by foreign central banks (from Germany, Kazakhstan, Russia, the Czech Republic, Switzerland, Qatar, Kuwait and Abu Dhabi) looking for a AAA government bond paying a good yield.

Why would US companies be doing this? In the past, the US companies mostly sent their Australian profits to the US, where some of their reserves are held in US treasury bonds. But very low yields on US treasuries and the weakness of the US dollar led them to invest in Australian debt instead.

Last week in the Financial Times, Neil Hume reported that there were a number of reasons posited for the current strength in the Australian dollar. They can be summarised as:

1. The Safe Haven - or diversification away from US$ and also from Euro exposure, (particularly the latter according to Gerard Minack from Morgan Stanley)
2. Australia's AAA rating
3. Good GDP numbers
4. Relatively high interest rates (3.5%)

It's not only government debt that is being sought by offshore investors: the statistics are rapidly rising in relation to State and Territory government debt, corporate bonds and bank bills.

Last week RBA Governor Glenn Stevens gave a speech entitled "The Lucky Country". 

Stevens spoke about the Australian dollar in connection with China. He said if there were a serious slump in China, the Australian currency would “probably” fall, providing a much-needed boost to the domestic economy but he also noted in the case of a Eurozone break-up that another financial crisis might result in a larger flow of funds into Australian denominated assets:

“In that case our problem might be not being able to absorb that capital”

Australians will be watching closely. WIll our currency remain a "commodity currency" or is the current decoupling a permanent shift?

Private Health Insurance - Should I pre pay before 30 June?

The legislation to apply an income test to the 30% private health insurance rebate will commence  from July 1, 2012.

A small window of time exists between now and 30 June 2012 to pre-pay your health insurance and preserve your rebate.  You should contact your fund for their specific offer. Some funds are offering to preserve their current terms until December 2013. You could save up to $1,500 in premiums, depending on your income and your fund's terms.

What are the proposed changes?
The essence of the proposed changes is to effectively "income test" the 30% private health insurance rebate for individuals whose income for Medicare levy surcharge purposes is more than $83,000 p/a and for families where that income is more than $168,000 p/a.

To achieve the means testing, the legislation introduces three new "Private health incentive tiers". 

New income thresholds The private health insurance rebate and Medicare levy surcharge will be income tested against the income thresholds in the table below. Unchanged Tier 1 Tier 2 Tier 3 Singles $84,000 or less $84,001-97,000 $97,001-130,000 $130,001 or more Families* $168,000 or less $168,001-194,000 $194,001-260,000 $260,001 or more Rebate Aged under 65 30% 20% 10% 0% Aged 65-69 35% 25% 15% 0% Aged 70 or over 40% 30% 20% 0% Medicare levy surcharge Rate 0.0% 1.0% 1.25% 1.5% * The family income threshold is increased by $1,500 for every child after the first child. Source: ATO Website, Updated 5 June 2012

In future years, the singles thresholds will be indexed to average weekly ordinary time earnings and increased in $1,000 increments (rounding down). The couples/family thresholds will be double the relevant singles thresholds.

Income Test
For those who think they may be affected by the changes, the income test includes the sum of a person's:

• taxable income (including the net amount on which family trust distribution tax has been paid, lump sums in arrears payments that form part of taxable income, and payments for unused annual and long service leave); plus
• reportable fringe benefits (as reported on the person's payment summary); plus
• total net investment losses (includes both net financial investment losses (eg. shares) and net rental property losses); plus
• reportable super contributions (includes reportable employer super contributions (eg. under salary sacrifice arrangements) and deductible personal super contributions),

Less:

• where the person is aged 55-59 years old, any taxed element of a lump sum superannuation benefit, other than a death benefit, which they received that does not exceed their low rate cap.

The rebate can currently be claimed in one of three ways:

1. The health fund can provide the rebate as a premium reduction.
2. Where the full, upfront cost of the private health cover premiums has been paid, people can receive a cash payment from the Government through their local Medicare office or by lodging the claim form by post.
3. The rebate can be claimed on annual income tax returns if the full, upfront cost has been paid.

Please call me if you need to discuss your specific "income test".

And from the ABC website read here: At the same time [as changes to the rebate], there'll be another change to the system. At present, if you earn a higher income then you pay an extra tax if you don't take out private health insurance. This extra tax is known as the Medicare Levy Surcharge (MLS). (It's called a surcharge because it's on top of the 1.5 per cent Medicare Levy which most of us pay whether we have health insurance or not.)

But from July 1, the MLS will increase for some high income earners. See the ATO table above.

The bottom line is that many of us will be reassessing our health insurance options to see if the choices we've made in the past still make sense under the new rules.

But...remember the changes depend on your income.

To ditch or not to ditch?  What about Extras Cover?
Health insurance premiums have already risen by an average of more than 5 per cent since April 2012. So the rebate changes mean affected health fund members will be faced with forking out substantially more cash for their cover than this time last year.

If that's enough to make you think about ditching your cover altogether, the consumer group CHOICE has some advice. It says you'll likely still end up ahead by keeping your hospital cover, even with the reduced rebate, because of the changes to the MLS.

To avoid paying the MLS, you need to have only basic hospital cover (ie cover that limits or excludes a range of services), which is cheaper than full hospital cover. The requirement for avoiding the surcharge is that the policy has an annual excess of up to $500 (single) or $1000 (family).

Even if you take out more expensive full hospital cover, CHOICE says it will normally cost you less than the MLS if you fall into higher income tiers, or are aged 65 or older and therefore eligible for a higher rebate.

If you can't prepay your premium, you should contact your insurer now to tell them which income tier you are in to avoid paying extra tax in the new financial year.

CHOICE is less clear cut about whether it will be worth hanging on to any cover you have for "extras" after July. (Extras, or ancillaries, is cover for non-hospital treatments not covered by Medicare such as dental, optical, physiotherapy, and some products such as glasses.)

The 30 per cent rebate applies to both hospital cover and extras, but unlike hospital cover, dropping extras won't see you pay extra tax through the MLS.

When considering your extras cover, CHOICE advises checking how much you've received in extras claims over the past year against what your new premium will be from July 1.

Depending on how often you use the extras services, you could be ahead by dropping the extras cover and simply paying the total amount for the services you use.  Alternatively, you might consider changing your extras cover. 

The best place to get unbiased up-to-date information about the different policies on offer is the website run by the private health insurance ombudsman, privatehealth.gov.au.