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.

The Aussie Bond

What's all the discussion about bonds?  We know and love the iconic logo of the maker of our favourite "comfy undies" but there is a very different significance attaching to government bonds in Australia and around the world at the moment.

A government bond is issued by a national government and is denominated in the country`s own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. The yield required by investors to loan funds to governments reflects inflation expectations and the likelihood that the debt will be repaid.

The Australian  bond yield looks like this today:

www.bloomberg.com.au 5/6/2012

This is called an inverted yield curve and is generally interpreted as a leading indicator of recessionary times. Orange line is yesterday, green is today.  This afternoon's rate cut by the RBA in the official cash rate of 25 bps is in line with the bond market's expectations with the expectation of more to come.


The 12 month chart for the Australian Government 10 year bond looks like this.



www.bloomberg.com.au 5/6/2012

Australia's Government Bond Yield for 10 Year Notes have declined since October 2011 which means it became less expensive for Australia to borrow money from investors. Historically, from 1969 until 2012, Australia Government Bond 10Y averaged 7.9%  reaching an all time high of 16.4% in May 1982 and a record low of 3.1% in May of 2012. 

The international picture for bonds can be seen here:


www.ritholtz.com 2/6/2012

This week US government bond prices reached all time lows. German and Swiss bonds currently can be bought with a negative interest rate.  Other than the obvious argument of "flight to safety", why would anyone want to buy sovereign debt with a negative return? John Mauldin writes here 

But even given the pessimism in Europe, why should Germany be able to sell €5 billion of two-year bonds at zero percent interest last week and see them trade this week at a slightly negative interest? Why would anyone buy a bond that is guaranteed to not even give you your money back? Is that a sign of severe potential deflation?
The answer is, not really. Buying German bonds, even at a slightly negative rate, is actually a cheap call option on the eurozone breaking up. A German bond that became a new Deutschemark-denominated bond would rise in value at least 40-50% almost overnight. If you are a pension fund, for instance, with a lot of sovereign debt from a variety of European peripheral countries and you think a break-up of the eurozone is possible, it is a way to hedge your investment portfolio.
Switzerland actually sold outright this week bonds that have a negative coupon. Again, not a sign of deflation but another call option, betting that the Swiss Central Bank will have to give up on its peg to the euro. That peg has got to be one of the biggest losing trades in central banking history, and the Swiss seem determined to lose even more money. If the euro goes to $1.15 or lower, that trade becomes an even more massive loser. At what point in the next year will the Swiss Central Bank decide it has endured all the pleasure it can stand in fighting the fall of the euro? If they abandoned the peg, the move in the Swissie (as traders call the Swiss franc) would be large and almost instantaneous. And the reward for investors outside of Switzerland buying Swiss bonds with a negative yield will be large. 

What about inflation?

We know PMI numbers are showing economic contraction.  We know we are living in deflationary times.  Australians are deleveraging fast - retail sales are down and we are paying back personal debt to the banks at very high rates.  Unemployment in the USA and Europe is at persistently high levels.  This leaves central governments around the world able to employ strategies such as Quantitative Easing without an immediate inflationary effect. Mauldin offers the theory that this is due to the slowdown in the velocity of money - for a fascinating explanation see here.  For those without the desire to read more deeply, it follows from his argument that low bond yields are here for a long time and will not change quickly.

He says the Fed "will be able to monetize more than you think without causing a repeat of the 1970s.  Eventually it will catch up to us, as there is no free lunch, but they are betting they will be able to reduce some of the actual inflation by cutting back on the money supply and raising rates.  But we are years off from that. So, yes, at some point inflation will be back".

The following chart shows the US Federal Reserve's holdings of US government bonds and the timing of such purchases, relative to each wave of quantiative easing:

Deutsche Bank

The significance of the above chart can be seen when reading, from Deutsche Bank:

In addition, central banks (Fed, ECB, BoE, BoJ) buying government bonds has lowered supply of risk-free bonds real money managers can buy (for example, the Fed currently holds 30% of all 5-10 year US Treasuries outstanding).

Bottom line: More demand for risk-free assets and less supply of risk-free assets combined with significant long-term risks to global growth imply that interest rates are likely to stay low for many more years.

and via FT Alphaville on 4 June 2012:

...from JP Morgan’s Flows and Liquidity team on Friday, we have five reasons, other than quantitative easing, why rates will stay down for the foreseeable future:

- Regulations such as Solvency II, pension fund regulations, Basel III

- It is not only regulations inducing financial institutions to buy bonds, demographics may also be playing a part

- Due to ultra low policy rates, retail investors replaced money market funds with bonds as savings vehicle

- G4 central bank QE

- An acceleration of the global savings glut since the Lehman crisis.

- The end of the equity culture

What does a long term low priced bond environment mean? 

Bottom line, for self funded retirees in Australia, it means that we are likely looking at a low yield investment environment over potentially quite a long time.  This is not great news.

Jeremy Warner wrote in the London Telegraph in June 2011 (not much has changed in Europe in 12 months!):

The traditional relationship, which has ruled with only a small number of aberrations since the late 1950s, is that bonds yield more than equities. This juxtaposition is underpinned by the idea that equities are able to grow their earnings at least in line with GDP, and therefore over time will offer a better rate of return than fixed income investment.
The man most credited with creating this relationship was George Ross Goobey, who back in the 50s headed the Imperial Tobacco pension fund. By advocating equity investment as an appropriate policy for pension funds, he brought about a revolution in investment thinking.
Pension funds developed a previously non-existent appetite for risk and switched wholesale from fixed income into shares. The "cult of equity" was born. Shares began to yield less than bonds to reflect their supposedly superior growth and inflation hedging characteristics.
But what happens when growth slows, society ages and risk appetite diminishes? Well as it happens, bonds have been outperforming equities for many years now, but it was only with the onset of the financial crisis that the cult of equity's fifty-year reign started to crumble.
Post the Lehman crisis, we saw an extreme reversal in the yield gap, followed, after the policy response and signs of a spluttering economic recovery, by an uneasy truce, when the two yields essentially tracked each other. But since June this year, the relationship has gone unambiguously back into the post Lehman danger zone.
It's still too early to say this is the new normal. We are once more in one of those periods of extreme risk aversion, with multiple uncertainties crowding in on investors. It's not surprising that there should be a dash for safe haven assets.
In a downturn, corporate profits will fall, dividends will get cut and insolvencies will rise. Bonds, by contrast, become the default security of choice. Money that would normally be spent on consumption or invested in productive assets gets hoarded instead, generally in cash or the nearest equivalent, government bonds.
As risk aversion grows, a vicious circle establishes itself of falling demand, employment, and economic activity. The more risk averse that companies and households become, the more they save. In Japan, they've had this phenomenon for twenty years now and still there is no end in sight to the deflationary funk.
The mood is infectious; having let rip with deficit spending in the immediate aftermath of the Lehman's collapse, governments too are losing their appetite for further risk and are reining in as fast as they reasonably can.
It's hard to be bullish about prospects for equities right now. Investors won't return until uncertainties over the US and eurozone economies are lifted, and that's going to require a level of political leadership which right now seems entirely absent on both sides of the Atlantic.
Extreme volatility and sideways trading look set to remain the order of the day for some while. That's not to say equities are not worth buying. Some businesses prosper, even in a depression. But we seem to be going back to the old, pre-war days, when equity was priced for risk.
Equity is becoming scarcer, and therefore more costly, just at a time when large swathes of the banking and corporate landscape, not to mention the economy as a whole, need most.

Interesting times continue.