One of many battles to come over minutae of the new healthcare law

This entry was originally posted on Monday, March 29, at 11:30pm.  I’ve UPDATED it at the end with a glance at the financial impact of this news on AT&T, Caterpillar, 3M, and Deere & Company.

So, I read this article and fully understand why people prefer phrasemongering. This shit is dull. But really, if you want to figure out whether healthcare is good or bad for people and employers, you’ve got to pay attention to this stuff. And, unfortunately, you sometimes might still need an interpreter. I’ll do my best to drop some MBA larnin on ya. Please feel free to comment if I get something wrong, or it isn’t clear.

As part of Medicare Part D, which provides supplemental drug insurance to seniors, companies that provide their retirees with their own prescription drug benefits get both a subsidy and a tax credit for providing the coverage. They get a tax credit, even though they aren’t paying the full cost of the benefit, because the government wanted to give them an incentive to keep seniors on private plans, off of Medicare Part D.

Starting in 2013, the subsidy to help companies pay for retiree prescription drug benefits will continue. But the tax credit will go away. So, yes, it will cost companies something in the form of higher taxes. It won’t cost them anything in cash until then.

But, accounting rules require that when there is a regulatory change like this, you have to estimate the total future cost and post it to your financial statements. Now. (Not the full dollar amount forever into the future; it gets discounted because it is cheaper to pay somebody a dollar in a year from now than it is to pay a dollar now–paying that dollar another year later makes it worth less, etc…) So what will be a cash cost in 2013 and later needs to be recorded as an expense today, but discounted because dollars in the future are worth less than dollars today. Got it?

So the companies need to reduce their paper profits today. That is what they are complaining about. Yes, even though we are only talking about paper profits, this is still cause for complaint, because it will eventually cost them some cash money in higher taxes.

But. How much it will cost them is very difficult for anybody to calculate. Actuaries calculate this, and it is important to understand that actuaries have to make assumptions about the future in their calculations. For one thing, they have to make an estimate, a highly educated guess, about when retirees will die.

A retiree’s lifespan will obviously have an impact on how long a company is paying the benefit, so a guess about when they will die is relevant. And there are other assumptions to make, too. The actuary’s job is to make assumptions with the best statistics and as little bias as possible, but in real life it doesn’t work that way. A chief financial officer might look at the actuary’s estimate, decide it is too low or too high, and ask the actuary to change the assumptions in order to tweak the outcome. And, since the CFO pays the actuary, how much do you think the actuary will fight the CFO? A little, for the sake of professionalism, but not enough to risk losing the CFO as a paying client.

So yes, these numbers that AT&T and Caterpillar are complaining about can be manipulated… or tweaked, to use a nicer word. Not only that, good financial analysts and smart investors (admittedly a small group, and I don’t include myself in it) automatically assume these calculations were manipulated. The manipulation can make the numbers look better or worse, depending on what the company needs to report that quarter.

And the fact that they have the numbers ready to go so fast means they were prepared ahead of time to drop this news at a calculated moment. If they really want this section of the healthcare law repealed, it is obvious that they will want to make this impact look really bad.

So will it really cost them what they say it will cost them? We don’t know, but I have my doubts. At the very least, these numbers reflect worst case assumptions. The timing of these announcements outs them as politically motivated. This isn’t automatically a bad thing. If I weren’t politically motivated, I wouldn’t be writing this blog! But just remember that you have to take these estimates on the future cost of healthcare policy change with several grains of salt. If we keep in mind their incentives to make it look worse than it is, and if we recognize that they have the ability to make it look worse than it is, we can be much better critical thinkers.

–UPDATE follows–

The point of my post above is that managers are not going to give us an objective read on the effect of politically charged policy changes. So, what about investors? Investors lack the depth of information that managers have, but they are motivated to make money. Their political views are usually not reflected in the bid-ask spread for a security. I’m certainly not saying that investors are unbiased. But their biases are going to be different.

AT&T (ATT): Stock price closed 0.11% higher on Friday, Mar 26, than it opened on Monday, Mar 22. That’s basically flat. AT&T’s market capitalization is $1.21B. I couldn’t make out the timing of AT&T’s announcement on Google Finance.

Caterpillar (CAT): It was a big week for CAT; the stock price climbed 5.17% (mostly on Monday and Tuesday, along with many other industrials on the basis of economic recovery optimism).  They made their healthcare tax cost announcement on Wednesday, March 24, and the market, apparently, said “meh.” No significant losses.

3M (MMM): 3M posted non-trivial losses  of 1.17% last week. Most of those losses were incurred on Thursday. The biggest Thursday news from 3M was that their CEO’s pay increased 21% in 2009 (all in bonus and options), and they spent $440,000 in lobbying in the Q4. Their announcement about healthcare charges was widely reported at the end of the day on Friday. The company said the tax change cost them 12 cents/share, which is a lot. The market didn’t seem to agree.

Deere & Company (DE): Deere gained 2.66% over the week. They made their healthcare charge announcement on Thursday, at the beginning of the day. They lost some ground at the end of the day. If those losses were related to healthcare charges, this was an uncharacteristically slow reaction in the market.

What to make of the effects of the tax change on these companies? Here’s a general recap from Market Watch. It makes sense.

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9 Comments

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9 responses to “One of many battles to come over minutae of the new healthcare law

  1. Matt Campbell

    I appreciate your muddling through the actuarial swamp for us. You’re right about the timing of the release and that such statistics may fall under the ‘damn lies’ category. That said, I think the general thrust of the numbers (that this is going to cost the private sector a LOT) is true. That cost will inevitably be passed onto shareholders at best, but more likely to employees, many of whom will be called ‘former employees.’

    And there. I have obliged and posted my comment to the blog and not on facebook. 🙂

  2. The only thing I would add to Matt’s comment is this. I don’t know if the incentives have always been a part of the deal with Medicare part D. I believe they have. If that’s the case, then it will cost them real dollars even if it’s because they are paying what they should have been paying all along. With all of these companies it may be true that the incentives were too generous but the costs are still substantial. (1.25B for ATT, Deere and Prudential) I haven’t decided yet what I think about this one because I don’t know all the facts yet.

    The more I learn, the less I seem to like things it seems so this may be my most positive comment on this topic. 🙂

    • Brian, you are right that this will bring a real tax cost. I tried to make that clear in my post. But it is a pretty dense post, and I’m not a good enough writer yet to boil it all down into the most concise telling.

      I truly will update when I can with stock price info, so we can see what value investors put on this extra cost. I doubt that these companies lost 1.25B in market value after this announcement, but we’ll see. If anybody wants to beat me to it, by all means go ahead.

      • I know Prudential’s stock price went up a little after the announcement which didn’t make a whole lot of sense to me.

        • Well, Prudential is an insurance company. Once the mandate goes into effect, the insurance companies should do pretty well on net. The benefit to insurance companies (more customers) is actually driving those in favor of a single-payor system nuts. This doesn’t exactly fit the “Robin Hood” image that some are trying to connect to Obama, does it?

          Likewise, hospital stocks have seen big gains.

  3. Is this really only a two star post? Tell me why, low-rater!

  4. It’s taken me a *long* time to figure out why this bothers me, in terms of most blog responses. This “cost” seems like it falls into a relatively unique category of “cost.” It’s a tax on a subsidy, right? As such, the money paid back to the government isn’t necessarily taken out of what a company earns through selling its wares, it’s paid back out of the subsidy. If the company takes the subsidy, it will be taxed. So it’s sort of like a tax on a gift, right, that may not affect the recipient’s position?

    If I have $50, and you gave me $50 but said I could only have it if 1) I gave $40 of it to charity and 2) $10 back to you, I still have $50, don’t I? Or is the question that the tax is going to be bigger than the $10?

    • Marc, it’s like this (I think, not being a tax expert):

      Medicare Part D wants to make it possible for retired seniors to buy an additional benefit (prescription drug coverage). Part of this cost is paid by the retiree, and part by the government. But if people get this coverage from their employers, they won’t need it from the government.

      So, under Medicare Part D, the government decided to give companies an incentive to offer the benefit themselves. They give the companies a subsidy, AND they let the company take a tax deduction, as though the company had paid for the benefit WITHOUT a subsidy.

      Why did the government decide to give the subsidy to companies instead of directly to retirees? I don’t know. It was probably one of the million little dirty deals that it takes to get major legislation through. When the Republicans passed Medicare Part D, the Democrats were mad about these kind of deals, just as the Republicans are mad about them now. The Democrats didn’t use crosshairs and words like “reload” to express their frustration, however.

      Back to the question… it’s like the government gives you $50, making you give that $50 as a benefit to your employee, and then the government lets you take a tax deduction as though you’d paid that $50 yourself.

      Under one provision of the new healthcare law, that last part, the tax deduction, goes away. It does cost the companies something, in that it is a change. They were given a pretty sweet deal, and now that sweet deal is being made less sweet.

      Some people see it as being anti-business. I see it as cutting back corporate welfare.

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