Health care reform brings challenges, opportunities for advisers

Investment advisers should be closely examining the sweeping bill to overhaul American health care to determine how it will affect their clients’ investment strategies. Some of the provisions in the bill President Barack Obama signed into law last Tuesday could have significant investment implications for clients in both the long and short term.

The obvious one is the 3.8% Medicare tax on dividends, capital gains, rent and royalties that will be paid by couples earning more than $250,000 a year and singles earning more than $200,000 a year. This means the tax rate on dividends and capital gains for those taxpayers will rise to 23.8% next year when the Bush tax cuts expire, from 15% this year.

Overall, the application of the Medicare tax to investment income for the first time will likely produce significant changes in investment behavior. When you tax something, you usually get less of it, and in this case, equity investing is facing higher taxes.

Anything that reduces the after-tax return on stock investing increases the attractiveness of fixed-income investments, particularly tax-exempt ones. As a result, some client portfolios might need to become more bond-oriented.

Likewise, investments in real estate and royalty trusts could become less competitive because of the new taxes and will need to be reviewed.

Unfortunately, those in the income brackets affected by the Medicare tax on investments also will be paying a higher Medicare tax on their income. They will be paying 2.35% instead of the 1.45% paid by the majority of workers.

Clients who own businesses also will be affected. Those who employ fewer than 50 workers will receive subsidies to help offset the costs of providing health insurance.

Those who employ more than 50 workers will pay fines if they don’t offer it. These provisions could affect decisions about whether to expand a business.

Advisers whose clients have invested in the health care sector, either through individual stocks or mutual funds, will need to consider carefully the impact of the bill on those investments. Some stocks may do well, while others will find their earnings prospects hurt in the long run.

Health insurance companies, for example, may find their earnings squeezed before the requirement that every individual buy insurance kicks in. Those companies are required to cover those with pre-existing conditions, and in the short run, there will be fewer healthy customers to help offset the costs.

Even if they can adjust rates quickly enough to compensate, insurers may realize lower profits in the long term, as the law gives the government the power to specify the medical loss ratio (how much of the premium dollar they must pay out in medical care versus salaries, administrative costs and profit).

Further, the law gives the government power to regulate premiums. Squeezed between government-set premiums, rising medical costs and a tight medical loss ratio, companies may find it difficult to earn a decent return on investment.

Drug makers and medical-device makers may be able to prosper under the new law, despite having to pay $28 billion in fees over 10 years, as millions of previously uninsured individuals who could not previously afford their products now may be able to do so. Hospitals, with fewer unpaid bills, may do well.

These are some of the more obvious possible implications for investors in the bill. There are likely others buried in its nearly 3,000 pages.

Individual clients are not apt to wade through such a bill to figure out how it might affect them. Therefore, it will be up to their advisers to do so.