HOW TO AVOID A MEDICAL FINANCIAL DISASTER - March 2005 Newsletter

The inability to pay mounting medical bills was the main cause for filing nearly half of all personal bankruptcies in 2004, according to a study recently released by Harvard University’s medical and law schools. So what can you do to avoid a financial disaster due to medical expenses?

Don’t assume you’re not vulnerable. Just because you have health insurance doesn’t mean you’re not at financial risk. In a surprise finding, the study learned that 76 percent of the households that filed for bankruptcy because they couldn’t pay their medical bills had health insurance when their illnesses began.

In fact, the study said the majority of the filers were middle-income homeowners. The problem for many was that they lost their employer-provided medical coverage when they lost their job due to the illness. With no paycheck, and mounting medical bills, they frequently turned to credit cards to try to keep themselves afloat, and eventually they could never recover financially.

Try to maintain coverage. Even if you lose your job, try to maintain medical coverage. One option is COBRA, a federal program that requires most employers to allow workers covered under group plans to continue that coverage for up to 18 months after loss of employment.

The downside is that the worker must pay the entire premium, plus administrative costs, which can be very difficult if you’ve lost your job. The upside is that it can keep major medical bills from piling up and it requires your next employer’s insurance company to cover you regardless of pre-existing conditions—something an individual policy probably won’t do.

Build an emergency fund. One way to help pay the COBRA premium or high co-pays and deductibles under current employer coverage is to have an emergency cash reserve in place before a catastrophe strikes. Build the reserve (to cover three to six months bare-bones living expenses) through judicious budgeting and diverting any extra income.
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Don’t skip coverage. Nearly a third of Americans under the age of 65 went without health insurance for a part or all of the two-year period from 2002–2003, according to Families USA.[harde copy in health insurance file] Two-thirds of them went six months or longer without coverage. Some households truly can’t afford their own coverage if it’s not offered through work, but others who can afford the coverage skip it just to “save money.” Don’t go without.

Know your plan’s coverage. If your plan lists approved doctors and hospitals, study it so there are no surprises later. Using providers not on the approved list, for example, can significantly increase out-of-pocket expenses.

Know which services are and are not covered by you policy, and what the lifetime limits are of the coverage. Talk to your human resources department if necessary.

The Harvard study found that unreimbursed medical bills often piled up even for people with coverage due to high co-pays and deductibles, and unreimbursed expenses such as prescription drugs and physical therapy. The average out-of-pocket medical costs for those filing for bankruptcy ran $11,854, according to the Harvard study. This is where an emergency fund can make the difference between solvency and bankruptcy.

Don’t be rejected. If the insurance company declines to pay for a particular expense, appeal the decline, and be persistent.

Don’t automatically choose the “cheapest plan.” It may leave serious gaps in coverage and actually be more expensive in the long run. For example, a plan with smaller co-pays and lower deductible or specific coverage—even though the premiums are higher—may make sense if you anticipate certain medical needs, such as starting a family.

Use flexible spending accounts. Employer-sponsored FSAs allow you to contribute pre-tax dollars from your paycheck into an account to later pay for co-pays, deductibles, and qualified medical expenses not covered by insurance. The downside is that any money in the FSA that you don’t use during the year is forfeited, so you need to conservatively estimate your anticipated expenses.

Coordinate coverage. Spouses often carry separate coverage at work. It may be less expensive to carry both under one plan, or at least be sure the plans don’t duplicate coverage. Otherwise, you’re wasting dollars you could stash in that emergency fund.

Improve your health. While you can’t always prevent a financially devastating illness, you can reduce your chances of a serious medical problem by staying healthy and minimizing risky behavior.

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March 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by

Bold Financial Planning, LLC , a local member of the FPA.

DO YOU KNOW WHAT YOUR CPI IS? - March 2005 Newsletter

The federal government announced in mid-January that consumer prices, as measured by the Consumer Price Index, rose 3.3 percent in 2004—the highest increase since 2000. But do you know what your personal inflation rate was for 2004? Or why it’s important to gauge how much it rose? Or what you can do about it?

Your personal CPI and the national CPI are not likely the same. They may not even be close. As the Bureau of Labor Statistics notes, the national CPI “seldom mirrors a particular consumer’s experience.”

The CPI is a measure calculated by the U.S. Bureau of Labor Statistics of the average change in prices paid by urban consumers for a fixed market basket of goods and services. The measure is taken monthly, then annualized for the previous 12 months.

There’s been much debate about how the CPI is calculated and whether it accurately reflects true price changes. Regardless, it’s a widely used number. Social Security uses it to adjust benefit payments to retirees, it’s a bargaining chip in wage negotiations, and the Federal Reserve uses it as one of many indicators in deciding whether to raise or lower interest rates (lately, the Fed has been raising interest rates in order to ward off more serious inflation).

But what does the national CPI say about your personal cost of living? Probably not a lot. [taken from their FAQ on Web site]

Take, for example, three major expenses for many families: housing, medical care, and college. Some critics say the national CPI underestimates the impact of these expenses. But beyond that, your personal CPI may differ dramatically from the national CPI depending on where you live and how much these three expenses figure into your cost of living.

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The housing component of the national CPI average, which is based primarily on changes in rents and which factors out equity gains for homes, came in a mere 2.6 percent in 2004. So for renters, the national CPI might be closer to their personal CPI, but not for someone buying a home.

According to the National Association of Realtors, the national median existing-home price rose 8.8 percent in 2004.[hard copy, attached to FPP. WSJ piece for Feb 15, 2005] And in nearly half of 129 metropolitan areas surveyed, home prices rose in double-digit figures, including a 47 percent increase in Las Vegas and better than 30 percent increases in certain markets in California and Florida.

Yet in some regions, prices barely budged. Even within a specific market, price increases can vary depending on the price range of the type of house you’re looking for.

While the national CPI’s medical-care component rose only 4.2 percent in 2004, the reality for many people is that the cost of medical care rose dramatically faster. This is especially true for older people who typically spend much more on health care than the average person.

Families with children in college also will have a different—typically higher—personal CPI than families who don’t have children in college. The “education and communication” component of the national CPI showed a mere 1.5 percent increase. Yet the average increase for the cost of tuition for in-state students at four-year public colleges for the 2004–2005 school year rose 10.5 percent, according to the College Board. That came on the heels of a 13 percent rise the year before.

All of this illustrates that your personal consumer price index may be quite different from the national CPI, and you need to plan your finances accordingly. In some cases, personal CPIs may be lower than the national average, but for others it will be higher. What can you do with your own CPI?

Plan for it. When calculating your budget or perhaps future retirement needs, be sure to take into account your inflation rate.

Trim high inflation areas. You may have the flexibility to trim expenses in some areas. If necessary, you can send your child to a less expensive college or you can buy a less expensive home. It’s more difficult for some expenses such as medical care, though one can make savings there, too.

Review your investments. A diversified portfolio can go a long way toward helping combat inflation. Assuming you have ample investment time ahead—say at least five to ten years—you should consider investments that have a history of outpacing the rate of inflation, such as stocks and investment real estate.

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March 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC , a local member of the FPA.

GO EASY ON HOME-EQUITY LOANS - March 2005 Newsletter

Homeowners are unlocking the equity built up in their homes like never before. But before opening the home-equity loan door, be certain you don’t overextend yourself and put your home at risk, caution financial planners.

With home values climbing dramatically in many regions in recent years, homeowners have piled up record amounts of home-equity-based loans, including a 35 percent increase in 2004, according to SMR Research Corp., a business and market research firm. Homeowners are tapping their equity so heavily that credit card companies are feeling the competition and are getting into the home-equity loan business. And traditional lenders of home-equity loans, such as banks and credit unions, are providing various incentives to encourage people to borrow against their home.

The most popular type of home-equity loan these days is the home-equity line of credit - HELOC for short. HELOCs operate much like the line of credit in a credit card. The lender determines the maximum amount you can borrow against the equity in your home. You can borrow any amount up to that limit and the interest charges apply only to the amount you borrow. Rates typically are around the prime lending rate, which was 5.5 percent in February 2005.

Say the line of credit is $30,000 and you borrow $4,000, leaving $26,000 available for additional borrowing later. The interest charges are based only on the $4,000, not the $30,000 credit limit, just as they would be on a credit card. You might borrow $4,000 today, pay part of it back, then borrow $7,500 a few months later. Flexibility is the key to HELOCs.

And just as credit card interest rates fluctuate, so do interest rates on HELOCs. Lately, after record lows, those rates have risen as the Federal Reserve has raised short-term interest rates.

That’s where the second type of home-equity loan comes in: the fixed-rate home-equity loan. Here, you take out a fixed amount at a fixed interest rate and make fixed payments for a specific loan period, much as you would with an automobile loan. Fixed-rate home-equity loans typically run 1 to 3 percent higher than HELOCs. But while short-term rates have climbed lately, longer rates have held, shrinking the gap between the two types of loans.

Beyond their relatively low rates compared with credit cards, home-equity loans have the added advantage of the interest on loans of up to $100,000 being tax deductible. (Taxpayers subject to the alternative minimum tax can deduct the interest only if the loan is used to buy, build, or remodel their home.)

Financial planners commonly recommend that the line-of-credit loans be used for shorter-term, fluctuating needs, such as college expenses or perhaps emergency funding for unreimbursed medical bills. The idea is to pay off the loan fairly quickly.

The fixed-rate loans tend to be better suited to longer-term needs requiring a fixed amount, such as major home remodeling, but which you can’t pay off for a while. They also are often used to consolidate and pay off higher-interest, nondeductible debt such as credit cards and auto loans.

The question of whether to use such loans for investing is a bit trickier. Most financial planners don’t recommend taking out a home-equity loan to invest in the stock market. But it may be appropriate for some households to borrow to invest in real estate because they are investing in a similar asset. And loans for home improvement that can add value to the home are also often recommended.

Whichever type of home-equity loan you are considering, and for whatever the purpose, keep the risks in mind.

The biggest risk is that you can lose your home if you can’t make the loan payments. In the case of a line of credit, rising interest rates could make it tough for households already financially squeezed. A drop in home values also could put a loan in jeopardy.

Another risk is that homeowners sometimes treat HELOCs like credit cards, using them for frivolous needs.

A special concern is when a homeowner uses a HELOC to pay off nondeductible debt, such as credit cards, only to turn right around and start using the cards again. A consolidation loan works only if borrowers get to the root of the problem - their spending habits.

March 2005 This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC , a local member of the FPA.