Are you paying for your fund’s advertising?

(2005-11-28) by David John Marotta

If you own some mutual funds, chances are you are paying a hefty marketing price. This marketing expense is called the 12b-1 fee. The annual fee not only reduces your earnings, but it may also jeopardizes whether or not your investment advice is unbiased or self serving.

Initially adopted by the SEC in 1980 to stimulate growth for struggling mutual funds, the SEC 12b-1 regulation allows fund managers to pay up to 1% out of fund assets for distribution costs such as advertising, sales literature, literature distribution and, most importantly, compensation to the brokers who sell them to you.

The logic behind such advertising fees was to provide a temporary means for fledgling mutual funds to quickly increase assets through promotion and advertising. By attracting new investors, mutual funds could achieve higher levels of operating efficiency, thereby reducing overhead and passing on savings to the shareholders. Now, twenty-five years later, it seems 12b-1 fees are costing shareholders more than ever and are here to stay.

The Investment Company Institute, a mutual fund company advocacy group, reported that investors paid more than 10 billion dollars in 12b-1 fees in 2004, up from a few million dollars in the early 1980’s. The same report estimated 40% of the 12b-1 fees go to line the pockets of investment brokers who sell the funds to their clients and another 52% pay brokers for the ongoing shareholder services such as toll-free phone lines for their clients. In some cases, 12b-1 promotion fees continue to siphon off mutual fund assets even after the funds are closed to new investors.

It is no surprise that brokers have lobbied the SEC to maintain the fees, claiming they receive up to half their gross salary from 12b-1 fees. The implication creates a conflict of interest between you and your financial advisor, who may be marketing only mutual funds with commissions and 12b-1 fees.

With more than 17,000 different mutual funds, navigating the legalese of fund disclosures and fee schedules to determine what you are really paying in fees is a daunting task. We use Morningstar’s Principia Pro software for our mutual fund information. When I search its mutual fund database I learned that 34% charge no 12b-1 fee. An additional 22% charge a fee less than or equal to 0.25%, allowing the funds to still qualify as no-load mutual funds. The remaining 44% of loaded funds charge more than 0.25% with the majority charging the 1% maximum allowable by law.

Salesmen whose livelihoods depend on 12b-1 fees provide a vivid example of the difference between those who have a legal obligation as a fiduciary to sit on your side of the table and seek your best interests and those who have no such obligation and sell a companies’ financial product. The latter, if being honest, must disclose, "Our interests may not always be the same as yours."

Many investors are hesitant to seek the advice of a fee-only financial planner, musing "Why pay someone a fee every year?" But most of them are paying 12b-1 fees every year and forfeiting access to professional asset management and comprehensive financial planning. Any fee can be earned if it brings you more value than cost, but 12b-1 fees are not those kinds of fees. Studies have shown that those funds with the highest 12b-1 fees have the lowest returns.

One brokerage firm is now offering a 12b-1 rebate program in which they refund up to 50% of your 12b-1 fees. This may sound like a good deal, but this is exactly the wrong message to send. Why would investors want to purchase investments with high fees simply because they will refund fifty cents on every dollar they charge you for marketing?

To find out the fees charged by your mutual fund, go to: www.morningstar.com and in the quotes box in the upper left portion of the screen type in your 5 letter mutual fund symbol and tap the ENTER key. Then, in the left column, click on "Fees & Expenses." If after seeing your losses to 12b-1 fees you are interested in finding a fiduciary who will sit on your side of the table, visit the National Association of Personal Financial Advisors website at www.napfa.org to find an advisor in your area.

from http://www.emarotta.com/article.php?ID=155

Government Controls Endanger Homeland Security

(2005-11-21) by David John Marotta

The threat of a bird flu pandemic and the shortages of ordinary flu vaccine reveal the failing health of the vaccine market. Some blame the pharmaceutical companies and demand tougher government controls, but it is this kind of misconception which landed us with the flu vaccine shortages in the first place.

Vaccine shortages will continue to be the norm as long as we fail to enact policies which support the industries that provide them.

Three of the past five flu seasons have seen shortages of flu vaccine in America. This season, hospitals and clinics are again reporting more shortages due to delays in production.

More than 36,000 Americans die each year of the flu and another 200,000 are hospitalized due to complications. The ongoing threat would suggest there is a viable market for flu vaccine providers, not to mention the strong demand for flu shots this season. But, providers have steadily abandoned the US market due to slim profits, high production costs, and the risk of litigation.

Government price-fixing is largely to blame for forcing producers out of the market. Forty years ago, more than 26 companies produced vaccine in the US. In 2004, only four companies remained.

To stop shortages, many are calling for government to control production and distribution of vaccines. However it is big-government programs such as Vaccines for Children—signed under the Clinton administration— which expanded the government’s role in providing vaccines and precipitated our current crisis.

Uncle Sam now purchases nearly 60% of all children’s vaccines and 20% of all flu vaccines sold in America. Using its monopoly, the government has strong-armed producers into selling vaccines far below market prices. Its demand for cheap vaccines has squeezed providers out of the market.

While it’s hard to muster pity for diminished drug company profits, negligible earnings from vaccine sales are what ultimately jeopardized their production and supply. With little opportunity to come out in the black, companies cannot afford to produce vaccines, let alone produce extra for emergency shortages.

Excessive FDA regulations further threaten vaccine producers. For example, it takes a pharmaceutical company 5 years to open a flu vaccine plant. Once open, production of the flu vaccine is limited to antiquated production methods which slow production to an eight-month process. Although faster production methods have already been developed, they have yet to be approved by the FDA.

Once a plant is operational, there is still the chance supplies won’t pass inspection, as in the case of last year’s flu vaccine supply. Overnight, Chiron had to dump 48 million doses of flu vaccine slated for the US market. And with that, we lost 50% of our flu vaccine supplies.

Litigation is another force driving suppliers out of the market. Because vaccines are given to millions, the threat of lawsuits is almost inevitable. In 1988, Congress passed a bill to limit the risk of litigation for negative effects caused by vaccines. Though the risk of litigation is somewhat lowered, it remains a real threat.

Ultimately, vaccine sales account for only 2% of drug company sales. For all the price controls and red tape, the risk of litigation drives the last nail is the coffin for producers.

The solution is not more government controls and price caps, but less. Removing government price caps, providing funding for new production technology, and offering tax credits for new vaccine production facilities will provide a long-term solution to vaccine shortages. Market supply and demand will take care of the rest.

from http://www.emarotta.com/article.php?ID=154

Medicare Part D deserves an F

(2005-11-14) by David John Marotta

Medicare’s prescription drug program debuts January 1, 2006, marking the largest government entitlement program since Johnson’s Great Society. Known as 'Medicare Part D,' the plan subsidizes prescription coverage for millionaire and destitute seniors alike. But, the pork spending and boondoggle regulations aren’t even half the problem. Part D may bring some prescription benefits to low-income seniors in the short-term, but the unintended consequences are guaranteed to make us all sick in the long run.

The unintended consequences are dire. It will drive up prescription drug costs for the rest of us. It will reduce the quality of drug coverage. And outlays for the program are expected to reach $720 billion over ten years, adding to Medicare’s $45 trillion shortfall.

Increased drug costs

Almost 12 million seniors will likely enroll in the program before the May 15th, 2006 deadline, including an influx of seniors forced to switch their drug coverage from private plans to the government subsidy. Covering 12 million seniors will make Uncle Sam the largest buyer of pharmaceuticals in the U.S.

Sixty percent of all prescription drugs sold in America will soon be purchased through government programs at fixed prices. Monopolistic demand is just as detrimental to a free–market as monopolistic supply. To offset revenue lost to governmental price-fixing drug companies will increase prices on drugs for the rest of us. At the end of the day, middle class Americans and even poor families with children will pay more for prescription drugs in order to finance millionaire seniors who never should have received subsidized drugs in the first place.

Pharmaceutical research and development will also suffer. The combination of increased regulation and price fixing will kill profits. A lack of profits will discourage innovation. This story is not new to Canadian drug companies. Canadian price caps killed Canadian pharmaceutical research and development long ago.

More is less

Socialized healthcare produces less healthcare overall. Unlike a free-market system which provides negative feedback mechanisms to control consumption, a socialized system has no way of stopping people from consuming healthcare they do not need. To check this impulse, socialized healthcare systems ration healthcare in order to hold down costs. Rationing inevitably means some seniors do not have access to life-saving drugs in a timely manner. Regulations will require doctors and patients to try several stair-steps of lower-cost, less-effective medications before they will pay for the optimal treatment. Socialized healthcare means less choice and access to the treatments that are in the best interests of the patient.

Socialized healthcare is doomed to providing anemic results because the person paying (the government), the person selecting the treatment (the doctor), and the person benefiting (the patient) are not all the same person. Separating these roles is a prescription for pathological results: high prices, shortfalls, poor service, and out-of-control spending.

The cost

Assuming the current usage, paying for drug subsidies for all American senior citizens will likely cost $720 billion over the next ten years. But as the winds of increasing spending gather speed, the total number will be closer to $1.2 trillion. Assuming this estimate, Part D will cost Americans the equivalent of 6 Katrina hurricane clean-ups over the next ten years. This level of spending will put any hope of spending restraint permanently under water.

The long-term prognosis is a terminal deficit. A study by The Heritage Institute estimates that by 2020, Medicare will consume 25% of tax dollars and by 2040, 50%. Paying for such outlays is only possible by increasing the national debt or increasing taxes—or both.

A bad idea

Thankfully, two thirds of seniors say they will not enroll in the plan or are still unsure about enrolling. The complex benefit structure and the maze of insurance plans are very unpopular.

Seniors are not the only ones with hesitations about the program. The bill passed the House by only one vote. Neither political party thought this was an effective means to curb drug costs or provide coverage for less-privileged seniors.

Subsidized healthcare is never the answer. It will drive up drug costs and will place more burdens on the private sector—which determines America’s job growth. The plan should have covered low-income seniors who need the drug coverage, not wealthy seniors who can provide for their own healthcare. The unintended consequences will be a hard pill to swallow.

from http://www.emarotta.com/article.php?ID=153

Seniors Face Six Month Deadline for Drug Coverage

(2005-11-07) by David John Marotta

Medicare launches its prescription drug program on January 1, 2006. The plan offers subsidies to seniors who sign up for Medicare’s prescription drug insurance. Although enrollment begins November 15th, many seniors are still confused about the program.

Dubbed 'Medicare Part D,' Congress passed the Medicare Modernization Act in November 2003. Unlike other government-sponsored health programs, this new program is not just for low-income seniors. All seniors may enroll in Part D.

The plan is estimated to cost between $724 billion and $1.2 trillion over the next eight years, making it the largest government entitlement program since Lyndon Johnson’s Great Society. Shortfalls are only part of the problem. Navigating the plan choices and coverage is proving difficult for seniors.

Part of the plan’s complexity is caused by the number of agencies involved. Medicare does not provide the insurance directly. Instead, each state has contracted with insurance providers to offer the drug coverage. If you are a senior, you must decide if you should sign up, and then which plan you should purchase.

Most states offer at least 40 different drug plans. Premiums average $37 per month, depending on the level of coverage and the types of drugs covered by the plan. Virginia residents may choose from 40 different plans with premiums ranging from $8.81 to $68.61 per month. Beneficiaries with limited income and resources will receive additional subsidies to cover the deductible, monthly premiums, and the out-of-pocket drug costs.

Determining the benefit to you can be difficult. The cost structuring is the same for each plan offered. The deductible is $250 per year. After that, you pay 25% of your costs up to $2,250. From $2,251 to $5,100—known as the 'donut hole'— you pay all drug costs. After $5,101, you pay only 5% of expenses. In other words, if you have high drug costs, you will pay $3,600 out of pocket. After that, Medicare pays 95% of your drug expenses.

The confusing cost-structuring has led many seniors to ask why they should sign up at all. This is not good for the financial health of the program. If seniors wait until they need excessive pharmaceuticals, then only the most expensive seniors to cover will be participating in the program. Any insurance program relies on those with lower health costs to fund the rest. Although the program is voluntary, it is also trying to be coercive as well.

Seniors who fail to sign up by May 15, 2006, and subsequently decide to sign up could be charged more than those who sign up before the deadline. Seniors who do not sign up before May 15, 2006, could pay 1% more in the cost of their premium for each month they delay registration.

That means if you sign up six months late, providing companies can charge six percent more than otherwise allowed. If you wait five years (sixty months), companies can charge you 60% more. That doesn’t necessarily mean every senior should sign up, but is intended to be a strong incentive.

For many, it is clear whether or not to sign up, but for others it is more confusing. Let’s start with some clear cases.

If you are eligible for government subsidies that will pay all or most of the cost of coverage, you should make certain that you sign up. Realistically, coverage for lower- income seniors is the only portion of this legislation that should have been funded and the only portion that has broad support. Government assistance is available if your income is less than $14,355 ($19,245 if married) and resources are less than $11,500 ($23,000 if married). Resources include your savings and investments but they do not include your house or car.

On the other hand, if you currently have prescription drug coverage you may not need to decide now. If your existing coverage is deemed equivalent to the standard Medicare drug coverage, keep your current coverage. You should receive a letter from your current insurance indicating whether your insurance equivalent to the Medicare standard. The specific term they use to describe equivalent coverage is 'creditable.' If your coverage is creditable, you do not face any penalty if you subsequently decide to switch to Part D.

If you don’t qualify for extra help to pay for Part D and you don’t have creditable coverage, your decision becomes more difficult. If you currently purchase prescription drugs you should take the time to determine if any of plans available in your state will currently save you money. Chances are good that one of the plans will help.

More information about the prescription drug program is available by visiting www.medicare.gov or by calling 1-800-MEDICARE.

Local businesses and pharmacies in your area may provide assistance in learning more about Part D. Residents of the Charlottesville, Virginia area can find help at the CVS pharmacy on Barracks Road which will offer informational meetings from 10AM to 4PM every Tuesday in November. The local Charlottesville Wal-Mart will also have a Medicare representative available to meet with customers during the month of November. Be sure to bring a detailed list of all the prescriptions you are currently using.

The decision to sign up is the most difficult for healthy seniors who don’t currently have or don’t need drug coverage. Medicare wants you to sign up now in order that you might subsidize coverage for those who will make money from the deal. This is an unfair piece of legislation because it requires tax payers and healthy middle class seniors to subsidize millionaire seniors with prescriptions over $250 a year. Never the less, it is now the law. Make your decisions carefully.

If you don’t currently have or need coverage you may still want to enroll in Medicare Part D. In some states coverage can be purchased for as little as $1.87 per month and will prevent you from having to pay much higher premiums later. If the cheapest coverage doesn’t have what you need in future years, you can change your coverage later to whichever plan will save you the most money.

Seniors don’t always take the actions they should to protect themselves and their finances. If you know a loved one who needs to make these decisions, connect them with objective advice that will sit on their side of the table and help them through the process.

Medicare Part D Prescription Drug Coverage Decision Table
IF...	THEN...
You currently receive Medicaid	You will automatically be enrolled in Part D
You qualify for government assistance	Sign up for Part D
You already have creditable coverage	Don’t sign up for Part D
You pay over $250 in prescriptions	Visit www.medicare.gov to determine the most cost-effective coverage
You pay less than $250 in prescriptions	Consider getting the cheapest Part D coverage to prevent future penalties

from http://www.emarotta.com/article.php?ID=152