5 Trending Topics among Financial Advisors, with Related Insights*

Fixed-Income Insights
At the "Cliff's" Edge, Look Beyond Taxes

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Investment Perspectives
Eight Indications of a Muni Market Metamorphosis

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Video Commentary

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Market View

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Investment Perspectives
Hats Off to Mega Caps--but for How Long?

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*Based on advisor conversations with Lord Abbett personnel through December 3, 2012. Special thanks to Lord Abbett Portfolio Specialist Michael Cibelli.

The insurance mandate will form part of the problem. Endorsed last year by the Supreme Court, it imposes penalties on those who fail to buy insurance, ranging from $695 for each uninsured individual to 2.5% of family income, whichever is higher, up to $12,500. Tracking compliance alone will burden the Internal Revenue Service (IRS). Though the implementation budget at present allocates funds for no more than 1,200 new IRS hires, reality may force additional hiring of up to 16,500. Enforcement will bring on further complications. Though the law makes the penalties clear, it makes no provision for either civil or criminal actions against those who refuse. The IRS has no ability either to seize bank accounts or to dock wages. Neither will interest accumulate on unpaid penalties. The only thing that the IRS can do, beyond intimidating letters (for which, admittedly, it has remarkable talent), is withhold refunds—hardly a motivation if the amount is less than the penalty.

More complex and potentially much more disruptive are the questions surrounding the state insurance exchanges. These are the centerpiece of what has come to be called the president's "signature" legislation. Those who framed the law anticipated that each state would set up its own exchange to enable its residents to buy adequate health insurance at the lowest possible cost. But at least 16 states have already refused outright to set up exchanges, some with more fanfare than others. Another five states have decided not to set up their own exchanges and have proposed a partnership with the federal government, while four others are considering partnerships. Beyond these 25 states, others clearly will fail to meet the deadline written into the regulations.

Part of the problem is purely partisan. Most of the governors who have refused outright are Republican. But political partisanship is not the whole story. Many states simply refuse to take on the ample administrative burdens and expense involved in setting up and administering the exchanges. There are also nonpartisan political considerations. Many state politicians want to avoid the thankless task of deciding what constitutes "essential health benefits," as the law demands the exchanges do. These governors and state legislators see only political downside in choosing which health plans can go into the exchanges and whether to include acupuncture, as California would, and chiropractic services, as Michigan would, or exclude both, as Oregon would. They would prefer that the Department of Health and Human Services (HHS) take the blame for such decisions. Though governors and state legislators might lose a measure of power by deferring to the federal authority on this, that is, it seems, a small price to pay to avoid the risk of incurring the wrath of constituent groups.

The task that has befallen the federal government will impose formidable and unanticipated burdens. HHS will have to create at least 25 front-end interfaces to take in users' personal information, screen insurance schemes, and itemize acceptable plans. It will also need to build systems to verify user identities, certify health plans that meet standards, and provide ways for users to navigate the exchanges and apply, not just via computer links but also over the telephone and by conventional mail. Complicating the process still further, HHS cannot build a single system. Each exchange will have to account for each state's insurance laws—a task that will require the federal authorities to come up to speed on local insurance markets in at least the 25 states that have balked on exchange building, and very likely more of them.

The overlap with Medicaid will complicate the effort further. Since the states control Medicaid eligibility and the Supreme Court has allowed states to opt out of federal requirements, the exchanges run by HHS will also have to cope with Medicaid questions. They will likely have to ask users to fill out separate Medicaid applications probably on a separate, state-administered site. Inevitable delays will develop, as users wait on the state authorities to determine their eligibility. Should they be rejected, they will have to return to federally run exchanges to make the mandated insurance purchase. Without diligent efforts, many users will become confused as to whether they qualify for Medicaid or whether they must buy personal insurance. Such people could easily fall through the cracks of a federally run system and lose all medical coverage.

To protect against such hardship and set up the massive administrative machinery involved, HHS will have to do a tremendous amount of work in the year remaining before the exchanges are supposed to begin operations. The effort should quickly burn through the $1 billion budgeted to the department for the Affordable Care Act's implementation. It will undoubtedly have to tap budgets from other programs under its jurisdiction and perhaps even return to Congress for additional funding. Such a request will open more room for complexity. House Speaker John Boehner (R-OH) has already indicated that such funding will become a bargaining chip in the fiscal cliff negotiations, as well as any subsequent fiscal debate.

HHS also is under considerable pressure to get it right from the start. If Affordable Care is to work, it needs participation. There is a huge business risk, then, if the exchanges fail to work efficaciously for users or the IRS cannot track participation effectively or enforce compliance. As one policy analyst at Consumers Union noted, "Consumers are going to form an impression [...] based on the first years' experience, and if you create a negative impression, it would take 10 years to overcome that." That is not the outcome the administration wants for its signature legislation. More, any level of dissatisfaction will almost certainly set a future legislative agenda for this already unpopular piece of legislation. Either way, the give and take, successes, failures, and foibles of this year of implementation will surely affect investor perceptions, fears, expectations, and pricing.