Financial Savvy – No Help for the Medically Bankrupt

Almost 2 million people filed for personal bankruptcy in 2005. The number in 2006 is expected to be smaller since some filers last fall rushed to get in before the new (and stricter) bankruptcy law took effect Oct. 17. More than 500,000 Americans filed for bankruptcy in the two weeks prior to the deadline.

How can so many Americans be in financial trouble? You may be surprised to learn that the typical bankrupt person is not a deadbeat credit abuser. In fact, the No. 1 most common precipitating cause (more than 50 percent of all personal bankruptcies) is unpaid medical expenses. And even more surprising, most of the medically bankrupt actually had health insurance at the time they first became ill.

Picture this: You have a good job with health insurance benefits. You’re stricken with a serious illness. Your medical bills (deductible and co-pays) pile up. You’re too sick to work and you don’t have disability insurance. Under COBRA, you’re eligible to extend your employer health insurance coverage, but you can’t afford the premium (often $3,000-$6,000 per year). You borrow money from family and friends and max out your credit cards to pay for medication and living expenses. Two years later, you’re back to work, but your credit is ruined and your monthly bills are more than your take-home pay.

If you’re one of the many families burdened by excessive debts – medical or otherwise – you should exhaust other options before considering bankruptcy, which has serious long-term financial consequences. Under recent reforms, bankruptcy will cost you more and may not provide the relief you need. Furthermore, it will stay on your record for 10 years, during which time you’ll find it difficult if not impossible to obtain credit.

Under a Chapter 7 liquidation bankruptcy, your non-exempt assets (if any) are sold to pay your creditors. Secured loans, such as car loans and home mortgages, allow the lender to take the car or home for nonpayment, so they aren’t affected by bankruptcy. Most remaining debts (such as credit cards and medical bills) are cancelled.

In a Chapter 13 bankruptcy, debtors agree to a payment plan under court supervision. At the successful conclusion of the debt repayment plan over several years, most remaining debts are cancelled. Under the new law, more debtors will be required to undertake a debt repayment plan option because the more favorable Chapter 7 liquidation bankruptcy will be limited to filers who pass a multi-stage "means test." The first hurdle is that you earn no more than the median state income (in Colorado, $41,401 for single filers). If you pass that test, then a complicated formula measures whether your income less certain allowances (for food, clothing, housing, utilities, etc.) is high enough to justify a payment plan.

Who are the winners under the new system? It’s certainly not the financially distressed consumers who will find it harder to resolve their medical debts. A glaring omission in the new law is that it failed to provide any specific relief for the medically bankrupt. The new law is good news for unsecured creditors – primarily credit card lenders and medical care providers – who will receive at least some payment on the debts owed to them. Given the power and money behind the credit card lobby that pushed for these reforms, it’s no surprise that they come out ahead.

The other bankruptcy reform winners are the lawyers-the greater complexity and longer time required to shepherd clients through the new process is expected to at least double the legal costs.

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Vickie Bajtelsmit, Professor of Finance, Colorado State University College of Business,,

(970) 226-1473