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A Vexing Retirement Planning Problem? Predicting Health Care Costs

What worries your clients most about their prospects for achieving a secure retirement? The cost of health care.

What worries your clients most about their prospects for achieving a secure retirement? The cost of health care.

Americans are less confident that they'll have enough money to pay for medical and long-term care expenses in retirement than they are about their ability to cover basic expenses, according to the Employee Benefit Research Institute's recently released Retirement Confidence Survey.

Affluent households seem especially worried. Seventy-nine percent of investors with $250,000 or more in investable assets responding to the most recent Merrill Lynch Affluent Insights Survey cite health care costs are their top financial concern – ahead of the nation's budget deficit, unemployment or possible tax hikes. And 34 percent say they are more worried about the financial strain associated with a chronic health situation than how it might compromise their quality of life.

It's the third year in a row that health care cost worries have topped Merrill Lynch's survey. Growing awareness among older Americans that longevity is rising is a key factor, since it raises the specter of ballooning lifetime cost, says David Tyrie, head of Personal Wealth and Retirement for Bank of America Merrill Lynch. “The longevity challenge is complex, and we need to think about it more holistically and find a comprehensive solution,” he says.

Health care cost inflation for retirees actually has moderated somewhat in recent years. Fidelity Investments reports that projected lifetime health care costs fell for those retiring in 2011 – the first time inflation abetted since the company began tracking it 10 years ago. Fidelity estimates that a 65-year-old couple retiring last year will need $230,000 to pay for lifetime medical expenses, not including nursing-home care. That represents an eight percent decline from 2010, when the estimate was $250,000 (Fidelity's 2012 report is due to be released later this month).

A key factor moderating prices is the Obama Administration's health reform law, according to Fidelity and other experts. The Affordable Care Act (ACA) contains several key changes to Medicare, including a gradual closing of seniors' out-of-pocket spending on prescription drugs in the notorious doughnut hole. The prescription drug program also has experienced lower-than-forecast enrollment and a major patient shift to generic drugs. The ACA also cuts reimbursement rates to hospitals, skilled nursing facilities, home health services and Medicare Advantage managed care plans.

While overall Medicare spending is soaring due to the country's aging demographics, the rate of average annual per capita spending is projected to be 3.5 percent for the coming decade – in line with projected GDP growth of 3.8 percent, according to the Congressional Budget Office. From 1985 to 2009, annual per capita spending growth averaged 6.7 percent. However, long term care costs have continued their inexorable rise. The annual rate for a private nursing home room last year was $77,745 in 2011, according to the Genworth 2011 Cost of Care Survey, up $17,520since 2005 – a compound annual growth rate of 4.35 percent over that period.

At the same time, the market for long term care insurance (LTCI) continues to struggle. The federal government threw in the towel last October on efforts to create a federally-sponsored option for long-term care coverage, called The Community Living Assistance Services and Supports Act (CLASS), due to worries that the program wouldn't be financially sustainable without adding significantly to the federal deficit.

The news in the private LTCI market hasn't been much better. Prices for LTCI policies this year are ranging from six to 17 percent higher than a year ago, according to the American Association for Long-Term Care Insurance (AALTCI) Many existing policy holders have been hit with double-digit rate hikes, as well.

Much of the premium hikes stem from the ultra-low interest rate environment, according to Jesse Slome,executive director of AALTCI. “Many people don't understand the importance of investment return in the insurance business. “About half of the assets carriers use to pay future claims comes from investment returns, and the other half comes from premiums” he says. “Every half point drop in interest rates translates into a 15 percent rate increase by insurers.”

Meanwhile, insurance carriers have been withdrawing from the market – 10 of the top-20 underwriters of individual LTCI policies five years ago have since announced that they will stop writing new policies, according to LIMRA, the insurance industry research and consulting group. And sales have been lackluster. In 2011, the number of people buying policies fell two percent to 230,000, according to LIMRA.

Helping Clients Cope

Mapping a strategy for managing health care costs in retirement is a critical component of any good financial plan. Yet the Merrill Lynch survey finds that, while respondents may be wringing their hands about the problem, they're not doing much to prepare. Seventy-eight percent of Americans under age 50 haven't planned for retirement health expense—but 62 percent of those over 50 haven't figured it out either.

Here are some key strategies to consider as you work with clients:

Create a savings goal for health care. Consider urging clients to set up a separate account to be tapped only for health expenses in retirement. Some may have access to a Health Savings Account at work, which permits investment of pre-tax dollars, tax-free growth and withdrawals for workers who want to save to offset health expenses. But HSAs are limited to workers enrolled in high-deductible insurance plans ($1,200 for an individual, $2,400 for families). Contributions are limited to $3,050 for individuals, and $6,150 for families.

Roth IRAs also can be useful vehicles for setting aside dollars tagged for health care, since they don't have Required Minimum Distributions for those over age 70 ½ and withdrawals generally are tax free.

Work longer. Staying on the job even a few years longer than planned is one of the best overall ways to counter health expenses, because it means more years of employer-sponsored health insurance and delayed Medicare enrollment.

Do a prescription drug benefit check-up annually. Seniors should re-shop prescription drug plans annually to ensure that they are getting the best price and appropriate coverage. Insurance companies often change their offerings year-to-year in ways that can increase premiums by thousands of dollars, or make it difficult to get certain drugs. And, your clients' health needs may change, too.

Manage Medicare carefully. Clients should be sure to sign up for Medicare within the correct enrollment windows to avoid major penalties for Part B – 10 percent for every year of delay for life.And high income seniors should pay careful attention to manage tax brackets to avoid premium surcharges levied for Part B and Part D.

Consider long-term care insurance. Despite the LTCI market's recent problems, there really aren't many viable alternatives for protecting clients against the risk of catastrophic cost. Medicare covers only a small amount of LTC costs; Medicaid, which funds the greatest share of the country's nursing home costs, requires beneficiaries to spend themselves into poverty and the quality of care available is spotty at best.

Some may be able to self-insure – a strategy that requires $500,000 to $750,000 in retirement assets in order to be confident of having sufficient resources to self-fund an LTC need, according to Dawn Helwig, a principal with Milliman, an actuarial consulting firm that works with the LTC insurance industry.

Helwig recommends that LTCI buyers consider trimming their costs by staying away from the most expensive policy types. “Especially with the way inflation has been running, people don't really need to be buying policies with five percent compound inflation features right now. The regulations usually require insurance agents to offer that, but most also offer lower inflation protection at lower rates, and that can make a big difference.”

And if rates jump on an existing policy, policyholders may be able to keep rates flat by reducing their benefit levels.

“There really isn't another game in town, unless you're willing or able to divest all your assets and qualify for Medicaid” says Helwig.

Mark Miller is a journalist and author who writes about trends in retirement and aging. Mark edits and publishes, featured as one of the best retirement planning sites on the web in the May 2010 issue of Money Magazine. He is a columnist for Reuters and also contributes to Morningstar and the AARP Magazine. Mark is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living (John Wiley & Sons, 2010).

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