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Managing Medicare's Costs

What is the cost of healthcare in retirement?

Three weeks ago when Fidelity Investments released its estimate that a 65-year-old couple who don’t have an employer supplement will pay $240,000 for medical costs during their retirement, it was seen as encouraging news. That’s because it was only four percent higher than last year’s estimate. As Fidelity said in its press release, over the past decade its annual estimates have increased at an average of six percent, with the exception of 2011, when the Health Reform law added several benefits to Medicare’s coverage.

To put Fidelity’s $240,000 number in perspective, the median net worth of all retirees is only $170,000, according to an analysis published by Pew Research last November. It’s true of course that the $170,000 number includes the net worth of millions of retirees with very modest incomes. Yet even if you unrealistically said that the almost seven million people 65 and older who have Medicaid coverage have zero net worth, the remaining 33 ½ million Medicare beneficiaries who are 65 or older would have a median net worth of only $203,000, and that includes their home equity.

Also, most retirees pay their healthcare costs with after-tax dollars. If a 65-year-old couple has an effective tax rate of 25%, it will take $320,000 of before-tax income in order to come up with $240,000 for health insurance premiums and cost-sharing over the course of retirement. That’s a daunting price tag, even for the most affluent seniors.

What if you think that Fidelity’s number is too high? You might use the projections from the Employee Benefits Research Institute (EBRI), which has been tracking and estimating retirement healthcare costs for almost 20 years. Last summer EBRI estimated that a 65-year-old couple with median prescription drug expenses needs $166,000 in savings set aside in order to have a 50% chance of having enough money to pay for healthcare. And if that couple’s prescription drug expenses are in the 90th percentile, EBRI says they will need between $244,000 and $331,000 set aside in order to have a 50% chance of having enough to pay for their healthcare.

Both Fidelity’s and EBRI’s estimates are highly educated guesses, and they are likely not accurate for most retirees. One-third of seniors have employer supplements, and so their healthcare costs during retirement may be lower. Also, people who remain in low-premium Medicare Advantage plans for much of their retirement will spend less.

But there are other factors that could make the $240,000 estimate too conservative. Fidelity used an average remaining life expectancy of 17 years for a 65-year-old man and 20 years for a 65-year-old woman. That’s in line with Social Security’s remaining life expectancies for 65-year-olds. But it’s important to remember that the government’s averages include large numbers of people who have Medicaid-eligible incomes (20%), who are smokers (12%), and who have serious chronic illnesses at age 65 (roughly 7%).

Each of those three groups will live three years less, on average, than other Medicare beneficiaries. True, the groups overlap, e.g., some very ill people smoke and also have Medicaid. Even so, it’s likely that people who are not in one or more of those three groups will live substantially longer than the averages, particularly if they have at least two years of post-secondary education and are not obese.

Because the later retirement years have the highest healthcare costs, people who live longer will likely pay more. On average, almost 70% of retirees’ healthcare costs are for premiums. That means that even if people use no medical services and take no prescription drugs, they will avoid only 30% of a typical retiree’s annual healthcare expenses. Because longer lives means additional years of paying premiums, even without healthcare inflation people will pay substantially more as they live into their late 80s and 90s.

Most retirees don’t closely track their healthcare costs from year to year and have no way of knowing how much they’re spending or whether their annual costs are increasing by four, six, eight, or even ten percent. If they are willing to take two or three hours a year to track their healthcare expenses by category (Part B premiums, health plan premiums, drug plan premiums, and cost-sharing for medical services and drugs), they can estimate future costs at various rates of growth (five percent, etc.). They can also quickly see when they go off track in one or more spending categories.

There are a few encouraging signs for retirees. For one thing, the provisions in the Health Reform law that deal with Medicare will save money for many retirees, assuming those portions are upheld by the Supreme Court. The law expanded Medicare’s coverage to pay the full cost of recommended preventive tests and reduced expenses for the 30% of beneficiaries who reach the Part D coverage gap known as the doughnut hole.

Moreover, Medicare’s cost growth per beneficiary has slowed, rising just 3.8% in 2009 and 3.9% in 2010 – about the same as the 4% that Fidelity used to inflate its 2012 estimate from the year-earlier number. Still, the slower growth in healthcare costs comes at a time of low inflation and modest growth in the nation’s gross domestic product (GDP), which has risen at an average annual rate of less than 2% since 2007.

For retirees, this sluggish GDP growth was the reason for the zero increases that they saw in their 2010 and 2011 Social Security payments. That’s also been the case with pensions that are linked to the rise in the consumer price index. Thus the distance between income and healthcare costs remained in the 2-3% range in 2009-2010 (the most recent years for which data are available) as it has over the last two decades.

Some analysts believe the reason that healthcare costs are increasing at 4% instead of 6% is that in a weak economy, people are skipping doctors’ visits and elective treatments. This theory gained credibility earlier this week when the Health Care Cost Institute issued its 2010 report. The Institute convinced four of the country’s largest insurance companies (Aetna, Humana, Kaiser Permanente, and United Healthcare) to permit the study’s authors to review three billion medical claims that identified the costs of various types of medical services.

As an article in Kaiser Health News pointed out, the prices for emergency room visits grew at five times the rate of consumer inflation, and only one category of spending – nursing home care – had prices that dropped. The report concluded that although healthcare costs rose less than four percent in 2010, it was not because the cost of services slowed. Instead, it was because people used fewer medical services.

Finally, in order to maintain Medicare’s fiscal viability, Congress will make changes in the next few years that will transfer some healthcare costs from the government to retirees. While there are conflicting proposals about how to do that, almost all of the suggestions will add costs for retirees with incomes of $50,000 a year or more. And once these added costs have been incorporated into law, Fidelity’s and EBRI’s estimates will need to be revised upward. ◊◊

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