Vanguard, Mercer roll out new retiree health care cost model
Reframing the conversation of retiree health care costs from overall lump-sum to annual costs is key.
Vanguard and benefits consultancy Mercer have rolled out a new proprietary model for forecasting annual out-of- pocket health care costs in retirement.
The effort marks an evolution from existing cost modeling tools, which have focused on a lump-sum dollar figure over the course of retirement that sometimes factors the cost of long-term care services, and sometimes does not.
The Employee Benefits Research Institute has been forecasting retiree health care costs for 15 years. The most recent projections from EBRI show a 65-year old couple will need $265,000 to cover Medicare premiums and out-of-pocket costs over the course of retirement. EBRI has modeling that includes long-term care costs and modeling that separates it.
Projections from the Boston College Center for Retirement Research put the figure at $197,000, which does not include the cost of long-term care.
Studies of pre-retirees underscore that they are aware of the challenge retirement health care costs present—a PwC study showed baby boomers were more concerned about covering health care costs than they were about running out of money.
But presenting those costs in a lump-sum projection over the full span of retirement risks shocking savers into a sense of defeat, and perhaps inaction.
“Most analyses available in the marketplace today point to a daunting out-of-pocket healthcare expense over the lifetime of a retiree,” said Jean Young, senior research associate in the Vanguard Center for Investor Research, in a statement.
“These large dollar values can be demotivating for investors from a psychological and behavioral perspective. Our model focuses on the more manageable task of planning for incremental, annual healthcare costs, while separately considering and integrating the potential for long-term care expenses,” she added.
And diverting the discussion from massive lump-sum figures must occur, the firms think.
“The expression of annual health care costs as a lump sum is not a useful framework for discussing retiree health care expenses. Instead, individuals should focus on annual costs, especially the incremental annual changes they will experience at retirement and at Medicare enrollment,” the paper says.
For example, Vanguard and Mercer’s modeling shows a typical 65-year-old woman will carry $5,200 in out-of-pocket expenses in 2018 if she enrolls in Medicare Supplemental Plan F and a standard prescription drug plan.
A less intimidating approach
More than new modeling, Vanguard and Mercer say their aim is to reconfigure how retirement health care costs are discussed to better equip savers.
Factors like health status, family history, income and geography will lead to variances in projections, and need to be considered on a personalized basis, according to a paper jointly authored by the firms.
Income replacement ratios used in retirement planning that set default savings rates should account for health care costs, which for some savers will mean increasing retirement plan contributions, the paper says.
Planning should also include what the firms call “substitution effects”—health care costs will increase as retirees age, but spending on other activities like travel and mortgages will decrease.
And accounting for the potential need for long-term care, which the paper says retirees have a “low but real probability” of experiencing, needs to be separate from preparing for core out-of-pocket expenses.
Drilling down on the numbers
The Mercer-Vanguard model identifies 12 chronic health conditions that can be used to drill down on what specific pre-retirees can expect to need when they leave the workforce.
A 65-year-old woman with medium health risks and living in an area of the country at the median cost of living will spend between $3,200 and $6,000 in 2018 for premiums and out-of-pocket medical, dental and vision costs, if she were enrolled only in Medicare with Part D coverage.
The same woman with a low-risk health profile is projected to spend 15 percent less, while the woman with a high risk profile can expect costs to be 90 percent more, with a probability that her poorer health would result in out-of-pocket costs exceeding five times the median risk in some years.
Because of the differing levels of risk in individuals’ health profiles, the out-of-pocket costs for the 65-year-old-woman range from $3,000 to $26,000.
The paper challenges the conventional wisdom of using a generic 70 to 85 percent income replacement ratio commonly used by financial advisors and workplace retirement plan savings calculators.
“The wide variation in incremental health care costs that individuals will encounter at retirement suggests that blindly accepting these default ranges may not be a good idea for some retirement savers,” the paper says.
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