Unlike the Last Few Years, the News Is Not Good
by Paul Fronstin, Ph.D., Dallas Salisbury, and Jack VanDerhei, Ph.D.,New research from the Employee Benefits Research Institute (EBRI). Reprinted with permission
In 2012, Medicare covered 60 percent of the cost of health care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounted for 13 percent, and private insurance covered 15 percent.
Medicare was never designed to cover health care expenses in full. Deductibles for inpatient and outpatient services were included in the program when it was established in 1965. As recently as 2003, when outpatient prescription drugs were added as an optional benefit, the program included a then-controversial coverage gap known as the so- called “donut hole.”
While the Patient Protection and Affordable Care Act of 2010 (PPACA) included provisions to reduce the size of this coverage gap, PPACA did not eliminate it. By 2020, enrollees will pay 25 percent of the cost of prescription drugs when in the coverage gap for both generic and brand-name drugs. In the future, individuals may pay a greater share of their overall costs because of the combination of the financial condition of the Medicare program and cutbacks to employment-based retiree health programs (Fronstin and Adams, 2012).
This analysis updates previous estimates by the Employee Benefit Research Institute (EBRI) on savings needed to cover health insurance premiums and health care expenses in retirement (Fronstin, Salisbury, and VanDerhei, 2014). Unlike EBRI’s 2014 report, this analysis finds that the savings targets for a 65-year-old retiring in 2015 have increased, with the increase ranging from 6–21 percent. This report discusses the model, the savings targets, and reasons for the recent increase in savings targets.
Determining how much money an individual or married couple needs in retirement to cover health insurance premiums and health care expenses is a complicated process. The amount of money a person needs depends on the age at which he or she retires; length of life after retirement; the availability and source of health insurance coverage to supplement Medicare; health status and out-of-pocket expenses; the rate at which health care costs increase; and interest rates and other rates of return on investments. In addition, public policy that changes any of the above factors also affects spending on health care in retirement. While it is possible to come up with a single number that individuals can use to set retirement savings goals, a number based on averages is too small for approximately one- half of the population.
This analysis uses a Monte Carlo simulation model1 to estimate the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses in retirement. Estimates are presented for those who supplement Medicare with a combination of individual health insurance through Medigap Plan F coverage and Medicare Part D for outpatient prescription drug coverage. For each source of supplemental coverage, the model simulates 100,000 observations, allowing for the uncertainty related to individual mortality and rates of return on assets in retirement,2 and computes the present value of the savings needed to cover health insurance premiums and out-of-pocket expenses in retirement at age 65. These observations are used to determine asset targets for adequate savings to cover retiree health costs 50 percent, 75 percent, and 90 percent of the time. Estimates are also jointly presented for a stylized couple, both of whom are assumed to retire simultaneously at age 65.
Savings Targets to Cover Health Insurance Premiums and Out-of-Pocket Costs in Retirement
As discussed above, there is uncertainty related to a number of variables, such as health care costs, longevity, and
interest rates. Among people with Medicare Part D, there is also the uncertainty related to health status and prescription drug use.
Projections of savings needed to cover out-of-pocket expenses for prescription drugs are highly dependent on the assumptions used for drug utilization. There are three sets of columns of estimates in Figure 2: in the first, prescription drug use is at the median throughout retirement; in the second set, prescription drug use is at the 75th percentile throughout retirement; and in the third set, prescription drug use is at the 90th percentile throughout retirement. Under each set of columns, a comparison of the savings targets is presented for 2011–2015.
Separate estimates are presented for men and women. Because women have longer life expectancies than men, women will generally need larger savings than men to cover health insurance premiums and health care expenses in retirement regardless of the savings targets. In other words, women will need greater initial savings than men even when both set the same goal—for example, of having a 90 percent chance of having enough money to cover health expenses in retirement.
Median Drug Expenses: As shown in Figure 2, in 2015 a man with median prescription drug expenses needs $68,000 in savings and a woman needs $89,000 if each has a goal of having a 50 percent chance of having enough money saved to cover health expenses in retirement. If either instead wants a 90 percent chance of having enough savings, $124,000 is needed for a man and $140,000 is needed for a woman.
A couple both with median drug expenses needs $158,000 to have a 50 percent change of having enough money to cover health expenses in retirement. They need $213,000 to have a 75 percent chance of covering their expenses and $259,000 to have a 90 percent chance of covering their expenses. These estimates are 6–8 percent higher than the savings targets estimated in 2014.
75th Percentile in Drug Expenses: Needed savings in 2015 for a man with drug expenditures at the 75th per- centile throughout retirement is $76,000 if he wants a 50 percent chance of having enough savings to cover health care expenses in retirement. For a woman, the savings target is $99,000 at the 50-percent target. If either instead wants a 90 percent chance of having enough savings, $138,000 is needed for a man, and $156,000 is needed for a woman.
A couple both with drug expenses at the 75th percentile needs $175,000 to have a 50 percent change of having enough money to cover health care expenses in retirement. They need $237,000 to have a 75 percent chance of covering those expenses, and $288,000 to have a 90 percent chance of covering their expenses. These estimates are 6–7 percent higher than the savings targets estimated in 2014.
90th percentile in Drug Expenses: Individuals at the 90th percentile in drug spending at and throughout retirement experienced an 18–21 percent increase in needed savings in the EBRI model. In 2015, a man needs $104,000 in savings and a woman needs $136,000 if each has a goal of having a 50 percent chance of having enough money saved to cover health care expenses in retirement. If either instead wants a 90 percent chance of having enough savings, $188,000 is needed for a man and $212,000 is needed for a woman.
A couple both with drug expenses at the 90th percentile needs $240,000 to have a 50 percent chance of having enough money to cover health care expenses in retirement. They need $323,000 to have a 75 percent chance of covering their expenses and $392,000 to have a 90 percent chance of covering their expenses.
Explaining the Increase in Savings Targets between 2014 and 2015
As mentioned above, while savings targets declined between 2011 and 2014, they increased between 6 and 21 per- cent between 2014 and 2015. For a married couple both with drug expenses at the 90th percentile throughout retirement who wanted a 90 percent chance of having enough money saved for health care expenses in retirement by age 65, their targeted savings increased from $326,000 in 2014 to $392,000 in 2015.
There are a number of factors that go into our model that can result in an increase or decrease in needed savings. The main reason for the increase in needed savings is related to the adjustment that is made each year to rebaseline out-of-pocket spending associated with prescription drug use. Out-of-pocket spending is tied to the Medical Expenditure Panel Survey (MEPS) and 2012 is now the most recent year of data available. Actual out-of-pocket spending at the median, 75th and 90th percentiles were higher than projected for 2012 when projections were based on pre-2012 data. As a result of the rebaselining, data on out-of-pocket spending for prescription drugs for 2012 and beyond have increased.
The increase in savings needed as a result of higher out-of-pocket spending on prescription drugs has been offset by other factors. The EBRI model uses Congressional Budget Office (CBO) and Centers for Medicare & Medicaid Services (CMS) projections for premium and health care cost increases in the future, and both of their projections of spending growth have slowed in recent years (Congressional Budget Office, 2014) (Levine and Buntin, 2013); EBRI’s estimate baselines are adjusted annually to account for this change. One adjustment was made this year to smooth out the effects of a projected 52 percent increase in Medicare Part B premiums in 2016 for new Medicare beneficiaries. Also, there have been slight improvements in the cost of Medicare Part D and CMS-projected growth rates in Part D premiums. In addition, using a person age 65 in 2015 instead of in 2014 means one less year until the coverage gap in Part D phases down to 25 percent coinsurance.
While savings targets increased between 2014 and 2015, the savings targets for persons with prescription drug use at either the median or 75th percentile continue to be lower than they were in 2012. For persons with prescription drug use at the 90th percentile, savings targets continue to be below where they were in 2011.
Individuals should be concerned about saving for health insurance premiums and out-of-pocket expenses in retirement for a number of reasons. Medicare generally covers only about 60 percent of the cost of health care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 13 percent. Furthermore, the percentage of private-sector establishments offering retiree health benefits has been falling. This is also true in the public sector.
This report provides estimates for the savings needed to cover health insurance to supplement Medicare and out-of- pocket expenses for health care services in retirement. PPACA is reducing cost sharing in the Part D coverage gap or so-called “donut hole.” By 2020, coinsurance in the coverage gap will be phased in to 25 percent. This year-to-year reduction in coinsurance will continue to reduce the savings needed for health care expenses in retirement, all else equal, for individuals with the highest drug use, which is one reason why this analysis finds past reductions in needed savings for health care expenses in retirement. Improvements in the outlook for growth in premiums related to the Medicare program also contributed to past declines in savings targets. However, more recently, these declines were offset by larger increases in out-of-pocket spending on prescription drugs as a result of rebaselining.
It is important to note that many individuals will need more than the amounts cited in this report. This analysis does not factor in the savings needed to cover long-term care expenses,3 nor does it take into account the fact that many individuals retire before becoming eligible for Medicare. However, some workers will need to save less than what is reported if they choose to work past age 65, thereby postponing enrollment in Medicare Parts B and D if they receive health benefits as active workers.
Finally, issues surrounding retirement-income security are certain to become an even greater challenge in the future, as policymakers begin to realistically address financial issues in the Medicare program with solutions that may shift more responsibility for health care costs to Medicare beneficiaries.