June 1, 2012
By Nevin Adams, EBRI
As a growing number of Americans near and enter retirement, concerns about the cost of post-retirement health care expenses loom larger. In fact, worker confidence about their ability to pay for medical expenses after retirement was just half what they expressed about their ability to pay for basic retirement expenses (see EBRI’s 2012 Retirement Confidence Survey).
Little wonder, since a recent EBRI Issue Brief noted that health-related expenses are not only the second-largest component in the budget of older Americans, they are the only component which steadily increases with age (see “Expenditure Patterns of Older Americans, 2001‒2009″).
Recognizing the potential financial impact, recent industry surveys have put a figure on the cost of post-retirement health care expense(1)—a figure above and beyond that of merely living in retirement. EBRI has gone to great lengths to model the major risks to retirement income adequacy—all the way back to the introduction of the EBRI Retirement Savings Projection Model (RSPM)® in 2003, including the incorporation of stochastic health care risks, such as nursing home and home health care costs.(2)
The RSPM has incorporated those expenses because, while those events will not be experienced by all retired households, or experienced to the same extent, when they do occur they can have catastrophic financial consequences for a household’s future retirement income adequacy. Many attempts to model retirement income adequacy either ignore this risk altogether, or just assume that all households purchase long-term care insurance at retirement—the former ignores a significant financial reality, while the latter glosses over reality.
Indeed, a major limitation of using income replacement rates as an accumulation target is that doing so generally fails to take into account these potentially catastrophic costs. How much difference does this make? A recently updated version of the RSPM(3) shows that, with the financial impacts of long-term care (nursing home and home health care costs) modeled, 68 percent of single male Gen Xers are projected to have no financial shortfall in retirement. On the other hand, if those long-term care costs are ignored, fewer than 1 in 10 would be projected to run short of funds in retirement. Similar results were found for single female and married Gen Xers.
The gaps are even more noticeable if you focus only on the situation of individuals with projected shortfalls in excess of $100,000. Ignoring long-term care costs, fewer than 1 percent of single male or married Gen Xers are projected to have shortfalls in excess of $100,000; however when you take those costs into account, approximately 18 percent of single males and 10 percent of families are now in this range, according to the model. The results are even more pronounced for single females, where ignoring those long-term care costs would indicate that fewer than 5 percent are modeled to experience shortfalls of more than $100,000, compared with approximately 34 percent when this reality is factored in.
It’s clear that those long-term care costs can be significant, and can have a dramatic impact on retirement security.
What’s less clear is why projections of retirement income needs and preparedness would continue to overlook them.
(1) For more information, see “The Impact of Repealing PPACA on Savings Needed for Health Expenses for Persons Eligible for Medicare,” EBRI Notes, August 2011, online here.
(2) The Retirement Security Projection Model® (RSPM) was developed in 2003, and in 2010 it was updated it to incorporate several significant changes, including the impacts of defined benefit plan freezes, automatic enrollment provisions for 401(k) plans, and the recent crises in the financial and housing markets. EBRI has recently updated RSPM to account for changes in financial and real estate market conditions as well as underlying demographic changes and changes in 401(k) participant behavior since January 1, 2010. For more information on the RSPM, check out the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,®” online here.
(3) More information about this update will be published in June 2012 EBRI Notes.