Security gap: as employers reduce and eliminate retiree health benefits, individuals must take up more of the burden.

Key Points

* Saving for health-care expenses in retirement is a growing element of retirement planning.

* For many reasons, baby boomers are particularly at risk for a retiree health-dollar shortfall.

* New kinds of health plans push more of a cost burden on employees, but give them new tools to control spending.

As if retirement planning weren't scary enough, a new worry has emerged.

Experts project that health care in retirement will cost considerably more than it has, due to seven consecutive years of health-care costs rising at multiples of the overall rate of inflation. That's especially bad news for the many households in the United States that are already behind in their retirement saving. According to the Washington, D.C.-based Employee Benefit Research Institute, health-care expenses are likely to be higher than most individuals anticipate, and they could add 20% or more to the amount of preretirement income workers need to replace in retirement.

Paul Fronstin, director of EBRI's Health Research and Education Program, has conservatively calculated that a person retiring at age 65 and dying at age 80 needs to save $160,000 to pay for employment-based retiree health premiums and Medicare Part B premiums. The amount would rise to $296,000 for life to age 90.

Employer reduction and elimination of retiree health benefits have exacerbated the problem. EBRI reports that only 13% of private-sector employers offered health benefits to retirees in 2002, down from 22% offering health benefits to early retirees and 20% to Medicare-eligible retirees in 1997. By comparison, 92% of state governments in 2002 offered coverage to retirees under age 65, up from 76% in 1997. Smaller government employers, such as municipalities, cut back, but 55% still offered coverage to retirees under age 65.

Large private-sector employers, meanwhile, have been terminating retiree health benefits for current and future retirees, and newer large companies do not offer them, according to EBRI.

Impact on Employees

The tough part about saving for health care in retirement is that it is a new message that must reach employees, most of whom are already underprepared. "To date, our society and workplace programs have encouraged workers to save for their retirements, but not for their health-care expenses in retirement," said Karin Landry, managing partner of the Boston-based Spring Consulting Group. "So as the health-care landscape undergoes sweeping change, as an increasing number of companies reduce or eliminate retiree health-care benefits, and as pharmaceutical costs rise, a new kind of retiree savings gap is emerging."

Fortunately, health care is not a wild card in retirement planning, but rather can be quantifiable, according to Fronstin. That's due in part to tools on Web sites that help individuals calculate how much they'll need to save. EBRI sponsors such a site, CboosetoSave.org. "You can plan for it much better than five years ago," said Fronstin, who holds a doctorate in economics. "The wild card is whether you will have retiree health benefits, but that's less of a wild card because chances are you're not going to have them."

Individuals, of course, can't use a calculator to determine how long they will live, and they can't plan for an average life span, as employers can for all their employees. "Individuals can't plan to be average because 99% of us will be wrong," said Fronstin. "Individuals need to take into account family history, personal health status and behavior. If all of my relatives lived to 100, I'd better plan to live to 100 and save enough money to pay my expenses."

According to Landry, many retirees now find they need 100% or more of preretirement income, up from 70%, due to higher-than-anticipated healthcare costs, said Landry. Her consulting group works with employers trying to identify the right mix of benefits for their employees, and with the providers who create and sell retirement-saving and health-care savings products.

Also putting a strain on retiree budgets is that premiums are rising sharply for Medicare Part B, which pays for doctor services and outpatient care. Landry said next January's Part B adjustment will result in a 34% increase in two years, far ahead of the annual cost-of-living increases in Social Security.

A positive note for employees is that by living healthier, they can reduce health-care costs in retirement. Landry said a government report showed that retirees in good health typically have three times the net worth of retirees in poor health, perhaps because they didn't have to spend as much on medical care. "The bottom line is that there's a cost to not taking care of yourself," she said.

Transferring Responsibilities

Burdened with rising costs, employers have clamored for the means to cap what they spend, but give their employees tools to make cost-efficient health-care decisions. According to Landry, providers are responding in four main ways:

* The development of health savings accounts. These employ a high-deductible health plan with a savings plan that can grow through investment and is portable. The savings plan can be tapped tax-free for routine health costs, while the health plan covers major expenses. Landry calls HSAs a "significant step" in enabling employees to take the lead in determining how much to save and how to invest it, while also taking their savings to their next job.

Landry advises clients to provide incentives to motivate employees to participate and make wise decisions about the cost and quality of the health-care services they choose and about lifestyle and behavior. She encourages tools that facilitate communication, education and self-service help. Employers and their vendors must work to understand the consumer habits of their employee population, she said. They must also demonstrate commitment and be ready to deal with employees' emotional reactions to change.

* Guidance for employees in retirement savings and HSAs. These include tools to help employees calculate health needs in retirement. They also include "set it and forget it" investment options, such as asset-allocation funds that provide a mix of investments based on a participant's risk profile or lifestyle.

* Health-care advice. Landry said best performers rely on health management programs that target lifestyle behavior, obesity and disease

RELATED ARTICLE: Holistic retirement plans.

SO things look bad for boomers in retirement. What can an individual do? Save sooner, save more, invest smarter and with an adviser, said Greg Salsbury, who is executive vice president of marketing with Jackson National Life Distributors and holds a doctorate in organizational communication.

"We don't offer long-tern>care or health insurance, but to the extent we try to help an investor save more and invest more, we address retiree health costs through those means,' said Salsbury, who is the Denver-based company's chief architect of field-development programs. "As we look at the retirement picture, it is clearer and clearer that health costs are an elephant in the living room."

Salsbury said clients first typically choose an adviser in their 40s, but should do so earlier. "Many have the perception that if they are maximizing contributions to their 401(k) plans, they are doing all they can to save for retirement, but that's not true," he said. "They should be saving above and beyond that, particularly because of the gloomy health-care situation."

Jackson National eschews a proprietary agent three and distributes through independent professionals. The company helps them prepare holistic financial plans that take into account taxes, inflation, the death of the traditional pension, typical investor errors, health-care costs and the changes likely to occur to Social Security. It also has produced a multimedia CD presentation, "But What If I Live: the American Retirement Crisis," that distributors can play for clients on their laptops or on screens at seminars. "It prepares clients up front," Salisbury said. "It brings them out of their mini reality and shares with them the truth about these issues."

Salsbury said the industry is moving from a focus on accumulation of assets to distributions during retirement, which is "dramatically more complex." Issues include how much to save for retirement, the effect of longer life expectancies, how much investment return to assume, calculating withdrawal rates, inflation, health-care costs, what to do in poorly per/brining markets, wealth transfer and other legacy questions.

To some degree, the vast majority of financial-services firms are making some change to get their arms around this movement, said Salsbury. "Some journals are calling the retirement movement in America the single largest event in the history of the financial-services industry."

America's Retirement
Readiness
By the Numbers

$18,750

Amount the typical working American household
has saved for retirement

15%

The share of households on track to replace 85%
or more of pre-retirement income.

55%

Share of pre-retirement income that households
ages 25 to 40 are on track to replace.

62% to 63%

Share of pre-retirement income that households
at least 41 years old are on track to
replace.

Source: The Fidelity Retirement index, June
2005; sponsored by Fidelity Investments

Health Care in Retirement

Annual Change in Average Health Benefit Cost

Higher deductibles and co-payments, along with the introduction of
consumerism and care management, has brought some improvement
in recent years.

1994   -1.1%
1995    2.1%
1996    2.5%
1997    0.2%
1998    6.1%
1999    7.3%
2000    8.1%
2001   11.2%
2002   14.7%
2003   10.1%
2004    7.5%

Note: Results for 1994-1998 include active and retired employees;
1999-2004 include active employees only.

Note: Table made from bar graph.

Health-Benefit Cost Per Active Employee

Steep out-of-pocket costs may be dampening utilization of services,
but costs are still rising rapidly.

1994   $3,644
1995   $3,653
1996   $3,703
1997   $3,594
1998   $3,817
1999   $4,097
2000   $4,430
2001   $4,924
2002   $5,646
2003   $6,215
2004   $6,679

Source: Mercer Human Resource Consulting, 2004 national survey of
employer-sponsored health plans

Note: Table made from bar graph.

Percentage of Private-Sector Establishments Offering
Health Insurance to Retirees

The percentage of private firms offering retiree health coverage has
declined since 1997.

        Early Retirees   Medicare-Eligible Retirees

1997         22%                   20%
1998         16%                   15%
1999         14%                   13%
2000         12%                   11%
2001         11%                   11%
2002         13%                   13%

Source: Employee Benefit Research Institute, Issue Brief of March 2005

Note: Table made from line graph.