Mary Beth Franklin: Slowing drug costs temper health care inflation

The latest projection of retiree health care cost trends is a good news-bad news story that can arm financial advisers with appropriate inflation estimates to crank into their retirement income plans.

In a positive development, overall annual health care inflation in retirement is now projected at 4.22%, down from last year’s 5.47% projection, according to HealthView Services’ 2018 Retirement Healthcare Costs Data report released Wednesday. HealthView Services is a leading provider of retirement health care cost projections based on 70 million health care cases, as well as actuarial, government and economic data.

The change is driven primarily by a slower rate of increase in expected drug costs, reflecting a consumer shift from brand-name to less-expensive generic drugs and scheduled changes to the Medicare Part D coverage gap, known as the “donut hole,” in which individuals must pay a larger share of the cost of their prescriptions.

In 2018, the donut hole begins once drug costs paid by both the beneficiary and Medicare Part D drug plan reach the plan’s initial coverage limit of $3,750. After that, consumers are responsible for 35% of the costs of brand-name drugs and 44% of generic drug costs. In 2019, the consumer portion of drugs in the coverage gap will drop to 25% of brand-name drugs and 37% for generics.

Your clients do not need to do anything to get the discounts. They will automatically be applied at the pharmacy. Prior to the passage of the Affordable Care Act, consumers were responsible for 100% of their drug costs while in the donut hole.

Fewer than 5% of Medicare beneficiaries make it out of the donut hole, according to the National Council on Aging. But those whose drug costs exceed their drug plan’s “catastrophic” limits would be responsible for the greater of 5%, or $3.40 of the cost of generic drugs in 2019 and $8.50 for brand-name drugs.

As a result of the slowing of drug-cost inflation, total lifetime retirement health care expenses for an average healthy 65-year-old couple, whose average life expectancy is 87 for men and 89 for women, are projected to be $363,946 in today’s dollars. That is down from $404,253 in HealthView’s 2017 report.

The cost estimates include Medicare Part B and Part D premiums, supplemental Medigap insurance, dental insurance, co-pays and out-of-pocket costs for medical care and prescriptions. It also includes costs for out-of-pocket dental, hearing and vision care not covered by Medicare. The estimates do not include long-term care costs.

But the good news on lower projected drug costs is tempered by the broader trend of ever-larger portions of health care costs being shifted to retirees, particularly higher-income individuals, as a result of recent legislative changes.

For example, the elimination of certain Social Security claiming strategies a few years ago will reduce potential lifetime benefits for a healthy 58-year-old couple by $37,000 in today’s dollars, leaving less guaranteed income to cover future health care costs, according to the HealthView report.

In addition, the Bipartisan Budget Act of 2018 added a new top tier to the Medicare surcharge brackets for Part B and Part D premiums for high-income beneficiaries starting in 2019. The act also postponed indefinitely the indexing of these brackets, which start at $85,000 for individuals and $170,000 for married couples, to inflation. Indexing was originally planned to begin in 2020. With surcharge thresholds expected to remain constant for the foreseeable future, more retirees will be subject to them in the future.

“Rising faster than both U.S. inflation and Social Security COLAs, retirement health care costs will require a growing portion of retirees’ budgets and must be planned for,” said Ron Mastrogiovanni, chief executive officer of HealthView Services.

The firm’s Retirement Healthcare Cost Index calculates the percentage of Social Security benefits required to pay for health expenses. The index shows a healthy 66-year-old couple retiring today will need 48% of their lifetime Social Security benefits to address total lifetime health care costs. Although this couple would need just 35% of their Social Security benefits during their first year of retirement to cover premiums, co-pays and out-of-pocket costs, by age 85 these expenses would be 158% higher and would consume about 56% of their future Social Security benefits.

The impact of future health care costs is even more dramatic for younger workers. A healthy 55-year-old couple will need 57% of their lifetime Social Security benefits to cover their health care costs in retirement, and a 45-year-old couple would need 63% of their benefits.

“A key planning challenge is to ensure retirees have the income they will need through retirement to address higher premiums and out-of-pocket expenses as they get older,” Mr. Mastrogiovanni said. “This requires new approaches to investment and decumulation strategies to specifically match health care expenses.”