Health care costs, planning take on more importance

Call it health care sticker shock. Between the ever-rising costs of health care services, the financially stressed state of the Medicare system and the more modest returns that one can expect from an investment portfolio these days, paying for health care is a crucial issue for retirees, and one that financial advisers need to address.

How bad is it?

A 65-year-old couple who retired last year can expect to spend an average of $230,000 on health care services not covered by Medicare during their retirement, according to a study done by Fidelity Benefits Consulting last March.

If either individual lives significantly longer than the average — 76 years for men or 81 years for women — the costs will be higher. And if either develops a serious health issue or requires long-term care, the costs will rise substantially more.

“We recommend that our advisers sit down and figure out clients’ likely health care costs [the following] year or their average expenses at the beginning of retirement and communicate the information in bite-size pieces,” said Shannon Reid, director of retirement solutions for Raymond James Financial Inc. “The big numbers can sometimes paralyze clients.

“Health care is older clients’ biggest concern, so financial advisers need to be aware of the issues,” she said. “If someone wants to be a retirement adviser, they need to be able to help clients through the process.”

It is a complicated process.

Joe Tomlinson, an actuary and financial planner based in Green-ville, Maine, recently turned 65 and spent five months educating himself on the ins and outs of Medicare and health care issues during retirement.

“At first, I was pretty confused, and I’m an actuary,” he said.

The issue comes down to identifying the risks and costs that a person is likely to face and determining how much of that risk a person is willing to shoulder themselves and how much they will insure against.

“In my experience, some people don’t want to pay a dime, and they overinsure, versus the other extreme, where people don’t do anything,” Mr. Tomlinson said.

Neither behavior is good from a financial planning perspective.

The first consideration is understanding what services Medicare provides for retirees and what services it doesn’t cover.

The system is organized into four parts.

MEDICARE AND BEYOND

Part A covers hospital services, while Part B coverage pays for doctor visits and outpatient care. Retirees pay a premium for the B coverage that varies with their income level, and have co-pay responsibilities and deductibles for some services.

They can purchase supplemental coverage from organizations such as AARP or Blue Cross and Blue Shield to fill in the gaps in Medicare coverage.

In some cases, employer-funded retirement health care benefits can cover much of the expenses not paid by Medicare, but with health care costs still rising at a 6% to 8% annual clip, the trend is toward companies’ dropping such plans.

Individuals also can opt for Part C coverage with so-called Medicare Advantage insurance plans. These private plans are an alternative to Parts A and B coverage, and have a variety of premium and co-pay structures and often have network service providers that enrollees must use.

These plans fill in some, though not all, of the gaps in Part A and B coverage.

Part D voluntary private insurance covers the cost of prescription drugs, a potentially huge expense if a person has a chronic health condition. One of the largest sources of out-of-pocket health care expenses for retirees still results from the so-called doughnut hole in Plan D care coverage of drug costs.

Individuals pay the first $320 in drug costs and 25% of the next $2,930. Individuals are responsible for all such costs between $3,250 and $6,658. Medicare coverage kicks back in after that, resulting in a maximum $4,700 of out-of-pocket drug expenses.

The choices on Medicare coverage depend on individual circumstances.

“Every client situation is different,” Mr. Tomlinson said.

“It’s like the 4% withdrawal rule in retirement. I’ve never had a client you could apply it to on a consistent basis,” he said. “Everyone has different sources of income and ex-penses that apply in real cases.”

For people who want to retire early or are forced to, the cost picture gets a lot scarier. If the individual’s employer provides no retirement health benefits, the cost of private insurance to bridge the gap before Medicare kicks in at 65 can be enormous.

EXPENSIVE INSURANCE

“Most people don’t appreciate what the costs and risks of retiring without health care insurance are,” said Michael Thompson, a principal in PriceWaterhouse-Coopers LLP’s human resources services division.

The insurance costs for someone between 55 and 65 can be several times more than for other age groups, and that is if they are in good health, he said.

There is also the spousal gap to consider for retirees covered by Medicare who have a husband or wife under 65. Unless they have an employer insurance plan remaining in force, they will face the same uncertainty as early retirees.

“The five years before age 65 could cost you as much [in health care costs] as the rest of your life,” Mr. Thompson said.

The health care risk factor that can undermine the most diligent retirement plan is the potential need for long-term health care, very little of which is covered by Medicare.

According to 2007 data from the Department of Health and Human Services, 70% of Americans over 65 will need some form of long-term care during their lifetime.

And it doesn’t come cheap. The average annual cost of a private room in a nursing home can run to $75,000 per year, and a home health care aide can cost $25 per hour.

“A lot of people don’t appreciate the risk it represents to go uninsured on that front,” said Mr. Tomlinson, who said between just 10% and 15% of his clients buy some form of LTC insurance. “It’s a tough sell because you have to pay significant premiums for a lot of years before you get any benefits, and there’s a fair chance you’ll never use it.”

DROPPING LTC

Making matters worse, insurers are having difficulty analyzing the claims experience and costs involved in the product. Many, including the two largest U.S. life insurers, MetLife Inc. and Prudential Financial Inc., have stopped writing new individual LTC policies.

Although premium costs can be lowered by taking on higher deductibles and/or creating terms where the insurer doesn’t pay for stays of a certain period or less, the cost of these policies is likely to continue to rise.

For retirees of modest means, the cost of LTC insurance may be prohibitive. Wealthier individuals, on the other hand, may choose to self-insure and take the chance that they won’t require the care. However, a multiyear stay in a nursing facility can burn through estate values quickly.

Paul Lee, a financial adviser at UBS Financial Services Inc., recommends a universal life insurance policy with LTC benefits offered by Lincoln Financial Group to many of his high-net-worth clients.

Depending on health status, age and gender, policies such as Lincoln MoneyGuard Reserve policy will pay out as much as five times a single upfront premium in LTC costs. If the individual never needs the care, there is a death benefit for beneficiaries.

The product is for those with “excess capital,” as Mr. Lee put it. But for a client in the sweet spot of between 50 and 60, the policy can solve a lot of uncertainty.

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