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29 August 2012

Retirement and your medical costs

Can you afford medical cover when you retire? Experts say it's getting less and less likely.

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Long-term medical inflation is estimated to be at least 2% or 3% above general inflation. However, the trend over the past three years has showed medical inflation to be above inflation by between 5% and 10%.

This, combined with the fact that less than 10% of South Africans are able to retire with the same lifestyle as they had during their working years, means that it is critical for individuals and employers to open a dialogue on how best to plan for their future medical costs

According to Olabode Olajumoke, Health Actuary at Aon Hewitt South Africa, medical costs, which currently occupy around 7% to 12% of an average retired person’s income, will take up an increasingly larger part of their total income in future. “Based on current assumptions, medical costs could rise substantially over the next 30 years to between 30% and 50% of someone’s post retirement income, unless rising medical inflation is checked. The current trends are not sustainable.”

Responsible for own medical funding 
Further, he notes that in about 15 to 20 years, the vast majority of those who retire will have been on a total cost-to-company arrangement during their last working years. “This means the responsibility for post-retirement medical funding will lie solely in their own hands. Statistics show that for most people, the value of real assets (through a monthly pension income or other investment) will be less during their retirement years, when compared to their final working salary. 

“At the same time, their medical costs are likely to increase disproportionately compared to when they were younger. This may be due in part to rising longevity statistics, which coincides with an increase in chronic diseases among South Africans who increasingly adopt western lifestyles.” 

Olajumoke says few of today’s retirees are still in the position of having their former employers contributing towards their medical expenses. “Employees are increasingly responsible for sorting out their own benefits, whether via retirement funding contributions in a defined contribution arrangement or funding of medical aid scheme and benefits levels in a total cost to company environment. Companies are increasingly trying to remove their liability from their balance sheets, resulting in greater freedom to the employee, while also transferring greater risk.” 

One of the most immediate risks is demonstrated when looking at current and recent investment returns. “The downturn in the markets, coupled with the rising costs of medical inflation, means that one is looking for an investment return of two or three percent above medical aid inflation in order to earn sufficient returns to cover one’s medical costs.” 

Investment pool could offset future costs
He says it is possible to fund a future liability during the present. When we look at modelling post-retirement medical costs, we can estimate the value of the medical aid lump sums that may be required to fund contributions upon an individual’s retirement. These projected costs could be spread backwards over the employee’s working life and funded through investments. The value of the investment would depend on the demographic composition of the group.

For example, an extra 1% could be added to an entry level employee’s salary to go directly into this investment pool, or even be linked to the employer-sponsored retirement arrangement. The rate would increase should the employee purchase this investment at a later age.

“Traditionally, pension and provident funds offered through an employer provide death and disability benefits in addition to retirement benefits, so theoretically it should be possible to add in a post-retirement medical benefit rider.”

“Best practice advice remains to consult a qualified financial adviser to assess whether one is on track both with  traditional retirement funding arrangements, as well as  post-retirement medical costs,” concludes Olajumoke.

(Press release from Aon Hewitt, August 2012) 

 
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