Risk Management and Insurance

There are a number of events, some of which are described below, that can change the economic circumstances of the individual retiree after retirement. The example in Table 1 illustrates one of these hypothetical individuals.

In this example, Joan’s family members are critical in her support from age seventy-seven until her death. But since no suitable family household was available for her to join, she has lived in special housing since age seventy-five. Starting at age seventy-eight, she has needed daily support, and starting at age eighty, support throughout the day.

The higher out-of-pocket costs of accommodating her functional limitations places Joan at risk of outliving the resources that she and Robert may have thought sufficient for their lifetimes. For low-income persons, Medicaid is available to pay for nursing home care, but not for help until the individual is severely disabled. If Joan had purchased long-term care insurance, exactly when benefits would be payable would vary depending on the provisions of the specific insurance policy, but benefits would have probably started around age eighty. Joan’s medications are about $250 per month, which are paid for by her private insurance, but not by Medicare. Many private insurance programs, however, limit what can be paid for drugs, and some policies offer no coverage for prescription drugs. If Joan has limited assets and income, she may become eligible for Medicaid at some point between ages eighty and eighty-two.

This example is presented to illustrate some of the economic issues involved with the gradual change of functional status, including the use of the telephone, ability to drive, ability to pay bills Table 1 Timeline of a hypothetical person (Joan) as she ages beyond 70. SOURCE: Author and manage personal affairs, management of medication, and going out independently. It intends to illustrate the key issue in risk management: how to assure coverage of increases in living costs when neither the timing nor the size of those increases can be precisely predicted for any individual.

Increasing life expectancies, even for retirees, increase the risk of a person outliving their resources. One can protect against this risk by annuitizing assets; for example, choosing a payment form that will continue income payments regardless of the number of years the annuitant (and surviving spouse) lives. However, other post-retirement risks interact with length of life in ways that make this an imperfect strategy for complete insurance of levels of economic well-being. For example, inflation over a longer lifetime will further erode the purchasing power of an annuity that is not indexed for inflation. In addition, while lengthening lifetimes may extend the period of joint survival for a couple, it also extends the number of years of widowhood when one’s spouse dies. Likewise, lengthening life expectancies increases the chances that at least one parent may still be alive when an individual retires, raising the possibility that a parent’s health care needs may place demands on a retiree’s resources.

Changed consumption needs. A variety of unexpected post-retirement changes in family, work, and health status can lead to changes in consumption needs. The death of a spouse diminishes the food and clothing consumption needs of a now smaller household, but may increase the costs of leisure and household repairs that were formerly provided by the deceased spouse. It may also mean there is no longer someone available to help other household members. Loss of functional status by any household member increases health care costs and may increase transportation and home maintenance costs when that person is no longer mobile or requires facility adaptations. If someone’s retirement planning did not incorporate the chances of these post-retirement risks, then the selected pattern of resource distribution may not be well matched to subsequent needs.

Death of a spouse. A spouse’s death can cause a major change in both the personal and financial situation for the survivor. While group probabilities of losing a spouse can be calculated, an individual’s death may be unexpected, leaving a spouse bereaved and impoverished. The survivor is most often female, but there are also differences in what typically happens after the loss of a spouse. Men are much more likely to remarry. Women often experience a substantial decline in economic status and discover that they and their spouse had not planned adequately for widowhood. Women’s longer life expectancies and marriages to younger men means that survival as a widow is expected to be much longer than it is for widowers.

A financial retirement plan for a couple is not adequate unless it also provides for what happens when one of them dies. There are a variety of different financial strategies available to help in planning for widowhood. Assets are generally left to the survivor, but depending on other resources of the survivor, they may not be adequate to meet lifetime needs. Life insurance provides lump-sum funds for widowhood. Survivor options in pensions and annuities provide for continued income, and a fully owned home can be an important asset.

Other family changes. Retirees increasingly find themselves responsible for the physical and financial care of parents and children. Unexpected events in the lives of these individuals and their families can lead to immediate changes in the financial demands placed on retirees. This can be addressed by reviewing the financial strategies of these individuals, but for parents of retirees there may be few options at their time of life (see discussion of uninsurable risks below).

Inflation. Price increases erode the purchasing power of savings, with a relatively low rate of 2 percent reducing purchasing power by one-third over a twenty year period, and a rate of 5 percent reducing it by two-thirds. Asset, annuity income, and life insurance amounts need to be planned with the expectation of future inflation, the exact path of which can only be imperfectly estimated. Social Security benefits rise annually with the consumer price index, but, in general, employer-provided pension benefits do not. Investment strategies in which the growth in personal assets counteract the effect of inflation on the purchasing power of a retiree’s portfolio can be used.

Unexpected health care needs. Post-employment medical coverage is important for retired individuals and spouses, particularly for retirees below the age of eligibility for Medicare coverage. While persons age sixty-five and over are covered by Medicare, this program covers only a portion of medical costs and does not provide coverage for prescription medications.

Changes in functional status. A decline in the ability to perform designated activities of daily living may require special help. These are tasks required on a daily basis, such as eating, toileting, and dressing. They are important because the ability to perform such tasks is the way most long-term insurance policies determine eligibility for receipt of benefits. Organized retirement systems do not adjust to increasing income needs as functional status declines, though medical coverage may reimburse for some care, and long-term care insurance can help pay for part of the cost of special disability help. However, as described below, the gradual nature of functional declines may not be well accommodated by insurance. Some declines can be addressed initially by redesigning housing space to make it more user-friendly to those with the anticipated problems, or so it can accommodate assistants.

It is important to be aware well ahead of time of the possible need for these services, and what is covered and what is not covered by available insurance. The alternative is financing extra costs through savings or income.