Advisors, Retirement Health Costs and the Inflation Reduction Act

First, the good news: The Inflation Reduction Act is expected to reduce cost growth for one significant driver of retirement health expenses — prescription drugs.

There are three main provisions that will impact Medicare and Medicare Advantage recipients.

Beginning in 2025, exposure to annual out-of-pocket expenses will be capped at $2,000 for prescription drugs covered by Medicare Part D or a Medicare Advantage plan that includes drug coverage.

Currently, retirees can face up to $7,050 in out-of-pocket costs for prescription drugs before "catastrophic coverage" begins.

For the first time, Medicare will be able to negotiate with drug companies on behalf of all 50 million beneficiaries for the price of some medications — providing far greater pricing leverage than in the past.

And, the government will now be able to penalize drug companies that increase prices by more than the inflation rate (as measured by the CPI-U), helping to put a lid on price increases.

It's important for advisors to understand the overall impact of these changes on the retirement health care expenses that working Americans need to plan for.

Which Clients Could Benefit?

Prescription drug costs (premiums and out-of-pocket spending) account for 20% to 25% of total lifetime health care expenses.

That's significant, but Medicare Part B and supplemental insurance — together a sizable portion of future expenses — are untouched by the new legislation.

Around 25% of retirees incur out-of-pocket drug costs in excess of $2,000 in a year.

The legislation will be significant for those dealing with chronic health issues like diabetes or a disease like cancer, but for the majority of retirees, the $2,000 limit will have no impact, unless a health event (such as a heart attack or broken hip) drives up their costs in a particular year.

Medicare's ability to negotiate drug prices, starting in 2026, will initially be limited to 10 commonly available drugs. The number of medications will rise to 20 by 2029.

New drugs and generic equivalents are excluded.

Because this list of drugs has yet to be revealed, the impact of this provision is currently unknown, but a realistic expectation is that overall costs will not dramatically decline for the majority of retirees.

The provisions of the act designed to keep drug price increases within CPI-U will be implemented in 2023, providing immediate relief to Medicare recipients.

CPI-U has averaged less than 2.5% annually since 2000. Prescription drug costs have typically risen at about double that pace.

The current period of high inflation will provide the capacity for more significant price increases, although these should be more closely aligned with Social Security cost-of-living adjustments (COLAs).

The Big Picture

Taking the long view, the trajectory of rising health care costs may be bent downward, but is unlikely to change dramatically.

Historically, health care inflation has risen between 1.5 times as fast the Consumer Price Index and twice as fast.

The CPI is the used as the benchmark to calculate Social Security cost-of-living adjustments, or COLAs. This means that, over time, retirement plans have to account for health care making up an increasing portion of retirement budgets.

Pricing pressure from inflation and COVID-19 on health care provider expenses, including labor costs and increased post-pandemic utilization of services, continue to impact consumer costs.

We expect the trend lines to continue upward as they have done through past economic cycles and efforts to rein in health care expenses.

As we highlight in our recent report, Healthcare Costs & The Inflation Reduction Act, the legislation has the potential to slow down inflation for one of the significant drivers of costs for Medicare and Medicare Advantage recipients, but does not significantly change the larger health care expense picture and the need to work with clients to ensure that this need is addressed.

It also underscores the multiple dimensions of the health care planning challenge and the value advisors can provide to help clients navigate the complexities of Social Security, Medicare premiums, supplemental insurance, and other out-of-pocket costs such as co-pays and deductibles, to address the one expense in retirement that is not discretionary.

Ron Mastrogiovanni is founder and CEO of HealthView Services, a provider of retirement health care, long-term care and Social Security planning software and data.