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The Effect of the Risk of Out-of-Pocket Spending for Health Care on Economic Preparation for Retirement

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Abstract

After retirement, the primary sources of uncertainty with respect to an individual’s economic status are longevity, investment outcomes and out-of-pocket spending on health care. In previous work, we estimated economic preparation for retirement, taking into account the risk of living to an advanced old age and the concomitant risk of running out of resources. But while we accounted for the average level out-of-pocket spending for health care, we did not account for the risk of out-of-pocket spending. In this paper we augment our model for this omission. We find that the risk of out-of-pocket health care spending reduces economic preparation for retirement from about 72% of persons in the age range 65-69 to about 63%. However, this relatively modest reduction is quite unequally distributed: about 57% of single persons are adequately prepared when health care spending is not stochastic, but just 44% when it is. Among single women who are not high school graduates the percentage adequately prepared declines from 33% to 15%.

Key Findings

In prior work, we developed a framework to analyze economic preparation for retirement, taking into account the risk of living to an advanced old age and the concomitant risk of running out of resources. We augment our previous model to account for the risk of out-of-pocket spending for health care and find:

  • The risk of out-of-pocket health care spending reduces economic preparation for retirement from about 72% of persons aged 65-69 to about 63%.
  • However, the effects of taking into account health-related out-of-pocket expenditure risk differ sharply across the population.
  • For example, among singles it reduces the fraction with adequate economic retirement resources disproportionately (from 57% to 44%).  Among single women who did not graduate from high school, the percentage adequately prepared declines from 33% to 15%.
  • The results suggest a role for better insurance: with perfect insurance, out-of-pocket spending would be at the mean level of our baseline simulations, resulting in an increase of about nine percentage points of persons adequately economically prepared for retirement.

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Project

Paper ID

WP 2010-232

Publication Type

Working Paper

Publication Year

2010