Unplanned healthcare costs can act like a landmine in retirement, damaging or even destroying what would otherwise appear to be the most carefully constructed portfolios. Even planned healthcare costs are an increasing financial challenge: The rise in medical inflation coupled with uncertainty about the future of government programs makes healthcare costs perhaps the biggest obstacle to a financially secure retirement. But there is one piece of good news in this otherwise gloomy scenario: "There is a real opportunity for advisors to truly help individuals and families as it relates to planning for healthcare costs," says Robert Cirrotti, Director of Retirement Planning Solutions at Pershing.

To persue this opportunity, Cirrotti recommends that advisors take practical steps, educating themselves about healthcare cost projections, potential prodcut solutions and their clients' needs. As he points out, "Dealing with healthcare is critical to the success of any retirement plan. It is also critical to building trust between clients and advisors."

Pershing's own retirement research has shown that individual investors are thirsty for "downside-scenario" planning right now, given the heightened sensitivity to risk that hasn't really gone away since the financial crisis. Advisors who have been able to meet this planning need saw a 19% increase in assets under management, according to Pershing's findings. Says Cirrotti, "When you are thinking about downside planning, if there ever was a wild card for retirement, healthcare is it."

Operating in tandem with clients' desire for downside scenario planning is an increased appetite for guarantees. Advisors and clients like the idea of having guaranteed products in place to provide income for basic needs in retirement. Healthcare costs are perhaps the most central of these needs, along with food and shelter, so it is incumbent upon advisors to find the right solutions to target these expenses. Of course this circles back to the central question: What are current healthcare cost projections? And what ripple effects do these costs have on client portfolios?

Healthcare Costs in Retirement

Employee Benefits Research Institute's (EBRI's) issue brief,"Funding Savings Needed for Health Expenses for Persons Eli- gible for Medicare" (Dec. 2010), provides aquantitative explanation for the savings required to cover healthcare costs in retirement. Researchers Paul Fronstin, Dallas Salisbury, and Jack VanDerhei found that men retiring in 2010 at age 65 need between $124,000 and $211,000 in savings earmarked to cover health insurance and premiums, and out-of-pocket health expenses in retirement if they wanted a 90% certainty of not running out of money for these ex- penses. For women the comparable numbers are slightly higher (because women live longer): $143,000 to $242,000. Even more disconcerting are cost projections for younger workers. The report found that a 56 year old, who plans to retire in 2020, would need to have accumulated savings for healthcare in the range of $109,000 to $354,000 for men and $147,000 to $406,000 for women, to reach a comparable level of security. Note that these are conser- vative estimates, because they don't include projections for long-term care expenses.

Paul Fronstin, Director, Health Research at EBRI and co-author of the report, says, "Because employers are continuing to scale back retiree health benefits and policymakers may soon begin to address Medicare's funding shortfall, more of the financial costs of healthcare will be shifted to Medicare beneficiaries in the future."

Funding Solutions

Innovations in guaranteed products and portfolio construction techniques can help provide protection against these looming and seemingly unpredictable cost challenges.

"One thing I've been seeing more and more of are income bucketing strategies that anticipate rising health costs," says John Diehl, Senior Vice President at The Hartford's Wealth Management Division. Variable Annuities and other insurance products may provide an increasingly effective way to tackle this daunting task.

Diehl, who is also a financial planner, points to longevity insurance as a basic building block of this strategy. Longevity insurance is another word for a deferred income annuity that kicks in at a later age. It is not a new concept. What is new is to increase the income targets as the client ages in order to match increasing healthcare costs.

This longevity insurance-type feature can be built directly into a variable annuity. For instance, some VAs include deferred fixed annuities inside them; clients can allocate inside the same contract between current investments and deferred fixed annuities. The portfolio is constructed in such a way that additional longevity income can be purchased by transferring assets from the investment account to the longevity account if needed. If the client dies before he or she reaches the age threshold for the deferred annuity, a death benefit is paid to the beneficiaries of the contract.

It's important to note that these longevity "buckets" are fixed and are not subject to the volatility of the market. This sort of guarantee makes sense. As Diehl puts it, "You can't just stop taking 10% of your medication if the market falls by 10%. You need regular and predictable income."

Other insurance products that incorporate medical costs include long-term-care insurance, LTCI-annuity hybrids and life insurance contracts with liquidity provisions for medical expenses. In all these instances, advisors and clients should be aware that there is typically no direct tie between income in these contracts and the rate of medical inflation. Hence, it is incumbent upon them to purchase additional income if they want to precisely match medical inflation.

However you look at it, individuals face pressure about how to best meet the basic costs of retirement, including healthcare expenses. Advisors can help by targeting income to provide for increased healthcare costs. This may help provide for a financially secure retirement.

A variable annuity is a long‐term investment designed to create guaranteed retirement income. Investment returns will fluctuate and the principal value, when redeemed, may be worth more or less than the original investment. Withdrawals or surrenders may be subject to contingent deferred sales charges. Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59 1/2 may be subject to an additional 10% federal income tax penalty. Withdrawals, for tax purposes are deemed to be gains out first. Withdrawals can reduce the account value and the living and death benefits. Annuity contracts contain exclusions, limitations reductions of benefits and terms for keeping them in force. All guarantees are subject to the claims paying ability of the issuing insurer.