Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Introduction: Surviving Health Costs to Retire: Health (and Retirement) Savings Accounts
New topic 2016-03-08 22:42:53 description

Thoughts on Transition: Revenue

Much of this proposal amounts to transfer of funds rather than the creation of them, but one novel addition is investment income, made newly significant by increased longevity. Both revenue and medical expenses increase with longevity. But along different curves, so we cannot always be sure whether the net result will be positive or negative unless we keep revenue and expense separate until we actually spend some.

That is, unbundling the net averages, allowing revenue and expense to grow independently. A slavish substitution of average net balance for individual account values is of some assistance to share-the-risk third-party insurance calculations, but it also leads individuals to drop a policy if they cannot afford this year's average cost, when in fact they personally had no actual health cost at all. Because of the volatility of health costs, this may actually be the majority direction of financial strain. The ability of the individual to hold back on elective expenses or to supplement revenue out of personal funds is a hidden advantage of partially paying for things yourself. (Of course, there is another side to this, for sick people.) Both revenue and expenses are growing, but at different rates, so the account infrequently goes into actual deficit. Some people can't afford to handle this, but third-party rigidities give the impression no one can, when in fact most people are used to making temporary accommodations. Health Savings Accounts end up being assured of investment growth, while medical costs are whatever they turn out to be. Since there is no purpose served by merging revenue and expenses until the end of the process, the choice is deferred until circumstances are clear. The running net balance between revenue and expense gets relegated into relative inconsequence.

What emerges is a subsidy of health care by those who use less of it, plus a subsidy of retirement by those who die too soon to enjoy it. That is, the average is the same, but the efficiency of allocation becomes far greater. In both cases, subsidy is increased by investment income, and to a large extent, choice is a blind one, made after the individual is sixty-five years old, tempered by his financial state at the time. A claim for perfection cannot be made, but it will help get him through the transition period, by which time both the precision and the popularity of various choices will have been defined. One rule persists: the more he invests when young, the more he will have accumulated, later. How much incentive for medical frugality this creates is uncertain, but early signs are encouraging.

The Nature of the Investment. A century of experience shows the result of investing in the equity stock market is superior for the long term, and the more recent work of Bogle shows that buy-and-hold everything is about all the manager needs to know. New investors will soon be told that bonds may be superior for elderly people. That may have some truth to it if the markets happen to be in a temporary state of turmoil, but there is the yield curve to consider. Ordinarily, the longer the term of a bond, the higher its yield. But this buy-and-hold situation could eventually last ninety years, while very few "long-term" bonds have a term of more than thirty years. Presumably, the yield curve would flatten out sooner than ninety years, so it is conceivable a tailor-made bond would give a higher yield than stock indices, but it would take a long time to find out.

The Choice of Financial Intermediaries. When passively invested index funds of over a trillion dollars can be found which produce long-term returns equalling those of very smart active investors, some explanation should be found, and it seems to lie in the very high fees which active investors charge for their services. The experience of investing in 401(k), most active mutual funds, most retirement funds, annuities and even reverse mortgages has been that management absorbs a disproportionate share of the savings, leaving the investor with a disappointing return on his money. Since improved returns of only a quarter or half a percent can make astonishing differences in investor returns over long periods of time, the small-time investor has difficulty detecting inequities. It is particularly disheartening to observe indignant opposition to converting brokers into fiduciaries as a general principle, even in an election year.

The conclusion has to be made that significant changes in this imperfect agency issue must require firms to emphasize profits from large volumes rather than wide mark-ups. Since no one gets rich by giving money away, it is necessary to caution against relying heavily on the sense of fairness of large famous firms. Throughout this book, the figure of 6.5% has been used to illustrate what might be a fair return for the investor; just about all conclusions rest on whether this figure can be approached by returning half of the 11% which Roger Ibbotson reports has been the steady average for blue-chip stocks in the past century, and similar figures for the Standard and Poor Average for the past fifty. After subtracting 3% for inflation, 8% net return seems to be the size of the pie for dividing between the investor and his manager. Judging by the slow pace of progress, the competitive force to readjust mindsets may come from abroad, perhaps Singapore or similar places which unfortunately have the weakness of lacking political protection for the American investor.

The Contingency Fund.In the final analysis, the individual has to deal with the cards he was dealt by fate. His health costs may be more than he can cope with, his retirement may be longer than he can afford. He may have been born in a year of war, or general financial collapse, feast or famine. But no matter what fate has dealt him, he almost certainly would be better off with more money. Trying to anticipate every disaster he might possibly encounter is wasteful, however. Dreadful as future possibilities may be, he is unlikely to experience all of them. A contingency fund can cover whatever happens to him, in spite of remaining woefully inadequate for everything else which might happen. Because of the J-shape of medical contingencies, it is surprisingly cheap to anticipate the unanticipated -- if you start doing it while you are young.

Once more, we return to 7% because of the quirk that compound interest will double money invested at 7% in ten years. If you live to be 90, an investment at birth will increase (2,4,8.16, etc) nine times, or to 512 times its original size. Remaining within the traditions of inheritance, it could double every ten years for one lifetime, plus 21 extra years -- eleven doublings, or 2048 times its original size, without being considered perpetuity. At least, in theory, a "premium" of one dollar at birth could "insure" against $2048 of lifetime contingency, if you settle up after the end of it. It's a little fanciful to imagine that result without overhead costs and inflation, but that's the outer boundary of a general idea which is so powerful you can dismiss the details. So long as you stay within the bounds of about $200 at birth ($400,000 after eleven doublings), a wide variety of solutions will have a good chance of working. We suggest a gift for the first transition period, eventually becoming self-sustaining in later generations, and dipping into the contingency fund whenever arithmetic fails you. Everything else is a matter of waiting for time to tell what the real numbers ought to be, and shifting numbers around until they balance.

Originally published: Sunday, June 12, 2016; most-recently modified: Monday, June 03, 2019