NBER Working Paper 23329; How the Growing Gap in Life Expectancy May Affect Retirement Benefits and Reforms

By Alan J. Auerbach, Kerwin K. Charles, Courtney C. Coile, William Gale, Dana Goldman, Ronald Lee, Charles M. Lucas, Peter R. Orszag, Louise M. Sheiner, Bryan Tysinger, David N. Weil, Justin Wolfers, and Rebeca Wong
National Bureau of Economic Research, April 2017

(Note: These excerpts from this paper are quite wonkish so you may want to skim down to the Comment, and then return to read this only if you are still interested in the specifics.)

ABSTRACT

Older Americans have experienced dramatic gains in life expectancy in recent decades, but an emerging literature reveals that these gains are accumulating mostly to those at the top of the income distribution. We explore how growing inequality in life expectancy affects lifetime benefits from Social Security, Medicare, and other programs and how this phenomenon interacts with possible program reforms. We first project that life expectancy at age 50 for males in the two highest income quintiles will rise by 7 to 8 years between the 1930 and 1960 birth cohorts, but that the two lowest income quintiles will experience little to no increase over that time period. This divergence in life expectancy will cause the gap between average lifetime program benefits received by men in the highest and lowest quintiles to widen by $130,000 (in $2009) over this period. Finally we simulate the effect of Social Security reforms such as raising the normal retirement age and changing the benefit formula to see whether they mitigate or enhance the reduced progressivity resulting from the widening gap in life expectancy.

From the Introduction

We have several major findings. First, consistent with other recent studies, we confirm that life expectancy at older ages has been rising fastest for the highest socioeconomic groups. For those born in 1930, the gap in life expectancy at age 50 between males in the bottom 20 percent and top 20 percent of lifetime income is 5 years, according to our estimates. For males born 30 years later (in 1960), the projected gap at age 50 between the highest and lowest quintiles widens to almost 13 years, an increase of nearly 8 years. Second, we find that there is a growing gap by lifetime income in projected lifetime benefits from programs such as Social Security and Medicare. For the 1930 cohort, the present value of lifetime benefits at age 50 is roughly equal for those in the highest and lowest quintile of lifetime income, as those at the top receive more from Social Security while those at the bottom receive more from Disability Insurance, Supplemental Security Income, and Medicaid. For the 1960 cohort, by contrast, there is a $130,000 gap in benefits between the highest and lowest quintiles, as those in the top quintile are increasingly likely to receive benefits over longer periods of time, relative to those at the bottom. Finally, we show that a number of commonly-discussed Social Security reforms would make the program more progressive, although their impact on progressivity tends to be small compared to the changes arising due to differential changes in life expectancy.

Policy Reform Simulations

Our final goal is to analyze policy reforms to determine how they would affect the progressivity of government programs and interact with projected changes in life expectancy. The reforms we simulate – five that affect Social Security and one that affects Medicare – were chosen because they are either frequently mentioned in policy discussions or meet objectives with which many stakeholders would agree. Unfortunately, the structure of the FEM (Future Elderly Model) made it impossible to simulate certain reforms, such as raising the Social Security maximum taxable earnings amount. The policy simulations we study include: raising the Social Security EEA (Early Eligibility Age) by 2 years (to age 64), raising the Social Security NRA (Normal Retirement Age) by 3 years (to age 70); reducing the cost-of- living adjustment applied to benefits by 0.2 percent per year; reducing the top PIA factor by one- third (from a 15% to 10% rate); reducing the top PIA factor (Primary Insurance Amount) to 0 above median AIME (Average Indexed Monthly Earnings); and raising the Medicare eligibility age by 2 years (to age 67).

There are two mechanisms by which a policy change may translate into change in
benefits. The first, which can be characterized as the “mechanical effect,” results directly from the policy change, holding behavior constant. For example, if the NRA were raised by 3 years, a worker claiming benefits at age 67 would see the monthly benefit amount fall from 100 percent of the PIA to 80 percent, experiencing a 20 percent reduction in benefits. The second channel, which can be characterized as the “behavioral effect,” results from changes in individual behavior in response to the policy. For example, the individual may claim Social Security later, work longer, or be more likely to claim DI. These responses can be captured by the FEM.

We show results for all reforms on Table 4, reporting only the change in net benefits as a fraction of inclusive wealth for brevity. We begin with the increase in the EEA. At first glance, it might seem that this policy would have little effect on the present value of benefits given the common belief that the actuarial adjustment is roughly actuarially fair. We find that this reform raises net benefits as a share of wealth by 0.1 for males in the lowest quintile under the 1960 mortality regime and by 0.4 for males in the highest quintile. Under our assumptions, the actuarial adjustment for delayed claiming is slightly more than fair, so when individuals are forced to claim later by this policy change, lifetime benefits increase, particularly for high- income individuals who have longer life expectancies. The policy change is thus mildly regressive, although its effects are fairly small.

Raising the NRA has a much bigger effect – we estimate that lifetime Social Security benefits fall by $30,000 (or 25% of the pre-reform value) for the lowest quintile of males in the 1960 mortality regime and by $59,000 (20%) for the highest quintile. The percentage drop need not be the same in the two quintiles because the behavioral response of the two groups to the policy change (captured by the FEM) could differ; also, the same response – say, postponing retirement and claiming by one year – could have a different effect on lifetime benefits because of differences in life expectancy. As low income males experience the larger percentage drop in benefits, this policy might be considered regressive. Yet the policy change reduces benefits as a share of wealth by 4.8 percent for males in the lowest quintile and by 5.2 percent for males in the highest quintile, as the larger dollar loss for high income males ends up being a slightly larger share of their lifetime wealth (as captured by our inclusive wealth measure). Viewed by this metric, the policy change is progressive. Thus, the progressivity of this policy change is somewhat sensitive to the particular measure used.

Reducing the cost-of-living adjustment (COLA) has a modest effect on benefits, reducing them by 0.4 percent of wealth for males in the lowest quintile under the 1960 mortality regime and by 0.6 percent for males in the highest quintile. The larger effect for high income men is due to their longer life expectancy, since the effect of a lower COLA is cumulative over time. Reducing the top PIA factor by one-third has a fairly modest impact of 0.1 percent of wealth for low-income males and 0.3 percent for high-income males; the larger effect on high-income males is expected, since the top PIA factor applies only to earnings past the second bend point of AIME (e.g., at higher earning levels). A related policy with a much bigger impact is reducing the top factor to zero and moving the second bendpoint to the median of AIME. This policy, which would reduce benefits for the top half of earners, is chosen an as example of a substantial benefit cut designed to have a smaller impact on low earners. We find that this policy would reduce benefits as a share of wealth by 1.1 percent for males in the lowest quintile and by 3.4 percent for men in the highest quintile. Finally, we simulate raising the Medicare eligibility age. This policy has a fairly similar effect across quintiles in dollar terms, reducing lifetime Medicare benefits by $8,000 for low-income males in the 1960 mortality regime and by $7,000 for high- income males. Measured as a share of inclusive wealth, there is a loss of 1.4 percent for low- income males and 0.5 percent for high-income males, indicating a regressive policy.

Overall, most of these policy changes would make overall net benefits more progressive. The exceptions are raising the EEA or the Medicare eligibility age, which make benefits less progressive. When compared to the changes in progressivity occurring due to mortality trends, however, the effect of these policies on progressivity is generally fairly small. For example, consider the policy reducing the top PIA factor to zero above median AIME, which is the most progressive of the policies we simulated. Absent any policy change, the gap in lifetime Social Security benefits between males in the highest and lowest income quintiles grows from $103,000 in the 1930 mortality regime to $173,000 in the 1960 mortality regime. Implementing this policy would eliminate 60 percent of the increase, so that the gap under the 1960 regime would be $131,000. This illustrates the scale of the policy reform that would be needed to counteract the changes in progressivity of government benefit programs that we project are occurring due to the widening gap in life expectancy.

From the Discussion

Life expectancy at older ages has been growing steadily in the U.S. over the past several decades. Yet there is growing awareness that these gains are not being shared equally. Our study confirms a substantial increase in the life expectancy gap between those with higher and lower income. For men, we project that the gap in life expectancy at age 50 between males in the highest and lowest quintiles of lifetime income will grow from 5 years for the 1930 cohort to nearly 13 years for the 1960 cohort. Estimates for women (from Committee, 2015) are somewhat less reliable, but show a similar if not larger change over time.

We also assess the effects of the growing gap in life expectancies among older adults on the major entitlement programs. The larger life expectancy gap means that higher-income people will increasingly collect Social Security, Medicare, and other benefits over more years than will lower-income people. We estimate the value of net lifetime benefits for different income groups from Social Security, Disability Insurance, Supplemental Security Income, Medicare, and Medicaid. Our estimates suggest that these net lifetime benefits are becoming significantly less progressive over time because of the disproportionate life expectancy gains among higher-income adults. The changes in life expectancy between the 1930 and 1960 mortality regimes generate an increase in benefits equivalent to an increase of 6.9 percent of wealth (measured at age 50) for men in the highest income quintile, while benefits for men in the lowest income quintile are essentially unchanged. While we caution that one cannot rely too heavily on the specific numbers we estimate, since these are projections that necessarily rely on assumptions and our analysis does not allow us to construct confidence intervals around these projections, our results clearly indicate that lifetime benefits are increasingly accruing to those in the top of the income distribution due to the widening gap in life expectancy.

We then consider how the differential changes in mortality would affect analyses of some possible reforms to major entitlement programs in the face of population aging. For example, many proposals to increase the normal retirement age under Social Security are motivated by the rise in mean life expectancy. The mean, however, masks substantial differences in mortality changes across income groups. We show the impact of that proposal and other possible Social Security and Medicare reforms on lifetime benefits across income groups and in a manner that reflects their different life expectancy trajectories. We find that while there are policy reforms that tend to raise the progressivity of government programs, the effect of these reforms are fairly small when viewed next to the reduction in progressivity that is occurring due to the growing gap in life expectancy. This suggests that policy changes that (alone or in combination) are more progressive than those we simulate here would be needed to undo the effect of the widening longevity gap on the progressivity of government programs.

Social Security, Medicare, and the other programs included in our study face rising expenditures over time, straining the ability of existing revenue sources to fully fund benefit promises at current tax rate. The US is far from unique in this regard – rising longevity, falling birth rates, and slowing economic growth threaten the long-term solvency of entitlement programs in many countries, particularly where financed via a pay-as-you-go mechanism or out of general revenues. Many countries have already implemented reforms to public pension, disability insurance, and other social insurance programs, for example by raising retirement ages or altering benefit formulas in a way that reduces program generosity, and many countries continue to contemplate implementing (further) reforms. As policy makers continue to debate the future of social programs in the United States, they would do well to consider the welfare implications not only of improved longevity, but also the increasing gap in life expectancy by socioeconomic status.

http://www.nber.org…

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Comment:

By Don McCanne, M.D.

This paper was authored by a team of prominent economists (some names you may recognize) who are members of the National Academies of Sciences’ Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population. It is an important paper because it demonstrates the disproportionate distribution of Social Security, Medicare, and other public benefits to wealthier individuals by virtue of the fact that they live longer and thus collect benefits for a longer period of time. Since the life expectancy differential is increasing, the inequity of distribution of benefits is also increasing.

This team begins with the basic assumption that entitlement programs, especially Social Security and Medicare, are growing too rapidly and will create an excess burden for the federal budget. In their concluding remarks they note that other nations have raised retirement ages and reduced generosity of benefits. So this analysis seems to aim for that same goal of controlling spending. Thus they direct their consideration to various proposals designed to reduce federal spending for these programs while not giving consideration to increasing revenues to cover the anticipated growth in spending. We’ll get back to this in a moment.

It is widely acknowledged that, over the past several decades, there has been an unacceptable transfer of income and wealth upwards such that the wealthier are becoming much wealthier while the incomes and wealth accumulation of America’s working families have largely stagnated. Public policies, especially tax policies, are now required to correct these inequities.

The authors of this report do understand the inequities and thus describe how the various proposals to reduce spending on entitlements are either regressive or progressive. They conclude, “most of these policy changes would make overall net benefits more progressive. The exceptions are raising the EEA (Early Eligibility Age for Social Security) or the Medicare eligibility age, which make benefits less progressive.”

An interesting observation is that they did not evaluate one of the more important proposals – raising the Social Security maximum taxable earnings amount – simply because the economic model they selected (Future Elderly Model or FEM) made it impossible to do such a simulation. Since this is one of the more important proposals that would improve progressivity, you would think that they might look for or create a model that would take this into consideration, but then this would be counter to their goal of decreasing spending rather than increasing revenues.

In decreasing spending they are concerned about the progressivity of the various proposals since currently the wealthier are favored because of their increased longevity resulting in greater accumulated benefits, thus reductions in spending should apply more to the wealthier individuals. But their concern is about relative progressivity; they still anticipate that reductions would also occur amongst those with lower incomes and wealth, except at a lesser percentage.

The difficulty is that they are addressing the dubious problem as to whether we can afford the increases in entitlement spending, which would require greater revenues, when the problem that they should be addressing is whether or not the benefits are adequate for America’s workforce. Clearly, reducing retirement and health benefits for the workforce is the wrong direction, especially considering the background of wealth moving to the top.

So instead of policies designed to reduce spending, we should be looking at policies designed to ensure adequate retirement and health security. That means protecting and expanding benefits for those with lower incomes (e.g., improving Medicare). Wealthier individuals do not need expanded benefits, but in an egalitarian system it is far easier to provide the same benefits to everyone. To make the system more equitable, revenues from the wealthier individuals with higher incomes should be increased. For those who say that the “economy cannot afford it,” that’s nonsense. Social Security checks are spent, moving that money into the economy, and health care is one of the largest, most robust sectors of the economy, which is supported by the Medicare program. The economy thrives on Social Security and Medicare.

Unfortunately, right now the Trump administration is recommending the opposite. The tax policy recommendations released this week would greatly reduce revenues from those with higher incomes and totally eliminate estate taxes which tax wealth.

The groupthink of this committee is on target to be concerned about the progressivity of entitlement reform, but they have totally missed the boat by suggesting that harmful reductions in benefits for the majority are acceptable merely because the wealthy have a greater percentage reduction. Though that percentage reduction may be greater, the accumulated benefits for the wealthy still remain much greater, and they certainly are not harmed by these reductions, as those with little wealth are. But instead of increasing administrative complexity by selectively reducing benefits for the wealthy, we can offset that inequity by increasing revenues from the wealthy.

We can afford to ensure that absolutely everyone has a decent retirement, including freedom from fear of medical debt though a well financed Medicare program (make that a Medicare program for everyone). Normative economics needs to have a prominent place in groupthink deliberations.

Where Does the Health Insurance Premium Dollar Go?

By Uwe Reinhardt, Ph.D.
The JAMA Forum, April 25, 2017

In early March, America’s Health Insurance Plans (AHIP), the national association of private US health insurers, released an interesting report that presents, for insured patients younger than 65 years, financial statistics for 2014 of commercial and nonprofit health insurance companies.

According to the report, “Where Does Your Premium Dollar Go?,” an average of 79.7 cents per premium dollar is spent by insurers on health care proper and 17.8 cents on the insurers’ “operating costs,” leaving only 2.7 cents per premium dollar as profits.

The nearly 80 cents per premium dollar that insurers report to spend on medical expenses are known in insurance jargon as the “medical loss ratio (MLR),” because it is the portion of premiums collected health insurers “lose” to physicians, hospitals, and other entities who offer health care.

The Affordable Care Act (ACA) mandated an MLR of at least 85% for large insurance companies and of at least 80% for smaller carriers. By their own admission, insurers selling policies for individually purchased health insurance before the ACA went into effect tended to have MLRs in the 55% to 65% range. Should a repeal of the ACA entail elimination of the mandated minimum MLRs, the market might well revert again to these extraordinarily low payouts of premiums for health care.

As already noted, the AHIP reports that insurers had an average profit margin (net profits divided by premium revenue) of only 2.7%. The number seems low, perhaps because it is a simple average. Profit margins for the larger US health insurers, for example, actually were much higher  than just 3% in recent years, with 4.7% for Aetna, 7.0% for Cigna, and 4.6% for United Health Group in 2015 and 3.5% for Anthem in 2014. (These numbers, however, also include the Medicare Advantage program for older people.)

But even a profit margin of 5% belies the frequent assertion that private health insurers divert huge fractions of their premiums to their own profits. Much more troublesome is the 18 cents per premium dollar reported to cover the insurers’ “operating costs.” These include the cost of marketing, determining eligibility, utilization controls (eg, prior authorization of particular procedures), claims processing, and negotiating fees with each and every physician, hospital, and other health care workers and facilities.

These operating costs are about twice as high as are the overhead costs of insurers in simpler health insurance systems in other countries. A 2010 study comparing per capita health spending in Canada and the United States, for example, found that administrative costs in 2002 accounted for 39% of the total per capita spending difference between the 2 countries.

Also worthy of note is that the 18 cents per premium dollar that insurers report as their “production costs” exclude 2 additional forms of administrative overhead. First, the number excludes the value of the time US patients must spend dealing with insurers, mainly over enrollment and over claims. It can be very time-consuming. Second, the insurers’ cost naturally excludes also the sizeable outlays that physicians, hospitals, and other health care workers and facilities make to negotiate prices for health care and to argue over medical bills.

A Costly “Coding War”

A “must read” in this regard is a recent article by Elizabeth Rosenthal, MD, “Indecipherable Medical Bills? They’re One Reason Health Care Costs So Much.” Rosenthal describes a costly “coding war” in which physicians, hospitals, and others who treat patients seek to maximize their profits by hiring legions of consultants who know how to “upcode” procedures in their medical bills. For their part, insurers hire legions of coding consultants who know how to protect insurers from such upcoding. Rosenthal vividly describes how individual patients can get mauled in the process.

We can think of the extraordinarily high overhead imposed on insured individuals and patients in the United States as the price they seem to be willing to pay for the privilege of choice among health insurers and, for each insurer, among multiple different insurance products. US consumers seem so fanatic about this choice that to keep it, they have been willing to give up their erstwhile freedom of choice among physicians, hospitals, and other clinicians and health care facilities. Citizens of most other countries have made that trade-off in exactly the opposite direction.

https://newsatjama.jama.com…

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Comment:

By Don McCanne, M.D.

The last paragraph sums up today’s message: “We can think of the extraordinarily high overhead imposed on insured individuals and patients in the United States as the price they seem to be willing to pay for the privilege of choice among health insurers and, for each insurer, among multiple different insurance products. US consumers seem so fanatic about this choice that to keep it, they have been willing to give up their erstwhile freedom of choice among physicians, hospitals, and other clinicians and health care facilities. Citizens of most other countries have made that trade-off in exactly the opposite direction.”

Medicaid Block Grants and Federalism; Lessons From Canada

Benjamin D. Sommers, M.D., Ph.D.; C. David Naylor, M.D., D.Phil.
JAMA, April 25, 2017

Republican leaders are proposing a fundamental reform in Medicaid financing—a shift to block grants. Instead of a matching subsidy and federal oversight, block grants would give states an annual lump sum with minimal conditions attached.

Block granting for social and health programs has been used with varying levels of success in welfare reform and in a modified version for the Children’s Health Insurance Program (CHIP), which provides federal matching funds up to a specified cap. But for such a large state-federal health insurance program, perhaps the most useful precedent is Canada, which made a similar shift to block grants several decades ago.

Canada’s Block Grant Experience

Canada’s health insurance system has been a joint federal-provincial initiative since the 1950s. Individual provinces enacted single-payer systems for hospital care and medical services between 1947 and 1962. The federal government implemented a 50% subsidy to support provinces’ universal coverage policies for hospital care in 1957 and extended this approach to physician services in 1968.

Costs of hospital and physician services escalated steadily across Canada in the 1970s. By that time, most provinces had extended public insurance to prescription drugs for low-income and elderly residents, partial coverage for home care and long-term care, and a mix of other services. Facing low economic growth and rising deficits, the federal government first capped the growth rate in its share of spending and then retreated from a match rate altogether. By 1977, block grants had been implemented. In doing so, the federal government agreed to give provinces an increased share of income tax revenues from their residents. Since then, 2 central issues in the current US debate—restraining the federal cost of Medicaid and giving states more control—have played out in Canada.

The primary long-term effects have been a downsizing of federal spending on health care and increasing strain on provincial budgets. The federal government reduced its spending in 2 ways. First, ending the 50% match uncoupled federal commitments from growth in health care spending; more specifically, the government capped the annual growth rate for the grants starting in 1986, sometimes freezing the growth rate entirely and other times setting it at 2% to 3% below per capita GDP growth. Second, one-time cuts to the block grants were made, amounting to 5% in 1982-1983, followed by a 30% reduction in health and social block grants in the mid-1990s. Overall, the proportion of provincial health spending derived from federal transfers declined from approximately 30% in the late 1970s to less than 15% by the mid-1990s.

Pushback from the provinces has resulted in some gains in recent decades. Once the economy recovered in the late 1990s, several short-term increases in the block grants were negotiated with earmarks for elements such as primary care reform, improved home care, and reduction of surgical waiting lists. In 2004, the Liberal federal government committed to a sizable increase in the annual growth rate to 6%. A Conservative government took office in 2006 and initially sustained that rate, but later announced that the annual growth rate would decrease in 2017 to either 3% or the per capita GDP growth rate, whichever was higher. When the Liberal party regained power in late 2015, it adopted the same position, albeit softened by modest one-time earmarks for home care and mental health.

Lessons for the United States

Block granting of social programs is not inherently good or bad. Rather, it is a policy associated with specific economic and political trade-offs. Increased local control and predictability for the federal budget come at the risk of increased cost-shifting to states or provinces. That, indeed, is the Canadian experience. Once block funding was initiated in 1977, health care funding became a line item in the federal budget that could be arbitrarily cut or capped for fiscal or political reasons, as opposed to a level of spending pegged to the needs and health care use of the population. Importantly, these cuts occurred under both conservative and liberal federal governments. The federal share of provincial spending today remains substantially lower than in the 1970s.

There is little evidence that the alleged advantages of block grants have materialized in Canada. Advocates argue that with greater flexibility and proper incentives, states can reduce costs by improving the efficiency of care. In Canada, however, the provinces’ primary means of coping with budget pressures under block grants has been to reduce funding to hospitals and bargain harder with provincial medical associations. Ironically, then, if this scenario plays out in the United States, it would exacerbate one of the chief Republican criticisms of Medicaid—that it pays clinicians such low rates that they have reduced incentives to care for low-income patients. In Canada, the effect of low payment rates to clinicians on care of low-income patients is blunted because federal and provincial legislation has effectively banned private insurance for publicly insured services; hospitals and clinicians accordingly have no choice but to participate. The situation is far more precarious in Medicaid precisely because the US market is segmented with multiple private payers. Facing steep payment cuts, many US physicians and hospitals would likely stop providing care for Medicaid patients entirely. Another likely scenario in the United States is that a block grant system would simply lead many states to restrict eligibility for Medicaid, leaving millions of low-income adults and children newly uninsured.

In conclusion, the Canadian experience suggests that a block grant policy for Medicaid is most likely to succeed in only one aspect—reducing federal spending on the program. It would do so by shifting costs to states and forcing untenable trade-offs that would limit access to care for low-income US residents. Although Canada has often been seen as a panacea for US liberals desiring a single-payer approach to health insurance, perhaps the most useful lesson from north of the border for the current policy debate is a demonstration of how a conservative policy model—block grants—may be a risk not worth taking.

http://jamanetwork.com…

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Comment:

By Don McCanne, M.D.

Republicans intend to change the financing of Medicaid to giving states an annual lump sum – block grants. The primary purpose is to reduce the federal contribution to state Medicaid programs, placing more of the burden on the states – a problem for residents of states with high poverty levels or with stingy governors and legislators.

Today’s message explains the experience with block grants in Canada wherein the supposed advantages of block grants failed to materialize, and each province has ended up bearing more of the costs. The United States would be wise to avoid that same outcome with our Medicaid program.

There is another lesson for single payer advocates. Block grants were used in Canada to shift costs from the federal government to each provincial single payer system. Having a single payer system in place is not enough. Continual vigilance and citizen action is essential. We cannot allow our government to be controlled by people who do not believe in government.