More employers are scaling back or revamping their retiree health benefits, while also realizing that there may be a hidden cost associated with older workers remaining in the workforce only to retain health care benefits. To complicate matters, many workers underestimate what they will actually have to pay in terms of medical expenses in retirement.

According to the HR consulting firm Mercer, among employers with 500 or more workers, 31% provided health benefits to early retirees, and 21% to Medicare-eligible retirees, in 2007, a drop from 46% and 40%, respectively, in 1993.

The drop in coverage, combined with the increase in costs, poses problems for employers and retirees alike.

Employers adopt differing cost-saving strategies

Great American Insurance provides property and casualty insurance for businesses, employs about 5,500 workers, and has 650 retirees.

It's a difficult issue. On the one hand, retiree health insurance can put a financial drain on the company's bottom line. While at the same time, if people don't have access to some kind of health care coverage, then they are going to stay in the workforce, and you are going to pay their health costs anyway, says Scott Beeken, vice president of human resources at the Ohio-based company.

To mitigate health care costs tied to retirees, the company put a cap on its subsidized defined benefit retiree health benefit in 1994. By 2004, the cap had been reached, and retirees were paying the entire amount of health care inflation.

This led Beeken and his team to investigate converting the retiree health benefit to a defined contribution retiree health reimbursement account. The health benefit for our retirees was a defined benefit in form, but it had become a defined contribution in substance after we reached the cap, Beeken explains.

The company worked with its outside actuarial consultants and created allowance-based health reimbursement accounts for retirees that range from $20,000-$25,000, depending on service and age at retirement. This amount was determined to be cost-neutral from the companys perspective. Employees can use the entire amount upfront as a bridge to when they become Medicare-eligible or use it to pay for Medicare Supplemental coverage if they retire at age 65 or older. They can use the funds to buy employer-sponsored coverage,insurance on the individual market or simply as a reimbursement for their out-of-pocket expenses.

We went to the employees and asked them whether they were willing to move to the DC approach, rather then having a DB type plan. The vast majority favored the account-based plan. It gives them much more flexibility in that retirees could now go on a spouses plan or pursue part-time work and still get a benefit from our program, explains Beeken.

Our DB retiree medical benefit, as it was designed, did not necessarily fit everyone's circumstances. When an employee retired, we offered the coverage, but you had to take the benefit then or waive your right to take it in the future, he adds.

In addition, the bulk of the actuarial cost of the old DB program was for the assumed cost for pre-Medicare retirees. However, if someone did not retire early they did not benefit, Beeken says. We found many of our employees increasingly are acknowledging that they will need to work to age 65 or older because of a lack of retirement savings. The new plan is a big help to these people.

The company also transferred its current retirees into insured Medicare Part D plans and converted its Medicare carve-out plan to a Medicare Supplemental plan for current retirees.

Salt River Project, an Arizona-based public power and water utility outfit, employs about 4,600 workers and has about 1,800 retirees. The company, which is self-insured, uses the Medicare retiree drug subsidies and Medicare Advantage plans to help defray retiree health medical costs.

It's been a real learning process with retiree health coverage because you not only have to educate workers and retirees about Medicare, but also about the value of their current retiree health benefits, says Kristin Dossey, a senior benefits analyst at SRP.

When we enroll workers into our Medicare options, we sometimes ask them what they think the company pays for retiree health insurance. Their response is typically off by a significant amount, Dossey says.

Scaling back

Last year, the Equal Employment Opportunity Commission ruled that employers could revamp their retiree health benefits without violating the Age Discrimination in Employment Act.

The regulation, in part, permits employers to reduce, eliminate or alter health benefits to workers over age 65, who are eligible for Medicare. Employers are not required to demonstrate that the retiree health coverage is on par with benefits offered to retirees under age 65. For instance, companies offering prescription drug benefits to Medicare-eligible retirees under Medicare Part D no longer have to give equal drug benefits to retirees under age 65.

The EEOC regulation will help employers be creative in addressing the need for retiree health care without worrying about calculating costs, says Kathryn Bakich, senior vice president and national director of health care compliance at The Segal Company.

It provides a realistic approach to situations where pre-Medicare and post-Medicare retirees have different needs, she adds.

The ruling is particularly appropriate given the large range of Medicare plans available to Medicare-eligible retirees. The regulation will especially benefit employers with workforces that typically retire before age 65.

The costs of health care are skyrocketing for everyone, from the corporate boardroom to the kitchen table, says David Certner, legislative policy director at AARP, the advocacy group for older Americans, which legally challenged the measure. By transferring health care costs, the EEOC merely passes the buck to those who can little afford it, he asserts.

Workers underestimate costs

The new landscape of retiree health benefits means workers have to become more sophisticated in earmarking retirement savings for health care premiums and out-of-pocket medical expenses.

The Employee Benefit Research Institute recently conducted a computer simulation analysis to forecast the amount of money Americans will need to cover health expenses in retirement.

For example, a 65-year-old man retiring in 2008 would need $64,000 in current savings to have a 50% chance of having enough money to cover health care expenses in retirement, or $122,000 in current savings for a 90% chance of having enough to cover retiree health costs.

In contrast, a 65-year-old woman would need current savings of $86,000 to have a 50% chance of having enough money for retiree health costs, or $140,000 to have a 90% chance of having enough to cover retiree health expenses, EBRI concludes. The numbers are higher for women because of their greater longevity.

Yet a 65-year-old married couple, according to the data, would need current savings of $154,000 to have a 50% chance of having enough money for health costs during retirement, or $235,000 for a 90% chance.

Under all three scenarios, the parties supplemented Medicare with retiree health benefits from a former employer who subsidized the premiums. EBRI notes, however, that [m]any individuals will need more money than the amounts reported in this [research] because this analysis does not factor in the savings needed to cover long-term care expenses. Whats more, the research doesn't take into account the fact that many individuals retire prior to becoming eligible for Medicare. Also, keep in mind, a worker may be less likely to retire if he or she does not have retiree health coverage, says Paul Fronstin, senior research associate at EBRI.

Therefore, workers who are retiring are more likely to have retiree medical coverage, compared to those without. You cannot simply look at whether a retiree has coverage in order to draw a conclusion about what is happening with retiree health benefits, contends Fronstin.

Hewitt Associates also found that employer-subsidized retiree medical coverage has a dramatic impact on an employee's ability to achieve adequate retirement savings levels.

Workers who are provided a high level of employer subsidy, typically covering half of total costs not covered by Medicare, will see a projected retirement income shortage of only 12% of final pay if they are saving in their 401(k) plan, the consulting firm reports (See related story Staying on their toes.)