Health Care & General Inflation

OK, this is getting confusing. Lets go back to basis for a little bit. Much of the following was copied/paraphrased from several web pages (links provided), I certainly didn't know all this stuff 😜. Get comfortable 🤓.

"General Inflation" doesn't have much meaning unless you know where it came from, how it was determined, and by who. I think what applies to PRC users the best is the Consumer Price Index for All Urban Consumers (CPI-U) which represents 93% of the U.S. population not living in remote rural areas. It doesn't cover spending by people living in farm households, institutions, or on military bases. CPI-U is the basis of the widely reported CPI numbers that matter to financial markets and is the most common way to define general inflation. The CPI (there are several versions) measures the monthly change in prices paid by U.S. consumers. The Bureau of Labor Statistics (BLS) calculates the CPI as a weighted average of prices for a basket of goods and services representative of aggregate U.S. consumer spending. The CPI is based on about 80,000 price quotes collected monthly from some 23,000 retail and service establishments as well as 50,000 rental housing units. Housing rents are used to estimate the change in shelter costs including owner-occupied housing that account for about a third of the CPI. However, income taxes and the prices of investments such as stocks, bonds, or life insurance polices are not part of the CPI. The attached image from Investopedia shows the 8 major groups of the CPI https://www.investopedia.com/terms/c/consumerpriceindex.asp Medical care is one of the 8 and represents 6.8% by weight. The CPI measures inflation by tracking retail prices of a good or service of a constant quality and quantity over time. Tracking retail prices allows CPI to capture changes in out-of-pocket household spending over time. Each month, the various item indexes reflect the observed price changes, aggregating up to the all items CPI.

In the aggregation process, each item index is assigned a relative importance, or weight. The weight of each item in the CPI is determined using the Consumer Expenditure Survey (CE) which collects information from the nation's households and families on their buying habits (or expenditures), income, and household characteristics. Goods and services that consumers spend the most on will be the most heavily weighted.

The CE tracks consumer out-of-pocket spending on medical care, which is used to weight the medical care indexes. CE defines out-of-pocket medical spending as:

• patient payments made directly to retail establishments for medical goods and services;
• health insurance premiums paid for by the consumer, including Medicare Part B; and
• health insurance premiums deducted from employee paychecks.

Employer paid portions of insurance premiums and fully tax-funded medical care (such as Medicare Part A and Medicaid) are not considered out-of-pocket, and therefore not used in weighting the indexes. While the weight of each CPI medical care related index is determined by out-of-pocket spending, price change reflected by the indexes measure the total reimbursement to medical care providers. This includes medical care payments made by private insurance companies, Medicare Part B, and Medicare Part D on behalf of consumers. https://www.bls.gov/cpi/factsheets/medical-care.htm

The way the medical care group is calculated by the CPI has changed a lot over the passes 25 or so years, so I think using historical data before about 1995 would not be advisable. The CPI also makes a lot of assumptions when calculating the medical care group, so it is not a perfect health care inflation number, to say the least, and may be lower than reality: http://soberlook.com/2014/10/how-well-does-cpi-measure-individuals.html?m=1 .

So, where does that leave us?? For people 62 and over (or retired people) the CPI-U probably does not closely reflect costs incurred by them. There is some talk about using CPI-E:

This version of the CPI is meant to track the expenses specifically for Americans who are 62 years of age or older. While both of these indexes measure the same categories of goods and services, they have different weightings to the categories. So for example, the CPI-E factors in around 11% of its index to healthcare cost. The CPI-W, (yes that is a little different than CPI-U) however, only counts 5.6% of the overall index as healthcare expenses. Since statistically, seniors spend more of their money on healthcare, an index that assigns a higher weighting should be more accurate to the way they spend money and experience inflation. https://www.socialsecurityintelligence.com/how-the-cpi-e-compares-with-the-cpi-w-for-the-annual-social-security-cola/

Since inflation calculated using CPI-U includes medical care as well as Medicare premiums, adding a separate healthcare inflation modifier in PRC may be double counting. I definitely think Medicare premiums should only be increased by CPI-U inflation. However, I do think there should be a PRC healthcare modifier, but not more than 2% at the most, based on what the above article talked about medical costs being higher in CPI-E.

Thoughts???????

More detailed info on what's in the CPI-U: https://www.pewresearch.org/fact-tank/2022/01/24/as-inflation-soars-a-look-at-whats-inside-the-consumer-price-index/

More tidbits on CPI-E: https://en.wikipedia.org/wiki/United_States_Consumer_Price_Index

Since at least 1982, the BLS has also computed a consumer price index for the elderly to account for the fact that the consumption patterns of seniors are different from those of younger people. For the BLS, "elderly" means that the reference person or a spouse is at least 62 years of age; approximately 24 percent of all consumer units meet this definition. Individuals in this group consume roughly double the amount of medical care as all consumers in CPI-U or employees in CPI-W.

However, from December 1982 through December 2011, the all-items CPI-E rose at an annual average rate of 3.1 percent, compared with increases of 2.9 percent for both the CPI-U and CPI-W. This suggests that the elderly have been losing purchasing power at the rate of roughly 0.2 (=3.1–2.9) percentage points per year.

So, @nc-cpl using your advanced mathematical skills 😎, if healthcare represents 6.8% of the CPI-U, and healthcare for those 62 and over is about double that of non-62 year olds 😟, what % does the double healthcare cost account toward the total CPI-U? Can that resultant number be used as the healthcare inflator (sp?) in PRC??

@pizzaman If I'm reading you correctly, I'd say no, because the 6.8% portion of the overall inflation percentage is not linked to an individuals expenditures. That said, if one's consumption of healthcare is greater, then the impact of the 6.8% would be felt more than someone who uses very little healthcare. The difficulty is that since it's blended into overall CPI, isolating (and further modifying) healthcare inflation is, to me, quite challenging.

I was thinking something more basic. In round numbers terms, if healthcare is 7% of the total CPI-U, and the CPI-U for, say 2022 was 8%, then healthcare represents 0.56% of the 8% inflation. If the healthcare increase in those 62 and greater is double, could we say that the portion of healthcare of the 8% inflation is 1%?? So the healthcare inflator in PRC would be 1%?????

I haven't heard much feedback on healthcare costs so I think this is what I am going to do; I am going to use the PRC healthcare inflation input to account for the general deficiencies in CPI-U (General Inflation) related to retirees, and to account for the separate increase in healthcare costs for retirees not reflected in CPI-U. Since CPI-U does have some healthcare costs in it, I am only going to input 2% in to the healthcare inflation input in PRC, which is less than the 4.3% I was using. Any thoughts????

@pizzaman For clarity, what is your general inflation rate on the home page and what is the added health care inflation on top of the general rate? I am using 3.5% and 2%, respectively for conservative purposes. So my healthcare inflation total is 5.5%

That's exactly what I am using, 3.5% general inflation (CPI-U) and 2% healthcare inflation (total 5.5%) for my PRC home page inputs. Great minds think alike 🤗.

I saw this stat: Approximately 80% of all Americans aged 60 and older are homeowners, and housing wealth accounts for about 48% of the median wealth of that group. https://finance.yahoo.com/news/vanguard-says-retirees-add-least-130039245.html

Then I saw this: The most widely watched measure of inflation is being driven up by a measure of housing costs that no one is actually paying.

The Consumer Price Index, the most-tracked way to measure the cost of living, rose 6% over the last year as of February, down from 6.4% in January, the Bureau of Labor Statistics said Tuesday. The 0.4% monthly increase in prices, down from 0.5% in January, was a sign that inflation, while receding, is still squeezing household budgets. Almost three-quarters of the monthly increase—some 70%—came from housing costs, and more specifically, a measure called Owners’ Equivalent Rent (OER), which rose by a record 8% over the year.

The bureau measures actual rental rates for houses, and, using that data, estimates how much owner-occupied houses would rent for if they were put on the market.

“It's a little bit of a fuzzy metric,” said Ryan Sweet, chief U.S. economist at Oxford Economics. OER is effectively the rent that the homeowner is giving up by living in their house instead of renting it out. It’s influenced by housing prices, but not directly tied to it.

Housing costs play less of a role in the inflation measure preferred by officials at the Federal Reserve. The Personal Consumption Expenditures inflation rate, created by the Bureau of Economic Analysis, is less influenced by rent and home prices, (giving it about half the statistical weight the CPI does), and is the one the Fed uses when deciding whether inflation is running at the 2% annual goal. https://www.investopedia.com/inflation-s-biggest-driver-7255348

So, does using CPI-U as the "general inflation" number we input into PRC over state inflation for retirees??

Perhaps an overall inflation assumption ranging between 3.0% to 3.5% is reasonable?

Attached here is a quick summary of assorted inflation index averages taken from the government web site data (see links for data and information). I used the monthly index values, then calculated the year-over-year (YoY) % changes for each month, and finally averaged over all of them for the data date range available.

According to the BLS website, the major groups composing the CPI "basket" are food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. The expenditure weights of the associated price groups obtained from the survey are (nowadays) updated every 2 years. It is also noted that COVID changed spending patterns for the recent period, and thus expenditure weights during that time had to be considered. (See: https://www.bls.gov/cpi/tables/relative-importance/weight-update-information-2022.htm )

A recent (Feb 2023) Investopedia article ( https://www.investopedia.com/terms/c/consumerpriceindex.asp ) has the CPI expenditure weights as follows:

The Core-CPI is around 3.7%, based on monthly data since 1957. The CPI-U is around 3.5% over the same time period. Note that the specialized Medical CPI average is around 5%, based on monthly data since 1947.

The PCE indices seem to have similar averages, based on monthly data since 1959: PCE=3.3% and Core-PCE=3.2%

Another note is that the (experimental) CPI-E that is offered by the BLS and intended as research toward a "Consumer Price Index for Americans 62 years of age and older". The average for this index is about 3% based on the monthly data dated back to 1983. It is noted that due to the data collection approach and limitations, this index has a higher uncertainty.

See this link for the methodology/details: https://www.bls.gov/cpi/research-series/r-cpi-e-home.htm

As of February 2022, this CPI-E index groups appear to be weighted as follows (from the spreadsheet link provided - the groupings are different than above for some reason. For example, energy expenditures for Housing and transportation are included within these respective categories.):

Medical care is included in this index, and seems to have a higher weight than the "standard" (health care?) CPI group above.

@wallace471 Great information! Thanks for digging in to the data. I think general inflation (CPI-U) of 3.0% to 3.5% sounds good for PRC input. I feel fairly comfortable about how inflation is tracked based on the past several posts with the exception of the Housing weighting. Since most people over 62 own there homes/condos and do not rent, it seems odd that the CPI-E index has a higher weighting for housing than CPI-U.

@pizzaman Yes...the weighting of the CPI-E seems peculiar. According to their spreadsheet, the Housing weighting of ~49% has 3 major contributions:

1. Shelter @ 38.6%

2. Fuels and Utilities @ 5.2%

3. Household furnishings and operations @ 5.6%

Inside "Shelter" are 2 major contributors:

Rent of primary residence @ 4.8%

Owners equivalent rent of residences @ 32.5%

Interesting analysis of CPI and the impact on the safe withdrawal rate (SWR) for a renter vs. home ownership by ERN. Includes a discussion of the math on deconvoluting the specialty indexes "Shelter", "CPI less Shelter", and what goes into "Housing" .

See: https://earlyretirementnow.com/2023/04/14/accounting-for-homeownership-swr-series-part-57

Conclusions:

"Homeownership probably helps you more consistently than some other whacky ideas I’ve come across (flexibility, the “Yield Shield,” a bucket strategy, and many others), but the small positive effect of a paid-off home on your safe withdrawal rate math has mostly to do with the respectable real yield of a home. Very little of the improvement in the SWR comes from the fact that shelter inflation runs a little bit hotter than overall inflation."

"In conclusion, the renting vs. homeownership discussion is likely still a lifestyle choice. If you want to put down roots in retirement, you will find that there’s an advantage of owning over renting. But if you want to be a global nomad in retirement, I don’t blame you for renting. Just set your withdrawal rate a little bit lower to hedge against rental inflation."