A question about compensation for elected officials has come up in a
local community forum. One of the ways that the city council members
are compensated is with life time health benefits if they serve six
(probably consecutive) years. How does one go about calculating
Let's say that there is at least one known factor: The health
insurance policy goes for about $300 a month for a member who is 50
For a rough estimate, you can apply the rule of 25. The rule of 25
says that, to generate $1 of annual income you need $25 in
investments. This accounts for inflation and assumes that you never
touch the principal. The rule of 25 is pretty conservative, but it's
a good starting point.
So $300 per month is $3,600 per year. Multiply by 25 and you get
$90K. That's a nice bonus for 6 years of service.
True, but as I read Bill's reply, I thought that the 25 rule is a very
conservative approach to be sure to not outlive your money, that an
immediate annuity with no beneficiary payout would likely be above the
4%, so your point and mine may just average back to Bill's number.
MEdical inflation is about 15% or doubling every five years.
Regular inflation is 3-4% or doubling about every 20 years.
You have to look at total costs for medical inflation. Some
years the premium goes up a lot, while other years they increase
the deductable and copays. You have to track premiums plus
of pocket for several "ordinary" years.
The National Coalition on Health Care claims a 2005 increase of 6.9%
'only' twice the inflation rate, and noting that Health Care is 16% of
GDP. They forecast similar growth and predict by 2015 it will rise to
20%. Using your numbers, it would be far greater than that. Either way,
tough to plan for such huge expenses.
Link to NCHC article - http://www.nchc.org/facts/cost.shtml
I computed my numbers from my own routine expenses for the past 15
and found a five year doubling. Include premiums, actual payouts,
dental and vision.
You get the same doubling period by comparing the premiums five years
to now, and factoring you are in the next five year older age cohort.
The premiums are up 40% and the age penalty for each five years is
(Unless you are in medicare where the premiums are up 79% in five
That's a good question with other applications...like "how much would I
need to have saved up to cover health insurance costs for life?" Or any
regular cost really. There's no equation, really, because it relies on
actuarial assumptions about longevity and, to a certain degree,
assumptions about inflation and investment returns.
First strip away the purpose (health insurance) and just think of it as
a cash flow occuring monthly, call it $300/month initially. In finance
that's called a "life annuity" (if paid until death) and you can put a
value on it. The value will be tied to the official's age and gender,
which affect life expectancy.
As one estimate you could get quotes for life annuities at
www.vanguard.com. Find out how much it costs to buy $300/mo -- that's an
estimate of the "present value" of this benefit. Whoever budgets for
this benefit would be doing something analogous. A complicating factor
is that the cost will rise over time. You can (and should) add an
inflation-adjustment rider to the Vanguard annuity to get a better
estimate. But whether health insurance premiums will rise at the same
rate as CPI is debatable. They've risen much faster recently. On the
flip side, there's plenty of fat in the system that must eventually be
cut, so perhaps CPI won't be so bad an estimate over the long run. I'd
leave that as an open question though.
My financial opinion: a city council member earning lifetime health
insurance for a mere six years of service, if that's what the benefit
is, sounds like very rich compensation. That is far in excess of what
you'd see in the private sector or better public-sector jobs, including
those with strong unions (e.g. teachers). Or do they just have the
ability to buy health insurance, through the same plan as public employees?
It is an enormously open question. Media reports in the last
few years testify amply to many large, well-known businesses
radically changing their health benefits offerings because
the costs were breaking their back. This includes changing
what is offered to current retirees along with future ones
and present employees. General Motors' and Ford's existence
appears to hinge in no small part on how much they will
continue to have to pay for retirees' health benefits.
I would not say the fat "must" be cut. We could be in for a
very rough decade or more at least of continued spiralling,
out-of-control costs. Media reports also testify amply to
how the health care system is so incomprehensible to
consumers that it is impossible for true free market action
to occur such that the fat would naturally be cut. Things
are on a better track, with consciousness raising of this
The OP is right to ask this question here, and elsewhere. I
strongly recommend in-depth reading of what other
contemporary private businesses and governments (federal,
state, and local) have attempted on this matter. I suspect
the ultimate decision will be something like qualifying
mightily what its promises for future health benefits, on
grounds that it is simply so unclear whether the
municipality can remain solvent and serve taxpayers
otherwise. Otherwise, backpedalling (that is, changing the
promises made) is likely. It's rampant now, from my reading.
It is the net present value (NPV) of the expected cash flows. Of
course, all of that depends on a number of uncertain variables.
Suppose that you expect the council member to live for 40 years (based
on actuarial tables), you expect health insurance costs to rise 7%
annually (based on financial planning inputs), and you fund this
annuity with an investment that you expect to increase at an average
rate of 5% annually. Then in Excel terms, the required initial
investment could be estimated with the following array formula (commit
=roundup( sum( (12*300)*(1+7%)^(ROW(A1:A40)-1) /
(1+5%)^(ROW(A1:A40)-1) ), -3)
ROW(A1:A40) simply generates the numerical sequence 1,2,...,40.
That formula assumes an annual annuity. It could be modified to
account for a monthly annuity. But that's a nitpick; after all, this
is just an approximation full much larger inaccuracies anyway.
The actual required initial investment should be determined using a
stochastic model that attempts to account for the varying health
insurance inflation rate and, probably more significantly, the varying
investment return rate over 40 years within a high level of confidence
(e.g. 99.7%). There are probably professional-grade (read:
expensive!) tools out there to do this kind of computation.
But if this is just an ideal curiosity, the formula above might
Thanks for the great answers - both the rule of 25 and the in depth
excel formula. (My brother-in-law is coming over this weekend can
help me with that and give me a good lesson in excel.)
I raised the question because I am commenting in a local community
forum discussing how much the city council members are being paid.
The idea that we could ever change this is almost as unrealistic as
thinking that congress will ever have the politcal will to fix the
social security or that the California legislature can fix their
Many government pensions are grossly out of wack with the private
sector and are going to be an unbearable burden for all us taxpayers
soon. Any tools that can show it to the voters might be helpful.
Knowing how to do calculation so that you can present credible numbers
and "showing your work" are two different things. In Calif, the
Legislative Analyst always explains the financial impact of a bond
initiative, and you can bet that he/she uses the correct mathematical
formulas and models to do so (or professional software that relies on
them). But of course, the LA simply reports the conclusions, not the
math behind them. That is how I interpreted the OP's intentions.
Also, knowing how to do the calculation allows us to validate (or to
see the flaws and over-simplifications in) the seemingly inexplicable
"rules" that pundits regurgitate, often ignorant themselves of the
basis and ass-u-me-tions behind the "rules".
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