# Equation for how much would you have to have in the bank....

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 that?
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 years old.
Thanks, \Samson
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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.
--Bill
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Since health care costs inflate noticeably faster than the cost of ordinary goods and services, a x25 factor might not be enough.
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bo peep wrote:

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. JOE
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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 out of pocket for several "ordinary" years.
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rick++ wrote:

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 JOE
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I computed my numbers from my own routine expenses for the past 15 years 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 ago 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 40%. (Unless you are in medicare where the premiums are up 79% in five years).
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Samson wrote:

Samson, 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?
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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 reality, but...
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.
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It's not possible to predict future health care cost with any sense of certainty. But does this life time health benefit goes on until they are 65, at which time Medicare takes over?
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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 with ctrl-shift-Enter):
=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 suffice.
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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 problems.
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.
Thanks.
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If you want to have an impact on the audience in your community forum, stay far far away from any Excel spreadsheets. Nothing turns an audience off faster than math formulas.
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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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PeterL wrote:

-Will
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Yes in a thread that talks about public employee compensations in a (local) public forum. The audience I referred to is the public forum audience, not the audience here in the ng.
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PeterL wrote:

Ah, sorry. Now I understand your comment.
-Will
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